Find out what are prepaid expenses and what are the prepayment rules.
What is a prepaid expense?
A prepaid expense is expenditure you incur under an agreement for something to be done (in whole or in part) in a later income year.
If you incurred expenditure for something completed in full this income year (1 July 2022 to 30 June 2023), it is not a prepaid expense and the prepayment rules do not apply.
Example: Expenditure that is not a prepaid expense
Jasmin is a solicitor. On 1 July 2022, she paid $1,500 for an annual subscription for the monthly provision of a professional journal. The subscription covers the period 1 July 2022 to 30 June 2023. The prepayment rules will not apply because the provision of the professional publication will be completed in 2022–23.
End of exampleWhat are the prepayment rules?
The prepayment rules alter the timing of deductions for certain prepaid expenses. These rules apply to prepaid expenses that would ordinarily be immediately deductible in full in the year in which they are incurred.
Generally, a prepaid expense is deductible over the ‘eligible service period’. The ‘eligible service period’ cannot exceed 10 years.
A prepaid expense may be immediately deductible if:
- it is ‘excluded expenditure’
- ‘the 12–month rule’ applies
- it relates to a ‘pre-RBT (Review of Business Taxation) obligation’.
The prepayment rules only apply to amounts that would be deductible under the general deductions or certain research and development (R&D) provisions.
Special rules apply to prepayments under tax shelter arrangements.
What is the ‘eligible service period’?
The eligible service period is the period during which the thing is to be done under the agreement in return for the expenditure.
The eligible service period begins on:
- the day the thing under the agreement begins to be done, or
- on the day the expenditure is incurred, whichever is later.
The eligible service period continues until the end of the last day the thing under the agreement ceases to be done or 10 years, whichever is earlier.
Example: Eligible service period
Mike runs a delicatessen from leased premises. On 1 December 2022, Mike makes a lease payment to cover the period 1 December 2022 to 31 December 2023. The eligible service period for this expenditure therefore starts on 1 December 2022 and ends on 31 December 2023, a period of 396 days.
Mike’s income year ends on 30 June of each year. The prepayment rules will apply as the provision of premises by the lessor is not wholly done within the expenditure year.
End of exampleWhat is ‘excluded expenditure’?
Certain types of expenditure are excluded from the prepayment rules. These are:
- amounts of less than $1,000 (excluding input tax credits)
- amounts required to be incurred by a court order or law of the Commonwealth, state or territory
- payments of salary or wages (under a contract of service)
- amounts that are capital, private or domestic in nature (except certain research and development amounts)
- certain amounts incurred by a general insurance company in connection with the issue of policies or the payment of reinsurance premiums.
Example: Expenditure required to be incurred under a state law
John operates a cartage business and pays $1,200 on 31 December 2022 to register his truck for 12 months from 1 January 2023 to 31 December 2023. The truck is used exclusively for business purposes. Although the registration fee is over $1,000 and it covers a period spreading across more than one income year, it is excluded expenditure. This is because it is required to be incurred under a state or territory law. The prepayment rules do not apply to this type of expenditure and the fee is deductible in the year it is incurred.
End of example
Example: Expenditure incurred by an entity that is registered for GST
Maree is registered for GST. On 30 June 2023 she prepays expenditure for services to be provided by another registered entity over the period 1 July 2023 to 30 June 2025.
The services to be provided are a taxable supply and Maree has acquired the services solely for a creditable purpose. The amount of the prepaid expenditure is $1,045, which includes GST of $95.
Maree’s prepaid expenditure is tax deductible (a deductible loss or outgoing). Maree has met the requirements to be entitled to an input tax credit. The prepaid expenditure will be reduced by the input tax credit of $95 so the prepaid expenditure amount is $950. As the $950 prepaid expenditure is less than $1,000, it is excluded expenditure and deductible in 2022–23.
End of exampleWhat is ‘the 12–month rule’?
If you are a small business entity or would be a small business entity if the aggregated turnover threshold was $50 million, or an individual incurring deductible non-business expenditure you can claim an immediate deduction. You can claim the deduction under the 12–month rule for prepaid expenditure if:
- the payment is incurred for an eligible service period not exceeding 12 months
- the eligible service period ends in the next income year.
Prepaid expenditure incurred under certain managed investments (tax shelter arrangements) is not eligible for the 12–month rule. If the 12–month rule does not apply, your deduction for prepaid expenditure is apportioned over the eligible service period or 10 years, whichever is less.
What is a ‘pre-RBT obligation’?
A pre-RBT obligation is any contractual obligation that:
- exists under an agreement at or before 11:45 am (by legal time in the ACT) on 21 September 1999, the date of the government’s release of the Review of Business Taxation (RBT)
- requires you to make a prepayment in return for something to be done under the agreement
- cannot be avoided by your own actions.
There are rules for deducting prepaid expenses incurred under a pre-RBT obligation. The rules are the same as those for small business entities and entities that would be small business entities if the aggregated turnover threshold was $50 million that have chosen to claim an immediate deduction.
Continue to: General deductions and research and development