Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 7 - Prepayments of deductible expenses
Outline of chapterXXX
7.1 This chapter explains the new 12-month rule for deducting prepayments of expenses made by:
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- STS taxpayers; and
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- individual taxpayers incurring deductible non-business expenditure.
This rule replaces the current 13-month rule used by small business taxpayers and taxpayers who are not carrying on a business.
7.2 This chapter also explains the transitional arrangements for those:
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- small business taxpayers who do not become STS taxpayers; and
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- non-individual taxpayers incurring deductible non-business expenditure,
who previously accessed the 13-month rule but will not be able to access the new 12-month rule.
Context of reform
What is the current treatment of prepayments?
7.3 Section 82KZM of the ITAA 1936 disallows an immediate deduction for prepayments that are deductible under the general deductions provision, section 8-1 of the ITAA 1997, unless the prepayment was incurred for something that is to be done wholly within 13 months of the payment being incurred (13-month rule). If the service period is 13 months or more, section 82KZM provides for the prepayment deduction to be spread over the service period (or 10 years, if that is less).
7.4 Amendments made by the New Business Tax System (Integrity and Other Measures) Act 1999 removed the 13-month rule for business expenditure other than by small business taxpayers. A limited amount of prepayments expenditure, based on the expenditure incurred in the year of income including 21 September 1999, was eligible for a 5 year transitional arrangement up to and including the year of income including 21 September 2002. These amendments are referred to as stage 1 amendments.
7.5 Amendments made by the New Business Tax System (Integrity Measures) Act 2000 removed the 13-month rule for all taxpayers if the prepayment was incurred under a tax shelter arrangement. These amendments are referred to as stage 2 amendments.
7.6 After the stage 1 and 2 amendments, section 82KZM only provides the 13-month rule to small business taxpayers and to all taxpayers incurring non-business expenditure providing the expenditure was not under a tax shelter arrangement.
Summary of new law
7.7 The 13-month rule will be replaced by a new 12-month rule for taxpayers who are either in the STS or are individuals incurring deductible non-business expenditure. The new 12-month rule allows immediate deduction for prepayments where:
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- the payment is incurred for a period of service not exceeding 12-months; and
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- the period of service ends in the next income year.
7.8 Small business taxpayers incurring business expenditure, and non-individual taxpayers incurring deductible non-business expenditure, will have their expenditure apportioned over the eligible service period unless they enter the STS. They will receive the balance of the stage 1 transitional arrangements that phase out the access to the existing 13-month rule.
7.9 This is the third stage in a series of amendments to implement the Governments announcements which strengthen the rules for prepayments, as recommended in A Tax System Redesigned .
| New law | Current law |
|---|---|
| A 12-month rule provides an immediate deduction for prepayments where:
|
The 13-month rule provides immediate deductibility for prepayments for something that will be wholly done within 13 months of the prepayment being incurred. |
| The 12-month rule applies to:
|
The 13-month rule applies to:
|
| The following taxpayers will enter the existing transitional arrangements that apply for the year of income including 21 September 2001 (assuming a taxpayer with a standard financial year):
For these taxpayers, the transitional provisions will cap the amount of prepayments eligible for the remaining transitional arrangements in any year, in relation to the prepayment expenditure incurred in the year of income including 30 June 2001. |
A 5 year transitional arrangement applies to non-small business taxpayers incurring business expenditure. The transitional provisions cap the amount of prepayments eligible for the transitional arrangements in any year, in relation to prepayments incurred in the year of income including 21 September 1999. |
Detailed explanation of new law
7.10 Currently, immediate deductibility for prepayments is available to small business taxpayers incurring business expenditure, and to all taxpayers incurring deductible non-business expenditure, where the service period is completed within 13 months.
7.11 These amendments will provide immediate deductibility for prepayments in respect of a service period of no longer than 12 months. In addition, the eligible service period must end by the last day of the year of income following the one in which the expenditure was incurred. The new 12-month rule will now apply only to STS taxpayers and individual taxpayers who are incurring deductible non-business expenditure. [Schedule 3, item 4, paragraphs 82KZM(1)(b) and (ba), items 2 and 3, subparagraphs 82KZM(1)(aa)(i) and (ii)]
7.12 Those taxpayers who, as result of these amendments, can no longer immediately deduct their prepayments must now apportion their expenditure over the eligible service period. These taxpayers are:
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- those small business taxpayers, who are not in STS, incurring business expenditure; and
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- non-individual taxpayers, who are not in STS, incurring deductible non-business expenditure.
[Schedule 3, items 6 to 8, paragraphs 82KZMA(2)(a) and (b) and subsection 82KZMA(3)]
7.13 The taxpayers, discussed in paragraph 7.12, will have their prepayments apportioned over the eligible service period. These taxpayers will receive the balance of the stage 1 transitional arrangements, contained in section 82KZMB of the ITAA 1936, that phase out the access to the existing 13-month rule. That is, they will enter the existing transitional arrangements that apply for the year of income including 21 September 2001 (assuming a taxpayer with a standard financial year). [Schedule 3, items 6 and 7, paragraphs 82KZMA(2)(a) and (b)]
7.14 Further, section 82KZMC limits the amounts of prepayments, incurred on business expenditure by business (other than small business), eligible for the transitional arrangements. Subsections 82KZMC(1A) and (1B) will reset the limit on the amount of prepayments eligible for the transitional arrangements in an income year by reference to the prepayments incurred in the year of income including 30 June 2001. [Schedule 3, item 10, subsections 82KZMC(1A) and (1B)]
7.15 As a consequence of the amendment described in the previous paragraph, similar transitional provisions will apply over the balance of the transitional period to those taxpayers, referred to in paragraph 7.12, as apply to non-small business taxpayers incurring business expenditure under the stage 1 amendments. [Schedule 3, item 9, subsections 82KZMB(8) and (9)]
Consequential amendments
7.16 The previously enacted stage 2 amendments which removed the 13-month rule for all taxpayers if the prepayment was incurred under a tax shelter arrangement, may not apply to a taxpayer under the second condition of the 12-month rule. Should the period of service end later than 13 months, but no later than the last day of the income year following that in which the expenditure was incurred, section 82KZME of the ITAA 1936 would not apply. Removing the timing constraint in paragraph 82KZME(1)(b) will ensure that apportionment applies to all taxpayers using tax shelter arrangements, as originally enacted. [Schedule 3, items 11 to 13, paragraph 82KZME(1)(b), subsection 82KZME(1) (notes 1 and 2)]
7.17 The heading to section 82KZMD is being amended to reflect the changes made by this Bill. [Schedule 3, item 14 and sub-item 15(2)]
Application and transitional provisions
7.18 These changes apply to assessments for the first year of income starting after 30 June 2001 and later years of income. [Schedule 3, sub-item 15(1)]
7.19 The stage 1 amendments automatically repeal the transitional arrangements, provided by sections 82KZMB and 82KZMC, once they expire. Notes 1 and 2 after subsection 82KZMA(1), which refer to those sections, also become redundant from that date and will therefore be repealed also from the same date. [Schedule 3, item 5, subsection 82KZMA(1) (notes 1 and 2), and sub-item 15(2)]