We have a few clients that sometimes have differing views to us as to what constitutes a legitimate business deduction. So we thought it was probably a good time to review exactly what a personal expense is and what a business expense is, according to the Australian Tax Office. Nearly all the income your business receives is assessable, which means you need to declare it and it’s subject to tax. However, most expenses you incur running your business are tax deductible. You can claim these deductions in the annual business tax return or, if you’re a sole trader, in your personal tax return. You can claim tax deductions for most expenses but there are exceptions. You can’t claim a deduction for the goods and services tax (GST) component of a purchase if you can claim it as a GST credit on your business activity statement. You also can’t claim private or domestic expenses such as childcare fees and clothes for your family or expenses that are specifically non-deductible, such as entertainment and parking fines.
It must be related to your job
You’re only entitled to claim deductions for expenses directly related to earning your income. But to claim a work-related deduction you must have spent the money yourself and were not reimbursed, it must be related to your job and you must have a record to substantiate the expense. If the expense was for both work and private purposes, you can only claim a deduction for the work-related portion. If you use something in your business for only part of a year, you may need to restrict your claim to the period it was used for only business purposes. You can generally claim everyday operating expenses such as office rent, electricity, stationery and wages in the year you incur them. However, you typically claim capital expenses such as computers, electrical tools, furniture, motor vehicles or plant and equipment over a longer period of time. A capital expense is either the cost of a non-current asset or an expense associated with establishing, replacing, enlarging or improving the structure of your business. Generally, you don’t claim the total of a capital expense in the income year you pay for it. Instead, you normally claim an amount for the decline in value (depreciation), each year over a number of years. A small business with an asset purchase of up to $20,000 can claim the full amount in the tax year it incurred the expense. You can also ‘pool’ most capital assets and claim depreciation for the pool, which is simpler than depreciating the individual assets.
Expense claims that cause the most confusion
I’m sometimes hesitant to discuss tax and deductions and what’s claimable and what’s not. The reason being is that the rules around tax deductions frequently change, every business and their circumstance is unique, and ultimately any final word on the matter lies with your accountant. Having said that, we regularly deal with the same client expense claims every quarter that cause uncertainty, so I thought I would investigate and clarify two of the most common ones: entertainment and travel.
Entertainment and meal expenses
Entertainment expenses are generally not deductible. This includes the cost of business lunches, attendance at sporting events, gala or social nights or similar types of functions. This is the case even if you discuss business matters at these occasions. You also may not claim concerts, movies, DVD rentals, music downloads, books and magazines (unrelated to your work) or pay TV subscriptions which are all considered entertainment expenses. You may only claim deductions for expenses that directly relate to your work and earning your income. If the expense was genuinely for both work and private purposes, you can only claim a deduction for the work-related portion. In the case of meals, drinks, coffees and meeting expenses there are certain guidelines that need to be followed. Some are legitimate deductions and some are not. In order to determine when food or drink provided to a person results in entertainment, you need to examine the circumstances surrounding the provision of that food or drink. You need to look at the why, what, when and where it’s being provided. Refreshments don’t generally have the character of entertainment, whereas food or drink provided in a social situation does, and the tax treatment of both of these is different. Nearly all of our clients will have receipts relating to a range of expenses from just coffees and light cafe meals or snacks to expensive lunches that include alcohol (especially around Christmas time). Expenses are generally classified as staff amenities if it’s one or two coffees near your regular workplace. If it’s a light cafe-style meal in your suburb or a client’s, then we’ll classify it as a client meeting, but any substantiation (receipt) should say exactly what the meeting is for such as client name and particular job or project. Both of these are fine to claim. But when it’s an expensive lunch or dinner then it may be either a legitimately deductable Christmas party or client event, or give rise to a non-deductible entertainment / fringe benefit expense.
Travel is another grey area of claimable expenses. You can claim deductions on airfares, train, bus and taxi fares you incur when travelling for business. You can also claim meal, accommodation and incidental expenses you incurred if you were away overnight. Generally though, if your travel did not involve an overnight stay, you cannot claim for meals. There are special rules for claiming expenses you incur while travelling overnight or using a motor vehicle for business purposes. If your travel is for both business and private reasons, you must exclude private expenses from your claim. Expenses relating to the attendance at conferences, seminars and other work-related events are deductible if it’s for the purpose of producing income. You will need to apportion your travel expenses where you undertake both work-related and private activities. Travel costs to and from the location of the work-related event will only be deductible where the primary purpose of the travel was to attend the event. If your spouse or children are travelling with you then their portion of the expenses must be excluded from any claims
The rules for business income and deductions vary depending on your business structure and the nature of your income and expenses. You must keep accurate and complete records of all your assessable income and the deductions you claim. If you make false or misleading statements the ATO might determine your income based on industry benchmarks and issue an amended assessment, apply penalties or even prosecute you. As a general rule, if you need to spend money to earn income, you can claim it, either as an immediate deduction or over time. But for it to be a legitimate expense claim, you must show you needed to incur the expense to earn the income, and the expense is not a private one.