Income Tax Fundamentals: Assessable Income, Deductions, and Timing
Core framework
Assessable income includes income from employment, business, and investments, plus specific inclusions such as certain capital gains, dividends, and rents. Deductions are allowed under the general permission (nexus with income) and the general limitation (not of a capital, private, or domestic nature). Candidates must apply both limbs together.
Key concepts: the ordinary concepts test for income; capital vs revenue (tree vs fruit); apportionment of mixed-purpose expenditure; the timing rules (accrual vs cash, the accrual rules for financial arrangements, and the treatment of prepayments and consumables); trading stock valuation (cost, market selling value, replacement price, discounted selling price); and the general capital limitation.
Traps
- Treating a capital receipt as income because it is recurring; recurrence is a factor, not decisive.
- Forgetting that private expenditure is non-deductible even where it produces income.
- Ignoring the accrual rules for financial arrangements; the cash basis is available only for certain small taxpayers.
- Confusing prepayments (deductible if the expense relates to a period of 12 months or less ending in the income year) with consumables (deductible when used).
Worked example
A business pays $30,000 for a two-year insurance policy. The prepayment relates to more than 12 months, so it must be apportioned: deduct the portion relating to the current year and carry forward the rest. If the policy had been for 12 months or less and ended in the year, the full amount would be deductible.
Rule of thumb
Ask: is it income under ordinary concepts or a specific provision? Is the deduction capital, private, or domestic? Then apply timing.