The “housing tax integrity” bill solidifies the government’s intention to deny all travel deductions relating to inspecting, maintaining, or collecting rent for a residential investment property. As well, second-hand plant and equipment that came with an investment property are now off the table as far as depreciation goes.

BLOG: Rental Property Owners Lose Some Deductions

Legislation that came into law in the last half of 2017 makes certain measures first announced with the 2017 Federal Budget now a reality. The measures will apply from July 1, 2017, so will affect returns for the current financial year. 

However the changes to depreciation are dependent on when assets were purchased (more below). 

The change to travel claims means that travel expenditure incurred relevant to gaining or producing assessable income from housing premises used as residential accommodation will not be deductible. 

The travel expenditure will also not be recognised in the cost base of the property for CGT purposes. 

It should be noted that the amendments do not affect deductions for travel expenditure incurred in carrying on a business, including where a taxpayer carries on a business of providing property management services.

Depreciation Change
The government has also limited plant and equipment depreciation deductions to outlays actually incurred by investors. In essence, unless you as the buyer have physically purchased the items, you can no longer depreciate them. In other words, if otherwise depreciable assets came with the investment property you purchase, there will no longer be an option to continue depreciating those assets in your hands. Being new rules however, there are calendar dates that may determine if you are affected or not. The amendments will apply from 1 July 2017 for assets purchased after 7.30 pm 9 May 2017 (when they were announced in the Federal Budget 2017). 

The changes apply to:
  • Previously used plant and equipment acquired at or after 7.30 pm on 9 May 2017 unless it was acquired under a contract entered into before this time
  • Plant and equipment acquired before 1 July 2017 but not used to earn income in either the current or previous year
Investors who purchase new plant and equipment will continue to be able to claim a deduction over the effective life of the asset. 

Exceptions  
A taxpayer will be able to continue to deduct travel expenditure and depreciate incumbent plant and equipment if:
  • The losses or outgoings are necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income; or
  • The taxpayer is an “excluded class of entity”.
  • The ATO explains these as being:
  • A corporate tax entity;
  • A superannuation plan that is not an SMSF;
  • A public unit trust;
  • A managed investment trust; or 
  • A unit trust or a partnership, all members of which are entities of a type listed above
The ATO says that its aim is to “improve the integrity of the tax system by addressing concerns that some taxpayers have been claiming travel deductions without correctly apportioning costs, or have claimed travel costs that were for private purposes”. However, it is also explained that these measures is not intended to affect deductions for institutional investors in residential premises, as “the same integrity concerns do not arise for such investors”.    
 
When refinancing, loan interest can be deductible to a partnership  
A general law partnership is formed when two or more people (and up to, but no more than, 20 people) go into business together. Partnerships are generally set up so that all partners are equally responsible for the management of the business, but each also has liability for the debts that business may incur.     

Partnership deduction for certain interest expenses   
A typical scenario when launching a business based on a general law partnership structure sees each partner advance some capital to start up the enterprise. As the income years come and go, each partner takes a share of the profit and counts this as part of their personal assessable income for tax purposes. 

However as the business becomes established, or better yet proves to be viable and becomes a successful operation, there is likely to come a time when its working capital — which had been financed from each partners’ pocket — can be refinanced through the partnership business borrowing funds.  

For such partnerships, there is a “refinancing principle” under tax law that spells out some general principles governing the deductibility of loan interest in such circumstances.  

As a general rule, interest expenses from a borrowing to fund repayment of money originally advanced by a partner, and used as partnership capital, will be tax deductible. This is covered in tax ruling TR 95/25 (you can ask this office for a copy).  

The ruling states that to qualify for a tax deduction, the interest expense “must have sufficient connection” to the assessable income producing activities of the business, and must not be “of a capital, private or domestic nature”. 
 
However interest on borrowings will not continue to be deductible if the borrowed funds cease to be employed in the borrower’s business or income producing activity. Nor will deductibility be maintained should borrowed funds be used to “preserve assessable income producing assets”. There is also a limitation on deductibility of loan interest in that borrowings to repay partnership capital can never exceed the amount contributed by the partners.  

The ability to make these interest expense deductions under the “refinancing principle” is generally limited to general law partnerships — and not tax law partnerships such as those used to jointly purchase an investment property. This principle would also not apply to companies or individuals. (There are very prescribed conditions where, for example, a company may make such a claim, but under very specific circumstances.) 

Other Partnership Facts and Foibles   
Partnerships can be less expensive to set up as a business structure than starting business as a sole trader, as there will likely be greater financial resources than if you operated on your own. On the flip side however, you and your partners are responsible for any debts the partnership owes, even if you personally did not directly cause the debt.  

Each partner’s private assets may still be fair game to settle serious partnership debt. This is known as “joint and several liability” – the partners are jointly liable for each other’s debts entered into in the name of the business, but if any partners default on their share, then each individual partner may be severally held liable for the whole debt as well.  

Other general factors to note about partnerships include: 
  • The business itself doesn’t pay income tax. Instead, you and your partners will each need to pay tax on your own share of the partnership income (after deductions and allowable costs) 
  • The business still needs to lodge a tax return to show total income earned and deductions claimed by the business. This will show each partner’s share of net partnership income, on which each is personally liable for tax 
  • If the business makes a loss for the year, the partners can offset their share of the partnership loss against their other income 
  • A partnership does not account for capital gains and losses; if the partnership sells a CGT asset, then each partner calculates their own capital gain or loss on their share of that asset 
  • The partnership business is not liable to pay PAYG instalments, but each partner may be, depending on the levels of their personal income 
  • As a partner you will need to take care of your super arrangements, as you are not an employee of the business 
  • Money drawn from the business by the partners are not “wages” for tax purposes. 
Lastly, as with any business, the partnership will need an ABN and will need to register for GST if the business’s annual turnover is more than $75,000 (before GST). 

Nexia Australia