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Allowable Deductions for Sole Traders and Partnerships

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Last amended: 20 June 2022

This topic provides information on the following:

  • business deductions:
    • allowable business deductions for the income test
    • depreciation of plants relating to a business
    • types of allowable business deductions for sole traders and partnerships
    • unacceptable business deductions for sole traders and partnerships, and
  • business losses:
    • assessment of business losses, and
    • losses which can be offset.

This topic should not be used for determining allowable deductions from income from real estate. This is because some deductions only apply to business income and not to income earned from real estate.   

Please refer to VEA section 46-'General meaning of ordinary income'

 

Allowable deductions for income test & taxation purposes

VEA section 46C allows the ordinary income of a business for income test purposes, to be reduced by the amount of certain deductions which are allowable for taxation purposes. However, the deductions MUST:

  • relate to the business, AND
  • be allowable under the relevant sections of the Income Tax Assessment Act 1997.

 

Depreciation of plants relating to a business

Division 40 of the Income Tax Assessment Act 1997 explains depreciation of plants relating to a business that are allowable deductions.

The definition of plant may include machinery, tools, structural improvements, plumbing fixtures and animals used in a business to produce assessable income.

 

Types of allowable deductions for sole traders & partnerships

The following table describes some allowable business deductions for BOTH sole traders and partnerships, for income test purposes.

Category

Description

Expenses

ONLY expenses directly relating to the normal operation of the business and which are allowable under VEA section 46C. That is, expenses:

  • incurred while earning taxable income, OR
  • necessary for the conduct of a business with the purpose of earning taxable income.

Depreciation

Depreciation is:

  • allowed on plant and equipment actually used, or ready to be used, in producing assessable income, and
  • NOT allowed on plant and equipment which ONLY provides an external environment for the income producing activity.

.

Superannuation contributions for employees

Deductions are allowed for superannuation contributions for employees who are either:

  • residents of Australia, OR
  • engaged in producing income which is taxable in Australia.

Rent or mortgage interest, when business is conducted from the income support recipient's home

A deduction is allowed from the gross income, ONLY for rent or mortgage interest on the portion of the premises actually involved in conducting the business.

Salary/wage

Note : The profit and loss statement MUST be checked to ensure the payments are a salary/wage.

Note : Care must be taken to ensure the salary/wage is counted once only (as part of the business income), and that they are NOT also counted as 'earnings'.

Any salary/wages (NOT a drawing) paid by a business to a sole trader or one or more of the partners (as well as any employees), is an allowable business deduction for income test purposes.

Deductions for salary/wages or dividends paid to:

  • an income support recipient who is a sole trader or in a partnership, are added back to business profits, and
  • the partner or children of an income support recipient who is a sole trader or in a partnership, MAY affect entitlement.

Normal income testing rules apply.

If the business makes a net loss the person's share of the loss can be offset against any salary/wage paid to them by the business.

 

Unacceptable business deductions for sole traders & partnerships

The following table lists items that are NOT allowable deductions when calculating business income for pension, benefit or allowance purposes. If further explanation or examples are required, they are provided in the second column.

Item

Example/Explanation

Capital expenditure

Example: Purchase of a new piece of machinery or replacement of fixtures (rather than repair).

Investments in Farm Management Deposits (this scheme, launched on 2 March 1999, replaces the Income Equalisation Deposits and Farm Management Bonds schemes)

Explanation: This investment type is only available to farmers.

Allowed as deductions from income for taxation purposes in the year in which they are made. The deposits are NOT regarded as income when withdrawn, however the equalisation deposits are the farmer's personal asset  and are therefore subject to deeming. Please refer to CLIK Policy Library 10.3.5 for further information.

Superannuation contributions for the sole trader or partner of the partnership

Explanation: A sole trader or a partner of a partnership is not considered to be an employee.

Obsolescence

Explanation: Obsolescence is a loss of capital value when an item can no longer be used productively. It is different from depreciation, in that the loss is NOT the result of the work the asset has performed but rather because it can no longer be used at all.

Donations to charities

Explanation: Donations to charities are allowable deductions for taxation purposes, however for social security purposes are NOT allowable deductions and will be assessed for the income test. Donations to charities are voluntary contributions and not necessary expenses of a business.

Carried forward business losses

See details below this table.

 

Assessment of business losses

If a business runs at a loss, a nil amount is included in the income test. Only the income support recipient's share of the net result from a partnership is assessed.

Business losses from previous years are NOT allowed as deductions for profits from the current year.

Business losses from the current year are generally NOT allowed as deductions from other profits or income derived from unrelated sources, such as:

  • earnings (from other employment)
  • superannuation
  • profits from investments, or
  • profits from unrelated businesses.

Although the ATO allows losses to be deducted from other income, this is not the case for income testing of pensions or allowances.

 

Losses which can be offset

Losses within a sole trader business or partnership CAN be offset against the profits of other NECESSARILY RELATED activities if an income support recipient is involved in:

  • a business or partnership which operates in more than one field, OR
  • 2 businesses, each operating under a different business structure.

Note: A necessarily related activity refers to a particular activity within a business operation and does not necessarily refer to the entire business operation.

Note: Necessarily related means that if the first activity that made a loss had not occurred, then the income from the second activity would:

  • not have been earned, or
  • have been substantially less.

Example: An income support recipient:

  • has an interest in a partnership that consists of a farm operation AND a quarrying operation, OR
  • is a sole trader in the same situation.

The following table describes when the losses can and cannot be offset.

If the farm and quarry operation are carried out on …

then the losses from farm activities …

the same site AND a tractor is used on the farm as well as to transport material and equipment to and from the quarry,

that relate SPECIFICALLY to the use of the tractor CAN be offset against the business income from the quarry operation.

Explanation: Even though the farm and quarry are 2 separate operations, they have NECESSARILY RELATED activities, as the income from the quarry would NOT have been generated without the use of the same site and the use of the tractor, both of which are used in the farm operation.

different sites AND are run as unrelated businesses not using equipment in common,

CANNOT be offset against the quarry operation income.

Explanation: They are separate operations which do NOT have necessarily related activities.

 

A sole trader or partner in a partnership is allowed to offset any loss from that business operation activities against their share of any attributed income from a private controlled trust or company (and vice versa), provided the loss of one business activity is NECESSARILY RELATED to the profit of the other business' activities.