Capital v Revenue, When Expenditure Is Incurred, Division 40 and Division 43
A deduction may fail under s 8-1 because it is capital, but that is often the beginning rather than the end of the analysis. Australian tax law contains capital allowance regimes that may provide deductions over time.
What you should be able to do
- Apply the classic capital/revenue tests without treating any one label as decisive.
- Use Sun Newspapers as the central structural analysis.
- Determine when a liability is incurred.
- Identify depreciating assets and calculate decline in value under Div 40.
- Identify capital works deductions under Div 43.
- Coordinate capital allowances with CGT and avoid double counting.
Capital expenditure is often about creating, enlarging or protecting the profit-yielding structure. Revenue expenditure is usually about operating that structure. If s 8-1 denies a capital outgoing, immediately ask whether Div 40, Div 43 or another specific rule gives relief over time.
Key language
Issue → Rule → Authority → Application
9.1 Why capital versus revenue matters
Section 8-1(2)(a) denies a general deduction for a loss or outgoing of capital, or of a capital nature. This is one of the most important boundaries in Australian income tax. An expense can have an obvious business purpose and still fail s 8-1 because it creates, acquires, enlarges or protects the profit-yielding structure rather than operating that structure.
The capital/revenue distinction is not determined by accounting treatment, the size of the payment or the taxpayer's description. It is a legal characterisation based on the advantage sought and the role of the expenditure in the taxpayer's income-producing operations.
9.2 The older indicators: once-and-for-all and enduring benefit
Vallambrosa Rubber Co Ltd v Farmer is associated with the “once and for all” versus recurrent-expenditure indicator. Recurrent expenditure is often revenue; a one-off payment is more likely capital. But recurrence is only an indicator. Annual licence fees can be revenue even though essential to the business, and a repeated capital acquisition does not become revenue merely through repetition.
British Insulated & Helsby Cables Ltd v Atherton is associated with the “enduring benefit” idea. Expenditure bringing into existence an asset or advantage for the enduring benefit of the business may be capital. “Enduring” does not mean permanent; the inquiry is practical and commercial.
9.3 Sun Newspapers: the central Australian framework
Sun Newspapers Ltd v FCT is the course's leading authority. Dixon J distinguished the business entity, structure or organisation set up for earning profit from the process by which that organisation operates to obtain regular returns. His Honour identified three matters:
- Character of the advantage sought—what is the taxpayer acquiring, preserving or obtaining, and what is its lasting quality?
- Manner of use, reliance or enjoyment—how is the advantage used and is recurrence relevant?
- Means adopted to obtain it—is the taxpayer paying periodically for use, or making a final provision to secure future use/enjoyment?
Later cases repeatedly emphasise the first factor: character of the advantage sought. In an exam, begin there. Identify the advantage precisely before deciding whether it belongs to the profit-yielding structure or the profit-making process.
9.4 Applying the capital/revenue distinction
Broken Hill Theatres Pty Ltd v FCT and National Australia Bank Ltd v FCT illustrate how the framework applies to different commercial advantages. The proper method is not to count capital indicators and revenue indicators mechanically. Explain what the expenditure buys or achieves in the context of the taxpayer's business.
Examples:
- ordinary wages, rent and consumables used in operations are typically revenue;
- acquiring land, plant or a new business structure is typically capital;
- repairing an existing asset may be revenue, but replacing the whole asset or substantially improving it may be capital;
- legal fees take their character from the advantage or dispute to which they relate.
9.5 “Incurred”: when does a deduction arise?
Even if an outgoing is deductible in character, the taxpayer must have “incurred” it. A cash payment is not always necessary, and payment is not always sufficient. The taxpayer generally needs to be definitively committed to the liability rather than merely expecting, budgeting for or making a contingent provision.
TR 97/7 is a key ATO ruling on when a loss or outgoing is incurred. The cases require attention to whether a presently existing legal liability has arisen, whether it is defeasible or contingent, and whether the amount can be reasonably estimated where exact quantification comes later.
This issue appears in the Mia tutorial where an accountant issues an invoice on 15 June for services already provided in April and May, but Mia pays in July. The legal question is not simply the payment date; it is when Mia became definitively committed to the liability.
9.6 If s 8-1 denies capital expenditure, ask whether Division 40 provides a deduction
Division 40 ITAA97 contains the capital-allowance regime for depreciating assets. A depreciating asset generally has a limited effective life and can reasonably be expected to decline in value over the time it is used. Land is excluded, and some structural assets are dealt with elsewhere.
The deduction is generally for the decline in value of a depreciating asset to the extent it is used for a taxable purpose. Students must identify:
- whether there is a depreciating asset;
- who holds it;
- its cost;
- when it starts to be used or installed ready for use;
- effective life;
- prime cost or diminishing value method;
- taxable-purpose percentage; and
- any balancing adjustment on disposal.
9.7 Diminishing value and prime cost
The course requires students to perform actual capital-allowance calculations. Under the diminishing-value method, the base value is multiplied by the statutory rate adjusted for days held/used. The prime-cost method spreads decline more evenly over effective life. Use the formula specified by the current legislation for the relevant acquisition date and income year; do not rely on a remembered accounting depreciation formula.
Where an asset is used partly for business and partly privately, calculate decline in value first and then limit the deduction to taxable-purpose use as required by the regime.
9.8 Balancing adjustments
When a depreciating asset stops being held or used—for example, it is sold—a balancing adjustment can compare its termination value with its adjustable value. A gain-like amount may be included in assessable income or a loss-like amount may be deductible. CGT interactions must also be considered because depreciating assets can fall within both regimes, with statutory coordination preventing double recognition.
9.9 Division 43: capital works
Division 43 provides deductions for qualifying capital expenditure on buildings and structural improvements. It is distinct from Div 40. A permanently affixed building or structural improvement may fall under Div 43 even though plant or removable equipment within it is a Div 40 depreciating asset.
The rate and eligibility depend on construction date, type of capital works and use. The course facts involving a commercial building and newly constructed storage structure are designed to teach this boundary. A student must distinguish the building itself from removable systems such as CCTV equipment.
9.10 Repairs, improvements and capital allowances must be coordinated
Section 25-10, covered more fully in the next chapter, allows certain repair expenditure. But an improvement, replacement of an entirety or initial repair may not qualify. If denied as a repair because it is capital, Div 40 or Div 43 may instead provide deductions over time. This illustrates a recurring tax method: failure under one provision does not end the inquiry.
9.11 Core authority and provision map
| Source | Proposition | Use |
|---|---|---|
| ITAA97 s 8-1(2)(a) | Capital or capital-nature outgoings denied under general deduction. | Always check after positive nexus. |
| Sun Newspapers | Structure versus process; three-factor framework. | Primary capital/revenue authority. |
| Vallambrosa Rubber | Recurrence/once-and-for-all indicator. | Supporting factor, not decisive rule. |
| British Insulated | Enduring benefit indicator. | Long-lasting advantage. |
| TR 97/7 | When an outgoing is “incurred”. | Invoice/liability timing. |
| Div 40 | Decline in value of depreciating assets. | Equipment, vehicles, removable systems. |
| Div 43 | Capital works deductions. | Buildings/structural improvements. |
9.12 Tutorial masterclass — Mia: periods of inactivity and recommencement
Mia's corporate-training business loses its only client on 30 June. From 1 July to 31 August she takes no steps to obtain new work and seriously considers leaving the market, although she retains website, insurance, software and storage infrastructure. From 1 September she actively markets again, and from 1 November earns income under a new contract.
The key issue is whether the business temporarily paused or had ceased and later recommenced. Apply the contemporaneity and business-continuity principles from Chapter 8. Retaining infrastructure supports continuity, but complete inactivity and contemplation of permanent exit point the other way. From 1 September, active efforts to obtain clients strongly support carrying on the business even before new revenue arrives.
Analyse the $2,500 holding costs in the inactive period separately from the post-1 September website, marketing and advertising costs. The latter are much more clearly connected with current business activity. The June accountant invoice raises the “incurred” timing issue: services were performed before 30 June and an invoice issued on 15 June, though paid in July.
9.13 Tutorial masterclass — Sarah: borrowed money, mixed use and a vehicle
Sarah increases a loan secured over her rental property but uses the additional $100,000 for a BMW, a personal handbag and dividend-paying shares. The security over a rental property does not determine interest deductibility. Following Munro and Steele, trace the use of borrowed funds.
Interest attributable to the personal handbag is private. Interest attributable to dividend-producing shares has an income-producing connection. Interest attributable to the vehicle requires apportionment according to its business/private use. The BMW itself is a depreciating asset under Div 40; if used 10% for business, the decline-in-value deduction is limited accordingly. The handbag remains private notwithstanding the business-secured loan.
9.14 HD IRAC method
I — Issue
Is the outgoing revenue or capital? If capital, does Div 40, Div 43 or another specific provision confer a deduction? When was it incurred?
R — Rule
State s 8-1 positive nexus, s 8-1(2)(a), Sun Newspapers, then the applicable specific capital-allowance regime and timing rule.
A — Application
Identify the advantage sought. Explain structure versus process. If Div 40 applies, identify asset, cost, start time, method, effective life and taxable-purpose use. Show the formula.
C — Conclusion
State whether an immediate deduction, declining-value deduction, capital-works deduction or no deduction is available and quantify it.
9.15 Plain-English summary
Revenue expenditure runs the profit-making machine; capital expenditure builds, buys or strengthens the machine. If s 8-1 says “capital”, do not stop. Check the capital-allowance rules. Then ask when the outgoing was incurred and how much is deductible for the income year.
Deep Teaching Commentary — Learn the Doctrine, Then Learn How to Use It
The capital/revenue distinction is one of the central organising ideas in deductions. Section 8-1 can have a strong nexus with income yet still deny an outgoing because it is capital or capital in nature. The practical consequence is not necessarily “no deduction”; the student must then look for capital allowance regimes such as Div 40 and Div 43 or other specific provisions.
Sun Newspapers provides the principal Australian framework: consider the character of the advantage sought, the manner in which it is used/recurred, and the means adopted to obtain it. Older indicators such as enduring benefit and once-and-for-all payment can assist, but no single slogan decides the issue. The question is whether the expenditure belongs to the profit-yielding structure or the process of operating that structure.
This chapter also introduces tax accounting for deductions—when an outgoing is “incurred”—and the capital allowance system. Depreciating assets under Div 40 and capital works under Div 43 must be coordinated with the general deduction rule and with CGT.
Provision-by-provision teaching guide
| Provision / regime | What it does | How to use it in a university answer |
|---|---|---|
| ITAA97 s 8-1(2)(a) | Denies capital or capital-nature losses/outgoings under the general deduction provision. | Use after establishing nexus; then move to a specific capital allowance if available. |
| ITAA97 Div 40 | Provides decline-in-value deductions for depreciating assets, subject to exclusions and special rules. | Identify whether the item is a depreciating asset, its cost, start time, effective life and chosen method. |
| ITAA97 ss 40-25, 40-65, 40-70 and related method provisions | Govern the basic decline-in-value calculation and methods in the Forum. | Show the statutory formula and apportion for taxable use. |
| ITAA97 balancing adjustment provisions | Adjust assessable income/deductions when a balancing adjustment event occurs for a depreciating asset. | Use on disposal, loss or cessation of use of Div 40 assets. |
| ITAA97 Div 43 | Provides deductions for qualifying capital works over statutory rates/periods. | Use for buildings and structural improvements that are excluded from ordinary Div 40 treatment. |
| Tax accounting “incurred” principles | An outgoing can be incurred before it is paid if the taxpayer is definitively committed to the liability; a mere estimate or contingent liability is insufficient. | Use where invoices, accruals, provisions or deferred payments straddle income years. |
Cases, rulings and authorities — proposition + exam function
| Authority | Proposition taught by the source material | When to use it |
|---|---|---|
| Vallambrosa Rubber Co Ltd v Farmer | Classic contrast between capital expenditure and revenue expenditure by reference to enduring/structural character. | Use as historical assistance, not as a substitute for Sun Newspapers. |
| British Insulated & Helsby Cables Ltd v Atherton | Enduring-benefit formulation: expenditure bringing into existence an enduring advantage can indicate capital. | Use as one indicator. |
| Sun Newspapers Ltd v FCT (1938) 61 CLR 337 | Principal Australian framework distinguishing the business entity/structure from the process by which it operates. | Use as the central authority in any capital/revenue deduction problem. |
| Broken Hill Theatres; NAB and related authorities | Show application of structural/advantage analysis in differing commercial contexts. | Use factually, focusing on what the payment secured. |
| Nilsen Development Laboratories and related “incurred” authorities | Used to determine when a liability is sufficiently definite to be incurred for tax purposes. | Use when a taxpayer has an invoice, provision or future obligation but payment occurs later. |
Matching tutorial — fact-by-fact reasoning map
Ask whether the business truly ceased or was temporarily inactive. The answer affects nexus, contemporaneity and whether post/pre-commencement expenditure retains connection.
Identify when the legal liability became definite. Do not equate “paid” with “incurred” unless the applicable accounting method/rule requires it.
Trace borrowed funds to income-producing/private uses. Interest follows use of funds and may require apportionment.
Apply Div 40 and apportion for taxable purpose. If disposed of, calculate the balancing adjustment.
Do not let business ownership alone create deductibility. Characterise actual use, private nature and whether it is genuinely a depreciating asset used for taxable purpose.
Investment assets can produce assessable income while acquisition cost remains capital; interest on borrowings may be deductible even though the share cost itself is not.
How to write this chapter in IRAC / tax-problem form
Issue. Identify the taxpayer, income year and transaction. Break the problem into separate receipts, outgoings, CGT events or administrative decisions. Do not write one broad issue such as “what tax is payable?”.
Rule / Law. Start with the exact Act and provision. If the section contains multiple limbs, subsections, paragraphs, exceptions or a method statement, set them out in the order in which they operate. Then add the case, ruling or ATO authority for the particular proposition it explains.
Application. Apply one fact to one legal element at a time. Compare the facts with the authority and deal with the strongest alternative characterisation. Where the law requires a calculation, show the legal order and the arithmetic together.
Conclusion. State the legal tax consequence and amount where possible. Then add any associated loss, penalty, objection/review, timing or administrative consequence relevant to the chapter.
Chapter mastery — 15 questions with model answers
Source-Coverage Audit — Every Statutory Reference in the Supplied Materials
This completeness layer preserves every detected Act, Part, Division, Subdivision, section, subsection, paragraph and method-statement reference from the supplied Forum/Tutorial materials. Use the teaching chapter above for explanation; use this audit to ensure no source reference is silently omitted.
Source-Coverage Audit — Every Case, Ruling and Authority in the Supplied Materials
Every detected case or ruling from the aligned materials is retained here. The blue link opens an AustLII search so the authority can be checked and later replaced with the most direct official/public judgment link where appropriate.
Detailed Forum / Lecture Source Notes — Completeness Layer
The following is the detailed teaching layer derived from the supplied Forum material. It is kept deliberately full at draft stage so that the final editing pass can improve prose without losing doctrine, examples, calculations or statutory detail.
Forum 9: Deductions (Continued)
REVENUE/CAPITAL DICHOTOMY UNDER s 8-1
Section 8-1(2)(a) - denies deductibility for losses or outgoings of capital, or of a capital nature
Judicial tests
The ‘once and for all’ test
Vallambrosa Rubber Co Ltd v Farmer (1910) 5 TC 529.
The enduring benefit test
British Insulated & Helsby Cables v Atherton (1926) 10 TC 155
The business entity or process-structure test
*Sun Newspapers Ltd; Associated Newspapers Ltd v FCT (1938) 61 CLR 337
The test that most judges keep coming back to is the one set out by Dixon J (later Dixon CJ) in the Sun Newspapers case. The following sets out his Honour’s statement, along with a brief comment as to the suggested meaning of his Honour’s guidance:
‘The distinction between expenditure and outgoings on revenue account and on capital account corresponds to the distinction between the business entity, structure, or organization set up or established for the earning of profit
and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlays and returns representing a profit or loss.’ [line break added]
‘There are, I think three matters to be considered,
the character of the advantage sought, and in this its lasting qualities may play a part [What is the advantage/asset, and how long will it last? Lasting/enduring (capital) benefit vs temporary (revenue) benefit]
the manner in which it is to be used, relied upon or enjoyed and in this and under the former head recurrence may play its part [How is the advantage used? Was it infrequent (or once and for all), vs recurrent (eg incurred every year)] and
the means adopted to obtain it; that is by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment [How was advantage paid for? One off payment (capital) vs recurrent payment (revenue)]’.
‘The facts of the present case show the following features:
The expenditure was of a large sum incurred to remove finally the competition feared from the Star and actually experienced from the World.
It could be regarded as recurrent only in the sense that the risk of a competitor arising must always be theoretically present and that the reality or imminence of the risk depends upon circumstances which can never clearly be foreseen.
The chief object of the expenditure was to preserve from immediate impairment and dislocation the existing business organization of the taxpayers.
The impairment or dislocation feared involved a lowering of selling price, a loss of circulation, a change in advertising rates and a reorganization of selling and production arrangements all of a lasting character; that is, the changes would be of indefinite duration and their effects would continue until they disappeared under influences brought by the future the exact nature of which could not be foreseen.
The transaction involved the acquisition for a cash consideration of the right to enjoy for three years all the property tangible and intangible of an existing undertaking, that is, the acquisition of a going concern for a period, a thing recognized as a capital asset. The advantage in terms of profit was not to be obtained by the use of the undertaking but by putting it out of use; but in itself it remained a capital asset.
In these circumstances I think that in principle the transaction must be regarded as strengthening and preserving the business organization or entity, the profit-yielding subject, and affecting the capital structure.’
Subsequent cases have stated that the key guide in those set out be Dixon J is the first one (i.e. the character of the advantage sought).
The cases also contain other statements that purport to describe the distinction between revenue and capital expenditure. Some of the statements are along the following lines:
Is the expense a working expense?
Is the expenditure one that establishes, acquires or adds to the taxpayer’s profit-earning structure, or is the expense a cost of operating that structure?
Is the expense one that is made to meet a continuous or constant demand, or is it made once and for all?
Does the expense bring into existence an asset or an advantage for the enduring benefit of the taxpayer’s business?
*Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423
*National Australia Bank Ltd v FCT 97 ATC 5153
The PLT textbook has the following Example 12.3:
“Dominic owns a pizza-making business. He pays $3,000 to purchase an oven which he uses to make pizzas and approximately $100 in monthly electricity expenses.
Applying [the] Sun Newspapers three factors to the two expenses:
Character of the advantage sought
The pizza oven will provide Dominic with a long-lasting benefit.
The monthly electricity expenditure is for a short-term, one-month benefit.
Manner in which the benefit is to be used or enjoyed
The pizza oven will provide Dominic with a benefit that he can rely on once and for all.
The electricity is a recurring benefit (in that he uses it monthly, on a recurring basis.
Means adopted to obtain the benefit
Dominic paid for the pizza oven in one lump-sum payment of $3,000.
The electricity bills are recurrent monthly expenses.
Overall, it is likely that the payment for the pizza oven would be capital and non-deductible under s 8-1 whereas the electricity payments would not be capital.”
As an administrative convenience, Practice Statement Law Administration PS LA 2003/8 (Practical approaches to low-cost business expenses) provides that expenditure of $100 or less (GST-included) incurred to acquire a tangible asset in the ordinary course of a business can be assumed to be revenue in nature for income tax purposes (if the Ruling applies to the expenditure).
Office equipment costing $100 or less - such as hand-held staplers, hole punches, manila folders, ring binders, calculators, tape dispensers, scissors and labelling machines
catering items in a café costing $100 or less - such as cutlery, saucers, cups and table linen)
a tradesperson’s small hand tools costing $100 or less - such as pliers, screwdrivers and hammers.
The $100 threshold recognises that expenditure falling within the rule will generally be revenue in nature. Conducting further enquiries to determine whether such expenditure is properly characterised as revenue or capital would likely entail disproportionate compliance costs without materially affecting the tax outcome.
Concluding Remark: What is the relationship between capital expenditure on the one hand, and general deductions, specific deductions (including the “cost” of depreciating assets) and CGT cost base on the other?
TAX ACCOUNTING FOR DEDUCTIONS UNDER s 8-1
When is a loss or outgoing ‘incurred’ under s 8-1 of the ITAA 97?
‘Incurred’ is not defined in the legislation. We must therefore consider the relevant case law.
The Commissioner in Taxation Ruling TR 97/7 (at para 6] provides a good summary of the relevant principles established by case law on when a loss or outgoing is incurred.
“The courts have been reluctant to attempt an exhaustive definition of a term such as 'incurred'. The following propositions do not purport to do this, they help to outline the scope of the definition. The following general rules, settled by case law, assist in most cases in defining whether and when a loss or outgoing has been incurred:
a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitively committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. That is, subject to the principles set out below, it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum; [emphasis added]
a taxpayer may have a presently existing liability, even though the liability may be defeasible by others;
a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation (based on probabilities);
whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise;
in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid; [emphasis added]
while the above principles may be applied to both losses and outgoings, the distinct nature of losses must be considered. A loss must be definitively encountered, run into, or fallen upon by the taxpayer. For a loss to be incurred it must be realised and more than impending, threatened or expected. A taxpayer will not have incurred a loss if some contingency means that they are not 'definitively committed' or 'completely subjected' to it.”
At para 21, the FCT adds: “Generally, a deduction is allowable because a liability arises necessitating the payment of an expense. However, some payments are not necessitated by a presently existing pecuniary liability, and they are incurred only upon payment. Examples of such expenses include gifts, insurance premiums, licence renewals and motor vehicle registration fees - these payments are at the discretion of the taxpayer, if the taxpayer wants those benefits.”
Harry is employed as a real estate agent. His second mobile phone is used exclusively for work purposes so he could turn it off when he did not want to be contacted on weekends by prospective tenants. On 20 June 2026, Harry’s mobile phone provider issues him with an invoice for his second mobile phone for $150 for usage from 19 May 2026 to 18 June 2026. Harry paid the invoice on 3 July 2026.
Jasmine is a small business entity who operates a mobile dog-washing business as a sole trader. On 10 June 2026, Jasmine received an invoice from her insurer for $1,500 for the comprehensive car insurance policy for her vehicle that is used solely in the business. The invoice is for insurance coverage from 6 July 2026 to 5 July 2027. Jasmine paid the invoice on 2 July 2026.
(Note s 82KZM ITAA36 would not apply to spread the deduction over the insurance period - see s 82KZM(ba)(ii) ITAA36).
In TR97/7, the Commissioner provides the following administrative convenience for taxpayers who use the cash basis of returning income [at paras 10 to 12]:
“10. The ATO recognises that there is a difference of opinion about the meaning of 'incurred' for taxpayers who use a cash based accounting system, and who do not keep elaborate books of account. This Ruling explains that, in certain circumstances, such taxpayers are able to claim relevant expenditure prior to the outgoing actually having been paid.
1) Capital Allowances Regimes
Introduction to the capital allowances regimes in Divisions 40 and 43.
Division 40 Of The Itaa 1997
Deducting amounts for depreciating assets
Operative provision - section 40-25(1):
You can deduct an amount equal to the decline in value for an income year (as worked out under Division 40) of a depreciating asset that you held for any time during the year.
Calculating depreciation deductions
What is a depreciating asset? See section 40-30
When is a depreciating asset ‘held’? See section 40-40.
Choice of methods to calculate decline in value: see section 40-65.
Prime cost method: see section 40-75; or
Days Held
100%
Asset’s Cost
x
-------------
x
--------------------------
Asset’s Effective Life
Diminishing value method (from 9 May 2006): see section 40-72.
Days Held
200%
Base Value
x
-------------
x
--------------------------
Asset’s Effective Life
The diminishing value method can not be chosen for some intangible assets. See the types of intangible assets covered by s 40-70(2) (and s 40-72(2)).
What other information is needed to calculate the decline in value?
Cost or base value (effectively, written down value): see sections 40-85, 40-175, 40-180, 40-185, 40-190.
Note the adjustment for the cost of a car (section 40-230). For the 2025-26 income year, the car limit is $69,674.
On 31 May CIY, Thaksin buys a fuel-efficient car for $86,000 and immediately starts using it exclusively in her business. The car is a type to which the car limit applies. The effective life of the car is 8 years, and Thaksin uses the diminishing value method. Ignore GST issues.
As the car limit applies, Thaksin’s capital allowance for the CIY for the car is:
= $1,479 [$69,674 x (31 days/ 365 days) x (200%/8)].
Effective life - choice (section 40-95) between Commissioner’s determination (section 40-100) and self-assessment (section 40-105).
The Commissioner’s determination of the effective life of depreciating assets is set out in the legislative instrument: Income Tax Assessment (Effective Life of Depreciating Assets) Determination 2025.
Exercise
As an exercise, search Table A in Schedule 2 of this Determination to find the effective life of a dishwasher in a rental property, and Table B for the effective life of a laptop computer.
Note that you can not self-assess the effective life for certain intangible assets as the legislation prescribes the effective life (see s 40-95(7)).
Taxable purpose is defined in section 40-25(7).
Reduction of deduction for decline in value for a purpose other than a taxable purpose: see section 40-25(2). The legislation requires you to first calculate the decline in value of the asset (s 40-25(1)) and then to “reduce” this by the non- income producing portion (s 40-25(2)).
Section 40-27 ITAA97 provides that individuals can not benefit from excessive deductions related to depreciating assets held to produce residential rental income.
Note that the decline in value of a depreciating asset that you hold is its’ cost, where, inter alia, that cost does not exceed $300 and you use the asset predominately for the purpose of producing assessable income that is not income from carrying on a business (see section 40-80(2)). Read this section carefully for all of the requirements!
Romek is a paralegal for a law firm on the Gold Coast. To match his suit and to keep a professional image, Romek spent $280 on an artificial leather, document wallet designed for the secure transport of confidential and sensitive documents for court events or client meetings. Assuming the wallet is used solely in Romek’s employment, the expense is immediately deductible to him pursuant to s 40-80(2) ITAA97.
Balancing adjustments
What happens on the sale or disposal of a depreciating asset?
Balancing adjustment event: section 40-295.
When a balancing adjustment event occurs, if:
the asset’s termination value > adjustable value, the difference is included in assessable income (statutory income): section 40-285(1).
the asset’s termination value < adjustable value, the difference is deductible (specific deduction): section 40-285(2).
Why do we need to make balancing adjustments?
What is an asset’s termination value? See section 40-300 and 40-305.
Adjustment for the termination value of a car which has a cost calculated by applying the section 40-230 car limit: see sections 40-320 and 40-325.
Balancing adjustments and CGT
If a depreciating asset is held 100% for the purposes of producing assessable income, any capital gain or loss arising from the happening of CGT Event A1 as a result of the disposal of the depreciating asset is disregarded (assuming that the disposal is also a balancing adjustment event): s 118-24(1).
Note that although section 118-24(1) disregards capital gains or losses on depreciating assets that are also balancing adjustment events, the exclusion does not apply to capital gains or losses from CGT Event K7 happening (see section 118-24(2)). CGT Event K7 is relevant when a balancing adjustment event occurs for a depreciating asset that you hold and use only partly for a taxable purpose. However, if the depreciating asset is also a personal use asset, any capital loss on its disposal is disregarded.
Example
On 1 July 2024, Gina installs a machine at a cost of $6,000 for use in her bakery. The machine is used in the business from the time it is installed. Gina self-assesses the effective life of the machine to be 4 years.
Calculate Gina’s depreciation deductions under the prime cost method and the diminishing value method for the 2024-25 and 2025-26 income years using the table below.
Prime Cost Method
Income Year
Calculation
Decline in Value
Depreciation deduction
Closing Adjustable Value
Opening Adjustable Value for the Following Year
2024/25
2025/26
Diminishing Value Method
2024/25
2025/26
Assume that Gina has chosen to use the prime cost method (for the sake of simplicity) in questions 2, 3 and 4. How would your answer to question 1 change if she used the machine 60% for business purposes and 40% for private purposes?
On 30 June 2026, Gina sells the machine to Max for $7,000. What tax implications arise on the disposal assuming that Gina had used the machine 100% for business purposes?
Again, assume that on 30 June 2026, Gina sells the machine to Martin, but this time for $1,000. What tax implications arise on the disposal assuming that Gina had used the machine 100% for business purposes?
And Coordinating The Various Capital Allowances Regimes
Capital Works (Division 43 of the ITAA 1997)
You can deduct an amount for capital works for the year if the requirements in s 43-10 are satisfied.
What are capital works? A taxpayer can claim deductions under Division 43 for capital expenditure incurred in constructing capital works being a building, or an extension, alteration or improvement to a building: section 43-20(1).
Division 43 also applies to capital works that are structural improvements, or extensions, alterations or improvements to structural improvements: section 43-20(2). Some examples of structural improvements are contained in section 43-20(3). Section 43-20(3) provides an inclusive list of examples of structural improvement and not an exhaustive list.
Section 43-10(2)(a) requires the capital work to have a “construction expenditure area” as one of the prerequisites for obtaining a Division 43 deduction. What is construction expenditure? See s 43-70(1). Note some of the types of expenditure that are excluded in s 43-70(2) (e.g. paragraphs (a), (b), (d), (e)) and therefore could not be added to other construction expenditure costs of the capital work for the purposes of the Division 43 deduction. Also read sections 43-120 and 43-125.
What is the amount of the deduction? The deduction is either 2.5% or 4% of the construction expenditure (over a 40 or 25 year period) depending on when the construction commenced and how the capital works are used. The rate is determined by the date construction commenced:
Construction Commenced After:
But Before:
19/7/82
22/8/84
21/8/84
18/7/85
17/7/85
16/9/87
15/9/87
27/2/92
26/2/92
Current
Non-residential income producing
2.5
4.0
4.0
2.5
2.5
Residential income producing
N/A
N/A
4.0
2.5
2.5
Eligible industrial buildings
2.5
4.0
4.0
2.5
4.0
For the purposes of this course, you can assume that most expenditure on capital works to which Division 43 apply are deducted at a rate of 2.5% per annum over 40 years. [Remember part year apportionment issues, where relevant, and the fact that the building must be used for the purposes of producing assessable income.]
The Div 43 deduction for the CIY is calculated using the formula:
(Construction Expenditure) x (Applicable Rate) x (Days used in the CIY/365)
There is no deduction until construction is complete: s 43-30. Therefore, you may need to apportion part of the deduction in the first year.
Of course, taxpayers can only get Division 43 deductions if the capital works are used in a deductible way (i.e. for the purpose of producing assessable income). Where only part of capital works are used to produce assessable income, an apportionment is required to reduce the deduction (usually on a floor area basis).
If the taxpayer satisfies the requirements for deductibility under Division 43 (even if the relevant expenditure is in respect of a depreciating asset), then depreciation deductions under Division 40 can not be claimed since Division 40 is deemed not to apply (see sections 40-45(2) and 43-50).
However, if the expenditure on a building (or other capital works) satisfies the definition of ‘plant’, then the capital works expenditure will not be deductible under Division 43 (see sections 43-70(2)(e), 43-10, and 43-15) and instead, will be deductible under Division 40.
Definition of ‘plant’: see section 45-40. You may need to print this out if it is not in your Core Tax Legislation. The s 45-40 definition is an inclusive definition. This means that an item can still be regarded as ‘plant’ if it is not on the list. Therefore, we need to know what the common law regards is ‘plant’.
Wangaratta Woolen Mills v FCT 69 ATC 4095
FCT v Faichney 72 ATC 4245
Carpentaria Transport Pty Ltd v FCT 90 ATC 4590
A subsequent owner (i.e. the original owner does some capital works which are later sold to another entity) can also claim capital works deductions based on the original construction expenditure of capital works. In this situation, the purchase price of the capital works is not relevant.
Interaction between Divisions 40 and 43, with CGT
What happens if an asset is both a Division 40 and a Division 43 asset? Then, if the asset is plant, for example, deductions will be calculated according to Division 40. As you know when you stop holding a Division 40 depreciating asset (eg. selling or scrapping the asset) a balancing adjustment event happens. If Division 40 prevails over Division 43 in respect of the asset, then to the extent that the depreciating asset has been used for a taxable purpose, the gain or loss on sale will be picked up under Division 40 and not CGT.
But what happens if the depreciating asset is part of a CGT asset? For example, the factory (or building) in Wangaratta Woolen Mills v FCT was obviously fixed to land and part of the land. If the owner in Wangaratta sold the land and factory, then the disposal of the factory would be a balancing adjustment event (because it was a Division 40 asset (plant) and the owner no longer holds it). Note the obvious practical point that some of the sale proceeds for the disposal would be attributable to the land and some of them to the building. Is it correct then to put the construction costs of the factory in the CGT cost base of the land? The answer is no. The CGT rules will treat the factory as a separate CGT asset from the land (see s 108-55) so that capital gain or loss on disposal of the factory is disregarded, with the gain or loss only being picked up under the Division 40 balancing adjustment provisions. The same logic applies to a depreciating asset that is part of a building: s 108-60.
On another matter, if Division 43 capital works expenditure forms part of the cost base of a CGT asset (eg 4th element if you incurred it, or 1st element if you purchased the capital work from someone else), then the cost base needs to be reduced to the extent of any Division 43 deductions you have claimed (if the CGT asset was acquired after 7.30pm on 13 May 1997). See s 110-45.
Expenditure does not form part of the reduced cost base to the extent you have deducted it or can deduct it (see section 110-55(4) and 110-55(9)).
Note the application of section 110-45(4): capital expenditure by a previous owner that you can deduct after acquisition.
Facts:
ABC Pty Ltd buys a vacant block of land for $2 million on 1 July 2025 with the intention of building a house on it for the purpose of producing rental income. Construction expenditure on the house was $1 million and was completed on 1 June 2026. The property is immediately tenanted. For the purposes of this example, ignore all other costs associated with the property.
Assume that the Company sells the rental property to Matthew on 30 June 2027 for $5 million. The amount of the sale proceeds ($5 million) attributable to the land is $3 million and the amount attributable to the house is $2 million. Advise the Company and Matthew on the tax implications of this transaction.
How would your answer to all of the above questions change if the Company initially built a factory instead of a residential building on the land, and the factory is regarded as plant?
Matching Tutorial — Full Problem Source and Teaching Integration
The tutorial is part of the chapter, not an afterthought. Read the facts by turning each receipt, outgoing, event or procedural step into a separate issue. Write the relevant provision beside each issue before applying the cases.
Tutorial 9 - Week 10
Part A
Mia has operated a corporate training business for 5 years. The business provides leadership training workshops to corporate clients. On 30 June 2025, Mia’s only client at the time terminated its ongoing services agreement. From 1 July 2025, the business had no active clients, no scheduled training engagements and no source of business income.
Between 1 July 2025 and 31 August 2025, Mia took no steps to obtain new clients. During that period, she considered permanently exiting the corporate training market and taking up unrelated employment. She did not advertise the business, approach prospective clients, issue proposals or otherwise seek new work. However, she retained the business infrastructure, including its website, professional indemnity insurance, software subscriptions and storage arrangements for training equipment. She incurred $2,500 in costs for those items during this period.
On 1 September 2025, Mia decided to recommence the business and resumed efforts to obtain income. She updated the business website, engaged a marketing consultant, advertised leadership training packages to corporate clients for $12,000 per workshop, and prepared proposals herself for prospective clients. Between 1 September 2025 and 31 October 2025, Mia received around 20 enquiries, although most prospective clients considered her proposed fees too high or deferred their training budgets. During this period, Mia derived no income yet incurred:
$2,000 in website update costs
$5,000 in marketing consultant fees, and
$3,000 in advertising costs.
On 1 November 2025, a new corporate client with a national presence entered into a 9-month training agreement with Mia at $10,000 per workshop. Mia delivered training services under that agreement until she sold the business assets on 31 July 2026. From 1 November 2025 to 30 June 2026, Mia incurred:
$10,000 in marketing consultant fees
$6,000 in advertising costs, and
$8,000 in business-related travel costs.
On 15 June 2026, Mia received a $1,500 invoice from her accountant for business accounting services provided during April and May 2026. Mia paid the invoice on 10 July 2026.
Advise Mia whether any of the above expenses are deductible to her for the 2025-26 income year. Support your answer with reference to relevant legislation and case law.
Part B
Sarah runs an interior design business, and she mainly services wealthy clients in Sydney’s eastern suburbs.
Sarah also owns a residential rental property in Bondi and derives gross annual rent of $120,000.
In February 2026, Sarah increased the loan secured over the Bondi property by $100,000, and the bank advanced the funds into her personal bank account.
Sarah used the extra borrowed funds on 10 February 2026 to go on a “shopping spree” as follows:
Sarah purchased a brand new, BMW electric vehicle for $80,000 and drove it out of the dealership on the same day. Logbook records show that Sarah uses the vehicle 10% for business purposes, and 90% for private purposes. If relevant, the vehicle has an effective life of 8 years.
Sarah purchased a Birkin handbag for her personal use for $15,000.
Sarah purchased shares in Gamma Ltd (which regularly pays franked dividends) for $5,000.
Mia incurred $2,000 in bank interest for the period 10 February 2026 to 30 June 2026 in respect of the increased loan.
Advise Sarah of the amount of any deductions she can claim for the 2025-26 income year in respect of the above expenses. Support your answer with reference to relevant legislation and case law principles. If relevant, Sarah prefers to use the diminishing value method of depreciation.