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Difference Between Capital And Revenue Expenditure

Question 1:

Difference Between Capital And Revenue Expenditure

Material Facts About John’s Prepaid Rent

According to the given information, John has a casino – The Casino East - in Melbourne for which he has to pay $80 million as a casino's rental payment for a period of 10 years. According to the Permanent Site Construction Lease (Wolters Kluwer Business, 2011), the rental prepaid is only the reflection of the Permanent Casino site for the duration of the license and hence, it is considered to be the part of the premium amount paid by The Casino East to acquire the license.

Moreover, under the Casino Exclusivity Agreement (Victorian Casino Control Authority, 2017),  the casino and its owner – John – has the exclusive right of conducting legally specified gambling activities and games. Like any other Casino in Melbourne, The Casino East is protected by the Casino Control Act 2006 (ACT Government, n.d.).

Capital Expense VS Revenue Expense

Before concluding whether the casino rent is revenue expense or capital expense, it is important to differentiate between these two important terminologies in the light of Australian Law.

Capital Expenditure

According to the ITAA, Section 40-880 (Commonwealth Consolidated Acts, n.d.), business capital expenditure are those expenses which are sustained by the companies while increasing the worth of their assets over a long period of time.

Until the 1940s, there was no legal definition of the term ‘capital expense’ in the Australian Law (Anon., 1952). However, the matter was settled by the courts to apply capital expenses in accounting and taxation law.

Revenue Expenditure

Australian Taxation Office (Australian Taxation Office, n.d.) have stated revenue expenses as the periodic expenses that are incurred for producing the revenues. Revenue expenses are generated via the income-earning process for a short period of time.

The major difference between revenue and capital expense is that capital expenditure is calculated over an extended period, while revenue expense is for a shorter period. Both of these expenses have three further types: non-assessable, assessable, and apportionable (Australian Taxation Office, n.d.). Capital expenses are usually much more than the revenue expenses. If an amount is more than a certain threshold of a certain type of property and assets, it is considered a capital expense. Otherwise, expenses are declared revenue expenditure.

Analysis of Legal Issues in Casino’s Rental Payment

Prepaid rental of a casino is a complex transaction because it covers many aspects and involves a huge amount of money for a long period. Moreover, some different authorities and laws govern the casinos in Melbourne. But a casino owner, like John, can only apply for a single license for the casino under the law.

Specifically, Section 6 of the Casino Control Act (ACT Government, n.d.) states that only one casino license is applicable for each Casino at a single time. This fact is important for the given scenario because John has applied for his casino’s licence for the first 10 years, but the agreement of the building itself is for an extended period of 90 years. The same section of the law also says that if The Casino East was to apply for another licence, it will be liable to pay damages fee and may suffer legal action from the authorities.

In terms of decided rental payment, John will have to pay about $32 million for the remaining 80 years of the lease, while he is paying $80 for the first 10 years.

A major legal issue that arises in the same question of this particular case is that whether casino rental can be considered revenue expenses or capital expenses. The Casino East can claim the prepaid rent of $80 million as a deduction under the section 51(1) of the Income Tax Assessment Act 1936 (Federal Register of Legislation, Australian Government, n.d.) and section 8-1 of the Income Tax Assessment Act 1977 (Federal Register of Legislation, Australian Government, n.d.)

Application of Tax Law to The Casino East

There is a great number of tax laws that apply to the current case of John's ownership of The Casino East and the prepaid rental. A direct application of the law can be found in the ruling of the Federal Commissioner of Taxation v Broken Hill Pty (2001) (Barwick C.J., 1969) in which the judge declared that in some cases it is necessary to go outside the contractual obligation to determine the true nature of the payment. The case was concerned with the prepaid rental of a shop and it was concluded that the rental was made for the exclusive arrangements, like the casino’s licence in the current case, and the arrangement between the parties was made for the payment of capital assets.

Section 36(1) and 52(2) of ITAA 1936 (Federal Register of Legislation, Australian Government, n.d.) suggests that the character of any payment can be found by asking two basic questions:

  1. What is the purpose of the prepayment?
  2. For which asset is the payment being made?

As can be observed from different cases related to rental payment and the Valuation of Land Act 1916 by the Valuer-General Council (Government Sector Finance Legislation (Repeal and Amendment) Bill, 2018), the value of any land and any amount spent on its development, for example, construction of The Casino East, and any licence and exclusivity agreements add to the capital expenses of the property. After carefully analyzing these laws and previous rulings, it is quite easy to conclude that the casino's prepaid rental is of capital nature.

Conclusion

In the current scenario, John paid $80 million as prepaid rent, which covered the rental payment of the casino for the 10 years. Since the 10-year period is a long period in terms of the life of the asset, so the prepaid rent is considered to be the capital expense.

Moreover, prepaid rent is of capital nature because it will give benefit to John every year, for the 10-year period. The deductibility terms of the licence under the section 4-880 of the ITAA 1997 (Commonwealth Consolidated Acts, n.d.) also indicates that the payment of $80 prepaid rental can be claimed as deductible and the fee for the licence of a casino is considered to be an intangible asset, which is a capital expense.

The conclusion that the casino prepaid rent is a capital expense is supported by the ruling of the Federal Court of Australia in a similar landmark case, Commissioner of Taxation v Star City Pty Limited (GOLDBERG, 2009). The Star City case went on for a long period as it needed thorough research by the lawyers, judges, and commissioners. In the early rulings, it was decided that the prepaid rent is part of the revenue expense; however, after several appeals and numerous law interpretations, the Federal Court that decided that the prepaid rental is of capital nature and hence, it sets a very important legal precedent, which is evidently applicable in the case of John’s The Casino East prepaid rental as well.

Question 2:

Traveling Between Two Places of Work

Material Facts about Alex’s Travelling Expenses

The utmost important material fact about Alex's situation is that he is travelling between two places where he is involved in manufacturing activities. The striking difference between both the workplaces is that at ABC Engineering in Melbourne, Alex is doing a job at a proper organization whereas his catering service, albeit well-structured, is home-based and he is utilizing the same property for residency.

In a normal situation, if Alex was travelling between two regular jobs, it would have been quite clear for him to claim travel expenses as an allowable deduction because the law supports that in many places, such as ITAA 1936 and ITAA 1997 (Federal Register of Legislation, Australian Government, n.d.). However, there is ambiguity involved in the present scenario in which he is travelling from one regular workplace to another home-based business. Before making any conclusion about the travel expenditure as allowable deductions, a thorough analysis of the relevant laws acts, and sections are conducted to ensure that the conclusion is supported by authentic facts and law.

Analysis of Legal Issues

Income Tax Assessment Act (ITAA) 1997 is the primary Act that consists of comprehensive information about travelling expenses and deductibility. There are numerous sections of the ITAA 1997 that deals with the deductibility claims. Specifically, section 25.100 of the ITAA 1997, (Commonwealth Consolidated Acts, n.d.) lists out the situations in which you can claim the travelling expenses as allowable deductions. 

Undoubtedly, the ITAA 1997 section 25.100 states that travel expenses between the workplaces are considered as a deductible allowance, but there are various nuances associated with this law. The concepts of 'workplace' and 'travel between workplaces' are discussed at length in various parts of the ITAA 1997.

The conditions which are part of the ‘travel between workplaces’ are:

  1. Travelling between two regular jobs
  2. Travelling from your workplace to another branch of the firm for the purpose of getting documents, equipment, or any other reason.
  3. From your regular workplace to another workplace of the same organization.
  4. Travelling from one workplace to another during your working hours.
  5. If you need some tools or things for your workplace and you have to travel to get them.
  6. Travelling between two regular workplaces, when one of them is not your residence.

The law also dictates that travelling expenses cannot be claimed as deductibles when:

  1. If the travelling is done to accomplish some minor tasks such as collecting mail from the route of the workplace to home.
  2. Due to the absence of public transport or while working from home part-time. (ITAA 1997 - SECT 40.880, n.d.)
  3. After the normal business hours, for example, working overtime.
  4. If you operate a business at your residence and you incur traveling expenses while going from your home to another job.

Application of ITAA 1997 to Alex’s Travelling

As stated in the previous section, ITAA 1997 section 25.100 (Commonwealth Consolidated Acts, n.d.) and section 40.880 deals with the travel between workplaces. The law applies to the workplaces where assessable incomes are being produced and you are travelling between both of the regular jobs.

ITAA 1997 section 28.25 (Acts, n.d.) gives out the details of the calculation of the travel expenses ('cents per kilometers') and deductibles. It deals with the details of the specific distance covered between workplaces and the amount that is claimable as a deductible allowance. 

In terms of our case of Alex in which he is travelling from one regular workplace in Melbourne to his home-based catering service in Victoria, he can't claim the travelling expenses as an allowable deduction. It is clearly stated in the given situation that Alex and his family are residing on the property in Dandenong, Victorian, where his catering business is based.

The law, ITAA 1997 section 25.100 (Commonwealth Consolidated Acts, n.d.), states in unambiguous terms that "travel between two places is not 'travel between workplaces' if one of the locations you are going to is a place at which you live." Hence, Alex's travelling expenses are not an allowable deduction.

Conclusion

Alex can get some type of benefits under the ITAA 1997 Subdivision 900-B, which deals with the work expenses based on the generation of assessable income of salary. Other than that, there is no way for Alex to claim travel expenses as a deduction because his catering business has the address as of his residence.

As observed from the previous discussion and thorough analysis, it is evident that ITAA 1997 section 25.100 does not allow Alex to claim traveling expenses incurred by him during his travels from ABC Company in Melbourne to his home-based catering business in Victoria as an allowable deduction because he is travelling from his workplace to his residence. He and his family are living at the property in Victoria from where he is operating his business and such places do not allow deductions on travel expenditure under the light of Australian Law.

References

ACT Government, n.d. Casino Control Act of 2006. [Online]
Available at: https://www.legislation.act.gov.au/a/2006-2 

Acts, C. C., n.d. INCOME TAX ASSESSMENT ACT 1997 - SECT 28.25. [Online]
Available at: http://classic.austlii.edu.au/cgi-bin/sinodisp/au/legis/cth/consol_act/itaa1997240/s28.25.html?stem=0&synonyms=0&query=workplace 

Anon., 1952. Broken Hill Theatres Pty. Ltd. v. Federal Commissioner of Taxation. s.l.:CLR 423.

Australian Taxation Office, n.d. Categories of revenue and expenses. [Online]
Available at: https://www.ato.gov.au/non-profit/your-organisation/in-detail/income-tax/mutuality-and-taxable-income/?page=10 

Barwick C.J., M. J. a. M. J., 1969. Federal Commissioner of Taxation v. The Broken Hill Proprietary Company Limited., Melbourne: High Court of Australia.

Commonwealth Consolidated Acts, n.d. INCOME TAX ASSESSMENT ACT 1997 - SECT 25.100. [Online]
Available at: http://classic.austlii.edu.au/cgi-bin/sinodisp/au/legis/cth/consol_act/itaa1997240/s25.100.html?stem=0&synonyms=0&query=workplace 

Commonwealth Consolidated Acts, n.d. INCOME TAX ASSESSMENT ACT 1997 - SECT 40.880. [Online]
Available at: http://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s40.880.html 

Federal Register of Legislation, Australian Government, n.d. Income Tax Assessment Act 1936. [Online]
Available at: https://www.legislation.gov.au/Details/C2017C00242/Html/Volume_1 

Federal Register of Legislation, Australian Government, n.d. Income Tax Assessment Act 1977. [Online]
Available at: https://www.legislation.gov.au/Details/C2017C00336 

GOLDBERG, D. &. J. J., 2009. COMMISSIONER OF TAXATION v STAR CITY PTY LIMITED (ABN 25 060 510 410), Melbourne: s.n.

Government Sector Finance Legislation (Repeal and Amendment) Bill, 2018. Valuation of Land Act 1916, s.l.: Valuer-General Council.

ITAA 1997 - SECT 40.880, n.d. [Online]
Available at: http://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s40.880.html 

Victorian Casino Control Authority, 2017. MELBOURNE CASINO PROJECT. In: s.l.:s.n.

Wolters Kluwer Business, 2011. Australian Master Tax Guide 2011. In: s.l.:s.n.

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