4.7.1.30 Assessment of business deductions & losses for sole traders & partnerships

Summary

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.

Act reference: SSAct section 8(1)-'income'

Policy reference: SS Guide 4.7.1.10 General Provisions for Sole Traders & Partnerships, 4.7.1.20 Assessment of income for sole traders & partnerships

Allowable deductions for income test & taxation purposes

SSAct section 1075(1) 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 SSAct section 1075. That is, expenses:

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

Example: Legal expenses to the extent that they are incurred in the course of producing income or in carrying on a business for that purpose and are neither of a capital, private or domestic nature.

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.

Examples: Child care facilities, (unless the business is involved in providing child care to make a profit (1.1.P.428)) and employees' quarters and amenities.

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 (1.1.A.320).
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.

Example: Premises which are mortgaged for $17,000 at 15% per annum interest, have an annual interest bill of $2,550. If 1/5 of the floor space is used for the business, the allowable deduction is $510 (1/5 of $2,550).

Salary/wage

Note 1: The profit and loss statement MUST be checked to ensure the payments are a salary/wage (refer to 'drawings' below).

Note 2: 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.

Act reference: SSAct section 7(2) An Australian resident is a person who …, section 1075(1) Permissible reductions of business income

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 (1.1.A.290) and are therefore subject to deeming.

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 (1.1.P.428) or income derived from unrelated sources, such as:

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

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

Act reference: SSAct section 8(1)-'income'

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.

Explanation 1: A necessarily related activity refers to a particular activity within a business operation and does not necessarily refer to the entire business operation.

Explanation 2: 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.

The rules concerning offsetting of business losses also apply to controlled private trusts and companies. 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.

Last reviewed: 6 May 2019