MLC301 Principles of Income Tax Law - Assessment Questions

QUESTION 4. 9

Sadiq (ed) et al. 2019, Question 12.1
The negative limbs. The first step in determining whether an expense is a general deduction under s 8- 1 is to determine whether or not either of the two positive limbs allow a deduction. Once this is proved, the next step is to ascertain whether the expense will be excluded from deductibility by one of the four negative limbs. Section 8-1(2) excludes from deductibility losses and outgoings that are:
(a) [First negative limb] capital
or
(b) [Second negative limb] private or domestic
or
(c) [Third negative limb] incurred in earning exempt income
or
(d) [Fourth negative limb] excluded under specific provisions of the Act.
The first two of these exclusions from deductibility are the most important and need to be considered in some detail. The third negative limb is self explanatory, and the fourth negative limb is covered in the last part of this topic as it applies to both general and specific deductions. First negative limb – capital expenses
The exclusion of capital expenses from deductibility produces a symmetry between deductions and assessable income. In topics 2 and 3 we saw that capital receipts are not ordinary income and are only assessable because of their specific inclusion under the capital gains provisions. A similar approach operates for deductions. Capital expenses are excluded from general deductibility, but the specific deductions do allow some capital expenses such as depreciation (see later discussion in this topic).
Capital expenses are not defined in the legislation, giving rise to the same difficulties that occurred with defining ordinary income. When considering the meaning of capital, in the context of income, we needed to resort to case decisions. Although there are some similarities between the courts’ approach to defining capital for income and expenses, it is important not to confuse the two.

The leading decision on the deduction side is Sun Newspapers Ltd v. FCT (1938) 61 CLR 337 in which Dixon J drew a distinction between structural expenses, being capital, and process expenses, being deductible. The analysis used by Dixon J has become known as the ‘business entity test’ but is also referred to as the profit yielding structure test’. Even though the ‘business entity test’ has become the most significant test of capital in Australia, it is still important to recognise that the ‘once and for all’ and the enduring benefit’ tests should still be considered when deciding whether an expense is capital or not.