Deduction for Prepayment
Individuals and businesses can use this guide to work out their deductions for prepaid expenses, which are then claimed at the appropriate item on the tax return.
Generally, a prepaid expense is deductible over the eligible service period, or 10 years if that is less, rather than being immediately deductible. However, a prepaid expense may be immediately deductible if:
- it is excluded expenditure (explained more below)
- the 12-month rule applies, or
- it relates to a pre-Review of Business Taxation (RBT) obligation.
Prepayments are payments that are made in one reporting period for goods or services that will not be received until a future period or are received over a longer period of time. This is often the case for expenses spread over a number of months (subscriptions or insurance premiums) and where the expense relates to separate financial periods.
The liability or the payment itself should be recognised in the first period it applies. Ie when the invoice comes in or the payment is made.
Some business will expense all payments (even where it is an expense that covers the whole year) immediately, when the amount is below a predetermined threshold. This threshold amount can be different for accounting purposes, as distinct to any tax treatment, explained below.
A “Prepayment” is considered an asset to the business until such a time as the goods or services have been received. So the payment or the recognition of the purchase will be allocated to the “Prepayments” asset account initially
Some examples of common prepayments are:
- Rent
- Airfares and accommodation
- Subscriptions
- Contract payments
- Insurance
- Advertising
- Booking for conferences, major events etc.
Prepayment Tax Rules If you are a small business entity (Small Businesses <$2m turnover), or an individual incurring deductible non-business expenditure, you can claim an immediate deduction under the 12-month rule for prepaid expenditure if the payment is incurred for an eligible service period not exceeding 12 months and the eligible service period ends in the next income year.
You are allowed to claim items straight away if the expenses are one of the excluded expenses:
Excluded expenditure
Certain types of expenditure are excluded from the prepayment rules. These are:
- amounts of less than $1,000
- amounts required to be incurred by a court order or law of the Commonwealth, state or territory
- payments of salary or wages (under a contract of service)
- amounts that are capital, private or domestic in nature (except certain research and development amounts) and
- certain amounts incurred by a general insurance company in connection with the issue of policies or the payment of reinsurance premiums
Example: Amount required to be incurred under a state law
John operates a cartage business and paid $1,200 on 31 December 2013 to register his truck for 12 months from 1 January 2014 to 31 December 2014. The truck is used exclusively for business purposes. Although the registration fee is over $1,000 and it covers a period spreading across more than one income year, it is excluded expenditure. This is because it is required to be incurred under a state or territory law. The prepayment rules do not apply to this type of expenditure and the fee is deductible in the year it is incurred.
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