Ordinary income has been interpreted by the courts to mean income as used in ordinary everyday language. This interpretation has resulted in income being viewed from the point of view of how income is earned. Generally, income is earned from labour such as salaries and wages which are known for tax purposes as personal services income. It is also earned from passive investments such as rent, interest and dividends which is known as property income. Finally income is earned from business activities which is known as business income.

Understanding the meaning of ordinary income is an important part of working out your assessable income. However, it is also valuable to understand what is not ordinary income. Receipts that are not ordinary income include:

Although this list does not cover all possibilities it does cover the most significant receipts that are not assessable as ordinary income. However, it is important to appreciate that some may be specifically assessable as statutory income. The most obvious example being capital sale that could be assessable under the capital gains provisions. Despite the fact that some of these receipts may be assessable as statutory income, it is important to understand which type of income a receipt is because different types of income may be taxed differently. For example, if a receipt is assessable as ordinary income the full amount is assessable, but if the receipt is assessable as a capital gain only 50 per cent or the gain may be subject to tax.

Sales of trading stock are assessable as ordinary income and a deduction is available for the purchase of trading stock. In addition, an adjustment to your tax is made depending on whether the value of your trading stock increases or decreases over the year. An increase in the value of trading stock (comparing opening stock values to closing values) is assessable and a decrease is deductible. This adjustment effectively defers the deduction for the purchase of trading stock until the year the stock is sold. Therefore there are four parts to the determination of your trading account for tax purposes:

Any trading stock that is taken from the business for personal use is also assessable income. The assessable amount is normally the value the stock is held at for tax purposes but it can be deemed to be market value. Trading stock that is lost, stolen or destroyed will give rise to assessable income if you are compensated with insurance or in some other way. The assessable amount will be the amount of the compensation received. However, if there is no compensation for the loss there is no assessable income.

Assessable income from trading stock may be treated differently if the sale is not a normal sale of the business. Abnormal sales may occur for example, with the sale of the whole business or on the death of the taxpayer. The tax effect of the special sales is explained in the section on tax concessions for primary producers.

Capital gains tax (CGT) is a form of statutory income (made assessable by legislation) which in turn forms part of your total assessable income. This form of statutory income affects assets that where acquired after 19 September 1985, and makes the net gain from the sale of these assets assessable income in the year they are disposed of. Capital gain may also arise if compensation is received for the loss or destruction of an asset, or even if you receive money for entering an agreement. For example, this last situation may arise if you are paid to not compete with the purchaser of the business that you have just sold, or paid to alter a lease agreement.

If you realise a loss on the sale of a capital item this loss can only be used to reduce capital gains. It cannot be used to reduce assessable income from other activities. If you cannot use all or part of the capital loss in the current year, it can be carried forward for use in later years. There are further restrictions to losses realised on the sale of collectibles and your personal assets.

The legislation covering CGT gives a very wide definition of assets that are subject to CGT and it includes all property and rights under a contract.

Assets that are normally subject to CGT:

Assets which are not normally subject to CGT include:

The amount of capital gain or loss is determined by subtracting the cost of the asset from the amount received from its disposal. When working out the cost and amount received for your asset, the legislation requires that you take into account not only the dollar amounts, but also the market value of any property transferred in relation to the purchase or sale of the asset. This means that swapping property could give rise to CGT. Also, if the actual values are not realistic or commercial then the market value will be substituted for the actual amounts.

The following can be included in the cost of an asset for CGT but only if they have not been allowed, or could be allowed as a deduction under some other provision of the legislation (this rule is different for assets acquired before 13 May 1997). Expenses such as entertainment, penalties and bribes which are denied deductibility are also excluded from the cost base for CGT purposes:

Most taxpayers are required to account for their tax-related business activities on an accruals basis. This means that amounts that are assessable income in the year that the right to receive the money arises, even though it may not have been received. The accruals approach is applicable to businesses that hold trading stock - most primary production businesses. However, an exception applies where produce is delivered to a marketing pool, because in this case the final income is not known and will only be assessable when the producer is notified of the payment due.

Small businesses that do not hold trading stock and only deal on a cash basis need only declare assessable income when it is received. Under the Small Business Entity provisions (see later) eligible businesses may also choose to be treated on a cash basis.

Expenses are deductible as a general deduction if you can show that the expense was incurred in earning your assessable income or in carrying on your business to earn income. The important thing to show is that the expense was part of the process of earning income. For example, expenditure on consumables such as fodder and fertiliser would be general deductions as these are used in producing business income. Also the cost of employees' wages, contracting fees, farm electricity, and fuel for farm machinery, veterinary expenses and interest on business loans would all be a general deduction.

However, expenditure will not de deductible if it is private or capital in nature. For example, the private proportion of telephone, electricity, rates, motor vehicle expenses and interest will not be deductible. In additional capital costs are not allowed as a general deduction but they may be able to be claimed over time as a specific deduction. For example, the cost of purchasing an item of farm machinery cannot be claimed as a general deduction but you are entitled to an annual claim for depreciation over the life of the asset.

For a list of some of the possible deductions, view the checklist below.

Normal repairs that simply enable the item to be returned to its previous working order are deductible. For example, replacing some of the tin blown from the machinery shed during a high wind is clearly a repair. However, if the repair actually improves or changes the plant or structure then it is not deductible as a repair. This would be the case if you decided to enclose part of the machinery shed to prevent damage from strong winds in the future. Also if an item is purchased in a state of disrepair then the cost of work done to bring it to a useful state will also not be deductible as a repair.

Although some of these costs are not deductible as repairs, they may be able to be added to the capital cost of the item and included in the value of the item for depreciation or part of the cost base for CGT.

Bad debts that have previously been included in your assessable income can be claimed as a deduction in the year you give up trying to collect the debt. A deduction for bad debts will only arise if you determine your assessable income using the accruals method. This is because businesses that only show their income as assessable on a cash basis, will never have included the amount in their assessable income and therefore cannot claim a deduction if it is not paid.

The bad debts of a company can only be used as a deduction if the company can show that it continues to carry on the same business as when the debt was incurred, or the majority ownership has remained the same over the period.

Your taxable income is calculated by subtracting deductions from assessable income. However, if your deductions are greater than your assessable income you will have a tax loss. This loss can be carried forward and used as a deduction in the next year. If there is still a tax loss in the next year it can continue to be carried forward indefinitely until it can be used as a deduction.

The tax losses of a company can only be carried forward as a deduction if the company can show that it continues to carry on the same business as when the loss was incurred, or the majority ownership has remained the same over the period.

A deduction for tax losses may also be restricted if the losses are non-commercial losses. These losses have to be kept separate and can only be used as a deduction when the business meets one of several requirements (see later discussion of non-commercial losses).

Expenses relating to the preparation of your income tax return are specifically made deductible by the legislation provided they are not capital in nature. These rules allow you to claim the cost of preparing income tax returns and complying with your obligations relating to income tax. Of course the actual cost of the income tax is not itself deductible.

Other taxes incurred in the operation of your business will normally be deductible if they are an actual cost and not just collected and passed on to the ATO. For example, GST paid on expenses by a business entitled to a GST credit is not an actual cost and therefore cannot be included in the amount claimed as a deduction. This is because the GST included in the purchase price is effectively refunded as it can be claimed as a credit against GST owed to the ATO (GST can be claimed as a deduction if you are not entitled to a GST credit on GST included in the cost).

In contrast, FBT is an actual cost of the business, as are property rates and production licences and levies, so these are all deductible as a general deduction.

Wide reaching changes to the taxation of superannuation come into affect on 1 July 2007. The following information relates to the new superannuation system.

The taxation of funds invested in superannuation need to be considered at three levels:

If you earn less than $58 980 (1/7/2007) a year then you could also be eligible for the government's superannuation co-contribution scheme for any contributions to your superannuation fund that have not been deductible. Under this scheme, for every $1.00 your contribute to your own fund, the Government will contribute an addition $1.50, up to a maximum of $1500 per year. The maximum Government co-contribution of $1500 reduces once your income goes over $28 980 (1/7/2007).

Additional information on the new superannuation arrangements can be accessed from the ATO web site.

The full cost of acquiring capital items such as new plant or buildings are normally not deductible in the year they are purchased as capital expense are not deductible as general deductions. However, a deduction in the form of an annual allowance may be permitted over the life of the asset. This deduction is based on an estimate of the annual loss in value of your asset over its life and is known as depreciation or a capital allowance.

You can claim a tax deduction for depreciation on assets used to produce assessable income that have an effective life, and decline in value over their life. For primary producers, fixtures and improvements to land are also included as depreciable assets. However, your private home is not depreciable for tax purposes but a percentage of the total depreciation may be deductible if part of the house is used exclusively for business purposes. Depreciable assets may include:

The amount of depreciation is based on the cost of the asset (excluding GST) and an estimate of its effective life. For example, if a piece of farm machinery has an estimated life of 10 years then the depreciation rate will be 10% (100%/10).

There are two methods of depreciation: the prime cost method is based on the purchase price of the item and allows the same depreciation each year until the asset is fully depreciated. The diminishing value method allows higher deprecation in the early years as the percentage depreciation is double that of the prime cost method, but the annual depreciation reduces each year.

For example, if a piece of farm, machinery that was purchased for $20 000, has an estimated life of 10 years, then the depreciation rate will be 10% (100%/10) and the prime cost depreciation will be $2000 per year ($20,000 x 10%) until the item has been depreciated to zero. Using diminishing value for the previous example, the depreciation claim in the first year would be $4000 ($20 000 x (10% x 2.0)), but in the second year the deduction would reduce to $3200 (($16 000) x (10% x 2.0)). This is because the depreciation for the second year is based on the asset's opening value for the year of $16 000 (20 000 - 4000) and not the original purchase price. Using the prime cost method can depreciate the item to zero in time, but under the diminishing value method the depreciated value never reaches zero.

If you do not hold the asset ready for use for all the year you can only depreciate the asset for the number of days you have held it. In the previous prime cost example, if the asset was purchased on 1 June the depreciation deduction for the first year would only be $164 ($2000 x (30/365)).

Once the depreciation is determined it is then necessary to calculate the amount of the depreciation that is deductible. Where the asset is used 100% for business purposes then the total deprecation will be deductible. However, if the asset is used partly for private purposes then the deduction for depreciation is also reduced by the amount of private use. For example, only 70 per cent of the depreciation can be claimed for a motor vehicle that is used 70 per cent for business and 30 per cent privately.

When a depreciated item is sold it is not subject to CGT but there may be a tax adjustment known as a balancing adjustment (see later discussion). This means that if the plant is sold for more than its depreciated value (purchase price less total depreciation), the excess will be assessable, but if it is sold for less the loss is deductible. There are also some special depreciation rules which limit the cost of the item for depreciation, or determine the depreciation using different methods including the special depreciation rules that may be used by Small Business Entities (SBEs).

Standard depreciation for tax is based on the cost and effective life of the asset but there are some special rules that should be noted. For example, primary producers may be eligible for higher rates of depreciation on some specific capital cost, or under the SBE depreciation system (see also primary producer tax benefits). These special rules may change from year to year but the most important include:

Deductions for depreciation are based on an estimate of the decline in value of an asset. Consequently, when the item is eventually sold the actual decline in value can be compared to the estimate that has been used for tax purposes. This difference between the tax depreciated value and the actual sale value is know as the balancing adjustment and may result in assessable income or a deduction.

If the tax depreciated value of the asset is less than the sale value then the difference is assessable income. Conversely, if the depreciated value for tax purposes is greater than the sale value then the difference is deductible.

Structural improvements not used in a business of primary production are not deductible under depreciation rules, but are written-off at either 2.5 per cent or 4 per cent per year. This allowance is only available on newly constructed buildings and improvements.

In addition to deductions being allowed for the depreciation of assets you may also be eligible for deductions for other capital items that would not normally be deductible. The most important of these are discussed in more detail in the section on primary producer tax concessions but some of the more general capital deductions that are permitted as part of the business include:

Items that cannot be claimed under any of the deprecation or special capital allowance rules may be able to be added to the cost base of an asset for CGT purposes. As a last resort, expenses may be deductible under the 'Blackhole' rules which allow some business capital costs such as business establishment expenses, feasibility studies and liquidation expenses to be deducted over 5 years.

Expenses of a capital nature are excluded from general deductibility, but they may still be deductible as a specific deduction such as depreciation, or they may be able to be added to the cost base of an asset for CGT purposes.

Capital items are those expenses that change or establish the business itself rather than just operating it. These expenses also usually benefit you for more than one year as compared to those that are consumed during the year. For example, the normal cost of employing labour to carry out daily farm operations is not capital and is fully deductible in the year. However, if the employee is used to build a new shearing shed then the cost of these wages is capital and needs to be added to the cost of the shed for depreciation purposes.

Private expenses are never deductible as they are not part of the cost of earning your assessable income. As a result, you will need to reduce the amount claimed on any expense if part of the cost was for private purposes. Some of the common examples include:

Entertainment expenses related to running your business are specifically excluded from deductibility unless they meet one of the types of expenses that are permitted. Entertainment expenses are defined as the provision of food and drink or the provision of property for entertainment (e.g. corporate boxes). Some entertainment expenses are permitted provided they are a general deduction:

Tax losses can be used as a tax deduction in future years but only if the losses are not non-commercial losses. Non-commercial losses cannot be used as a deduction unless one of the following criteria has been met:

Non-commercial losses can still be carried forward if they cannot be used as a deduction in the current year. These losses can be used as a deduction in later years once the business meets one of the above tests.

Deductibility of investments in agricultural Management Investment Schemes (MIS) will be determined by whether the investor is in business and whether or not the investment is capital in nature. Income tax ruling TR 2007/8 will apply from 1/7/2008 to give affect to the Commissioner's view that these investors are not in business and are therefore the investment is capital and not deductible. The exception is that legislation has been introduced to allow as a deduction the costs of establishing timber plantations (see section on primary producers).

GST may form part of your expenses in the operation of your business. However, if you are registered for GST, the GST component of business expenses will be refunded as a credit via the ATO. As a result, the GST component is not an actual expense and therefore cannot be included in your deductions. For example, if you purchase stock feed for $11 000 and $1000 of this was GST for which you received a credit, then the deduction allowed is only $10 000 (($11 000 - $1000). If you are not entitled to a credit for any GST you pay then the full cost of the item including GST is deductible. GST must also be removed from the cost of items to be depreciated, the costs of CGT assets and the value of closing trading stock.

Legislation also disallows a deduction for the following expenses:

Some of these expenses that are excluded from deductibility may be deductible if an employer incurs the expense on behalf of the employee, and the benefit provided to the employee is a Fringe Benefit under the Fringe Benefits Tax Act (see discussion of Fringe Benefits).

There a two steps in establishing whether or not your activities meet the requirements of a business of primary production:

To satisfy the first requirement it is necessary to understand what constitutes a business for tax purposes? This primarily requires that your activities be conducted in a commercial manner. Further detail on what constitutes a business of primary production is contained in Income Tax Ruling TR 97/11. To access this ATO Tax Ruling go to the ATO website - www.ato.gov.au.

To satisfy the second requirement your business must engage in primary production which is defined as:

Unfortunately there are no general rules that specify what a business of primary production is and there are in fact cases that show that owning just one cow could be a business of primary production. Therefore each case has to be decided on its own merits when making this determination. It is generally accepted that a sharefarmer or lessee will be in the business of primary production, but the owner of the property in these cases will only be a primary producer if they have a direct interest in the business activities or if the arrangment is a partnership.

To view a web page containing further information relating to this topic go to the ATO website - www.ato.gov.au.

Deductions for general capital allowances are available as depreciation and the write-off for structural improvements but several special capital allowances are available to primary producers.

Agricultural businesses are eligible for a number of income tax concessions if they are in receipt of abnormal income. These concessions aim to reduce the disadvantage of unavoidably high income that may result in high marginal tax rates.

If your annual turnover and your business assets are below $2 mil you may choose to take advantage of simplified methods of taxation. SBE taxpayers may use a simplified method for depreciation calculation, reporting GST, trading stock valuation and prepayment of deductible expenses. These simplifed methods are aimed at reducing the time that you have to spend keeping records for income tax purposes. In addition SBEs may also be eligible for reduced tax on capital gains. You are eligible to use the SBE system (it is not compulsory) if your:

There are rules to prevent you dividing your business up so that each part meets the SBE requirements.