A recent Parliamentary Inquiry into Tax Deductions created some fairly sensational headlines. How much deductions were claimed? – $22 billion worth to be exact.
In Australia, tax deductions are available for expenses incurred in producing assessable income. These deductions are generally work or investment-related. They can also be offset against taxable income including wages.
Tax Commissioner Chris Jordan highlights in his recent speech that in 2014-2015, there were claims of more than $22 billion for expenses relating work. “While each of the individual amounts over-claimed is relatively small, the sum and overall revenue impact for the population involved could be significant – in the vicinity of, or even higher than the large market tax gap of $2.5 billion – and that’s just for this category of deductions, work-related expenses.”
He went on to say that in this same period, around 6.3 million people made claims for clothing expenses amounting almost $1.8 billion. “That would mean that almost half of the individual taxpayer population wears a uniform or protective clothing or had some special requirements for things like sunglasses and hats.” Clearly, that’s unlikely.
The individual amounts over-claimed are relatively small. This is despite the ATO’s conduct of random audits of taxpayers making claims for work-related expenses. The administrative cost of a crackdown is likely to be more than the potential gain. The likely ‘solution’ then is to change what taxpayers can claim.
If you want to see the likely ‘hit list’ of deductions with a potentially short future, then Treasury’s submission to the Inquiry is a starting point:
Investment expenses
Investment related expenses can include the following: management fees for an investment, insurance, land tax, and depreciation among others. It can also include maintenance expenses and interest on borrowings used to purchase an income-producing asset. The activities usually focus on property.
There are claims of $41.7 billion in rental expenses against $36.5 billion of rental income in 2012-2013. Two thirds of taxpayers with rental income in this same period made a loss (net rental losses of $12 billion). If the expected capital gain exceeds the rental losses over the life of the investment when the owner sells the property, then negative gearing proves to be a good investment strategy. However, there is little doubt that the use of investment property losses to reduce personal income tax is an attractive strategy for high income earners.
The Grattan Institute’s submission to the Inquiry flags two potential scenarios. First is quarantining losses against investment income only. That is, you would lose the ability to offset investment losses against salary and wages and instead could only offset these against capital profits or gains. Or, to entitle you to an equivalent deduction for expenses, they can also align gains and taxes. This is if you have an entitlement to a 50% reduction on a capital gain.
When it comes to convincing voters that cutting back on deductions is a good thing, investment related deductions are generally targeted as they are not as transparent and are generally attributed to more affluent members of the community (although this is not an accurate picture as many self-funded retirees and Mum & Dad property investors will tell you).
With the next election just around the corner, it’s unlikely to see a major overhaul in the very near future. The path of least resistance is to reduce the discount on capital gains available to individuals, trusts, and super funds. It’s more likely however that the regulators will continue to whittle away deductions rather than making wholesale changes. We have already seen this with the recent changes impacting residential investment property. All while relying on the ATO to reign in excessive claims.
Work related expenses
At $19.7 billion, work-related expenses accounted for nearly two thirds of total deductions claimed by individuals in 2012-2013. 
The most common claims were for car expenses ($8 billion or around 40%). What follows it are the $7 billion in ‘other expenses’ comprising home office costs and tools, equipment and other assets. Work-related travel expenses counted for $2 billion, uniforms $1.6 billion, and $1.1 billion for work related self-education expenses. Unsurprisingly, you can observe that the pattern of expense claims closely follow the ATO’s compliance focus and activities.
By comparison, New Zealand does not allow work related deductions. They have a top personal tax rate of 33% though. In other countries, the range of claimable deductions are much narrower. In the UK for example, only certain occupations can claim work related expenses. And this is generally at a flat rate. Taxpayers have the ability to claim outside of the flat rate but only after passing stringent tests. The tests require that the item must be ‘wholly, exclusively and necessarily in the performance of an employee’s duties’. It should also be an expense typical for the industry.
It would be a bold and confident Government that removed the ability for many taxpayers to claim a tax refund. As for investment expenses, it is likely that deductions will slowly whittle away.