Simplified calculation of deductions for dual use vehicles and premises
(Clauses 62, 64, 65, 66, 67, 68 and 71)
Summary of proposed amendment
The proposed amendment allows taxpayers to use a simplified method for the calculation of deductions for premises and vehicles that are used for both business and personal purposes. This will reduce compliance costs for taxpayers.
The proposed amendment will apply for the 2017–18 and later income years.
Subpart DE of the Income Tax Act 2007 is being amended to modify and extend the current per kilometre rate method for determining a taxpayer’s deductions for a vehicle used for both business and private purposes (the current rules only allow the method to be used if the business use is less than 5,000 km).
Under the modified per kilometre method in section DE 12, taxpayers will deduct a fixed amount per kilometre travelled for business purposes based on rates published by Inland Revenue. This is instead of deducting any actual costs.
The rates will be:
- set by reference to industry figures, and based on the average per kilometre cost for the average vehicle;
- divided into 2 tiers. The first tier will provide for the recovery of both the vehicle’s fixed costs and its per kilometre costs. The second tier will provide for the recovery of the per kilometre costs only (as the fixed costs of vehicle ownership would be over-deducted with increasing usage if a single fixed rate were used); and
- published by Inland Revenue and updated each year to ensure the rates are accurate.
The first tier of rates will apply to the total distance travelled (including for both business and personal purposes) up to a specified limit. To calculate the deduction for this tier, taxpayers will multiply the total kilometres travelled (to which the first tier applies) by the proportion of business use for the vehicle and the income year. The product of that calculation will then be multiplied by the rate for the first tier to produce the deductible amount.
The calculation will be repeated for the second tier of rates. That is, the total kilometres travelled (to which the second tier of rates applies) will be multiplied by the proportion of business use for the vehicle and the income year. The product of this calculation is then multiplied by the rate for the second tier to give the deductible amount. The deductible amounts for the first and second tiers of rates are then added together to determine the taxpayer’s total deduction for their business use of the vehicle.
Under the existing legislation, taxpayers may keep a logbook for a three-month representative test period to determine a vehicle’s proportion of business use for the next three years.
The new method is optional, and taxpayers may elect to use it on a per-vehicle basis. However any election must be made when the tax return is filed for the year in which the vehicle is acquired. The election is non-revocable, so taxpayers cannot switch between methods for the same vehicle (although they may apply different methods to different vehicles). This is because it would be too complex to account for depreciation if a taxpayer switched methods, given that separate depreciation deductions are not claimed under the new method and no depreciation recovery income arises on sale.
Taxpayers who own a vehicle which they use partly for business purposes may switch to the new method for the 2017–18 income year, when the new method is introduced. This is provided they do not dispose of the vehicle in that income year.
Amendments to subpart DE and section EE 49 are also proposed, to clarify some aspects of how the per kilometre method is intended to operate.
Mr Smith is a real estate agent who uses his personal car for business purposes.
Mr Smith buys a new car and elects to use the per kilometre method to calculate his deductions when he files his tax return. Mr Smith has kept a log book for the first three months of the year, which shows a proportion of business to total kilometres of 0.55. Over the entire year Mr Smith has driven 30,000km.
The rates that Inland Revenue has published are 75 cents per km for the first 10,000km and 25 cents for every km thereafter (these rates are indicative only).
Mr Smith needs to calculate his deductions for each tier of rates, and then add them together.
The formula to calculate his deductions for each tier is:
Total kilometres travelled (to which the tier applies) x business proportion x tier rate
Applying this formula, Mr Smith makes the following calculations:
First tier: 10,000 km x 0.55 business use x $0.75/km = $4,125
Second tier: (30,000 total km – 10,000km) x 0.55 business use x $0.25/km = $2,750
Adding the results for each tier together gives $4,125 + 2750 = $6,875. Therefore Mr Smith can claim deductions of $6,875.
The proposed amendment inserts a new section DB 18AA into the Income Tax Act 2007. The proposed new section provides an optional alternative method for calculating the deduction for premises that are used for both business and personal purposes. The “premises” for this purpose includes only the relevant building and not any curtilage.
The new method first requires the taxpayer to determine the area of their building (in square metres) that is both separately identifiable and used primarily for business purposes. This area is then multiplied by a single rate to give the first amount of the deduction. The rate will be:
- set by Inland Revenue, based on the average cost of utilities per square metre of housing, but excluding mortgage interest and rates or rent
- updated each year; and
- reasonably accurate for most taxpayers.
Taxpayers using this proposed new method will be able to claim a second deduction for their actual mortgage interest and rates or rental costs. This second deduction is calculated by multiplying the amount of these actual costs by the fraction of the premises that is both separately identifiable and used primarily for business purposes. The reason this deduction is calculated separately is because mortgage interest, rates and rental costs are too variable to be included in a single representative rate.
No other deduction in relation to the premises is permitted for taxpayers who use this method.
Taxpayers may elect to use the proposed new method for an income year by using it to calculate their deductions in their income tax return. There are no restrictions on the ability of a taxpayer to choose the method.
Mr Smith has a room in his house which is set aside as an office. Mr Smith uses the office primarily for business purposes. Mr Smith decides to calculate his deductions for this office using the new method. The office has an area of 10m2, while Mr Smith’s house has an area of 100m2. Inland Revenue has set the fixed rate for premises at $100/m2 (this amount is indicative only).
Mr Smith calculates his first deduction using the fixed rate. To do this he simply multiplies the area of his office (in square metres) by the fixed rate. Accordingly, Mr Smith’s first deduction is:
10m2 x $100/m2 = $1,000.
Mr Smith next calculates his second deduction for his mortgage interest and rates (as Mr Smith owns his house). To do this, he calculates the fraction of his house occupied by his office. He then multiplies his actual mortgage and interest costs by that fraction.
The fraction of Mr Smith’s house that is occupied by his office is: 10m2 office ÷ 100m2 house = 0.10 (or 10%).
Mr Smith’s mortgage interest for the year is $20,000 and his rates are $3,000. Therefore Mr Smith’s second deduction is: ($20,000 + $3,000) x 0.10 office fraction = $2,300.
Adding the two deductions together, Mr Smith has a total deduction for his office of $1,000 + $2,300 = $3,300. Accordingly he can claim a deduction for his home office of $3,300.
Small business owners often use their vehicles and premises for both business and private purposes. This can create a large compliance obligation compared with the amount of tax at stake, as there are numerous expenses for these items, all of which must be recorded and apportioned between business and personal use. The proposed amendment will simplify taxpayers’ compliance obligations for these items.