Deduction Basics of the Tax Law
Section 8-1 ITAA 1997 is the fundamental legal authority for claiming tax deductions. It says:
(1) You can deduct from your assessable income any loss or outgoing to the extent that:
- It is incurred in gaining or producing your assessable income; or
- It is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
(2) However, you cannot deduct a loss or outgoing under this section to the extent that:
- It is a loss or outgoing of capital, or of a capital nature; or
- It is a loss or outgoing of a private or domestic nature; or
- It is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or
- A provision of this Act prevents you from deducting it.”
For the most part, deductions for working from home by employees are claimed under 8-1(1). If a business is being carried on, a deduction can also be claimed under 8-1(1). If, for some reason the outgoing can’t be claimed under 8-1(1), businesses can also rely on 8-1(2), which specifically mentions amounts necessarily incurred in carrying on a business earning assessable income.
Note that both subsections use the words “to the extent that”. The use of these words provides the requirement for a taxpayer to apportion an expense between the amount incurred in deriving assessable income and the amount that is not 8-1(1) and for the various types of expenditure in 8-1(2).
There are two methods of claiming deductions related to working from home. The first method is the “actual expenses” method. This method is what might be referred to as the technically correct method and mainly uses 8-1 and the depreciation provisions to calculate the deduction using – as the name suggests – the actual expenses that have been incurred.
The second method is a concessionary, short cut, method permitted by the ATO known as the “revised fixed-rate” method. This method is provided for in PCG 2023/1 and permits “a proxy rate used as an exercise of the Commissioner’s general power of administration as to how it will apply compliance resources”
TR 93/30 Deductions for home office expenses
In 1993, the ATO released what is still its most important ruling on home office expenses, TR 93/30. This is a “public ruling” and therefore has a legal status under the Taxation Administration Act as compared to website guidance and practical compliance guidelines which do not have such status.
The ruling commences by stating that, as a general rule, expenses associated with a taxpayer’s home are of a private or domestic nature. However, there is an exception to this general rule if the home is used for income producing activities and has the character of a “place of business”. When this is the case, expenses of occupancy can be partly deductible. Expenses of occupancy include rent, interest, repairs, house and contents insurance, rates and property taxes.
The ruling states that there is a second exception to the general rule. This is when the taxpayer’s income earning activities result in the use of the home as not a place of business. In this case there is a more limited range of deductions available. These deductions relate to “running expenses” of the home. These include heating, cooling, lighting, cleaning, depreciation and repair expenses.
Place of business
The ruling states that there is likely to be an area of a home that is a place of business where (for example) there is part of a residence that is set aside exclusively for the carrying on of a business by a self-employed person. Another example is where part of the home is used as a taxpayer’s sole base of operations for income producing activities (e.g. where no other work location is provided to an employee by an employer). The ruling lists these factors as possible indicators that there is a place of business:
- The area is clearly identifiable as a place of business;
- The area is not readily suitable or adaptable for use for private or domestic purposes in association with the home generally;
- The area is used exclusively or almost exclusively for carrying on a business; or
- The area is used regularly for visits of clients or customers.
Another way in which courts or tribunals have considered that a taxpayer has a place of business at home is where there is an absence of an alternative place for conducting income producing activities. That is a person is (in a sense) “forced” to work at home because there is no other place for them to undertake the work. This can apply in respect of an employee. Put another way, the work area at home has not been set up “as a matter of convenience”.
Where there is a place of business, some part of both the occupancy and running expenses will be claimable as a deduction and an apportionment method must be applied to calculate what amount is deductible.
With regard to occupancy expenses, the apportionment method that should be used “in most cases” is nominated as the percentage of floor area of the home office as compared to the rest of the house. In addition, if the area in the home is a place of business for part of the year, a time basis should also be applied.
Area is not a place of business
Where an area of a home is simply used in connection with income producing activities, but does not have the character of a place of business, only running expenses can be claimed as a deduction. The courts and tribunals have referred to this type of home office as existing “merely as a matter of convenience”. The amount that is allowable as a deduction is the additional expenses incurred as result of the income producing activities.
TR 93/30 states that deductions can be claimed for such areas where the facilities are provided exclusively for the taxpayer’s benefit while he or she works. It is not mandatory that the area be set aside exclusively for work. However, when the area is being used, if the taxpayer wants to claim a tax deduction, no one else can be present in the area. That is, the taxpayer is exclusively using the area for work.
The ruling states that the claiming of lighting, heating (and presumably cooling) expenses is “different to most other home office expenses”. Accordingly, the ruling provides a formula to calculate the deduction for an appliance. That is, the ATO seems to expect that this calculation will be made for each applicable heating, cooling and light generating appliance in a home.
The ruling provides this “appropriate formula” for calculating the additional expense for an appliance:
The cost per unit of power used X the average units used per hour X the total annual hours used for income producing purposes.
To be clear, this calculation is supposed to be undertaken for each appliance that consumes energy. Nothing is said in the ruling about how the annual hours of income producing use of the appliance is determined or recorded. There is no mention of whether an estimate of these hours is acceptable.
Most people would consider what is required by these formulas is impractical. Who can possibly follow what this formula requires for each appliance? Perhaps because the ATO recognises the difficulties in following the formula it states in paragraph 25 of the ruling:
“Generally speaking however, the quantum of any allowable deduction for the additional expense will be small. Accordingly, a bona fide estimate based on a reasonable percentage of the household annual fuel bill will be acceptable.”
Note that the ATO is of the opinion that the additional running expenses will be “small”. It is to be appreciated that this statement was made in 1993. 30 years later, following the working from home revolution that was instigated by COVID-19, that idea has to be questioned. Further, as we are all aware, energy prices are a good deal higher now when compared to 1993.
To summarise, there are two ways to determine the tax benefits of working from home:
- Actual cost method: This method allows you to claim a tax deduction based on the actual expenses you incur for working from home with reference to the eligible items provided above.
- Revised fixed rate method: This method allows you to claim 67c per hour you work from home and for the eligible expenses discussed above.
Actual cost method
The approach to actual costs hasn’t altered. Taxpayers who work from home may deduct the real portion of all operating costs that is linked to their employment. This entails maintaining thorough records for all reimbursements made for expenses incurred while working from home, such as:
- all receipts, bills and other similar documents to show taxpayers have incurred the expenses, a record of the number of hours worked from home during the income year (either the actual hours or a diary or similar document kept for a representative 4-week period to show the usual pattern of working at home).
- a record of how taxpayers have calculated the work-related and private portion of their expenses (for example, a diary or similar document kept for a representative 4-week period to show the usual pattern of work-related use of a depreciating asset such as a laptop).
If you’re deducting your actual costs associated with working from home, you can’t deduct costs which your employer has already paid for.
Revised fixed rate method
From the 2022-23 income year the 67c per hour revised fixed rate method has replaced the 80c per hour shortcut method for calculating the work related additional running expenses incurred as a result of working from home (WFH).
To use the new revised fixed rate method, you must:
- work from home while carrying out employment duties or carrying on a business on or after 1 July 2022 (minimal tasks such as occasionally checking emails or taking phone calls while at home will not qualify as working from home);
- incur additional running expenses which are deductible under ITAA 1997 section 8-1 as a result of working from home that is not reimbursed by a third party (ie employer); and
- keep and retain relevant records in respect of the time spent working from home and for the additional running expenses incurred.
The revised fixed rate method doesn’t require you to have a dedicated home office space to claim working from home expenses.
Running expenses vs additional running expenses
Running expenses and additional running expenses must be differentiated in order to be clear about the costs you can deduct.
Running costs are what you typically pay to use products in your home. Running costs include, for instance, power costs associated with using household appliances.
The costs you accrue as a direct result of working from home, on the other hand, are known as additional running expenses. Some instances of extra operating costs include:
- Considering that you might use your home and mobile phones to contact clients,
- Expenses for office supplies, such as stationery and printer ink since you can be utilising these to print documents, etc.
- Costs associated with using mobile data or home internet to stay connected while working, etc.
- Utility costs, such as electricity or gas to keep your home office comfortable, etc.
- The value of the depreciation in the assets you use to work from home, including your office supplies and furnishings.
- Repair costs to get your work from home equipment back in working order
- Maintenance costs to keep your work from home assets in good working order
You may only deduct additional running expenses from your taxable income, not running expenses. As a result, you must allocate your spending using one of the two strategies described below.
Also keep in mind that, in some cases, you may be able to deduct the costs of having your work related home office cleaned as well as your occupancy costs.
Fixed rate method – what’s covered
The revised fixed rate method covers energy expenses including electricity and gas for lighting, heating, cooling, and use of electronic items while working. It also covers internet, mobile, and home phone expenses, as well as stationery and computer consumables such as ink. While the new revised fixed-rate method of 67c per hour is lower than the previously available shortcut method, it does not include the work related decline in value of any depreciating assets used during the income year or any other running expenses not specifically covered above.
However, 3 years on from the pandemic, with many taxpayers having already purchased depreciating assets early in the piece to be able to perform their duties effectively from home, the lower revised fixed-rate method means many taxpayers will be losing around $100 in deductions going forward. For example, a taxpayer working 3 days per week from home at 8 hours per day over 49 weeks will only be able to get a deduction of $787 under the new rate compared to $940 they would previously be able to claim under the shortcut method.
In addition, if a taxpayer chooses to use the new revised fixed-rate method, no additional separate deductions can be claimed for any of the expenses covered. This includes instances where taxpayers use their mobile phones to work from home and elsewhere (ie in the office). The total deduction for the year would consist of the amount covered by 67c per hour.
Fixed rate method – record keeping
For the 2022-23 income year only, you need to keep a record that is representative of the total number of hours worked from home during the period from 1 July 2022 to 28 February 2023, and a record of the total number of actual hours worked from home for the period 1 March 2023 to 30 June 2023.
For 2023-24 and later income years, you need to keep a record for the entire income year of the actual number of hours worked from home during that income year. An estimate for the entire income year or an estimate based on the number of hours worked from home during a particular period and applied to the rest of the income year will not be accepted. A record of hours worked for the entire income year can include timesheets, rosters, logs, time-tracking apps, and diaries that are kept contemporaneously.
To be able to claim expenses for 2022-23 and later income years, one document for each of the additional running expenses incurred must be kept. For energy, mobile, phone and internet, one monthly or quarterly bill in the relevant name must be kept. If the bill is not in the relevant name, additional evidence such as credit card statements showing payment or lease agreements showing sharing of property and expenses must be present. For stationery and computer consumables, receipts must be kept for any purchases. Those claiming a deduction for any decline in value of depreciating assets must also keep documents that demonstrate the income-producing use of the assets.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.
