Prepayments: 'required to be incurred by a law'

Is an amount of expenditure 'required to be incurred by a law' and therefore 'excluded expenditure' for the purposes of the prepayment rules of the Income Tax Assessment Act 1936 (ITAA 1936) where the expenditure is a fee paid by a company to have its financial reports audited as required by section 301 of the Corporations Act 2001 ?

No. Although section 301 of the Corporations Act 2001 states that a public company must have its financial reports for a financial year audited there is no requirement that the audit fee be paid in advance. Accordingly, the audit fee is not 'excluded expenditure'.

The taxpayer is a public company listed on the Australian Stock Exchange. It is neither a small business taxpayer nor an STS taxpayer. In accordance with section 301 of the Corporations Act 2001 the taxpayer is required to have its financial reports audited each financial year. On 1 June 2003 the taxpayer contracts with an accounting firm to provide audit services for the following 12 months. Under the terms of the contract the taxpayer is required to prepay the full audit fee of $10,000.

A prepaid expense is expenditure incurred in one year for things to be done (in whole or in part) in a later year of income.

The prepayment rules contained in Subdivision H of Division 3 of Part III of the ITAA 1936 affect the timing of deductions for prepaid expenditure.

Certain types of expenditure are excluded from the prepayment rules. Subsection 82KZL(1) of the ITAA 1936 defines 'excluded expenditure' to mean, inter alia, an amount of expenditure 'required to be incurred by a law, or by an order of a court, of the Commonwealth, a State or a Territory'.

The prepayment rules reflect the policy set out by the Treasurer in his May 1988 Economic Statement in which it was stated that, 'the proposed changes will act against these [prepaid expenditure] schemes yet ensure ... taxpayers required to make advance payments by law , are not effected (emphasis added)'.

Within the context of the prepayment rules the test is not only that the expenditure be paid but that the expenditure is required to be paid in advance , as required by a law, or by an order of a court, of the Commonwealth, State or Territory.

Although the taxpayer contracted to pay the audit fees in advance, it was not compelled by the Corporations Act 2001 to prepay the fees. Accordingly, the prepaid audit fees are not 'excluded expenditure'. The taxpayer will not be entitled to an immediate deduction for those fees in the 2002-03 income year when they were incurred. Instead, the fees will be apportioned over the period in which the services are provided in accordance with the rules contained in Subdivision H of Division 3 of Part III of the ITAA 1936.