What the ATO wants to prove your deduction claim

This article is a general overview of the substantiation provisions of the Australian income tax law.  It is important to understand that these rules only apply to individuals or partnerships where at least one of the partners is an individual.  These rules can also apply to individuals where certain ‘withholding payments’ are made in relation to payments to the individuals.

For many years the Australian tax laws require individuals, in certain situations, to keep documentary evidence to prove that they have incurred expenses they are claiming as a tax deduction.  This evidence has the further purpose of showing that the expense was incurred in deriving the income of the individual.

Generally, if the required records are not kept, the individual is not permitted to claim a tax deduction for the expense – even if the expense was, in truth, incurred.

You might think that this is as easy as being required to keep documents for all expenses.  However, the law concerning substantiation is reasonably complex.  This is because the law deals with different types of expenses and there are several exceptions.  Broadly, the exceptions are designed to make the substantiation requirements easier to comply with.

The substantiation rules can be broken into three ideas.  These are:

1. The type of expenses requiring substantiation.
2. The records that must be kept.
3. Relief from the substantiation rules.

Types of expenses

The substantiation rules are referred to as three types of expenses.  These are:

1. Work related expenses.
2. Car expenses.
3. Business travel expenses.

Work related expenses are, generally, expenses incurred in the derivation of salary and wages income and for non-employees where certain ‘withholding payments’ are made from amounts paid to them.

These types of expenses also cover travel allowance expenses and meal allowance expenses.  Car expenses are not covered by work related expenses, except if the expense is for a taxi or travel is outside Australia.  There are also some other miscellaneous items covered under work related expenses such as depreciation and transport between workplaces.

Importantly, there are several exclusions and limitations on the extent of substantiation required for various expenditures.  The detail of this is not discussed here.  These expenses include laundry and expenses in relation to travel and meal allowances.

Car expenses are claimable under one of two methods.  These are the ‘cents per kilometre’ method and the ‘logbook’ method.  These methods have their own special provision in the income tax law.  There used to be two other methods, but these were withdrawn some years ago.

Business travel expenses relate to a ‘travel expense’ that has been incurred to produce assessable income other than salary and wages.  So, this does not relate to claims made by employees.  Also, these expenses are not expenses related to a ‘travel allowance’.  Travel allowance expenses are dealt with under the work related expenses provision.  Further, an expense related to a motor vehicle is not treated as a business travel expense unless it is for travel outside Australia or is for a taxi fare, or similar.

A ‘travel expense’ is where an expense is incurred for travel that involves being away from the individual’s ordinary residence for at least one night.  The travel may be in or out of Australia.

If the travel requires an individual to be away from their ordinary residence for 6 or more consecutive nights, the person must keep and retain ‘travel records’.  Broadly, this is a travel diary.

Records that must be kept

The second broad idea in relation to substantiation is the nature of records to be kept in relation to the types of expenses just discussed.  Also included in this idea is the amount of time you need to retain those records.

Without discussing the detail, the legislation sets out a number of requirements for the information that should be shown on a document that provides ‘written evidence’.  Much of this is what you would normally see on a supplier’s receipt or invoice.

There is no time limit set for when you must obtain the written evidence.  However, you are not allowed to claim the deduction until you have the written evidence.  Nevertheless, you are permitted to lodge your tax return and claim the deduction if you consider you will receive the necessary document within a reasonable time.  If it later transpires that you did not receive the document, you must amend your return so as to not claim the deduction.

The expense must be claimed in the year in which the expense has been incurred.  If you obtain the written evidence after the year end (30 June) in which you incurred the expense, you still claim the expense in the prior year when the expense was incurred.

There are some exclusions and ‘work arounds’ in the legislation for certain situations.

With regard to ‘travel records’ (mentioned above), this is, broadly, a diary of the events that have occurred while you were travelling. The key purpose of the travel record is to demonstrate the income earning activities you engaged in while travelling.  If you don’t record an income earning activity, it can’t be used to compute the proportion of an expense that can be claimed as a tax deduction that relates to the travel.

With regard to the retention of records, generally, this is a five-year period.  This required period is extend where there is a dispute over the expenses claimed.

The ATO is permitted to ask you to produce your substantiation records within the 5 year period.  If you don’t produce the records, the expense becomes non-deductible and the ATO will issue you with an amended assessment asking you to pay the extra tax.  It is not an offence if you don’t produce the records.

Relief from substantiation

The last idea applicable to the substantiation rules is that the rules are not applied to the strict letter of the law in certain circumstances.

The legislation (somewhat confusingly) says that not complying with the requirements of the substantiation rules does not affect your right to claim a tax deduction if the nature and quality of the evidence you have to substantiate your claim satisfies the ATO that you should be allowed the deduction.

Also, (again somewhat confusingly), if you had a ‘reasonable expectation’ that substantiation of an expense would not be required to claim a tax deduction for the expense, the fact that you did not obtain the substantiation does not mean you lose your entitlement to the deduction.

There are also some special rules that deal with the situation where records have been lost or destroyed.

There is also a special provision for ‘Award Transport Payment’ expenses.  These are expenses incurred that relate to a ‘transport payment’ that was made under an industrial award that existed on 29 October 1986.  This includes industrial awards that are in substitution for awards that existed, or originally existed, on 29 October 1986.