Start-ups told to beware ATO black hole

Start-ups may lose the ability to deduct start-up related expenses such as feasibility studies from their income tax due to a new draft ruling by the ATO relating to so-called “black hole” expenditure.


Under tax rules that have been in place for nearly a decade, businesses have been able to deduct certain start-up related costs – such as the cost of feasibility studies and setting up a business entity – that were not dealt with elsewhere in income tax laws. The black hole deduction rules give a five-year write-off for capital expenses incurred for a taxable purpose during the start-up phase.


However, a new draft ruling issued recently by the ATO has tightened the rules around black hole deductions in a move that could prevent start-ups from deducting these expenses.


Tax advisers say the ATO’s narrow interpretation of its draft ruling this week pushed more costs into black hole territory, even though the legislative intent was to do the opposite.


Yasser El-Ansary, of The Institute of Chartered Accountants in Australia, says start-ups will have to pay close attention to any changes made to the ruling.


“Because it’s a draft ruling, we won’t know probably until around mid-2011 what the final ATO interpretation of the law is so businesses should keep an eye out in this area to see what the final position is,” he says.


“The ATO believes that simply having an idea of starting a small business – and then going through a process of incurring expenditure and analysing the pros and cons of that business opportunity – that sort of process is too preliminary in nature to satisfy the tests that they believe exist in this provision in the law.”


“What the ATO is saying is if you incur costs, we want to see evidence that at the point you incurred the costs, you had a very firm and very specific idea of precisely the form of business that you were looking to set up.”


According to El-Ansary, if this ruling becomes the final ATO interpretation, businesses will need to:


  • Ensure they have a documented business plan.
  • Produce evidence, where appropriate, of the fact that they have committed to securing business premises, including producing or retaining evidence of the research they undertake into the markets they want to operate in or the profitability of those market opportunities.


“If they start to acquire assets for use in the business, including office and production equipment, that will contribute to evidencing to the ATO that you’ve done more than just come up with a fanciful idea for a business; you’ve actually taken solid actions that can be evidenced to prove that you’re embarking on a path towards setting up a business,” El-Ansary says.


Ernst & Young partner Tony Stolarek says the ruling sets up a good case for simplifying the black whole rules and he expects businesses will lobby the government to change the law.


Submissions on the draft ruling are due by February 8 next year. The Tax Office has proposed to apply the ruling from the date of the draft, not retrospectively.


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