Leading into the end of the financial year, there is often a strong demand from individual taxpayers to make payments for expenses in advance for goods or services that will be provided over the following year.  These prepaid expenses can include payments such as subscriptions to professional associations, interest on equity loans and insurance on income-earning properties.

Prepaid expenses are subject to prepayment rules, which prescribe that a prepaid expense that otherwise satisfies all the normal rules for deductibility is often only deductible over the period in which the goods or services are provided.  However, there are a number of circumstances where a prepaid expense may be immediately deductible.  One of these circumstances is where the 12-month rule applies.

What is the 12-month rule?

Simplified tax system (STS) taxpayers or individuals incurring deductible non-business expenditure, can claim an immediate deduction under the 12-month rule for certain types of prepaid expenditure that provides a benefit for a period not exceeding 12 months and ending in the next financial year.  Generally, interest on a loan to purchase a rental property, listed shares or units in widely held trusts falls in this category, so a prepayment of such interest for up to 12 months can be fully deductible.

Deductions for prepaid expenses that satisfy the 12-month rule may assist with cash-flow planning and also allows the payer to claim the deduction a full year in advance. This may be of particular benefit to those individuals taxpayers who are likely to be on a lower marginal tax rate in the next financial year.

The following examples illustrate when the 12-month rule may apply.

i. Deduction - where the 12-month rule is satisfied.
Michael is an STS taxpayer.  On 20 June 2006 he makes an interest payment of $50,000 for his Westpac Protected Equity Loan (Westpac PEL Plus) for a 12-month period from 20 June 2006 to 20 June 2007.

The prepayment satisfies the 12-month rule because it is for a period of service of less than 12 months that ends in the next year. Michael can therefore claim an immediate deduction of a significant portion of the $50,000 in the 2006-2007 income year (please refer to the ATO PR 2004/15* for guidance around the deductibility of interest under the Westpac PEL Plus).

ii. Deduction where the 12-month rule is not satisfied
On 1 July 2005 Eve paid $20,000 to cover interest on an investment loan for the period 1 July 2005 to 30 June 2006.  Because the payment is made in the 2005-2006 year and the interest relates to the same period, the prepayment rules will not apply and the interest expense can only be deducted in the 2005-2006 income year.

iii. Deduction with an eligible service period of more than 12 months
On 1 January 2006, Robert, a senior tax lawyer at a large financial firm, paid a $2,500 subscription for the monthly provision of a professional journal to cover the period 1 January 2006 to 31 January 2007.  As the eligible service period is more than 12 months, Robert must apportion his deduction over the 2006 and 2007 income years.  Robert's deductions are calculated as follows:

2005-06	$2,500 x 182/397 (1 January 2006 to 30 June 2006) = $1,146
2006-07	$2,500 x 215/397 (1 July 2006 to 31 January 2007) = $1,354

Over the 2005-2006 and 2006-2007 income years, Robert will get a total deduction of $2,500.

For more information, simply contact Westpac on (02) 8204-2727.

Important information
Westpac Banking Corporation ABN 33 007 457 141, AFSL 233714 (“Westpac”) is the issuer of the Westpac Protected Equity Loan Plus (“PEL Plus). A product disclosure statement (“PDS”) is available for the Westpac PEL Plus. A copy of the Westpac PEL Plus PDS and a copy of Westpac’s Financial Services Guide can be obtained by calling 1800 990 107 or visiting www.westpac.com.au/structuredinvestments. You should obtain and consider the PDS before deciding whether to acquire, continue to hold or dispose of the Westpac PEL Plus.  This information is of a general nature and does not constitute any recommendation, tax or investment advice as to the suitability of PEL Plus.  This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. The information in this newsletter is factual only. It does not constitute financial product advice. Before acting on this information you should seek independent financial advice to determine its appropriateness to your objectives, financial situation and needs.  The taxation position described is a general statement only and should only be used as a guide. It does not constitute tax advice and is based on current tax laws and their interpretation. Westpac financial planners are not qualified to give tax advice. The individual situation of investors may differ and investors should seek independent professional tax advice on any taxation matters.  *ATO Product Ruling  The Product Ruling issued by the Australian Taxation Office is only a ruling on the application of the taxation law and is no way expressly or impliedly a guarantee or endorsement of the commercial viability of the Westpac PEL Plus, or the soundness or otherwise of the Westpac PEL Plus as an investment, or of the reasonableness or commerciality of any fees charged in connection with the Westpac PEL Plus. The Product Ruling is only binding on the Commissioner of Taxation if the Westpac PEL Plus is implemented in the specific manner provided in the Product Ruling. Investors should read the Product Disclosure Statement available for the Westpac PEL Plus in their entirety and seek professional advice to determine whether or not this product meets their investment needs.  Copies of the Product Ruling can be obtained by calling Westpac on 1800 990 107.  The projections given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the projections are based are reasonable, the projections may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these projections.
Information current as at 26 April 2006.