Nexus between Expenditure and Income

The Oxford Dictionary defines “nexus” as “a connection or series of connections linking two or more things.”

This is a rarely used word outside smartphone or tax circles.  But it is an important concept for business owners when determining whether expenses will be tax deductible.  For expenditure to be deductible, it must have a clear nexus with generating taxable income.  For example, it is clear that a business that manufactures say barbeques will be able to claim a deduction for the purchase of the sheet metal they use in the production process.  That expenditure has a nexus with the income generated from the sale of finished barbeques.

One of the interesting areas that have come before the courts recently to test the principle of is around repairs and maintenance of buildings, so we will examine this as a good example.

Consider these two similar scenarios – both of which involve repairs and maintenance on an untenanted property:

Scenario One

Will owns a rental property which has been rented for the past ten years. He hasn’t paid much attention to maintenance and the property has become a little tired over the years. Will’s tenants moved out six weeks ago and he is struggling to  re-let the property due to its tired state. Will decides to spend $10,000 on sprucing the property up in order to attract a quality tenant.

Scenario Two

Kate also owns a residential rental property which has been rented for the past ten years. She hasn’t paid much attention to maintenance either. Her property has also become a little tired over the years – and her tenants also moved out six weeks ago. Kate decides to spend $10,000 on sprucing the property up – and she decides that once the property is back to its original state, she will move in and live there herself.

Will and Kate have both spent $10,000 bringing their properties back to the standard they were when their tenants originally moved in – and both include the $10,000 as a deduction in their tax returns. One, however, will  fall foul of the IRD in the event of an audit.

Will’s maintenance expenditure will probably be tax deductible as it has a nexus to generating rental income. But Kate’s house is no longer being rented, so her maintenance expenditure does not have sufficient nexus to her income.

With one or two exceptions, this principal applies to all expenditure – regardless of whether one is a business owner or a property investor. In order to be tax deductible, expenditure must have a clear nexus to deriving taxable income. As always, real life cases have their own unique set of circumstances so be sure to call us before taking a tax position!