|The edited version of the Compendium of Comments is a Tax Office communication that is not intended to be relied upon as it provides no protection from primary tax, penalties, interest or sanctions for non-compliance with the law. In accordance with PS LA 2008/3 it only affords level 3 protection.|
This is a compendium of responses to the substantive issues raised by parties to draft TR 2010/D7 - Income Tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues.
Summary of issues raised and responses
|Issue No .||Issue raised||Tax Office Response/Action taken|
Expenditure which serves more than one purpose or object - underlying statutory interpretation principles to support apportionment
Paragraphs 21 and 116 deal with the ability to apportion expenditure when it indifferently serves more than one purpose or object.
As the interpretation in the draft is not consistent with a literal reading of subsection 40-880(2) reference should be made to a judicial authority such as CIC Insurance v Bankstown Football Club (1997) 187 CLR 384 to support the plain words being read in light of the then existing state of the law and the mischief which the provision was intended to remedy.
The ATO considers that explanation at paragraphs 116 to 118 of TR 2010/D7 is sufficient.
Expenditure which serves more than one purpose or object - fair and reasonable apportionment
Example 11 states that expenditure that serves more than one purpose or object must be apportioned on a fair and reasonable basis.
Guidance should be provided on how a fair and reasonable apportionment is to be performed.
The following new paragraphs have been inserted as paragraphs 146 to 150:
Expenditure which serves more than one purpose or object - passive income
Paragraph 118(a) states that apportionment is required where a single amount is incurred for a thing or service that indifferently serves business and non-business objects. The use of the term 'objects' seems inconsistent with the rest of the draft which focuses on the business and non-business 'activities'.
Clarification of the difference between the words 'objects' and 'activities' by way of example would be helpful. For example if a company incurred costs in raising funds, some of which were to be used to expand its business and some of which were invested in a share portfolio to be held as a passive investment.
This issue is addressed at issue 5 below.
Definition of a business
The draft does not make any reference to the application of section 40-880 in a consolidated group environment.
1. The draft should identify the relevant business in a consolidated context where there may be multiple businesses and activities.
The following new paragraphs have been inserted as paragraphs 20 to 22:
|2. The draft should refer to recently issued Tax Determinations TD 2010/D4, 2010/D5, 2010/D6 and TD 2010/1 which deal with incidental costs incurred when a subsidiary member joins or leaves a consolidated group.||Agree.
Draft TDs 2010/D4, 2010/D5 and 2010/D6 have now been finalised as TD 2011/8, 2011/9 and 2011/10 respectively. The following new paragraph has been inserted as paragraph 262:
|3. An example should be given that confirms the common industry practice that capital raising costs of new managed funds or collective investment vehicles (whose business activity is to acquire and hold investments) would be considered business related capital expenditure. (This would clarify paragraph 74 which indicates that capital expenditure relating to non-business activities does not constitute business related capital expenditure).||Noted.
The principle relating to non-business activities has been clarified by the response to issue 5.
|5||The final ruling should include a discussion on whether 'business' in section 40-880 should be interpreted broadly (as per IT 2423) so as to include a broad range of activities having a commercial flavour. In this regard specific guidance should also be provided on:
See issue 4 above which identifies new paragraphs to be inserted to explain the relevant business.
The following new paragraph has been inserted as paragraph 97:
Taxable purpose and apportionment - application to the business
The draft should include a simple example where the expenditure was clearly incurred in connection with a specific business operation of a taxpayer which solely generated assessable income (despite there being other business activities unconnected with the relevant expenditure). This would be fairly typical in a consolidated group.
The following new example has been inserted as paragraphs 28 to 31.
Taxable purpose and apportionment
Paragraph 29 and examples 12, 13, 14 and 33 of the draft refer to an apportionment approach.
7.1 Lag times
Companies in the mining sector commonly incur a significant amount of business related expenditure in the raising of capital. This capital ultimately ends up being spent on the development of foreign mining and exploration projects. These projects do not typically yield assessable income to those companies because the capital is invested in the form of interest-free loans or equity share capital.
The same can be said of the funding of typical start-up ventures (including interest-free loans).
However, there is ordinarily a long time lag between the time at which the capital is raised and the time at which it is required to be spent. This time lag means that these companies hold cash balances or other investments on which assessable income is derived. In addition, these companies typically maintain only a minimal administrative staff and presence in Australia for overall cost efficiency.
The draft should explain the extent to which such a company's business carried on for a taxable purpose and what is the resulting apportionment calculation?
The apportionment method contemplated in the body of the draft is based on comparing total income to exempt and non-assessable non-exempt income (NANE) income. A time based apportionment method is also contemplated in example 14 of the draft.
7.1.1 Example 33, in which business related expenditure is simply denied outright, is of some concern.
Example 33 should be expanded to deal with a taxpayer carrying on business which generates assessable, NANE and exempt income. This would clarify how the need to apportion the income producing activities of the business to ascertain taxable purpose (in paragraph 25) interacts with the exclusion in paragraph 40-880(5)(j) (for example, reconciling the outcomes from Example 12 and Example 33).
The draft should include a complete example demonstrating the application of the two conditions.
7.2 Activities of multinational groups
7.2.1 The principle behind Examples 12, 13 and 14 regarding the apportionment of expenditure is unclear and requires more practical guidance. It will affect many Australian multinational groups setting up offshore and also when their operations lead to the derivation of section 23AJ NANE income.
7.2.2 There appear to be two main acceptable approaches of apportioning section 40-880 expenditure that is for a 'taxable purpose'. However, the draft needs to clarify when it is appropriate to use the income approach and when it is appropriate to use the business activity approach.
7.3 Other observations
The following new example has been inserted at paragraphs 42 and 43:
This comment also touches on the question of how you identify whether a set of activities comprises a discrete business or whether there is only one business - see issue 4 above.
7.1.1 Refer to issue 8 below regarding example 33.
7.2.1 Disagree. The principles behind examples 12, 13 and 14 are explained at paragraphs 125 to 136.
7.2.2 Paragraph 136 states that the general rule is that NANE is compared to total income. The facts of an individual case will determine whether it is appropriate to substitute another method for the general rule.
|8||Further elaboration is required on how the taxable purpose test and paragraph 40-880(5)(j) applies where an Australian resident company incurs capital expenditure to raise funds to acquire shares in a foreign subsidiary. In this regard, it is unclear as to whether Example 33 in the draft is consistent with ATO ID 2009/91. It is not clear from Example 33 as to whether the ATO would have a different view from that expressed in ATO ID 2009/91. Example 33 does not give a clear answer on what the outcome would be if Company Y expected to derive management fee income (or any other form of income) from the acquired foreign subsidiary.||Agree.
The current ATO view, regarding the expected derivation of management fees, differs to that expressed in ATO ID 2009/91. The ATO ID will be withdrawn.
The example has been omitted and the following new paragraphs have been inserted as paragraphs 291 to 295:
Where expenditure is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income and an apportionment is required under subsection 40-880(3) or (4) (because the relevant business or aspect of the business was not carried on wholly for a taxable purpose) this does not mean that the section 40-880 deduction is reduced twice.
The interaction of subsection 40-880(3) or (4) and paragraph 40-880(5)(j) results in only one reduction under these respective provisions to the amount that a taxpayer can deduct under section 40-880.
Taxable purpose and apportionment - taxable purpose - consideration of future plans
9.1 Paragraph 148 of the draft states that taxable purpose may be determined by considering activities which are currently carried on and reasonably expected to be carried on by the business.
The draft should clarify the evidence required to establish activities which are reasonably expected to be carried on. For example, is an intention to provide management services in the future sufficient to demonstrate that there is a reasonable expectation of carrying on activities that will be for a taxable business purpose?
9.2 In addition, the draft should clarify how the taxable purpose test applies to taxpayers who are not deriving income such as start-up ventures and loss-making companies.
The absence of current year income should not mean that there is not a taxable purpose if there is an expectation that, in future years, assessable income will be generated.
The ATO considers paragraphs 148 and 149 of TR 2010/D7 provide sufficient clarity.
The ATO considers that no further explanation is required.
Taxable purpose and apportionment - known and predictable facts
10.1 For an existing or proposed business, paragraph 26 of the draft states that the taxable purpose test takes into account all known and predictable facts about the business in future years, not just in the year the expenditure is incurred or the years in which the section 40-880 claim would be made.
In contrast paragraph 29 indicates that apportioning the expenditure on the basis of taxable purpose is determined by comparing the income the business 'has derived or will derive'.
Is there a preferred ATO position in relation to looking forward versus looking back to make this assessment? If so, this should be covered in the draft.
10.2 The draft should include, under the heading of taxable purpose, some discussion and an example of the test applying where a business made losses.
The meaning is clear when paragraphs 26, 27 and 28 of TR 2010/D7 are read together. The requirement to look backwards is directed only to a former business and does not apply in the context of an existing business.
The test compares total income (assessable income plus exempt income plus non-assessable non-exempt income) to non-assessable non-exempt income and exempt income. Whether deductions exceed assessable income to produce a tax loss is not relevant.
Reasonable time - subsection 40-880(7)
Further examples of what timeframes will be regarded as 'reasonable' should be included apart from example 10.
There is concern that notwithstanding paragraph 104, in the absence of further examples the two month period will be interpreted by ATO staff as the benchmark for determining a 'reasonable time'.
The following example has been included as paragraphs 128 and 129:
Connection between expenditure and former or proposed business
Where a taxpayer incurs expenditure for a business that another entity used to carry on or proposes to carry on, subsection 40-880(4) only allows a deduction to the extent that the expenditure is in connection with:
In a submission by the Institute of Chartered Accountants in Australia dated 12 May 2006 to the ATO guidance was sought on the application of this provision to the following examples:
Aco, as the holding company of the group, may derive assessable income in the form of dividends from Bco in future years of income. The dividends that Bco pays may consist of profits from its own activities and dividends paid by Cco. Given the use of the expression 'to the extent' in subsection 40-880(4), it appears that expenditure in relation to establishing Cco would only satisfy subsection 40-880(4) to the extent that future dividends paid by Bco will represent dividends received by Bco from Cco.
It would be helpful if the ATO could provide guidance on this example in the draft.
Guidance is sought on whether the requirements of subparagraph 40-880(4)(b)(i) will be satisfied given that only one party has incurred the expenditure, and that party has a less than 100% interest in the entity.
Guidance is sought on whether the requirements of subparagraph 40-880(4)(b)(i) will be satisfied where a beneficiary of a discretionary trust incurs pre-business capital expenditure.
The following new paragraphs have been inserted as paragraphs 186 and 187:
The following new example bas been inserted as paragraphs 32 and 33.
The following new paragraph has been inserted as paragraph 191:
Exception for leases and legal and equitable rights
The approach taken in Example 25 of the draft is likely to cause (at the very least) confusion for affected taxpayers (including Small and Medium Enterprises (SME)) and their advisors:
'Make good' clauses to restore premises to the condition they were in at the start of a lease are a common feature of many leases, particularly those entered into by SMEs. A number of businesses will therefore, at some stage in their business cycles incur expenditure to restore premises to the condition they were in at the start of a lease as required under the relevant lease agreement.
If, as per Example 25 of the draft, such expenditure cannot be deducted under section 40-880 then guidance should be provided as to which section(s) this expenditure can be claimed under.
In this regard, it is noted that:
There is therefore, a 'vacuum' on ATO guidance as to which section(s) 'make good' expenditure can be claimed under.
Given the large number of leases that contain 'make good' clauses, it is incumbent on the ATO to provide guidance in this area as quickly as possible.
The appendix to the submission, sets out:
The approach taken in Example 25 of TR 2010/D7 clearly states that the expenditure is excluded from deduction under section 40-880. It is acknowledged that this view differs to the view expressed in ATOID 2003/788 which was withdrawn on 9 June 2006.
The expression 'in relation to' is used throughout section 40-880 and it should be interpreted consistently (particularly where the context of the provision does not suggest that the expression should be interpreted otherwise). The meaning of 'in relation to' is explained at paragraphs 55 to 57 of TR 2010/D7.
The Commissioner does not consider it appropriate for a ruling about the scope and operation of section 40-880 to explore the alternative tax treatments which may arise in individual cases -particularly when expenditure incurred to satisfy a 'make good' clause does not have a universal treatment under the tax law. In other words, the circumstances of each case will determine whether the expenditure (or any part thereof) is allowable or taken into account under another provision of the income tax legislation.
|14||The interpretation of paragraph 40-880(5)(d) that leads to the conclusion in example 25 of the draft is incorrect.
The example deals with expenditure incurred under a condition of a lease agreement to restore premises to its original condition.
Taxpayers have been relying on the view expressed in ATO ID 2003/788 (Withdrawn) that this expenditure is not excluded even though the expenditure was required under a condition of the lease agreement.
The ATO is applying too narrow a view when interpreting the expression 'in relation to'. To align with the intent of section 40-880 'in relation to' should be interpreted to apply directly to expenditure on the lease itself (such as legal fees in preparing the lease, etc.), not the underlying asset.
The expression 'in relation to' is used throughout section 40-880 and it should be interpreted consistently (particularly where the context of the provision does not suggest that the expression should be interpreted otherwise).
The meaning of 'in relation to' is explained at paragraphs 55 to 57 of TR 2010/D7.
Exception for leases and legal and equitable rights - other issues
The exception for leases or other legal or equitable rights in paragraph 40-880(5)(d) is considered in ATO IDs 2007/93, 2007/111, 2009/36, 2010/30 and 2010/157, and in various private rulings. In addition to 'make good' clauses, aspects of the exception that have been covered in ATO IDs and private rulings, but which are not discussed in the draft include:
Right or obligation
Although the provision refers to expenditure in relation to a legal or equitable right, the exception appears to cover both rights and obligations of a taxpayer (that is obligations of a taxpayer are rights held by another party). For example, in Private Ruling 93599, which is about payments made by a taxpayer in discharge of obligations under an earn out arrangement, the ATO states:
Paragraph 33 of the draft, however, states:
15.1 This statement suggests that paragraph 40-880(5)(d) cannot apply, for example, to expenditure incurred by a taxpayer to, say, acquire or defend rights that it holds, which is inconsistent with the discussion in Private Ruling 93599. Furthermore, the draft states, also at paragraph 33, that the existence of paragraphs 40-880(5)(a) and 40-880(5)(f) mean that paragraph 40-880(5)(d) has limited practical application. Both of those exceptions are likely to apply to rights that a taxpayer holds or acquires.
15.2 Accordingly, the draft should generally clarify the application of paragraph 40-880(5)(d) to rights of, or against a taxpayer. At the very least, the draft should deal with the ATO's views on section 40-880 and earnouts.
Scope of the exception
15.3 The draft attempts to provide guidance on the ambit of the exception. At paragraph 33, the draft states that the rights in question are not all legal rights, only those similar to leases which give the taxpayer a right to exploit the asset with which the right is associated.
All of the examples in the draft of where the exception applies relate to rights associated with land although paragraphs 33 and 207 clearly state that the exception is not limited to such rights. We recommend that further discussion and examples should be included in the draft on how the exception applies to rights to exploit assets other than land (leases over chattels or licences over intellectual property).
15.4 It is also noted that ATO IDs 2007/93 and 2007/111 take the view that rights over shares are not the sorts of rights that fall within paragraph 40-880(5)(d). The first ATO ID concerned demerger costs paid by the taxpayer, an Australian resident company, in demerging the international business it carried on. The second ATO ID was about costs incurred by the taxpayer, a public company, in facilitating a merger. These examples should also be incorporated in the ruling, especially if the ATO IDs are going to be withdrawn, to provide additional guidance on the scope of the exception.
Paragraph 40-880(5)(d) is expressed in broad terms. It is wide enough to capture most expenditure on leases and rights that is already captured by paragraphs 40-880(5)(a) and (f). However since those more specific paragraphs will already deny a deduction under section 40-880 there is no need to resort to paragraph 40-880(5)(d).
Paragraph 33 merely expresses the principle that because most expenditure relating to leases and rights is already captured by the more specific exceptions the additional operation of paragraph 40-880(5)(d) is limited in practice.
The Government's proposed capital gains tax look-through treatment for earnout arrangements was announced in the 2010-11 Federal Budget. The Ruling will therefore not deal with earnout arrangements.
The ATO considers that the principle is clearly stated at paragraph 207 of TR 2010/D7. In other words, a share is not a right similar to a lease. A share is not a right which allows a taxpayer to exploit an asset with which the right is associated.
The ATO considers that additional examples are not necessary as the principle is clearly stated.
15.4 The ATO considers that additional examples are not necessary as the principle is clearly stated.
CGT exception - consolidated groups
There should be some reference to how the CGT exception in paragraph 40-880(5)(f) applies in the context of capital expenditure incurred by a consolidated group.
The exclusion should not be read so broadly to apply to the extent that any relevant section 40-880 claim for a non-CGT capital asset might subsequently feature in the recreated tax cost of a membership interest of an entity that exits a consolidated group.
Such a broad interpretation would be contrary to policy which clearly recognises that section 40-880 deductions can be inherited deductions for allocable cost entry and exit calculations.
The interaction of section 40-880 with subsection 701-55(6) was the subject of a review by the Board of Taxation (Review into the Consolidation Rights to Future Income and Residual Tax Cost Setting Rules). The Board completed its review and provided its report to the Assistant Treasurer on 31 May 2011. The ATO will give further consideration to the issue after the Government releases its response to the report.
Acquisition of goodwill
The draft briefly addresses at paragraphs 285 to 288 the issue of expenditure which preserves but does not enhance the value of goodwill and falls within subsection 40-880(6).
However, more than one example should be given of when expenditure will be taken to preserve or enhance the value of goodwill. For example, will the acquisition of goodwill in the following situation preserve any existing goodwill or enhance the value of such goodwill?
This example was previously raised with the ATO in a submission by the Institute of Chartered Accountants in Australia dated 12 May 2006.
In this example, paragraph 40-880(5)(f) would apply because the expenditure of $1 million would be included in the cost base of the goodwill. On the basis that the goodwill represents a legal right to conduct business in a certain manner, the expenditure would also relate to a legal or equitable right as required by the provision.
It is then necessary to consider if the expenditure only preserves and does not enhance the value of goodwill, and if the value of the right is solely attributable to the effect it has on goodwill.
Although our preliminary view is that the expenditure would not merely preserve the value of goodwill, the ATO's views on this example are sought.
Example 37 is merely included to illustrate the principle.
A further example would not clarify the principle. Whether expenditure preserves or enhances goodwill is a question of fact.
Exception for expenditure that forms part of cost of land
Paragraph 31 of the draft relates to expenditure which forms part of the cost of the land (subsection 40-880(5)(c)).
It is not clear from this paragraph how building demolition costs will be treated. In the event that demolition costs are not included in the cost base of land, clarification is required as to whether such costs form part of the cost of the land for the purpose of subsection 40-880(5)(c).
The relevant paragraph has been amended to state that the cost of land means the cost of acquiring the 'freehold title to' land.
The principles expressed in the ruling are sufficient to allow taxpayers to determine whether building demolition costs are allowable under section 40-880. Inserting a specific example about demolition costs is likely to confuse rather than clarify the operation of the provision. The treatment of demolition costs under section 40-880 depends on whether the expenditure is allowable under another provision of the Act, for example whether it is a project pool amount under section 40-840.
Restraint of trade agreements
Under the heading 'Expenditure which preserves (but does not enhance) the value of goodwill' in the Explanation section of the draft, an Example is included that involves a restraint of trade agreement:
The Example however, does not set out whether the capital expenditure that Felicity incurs is:
Nor does the Example go on to explain how the facts meet the requirements set out in the paragraphs preceding this Example (paragraphs 286 and 287).
Without this additional information the Example is not only incomplete but may lead to confusion, for both advisors and ATO staff, as to exactly how a restraint of trade agreement should be treated under section 40-880.
In paragraph 286, the draft states that subsection 40-880(6):
This paragraph therefore, essentially just paraphrases this subsection.
Paragraph 287 however, then goes on to say (emphasis added) that in the view of the ATO subsection 40-880(6):
It is unclear what the ATO means by the reference to a right (such as a restraint of trade agreement or a restrictive covenant) having 'no value of itself'and request the ATO to expand upon/explain exactly what the ATO has in mind by using this phrase.
In this regard, it is noted that in Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business the ATO states that if:
Example 37 in the draft should be cross referenced to the above discussion in Taxation Ruling TR 1999/16.
In addition, if the statement that a right 'has no value of itself' in paragraph 287 of the draft is merely a reference to the fact that (as in Taxation Ruling TR 1999/16) no separate amount is allocated to a restraint of trade/restrictive covenant by the parties, then we would request the ATO to specifically state this in paragraph 287.
Finally, whilst it is not crucial for the purposes of the draft, a discussion on the interaction between section 40-880, section 110-25 and section 110-55 for the cost bases/reduced cost bases of the goodwill and the restraint of trade agreement could be the subject of further ATO guidance in the future.
|The example deals with a restraint of trade agreement entered into by a partner who continues to carry on the business as a sole trader. It clearly states that the expenditure is incurred to preserve the value of the goodwill of the taxpayer's business. By implication the expenditure does not enhance the value of the goodwill. The example does not purport to explain how all restraint of trade agreements are treated.
Whether the capital expenditure is for legal fees or consideration for entering into the agreement does not affect the outcome.
Paragraph 287 paraphrases the following paragraphs from the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 1) Bill 2006:
Withdrawal of ATO IDs
At paragraph 36, the draft indicates that ATO views on most of the matters covered by the ruling are already stated in a number of ATO IDs.
Three of those ATO IDs have been withdrawn on the basis that they are inconsistent with the draft. The ruling states that the remaining ATO IDs will be withdrawn once the draft is finalised, as they will then be redundant.
Although the principles discussed in most of the ATO IDs have now been covered in the draft, many of the ATO IDs would continue to be useful in that they illustrate the application of section 40-880 in a number of different scenarios, some of which have not been covered by examples in the draft.
Some examples are:
Prior to withdrawing the ATO IDs, we recommend that the ATO review the ATO IDs on section 40-880 to confirm that there are no further factual scenarios that should form the basis for examples in the draft.
Although not all the ATO IDs have been included as examples the ATO considers that the principles have been clearly explained and that, examples are therefore not necessary for all of the ATO IDs.
The draft, with the exception of paragraphs 20 to 22 and paragraph 31, should apply retrospectively from 1 July 2005, the commencement date of the current section 40-880. This is because the ruling sets out the ATO views on a number of aspects of the application of section 40-880 which are currently contained in ATO IDs that have been issued since 1 July 2005. However, since paragraphs 20 to 22 and 31 change views expressed in those ATO IDs, they should only apply prospectively from 8 December 2010.
Capital expenditure on landscaping leased land
The draft has resulted in the withdrawal of ATO ID 2009/37. Paragraph 36 footnote 1 states that this is on the basis of paragraph 31 of the draft which states that paragraph 40-880(5)(d) 'excludes from deductibility expenditure incurred to acquire land in relatively uncommon situation where the cost of acquiring land does not form part of the cost base or reduced cost base of the land'.
The draft should clarify whether 'land' includes all real property interests or only freehold - particularly since ATO ID 2009/37 is now withdrawn.
The relevant paragraph has been amended to state that the cost of land means the cost of acquiring the 'freehold title to' land.
|23||The draft ruling, TR 2010/D7, overturns established practice and indeed the ATO's previous views, to put forward an interpretation of the section that could not have been originally contemplated.
Most deduction sections in the ITAA 1997 and ITAA 1936 require a purpose of producing assessable income. Section 8-1 also allows a deduction incurred in carrying on a business for the purpose of gaining or producing assessable income. In enacting section 40-880, the purpose of Parliament was to provide a deduction for so-called 'blackhole' expenditure that would not otherwise meet the test for a deduction under these other provisions. Because the expenditure lacks a direct nexus with the production of assessable income, section 40-880 requires the expenditure have a nexus with a 'business'.
That 'business' must be carried on for a taxable purpose.
It is unfortunate that the draftsman did not link this language to the well established understanding of the second limb of section 8-1, an amount incurred in carrying on a business for the purpose of gaining or producing assessable income. However, the ATO thinks the section 8-1 test is actually more narrow!
The ATO has chosen in the ruling to define the business in these circumstances as including non-assessable non-exempt income such as section 23AJ dividends, or businesses carried on in foreign branches and subject to section 23AH.
Thus, the ATO believes an apportionment is required across these types of NANE income items to effectively disallow deductions - refer paragraphs 23 to 30 and various examples.
This approach is wrong as it incorrectly includes in the 'business' items that are expressly excluded in paragraph 40-880(5)(j). That is, expenditure that is incurred in relation to gaining or producing exempt income or NANE income is excluded by paragraph 40-880(5)(j).
Thus, under the ATO view, expenditure that was not for that purpose (does not fall into paragraph 40-880(5)(j)) could nevertheless be apportioned to that purpose because the NANE items are included in the ATO's definition of 'business'.
This desire to include exempt income and NANE income in the business then leads the ATO to numerous difficulties in arriving at a sensible apportionment methodology. Presumably, the 'business activities' that relate to foreign subsidiaries are covered by management fees; clearly any dividend income is not generated by the Australian management but by the employees of the foreign company.
The ATO in its Blackhole Risk Review activities is using this draft ruling to review the costs of various capital raisings. Where the capital raised is used to fund an offshore business, clearly no deduction arises. Where the funds are used solely in the Australian business, to repay debt where the interest expense is deductible under section 8-1, the ATO is arguing that an apportionment is required.
This very wide interpretation of the 'business' appears to defeat the purpose of section 40-880 and result in inconsistent outcomes. In addition, it causes significant difficulties in defining how such an apportionment can be made and provides no certainty for taxpayers. It cannot be the case that a taxpayer cannot work out the exact amount of the deduction at the time of incurrence but rather must calculate a forecast or rolling average at year end to make the determination - if indeed this methodology can be said to be right.
We submit that the ATO should urgently re-consider its position on this issue.
The following new paragraphs have been inserted at paragraphs 20 to 22 to explain the relevant business:
The discussion relating to the extent to which the taxpayer's business is carried on for a taxable purpose has also been amended. Paragraphs 26 to 39 now read as follows:
In addition, the following new paragraphs have been inserted at paragraphs 51 and 52 to explain the interaction of subsection 40-880(3) or (4) and paragraph 40-880(5)(j):