ATO Interpretative Decision

ATO ID 2007/109

Income Tax

Issue

Was the taxpayer's capital expenditure incurred 'in relation to your business' for the purpose of paragraph 40-880(2)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

Yes. The taxpayer's capital expenditure was incurred 'in relation to your business' for the purpose of paragraph 40-880(2)(a) of the ITAA 1997 because there was a sufficient and relevant connection between the taxpayer's incurrence of the expenditure and the taxpayer's business.

Facts

The taxpayer, a public company limited by shares that carried on business for a taxable purpose, was approached by an unrelated entity with a proposal for the two companies to merge. The taxpayer had not been actively seeking any such offers at the time the offer was made but decided to proceed with the merger.

The merger was implemented by a scheme of arrangement in accordance with Part 5.1 of the Corporations Act 2001. The scheme of arrangement involved the existing shares in the taxpayer being transferred from the taxpayer's members to the unrelated entity in exchange for the taxpayer's members being issued shares in the unrelated entity. The result of the arrangement was the taxpayer becoming a wholly owned subsidiary of the unrelated entity.

The taxpayer displayed the following characteristics:

•

a customer of the taxpayer was required to become a member by acquiring a share in the taxpayer

•

a member was entitled to only one share in the taxpayer

•

a member therefore had the right to only one vote in respect of the taxpayer's affairs, and

•

the taxpayer's constitution prevented the taxpayer from paying a dividend to the members.

In order to implement the merger, the taxpayer was required to change its characteristics so that customers of the taxpayer would no longer have to be members of the taxpayer and the restrictions on the issue of shares removed. This required the taxpayer's constitution to be amended. The changes to the taxpayer's constitution would permit the taxpayer to pay a dividend to its members. A dividend was subsequently paid by the taxpayer to all existing shareholders in the taxpayer.

The taxpayer incurred the following capital expenditure in respect of evaluating the merger proposal, changing its constitution and implementing the scheme of arrangement:

•

legal fees

•

consulting fees in respect of corporate advice, tax advice, tax and financial due diligence and an independent expert opinion

•

member communications, including printing costs, postage and call centre costs, and

•

other expenses such as media release costs and other miscellaneous expenses.

The expenditure was incurred on or after 1 July 2005.

The taxpayer's business activities continued after the scheme of arrangement was completed. The nature of the taxpayer's business activities did not materially alter as a result of the scheme of arrangement.

Reasons for Decision

Subject to the limitations and exceptions contained in subsections 40-880(3) to 40-880(9) of the ITAA 1997, subsection 40-880(2) of the ITAA 1997 provides that you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure you incur:

(a)

in relation to your business; or

(b)

in relation to a business that used to be carried on; or

(c)

in relation to a business proposed to be carried on; or

(d)

to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.

In considering the phrase 'in relation to' contained within subsection 40-880(2) of the ITAA 1997, paragraph 2.25 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states:

The provision is concerned with expenditure that has the character of a business expense because it is relevantly related to the business. The concept used to establish this character or requisite relationship between the expenditure incurred by the taxpayer and the business carried on (current, past or prospective) is 'in relation to'. The connector 'in relation to' allows the appropriate latitude to enable the deductibility of qualifying capital expenditure incurred before the business commences or after it has ceased.

The phrase 'in relation to' was considered by the High Court in PMT Partners Pty Ltd (In Liquidation) v. Australian National Parks & Wildlife Service (1995) 184 CLR 301. Brennan CJ, Gaudron and McHugh JJ observed, in considering the application of the Commercial Arbitration Act 1985 (NT), at 313:

Inevitably, the closeness of the relation required by the expression 'in or in relation to' in s 48 of the Act, indeed, in any instrument - must be ascertained by reference to the nature and purpose of the provision in question and the context in which it appears.

In that case Toohey and Gummow JJ also observed:

It is apparent that the words 'in or in relation to' are particularly wide. ... Cases concerning the interpretation of this phrase in other statutory contexts are of limited assistance. However, the cases do show that the words are prima facie broad and designed to catch things which have sufficient nexus to the subject. The question of sufficiency of nexus is, of course, dependent on the statutory context. (at 330) ...

The connection which is required by the phrase 'in relation to' is a question of degree. There must be some "association" which is "relevant" or "appropriate". The question of the relevance or appropriateness of the connection is a question which cannot be divorced from the particular statutory context. (at 331)

In First Provincial Building Society Limited v. FC of T 95 ATC 4145; (1995) 30 ATR 207, Hill J. considered the phrase 'in relation to' within the context of paragraph 26(g) of the Income Tax Assessment Act 1936. He considered the words 'in relation to' in that context included a relationship that may either be direct or indirect, provided that the relationship consisted of a real connection, but that a merely remote relationship is insufficient (at ATC 4155; ATR 218).

It is therefore necessary to consider the legislative context of subsection 40-880(2) of the ITAA 1997 in order to determine whether there is a sufficient and relevant connection between the incurrence of the expenditure and the taxpayer's business. In discussing the types of business capital expenditure to which subsection 40-880(2) of the ITAA 1997 applies, the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states:

2.19. Expenditure on the structure by which an entity carries on (or used to or proposes to carry on) their business and on the profit yielding structure of the business would ordinarily be expected to be of a capital nature. Capital expenditure can also relate to a business's trading operations or the entity that will carry on the business.

2.20. The structure covers the legal entity (such as a company) or the legal relationship (such as a partnership or trust) that is the entity that carries on the business for a taxable purpose and that holds the business assets.

These paragraphs indicate that capital expenditure incurred on the structure by which an entity carries on (or used to or proposes to carry on) their business, on the profit yielding structure of the business, or relating to the business's trading operations, are capable of being described as capital expenditure incurred 'in relation to' that business for the purposes of subsection 40-880(2) of the ITAA 1997. Whether such capital expenditure is incurred 'in relation to' the particular business will depend on whether there is a sufficient and relevant connection between the incurring of the expenditure and that business on the facts of the particular case.

The evaluation of the merger proposal involved the taxpayer considering how the implementation of the proposal would affect the structure by which the taxpayer carried on its business, the profit yielding structure of that business and the business's trading operations. The implementation of the proposal presented to the taxpayer required the taxpayer to undertake structural changes to change its constitution and to undertake a statutory scheme of arrangement relating to the holding of the taxpayer's share capital. Additionally, the taxpayer's business's trading operations were to be affected so as to better compliment the business trading operations undertaken by the unrelated entity. On the facts, there is a sufficient and relevant connection between the taxpayer's incurrence of the capital expenditure on evaluating the merger proposal and the taxpayer's business.

The constitutional change undertaken by the taxpayer involved changing the taxpayer's constitution such that shareholders in the taxpayer would no longer be limited to only one share in the taxpayer or the right to only one vote in respect of the taxpayer's affairs. Such a change represents a change to the structure by which the taxpayer carried on its business and on the facts there is a sufficient and relevant connection between the taxpayer's incurrence of capital expenditure in undertaking that change and the taxpayer's business.

The scheme of arrangement involved the issued shares in the taxpayer being transferred to the unrelated entity in exchange for shares in the unrelated entity being issued to the members of the taxpayer, thereby resulting in the taxpayer becoming a wholly owned subsidiary of the unrelated entity. This was effected through the taxpayer implementing a scheme of arrangement in accordance with Part 5.1 of the Corporations Act, which by its nature imposed statutory obligations upon the taxpayer. For example, paragraph 412(1)(a) of the Corporations Act required the taxpayer to provide its members with an explanatory statement including information that was material to the taxpayer's members making the decision whether or not to agree to the scheme of arrangement as well as any material interests of the taxpayer's directors in the scheme of arrangement. On the facts, there is a sufficient and relevant connection between the taxpayer's incurrence of the capital expenditure to implement the scheme of arrangement in accordance with Part 5.1 of the Corporations Act and the taxpayer's business.

In the circumstances, there is a sufficient and relevant connection between the taxpayer's incurrence of the capital expenditure on the evaluation of the merger proposal, undertaking the process of constitutional change and the implementation of the scheme of arrangement and its business. Accordingly, the capital expenditure was incurred by the taxpayer in relation to its business for the purposes of paragraph 40-880(2)(a) of the ITAA 1997.

Year of income:  Year ended 30 June 2006

Legislative References:
Income Tax Assessment Act 1997
   section 40-880
   subsection 40-880(2)
   paragraph 40-880(2)(a)
   paragraph 40-880(2)(b)
   paragraph 40-880(2)(c)
   paragraph 40-880(2)(d)
   subsection 40-880(3)
   subsection 40-880(5)
   paragraph 40-880(5)(d)
   paragraph 40-880(5)(f)
   subsection 40-880(9)

Case References:
First Provincial Building Society Ltd v. Federal Commissioner of Taxation
   (1995) 56 FCR 320
   (1995) 30 ATR 207
   95 ATC 4145

Related ATO Interpretative Decisions
ATO ID 2007/110
ATO ID 2007/111
ATO ID 2007/112

Other References:
Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006

Keywords
Blackhole expenditure
Capital Allowances CoE
Capital expenditure
Taxable purpose
Uniform capital allowances system

Siebel/TDMS Reference Number:  5310508

Business Line:  Public Groups and International

Date of publication:  1 June 2007

ISSN: 1445-2782