ATO Interpretative Decision
ATO ID 2004/657
Income Tax
Deduction: tax indemnity paymentFOI status: may be released
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Is a deduction allowable under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for payments made under a tax indemnity clause in a contract for sale of shares in the year in which the expenditure was incurred?
Decision
No. A deduction is not allowable under section 8-1 of the ITAA 1997 as the payments are capital or of a capital nature.
Facts
The taxpayer agreed to sell its shares in a wholly owned subsidiary to an unrelated company during the 1997-98 income year.
In the Sale Agreement the taxpayer agreed to indemnify the purchaser for any tax relating to the period the subsidiary was owned by the taxpayer and for which the purchaser become liable over a period of 6 years from the date of the Sale Agreement.
Several years after the subsidiary was sold, the subsidiary became liable to tax as a result of income tax audits relating to the period during which it was owned by the taxpayer.
In the 2000-01 and 2001-02 income years, the purchaser acted on the indemnity clause and the taxpayer had to pay amounts to the purchaser in respect of tax paid by the subsidiary as a result of the income tax audits.
Reasons for Decision
Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earnings of exempt income.
The Full Federal Court in Federal Commissioner of Taxation v. Email Ltd [1999] FCA 1177; (1999) 42 ATR 698; 99 ATC 4868 (Email) considered the deductibility of payments made pursuant to indemnities. In that case a holding company, in the seven years following the sale of shares by its subsidiary, paid amounts under indemnities it had granted on the sale of the shares.
The Court held that the indemnity payments were not deductible. The occasion for the outgoings was found in the giving of the indemnity, not directly in the outgoings themselves. The immediate advantage which the indemnity was calculated to effect was the sale of the shares at the maximum price possible. The advantage to the taxpayer was an increase in the value of its shares in its subsidiary, which went to the dividend yielding structure of the taxpayer rather than to the process by which the dividends were earned and was thus of a capital nature.
In the circumstances here the outgoings were paid under the tax indemnity given by the taxpayer to the purchaser and which was contained in the Sale Agreement. It is considered that the decision in Email applies to these circumstances. The occasion for the outgoings is to be found in the giving of the tax indemnity which goes to achieving the sale and enhancing the sale price of the shares in the subsidiary. Accordingly the amounts are outgoings of capital or of a capital nature and are not allowable deductions under section 8-1 of the ITAA 1997.
Date of decision: 8 June 2004Year of income: year ended 30 June 2001 year ended 30 June 2002
Legislative References:
Income Tax Assessment Act 1997
section 8-1
Case References:
Federal Commissioner of Taxation v. Email Ltd
[1999] FCA 1177
(1999) 42 ATR 698
99 ATC 4868
Keywords
Deductions
Indemnity
ISSN: 1445-2782
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