Edited version of private ruling

Authorisation Number: 1011820791532

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Ruling

Subject: Division 41 - deduction for new business investment

Question

Will expenditure incurred in purchasing components for installation in assets manufactured by the taxpayer and held as depreciating assets by the taxpayer constitute expenditure in respect of construction of those assets for the purposes of subsection 41-25(3A) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Relevant facts and circumstances

The taxpayer owns a manufacturing facility where it manufactures assets that are depreciating assets for the purposes of Division 40 of the ITAA 1997. These assets are manufactured both for sale as trading stock and for retention and internal use within the multiple entry consolidated (MEC) group of which the taxpayer is a member.

During the period from 13 December 2008 to 31 December 2009, the taxpayer received a number of orders to manufacture assets to be retained for internal use within the MEC group.

As part of the normal manufacturing process, entities within the MEC group order various components from suppliers for incorporation into the assets being built. Some of these components are manufactured by an entity that is an associate entity of the taxpayer but in which the taxpayer has no ownership interest.

When such components are ordered for the manufacture of assets, the taxpayer and the associate enter into scheduling agreements which usually operate for a calendar year period. Scheduling agreements provide a framework under which arrangements between the taxpayer and the associate are outlined and may be updated from time to time to reflect changes in the supply price of ordered components.

Orders for assets were placed before 31 December 2009. As a result, the scheduling agreement between the taxpayer and the associate for that year was varied to enable the taxpayer to issue Purchase Orders for the components.

Purchase Orders for the components to be installed in the assets were signed by the taxpayer and the associate before 31 December 2009. These Purchase Orders specified the type, quantity and price of the components to be supplied and the date of delivery. The Purchase Orders could only be terminated by the taxpayer if the orders for assets were cancelled or the taxpayer ceased manufacturing the assets.

The Purchase Orders further specified that the associate would issue invoices requiring the taxpayer to make an up front instalment payment of 5% of the purchase price of the components. Accordingly, invoices for the instalments were issued by the associate to the taxpayer and the taxpayer made the instalment payments by 31 December 2009. The instalment payments were applied to the total price payable by the taxpayer on the Purchase Orders.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the taxpayer.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Division 41 of the ITAA 1997

Division 41 of the ITAA 1997 provides for an additional deduction for certain new business investment where the conditions specified in the Division are met. The new investment amount must be for an asset that is a depreciating asset for which the taxpayer is able to claim a deduction under section 40-25 of the ITAA 1997 for the 2008-09, 2009-10, 2010-11 or 2011-12 income year.

Relevantly, paragraph 41-20(1)(b) of the ITAA 1997 also provides that a new investment amount is a recognised new investment amount if the investment commitment time for the amount occurs between 12.01 am on 13 December 2008 (ACT time) and 31 December 2009.

The investment commitment time

Section 41-25 of the ITAA 1997 sets out what constitutes the investment commitment time. For current purposes, it occurs when a taxpayer starts to construct the asset in relation to which the new investment amount is being claimed (subparagraph 41-25(1)(a)(ii) of the ITAA 1997). Subsection 41-25(3A) of the ITAA 1997 states that for the purposes of inter alia paragraph 41-25(1)(a) of the ITAA 1997, a taxpayer may regard the start of the construction of the asset as occurring at the time when '…you first incur expenditure in respect of the construction of the asset...'

When is the expenditure incurred?

The meaning of the term 'incur' that is used in subsection 41-25(3A) of the ITAA 1997 is most frequently considered in the context of its use in section 8-1 of the ITAA 1997 and its predecessor, subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936). The decisions in FCT v James Flood Pty Ltd (1953) 88 CLR 492 and Nilsen Development Laboratories Pty Ltd v FCT (1981) 144 CLR 616 are two of the leading cases on the meaning of 'incurred'.

These decisions hold that while there does not need to be an actual disbursement for expenditure to be incurred, it is necessary that there should be a presently existing liability to which the taxpayer is definitely committed and it not merely impending, threatened or expected.

The revised Explanatory Memorandum to Tax Laws Amendment (Small Business and General Business Tax Break) Bill 2009 provides the following example that is pertinent to the taxpayer's situation and illustrates when expenditure is incurred for the purposes of determining the investment commitment time under section 41-25 of the ITAA 1997:

Example 1.16

Greenfield Power is a power supply company that builds its own transmission lines. During mid 2008, the company started to contemplate building a number of new transmission lines. Over the remainder of 2008, preliminary design planning and work was undertaken in anticipation of the project going ahead.

On 15 January 2009, the company's directors signed off a decision to proceed with construction of the lines. While the company does not start to physically construct the transmission lines at this point, it places an order for some of the materials it will need. Upon placing the order for the materials, the company is liable to pay a deposit and, therefore, incurs expenditure in relation to the materials.

On 10 February 2009 the relevant division of the company started to finalise the specification of the lines and placed further orders for materials.

The investment commitment time for each of the transmission lines is 15 January 2009 as this is when the company first incurred expenditure in respect of the construction of the assets.

In this instance, the taxpayer signed the Purchase Orders before 31 December 2009. These Purchase Orders specified the goods to be supplied, the price and the delivery date. The Purchase Orders could only be terminated by the taxpayer under limited conditions and required the taxpayer to make the associate an instalment payment of 5% of the purchase price. Invoices for the instalments were duly issued by the associate and the instalment payments made by the taxpayer. The instalment payments were applied to the total amount payable by the taxpayer for the components.

Accordingly, the taxpayer had a presently existing liability to which it was definitely committed on the dates it signed the Purchase Orders for the components, that is, before 31 December 2009. The relevant expenditure was therefore incurred for the purposes of subsection 41-25(3A) of the ITAA 1997 on these dates.

Is the expenditure 'in respect of' the construction of an asset?

The use of the expression 'in respect of' in subsection 41-25(3A) of the ITAA 1997 indicates that the expenditure need not be limited to expenditure directly incurred in the actual cost of the construction of the asset. The words expand the range of expenditure that may be counted in determining the investment commitment time for an investment amount.

In Federal Commissioner of Taxation v Tully Co-operative Sugar Milling Association Limited 83 ATC 4495; (1983) 14 ATR 495, the Court considered the operation of the former section 82AB of the ITAA 1936. At ATC 4505-6, Fitzgerald J held:

However, that does not mean that there will not be cases in which it is proper to consider that there is but a single unit of property constructed by the taxpayer although there have been purchases by the taxpayer of plant, equipment or materials which have been incorporated into that unit. … Expenditure ``in respect of'' construction may in appropriate cases include costs of purchases, and expenditures ``in respect of'' acquisition might conceivably include costs other than the purchase price, including perhaps delivery and installation expenses.

The components were parts of assets being constructed by the taxpayer and which, when completed, became depreciating assets in relation to which the taxpayer was entitled to claim a deduction. In the light of his Honour's views, it is reasonable to conclude that the cost of acquiring components to be incorporated into the assets is expenditure incurred 'in respect of' the construction of the assets within the meaning of subsection 41-25(3A) of the ITAA 1997.

As such, for the purposes of subsection 41-25(3A) of the ITAA 1997, the expenditure on the components for installation in assets manufactured by the taxpayer and held as depreciating assets by the taxpayer constitutes expenditure that has been incurred and is 'in respect of' the construction of those assets.

Note: In view of the requirements of subsection 41-25(3A) of the ITAA 1997 having been met, the investment commitment times in accordance with section 41-25 of the ITAA 1997 will be before 31 December 2009. Since these investment commitment times will fall within the requirements of section 41-20 of the ITAA 1997, the expenditure will be a recognised new investment amount if all the other requirements of section 41-20 of the ITAA 1997 are met.

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