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Advice

Subject: Deductibility of Licence Fees

Issue 1

Question 1

Will the annual payment of the Licence Fee be deductible for the taxpayer under section 8-1 of the Income Tax Assessment Act 1997 when it is incurred?

Advice

Yes.

Issue 2

Question 1

Will a prepayment of Licence Fees by the taxpayer be deductible for the taxpayer under section 8-1 of the Income Tax Assessment Act 1997 when the prepayment is made?

Advice

Yes.

Question 2

Will the proportion of the prepayment of Licence Fees that is deductible for the taxpayer in a relevant year of income be determined in accordance with the formula in section 82KZMD of the Income Tax Assessment Act 1936?

Advice

Yes.

Relevant facts and circumstances

Your advice is based on the facts stated in the description of the scheme that is set out below. If your circumstances are significantly different from these facts, this advice has no effect and you cannot rely on it. The fact sheet has more information about relying on ATO advice.

The taxpayer will be granted a Licence to use property which will enable the taxpayer to produce its assessable income. In return for the grant of the Licence, the taxpayer can choose to pay annual Licence Fees on their Licence Fee Payment Dates or prepay the annual Licence Fees when the Licence is granted.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)

Paragraph 8-1(1)(a) of the ITAA 1997

Paragraph 8-1(2)(a) of the ITAA 1997

Section 230-45 of the ITAA 1997

Subparagraph 230-460(2)(e)(i) of the ITAA 1997

Subsection 82KZL(1) of the Income Tax Assessment Act 1936 (ITAA 1936)

Subsection 82KZL(2) of the ITAA 1936

Paragraph 82KZL(2)(b) of the ITAA 1936

Section 82KZMA of the ITAA 1936

Paragraph 82KZMA(1)(a) of the ITAA 1936

Paragraph 82KZMA(1)(b) of the ITAA 1936

Subsection 82KZMA(2) of the ITAA 1936

Subparagraph 82KZMA(2)(a)(i) of the ITAA 1936

Subsection 82KZMA(3) of the ITAA 1936

Subparagraph 82KZMA(3)(a)(i) of the ITAA 1936

Subparagraph 82KZMA(3)(b) of the ITAA 1936

Subparagraph 82KZMA(3)(c) of the ITAA 1936

Subsection 82KZMA(4) of the ITAA 1936

Subsection 82KZMA(5) of the ITAA 1936

Section 82KZMD of the ITAA 1936

Does Part IVA apply to this advice?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtain a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies, the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not considered the application of Part IVA to the arrangement you have asked us to provide advice on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to provide advice on whether Part IVA applies, we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website (www.ato.gov.au) and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Issue 1 Question 1

Summary

The Licence Fees will be incurred in gaining or producing the taxpayer's assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997.

The Licence Fees will not be outgoings of capital or of a capital nature for the purpose of paragraph 8-1(2)(a) of the ITAA 1997.

Each Licence Fee will be incurred on its payment date and will be properly referable to the income year in which it is incurred.

The payment of the Licence Fees will be deductible for the taxpayer under section 8-1 of the ITAA 1997 when they are incurred.

Detailed reasoning

Will the Licence Fees be deductible under section 8-1 of the ITAA 1997?

Section 8-1 of the ITAA 1997 states that:

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or…

Will the Licence Fees be incurred in gaining or producing the taxpayer's assessable income?

The connection between a taxpayer's outgoings and the generation of assessable income was considered in Ronpibon Tin NL and Tongkah Compound NL v FC of T (1949) 78 CLR 47. The High Court stated at pages 56-57 that:

For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income.

And:

In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.

The Licence will allow the taxpayer to access the property to perform activities that will produce the taxpayer's assessable income.

Without the Licence and the payment of the Licence Fees, the taxpayer will not be able to perform the activities that will produce its assessable income. The Licence and the Licence Fee payments allow the taxpayer to perform the activities in order to produce its assessable income.

The occasion of the payment of the Licence Fees will be found in what will be productive of the taxpayer's assessable income. Each Licence Fee will be an outgoing incurred by the taxpayer in gaining or producing its assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997.

Will the Licence Fees be outgoings of capital or of a capital nature?

In Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 (Sun Newspapers) at page 359 Dixon J said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

And at page 363:

There are, I think, three matters to be considered [in determining whether expenditure is on revenue or capital account], (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play a part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

Later in Hallstroms Pty Ltd v FC of T (1946) 72 CLR 634 at pages 646 and 647 Dixon J said as an introductory remark:

…it may be useful to recall the general consideration that the contrast between the two forms of expenditure [income and capital] corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.

And later at page 648:

What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view...

In Colonial Mutual Life Assurance Society Ltd v FC of T (1953) 89 CLR 428 at page 454 Fullagar J said:

The questions which commonly arise in [determining whether expenditure is on revenue or capital account] are (1) What is the money really paid for? - and (2) Is what it is really paid for, in truth and in substance, a capital asset?

These propositions have been applied in more recent cases.

In FC of T v Citylink Melbourne Limited 2006 ATC 4404 (Citylink Melbourne), Crennan J (with whom Gleeson CJ, Gummow J, Callinan J and Heydon J agreed) stated at page 4427 that:

The characterisation of an outgoing depends on what it is calculated to effect to be judged from a practical and business point of view .. [and] .. [t]he character of the advantage sought by the making of the expenditure is critical.

In FC of T v Star City Pty Ltd (2009) FCR 39 at pages 51 and 52 Goldberg J said that:

The primary judge correctly identified the relevant principles to apply in determining whether [the outgoing] was an item of revenue or of capital and in determining the character of the advantage sought and the characterisation of the [outgoing]. In particular, the primary judge observed that an examination of the character of the advantage sought was assisted by asking two questions: What was the [outgoing] really paid for; and, is what it was really paid for, in truth and in substance, a capital asset? Her Honour accepted that the answer to these questions…depended upon what the expenditure was calculated to effect from a practical and business point of view.

Each Licence Fee payment will secure for the taxpayer the right to access the property to perform the activities for the period to which the Licence Fee payment relates (no longer than twelve months). This advantage will not have any lasting quality beyond the period to which the Licence Fee payment relates. Each Licence Fee will be a recurring expense of the taxpayer. The advantage sought will be used by the taxpayer to perform the activities so that it can produce regular income. Each Licence Fee will represent an outgoing in carrying on the taxpayer's business rather than an outgoing to establish its business organisation or structure. Each Licence Fee will be on revenue account.

When will the Licence Fees be incurred?

Paragraph 6 of Taxation Ruling TR 97/7 Income tax: section 8-1- meaning of 'incurred'- timing of deductions lists the following general rules, settled by case law, that assist in most cases in defining whether and when a loss or outgoing has been incurred:

(a) a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitively committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. That is, subject to the principles set out below, it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum;

(b) a taxpayer may have a presently existing liability, even though the liability may be defeasible by others;

(c) a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation (based on probabilities);

(d) whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise;

(e) in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid.

Under the Licence, a liability to pay each Licence Fee will arise on each Licence Fee Payment Date. On each Licence Fee Payment Date the taxpayer will have a pecuniary (monetary) obligation under the Licence to pay each Licence Fee. As a result, it will be on each Licence Fee Payment Date that a liability will 'come home' to the taxpayer and each Licence Fee will be incurred. Prior to each Licence Fee Payment Date each Licence Fee is no more than 'impending', 'threatened', or 'expected' because the Licence may be terminated earlier.

To which income year will the Licence Fees be properly referrable?

In Coles Myer Finance Ltd v FC of T (1993) 176 CLR 640 at page 663, the majority of the Full High Court stated:

'But it is not enough to establish the existence of a loss or outgoing actually incurred. It must be a loss or outgoing of a revenue character and it must be properly referable to the year of income in question.'

Taxation Ruling TR 94/26 Income tax: section 8-1 - meaning of 'incurred' - implications of the High Court decision in Coles Myer Finance gives guidance as to when an outgoing incurred is properly referable to a year of income. Paragraph 11 of TR 94/26 states:

The courts have provided little guidance as to the meaning of 'properly referable'. We believe that 'properly referable' is concerned with the period of time during which the benefit from incurring the loss or outgoing is put to 'profitable advantage', i.e., the period during which the benefit obtained from the liability is used in the taxpayer's assessable income producing activity.

Further, paragraph 15 of TR 94/26 states:

It is not necessary to have regard to the period to which an expense is properly referable where the liability comes into existence and is discharged in the same year.

The Licence Fees are payable in arrears on their Licence Fee Payment Dates. On each Licence Fee Payment Date the benefit from incurring the Licence Fee (the access to the property) will have been put to full 'profitable advantage' over the previous period. The Licence Fees will not be incurred in respect of access to the property for a period past their Licence Fee Payment Date.

As a result of the benefit from incurring the Licence Fees being put to full profitable advantage by the time they are incurred, each Licence Fee will be properly referable to the income year in which it is incurred.

Issue 2 Question 1

Summary

The prepayment will be incurred in gaining or producing the taxpayer's assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997.

The prepayment will not be an outgoing of capital or of a capital nature for the purpose of paragraph 8-1(2)(a) of the ITAA 1997.

The prepayment will be incurred when the prepayment is made.

The prepayment of Licence Fees by the taxpayer will be deductible for the taxpayer under section 8-1 of the ITAA 1997 when the prepayment is made.

Detailed reasoning

Will the prepayment be deductible under section 8-1 of the ITAA 1997?

Section 8-1 of the ITAA 1997 states that:

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or…

Will the prepayment be incurred in gaining or producing the taxpayer's assessable income?

For the same reasons given above (Issue 1, Question 1) in relation to whether the Licence Fees will be incurred in gaining or producing the taxpayer's assessable income, the prepayment will be incurred in gaining or producing the taxpayer's assessable income for the purpose of paragraph 8-1(1)(a) of the ITAA 1997.

Will the prepayment be an outgoing of capital or of a capital nature?

The case law cited above (Issue 1, Question 1) in relation to whether the Licence Fees will be outgoings of capital or of a capital nature is equally applicable to whether the prepayment will be an outgoing of capital or of a capital nature.

In addition, in Sun Newspapers at page 362 Dixon J said:

Recurrence is not a test, it is no more than a consideration the weight of which depends on the nature of the expenditure.

And:

But the idea of recurrence and the idea of endurance or continuance over a duration of time both depend on degree and comparison. As to the first, it has been said it is not a question of recurring every year or every accounting period; but "the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once and for all"… By this I understand that the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely.

For the reasons given above (Issue 1, Question 1), each annual Licence Fee payment will be on revenue account. The main difference between the payment of the annual Licence Fees and the prepayment of those annual Licence Fees is that the prepayment will bring forward the payment of otherwise periodic Licence Fees. Those otherwise periodic Licence Fee payments would be on revenue account. The prepayment will also be on revenue account. The prepayment will be in substitution for a continuous demand for annual Licence Fees. The annual Licence Fees form part of the constant demand which must be answered out of the taxpayer's assessable income.

When will the taxpayer incur the prepayment?

In Emu Bay Railway Co Ltd v FC of T (1944) 71 CLR 596 (Emu Bay) at page 606, Latham CJ said '[t]he words "outgoings incurred" should not be limited to expenditure actually made'.

Later in FC of T v Ilbery 81 ATC 4661 (Ilbery) at page 4666, Toohey J stated when referring to Latham CJ's statement in Emu Bay that the statement 'takes for granted that expenditure actually made is an outgoing incurred, as do [statements] in a number of other cases'.

In accordance with Emu Bay and Ilbery, the taxpayer will incur the prepayment when the prepayment is made.

Issue 2 Question 2

Summary

The conditions in subsection 82KZMA(1) of the ITAA 1936 will be met and section 82KZMD of the ITAA 1936 will apply to set the amount and timing of deductions for the prepayment. As a result, the portion of the prepayment of Licence Fees that is deductible in a relevant year of income will be determined in accordance with the formula in section 82KZMD of the ITAA 1936.

Detailed reasoning

Subsection 82KZMA(1) of the ITAA 1936 states that:

Section 82KZMD sets the amount and timing of deductions for expenditure that a taxpayer incurs in a year of income (the expenditure year), if:

· apart from those sections, the taxpayer could deduct the expenditure under…section 8-1 of the Income tax Assessment Act 1997 for the expenditure year; and

· the requirements in subsections (2), (3), (4) and (5) are met.

The requirement in paragraph 82KZMA(1)(a) of the ITAA 1936

For the reasons given above (Issue 2, Question 1) the prepayment will be deductible under section 8-1 of the ITAA 1997 when the prepayment is made.

Paragraph 82KZMA(1)(a) of the ITAA 1936 is satisfied because the prepayment could otherwise be deducted when the prepayment is made under section 8-1 of the ITAA 1997.

The requirements in paragraph 82KZMA(1)(b) of the ITAA 1936

The requirements in paragraph 82KZMA(1)(b) of the ITAA 1936 will also be satisfied.

The requirement in subsection 82KZMA(2) of the ITAA 1936

Subparagraph 82KZMA(2)(a)(i) of the ITAA 1936 requires the taxpayer to 'carry on a business'.

The performance of the activities will constitute a business carried on by the taxpayer. As a result, the taxpayer will meet the requirement in subsection 82KZMA(2) of the ITAA 1936.

The requirement in subsection 82KZMA(3) of the ITAA 1936

Subsection 82KZMA(3) of the ITAA 1936 requires the prepayment to be:

· incurred in carrying on a business (subparagraph 82KZMA(3)(a)(i) of the ITAA 1936), and

· incurred under an agreement (paragraph 82KZMA(3)(b) of the ITAA 1936), and

· incurred in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year (paragraph 82KZMA(3)(c) of the ITAA 1936).

The prepayment will be incurred by the taxpayer in carrying on a business and will be incurred under an agreement. As a result, subparagraph 82KZMA(3)(a)(i) of the ITAA 1936 and paragraph 82KZMA(3)(b) of the ITAA 1936 will be met.

Paragraph 82KZMA(3)(c) of the ITAA 1936 also requires the prepayment to be 'incurred in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year'.

Subsection 82KZL(2) of the ITAA 1936 states:

Without otherwise limiting the generality of references in this Subdivision to expenditure being incurred under an agreement in return for the doing of a thing under the agreement:

(a) …

(b) where expenditure incurred under an agreement consists of a payment of rent, a lease payment or a payment of a similar kind, the expenditure shall, for the purposes of this Subdivision, be taken to be incurred in return for the making available or continued making available, as the case requires, of the thing rented or leased, or other thing of a similar kind, under the agreement during the period to which the payment relates; and (emphasis added)

(c) …

Paragraph 14 of IT 2646 Income Tax: Television Program Licences provides guidance on the phrase 'payment of a similar kind'. It states:

The expression "payments of a similar kind" in paragraph 82KZL(2)(b) is considered to refer to payments:

a. the nature of which is similar to the nature of rent and lease payments; and

b. the object or benefit sought by the payments is similar to the object or benefit sought by a payment of rent or a lease payment.

Rent has been defined as 'the consideration payable under [a] lease for the right of use and occupation of the leased premises during the term of the lease' (FC of T v Krakos Investments Pty Ltd 96 ATC 4063, per Hill J at 4074). Further, 'an inherent feature of rent is that it typically involves a (generally regular) periodical payment' and 'rent is fundamentally the consideration for the right to use property' (FC of T v Citylink Melbourne Limited 2006 ATC 4404, per Kirby J at 4413).

The Licence Fees will not be payable under a lease and the Licence will not give the taxpayer an interest in the property or a right to exclude others from using the property. However, the Licence Fees will be annual periodic payments for the access to and use of the property. As a result, the Licence Fees (and consequently the prepayment) will be similar to rent and the advantage secured by the prepayment of the Licence Fees will be similar to the advantage secured by the payment of rent.

The prepayment of the Licence Fees will be a payment of a similar kind to the payment of rent for the purpose of paragraph 82KZL(2)(b) of the ITAA 1936. The prepayment of the Licence Fees will be incurred in return for the property being made available during the period to which the prepayment relates, which is the term of the Licence. As a result, paragraph 82KZMA(3)(c) of the ITAA 1936 will be met.

The requirement in subsection 82KZMA(4) of the ITAA 1936

Subsection 82KZMA(4) of the ITAA 1936 requires that the prepayment 'must not be excluded expenditure'.

'Excluded expenditure' is defined by subsection 82KZL(1) of the ITAA 1936. The amount of the prepayment will not be less than $1,000., it will not be required to be incurred by a law, or by an order of a Court, of the Commonwealth, a State or Territory. It will not be a payment under a contract of service, it will not be a payment of a capital, private or domestic nature and it will not come within paragraphs (e) or (f) of 'excluded expenditure' as defined in subsection 82KZL(1) of the ITAA 1936.

The prepayment does not fall within any of the limbs of the exhaustive definition of 'excluded expenditure' as defined in subsection 82KZL(1) of the ITAA 1936. As a result, the requirement in subsection 82KZMA(4) of the ITAA 1936 will be met.

The requirement in subsection 82KZMA(5) of the ITAA 1936

Subsection 82KZMA(5) of the ITAA 1936 requires that the prepayment 'must not meet a pre-RBT obligation'.

A 'pre-RBT obligation' is defined by subsection 82KZL(1) of the ITAA 1936. The definition has four limbs, all of which must be satisfied. The first limb of the definition of a pre-RBT obligation is a contractual obligation that 'exists under an agreement at or before 11.45 am (by legal time in the Australian Capital Territory) on 21 September 1999'.

The prepayment is not capable of meeting a pre-RBT obligation because the obligation to make the prepayment did not exist under an agreement at or before 11.45 am on 21 September 1999. As a result, the requirement in subsection 82KZMA(5) of the ITAA 1936 will be met.

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