Edited version of your private ruling

Authorisation Number: 1012477194479

Ruling

Subject: Deduction under section 8-1 of the Income Tax Assessment Act 1997

Question 1

Is the loss incurred by X Ltd on the disposal of its shares in Y Pty Ltd a loss or outgoing incurred in carrying on a business for the purpose of gaining or producing assessable income and therefore deductible under subsection 8-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the loss incurred by X Ltd on the disposal of its shares in Y Pty Ltd a loss or outgoing of capital, or of a capital nature under subsection 8-1(2) of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

For the year ended 30 June 20ZZ

The scheme commences on:

December 200T

Relevant facts and circumstances

· X Ltd is listed on the Australian stock exchange. It is involved in real estate business consisting of direct investment and fund management. The real estate business consists of direct investment and fund management. From the direct investment, X Ltd derives development profits, preferred equity interest income and development management fees. Such activities are undertaken either directly via a subsidiary or via a joint venture entity.

· In 200T, Y Pty Ltd signed an option agreement (the Option Agreement) for the acquisition of certain property (the Property). An option fee was paid for this option.

· At the time X Ltd signed the Option Agreement, it was 100% owned by X Ltd.

· The property was unzoned farmland but within the urban growth boundary (UGB) and the strategy was to acquire the Property and to pursue a rezoning of the site (the Project)

· The rezoning time horizon was five to six years.

· The disposal of the property was to occur upon appropriate uplift in value obtained at or before the land is formally rezoned.

· Given the size of the acquisition, it was X Ltd's intention to source a joint venture partner for the contemplated Project.

· Z Pty Ltd agreed to invest as a joint venture partner in the Project and to acquire 80% interest in Y Pty Ltd.

· Following completion of satisfactory due diligence, X Ltd submitted a recommendation to the its Board seeking approval for X Ltd to acquire a 20% interest in the Project.

· The submission to the Board included the following details:

- X Ltd's role in the Project was:

1. to manage the acquisition and rezoning of the Property in return for project management fees; and

2. to be a 20% equity participation in the project

- In relation to project management fees, X Ltd was entitled to project management fees per annum for four years. If the rezoning process exceeded four years, the project management fees would be reviewed for future years.

- In relation to profit split, profit up to an equity internal return (IRR) of 20% was Z Pty Ltd 80% and X Ltd 20%.

- Profit in excess of an equity IRR of 20% were to be split Z Pty Ltd 60% and X Ltd 40%

· New shares were issued by Y Pty Ltd to X Ltd and Z Pty Ltd to achieve the agreed equity interest.

· X Ltd, Y Pty Ltd and Z Pty Ltd entered into a shareholder agreement (Shareholders Agreement) which recorded the aims and objectives in relation to the project and joint venture and set out the commercial terms for the funding, activities and management of Y Pty Ltd and conduct the Project.

· Shareholders Agreement states that the objectives of X Ltd and Z Pty Ltd (the Shareholders) in entering into the Shareholders Agreement included

- to use their respective business skill, know how, experience and expertise to manage and conduct the Project; and

- to ensure that the Project is managed to maximise the value of Y Pty Ltd for the benefit of the Shareholders.

· In regards to the exit from the Project, the Shareholders acknowledged in the Shareholders Agreement that:

- it is intended that the Project will be completed by way of sale of the property by Y Pty Ltd at market value upon completion of the Project objectives, namely a successful rezoning of the Property which achieves an internal rate return (IRR) on equity in excess of 20% per annum (Project Objectives)

- at the time of the completion of the Project Objectives, alternative exit options may exist. It was agreed that these alternative exit options should be negotiated between the Shareholders with a view to maximising the Project IRR of both Shareholders.

· The Shareholders Agreement clearly acknowledged the potential sale of shares in Y Pty Ltd as an exit mechanism in specific clauses (i.e., as an alternative exit option).

· No dividends were to be paid by Y Pty Ltd until the senior debt facility had been repaid with the proceeds from the disposal of the Property.

· After three years of entering into the Shareholder Agreement, it was amended.

· In the amended Shareholders Agreement, the Shareholders acknowledged that:

- it is the current intention that the Project will be completed by way of sale of the Property by Y Pty Ltd at the market value upon completion of the Project objectives by no later than certain date; and

- at the time of the completion of the Project Objectives, a number of alternative exit options may exist including the further development of the Property by Y Pty Ltd. The Shareholders acknowledge that they will consider such Alternative Exit Options and will negotiate with good faith in relation to the implementation of one or more such Alternative Exit Options, with a view to maximising the project IRR of both Shareholders.

· The definition of the Project Objectives was amended as to provide an opportunity for both Shareholders by certain time to crystallise their investment at market value and exit the property or to consider further development of the Property upon achieving the rezoning of the property.

· The profit split of any Y Pty Ltd distribution proceeds was amended such that all profits were to be split Z Pty Ltd 80% and X Ltd 20%.

· X Ltd and Y Pty Ltd entered into a Development Management Agreement under which X Ltd was obliged to provide services defined as the day-to-day management of the project in accordance with the Project Objectives for an annual fee for four years.

· Following the acquisition of the property, X Ltd commenced works required to achieve the Project Objectives. The parties had originally expected the rezoning process to take up to 4 years. However, through X Ltd's efforts, a rezoning of the site was achieved well ahead of schedule time. A valuation report valued the site certain price assuming the property had been rezoned.

· The rezoning triggered the completion of the Project Objectives and the Shareholders reviewed and agreed to pursue an alternative exit strategy as they did not believe putting the Property to the market in the market conditions at that time would maximise the Shareholders IRR.

· The joint venture parties agreed to contribute further equity to bring infrastructure services (power, water, sewer, roads) to the site boundary so that the land was well serviced and in a position to capitalise on any new requirements for broad-acre land in the market.

· Following first the valuation, the implied value of the land started to fall as market conditions deteriorated and demand for broad-acre land continued to soften.

· A second valuation commissioned valued the site lesser than the first valuation.

· A third valuation of X Ltd's 20% interest in the Project was undertaken to assist with X Ltd's, then, equity raising. This valuation valued the site below the price paid for the land plus development costs incurred from the beginning of the Project. This resulted in around certain amount of impairment write down of X Ltd's investment in this project.

· A detailed review of the Project was undertaken and the key focus for the Project was to deal with the re-financing of the debt which was due to expire and to find a liquidity event for the joint venture partners by certain dates in accordance with the terms of the Shareholders Agreement.

· The Shareholders commenced discussion with another entity who was interested in acquiring certain area of land.

· The offer to acquire the land was of a magnitude that it would repay the majority of the senior debt facility.

· X Ltd negotiated a position with Z Pty Ltd whereby Z Pty Ltd acquired X Ltd's 20% interest in Y Pty Ltd subject to the other entity acquiring and settling on the agreed parcel of land. X Ltd sold its shares in Y Pty Ltd. The sale crystallised certain amount of loss.

· Prior to the commencement of the Project, X Ltd had entered into a joint venture with an unrelated third party for the acquisition and development for profit of another real estate project. The terms and conditions of this joint venture were broadly consistent with the terms and conditions of the Project other than the investment vehicle used, namely unincorporated joint venture rather than a company structure.

· Subsequent to the commencement of the Project, X Ltd entered into a further two projects as a joint venture partner. The terms and conditions of these projects are broadly consistent with the terms and conditions of the Project.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 subsection 8-1(2)

Does Part IVA apply to this ruling?

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 obtains 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 fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule 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

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

Question 1

Summary

The loss incurred by X Ltd on the disposal of its shares in Y Pty Ltd is a loss or outgoing incurred in carrying on a business for the purpose of gaining or producing assessable income and therefore deductible under subsection 8-1(1) of the ITAA 1997.

Detailed reasoning

Section 8-1 of the ITAA 1997 states as follows:

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.

X Ltd can claim deduction for the loss it incurred from the sale of its shares in Y Pty Ltd if that loss is incurred in gaining or producing its assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing its assessable income.

In the Federal Court decision of Jennings Industries Ltd v FC of T, 84 ATC 4288(the Jennings case) where shares taken up in an entity set up for constructing and leasing a building as part of a diversified business of the taxpayer Jennings Industries Ltd's, but were subsequently sold before completion of the project, it was considered whether the sale of the take up of initial shares in the relevant entity was a mere realisation of an investment or whether it was an act done in carrying on or carrying out of a business so that the profit was income under 25(1) of the Income Tax Assessment Act 1936. It was held (at pp 4294) that:

An intention to retain the shares in T.P.D. for a lengthy period and to derive income from them during that period might tend to support a conclusion that the shares where an investment, particularly if the share acquisition itself constituted the entire transaction. It was an integral element of a wider transaction. Each aspect of the transaction and the transaction as a whole had profit as the motive. Although the taxpayer had not previously entered into other similar projects, and did not in the event enter into further such transactions for a substantial period after 1972 and then only infrequently, the agreement of 4 February 1972 was at the time contemplated as merely the first of a number of transactions. The policy at that time was that the taxpayer would lease instead of immediately selling some of the buildings which it constructed. The first transaction to give effect to the policy cannot properly be regarded as an isolated transaction merely because the policy was not thereafter fully effectuated. All profit from the project at 45 Grenfell Street, including profit on the sale of the shares in T.P.D., was profit from the taxpayer's diversified business. The sale of the shares was not a mere realisation of an investment at a profit but a step taken in the course of a new part of the taxpayer's ordinary business.

In the present case, it is noted that direct investment is part of X Ltd's real estate business as put forward in the general facts pertaining to X Ltd.

It is submitted that the intention of X Ltd with respect to the Project was to develop the unzoned farm land and rezone the land with an expected uplift in value within a period of five to six years. It is also stated that it was the intention that a disposal of the property was to occur upon an appropriate uplift in value before the land is formally rezoned.

It is also submitted that given the size of the acquisition, and X Ltd's limited net asset worth at the time, it was intended that a joint venture partner would be sourced to take the project forward. In this regard, the acquisition of the 20% interest in Y Pty Ltd by X Ltd under the Shareholder Agreement with Z Pty Ltd appears to be an integral step towards undertaking the development of the Property held under Y Pty Ltd.

It is submitted that a valuation of the partially rezoned site initially revealed an uplift in value, but had dropped in value following the completion of the rezoning. A further valuation conducted for the purposes of equity raising done revealed a value for the site, which was below the price paid for the property prior to the rezoning. From these submissions made in relation to the valuations done of the site, it can be inferred that X Ltd appears to have been periodically reassessing the profitability of the Project.

Furthermore, given the drop in value of the site, it is submitted that the means of re-financing and repayment of the debt taken out to fund the Project, which it is claimed was due on certain date was a foremost concern for X Ltd and the joint venture party Z Pty Ltd.

The decision therefore to exit the Project appears to have been a step taken in minimising the losses arising from both the drop in value of the site as well as the outgoings with respect to the loan acquired to fund the Project, and can be viewed as an integral step in the overall transaction undertaken with respect to the Project which had a profit motive from the outset to the time of exit by X Ltd and therefore can be likened to the outcome in Jennings case.

Where a loss is incurred by a taxpayer disposing of its interest in the structure itself rather than the loss from the disposal of assets within the structure the focus should be on identifying the intent of the taxpayer that had entered into the business operation or commercial transaction.

FC of T v Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer case), concerned a taxpayer company which made an interest bearing loan to a subsidiary. Three days later, as had always been intended, the taxpayer assigned the right to receive interest income from the loan in return for a lump sum. The court relied on 2 strands of reasoning in holding that the amount received by the taxpayer was income:

§ The amount in issue was a profit from a transaction which, although not within the ordinary course of the taxpayer's business, was entered into with the purpose of making a profit and in the course of the taxpayer's business.

§ The taxpayer sold a mere right to interest for a lump sum, that lump sum being received in exchange for, and as the present value of, the future interest in would have received. The taxpayer simply converted future income into present income.

The Full High Court in Myer (at pp 4366-4367) stated that:

Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income ( Whitfords Beach 150 CLR at 366-367, 376; 82 ATC at 4036-4037, 4042; 12 ATR at 695-696, 705). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.

The Full High Court also said in Myer that:

If the profits be made in the course of carrying on a business that in itself is a fact of telling significance. It does not detract from its significance that the particular transaction is unusual or extraordinary, judged by reference to the transactions in which the taxpayer usually engages, if it be entered into in the course of carrying on the taxpayer's business.

In Taxation Ruling TR 92/3 (TR 92/3) which provides the Commissioner's view as to whether profits on isolated transactions are income states that:

6. Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, profit from an isolated transaction is generally income when both the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

It would follow from paragraphs 6, therefore that if the relevant intention exists then the profit on disposal of the structure will be income.

Paragraph 16 of TR 92/4 (which sets out the ATO's view as to whether losses on isolated transactions are deductible on revenue account) states that:

Consequently, a loss from an isolated transaction is generally deductible under subsection 51(1) if:

(a)   in entering into the transaction the taxpayer intended or expected to derive a

profit which would have been assessable income; and

(b) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Relying on paragraph 16 of TR 92/4 therefore, it follows that if a loss is incurred by the same means then that loss will be deductible.

Paragraph 7 of TR 92/3 states that the relevant intention or purpose of the taxpayer of making a profit or gain is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

The TR 92/3 further states that profit making intention need not be the sole or dominant intention or purpose of entering into the transaction. It is sufficient if profit-making is a significant purpose (paragraph 7). However, if the transaction or operation is outside the ordinary course of carrying on a business, the intention or purpose of profit-making must exist in relation to the transaction or operation (paragraph 10). Again, the transaction needs to have a commercial or business character (paragraph 12).

Paragraph 13 of the TR 92/3 lists certain factors which may be relevant in considering whether a transaction amounts to business operation or commercial character as follows:

(a) the nature of the entity undertaking the operation or transaction;

(b) the nature and scale of other activities undertaken by the taxpayer;

(c) the amount of the money involved in the operation or transaction and the magnitude of the profit sought or obtained;

(d) the nature, scale and complexity of the operation or transaction;

(e) the manner in which the operation or transaction was entered into or carried out;

(f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

(g) if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h) the timing of the transaction or the various steps in the transaction.

In the present case, X Ltd's take up of the 20% shares in Y Pty Ltd was undertaken with the stated intention of developing and selling of the Property for a profit. Prior to the share take-up, Y Pty Ltd had entered into an Option Agreement for the acquisition of the Property and paid option fees. Y Pty Ltd was 100% owned by X Ltd at the time when the Option Agreement was signed.

Considering the size of the acquisition, X Ltd looked for a joint venture (given that X Ltd's net asset worth was small, and therefore it had limited capacity to fund any further development of the Property without an injection of significant funds).

Following completion of satisfactory due diligence, X Ltd submitted a recommendation to its Board seeking approval for X Ltd to acquire 20% interest in the Project. It succeeded in obtaining Z Pty Ltd to invest as a joint venture partner whereby the latter would acquire 80% of the shares in Y Pty Ltd. Accordingly it entered into the Shareholders Agreement with Z Pty Ltd. These steps taken by X Ltd prior to entering into the Shareholder Agreement show that it was well planned, organised and carried on in a business-like manner.

There was a definite formula as to how the profit was to be split between X Ltd and Z Pty Ltd namely, profit up to an equity IRR of 20% was Z Pty Ltd 80% and X Ltd 20%; profit in excess of an equity IRR of 20% were to be split Z Pty Ltd 60% and X Ltd 40%.

The Project Objective was to ensure that the Project is managed to maximise the value of Y Pty Ltd for the benefit of the Shareholders. The amended Project Objectives was to provide an opportunity to both Shareholders to crystallise their investment at market value and exit the Property or to consider further development of the Property.

Besides acquiring 20% interest in Y Pty Ltd, X Ltd entered into a Development Management Agreement with Z Pty Ltd whereby X Ltd was to manage the acquisition and rezoning of the Property in return for project management fees.

All these show that the decision to enter into the Shareholder Agreement with Z Pty Ltd and take up the 20% stake in Y Pty Ltd, had a significant commercial purpose or character, namely acquisition and rezoning of the Property through a joint venture partnership for profit. There was more than just an intention to engage in business. From the Project Objectives, it is clear that both the Shareholders had the intention to make a profit. While the Project was to end by way of sale of the Property, alternative exit options could be negotiated between the Shareholders so that the Project IRR is maximised for the Shareholders. The size and the scale of the Project are also evidence that the project was entered into and carried on as a business.

Paragraphs 56 and 57 of TR 92/3 further states that:

56. In our view a profit made in either of the following situations is income:

(a)  a taxpayer acquires property with a purpose of making a profit by which ever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose ( Steinberg ; Premier Automatic Ticket Issuers Ltd v. FC of T (1933) 50 CLR 268 at 300; Myer , especially at 163 CLR 211; 87 ATC 4367; 18 ATR 698); or

(b)  a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit.

57. We also consider that an assessable profit arises if a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means. Thus, a taxpayer may contemplate making a profit by sale but may ultimately obtain it by other means (such as compulsory acquisition, through a company liquidation or a distribution in specie) that were not originally contemplated."

Applying the above authority to the present case, the loss in relation to the Project was incurred as a result of the sale of the 20% stake and was triggered by X Ltd as a means of minimising the expected future losses as a result of the fall in value of the land and expected costs of funding the debt in relation to the project.

The fall in the value of land occurred due to market conditions deteriorating and the drop in demand for broad-acre land, something which X Ltd did not predict at the time to its entering into the arrangement with Z Pty Ltd to develop and realise a profit from the Project. Therefore the sale of the shares can be viewed as a timely exercise in minimising further losses that may have resulted from continuing in the Project and therefore in the words of the Jennings case, an integral element of a wider transaction comprising the development of the site with a view to profit.

Furthermore, it is submitted for X Ltd that while the Shareholder Agreement implies that the Shareholders probably intended to retain their shares in Y Pty Ltd and receive franked dividend from the sale of the Property, but the Shareholders considered alternative exit options too as could be found in several clauses which considered exit through sale of the shares.

Thus, the sale of the share by X Ltd, although not its usual business but it was done, as stated in Jennings case, an integral element of a wider transaction and as stated in the Myer case, was in the course of X Ltd's business for the purpose of making a profit. Therefore, the loss incurred by X Ltd from the sale of the shares is deductible under subsection 8-1(1) of the ITAA 1997.

The courts have not given the word "necessarily" a strict interpretation in the sense of being compulsory payment, but rather that the loss or outgoing must be clearly appropriate and adapted for the ends of the business: Ronpibon Tin NL v FCT (1949) 78 CLR 47.

In Magna Alloys and Research Pty Ltd v FC of T, 80 ATC 4542 per Deane and Fisher JJ at 4561, an outgoing incurred by a company will be "necessarily incurred" if

…. the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of that business …

In FC of T v Snowden and Wilson Pty Ld (1958) 99 CLR 431; 11 ATD 463, the issue was whether certain legal expenses, incurred in connection with the company's appearance before a Royal Commission appointed to enquire in to allegations relating to its methods of trading, had been necessarily incurred in carrying on business for the purpose of gaining or producing assessable income. Dixon CJ said (99 CLR at pp 436-437; 11 ATD at pp 464-465):

…throwing light on the use of the word 'necessarily' in section 51(1). Clearly the expression is used in relation to business. Logical necessity is not a thing to be predicted of business expenditure. What is meant by the qualification is that the expenditure must be dictated by the business ends to which is it directed, those ends forming part of or being truly incidental t the business.

In the present case it appears to me that the taxpayer company could do nothing else but defend itself, if it was to sustain its business and continue carrying it on in anything like the same volume or according to the same plan. That seems to me to be enough.

Applying the above authorities, the sale of the 20% stake in Y Pty Ltd by X Ltd was an appropriate step in the direction of minimising its losses from the Project and therefore incurred in the course of carrying on its business.

Question 2

Summary

The loss incurred by X Ltd on the disposal of its shares in Y Pty Ltd is not a loss or outgoing of capital, or of a capital nature under subsection 8-1(2) of the ITAA 1997.

Detailed reasoning

Under paragraph 8-1(2)(a) of the ITAA 1997, a loss or outgoing is not deductible under section 8-1 of the ITAA 1997 to the extent that the loss or outgoing is capital or of a capital nature. The terms "capital" and "of a capital nature" are nor defined in the taxation legislations and there are no statutory guidelines for distinguishing between capital and revenue. It is through case laws that certain criteria have been developed to determine whether a receipt is capital or revenue. According to the authority established through case law, whether an amount of expenditure is capital or revenue depends upon the specific facts applicable to each case.

Nevertheless, the courts have generally addressed the issue as to whether a particular asset disposed of was held on capital account or not as being the distinction between a mere realisation or change of investment and a transaction that is an act done in what is truly carrying on or carrying out of a business: California Copper Syndicate v Harris (Surveyor of Taxes) (1904) 5 TC 159.

In London Australia Investment Co Ltd v FCT (1977) 138 CLR 106, Gibbs J, when considering the criterion of whether a sale was a business operation carried out in the course of the business of profit-making, stated that:

To apply this criterion it is necessary "to make both a wide survey and an exact scrutiny of the taxpayer's activities": Western Gold Mines N.L v C. of T (W.A) (1938) 59 C.L.R. 729, at p 729, at p. 740. Different considerations may apply depending on whether the taxpayer is an individual or a company. In the latter case it is necessary to have regard to the nature of the company, the character of the assets realized, the nature of the business carried on by the company and the particular realization which produced the profit: Hobart Bridge Co. Ltd v F.C. of T. (1951) 82 C.L.R. 371, at p. 383, citing Ruhama Property Co. Ltd. v F.C. of T., at p. 154.

The leading Australian judgement on the distinction between capital and revenue expenditure is that of Dixon J in Sun Newspapers Ltd v FCT (1938) 61 CLR 337 (Sun Newspaper). In that case, Sun Newspaper Ltd published an evening newspaper called The Sun which was sold at a penny halfpenny per copy. The optionees of a competing evening newspaper proposed to replace the newspaper with another newspaper to be sold at one penny per copy. To prevent the publication of the proposed newspaper, an agreement was entered into whereby Associated newspaper Ltd, a company which held nearly all the shares in Sun Newspapers Ltd, agreed to pay £86,500 to those interested in the production of the new newspaper for their interest in the competing newspaper and in consideration for them not becoming associated for a period of three years with the publication of any other newspaper in Sydney or within 300 miles thereof. It was held that the moneys so paid were in the nature of capital. At pp 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.

Elaborating upon this concept, Dixon J then said at pp 359-360:

The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested …But in spite of the entirely different forms, materials and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a 'profit-yielding subject' …As a general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of obtaining it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses, which are or ought to be supplied continually out of the returns or revenue.

Dixon J said (at p 363) that there were 3 matters to be considered:

(a) the character of the advantage sought

(b) the manner in which it is to be used, relied upon or enjoyed; and

(c) the means adopted to obtain it.

In Hallstroms Pty Ltd v FCT (1946) 72 CLR 634, Dixon J added the following comments to his criteria in Sun Newspaper (at 648):

The contrast between the two forms of expenditure 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.

………

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, rather than upon the juristic classification of the legal rights, if, any secured, employed or exhausted.

However, in BP Australia Ltd v FCT (1965) 9 AITR 615, the Privy Council cautioned (at 622):

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances which may point in one direction, some in the other. ….It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in borderline cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree.

In FC of T v The Myer Emporium Ltd (1987) 163 CLR 199, the Full High Court held that a receipt may constitute income if it arises from an isolated business operation or commercial transaction entered into otherwise than in the course of carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the purpose of making a relevant profit or gain from the transaction.

Therefore, from the above principles and considerations, what is important is not only to look at the business or the profit yielding structure but also the intention as well as the nature of the transaction and the nature of the asset realised that gave rise to the profit or loss.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) discusses the Tax Office policy on whether profit from isolated transaction would be income Although, it discusses the situation where there is a profit and where such profit arises in case of isolated transaction, it can provide direction as to how the principle can be applied generally and when there is a loss instead of profit.

In the present case, X Ltd acquired the 20% interest in Y Pty Ltd and entered into a Shareholders Agreement with Y Pty Ltd and Z PTY LTD with the objective of rezoning the Property and selling the rezoned land.

The 20% equity participation by X Ltd was part of the overall transaction entered into with Y Pty Ltd and Z PTY LTD to rezone and sell the Property at a profit and is evidenced by the Shareholders Agreement which contemplates a specific overall internal rate of return from the project.

The project being the rezoning and sale had a specific time frame in contemplation and at the time of the take up of the 20% equity interest in Y Pty Ltd, it was not the intention of X Ltd to hold the shares in Y Pty Ltd for an indefinite period so as to derive dividend income from these shares or hold them for likely capital appreciation. Rather it was the intention of X Ltd, as evidenced in the Shareholders Agreement, to rezone the Property and sell it for a profit within a specific period of time.

In this context, it is regarded that the acquisition of the shares being the 20% interest in Y Pty Ltd by X Ltd was an integral part of a wider transaction comprising the rezoning and sale at a profit of the Property which also included provision for project management services from which X Ltd derived assessable project management fees.

It is evident from the various valuations conducted of the Property that both X Ltd and Z PTY LTD were assessing the potential for maximising the profit from the development of the property along the timeframe agreed at the outset and with reference to the desired internal rate of return agreed at the outset. The deliberations around the best possible method of realising this profit, including from a sale of shares in Y Pty Ltd was clearly part of this assessment.

Having regard to the valuations which showed a decline in the market value of the Property, X Ltd then went about the best possible method to minimise its losses. The sale of the 20% equity interest in Y Pty Ltd to Z PTY LTD which was part of this realisation of the project therefore, is also regarded as an integral part of the overall transaction relating the Property under which X Ltd sought to maximise its profits and therefore, the loss on sale is regarded as having that of a revenue character and not a loss derived on capital account as with a passive investment.

Therefore, the loss incurred by X Ltd from the sale of the shares will not be a loss or outgoing of capital or of a capital nature under subsection 8-1(2) of the ITAA 1997.

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