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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your private ruling

Authorisation Number: 1012575298530

Ruling

Subject: Deductibility of incentives

Question 1

Are cash incentive payments and expenditure on property incentives incurred by the taxpayer deductible pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are the cash incentive payments and expenditure on property incentives deductible in full in the year in which the expenditure is incurred?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

1 January 2011

Relevant facts and circumstances

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for Decision

Note: Footnote references are displayed at end of document.

Question 1

Summary

The Cash Incentives and expenditure on Property Incentives are deductible as they are outgoings incurred in gaining or producing the taxpayer's assessable income and they are not excluded from being deductible pursuant to subsection 8-1(2) of the ITAA 1997.

Detailed Reasoning

1. Subsection 8-1(1) of the ITAA 1997 allows a deduction for any loss or outgoing to the extent that:

2. However, subsection 8-1(2) of the ITAA 1997 provides that a loss or outgoing is not deductible to the extent that:

Positive limbs

3. For the relevant expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of your assessable income. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income. The occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if no assessable income is produced, what would have been expected to produce assessable income: Ronpibon Tin NL v FC of T (1949) 78 CLR 47.

Application to the taxpayer's circumstances

4. When the taxpayer provides cash or expends money to provide the Property Incentives to venue operators, there is an outgoing. The incentives are provided to the venue operators as inducements to enter into a contract for the provision of venue management services so that the taxpayer may enjoy the receipt of revenue in the form of fees in respect of the provision of those services. The occasion for the outgoing is incidental or relevant to the production of assessable income.

5. It is noted that on certain occasions the taxpayer may provide services at no charge and in such cases no loss or outgoing arises in respect of revenue forgone.

Negative Limbs

6. The payment of Cash Incentives or expenditure on Property Incentives is not of a private or domestic nature or incurred in relation to gaining or producing exempt income or non-assessable non-exempt income.

First negative limb - Capital v revenue expenditure

7. The guidelines for distinguishing between capital and revenue outgoings were laid down in Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1938) 5 ATD 87; (1938) 61 CLR 337 (Sun Newspapers). In that case, Dixon J stated that the distinction between expenditure on revenue account and on capital account corresponds with" the distinction between the business entity, structure or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay". After discussing this distinction and the difficulties inherent in applying the distinction in a practical sense, his Honour said:

8. In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court pointed out that the character of expenditure is ordinarily determined by reference to the nature of the asset acquired and that the character of the advantage sought by the making of the expenditure is the chief, if not critical, factor in determining the character of what is paid.

9. In Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634 Dixon J stated:

10. In BP Australia v Federal Commissioner of Taxation (1965)112 CLR 386; (1965) 9 AITR 615 (BP Australia) the company claimed deductions for amounts paid as trade ties to service station proprietors so that those proprietors would deal exclusively in its products for a fixed period. The payments were calculated by reference to expected sales by the service stations. The Privy Council held that the real object of the outgoing was not the tie but the orders that would flow from it and that the payment of the sums became part of the regular conduct of the business. The Privy Council noted at page 399 that:

11. The decision of the Privy Council overturned the decision of the High Court in BP Australia Ltd v Federal Commissioner of Taxation (1964) 110 CLR 387 where, in their dissenting judgments:

Kitto J stated:

12. In National Australia Bank v. Federal Commissioner of Taxation (1997) 80 FCR 352; 97 ATC 5153; (1997) 37 ATR 378 (National Australia Bank), the bank purchased from the Commonwealth government the exclusive right to provide Commonwealth subsidised loans to Australian Defence Force personnel for a period of 15 years for $42 million dollars and annual amounts thereafter if the scheme was successful. The Full Federal Court held that the case was not unlike the case of BP Australia and considered that the payment was made "in order to secure the practical certainty that most of those ADF personnel who qualified for a subsidy and wanted a home loan would become customers of the Bank'. The payment was made for the purpose of attracting an additional class of borrower to whom the bank could sell its product. By granting loans to the ADF personnel the bank also expected to gain revenue from other products provided to the home loan customers. The Full Federal Court found that the payment was made as part of a marketing strategy implemented in the course of conducting the bank's business of selling home loans and other products which generated its interest income.

13. In Tyco Australia Pty Ltd v FC of T 2007 ATC 4799 (Tyco) the taxpayer (an electronic security monitoring company) in the relevant income years, derived income in the form of fees paid by home owners and small businesses for security monitoring services. The taxpayer engaged contractors (Authorised Dealers under a programme established by the taxpayer) to secure customers and to enter into alarm monitoring contracts directly with those customers. The taxpayer then paid the Authorised Dealers a lump sum 'assignment fee' for the novation of each contract. The assignment fee changed over the relevant periods. Under the first two versions of the contract the fee was based on a multiple of the monthly fee payable by the customer and under the third version it was a flat fee. Under the first two versions, the assignment fee represented most, if not all, of the total of the fees payable under the life of the contract. It was noted that the contract would only be profitable to Tyco Australia Pty Ltd if the customers would continue with the contracts after the initial term expired.

14. The issue in Tyco was whether the payments made by the taxpayer to the authorised dealers were of a capital nature and therefore not deductible under section 8-1 of the ITAA 1997. Allsop J held that the payments were on revenue account and therefore deductible under section 8-1 of the ITAA 1997.

15. After referring to BP Australia and the Privy Council's approval of the above quoted passages of Dixon CJ and Kitto J in their dissenting judgments in the High Court, Allsop J stated:

16. Although the rights under the contracts could be seen to be assets purchased by the taxpayer, and the amount paid for each contract represented almost the whole of the contracted revenue stream, his Honour held that this did not make the matter an affair of capital. It was held that the advantage sought by each payment was the winning of a customer to be retained for future revenue for services to be provided. Each payment was made to secure an incremental accretion to the customer base of the taxpayer and the expenditure was incurred in the ordinary business activity of winning customers.1

17. Allsop J at paragraph 78 described the case as:

18. Further, Allsop J stated at paragraph 81:

19. Allsop J also held that the accounting treatment (the booking of the payments as assets to be amortised against the profit and loss account) could not be determinative of the issue and, in the circumstances of the case, it was of little assistance in characterising the payments as capital or revenue.2

20. In Taxation Ruling No. IT 2631 Income Tax: Lease Incentives paragraph 38 provides:

Application to the taxpayer's circumstances

21. From a practical and business point of view, the advantage sought by the payment of the Cash Incentives and expenditure on the Property Incentives is the incremental addition to the customer base of the taxpayer and the earning of revenue from the customer relationship.

22. The circumstances are similar to the cases of BP Australia, National Australia Bank and Tyco. Following the approach of Allsop J (paraphrasing the words of Dixon J In Sun Newspapers), in making the payments the taxpayer is building the extent of the profit-yielding subject (being its customer base) as the product of the course of operations, by the incremental winning of customers by the chosen method of providing cash and property incentives and earning revenue from the customer relationship over the length of the contracts and perhaps into the future. There are also similarities with lease incentives which are generally treated as being deductible (paragraph 38 of IT 2631).

23. Although a lump sum cash incentive or expenditure on fitting out in a venue may be provided at the beginning of a particular customer relationship it cannot be said that the expenditure is not regular or recurrent. As held by the Privy Council in BP Australia, to find whether expenditure is recurrent one needs to take a "broad view of the general operation under which the expenditure was incurred" and "Prima facie matters connected with the ever recurring question of marketing and customers, though not themselves recurrent in an identical form, share the same quality of recurrence possessed by matters "connected with the ever-recurring question of personnel ".

24. The taxpayer provides cash and property incentives per its negotiations with prospective clients. These may be provided for a number of customers and at various times during the customer relationship. As and when venue management contracts expire the question will arise as to how the taxpayer will retain its customers. The provision of the incentives is expenditure of a recurrent nature. As in BP Australia, the length of the agreements itself does not indicate either a capital or revenue expenditure.

Fourth Negative Limb - a provision of the Act denies deduction

25. Subdivision H of Division 3 of Part III of the ITAA 1936 modifies the operation of section 8-1 of the ITAA 1997 (the general deductions provision) in relation to the timing of deductions for certain expenditure incurred in advance.

26. Generally, a prepaid expense is deductible over the eligible service period (a maximum period of 10 years) rather than being immediately deductible. However, is come cases a prepaid expense may be immediately deductible.

27. For the operation of section 8-1 of the ITAA 1997 to be modified, inter alia, the expenditure in question must be incurred under an agreement and in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year.3

Application to your circumstances

28. The payment of Cash Incentives or expenditure in respect of Property Incentives under a venue management contract is incurred under an agreement but it is not in return for the doing of a thing under the agreement that is not wholly done within the expenditure year. The taxpayer agrees to provide the Cash Incentives and Property Incentives to induce the client to enter into the contract so that it can earn the fees for the contracted term. The incentives are not provided in return for the doing of any further things under the agreement by the client after the time that the outgoing is incurred.

Question 2

Summary

The Cash Incentives and expenditure on Property Incentives is deductible in full in the year in which the expenditure is incurred. There is no apportionment required to pro-rate the costs over the life of the venue management contract.

Detailed Reasoning

29. To qualify for deduction under section 8-1 of the ITAA 1997, a loss or outgoing must have been incurred. In working out your taxable income for the income year you add up all your assessable income and deductions for the income year and subtract the later from the former.

30. Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of "incurred" - timing of deductions sets out the view of the Australian Taxation Office on whether the word incurred has the same meaning for taxpayers who return income on a receipts and those who do so on an accruals basis.

31. TR 97/7 explains that in some cases a loss or outgoing although incurred also needs to be properly referrable to the year of income in which the deduction is sought: Coles Myer Finance Pty Ltd v FC of T 93 ATC 4214 (Coles Myer Finance).

32. The joint judgment of the High Court in Coles Myer Finance stated (93 ATC at 4222):

33. At paragraph 15 of TR 97/7 it is recognised that the question of timing will often not arise when a liability is incurred and discharged in the same income year. However a concern may arise where taxpayers have undischarged liabilities at year end.

34. Taxation Ruling TR 94/26 Income tax: subsection 51(1) - meaning of incurred - implications of the High Court decision in Coles Myer Finance, explains that there are certain cases where the following three criteria must be satisfied: (a) there is a presently existing liability; (b) the loss or outgoing is of a revenue character; and (c) all or part of the loss or outgoing is properly referrable to the particular year in question4. TR 94/6 gives the following examples of transactions that will require a determination of the year of income to which the loss or outgoing is properly referrable5:

35. TR 94/26 clarifies that Coles Myer Finance does not introduce into the law any principle of specifically matching expenses to income derived in a particular year.7

36. Taxation Ruling TR 94/25 Income tax: implications of the decision in Coles Myer Finance Ltd v. FC of T for the timing of deductions for prepaid expenses also explains that Coles Myer Finance did not alter the position for prepayments which were considered fully deductible in the year that they were paid. In that ruling it is recognised that the Court in Coles Myer Finance was concerned with the situation where the legal liability to pay is incurred in a particular year but the amount is not payable until a subsequent year of income.8

Application to your circumstances

37. The payment of the Cash Incentives and expenditure on Property Incentives will be deductible in full in the year that they are incurred. There is no timing difference between incurring the liability and its deductibility. No apportionment is required to pro-rate the costs over the life of the venue management contract.

1 Tyco Australia Pty Ltd v FC of T 2007 ATC 4799 at paragraph 75 - 79

2 Ibid at paragraph 82

3 In the taxpayer's circumstances (carrying on a business and not being a small business taxpayer) the relevant provision is subsection 82KZMA(3) of the ITAA 1936

4 Taxation Ruling TR 94/26 Income tax: subsection 51(1) - meaning of incurred - implications of the High Court decision in Coles Myer Finance Paragraph 7

5 Paragraph 8 of TR 94/26

6 TR 94/26 refers to the case of Australian and New Zealand Banking Group Limited v Federal Commissioner of Taxation 94 ATC 4026

7 TR 94/26 Paragraph 16 and paragraphs 35 - 42

8 TR 94/25 Paragraph 10


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