Edited version of your written advice

Authorisation Number: 1012744000715

Ruling

Subject: Business related expenses

Question 1

Is the partnership entitled to a deduction for a deposit incurred on a contract to acquire an item of `depreciable plant, that was lost when the supplier went into liquidation, as a balancing adjustment under subsection 40-285(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the partnership entitled to a deduction for a deposit incurred on a contract to acquire an item of depreciable plant that was lost when the supplier went into liquidation, under section 40-880 of the ITAA 1997?

Answer

No

Question 3

Will the partners be entitled to a capital loss for a deposit incurred on a contract to acquire an item of depreciable plan that was lost when the supplier went into liquidation?

Answer

Yes

This ruling applies for the following periods

Year ending 30 June 2015

The scheme commences on

1 July 2014

Relevant facts and circumstances

You carry on a business in partnership.

You entered into a contract with a company (the supplier) to build an item of plant for business use.

You paid a deposit to the supplier.

You recently received notification that the supplier has been placed into voluntary liquidation and as a consequence has now ceased to trade.

You did not receive the item and you are unlikely to receive any refund, despite having a contractual obligation for the supplier to supply the item.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 paragraph 40-880(5)(d)

Income Tax Assessment Act 1997 paragraph 40-880(5)(f)

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 subsection 106-5(1)

Income Tax Assessment Act 1997 paragraph 108-5(1)(b)

Reasons for decision

A balancing adjustment event occurs for a depreciating asset when:

• you stop holding it, for example, if the asset is sold, lost or destroyed

• you stop using it and expect never to use it again

• you stop having it installed ready for use and you expect never to install it ready for use

• you have not used it and decide never to use it, or

• a change occurs in the holding or interests in an asset which was or is to become a partnership asset.

You must have held a depreciating asset before you are entitled to claim a deduction for its decline in value or any balancing charge under Division 40 of the ITAA 1997. In your case, as the item was never held, the item does not qualify for depreciation or a balancing adjustment.

Section 40-880 of the ITAA 1997 is a provision of last resort which, in general, subject to its exclusions, allows a deduction over five income years for certain business capital expenditure incurred after 30 June 2005 which is not otherwise taken into account or denied a deduction by some other provision.

Taxation Ruling TR 2011/6, which is about section 40-880 of the ITAA 1997, states the capital expenditure must be business related. Paragraph 69 states:

69. Under paragraphs 40-880(2)(a), 40-880(2)(b) and 40-880(2)(c), the taxpayer can deduct capital expenditure they incur if it is in relation to their business, or in relation to a business that used to be carried on or is proposed to be carried on.

However, there is an exclusion in paragraph 40-880(5)(d) of the ITAA 1997, which states you cannot deduct anything under this section for expenditure you incur that is 'in relation to a lease or other legal or equitable right'.

Similarly, there is an exclusion in paragraph 40-880(5)(f) of the ITAA 1997, which states you cannot deduct anything under this section for an expenditure incurred that could be taken into account in working out the amount of a capital gain or a capital loss from a CGT event.

Meaning of 'leases or other legal or equitable right'

Paragraph 2.68 of the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 ('the EM') states:

This exclusion replicates that found in the repealed section 40-880, having been added in 2002 in the context of the Government's review of the treatment of expenditure incurred on leases or other legal or equitable rights. The 2005-06 Budget announced that the Government would take a case-by-case approach in relation to the taxation of rights.

Since that paragraph states that the exclusion contained in paragraph 40-880(5)(d) of the ITAA 1997 replicates that found in the repealed section 40-880 of the ITAA 1997, it is relevant to consider the repealed paragraph 40-880(3)(d) of the ITAA 1997. In discussing that exclusion, paragraph 3.67 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 stated:

The Government is reviewing the treatment of expenditure incurred in relation to leases or other legal or equitable rights as part of the consideration of the recommendations of the Review of Business Taxation. The appropriate income tax treatment of capital expenditure incurred in relation to these leases and rights will be determined as part of that review. Consequently, capital expenditure on leases or other legal or equitable rights will be excluded from deduction under section 40-880. For example, expenditure representing lease surrender payments incurred in closing down your business will not be deductible under section 40-880.

It is therefore relevant to consider what 'leases and rights' were considered in the recommendations of the Review of Business Taxation in order to determine the intended scope of the phrase 'in relation to a lease or other legal or equitable right' in paragraph 40-880(50(d) of the ITAA 1997 and former paragraph 40-880(3)(d) of the ITAA 1997.

The proposed review of the taxation of 'leases and rights' was discussed at pages 213-280 of the Review of Business Taxation, A Platform for Consultation , Discussion Paper 2 Volume I, February 1999. Specifically, at paragraph 8.1 on page 217, the following is stated:

    What is a lease or right?

Leases and rights are essentially arrangements for transferring some or all of the benefits of ownership of an asset from the owner to the recipient of the lease or right. The following kinds of rights contracts are covered by the discussion:

• leasing and similar contracts which provide rights over physical assets, for example, leases of equipment;

• contracts giving rights over intangible assets, such as spectrum licences and rights in films, patents, copyright, and industrial designs;

• indefeasible rights of use over assets, such as telecommunication cables;

• profits á prendre , that is, a right to take a product such as standing timber from another person's land;

• contracts for services;

• restrictive covenants; and

• rights to receivables arising from 'rights' contracts, for example, lease receivables.

On the facts, we consider that the contract to build and supply the item constitutes a legal right of the type considered by the Review of Business Taxation.

Therefore, paragraph 40-880(5)(d) of the ITAA 1997 will prevent you from claiming a deduction under section 40-880 of the ITAA 1997 for the lost deposit.

Further, paragraph 40-880(5)(f) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 of the ITAA 1997 for an amount of expenditure you incur to the extent that 'it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event'.

Contractual rights are a CGT asset, as per paragraph 108-5(1)(b) of the ITAA 1997.

CGT event C2 will occur if an entity's ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. The Commissioner takes the view that in certain circumstances contractual rights can be discharged or come to an end merely by being treated as being at an end by the parties

In your case, it will be considered that CGT event C2 will occur and you will make a capital loss at the time the contractual rights end by being abandoned, that is, when it is reasonably certain that there is no real hope of recovering any of the funds.

Consequently, paragraph 40-880(5)(f) of the ITAA 1997 will also prevent you from claiming a deduction under section 40-880 of the ITAA 1997 for the lost deposit, by reason of you being entitled to a capital loss from the CGT event.

Under subsection 106-5(1) of the ITAA 1997, a capital loss from a CGT event happening in relation to a partnership CGT asset is made by the partners individually, and not the partnership.

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