Edited version of private advice

Authorisation Number: 1051720866096

Date of advice: 16 July 2020

Ruling

Subject: Income tax - Black hole expenditure - section 40-880

Question 1

Are the consulting fees and legal fees (professional advisor fees) paid by Company X to Consulting Firm and Legal Firm B (professional advisors) deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent they relate to the services provided by Company X under the Services Agreements?

Answer

Yes

Question 2

To the extent the professional advisor fees are not deductible under section 8-1 of the ITAA 1997, are they deductible under section 40-880 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Income years xx to xx

Relevant facts and circumstances

1.     Company X is an Australian resident company involved in a particular industry.

2.     Company X is one of a number of operating entities majority owned by investment vehicles controlled by Individual X.

3.     These operating entities comprised the Group. The Group is not an income tax consolidated group for the purposes of Part 3-90 of the Income Tax Assessment Act 1997. The operating entities include Company Z and Others.

4.     The operating entities operate a particular business operation. Each operating entity undertakes a different business within that operation. Specifically:

a.     Company X fulfils the corporate head office function for the group. Management are employed via this entity. It acquires and provides professional services to the group and pays for expenses which relate to the group. These costs and services provided to the operating entities are charged via a management fee and pursuant to a Services Agreement with the other operating entities. The management fees are not a recharge of general expenses.

b.     Company Z manages the external sales for the group and holds the contracts with the third-party customers.

5.     A sale was considered by the Board of the operating entities in the past but was aborted.

6.     The Board was prompted to consider the strategic direction of the business once again following an unsolicited approach to sell the operation from an unrelated entity.

7.     This prompted consideration of a number of succession options by the Board.

8.     Company Z engaged a number of professional advisors, including Consulting Firm and Legal Firm B, to assist in the consideration of the options available.

9.     The advice sought was used by the Group and its shareholders to determine if the share sale should proceed, under what structure and to whom. The value that any potential investor could bring to the businesses was critical to the decision making process.

10.  At the time advisors were engaged it was not known whether any sale would be a sale of business assets or a sale of shares.

11.  Consulting Firm were engaged as financial advisors to Company Z and its shareholders, to advise and assist throughout the transaction (whatever form it may take, whether it involved the sale of the whole or part of the shares or assets of Company Z and/or all the entities in the Group).

12.  Consulting Firm were engaged on a success fee basis. They were paid a monthly retainer which allowed the Group to pull out if the right partner, or the value, wasn't received. A success fee would be payable based on the sale value (less the retainer already paid) if the right value or partner was found.

13.  Legal Firm B were engaged by Company Z. They were engaged per standard terms and conditions, which is based on time spent. They were engaged to act as legal advisors to Company Z, the other operating entities, the board and business management throughout the proposed sale process.

14.  The engaging party for Consulting Firm and Legal Firm B was Company Z. The terms of the engagement letters stipulate that Company Z (and the shareholders in the case of Consulting Firm A) as the engaging party was liable for the payment of fees.

15.  As the engaging party, Company Z was invoiced and liable for the provision of this professional advice. Amounts were invoiced to Company Z.

16.  It was ultimately decided that Overseas Corp would be the acquirer of shares.

17.  The ultimate sale structure was negotiated between the parties. Director B and Secretary with Consulting Firm's assistance led the negotiations and were appointed by the entities with an obligation to act in the best interests of the business group and all its shareholders.

18.  Company X charges Company Z and Others a management fee for the services it provides.

19.  The management fee is charged pursuant to individual Services Agreements entered into by Company X and each of Company Z and the Others.

20.  The Services Agreements are entered into by Company X with the other entities in the Group in advance on an annual basis.

21.  The Services Agreement between Company X and the other Group entities outlines the services to be provided by Company X in return for the management fee charged.

22.  According to the Services Agreements the services to be provided by Company X include:

a.     Senior management and consultancy

b.     Provision of finance and administrative support

c.      Provision of sales staff

d.     Provision of IT services

e.     Provision of Foreign exchange management

f.       Provision of land and buildings.

23.  Pursuant to the Services Agreement and consistent with general practice within the Group, Company X pays for services from external parties which are for the benefit of all the operating entities.

24.  The management fees charged to Company Z and Others by Company X are determined annually in advance by mutual agreement in line with expected activity and scope of services to be provided.

25.  Company X invoices the respective operating entities on a quarterly basis in accordance with the executed Services Agreements.

26.  For accounting purposes, the agreed management fee is accounted for on an accruals basis. It is expensed by the operating entities on the basis of invoices provided consistent with general accrual accounting principles. The management fee is accounted for as an expense in the operating paying entities, and as income in Company X.

27.  The Services Agreements between Company X and each of the other operating entities were executed on the day prior to the start of the income year.

28.  It was known by the Group that consultants would be required to be engaged over the coming financial year in relation to the proposed sale of the operating business. One of the Directors sitting on the Group Board had an extensive background in mergers and acquisitions, and was able to advise the Board with a reasonable estimate of what costs could be expected for consultancy. This information, along with the standard budgeting process, was considered and used by the Board to determine the appropriate management fees for the coming year.

29.  As Company X serves a head office function for all entities within the Group, it was determined to be appropriate that the professional advisor fees form part of the annual management fee assessment to be charged to each operating entity. A similar approach is taken with amounts such as audit fees, and these amounts form part of the annual management fee charged to the other operating companies. As such the professional advisor fees were proportionally included in the management fee for each operating entity.

30.  Whilst Company Z signed engagement letters with the respective professional advisors on behalf of the Group, pursuant to the Services Agreements and consistent with general practice within the group of operating companies, Company X assumed the liability to the professional advisors and paid the professional advisor fees.

31.  In respect of the professional advisor fees, Company X has not claimed an income tax deduction in the income tax return for any period. Similarly, no deduction has been claimed in respect of the professional advisor fees in any of the income tax returns of any of the other operating entities.

32.  In relation to the respective management fees regarding income and expenses, no tax adjustment has been made at present in any entity. The income has been treated as assessable in Company X and expensed as deductible in the other operating entities.

33.  Company X accounted via its profit and loss the cost of paying the invoices. It did not account for the invoices on the basis it paid the invoices on behalf of other Group entities (e.g. as an agency type arrangement).

34.  Company X did not have any exempt income or non-assessable non-exempt income.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

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

Income Tax Assessment Act 1997 paragraph 8-1(1)(b)

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

Income Tax Assessment Act 1997 paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 subsection 40-25(7)

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 subsection 40-880(2)

Income Tax Assessment Act 1997 paragraph 40-880(2)(a)

Income Tax Assessment Act 1997 subsection 40-880(3)

Income Tax Assessment Act 1997 subsection 40-880(4)

Income Tax Assessment Act 1997 subsection 40-880(5)

Income Tax Assessment Act 1997 subsection 40-880(6)

Income Tax Assessment Act 1997 subsection 40-880(7)

Income Tax Assessment Act 1997 subsection 40-880(8)

Income Tax Assessment Act 1997 subsection 40-880(9)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

All references are to the Income Tax Assessment Act 1997 (ITAA 1997).

Question 1

Section 8-1 contains the general deduction provision. It states that:

(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.

(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

(b) it is a loss or outgoing of a private or domestic nature

(c) it is incurred in relation to gain or producing your exempt income

or non-assessable non-exempt income, or

(d) a provision of this Act prevents you from deducting it.

Consequently, for the professional advisor fees to be deductible under section 8-1, they must satisfy one of the 'positive limbs' in subsection 8-1(1) and not fall within any of the 'negative limbs' in subsection 8-1(2).

Section 8-1 positive limbs

To be deductible under section 8-1, the positive limbs in subsection 8-1(1) require there to be a nexus between the professional advisor fees that Company X paid and the gaining or production of its assessable income, or the carrying on of its business as the corporate head office and service provider for the operating entities.

Relevant connection between the outgoing and the business

For an outgoing incurred to be deductible under section 8-1, there must be a relevant connection between the outgoing and the business.

An outgoing has the relevant connection to the business when it is 'desirable or appropriate in the pursuit of the business ends of the business' (Ronpibon Tin NL and Tongkah Compound NL v FC of T (1949) 78 CLR 47 (Ronpibon); Magna Alloys & Research Pty Ltd v Federal Commission of Taxation (1980) FCA 150).

In determining whether a loss or outgoing is characterised as having been incurred in gaining or producing assessable income, the courts have considered whether the loss or outgoing is incidental and relevant to the operations or activities regularly carried on by the taxpayer for the production of income.

The High Court in Ronpibon at 57 said 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 assessable income' mean in the course of gaining or producing such income-... 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 loss or outgoing must be incidental and relevant in the sense of having the essential character of a business or income-producing expense. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts: FC of T v. Smith, which provides the Commissioner's view on the deductibility of interest expenses, explains at paragraph 24 that:

24. Where the taxpayer carries on a business the second limb of section 8-1 requires there to be a relevant connection between the outgoing and the business. In deciding whether the interest is 'necessarily incurred' in the sense of 'clearly appropriate' to that business (FC of T v. Snowden and Willson Pty Ltd (1958) 99 CLR 431), regard must be had to the nature of the business activity (Magna Alloys & Research Pty Ltd v. FC of T 80 ATC 4542; 11 ATR 276), the business purpose for which the outgoing was incurred (FC of T v. The Midland Railway of Western Australia Ltd (1952) 85 CLR 306), the objective circumstances surrounding the incurring of the expenditure (FC of T v. South Australia Battery Makers Pty Ltd (1978) 140 CLR 645) and the character of the expense (John Fairfax & Sons Pty Ltd v. FC of T (1959) 101 CLR 30).

Hill J summarised the principles in FC of T v Firth [2002] FCA 413 at [6] as:

The positive tests require that there be a connection between the loss or outgoing on the one hand and the assessable income or business on the other. The nature of that connection has been expressed in different ways in the cases. It is sometimes said that there must be a 'perceived connection' between the loss or outgoing and the assessable income or business: FC of T v Hatchett 71 ATC 4184 at 4187... In other cases it has been said that the expenditure must be 'incidental and relevant' to the operations or activities regularly carried on by the taxpayer for the production of income: Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431 at 435; (1949) 78 CLR 47 at 56, FC of T v Smith 81 ATC 4114 at 4117. These ways of describing the connection that is a necessary prerequisite to deductibility are but part of the process of identifying the essential character of the expenditure in order to determine whether a particular loss or outgoing is in fact incurred in gaining or producing the assessable income or in carrying on a business which more directly contributes to the gaining or production of the assessable income: Lunney v FC of T (1958) 11 ATD 404; (1957-1958) 100 CLR 478 at 413 and 499 respectively.

Accordingly, for the professional advisor fees to be deductible under paragraph 8-1(1)(b), the costs must have the essential character of a loss or outgoing incurred in carrying on a business which more directly contributes to the gaining or producing of Company X's assessable income. The costs must be clearly appropriate to its business, having regard to the nature of Company X's business activities, the business purpose for which the costs are to be incurred, and the objective circumstances surrounding the incurring of the costs.

Company X's business activities include the supply of services to the other operating entities pursuant to the Services Agreements it enters with each of the operating entities on an annual basis. According to these Services Agreements the services to be provided by Company X include:

a. Senior management and consultancy

b. Provision of finance and administrative support

c. Provision of sales staff

d. Provision of IT services

e. Provision of Foreign exchange management

f. Provision of land and buildings.

Pursuant to the Services Agreements and consistent with general practice, Company X pays for services from external parties and which relate to all the operating entities. Company X derives revenue from the services it provides and sources to the other operating entities under the Services Agreement by charging a management fee.

The Services Agreements between Company X and each of the other operating entities were executed the day prior to the beginning of the income year. It was known by the Group that consultants would be required to be engaged over the coming financial year in relation to the proposed sale of the Group business. One of the directors sitting on the Group Board (the Board) had an extensive background in mergers and acquisitions, and was able to advise the Board with a reasonable estimate of what costs could be expected for consultancy. This information, along with the standard budgeting process, was considered and used by the Board to determine the appropriate management fees for the year. As Company X serves a head office function for all entities within the Group, it was determined to be appropriate that the professional advisor fees form part of the annual management fee assessment.

This was necessary for Company X to conduct its business activities as the head office function within the Group and for it to meet its obligations under the Services Agreements with the other operating entities. There is a clear and direct relationship between Company X's payment for the professional advisor fees and its ordinary business activities.

Therefore, having regard to the nature of Company X's business activities and the objective circumstances surrounding the professional advisor fees, the professional advisor fees were relevantly connected to Company X in the carrying on of its business for the purpose of gaining or producing its assessable income.

'Incurred'

For the professional advisor fees to be deductible under the positive limbs of section 8-1, also requires the professional advisor fees be incurred by Company X. Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioner's views on the meaning of incurred in section 8-1. There is no statutory definition of the term 'incurred' (paragraph 4 of TR 97/7). As a broad guide, the taxpayer incurs an outgoing at the time they owe a present money debt they cannot escape (paragraph 5 of TR 97/7). Paragraph 6 of TR 97/7 states the courts have been reluctant to attempt an exhaustive definition of a term such as 'incurred' and then sets out the following number of principles developed by case law, which do not attempt to do this, but help to outline the scope of the definition and assist in most cases in defining whether a loss or outgoing has been incurred. These are:

(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.

In this case, Company Z engaged the professional advisors. The terms of the engagement letters make Company Z liable for the payment of fees. Company Z was invoiced by these professional advisor fees. When invoiced by the professional advisors, it was Company Z who then had a presently existing liability to pay for these fees. However, Company Z did not pay for these professional advisor fees. It was Company X that in fact paid these professional advisor fees. Company X assumed the liability and paid the professional advisor fees pursuant to the Services Agreements and consistent with general practice within the Group and that of performing the role of head office, including that of acquiring and providing financial services to the other operating entities. It accounted for paying these professional advisor fees via its profit and loss. It did not account for these invoices on the basis that it paid the invoices on behalf of the other operating entities via an agency type arrangement.

Therefore, having regard to the above, Company X, upon the assumption of the liability to pay these professional advisor fees and then paying for them, incurred the professional advisor fees.

Accordingly, the costs of the professional advisor fees will be deductible under section 8-1, subject to the exclusions under the negative limbs of section 8-1 applying.

Subsection 8-1 negative limbs

Pursuant to subsection 8-1(2), the negative limbs of the general rule regarding deductibility of expenditure, requires consideration of whether the professional fees incurred by Company X are non-deductible as a consequence of being losses or outgoings precluded from being deductible under section 8-1 to the extent that the loss or outgoing is:

-  capital or of a capital nature,

-  of a private or domestic nature,

-  incurred in relation to exempt income or non-assessable non-exempt income, or

-  otherwise prevented from being deducted under the ITAA 1997.

On these facts, the only relevant provision in the negative limb of section 8-1 is paragraph 8-1(2)(a) which relates to losses or outgoings that are capital or of a capital nature. Therefore, the issue is whether the professional fees expenditure is 'capital or of a capital nature'.

The expression 'capital expenditure' is not a defined term. Whether expenditure is revenue or capital in nature is a question of fact and degree that depends on the particular circumstances of the case, having regard to the principles established by the case law.

The High Court decision in Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CRL 337; (1938) 5 ATD 23; (1938) 1 AITR 403 (Sun Newspapers) is the leading authority on the distinction between revenue and capital expenditure. In Sun Newspapers, Dixon J said at 363:

"There are, I think, three matters to be considered,(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 its 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."

The character of the advantage sought provides important direction. It provides the best guidance as to the nature of the expenditure as it says the most about the essential character of the expenditure itself. This was emphasised in the decision of the High Court in G.P. International Pipecoaters v Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR1 (paragraph 67 of TR 2011/6).

If expenditure produces some asset or advantage of a lasting character for the benefit of the business, it will be considered to be capital expenditure. As stated in Sun Newspapers at 355 per Latham J, an enduring benefit does not require that the taxpayer obtain an actual asset, it may be a benefit which endures, in the way that fixed capital endures. In Foley Brothers Pty Ltd v. FC of T (1965) 13 ATD 562; (1965) 9 AITR 635, outgoings incurred for the purpose of altering the organisation or structure of the profit-yielding subject (including its demise) were considered to be of a capital nature (paragraph 68 of TR 2011/6). In ATO ID 2007/109 Income Tax - Capital Allowances: business related costs - in relation to your business, a company which incurred legal fees and consulting fees in respect of evaluating a merger proposal from an unrelated entity were considered capital expenditure.

The test for determining whether an outgoing is incurred on revenue or capital account primarily depends on what the outgoing is calculated to effect from a practical and business point of view (paragraph 18 of Commissioner of Taxation v Sharpcan Pty Ltd [2019] HCA 36):

Authority is clear that the test of whether an outgoing is incurred on revenue account or capital account primarily depends on what the outgoing is calculated to effect from a practical and business point of view. Identification of the advantage sought to be obtained ordinarily involves consideration of the manner in which it is to be used and whether the means of acquisition is a once-and-for-all outgoing for the acquisition of something of enduring advantage or a periodical outlay to cover the use and enjoyment of something for periods commensurate with those payments. Once identified, the advantage is to be characterised by reference 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; and between an enterprise itself and the sustained effort of those engaged in it. Thus, an indicator that an outgoing is incurred on capital account is that what it secures is necessary for the structure of the business.

The professional advisors were engaged for the purpose of obtaining advice and support in considering the options available. The advice sought was used to determine if the share sale should proceed, under what structure and to whom. The value that any potential investor could bring was critical to the decision-making process.

At the time advisors were engaged it was not known what the preferred future option was, including whether any sale would be a sale of business assets or a sale of shares.

When the decision was made to sell the shares to Overseas Corp, the decision was made by reference to the sale price but also by reference to other considerations.

The above shows that the advantage sought by the expenditure on the professional advisor fees as one related to the purpose of altering the organisation or structure of the profit-yielding subjects; being Company X. The options considered and the considerations taken into account when selling to Overseas Corp were largely based on what it secured for the structure of Company X's business. The expenditure related to the structure of how Company X's business was organised.

'To the extent'

However, both the positive limbs and the negative limbs of section 8-1 state the deductibility of the loss or outgoing to be 'to the extent' it fulfils the criteria in the positive limb of section 8-1 and 'to the extent' it does not fulfil the criteria in the negative limb of section 8-1. 'To the extent' may require an apportionment between different categories of expenditure. The leading comments on apportionment can be found in Ronpibon. The Full High Court (Latham CJ, Rich, Dixon, McTiernan and Webb JJ at p 59, 473), pointed out in relation to the former general deductibility provision:

"... there are at least two kinds of items of expenditure that require apportionment. One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. Of this directors ' fees may be an example. With the latter kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income. "

The professional advisors were also engaged pursuant to the Services Agreements that Company X entered into with the other operating entities. They were engaged as Company X, acting in its capacity of head office for the operating entities, did so according to its obligations pursuant to the Services Agreements and general practice in acquiring and managing the provision of professional services to the Group. The professional advisor fees were paid as Company X had the obligation to do so on behalf of the other operating entities. The professional advisor fees paid consisted of outlays which also served another object indifferently, the undertaking of Company X's daily business.

That is, the professional advisor fees paid by Company X had the character of being related to Company X's capital structure but they also had the character of being in respect of Company X earning its assessable income and in carrying out its business.

Therefore, the professional advisor fees will need to be apportioned between the two objects. This will need to occur on a fair and reasonable assessment of the extent of the relation of the outlay to assessable income.

Conclusion

The professional advisor fees paid by Company X to Consulting Firm and Legal Firm B are deductible under section 8-1 to the extent they relate to the services provided by Company X under the Services Agreements.

Question 2

Section 40-880 allows certain business expenditure to be written off in equal proportions over five income years provided the requirements of the provision are met. Subsection 40-880(2) sets out entitlement to the deduction whilst subsections 40-880(3) and 40-880(4) set out limitations and subsection 40-880(5) sets out the exceptions to the amount deductible under subsection 40-880(2).

According to subsection 40-880(1), the object of section 40-880 is to allow a deduction over 5 years for certain business capital expenditure, incurred on or after 1 July 2005, if:

(a)   the expenditure is not otherwise taken into account; and

(b)   a deduction is not denied by some other provision; and

(c)   the business is, was or is proposed to be carried on for a taxable purpose.

Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6) sets out the Commissioner's views on the interpretation of the operation and scope of section 40-880.

Paragraph 23 of TR 2011/6 states that determining the amount allowable as a deduction under section 40-880 is a multi-step process:

-  First, it is necessary to determine initial entitlement under subsection 40-880(2); and

-  Then, the limitations and exceptions in the subsequent subsections must be considered.

Therefore, it must be determined whether, to the extent that professional advisor fees are not deductible under section 8-1, if they are deductible under section 40-880.

Subsection 40-880(2) - Establishment of an initial entitlement to a deduction

Subject to the limitations and exceptions contained in subsections 40-880(3) to (9), subsection 40-880(2) provides that you can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur:

(a)   in relation to your business; or

(b)   in relation to a business that used to be carried on; or

(c)   in relation to a business proposed to be carried on; or

(d)   to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.

In this case only paragraph 40-880(2)(a) is relevant as the professional advisor fees relate to Company X's current business. In order to determine whether Company X will be entitled to claim a deduction under section 40-880 with respect to the payments made to the professional advisors in the income year, it is necessary to consider whether all the conditions of subsection 40-880(2) are satisfied.

The expenditure must be incurred on or after 1 July 2005

The professional advisor fees were paid by Company X after 1 July 2005. There is no statutory definition of the term 'incurred' for the purposes of section 40-880. As a broad guide, a taxpayer incurs an outgoing at the time they owe a present money debt that they cannot avoid paying (paragraph 62 of TR 2011/6).

Paragraph 63 of TR 2011/6 refers to Taxation Ruling TR 97/7 Income Tax: section 8-1 - meaning 'incurred' - timing of deductions which sets out the following principles developed by case law to help determine whether and when expenditure is incurred in relation to section 8-1. Whether the professional advisor fees were incurred by Company X pursuant to section 8-1 was considered above.

Accordingly, for the same reasons as above, it is considered that the professional advisor fees paid by Company X to the professional advisors were incurred by Company X on or after 1 July 2005 for the purposes of section 40-880.

The expenditure must be capital in nature

The expression 'capital expenditure' is not a defined term for the purposes of section 40-880. Whether expenditure is capital in nature is determined on the facts of each particular case having regard to the principles established by the case law (paragraph 64 of TR 2011/6). Paragraph 66 of TR 2011/6 refers to the classic test for determining whether expenditure is of a capital or revenue nature which is explained in the judgment of Dixon J in Sun Newspapers.

Whether the professional advisor fees paid by Company X were capital or capital in nature pursuant to section 8-1 was considered above according to those case law principles.

Therefore, for the same reasons as above, it is considered that the professional advisor fees paid by Company X are capital expenditure for the purposes of section 40-880.

The capital expenditure must be business related

Relevantly and subject to the specified limitations and exceptions, paragraph 40-880(2)(a) allows a taxpayer to deduct capital expenditure if it is incurred in 'relation to' a business currently carried on by them. 'In relation to' is not a defined term for the purposes of section 40-880 and so it takes its ordinary meaning (paragraph 76 of TR 2011/6).

The expression 'in relation to' denotes the proximity required between the expenditure on the one hand and the current business on the other. For capital expenditure to be 'in relation to' a business there must be a sufficient and relevant connection between the expenditure and the business (paragraph 15 of TR 20011/6).

Whether capital expenditure is truly business expenditure is determined by the facts. Determining whether the expenditure has the character of a business expense can be approached by asking what the expenditure is for, in the sense of identifying the need or object that the expenditure serves. If the facts show that the expenditure satisfies the ends of the relevant business, it will have the character of business expenditure (paragraph 79 of TR 2011/6).

Paragraph 84 of TR 2011/6 states that expenditure relating to the ownership of the entity carrying on the business is not business related capital expenditure unless it can be demonstrated that the change of ownership serves an objective of the business. This is demonstrated in Example 6 of TR 2011/6:

Example 6

85. Company B approaches Company A with a merger proposal. To evaluate the proposal Company A incurs capital expenditure on professional fees for legal, corporate and tax advice and for the performance of financial due diligence. The object of the expenditure is to determine the commercial merit of the proposal including the effect on the company's structure and its trading operations. The expenditure is in relation to Company A's business for the purpose of paragraph 40-880(2)(a).

ATO ID 2007/109 also provides an example where a company which was approached by an unrelated entity with a proposal for the two companies to merge relevantly incurred consulting fees and legal fees in relation to this eventual merger. The evaluation of the merger proposal involved the taxpayer considering how the implementation of the proposal would affect the structure by which the taxpayer carried on its business, the profit yielding structure of that business and the business trading operations. The merger required changes to the constitution of the taxpayer and the shareholdings. The consulting and legal fees were found to be capital expenditure in relation to the taxpayer's business for the purpose of paragraph 40-880(2)(a).

By analogy, Company X also incurred capital expenditure in the form of the professional advisor fees in relation to the proposed sale of its shares or assets. It had to evaluate Overseas Corp's proposal in terms of the final sale structure, how it would affect its business on a day to day basis, how Company X would be able to access Overseas Corp's global network and the synergies the sale to Overseas Corp would bring to it and the consequences to the profit yielding structure.

Therefore, Company X's payment of professional advisor fees was capital expenditure in relation to a business.

The relevant business and expenditure which serves more than one purpose or object

The term 'business', is defined in subsection 995-1(1) as any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The nature and scope of a business for the purposes of section 40-880 is a question of fact in each case.

The reference in paragraph 40-880(2)(a) to 'your business' is a reference to the taxpayer's overall business rather than a particular undertaking or enterprise within the overall business. Where the taxpayer is the head company of a consolidated group, 'your business' refers to the overall business of the head company (paragraph 72 of TR 2011/6).

Paragraph 40-880(2)(a) gives an entitlement to a deduction for capital expenditure the taxpayer incurs in relation to their business. The expenditure must relate to an existing business that the taxpayer is carrying on at the time they incur the expenditure (paragraph 98 of TR 2011/6).

Under this paragraph, only the taxpayer carrying on the business, and no other taxpayer, is entitled to a deduction (paragraph 99 of TR 2011/6).

In this case, what needs to be considered is whether the professional advisor fees were incurred in relation to the current business being carried on by Company X. Company X's overall business rather than a particular undertaking or enterprise within the overall business is thus one of fulfilling the corporate head office function, employer of the management team, foreign exchange hedging and of land ownership. The business of Company X does not consist of every aspect of the whole operation. The other operating entities each undertake different businesses of the operation. Further there is no income tax consolidated group so as to say 'your business' refers to the overall business of the head company.

Further, paragraphs 24 and 25 of TR 2011/6 state that:

24....the Commissioner's view the absence of the expression 'to the extent that' in subsection 40-880(2) does not prevent an apportionment of expenditure on a single thing or service which serves more than one purpose or object. This is equally so whether the thing or service serves distinct and separate purposes or objects, or whether the thing or service serves two or more purposes or objects indifferently.

25. The basis for any such apportionment must be fair and reasonable.

Paragraphs 135 to 141 of TR 2011/6 state that in general 40-880 is structurally similar to section 8-1 and Ronpibon is also relevant here regarding apportionment. The apportionment on a fair and reasonable basis of the professional advisor fees was considered above in relation to section 8-1.

For similar reasons, the professional advisor fees to the extent they are in relation to Company X's business would require to be apportioned on a fair and reasonable basis.

Accordingly, the professional advisor fees paid by Company X are considered to be incurred by Company X to the extent they relate to Company X's current business as there is a sufficient and relevant connection between the professional advisor fees and the current business of Company X for the purposes of paragraph 40-880(2)(a).

Limitations on the amount of expenditure allowable as a deduction

Subsections 40-880(3) and (4) both contain a 'taxable purposes test' which applies to the expenditure identified in subsection 40-880(2) by reference to the extent to which it relates to carrying on the business for a taxable purpose. Subsections 40-880(3) and (4) may apply to limit deductibility of the capital expenditure to the extent that it relates to that business being carried on for a taxable purpose.

If the capital expenditure is incurred in relation to more than one business identified in subsection 40-880(2) and is apportioned accordingly, the limitation in subsections 40-880(3) and (4) is applied to each apportioned amount on the basis of the extent of the taxable purpose of the business to which that amount relates (paragraph 152 of TR 2011/6).

Subsection 40-880(3)

Relevantly, subsection 40-880(3) provides that "you can only deduct the expenditure, for a *business that you carry on to the extent that the business is carried on for a *taxable purpose."

Taxable purpose is defined in subsection 40-25(7) to include 'the purpose of producing assessable income'. The 'purpose of producing assessable income' is defined in subsection 995-(1) as being something done:

-  for the purpose of gaining or producing assessable income; or

-  in carrying on a business for the purpose of gaining or producing assessable income.

Company X only has assessable income and has no exempt income or non-assessable non-exempt income

Therefore subsection 40-880(3) will not limit the deductibility of the professional advisor fees.

Subsection 40-880(4)

Subsection 40-880(4) is not applicable here as it relates to the deductibility of capital expenditure for a business that another entity used to carry on or proposes to carry on.

The professional advisor fees were made in relation to Company X's current business and not a business that another entity used to carry on. Therefore, subsection 40-880(4) has no application.

Exceptions to allowing a deduction

Once entitlement is initially established under subsection 40-880(2) and the limitations in subsection 40-880(3) or 40-880(4) are considered, further restrictions may be placed on the amount of expenditure which is deductible. That is, further restrictions may apply to the amount of the professional advisor fees which was apportioned on a fair and reasonable basis as being deductible under subsection 40-880(2). There are a further 12 possible restrictions which are contained in subsections 40-880(5), 40-880(8) and 40-880(9).

The limitations and exceptions contained in subsections 40-880(3)-(9) are not relevant in this case and will not apply to reduce the deductibility of the apportioned professional advisor fees under section 40-880.

Conclusion

To the extent the professional advisor fees are not deductible under section 8-1, Company X is entitled to deduct that capital expenditure on a fair and reasonable basis in equal proportions over a period of 5 income years in accordance with subsection 40-880(2).

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