1051812529946 | Legal database

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Edited version of private advice

Authorisation Number: 1051812529946

Date of advice: 25 March 2021

Ruling

Subject: Deductibility of payments

Question

Are repayments made pursuant to a funding agreement with a government agency deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1/07/20XX

Relevant facts and circumstances

A government entity has agreed to provide you with funding for your project subject to the terms and conditions of the Funding Agreement executed on xx.

The Funding Agreement relates to the development of technology.

The Commissioner made a private ruling on xx, pursuant to section 359-15 of the Taxation Administration Act 1953, that the funding provided under the Funding Agreement is assessable income pursuant to section 6-5 of the ITAA 1997.

Funding Agreement - repayment of funding

You have provided a copy of the Funding Agreement.

Under that Funding Agreement you are required to pay a percentage of the revenue you receive from that project for a period to the government agency up to the specified amount or you may pay the amount as a lump sum.

Reasons for decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for that purpose. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible (subsection 8-1(2) of the ITAA 1997).

In determining whether a deduction for the Upside Recoupment payments are allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634, (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the Upside Recoupment payments follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

In paragraph 9 of Taxation Ruling TR 95/33 the Commissioner states that an outgoing will be characterised as necessarily incurred in carrying on the business of the taxpayer for the purpose of earning the assessable income where the expenditure has the necessary connection with the operations or activities which more directly gain or produce assessable income.

The judgment of Dixon J in Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337 (1938) 5 ATD 87 (the Sun Newspapers Case) is a leading exposition of the matters that must be examined in order to differentiate whether an amount is capital or revenue in nature.

Accordingly, the following indicators, consistent with the matters raised by Dixon J, in the Sun Newspapers Case point towards an expense being capital in nature:

• The expenditure is related to the business structure itself. This includes the establishment, replacement or enlargement of the profit yielding structure of business rather than the money earning process.

• The nature of the asset has lasting and enduring benefit to the business.

• The payment is made 'once and for all' being a single final provision for the future use or enjoyment of the asset rather than a periodical outlay to cover its use for that period.

• The payment is not a loss or outgoing of a capital nature.

Under the Funding Agreement, you are required to make the payments in return for the granting of and use of the funds to carry on the business of developing and exploiting technology. The payment is neither a repayment of a loan nor is it interest, but a payment that arises under the funding agreement. The expenditure is not of a capital nature and is required under the terms of the funding agreement, where revenue is derived, until such time as the recoupment cap is met. Although you are developing technology to exploit it rather than necessarily to receive grants, a requirement to repay the grant arises in the course of your business and does not arise on capital account (because it does not produce a lasting benefit and arises as a consequence of the carrying on of your business). Consequently, in these circumstances, the payments are incurred in carrying on your business of deriving income from the technology and is deductible under section 8-1 of the ITAA 1997.

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