Edited version of private advice

Authorisation Number: 1052124542585

Date of advice: 7 June 2023

Ruling

Subject: Deductibility of advisor costs

Question 1

Are the 'Advisor Costs' (as defined in the facts) incurred by Company A in the year ended 30 June 20XX deductible over five years under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are the 'Tax Advisory Costs' (as defined in the facts) incurred by Company A in the year ended 30 June 20XX deductible under section 25-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1.    A Merger Agreement was completed between Company A and Company B.

2.    Company A incurred Advisor Costs' (as defined in the facts) in relation to the merger.

3.    Company A also incurred 'Tax Advisory Costs' (as defined in the facts) which it paid to Advisor A.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 25-5(1)

Income Tax Assessment Act 1997 Subsection 25-5(2)

Income Tax Assessment Act 1997 Subsection 25-5(4)

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 legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

Summary

The Advisor Costs, as defined in the Relevant Facts, are deductible over five years as business capital expenditure under section 40-880 of the ITAA 1997.

Detailed reasoning

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

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 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, and provides:

•         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.

Subsection 40-880(2)

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 five 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 Advisor Costs (as defined in the Facts) relate to Company A's current business.

The expenditure must be incurred on or after 1 July 2005

Tax Laws Amendment (2006 Measures No. 1) Act 2006 repealed the former section 40-880 and replaced it with the current provision which applies to business related capital expenditure incurred on or after 1 July 2005.

The Advisor Costs were incurred by Company A 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 of 'incurred' - timing of deductions, which sets out principles developed by case law to help determine whether and when expenditure is incurred in relation to section 8-1. The principles established by case law regarding the meaning of the word 'incurred' in section 8-1 also apply to section 40-880.

Paragraph 6 of TR 97/7 states the courts have been reluctant to attempt an exhaustive definition of a term such as 'incurred' and sets out the following 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 (as reproduced in paragraph 63 of TR 2011/6):

(a)  a taxpayer need not actually have paid any money to have incurred an outgoing provided they are definitively committed. Accordingly, expenditure may be incurred even though it remains unpaid, provided the taxpayer is 'completely subjected' to the obligation to pay. 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;

(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.

Company A engaged professional advisors, for services rendered in relation to the Transaction.

It is considered that the Advisor Costs paid by Company A to the professional advisors were incurred by Company A 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 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 (paragraph 64 of TR 2011/6).

The High Court decision in Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 23; (1983) 1 AITR 403 (Sun Newspapers) is the leading authority on the distinction between revenue and capital expenditure. In Sun Newspaper, 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."

TR 2011/6 provides:

67. The character of the advantage sought provides important direction. It provides the best guide 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 ATR 1 (paragraph 67 of TR 2011/6).

68. 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.

The professional advisors were engaged for the purposes of obtaining advice and support in relation to the Transaction. As outlined in the Relevant Facts, there was a strong commercial rationale for the merger.

The present circumstances are analogous with the example provided in ATO ID 2007/109 Income tax - Capital Allowances: business related costs - in relation to your business which considers a company that incurred legal fees and consulting fees (relating to corporate advice, tax advice, tax and financial due diligence and an independent expert opinion) in respect of evaluating a merger proposal from an unrelated entity. These fees were considered capital expenditure incurred by the taxpayer for the purposes of section 40-880.

Having regard to the Relevant Facts, it is considered that the Advisor Costs were incurred to secure enduring advantages and long term benefits to Company A through evaluating and implementing the Transaction, and are therefore capital in nature.

The capital expenditure must be business related

Subject to the limitations and exceptions contained in subsections 40-880(3) to (9), 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.

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 (paragraph 20 of TR 2011/6).

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 21 of TR 2011/6).

'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).

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 a business expense (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 object 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 purposes of paragraph 40-880(2)(a).

Paragraph 40-880(2)(a) is relevant as the Advisor Costs (as defined in the Relevant Facts) relate to Company A's existing business which was intended to continue and grow as a result of the Transaction.

Having regard to the Relevant Facts, it is considered there is a sufficient and relevant connection between Company A's incurrence of the Advisor Costs and its business. Accordingly, paragraph 40-880(2)(a) is satisfied.

Limitations on the amount of expenditure allowable as a deduction

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

Subsection 40-880(3)

Relevantly, subsection 40-880(3) provides:

(3) You can only deduct the expenditure, for a *business that you carry on, used to carry on or propose to 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:

(a)  for the purposes of gaining or producing assessable income; or

(b)  in carrying on a business for the purpose of gaining or producing assessable income.

Assessable income has the meaning given by sections 6-5, 6-10, 6-15, 17-10 and 17-30 of the ITAA 1997 (subsection 995-1(1)) and is taken to mean income that is assessable pursuant to the ITAA 1997. This is income that is assessable in Australia. Since its establishment, Company A has carried on a business in Australia and has derived assessable income.

As set out in paragraph 35 of TR 2011/6:

As a general rule the extent to which a business is, was or is proposed to be carried on for a taxable purpose is determined by comparing the amount of any exempt income or non-assessable non-exempt income the business derived or will derive with total income (that is, assessable income plus exempt income plus non-assessable non-exempt income). This percentage is then applied to the amount of expenditure to reduce the deduction.

The Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 further explains:

A taxpayer whose business is not carried on for a taxable purpose cannot deduct expenditure to that extent. This limitation is not an annual test: that is, it is not to limit deductions to only the income years in which the business is carried on for a taxable purpose. The test as to the taxable purpose of the business is applied - as at the time the expenditure is incurred - to the taxable purpose of the business by reference to all known and predictable facts in all years.

Accordingly, subsection 40-880(2) requires a determination as at the time the capital expenditure was incurred, of the extent to which the business was carried on for a taxable purpose by reference to all known and predictable facts in all years.

Paragraph 27 of TR 2011/6 also notes that if the expenditure related to the whole of the business but part of the business is carried on to derive exempt income or non-assessable non-exempt income, then to that extent the expenditure will not be deductible.

Paragraph 41 of TR 2011/6 provides that:

41.The taxable purpose of the business is tested as at the time the expenditure is incurred. Where expenditure is incurred for an existing or proposed business, the test takes into account all known and predictable facts about the taxable purpose of the business in future years - not just in the year the expenditure is incurred or the years for which a deduction under section 40 880 is sought.

Accordingly, at the time Company A incurred the Advisor Costs, Company A was carrying on business for a taxable purpose. As such, subsection 40-880(3) will not apply to limit Company A's deduction under section 40-880.

Subsection 40-880(4)

Subsection 40-880(4) is not applicable to the present case 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 Advisor Costs were incurred in relation to Company A's current business and not a business that another entity used to carry on or proposes 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 under section 40-880. That is, further restrictions may apply to the amount of the Advisor Costs which are deductible under section 40-880(2). There are a further twelve possible restrictions which are contained in subsection 40-880(5), 40-880(8) and 40-880(9).

These are:

1.    Expenditure which forms part of the cost of a depreciating asset - paragraph 40-880(5)(a)

2.    Expenditure is deductible under another provision - paragraph 40-880(5)(b)

3.    Expenditure that forms part of the cost of land - paragraph 40-880(5)(c)

4.    Expenditure in relation to a lease or other legal or equitable right - paragraph 40-880(5)(d)

5.    The expenditure would otherwise be taken into accounting in working out a profit including in the taxpayer's assessable income, or a loss that they can deduct - paragraph 40-880(5)(e)

6.    The expenditure could be taken into account in working out the amount of a capital gain or capital loss from a CGT event - paragraph 40-880(5)(f)

7.    Another provision would make the expenditure non-deductible if it was not of a capital nature - paragraph 40-880(5)(g)

8.    Another provision expressly prevents the expenditure being taken into account as described in paragraphs 40-880(5)(a) to (f) for a reason other than the expenditure being of a capital nature - paragraph 40-880(5)(h)

9.    The expenditure is of a private or domestic nature - paragraph 40-880(5)(i)

10.  The expenditure is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income - paragraph 40-880(5)(j)

11.  The expenditure is excluded from the cost of a depreciating asset or the cost base or the reduced cost base of a CGT asset because of a market value substitution rule - subsection 40-880(8)

12.  The expenditure is a return of an amount previously received or a return on or of debt or equity - subsection 40-880(9)

Subsection 40-880(5)

Expenditure which forms part of the cost of a depreciating asset - paragraph 40-880(5)(a)

Paragraph 40-880(5)(a) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that it forms part of the cost of a depreciating asset that they hold, used to hold or will hold.

Company A does not hold, did not used to hold or will hold any depreciating asset to which the Advisor Costs relate. Therefore, the Advisor Costs do not form part of the cost of a depreciating asset as defined in Subdivision 40-C.

Accordingly, paragraph 40-880(5)(a) does not exclude the Advisor Costs from deductibility under section 40-880.

Expenditure deductible under another provision - paragraph 40-880(5)(b)

Paragraph 40-880(5)(b) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent they can deduct an amount for it under a provision of the income tax law other than section 40-880.

The Advisor Costs do not qualify for a deduction elsewhere under the income tax law. Therefore, paragraph 40-880(5)(b) has no application.

Accordingly, paragraph 40-880(5)(b) does not exclude the Advisor Costs from deductibility under section 40-880.

Expenditure that forms part of the cost of land - paragraph 40-880(5)(c)

Paragraph 40-880(5)(c) provides that the taxpayer cannot deduct expenditure they incur to the extent it forms part of the cost of land.

The Advisor Costs do not relate to acquisition of land and therefore do not form part of the cost of land for the purposes of paragraph 40-880(5)(c).

Accordingly, paragraph 40-880(5)(c) does not exclude the Advisor Costs from deductibility under section 40-880.

Expenditure in relation to a lease or other legal or equitable right - paragraph 40-880(5)(d)

Paragraph 40-880(5)(d) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that it is in relation to a lease or other legal or equitable right.

The expression 'in relation to a lease or other legal or equitable right' is not defined in legislation. Taxation Ruling TR 2011/6 suggests that the 'rights' in question do not include all legal rights but only those rights that relate to leases or other legal or equitable rights that fall short of full ownership of an asset. Paragraph 235 of TR 2011/6 states that:

... paragraph 40-880(5)(d) relates to rights granted over the use of physical and intangible business asset... at a practical level the paragraph does not have a wide operation because the other, more specific exceptions in subsection 40-880(5) capture the majority of expenditure relating to leases or other legal or equitable rights.

The Advisor Costs were not made in relation to a lease nor other legal or equitable rights for the purposes of paragraph 40-880(5)(d).

Accordingly, paragraph 40-880(5)(d) does not exclude the Advisor Costs from deductibility under section 40-880.

The expenditure would otherwise be taken into account in working out a profit included in the taxpayer's assessable income or loss that they can deduct - paragraph 40-880(5)(e)

Paragraph 40-880(5)(e) provides that to the extent expenditure incurred by the taxpayer is taken into account in working out a profit included in their assessable income or a deductible loss, it cannot be deducted under section 40-880.

As outlined above in the Relevant Facts, the Advisor Costs are capital expenditure that was not taken into account in working out a profit included in Company A's assessable income or a loss that it could deduct.

Accordingly, paragraph 40-880(5)(e) does not exclude the Advisor Costs from deductibility under section 40-880.

The expenditure could be taken into account in working out the amount of a capital gain or capital loss from a CGT event - paragraph 40-880(5)(f)

Paragraph 40-880(5)(f) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that it could be taken into account in working out the amount of a capital gain or capital loss from a CGT event.

Section 105-8(1) of the ITAA 1997 defines a CGT asset as being:

(a)  any kind of property; or

(b)  a legal or equitable right that is not property.

Section 105-5(2) includes examples of CGT assets, being:

•         Land and buildings;

•         Shares in a company;

•         Options;

•         Debts owed to you; and

•         A right to enforce a contractual obligation.

The payments made by Company A for the various services outlined above are capital in nature, but were not made in consideration for any CGT assets owned by Company A. The expenditure was not incurred in respect of any kind of property owned by Company A.

As outlined above in the Relevant Facts, the Advisor Costs were not able to be taken into account in working out the amount of a capital gain or capital loss from a CGT event.

Accordingly, paragraph 40-880(5)(f) does not exclude the Advisor Costs from deductibility under section 40-880.

Another provision would make the expenditure non-deductible if it was not of a capital nature - paragraph 40-880(5)(g)

Paragraph 40-880(5)(g) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that a provision of the income tax law other than section 40-880 would expressly make the expenditure non-deductible if it were not of a capital nature.

No relevant provision has been identified which would expressly make the Advisor Costs non-deductible if they were not capital in nature. For the exclusion in paragraph 40-880(5)(g) to apply, the expenditure must be expressly prevented from being deductible. Therefore, expenditure that merely fails to be deductible under a general provision (such as section 8-1) is not excluded under the paragraph.

Accordingly, paragraph 40-880(5)(g) does not exclude the Advisor Costs from deductibility under section 40-880.

Another provision expressly prevents the expenditure being taken into account as described in paragraphs 40-880(5)(a) to (f) for a reason other than the expenditure being of a capital nature - paragraph 40-880(5)(h)

Paragraph 40-880(5)(h) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that a provision of the income tax law other than this section expressly prevents the expenditure being taken into account as described in paragraphs 40-880(5)(a) to 40-880(5)(g) for a reason other than the expenditure being of a capital nature.

No relevant provision can be identified that expressly prevents the Advisor Costs being taken into account as described in paragraphs 40-800(5)(a) to 40-880(5)(f) for a reason other than the payment being of a capital nature.

Accordingly, paragraph 40-880(5)(h) does not exclude the Advisor Costs from deductibility under section 40-880.

The expenditure is of a private or domestic nature - paragraph 40-880(5)(i)

Paragraph 40-880(5)(i) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that it is expenditure of a private or domestic nature.

The Advisor Costs were incurred in relation to Company A's business. Therefore, the expenditure was not of a private or domestic nature.

Accordingly, paragraph 40-880(5)(i) does not exclude the Advisor Costs from deductibility under section 40-880.

The expenditure is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income - paragraph 40-880(5)(j)

Paragraph 40-880(5)(j) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income.

As the Advisor Costs were not incurred in relation to the gaining or producing of exempt or non-assessable non-exempt income, paragraph 40-880(5)(j) will not apply to limit the deduction.

Subsection 40-880(8)

The expenditure is excluded from the cost of a depreciating asset or the cost base or the reduced cost base of a CGT asset because of a market value substitution rule

Subsection 40-880(8) provides that the taxpayer cannot deduct anything under this section for an amount of expenditure that, because of a market value substitution rule, was excluded from the cost of a depreciating asset or the cost base or reduced cost base of a CGT asset.

A market value substitution rule replaces what would otherwise be the cost of a depreciating asset or the cost base or reduced cost base of a CGT asset with the market value of the asset. A market value substitution rule will apply, for example, if the taxpayer acquires an asset for more than the asset's market value and the taxpayer did not deal with another party to the transaction at arm's length (section 112-20).

As stated above, the Advisor Costs do not form part of the cost base or reduced cost base of any CGT assets or of the cost of a depreciating asset. As such, a market value substitution rule does not apply in this situation.

Accordingly, subsection 40-880(8) does not apply to exclude the Advisor Costs from deductibility under section 40-880.

Subsection 40-880(9)

The expenditure is an amount previously received or a return on or of debt or equity

Subsection 40-880(9) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur:

(a)  by way of returning an amount they have received (except to the extent that the amount was included in their assessable income or taken into account in working out an amount so included); or

(b)  to the extent that, for another entity, the amount is a return on or of:

(i)    an equity interest; or

(ii)   a debt interest that is an obligation of theirs.

Subsection 40-880(9) ensures that amounts that comprise the transfer or distribution of or on funds, that comprise repayments or that comprise amounts that do not otherwise give rise to any income tax consequences are not deductible under section 40-880. Such amounts do not represent an economic loss to the taxpayer.

The Advisor Costs are not a return of an amount previously received by Company A or a return on or of an equity interest or a debt interest for the purposes of subsection 40-880(9).

Accordingly, subsection 40-880(9) does not apply to exclude the Advisor Costs from deductibility under section 40-880.

Subsections 40-880(6) and 40-880(7)

It is not necessary to consider the operation of subsection 40-880(6) because a deduction is not limited by paragraphs 40-880(5)(d) or (5)(f).

Subsection 40-880(7) also has no application because the Advisor Costs were not made in relation to a business proposed to be carried on.

The limitations and exceptions contained in subsections 40-880(3) - (9) therefore will not apply to limit the deductibility of the Advisor Costs under section 40-880.

Conclusion

Having regard to the Relevant Facts, the Advisor Costs are deductible over a period of five income years, commencing in the year the Advisor Costs were incurred by Company A, pursuant to section 40-880.

Question 2

Summary

The Tax Advisory Costs (as defined in the Facts) are deductible under section 25-5 as they were incurred by Company A in managing its tax affairs and were not capital expenditure for the purposes of subsection 25-5(4).

Detailed Reasoning

Section 25-5 allows a deduction for expenditure incurred in managing one's own tax affairs and complying with a legal obligation that relates to an entity's tax affairs.

Subsection 25-5(1) states:

You can deduct expenditure you incur to the extent that it is for:

(a)  managing your *tax affairs; or

(b)  complying with an obligation imposed on you by a *Commonwealth law, insofar as that obligation relates to the *tax affairs of an entity; ...

The exclusions in subsections 25-5(2) and 25-5(4) are relevant. These subsections provide:

(2) You cannot deduct under subsection (1):

...

(e) a fee or commission for advice about the operation of a *Commonwealth law relating to taxation, unless that advice is provided by a *recognised tax advisor.

...

(4) You cannot deduct capital expenditure under subsection (1). However, for this purpose, expenditure is not capital expenditure merely because the tax affairs concerned relate to matters of a capital nature.

Example: Under this section, you can deduct expenditure you incur in applying for a private ruling on whether you can depreciate an item of property.

Meaning of tax affairs

Subsection 995-1(1) defines 'tax affairs' to mean 'affairs relating to *tax'.

Subsection 995-1(1) states that 'tax' means:

(a)  income tax imposed by the Income Tax Act 1986, as assessed under this Act; or

(b)  income tax imposed as such by any other Act, as assessed under this Act.

Meaning of recognised tax adviser

Subsection 995-1(1) states that 'recognised tax adviser' means:

(a)  a *registered tax agent, BAS agent or tax (financial) adviser; or

(b)  a legal practitioner.

As such, Advisor A falls within the definition of a 'recognised tax adviser'.

In Falcetta v FCT (2004) FCAFC 117, his Honour considered the following relevant with regard to the construction of section 25-5:

19. Section 69, his Honour said, replaced a much narrower definition which had been introduced by the 1936 Act allowing a deduction for amounts paid to a tax agent for the preparation of an income tax return for the taxpayer. He considered it was obvious that Parliament intended that the scope of 'tax-related expenses' in s 69 should include expenditure which went beyond the preparation of an income tax return and that a deduction was to be allowed for the cost of obtaining professional advice, not only where the tax advice related to the taxpayer's own tax affairs, but also where it related to compliance with obligations imposed upon the taxpayer so far as those obligations related to the tax affairs of another taxpayer. Obligations imposed upon a taxpayer where he or she was the public officer of some company or trust estate were said to be the most obvious of the cases falling within the 'obligation' limb of s 69 (2)(b).

Application of section 25-5 to the Tax Advisory Costs

Based on the Relevant Facts, the tax invoices provided, and the detail provided on each tax invoice, the Commissioner considers that the Tax Advisory Costs paid to Advisor A were for managing Company A's tax affairs for the purposes of section 25-5.

Exclusion under subsection 25-5(4)

Subsection 25-5(4) states that you cannot deduct capital expenditure under subsection (1). This is qualified by the proviso that 'expenditure is not capital expenditure merely because the tax affairs concerned relate to matters of a capital nature'.

TR 2011/6 provides at paragraphs 64 to 66:

...'Capital expenditure' is not a defined term. 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. The High Court decision in Sun Newspapers is the leading authority on the distinction between revenue and capital expenditure. In Sun Newspaper, 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."

Paragraph 67 of TR 2011/6 provides:

The character of the advantage sought provides important direction. It provides the best guide 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 ATR 1 (paragraph 67 of TR 2011/6).

As per the Reasons for Decision for Question 1, the Transaction is considered to be one of capital in nature, however the proviso in subsection 25-5(4) indicates that costs incurred by a taxpayer for managing tax affairs may still be deductible under section 25-5 even though the broader matter it relates to may be capital in nature.

In Drummond v FC of T [2005] FCA 1129, the Federal Court commented that:

an amount paid "for" tax advice in relation to the establishment of a superannuation fund structure would be deductible, but that any amount expended for establishing the structure (i.e. implementation of the structure) would not be for "managing the taxpayer's tax affairs" and would be capital expenditure.

It is considered that the specific cost items that together form the Tax Advisory Costs are not capital expenditure; and are therefore not excluded from being deductible by virtue of subsection 25-5(4).

Accordingly, the Tax Advisory Costs paid to Advisor A are deductible under section 25-5 as they were incurred by Company A in managing its tax affairs.

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