Edited version of private ruling

Authorisation Number: 1011666100593

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Ruling

Subject: Business related costs under section 40-880 of the Income Tax Assessment Act 1997

Issue

Is the Relevant Expenditure incurred by the taxpayer deductible under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods

Income year ended 30 June 2010

Income year ended 30 June 2011

Income year ended 30 June 2012

Income year ended 30 June 2013

Income year ended 30 June 2014

The scheme commenced on

Income year ended 30 June 2010

Relevant facts

The taxpayer is an Australian resident company.

The taxpayer owned and operated certain assets. It carried on business through Company A and Company B. Company A is a resident of Australia and Company B is a non-resident company.

External management arrangements

Since its establishment, the taxpayer was externally managed by the Manager Company.

The Manager Company is a wholly-owned Australian resident subsidiary of the Manager Group.

The Manager Company provided management services to the taxpayer and other entities.

To enable the Manager Company to provide these management services, a related entity in the Manager Group provided certain services and resources to the Manager Company under the Agreement.

The resources provided by the related entity were not exclusively provided to the Manager Company.

The Agreement had no set term, but a term of the Agreement enabled the parties to terminate on such terms as the parties agree.

The Transaction

The taxpayer announced a proposal to restructure its management structure (the Transaction). The Transaction involved the acquisition of the Manager Company by the taxpayer and termination of the Agreement.

The taxpayer and relevant Manager Group entities entered into a number of agreements collectively referred to as the Transaction Documents.

Under the Transaction Documents, an amount would be payable by the Manager Company to the Manager Group immediately after the Manager Company was acquired by the taxpayer (the Relevant Expenditure).

The Relevant Expenditure is consideration for:

§ the Manager Group agreeing to release the Manager Company from its obligation to pay fees under the Agreement, and

§ the Manager Group's co-operation and assistance in implementing the Transaction.

The Relevant Expenditure was negotiated at arm's length.

The Relevant Expenditure was not consideration for the actual provision of any assets, services or resources; nor did it constitute consideration for the acquisition of the Manager Company by the taxpayer. The provision of each of the assets, services and resources, and the acquisition of the Manager Company were subject to separate agreements which were not part of the Transaction Documents.

No accounting goodwill was recognised in relation to the acquisition of the Manager Company.

The taxpayer acquired all of the shares of the Manager Company.

The Relevant Expenditure was incurred immediately after completion of the transfer of the shares of the Manager Company to the taxpayer. The taxpayer provided sufficient funds to the Manager Company for payment of the Relevant Expenditure.

The Manager Company paid the Relevant Expenditure to the Manager Group.

The Agreement was terminated and the Transaction completed.

Taxpayer's business

After the Transaction, the taxpayer became the head company of a tax consolidated group, which owned certain assets in Australia. The taxpayer operated its business through the use of those assets (asset operations).

After implementation of the Transaction, the Manager Company became a subsidiary member of the tax consolidated group and continues to provide management services to entities within the tax consolidated group.

The taxpayer carries on business entirely for a taxable purpose and does not currently derive, nor does it anticipate that it will derive in future years, any exempt income or non-assessable non-exempt income. No dividends are expected from controlled offshore subsidiaries.

Relevant legislative provisions

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(5)

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 108-5

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 701-1

Income Tax Assessment Act 1997 Subsection 701-1(1)

Income Tax Assessment Act 1997 Subsection 701-1(2)

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

Reasons for decision

Section 40-880 of the ITAA 1997 provides a deduction over five years for capital expenditure incurred in relation to a business, to the extent that none of the limitations or exclusions apply.

DEDUCTION FOR BUSINESS RELATED COSTS

Subject to the limitations and exceptions contained in subsections 40-880(3) to (9), subsection 40-880(2) of the ITAA 1997 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.

On the facts, there is no issue of the Relevant Expenditure being incurred in relation to a business that used to be carried on or in relation to a business proposed to be carried on. Further there is no issue of paragraph 40-880(2)(d) of the ITAA 1997 applying on the facts. Accordingly, the Relevant Expenditure falls for consideration under paragraph 40-880(2(a).

Business capital expenditure

Section 40-880 of the ITAA 1997 only applies to certain business capital expenditure. The phrase 'business capital expenditure' is not defined in the ITAA 1997.

Paragraph 2.18 of the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 (the EM) provides that what constitutes 'business capital expenditure' is to be determined on a case by case basis having regard to the general principles established by the Courts.

In Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 (Sun Newspapers) Dixon J set down three matters to consider when deciding whether an expense is of capital or revenue nature:

a) character of the advantage sought by the outgoing;

b) the manner in which the advantage is to be used, relied upon or enjoyed by the taxpayer; and

c) the means adopted to obtain the advantage, i.e. recurring payments for periods commensurate with payment of a final provision to secure future use or enjoyment.

Consistent with the matters raised by Dixon J, the following indicators point towards an expense being capital in nature:

§ the expenditure is related to the business structure itself;

§ the nature of the asset has a 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.

In this case, the Relevant Expenditure relates to a restructure of the management of the business and is a once-off payment intended to effect a lasting and enduring benefit to the taxpayer's business. As such, the Relevant Expenditure is characterised as an outgoing of a capital nature.

Incurred

To be deductible under section 40-880 of the ITAA 1997, the business capital expenditure must have been incurred. There is no statutory definition of the word 'incurred'.

It was accepted by the majority of the High Court in Coles Myer Finance Limited v. FC of T (1993) 176 CLR 640; (1993) 25 ATR 95; 93 ATC 4214 (Coles Myer Finance) that the present existence of a legal liability to meet expenditure at a later date establishes an incurrence of expenditure. The majority decision in Coles Myer Finance was endorsed by the Commissioner in Taxation Ruling 94/26, which provides that in most cases, where a loss has not been realised or an outgoing has not been made, a presently existing pecuniary liability will be a necessary prerequisite to an expense being incurred.

On the facts, the Relevant Expenditure was incurred by the taxpayer.

Carrying on a business

Section 40-880 is concerned with expenditure that has the character of a business expense because it is relevantly related to your business. It is therefore necessary to determine whether the taxpayer is carrying on a business for the purposes of section 40-880.

The term 'business' is defined in subsection 995-1(1) of the ITAA 1997 to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Factors considered in determining whether a business is being carried on include:

§ profitability - the fact profit is being made is strong indication that a business is being carried on

§ size - the bigger the operation, the more likely a business is being carried on

§ effort - if the activities involve a substantial and regular effort over a period of time, they are more likely to constitute a business

§ business records - detailed business records are a strong indicator of the existence of a business.

On the facts, the taxpayer is carrying on a business through its asset operations.

Capital expenditure you incur 'in relation' to your business

In considering the phrase 'in relation to' contained within subsection 40-880(2) of the ITAA 1997, paragraph 2.25 of the EM states that the provision is concerned with the expenditure that has the character of a business expense because it is relevantly related to the business.

In First Provincial Building Society Limited v. Federal Commissioner of Taxation (1995) 56 FCR 320; (1995) 95 ATC 4145; (1995) 30 ATR 207, Hill J. considered the phrase 'in relation to' within the context of paragraph 26(g) of the Income Tax Assessment Act 1936 . He considered the words 'in relation to' in that context included a relationship that may either be direct or indirect, provided that the relationship consisted of a real connection, but that a merely remote relationship is insufficient.

It is therefore necessary to consider the legislative context of subsection 40-880(2) of the ITAA 1997 in order to determine whether there is a sufficient and relevant connection between the incurrence of the expenditure and the taxpayer's business.

Paragraphs 2.19 and 2.20 of the EM indicate that capital expenditure incurred on the structure by which an entity carries on (or used to or proposes to carry on) their business, on the profit yielding structure of the business, or relating to the business' trading operations, are capable of being described as capital expenditure incurred 'in relation to' that business for the purposes of subsection 40-880(2) of the ITAA 1997. Whether such capital expenditure is incurred 'in relation to' the particular business will depend on whether there is a sufficient and relevant connection between the incurring of the expenditure and that business on the facts of the particular case.

Where more than one business is identified, the business to which the expenditure relates is that most relevant to the expenditure.

In identifying, for the purposes of subsection 40-880(2) of the ITAA 1997, the business that is most relevant to the expenditure, it is necessary to look to the character of the expenditure and what it achieved rather than simply the broad intent of its incurrence.

The taxpayer carries on management activities through the Manager Company and its asset operations. On the facts, the management activities carried on by the Manager Company cannot be distinguished between each separate business activity carried on by the taxpayer. Accordingly, there is a sufficient and relevant connection between the taxpayer's business and its incurrence of the Relevant Expenditure.

However, any deduction under subsection 40-880(2) of the ITAA 1997 is subject to the limitations and exceptions contained in subsections 40-880(3) to 40-880(9).

LIMITATIONS AND EXCEPTIONS

Taxable purpose

As the Relevant Expenditure was incurred by taxpayer in relation to a business it carries on, any deduction under section 40-880 of the ITAA 1997 is subject to the limitation set out in subsection 40-880(3), rather than those set out in subsection 40-880(4).

To the extent it is relevant here subsection 40-880(3) of the ITAA 1997 provides that you can only deduct expenditure for a business that you carry on to the extent that the business is carried on for a taxable purpose. The relevant business for the purposes of the application of subsection 40-880(3) is the business to which the relevant paragraph in subsection 40-880(2) applies. In this case, the relevant business is taxpayer's business through the use of certain assets it owns.

The application of subsection 40-880(3) of the ITAA 1997 requires that the taxpayer determine, as at the time the capital expenditure was incurred, the extent to which the taxpayer's business will be carried on for a taxable purpose by reference to all known and predictable facts in all years.

On the facts, the taxpayer carries on its business entirely for a taxable purpose.

Subsections 40-880(5) to (9) of the ITAA 1997 set out further limitations and exceptions to the amount that can be deducted under section 40-880.

On the facts, only paragraphs 40-880(5)(d) and (f) of the ITAA 1997 need be considered.

Expenditure that is in relation to a lease or other legal or equitable right

Paragraph 40-880(5)(d) 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 is in relation to a lease or other legal or equitable right'.

A 'lease or other legal or equitable right' is not defined in the legislation. However, the appropriate income tax treatment of capital expenditure incurred in relation to leases and rights was considered by the Review of Business Taxation.

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(5)(d) of the ITAA 1997 and former paragraph 40-880(3)(d).

The Review of Business Taxation considered that 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. Service contracts that are, in substance, broadly similar to leases' were part of the review.

While the recommendations did not explain what was encompassed by the expression 'leases and rights', it can reasonably be inferred that it was referring to the sorts of leases and rights considered by the Review of Business Taxation.

Draft Taxation Ruling TR 2010/D7 Income tax business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues provides guidance on the interpretation of paragraph 40-880(5)(d).

Paragraph 197 of TR 2010/D7 provides that the Review of Business Taxation was concerned with the lack of a consistent framework for taxing income from and recognising expenditure associated with leases over non-wasting assets and other rights. The main focus of its review of leases and rights was on anomalies in the tax treatment of payments for the acquisition of a right and receipts from the use of those rights, and in the tax treatment of payments from the grant of a right and losses from the grant of the right.

The rights with which the discussion paper deals are rights in respect of tangible and intangible assets which were divided between the following three broad categories:

I. rights granted over the use of physical and intangible business assets;

II. rights under financial transactions; and

III. rights that are trading stock such as software produced or developed for sale.

On the facts, there are no leases or other legal or equitable rights of the types considered by the Review of Business Taxation (in the context of its review of the taxation of leases and rights) in relation to which the Relevant Expenditure referred to in the facts could reasonably be said to have been incurred. The Agreement did not transfer some or all of the benefits of ownership of the assets from the Manager Group to the Manager Company.

For the foregoing reasons, paragraph 40-880(5)(d) of the ITAA 1997 does not apply so as to reduce the taxpayer's deduction under section 40-880 in respect of the capital expenditure it incurred.

Expenditure that could be taken into account in working out a capital gain or loss

Paragraph 40-880(5)(f) of the ITAA 1997, subject to subsection 40-880(6), provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that it could, apart from section 40-880, be taken into account in working out a capital gain or loss from capital gains tax (CGT) event.

In most cases, capital proceeds and cost base (or reduced cost base) are taken into account in working out a capital gain or capital loss from a CGT event. Therefore, capital expenditure which reduces capital proceeds from a CGT event or forms part of the cost base (or reduced cost base) of a CGT asset could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f) of the ITAA 1997.

A CGT asset is defined in section 108-5 of the ITAA 1997 to mean any kind of property or a legal or equitable right that is not property.

On the facts, no CGT event happens in respect of which there are capital proceeds that are reduced by the Relevant Expenditure and the Relevant Expenditure does not form part of the cost base (or reduced cost base) of a CGT asset.

Accordingly, paragraph 40-880(5)(f) of the ITAA 1997 does not apply so as to reduce the deduction available to the taxpayer for the Relevant Expenditure under section 40-880.

CONCLUSION

For the foregoing reasons, the taxpayer can deduct under section 40-880 of the ITAA 1997 the amount of the Relevant Expenditure.