Edited version of private ruling

Authorisation Number: 1011857323315

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Ruling

Subject: Application for a Private Ruling - Deduction

Question

Is expenditure incurred by the company for donations or sponsorship deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

September 2010

Relevant facts

The Company runs a manufacturing and retail business.

As part of The Company's promotional activities, a company representative appeared on a media program.

The Company's purpose for the appearance was to raise and broaden the profile of the brand and products so that it can continue to attract and increase customers in Australia.

It was believed that the exposure would benefit the business in the form of advertising and promotion of the company's image, and so enhance the company's income producing activities.

That is by raising The Company's profile there was expected to be a reciprocal increase in sales.

The company agreed to give away donations/sponsorship to individuals and community groups.

The Company donated a series of cheques.

Throughout the appearance the company's representative extensively promoted The Company brand and products both directly and indirectly.

Subsequent to the program there were various types of media exposure as further promotion of the brand and products.

The recipients were not always endorsed as a 'Deductible Gift Recipient'.

The Company wishes to claim a deduction under section 8-1 of the ITAA 1997 on the basis that expenses were incurred as part of the advertising and promotional activities of The Company brand.

As a result of The Company incurring the expenditure, its brand received extensive market exposure and publicity.

In accordance with the definition provided by the Macquarie MultiMedia (Version 5.0.0 01/10/01) the definition of 'donation' is the act of presenting something as a gift and 'sponsorship' is defined as '…a person, firm or other organisation that finances…a program in return for advertisement of a commercial product, a service etc.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Summary

A donation or sponsorship is eligible for a deduction in terms of paragraph 8-1(1)(b) of the ITAA 1997 to the extent that it is incurred in carrying on a business.

Detailed reasoning

Expenditure incurred in advertising or promotion is deductible under section 8-1 of the ITAA 1997 to the extent that it sufficiently relates to the production of assessable income or is necessarily incurred in carrying on a business for the purpose of producing assessable income.

Losses or outgoings are incurred in gaining or producing assessable income where they are 'incidental and relevant to that end': Ronpibon Tin NL and Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236. Where a taxpayer is carrying on a business for the purpose of gaining or producing assessable income, the commercial and practical implications of the term 'necessarily incurred' imply that voluntary expenditure incurred for business needs may be deductible. It is the taxpayer who decides whether the expenditure 'is dictated by the business ends to which it is directed': Federal Commissioner of Taxation v. Snowden & Willson Pty Ltd (1958) 99 CLR 431; (1958) 11 ATD 463; (1958) 7 AITR 308 (Snowden & Willson's Case). This was further supported in Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation (1980) ATC 4542; (1980) 11 ATR 276, when the Court stated:

For practical purposes and within the limits of reasonable human conduct, it is for the man who is carrying on the business to be the judge of what outgoings are necessarily incurred.

To claim a deduction for a donation or sponsorship given as part of a contractual arrangement that expenditure must satisfy the tests under section 8-1 of the ITAA 1997.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and 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 the purpose of gaining or producing assessable income. However, no deduction is allowed under subsection 8-1(2) of the ITAA 1997 for expenses to the extent that they are of a capital, private or domestic nature.

Taxation Ruling TR 95/33 at paragraph 11 states:

Where, having regard to the overall objective circumstances, there is an obvious commercial connection between the loss or outgoing and the carrying on of the taxpayers' business, it will not be generally necessary to have regard to the taxpayer's subjective purpose, motive or intention.

In order to consider the issue, two questions need to be answered in determining whether the expense is deductible under section 8-1 of the ITAA 1997. The first is whether the expense has the essential character of expenditure that has a sufficient connection with the operations or activities, which more directly gain or produce assessable income. If the answer is in the negative, the second question does not arise because the loss or outgoing is not deductible under the subsection. If the answer is affirmative, we need to consider whether the expense falls within the exclusory provision of the section, being of a capital nature.

The essential character of the payment

The expenditure incurred in donating cheques was an expense incurred as a direct result of the company representative in the media program in which it was anticipated that such payments would be made. The immediate benefit to the company was expected to be that of any corporate sponsorship.

The phrase 'necessarily incurred' does not mean that the expense was unavoidable or logically necessary. The expense must be clearly and appropriately adapted for the ends of the business. Where the expense is voluntary, the controlling factor is whether the expense can objectively be seen to be appropriate to the business activity: Magna Alloys & Research v. FC of T 80 ATC 4542; (1980)11 ATR 276.

Your business received market exposure therefore the expenditure incurred is considered to be incurred in relation to the promotion of the business.

The distinction between a revenue and capital expense

The courts have differentiated between two types of expenses when determining deductibility. The first being deductible revenue or income related expenses and secondly expenses referrable to capital account that will not qualify for deductions under section 8-1 of the ITAA 1997.

The decision of the High Court in Sun Newspapers Ltd & Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 (1938) 5 ATD 23 ; (1938) 1 AITR 403 (Sun Newspapers) is the leading authority on the distinction between revenue and capital expenditure. The general rule is found at 359 where Dixon J said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss….

As general conceptions, it may not be difficult to distinguish between the profit yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue.

When the matters stated by Dixon J in the Sun Newspapers Case are considered, the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid. The nature or character of the expenditure will therefore follow the advantage that is sought to be gained by incurring the expenditure. If the advantage to be gained is of a capital nature, then the expenditure incurred in gaining the advantage will also be of a capital nature.

You have stated that the 'advantage' sought was the immediate (or at least anticipated) increase in sales resulting from the profile of the company being raised in the marketplace. Any increased value in goodwill is a natural by-product of increased business confidence and sales.

It was anticipated that the business would immediately benefit financially from the representative's media appearance and this intention would support the contention that the deduction should be allowed as a revenue expense. It was anticipated that there would be a short-term (immediate) benefit from such an appearance rather than a sustained benefit (in the nature of increased goodwill) for the organisation as a whole.

Conclusion

Having regard to the whole set of circumstances, it is considered that the amounts expended were necessarily incurred in carrying on the business and are deductible in terms of section 8-1 of the ITAA 1997.