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Ruling

Subject: Income Tax: Deduction -Blackhole Expenditure

Question 1

Are establishment costs incurred to obtain the right to construct the feedlot deductable for five years under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period

Financial year ended 30 June 2011

Financial year ended 30 June 2012

Financial year ended 30 June 2013

Financial year ended 30 June 2014

Financial year ended 30 June 2015

The scheme commenced on

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The XY partnership (the taxpayer) established cattle feedlot as an extension of their existing live stock business. The taxpayer incurred establishment expenses to obtain the right (relevant licence) to construct the feedlot such as consultancy fees for the submission of applications to the governing bodies, analysis for Environmental Protection Authority (EPA) licence etc.

It is a requirement for the taxpayer to obtain an EPA licence where a feedlot licence is issued for a facility to house more than 999 head of livestock. This facility has more than 999 head of livestock.

It is a compulsory requirement to the taxpayer to obtain the EPA licence in relation to the treatment of effluent and waste.

Annual fees are payable to the EPA as the feedlot is not permitted to operate without the proper EPA licence and approval for operation ceases if the annual fee remain unpaid.

The taxpayer constructed yards, excavation work, pens, fences, loading ramps, concrete pads for loading of transports and drafting facilities. These structural costs such are related to the operation of the feedlot are subject to depreciation and have a depreciable life of 20 years.

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 Paragraph 40-880(2)(b).

Income Tax Assessment Act 1997 Paragraph 40-880(2)(c).

Income Tax Assessment Act 1997 Paragraph 40-880(2)(d).

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 Paragraph 40-880(5)(a).

Income Tax Assessment Act 1997 Paragraph 40-880(5)(f).

Income Tax Assessment Act 1997 Subsection 40-880(6).

Reasons for decision

Summary33819943

The taxpayer is eligible to claim deduction for the establishment cost incurred to obtain the right to construct the feedlot for five years under section 40-880 of the ITAA 1997.

Detailed reasoning

Section 40-880 of the ITAA 1997 provides a deduction over 5 years for certain business-related capital costs that are incurred on or after 1 July 2005 if:

· the expenditure is not otherwise taken into account; and

· a deduction is not denied by some other provision; and

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

The ways in which expenditure can be taken into account are listed in subsections 40-880(5) to (8) of the ITAA 1997.

Subsection 40-880(2) of the ITAA 1997 allows the taxpayer to deduct, in equal proportions over a period of 5 income years starting in the year in which the taxpayer incurs it, capital expenditure the taxpayer incurs 'in relation to', inter alia, his business.

In considering the phrase 'in relation to' contained within subsection 40-880(2) of the ITAA 1997, paragraph 2.25 of the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 (the EM) states:

The provision is concerned with expenditure that has the character of a business expense because it is relevantly related to the business. The concept used to establish this character or requisite relationship between the expenditure incurred by the taxpayer and the business carried on (current, past or prospective) is 'in relation to'. The connector 'in relation to' allows the appropriate latitude to enable the deductibility of qualifying capital expenditure incurred before the business commences or after it has ceased.

The phrase 'in relation to' was considered by the High Court in PMT Partners Pty Ltd (In Liquidation) v. Australian National Parks & Wildlife Service (1995) 184 CLR 301. Brennan CJ, Gaudron and McHugh JJ observed, in considering the application of the Commercial Arbitration Act 1985 (NT), at 313:

Inevitably, the closeness of the relation required by the expression 'in or in relation to' in s 48 of the Act, indeed, in any instrument - must be ascertained by reference to the nature and purpose of the provision in question and the context in which it appears.

In that case, Toohey and Gummow JJ also observed:

It is apparent that the words 'in or in relation to' are particularly wide. ... Cases concerning the interpretation of this phrase in other statutory contexts are of limited assistance. However, the cases do show that the words are prima facie broad and designed to catch things which have sufficient nexus to the subject. The question of sufficiency of nexus is, of course, dependent on the statutory context. (at 330) ...

The connection which is required by the phrase 'in relation to' is a question of degree. There must be some "association" which is "relevant" or "appropriate". The question of the relevance or appropriateness of the connection is a question which cannot be divorced from the particular statutory context. (at 331)

In First Provincial Building Society Limited v. Commissioner of Taxation (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207, Hill J considered the phrase 'in relation to' within the context of paragraph 26(g) of the ITAA 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 (at ATC 4155; ATR 218).

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 a particular business. In discussing the types of business capital expenditure to which subsection 40-880(2) of the ITAA 1997 applies, paragraphs 2.19 and 2.20 of the EM state:

2.19 Expenditure on the structure by which an entity carries on (or used to or proposes to carry on) their business and on the profit yielding structure of the business would ordinarily be expected to be of a capital nature. Capital expenditure can also relate to a business's trading operations or the entity that will carry on the business.

2.20 The structure covers the legal entity (such as a company) or the legal relationship (such as a partnership or trust) that is the entity that carries on the business for a taxable purpose and that holds the business assets.

These paragraphs 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's 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.

The statement in paragraph 2.48 of the EM below:

the business to which the expenditure relates is that most relevant to the expenditure

indicates that when there is such a connection between the incurring of the expenditure and more than one business, the expenditure is treated for the purposes of subsection 40-880(2) of the ITAA 1997 as incurred in relation to the business that is 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 is achieved rather than simply the broad intent of its incurrence.

In this case, the taxpayer incurred the expenses in relation to the construction of feedlots for their live stock business. It is a requirement that the taxpayer have to obtain the feedlot licence as well as the EPA licence to operate the business.

Accordingly, it is considered that the taxpayer incurred the capital expenditure to obtain the licence to construct the feedlot in relation to the profit yielding livestock business.

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

Subsection 40-880(3) of the ITAA 1997 provides that 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, was carried on or is proposed to be carried on for a taxable purpose. The relevant business for the purposes of the application of subsection 40-880(3) of the ITAA 1997 is the business to which the relevant paragraph in subsection 40-880(2) of the ITAA 1997 applies. In this case, the relevant business of the taxpayer is live stock.

Paragraphs 2.46 and 2.47 of the EM state:

2.46 The definition of 'taxable purpose' is provided by subsection 40-25(7) of the ITAA 1997 and covers various purposes, including the purpose of producing assessable income. The term purpose of producing assessable income is further defined in subsection 995-1(1) of the ITAA 1997 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.

2.47 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.

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 is carried on for a taxable purpose by reference to all known and predictable facts in all years.

The private ruling application and the relevant attachments confirm that the taxpayer is carrying on a profit yielding business, did not derive any non-assessable non-exempt income and/or exempt income at the time the capital expenditure was incurred and there is no evidence to suggest such income will be derived.

Therefore, the taxpayer obtained licence from EPA and other relevant government authorities to construct feedlot for his live stock business for producing assessable income.

Subsection 40-880(4) of the ITAA 1997 does not apply in the present case as it deals with business that is carried on by another entity.

Paragraph 40-880(5)(a) of the ITAA 1997 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 forms part of the cost of a depreciating asset that you hold, used to hold or will hold.

The taxpayer constructed yards, excavation work, pens, fences, loading ramps, concrete pads for loading of transports and drafting facilities. These structural costs such are related to the operation of the feedlot are subject to depreciation and have a depreciable life of 20 years. However, the right to construct the feedlot and the EPA licence is not any part of a depreciable asset.

Paragraph 40-880(5)(f) of the ITAA 1997 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 that section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event.

To the extent that the capital expenditure incurred by the taxpayer in relation to obtain the feedlot and EPA licence will not form the cost base on a CGT asset to work out the capital gain or loss of the property.

Since there is no CGT event for not carrying out proposed activities, the expenditure cannot be taken into account in working out a capital gain or loss.

Paragraph 40-880(5)(g) of the ITAA 1997 states that:

(g) a provision of this Act other than this section would expressly make the expenditure non-deductible if it were not of a capital nature; or

There are no provisions of this Act other than this section which expressly makes the expenditure non-deductible if it were not of a capital nature. If it was not capital in nature, the expense could be deducted as losses or outgoing in gaining or producing assessable income under section 8-1 of the ITAA 1997.

Further, paragraph 40-880(h) states that:

(h) a provision of this Act other than this section expressly prevents the expenditure being taken into account as described in paragraphs (a) to (f) for a reason other than the expenditure being of a capital nature; or

No provision of this Act other than this section prevents the expenditure being taken into account as described in paragraphs (a) to (f) for a reason other than the expenditure being of a capital nature.

Paragraph 40-880(5)(i) of the ITAA 1997 states that:

(i) it is expenditure of a private or domestic nature; or

The expenditure is not of a private or domestic nature.

Paragraph 40-880(5)(j) states as;

(j) it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income.

The capital expenditure is not incurred in gaining or producing exempt or non-assessable non-exempt income.

Subsection 40-880(6) of the ITAA 1997 is an elaboration of the exceptions described in paragraphs 40-880(5)(d) and (f) of the ITAA 1997. Since these exceptions do not apply to the taxpayer, this subsection is not relevant.

Subsection 40-880(7) of the ITAA 1997 is also not relevant as it applies in relation to subsection 40-880(2)(c) of the ITAA 1997, ie., business proposed to be carried on as the taxpayer is already carrying on a business.

Subsection 40-880(8) of the ITAA 1997 is not relevant either as this subsection deals with expenditure that is cost base of a depreciating asset or a CGT asset. In this case the cost of EPA licence and approvals from the relevant government authorities will not be included in the cost base of a depreciating asset or a CGT asset.

Subsection 40-880(9) of the ITAA 1997 is not relevant to this case which deals with an amount of an expenditure that is incurred:

(a) by way of returning an amount you have received …; or

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

· an equity interest; or

· a debt interest that is an obligation of yours.

Therefore, the limitations and exceptions under subsections 40-880(3) to (9) of the ITAA 1997 do not apply in relation to the capital expenditure at issue in this case.

Accordingly, the expenditure in issue has not otherwise been taken into account. The deduction is not denied by any other provision of the tax legislation. The taxpayer is carrying on the business of live stock.

Therefore, the taxpayer is eligible to claim deduction for five years from the income years 2011 to 2015 for the expenses incurred for the establishment costs to obtain the licence to construct the feedlot for their live stock business.