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Ruling

Subject: Deductibility of Access Payments

Question 1

To Confirm that Access Payments that will be incurred in respect of operating the Facility are deductible pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

Answer

Yes, the Access Payments that will be incurred in respect of operating the Facility will be deductible under section 8-1 of the ITAA 1997.

This ruling applies for the following periods:

The scheme commences on:

Relevant facts and circumstances

The Finance Entity and the Construction Entity are part of a group of entities which has been engaged by Party A to construct and operate a Facility over a number of years and to finance the cost of construction to Party A including Progress Payments.

Construction Entity will obtain a Right of Access which will provide it with access to the Site and the ability to carry out its service commitments to Party A during the Operation Phase. Pursuant to certain contractual terms, Construction Entity will make periodic Access Payments and will receive periodic service payments for providing services during the Operation Phase.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 sub section 230-20(4)

Income Tax Assessment Act 1997 paragraph 230-45(1)(e)(ii)

Income Tax Assessment Act 1997 paragraph 230-45(1)(f)

Income Tax Assessment Act 1997 paragraph 230-460(2)(e)

Reasons for decision

The Taxation of Financial Arrangements (TOFA) rules contained in Division 230 of the Income Tax Assessment Act 1997 (ITAA 1997) set out the income tax treatment of gains and losses on financial arrangements. Subsection 230-20(4) provides that if the TOFA rules apply then section 8-1 will not apply. Prior to considering whether section 8-1 applies it is necessary to consider if the TOFA rules apply to the payments and receipts under the Right of Access.

The ATO accepts that Access Payments that will be made by Construction Entity will not be subject to the TOFA rules.

Section 8-1

Section 8-1 of the ITAA 1997 states:

'(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

'(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income; or

(d) a provision of this Act prevents you from deducting it.'

Business expenditure is deductible as a general (revenue nature) deduction if it has the necessary and relevant connection with the operation or activities which directly gain or produce assessable income (Charles Moore & Co (WA) Pty Ltd v. Federal Commissioner of Taxation (1956) 95 CLR 344; 11 ATD 147; 6 AITR 379, Federal Commissioner of Taxation v. Smith (1981) 147 CLR 578; (1981) 11 ATR 538; (1981) 81 ATC 4114, Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Provided that a loss or outgoing can be objectively viewed as a necessary or natural consequence of the taxpayer's income earning activities, it will be 'incidental and relevant' to the income earning activities of the taxpayer and deductible as a revenue deduction under section 8-1 of the ITAA 1997, except to the extent that it is a loss or outgoing of capital or of a capital nature (see discussion of the High Court in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139)).

The established principles on the distinction between capital and income are well known; see for example, Dixon J's judgement in Sun Newspapers Ltd & Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87 (Sun Newspapers Case), and the Full Federal Court decision in FC of T v. Email (1999) 99 ATC 4868 at 4873; 42 ATR 698 at 704). The character of the advantage sought provides guidance as to the nature of the expenditure as it says most about the essential character of the expenditure itself. The decision of the High Court in G.P. International Pipecoaters v. Federal Commissioner of Taxation (90 ATC 4413; (1990) 170 CLR 124; 21 ATR 1) emphasised this, stating:

'… the character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for 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: Sun Newspapers Ltd and Associated Newspapers Ltd v FCT (1938) 61 CLR 337, at 363; 1 AITR 353.'

Negative limb

The next test is to determine whether any of the negative limbs of section 8-1 ITAA 1997 apply. In this case the relevant negative limb is contained in paragraph 8-1(2)(a) for:

'… a loss or outgoing of capital, or of a capital nature.'

In Hallstroms Pty Ltd v FC of T (1946) 8 ATD 190 at p 196; (1946) 72 CLR 634 at p 648., Dixon J said that the answer to the income/capital question:

'… depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.'

The test for when expenditure is capital or capital in nature and therefore whether the expenditure goes to the profit-yielding structure (or otherwise is revenue in nature and is concerned with the process by income is derived) is classically outlined in Sun Newspapers (1938) 61 CLR 337;at 363 per Dixon J:

'There are, I think, three matters to be considered, (1) the character of the advantage sought, and in this its lasting qualities may play a part, (2) 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 (3) 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.'

Consideration of the Sun Newspapers' factors

The Access Payments will be paid periodically.

The Access Payments are calculated to effect the limitations placed on the use of the Site by Construction Entity pursuant to certain contractual terms including the terms of the Right of Access to those services by which Construction Entity may perform to earn its assessable income.

Should Construction Entity fail to make an Access Payment, Party A may terminate the contractual arrangements which may render Construction Entity unable to earn the periodic service payments.

Conclusion

The periodic service payments will form part of Construction Entity's assessable income and the Access Payments for access to the Site will be an incidental consequence of the service activities by which Construction Entity will derive its assessable income. The Access Payments fulfil the positive test for a deduction under subsection 8-1(1) of the ITAA 1997 being 'outgoings incurred in gaining or producing assessable income'.

The Access Payments will not be capital nor capital in nature as the Payments are a cost that will be incurred by Construction Entity in the process of obtaining its assessable income rather than a cost in establishing or enlarging Construction Entity's income earning structure.