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Ruling

Subject: Application of section 8-1 and Division 250 of the Income Tax Assessment Act 1997

All legislative references are to the Income Tax Assessment Act 1997.

Issue 1

Question 1

Are the Payments made by the taxpayer deductible under section 8-1?

Answer

Yes.

This ruling applies for the following period:

From Commencement date to completion

The scheme commences on:

Commencement date (as specified in the ruling)

Issue 2

Question 1

Does the taxpayer satisfy the test in paragraph 250-15(d) in relation to the capital assets, such that Division 250 applies to the taxpayer?

Answer

No.

This ruling applies for the following period:

From Commencement date to completion

The scheme commences on:

Commencement date (as specified in the ruling)

Relevant facts and circumstances

The taxpayer is a resident of Australia for income tax purposes.

The taxpayer entered into a Project Agreement with an unrelated entity (the Owner) to design and construct certain assets for and on behalf of the Owner and then to provide maintenance services in relation to the assets (the Project). In return, the taxpayer receives specified payments from the Owner. These amounts are assessable income in the hands of the taxpayer.

The main business of the taxpayer is the design and construction (D&C) and the maintenance of the assets.

The assets include depreciating assets for the purposes of Division 40 and capital works for the purposes of Division 43.

The taxpayer makes periodic payments (the Payments) to the Owner for the right to use the capital assets for the purposes of satisfying its obligations under the Project Agreement.

The taxpayer incurs expenditure in carrying out the D&C of the assets and in delivering the maintenance services. The expenditure incurred does not provide the taxpayer with rights or title over the assets or any other property.

The taxpayer has also incurred certain other capital expenditure which is deductible under Subdivision 40-I of the ITAA 1997. The taxpayer will claim capital allowances under Subdivision 40-I in relation to those capital expenditure incurred.

The Owner retains ownership of all the assets at all times and will bear all the benefit and risks associated with ownership of the assets.

The taxpayer has no right to remove or recover any of the assets constructed for the Project except to the extent that it is required as part of its maintenance activities. Where assets are replaced as part of its maintenance activities, those assets are for the use by the Owner and are paid for by the Owner.

The taxpayer does not and will not have an option to acquire the assets under the Project Agreement or other agreements in relation to the Project.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 subsection 8-1(2)

Income Tax Assessment Act 1997 paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 40-40

Income Tax Assessment Act 1997 Subdivision 40-I

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 section 43-10

Income Tax Assessment Act 1997 subsection 43-70(1)

Income Tax Assessment Act 1997 subsection 43-70(2)

Income Tax Assessment Act 1997 subsection 43-75

Income Tax Assessment Act 1997 Division 250

Income Tax Assessment Act 1997 paragraph 250-10(b)

Income Tax Assessment Act 1997 section 250-15

Income Tax Assessment Act 1997 paragraph 250-15(d)

Income Tax Assessment Act 1997 subparagraph 250-15(d)(i)

Income Tax Assessment Act 1997 subparagraph 250-15(d)(ii)

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

Reasons for decision

Issue 1 Question 1

Summary

The Payments are necessarily incurred by the taxpayer in carrying on a business for the purpose of gaining and producing assessable income. The Payments are not capital in nature or otherwise excluded by subsection 8-1(2). Therefore, the Payments are deductible to the taxpayer under section 8-1.

Detailed reasoning

Subsection 8-1(1) provides that 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.

Based on the facts, the Payments are necessarily incurred by the taxpayer in the ordinary course of carrying on its business for the purpose of gaining or producing assessable income and will be deductible to the taxpayer under subsection 8-1(1), subject to any exclusions applying.

Subsection 8-1(2) provides that you cannot deduct a loss or outgoing 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 your non-assessable non-exempt income; or

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

The first exclusion in paragraph 8-1(2)(a) prevents an amount from being deducted if it is capital or of a capital nature.

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, 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 important direction. It provides the best guidance as to the nature of the expenditure as it says most about the essential character of the expenditure itself. The nature or character of the expenses follows the advantage that is sought to be gained by incurring the expenses.

In this case, the character of the advantage sought by making the Payments is the ability to derive assessable income. The Payments do not create an enduring benefit for the taxpayer. Therefore, the Payments are not capital or of a capital nature.

On the facts, the Payments do not fall within any other exclusion in subsection 8-1(2). Accordingly, the Payments made by the taxpayer are deductible under section 8-1.

Issue 2 Question 1

Summary

Division 250 will not apply to the taxpayer because the test in paragraph 250-15(d) is not satisfied. The test in paragraph 250-15(d) is not satisfied because the taxpayer would not be entitled to a capital allowance in relation to a decline in value of, or expenditure in relation to, the assets.

Detailed reasoning

Division 250 operates to deny or reduce certain capital allowance deductions that would otherwise be available to you in relation to an asset if the asset is put to a tax preferred use in certain circumstances.

Division 250 applies to you and an asset at a particular time if the 'general test' in section 250-15 is satisfied in relation to you and the asset and none of the exclusions referred to in paragraph 250-10(b) apply. The general test in section 250-15 has five requirements, all of which must be satisfied for Division 250 to apply. Among other things, paragraph 250-15(d) requires that you be entitled to a capital allowance in relation to:

(i) a decline in the value of the asset; or

(ii) expenditure in relation to the asset.

A capital allowance is defined in subsection 995-1(1) to relevantly mean a deduction under Division 40 (capital allowances) or Division 43 (capital works).

The asset being tested is the assets constructed for the Project. This ruling considers the application of paragraph 250-15(d) of the general test.

Subparagraph 250-15(d)(i): be entitled to a capital allowance in relation to a decline in value of the asset

To satisfy this requirement, you must be entitled to a deduction under Division 40 for the decline in value of depreciating assets you hold during the year of income. The table in section 40-40 identifies a holder of a depreciating asset in any particular circumstance. It is necessary to determine if the taxpayer holds the assets or any part of the assets in accordance with this table.

Based on the facts, the taxpayer does not hold the assets under any item of the table in section 40-40. The taxpayer would not be eligible to deduct an amount equal to the decline in value of the assets that are depreciating assets and therefore, would not satisfy subparagraph 250-15(d)(i).

In addition, the expenditure incurred by the taxpayer in providing the D&C and maintenance services in relation to the assets are not capital expenditure in the hands of the taxpayer. This is to be discussed below.

Subparagraph 250-15(d)(ii): be entitled to a capital allowance in relation to expenditure in relation to the asset?

Subparagraph 250-15(d)(ii) considers whether you are entitled to a deduction for capital works under Division 43 or a deduction under Division 40 other than a deduction in relation to the decline in value of the asset.

Section 43-10 provides that you can only deduct an amount for capital works for an income year if, among other things, the capital works have a 'construction expenditure area'.

'Construction expenditure area' is defined in section 43-75 to broadly mean the part of the capital works on which the 'construction expenditure' was incurred.

'Construction expenditure' is defined in subsection 43-70(1) as capital expenditure incurred in respect of the construction of capital works, subject to the exclusions listed at subsection 43-70(2).

The distinction between business expenditure that is revenue and capital in nature was outlined in Issue 1 above.

In this case, the taxpayer carries out D&C activities and provides maintenance services in relation to the assets as part of its ordinary business operations and in accordance with its obligations under the Project Agreement. The intention or purpose of the taxpayer in entering into the D&C and maintenance services is to make a gain or profit in carrying out activities that are in the ordinary course of its business operations.

The character of the advantage sought by the taxpayer in incurring the D&C and maintenance expenditure is the fulfilment of its obligation to deliver D&C and maintenance services to the Owner, allowing derivation of its assessable income. The expenditure does not create an enduring benefit for the taxpayer.

Accordingly, the expenditure the taxpayer incurs in the course of the Project, pursuant to the Project Agreement, are not capital expenditure in the taxpayer's hands. As the taxpayer does not incur capital expenditure in the course of the Project, it does not have a 'construction expenditure area' for the purposes of section 43-75. Therefore, the taxpayer is not entitled to a capital allowance in relation to the expenditure in relation to capital works under Division 43.

Based on the facts and in light of the above, the taxpayer would not be entitled to a capital allowance under any other provision of Division 40 for expenditure it incurs in relation to the asset.

Conclusion

Since the taxpayer is not entitled to a capital allowance in relation to a decline in value of the assets, or expenditure in relation to the assets, paragraph 250-15(d) is not satisfied and Division 250 will not apply to the taxpayer.

Capital expenditure which falls within Subdivision 40-I

Broadly, Subdivision 40-I allows a taxpayer to claim a deduction over a period of time for certain capital expenditure that is incurred on a qualifying project or that is business related expenditure.

The taxpayer has incurred other capital expenditure which is deductible under Subdivision 40-I. However, the capital expenditure that is deductible under Subdivision 40-I will not, by itself, give rise to a separate asset to which Division 250 can apply. The expenditure will not give rise to capital allowances in relation to the decline in value of an asset for the purposes of subparagraph 250-15(d)(i). Further, for the purposes of subparagraph 250-15(d)(ii), the expenditure incurred is not in relation to an asset for which the taxpayer will be entitled to capital allowances under either Divisions 40 or 43.

Accordingly, Division 250 will not apply to the taxpayer in relation to expenditure which falls within Subdivision 40-I.