Edited version of your private ruling

Authorisation Number: 1012515573892

Ruling

Subject: Income Tax - Deductions - Business expenses incurred whilst in administration

Issue 1

Question 1

Can the directors of a company acting as trustee for a family trust claim a deduction under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997) for expenses incurred as directors' contribution under a Deed of Company Arrangement (DOCA) in relation to the trustee company?

Answer

No

Question 2

Can the directors of a company acting as trustee for a family trust claim a capital loss under section 100-20 of the ITAA 1997 for expenses incurred as a directors' contribution under a DOCA in relation to the trustee company?

Answer

No

Issue 2

Question 1

Can a company acting as trustee for a family trust claim a deduction under section 40-880 of the ITAA 1997 for fees incurred in relation to the insolvency processes involving the company?

Answer

Yes

This ruling applies for the following periods:

1 July 200X to 30 June 201Y

The scheme commences on:

1 July 200X

Relevant facts and circumstances

A company acting as trustee for a family trust entered into administration

The trust is a discretionary trust and the business was conducted through the trust. The trust owns all of the shares in the company.

The company directors were also employees of the trust deriving annual salaries from the trust.

The trust has always carried on business for a taxable purpose.

The courts appointed liquidators to the trustee company and the liquidators in turn appointed administrators.

As a consequence of the administration process, a Deed of Company Arrangement (DOCA) was entered into.

The DOCA was entered into to allow the company (trust) to continue trading during and beyond the DOCA period. The arrangement has enabled the business to trade through the period of administration and is currently carried on.

The liquidators and administrators were the same enterprise. Therefore there were expenses paid to them in both roles.

Under the terms of the DOCA, the directors of the company made payments in a number of tranches into the 'administration fund' over a period of time. These payments are known as the directors' contribution'.

The directors' contribution was made to ensure that the administration fund contained sufficient money to make various payments detailed in the DOCA.

There was no intention between the relevant parties that the directors' contribution was to be repaid to the directors.

The directors' contribution was not a repayment of any amount previously received nor was it a return on, or related to, equity or a debt interest.

Income derived by the trust during the administration period was distributed equally between the company directors.

There were general and legal fees incurred by the company and paid to the administration company regarding the administration and insolvency processes.

Legal fees were also incurred in order to terminate the liquidation.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

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(5)

Income Tax Assessment Act 1997 paragraph 40-880(5)(b)

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

Income Tax Assessment Act 1997 section 100-20

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 110-25(5)

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Issue 1 Question 1

Summary

The deduction claimed in equal amounts over a period of five years from the date on which the capital expenditure was incurred is not allowed.

Detailed reasoning

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

The business which was carried on whilst the company was in liquidation, administration and under the Deed of Company Arrangement (DOCA), is still being carried on. Therefore, there is no need for consideration of factors relating to a business that used to be carried on or proposed to be carried on.

Capital Expenditure

In order to establish the basic eligibility under paragraph 40-880(2)(a) of the ITAA 1997, we need to consider the application of the term 'capital expenditure' you incur in relation to your business.

To be considered for deduction under section 40-880 of the ITAA 1997, expenditure must firstly be capital expenditure. The judgment of Dixon J in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation [1938] ALR 498;[1939] ALR 10;(1938) 12 ALJ 411;(1938) 5 ATD 23;5 ATD 87;61 CLR 337;(1938) 61 CLR 337 at 351 (Sun Newspapers) is the leading authority on the distinction between revenue and capital expenditure. In Sun Newspapers, Dixon J referred to what are now considered guidelines in determining whether a loss or outgoing is of a capital or revenue nature:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) 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.

The character of the advantage sought provides important direction as it says most about the essential character of the expenditure itself. In relation to the character of the advantage sought by the expenditure it is necessary to examine whether the expenditure secures an enduring benefit for the business.

Expenses have been incurred in the nature of a directors' contribution paid to company administrators under a DOCA. The purpose of the expenditure has been to enable the company to continue to trade and to pay creditors thereby maintaining the structure under which the business has been carried on. The DOCA and payments made under the director's contribution prevented the company from going into liquidation. The business conducted by the trust was able to continue. Therefore it has been determined that the expenditure which is the subject of this ruling was incurred for an enduring benefit and is in the nature of capital expenditure.

You incur

There is no statutory definition of the term 'incurred, however the principles established by case law regarding the meaning of the word 'incurred' can be applied. The accepted definition of incurred means that a taxpayer incurs expenditure at the time they owe a present money debt that they cannot avoid paying.

Information submitted with your application indicates that you and your spouse, as directors of the company made directors' contributions under the DOCA. Therefore the expenses were incurred by you.

In relation to

The legislation does not define the expression 'in relation to' and so it takes its ordinary meaning. The Macquarie Dictionary Online defines 'related' as 'associated; connected'. Accordingly, the expenditure and the business need to be associated or connected for the expenditure to be described as being 'in relation to' the business. Although the phrase 'in relation to' uses wide words of connection, the intended width of the relationship between the two connected subjects must be considered against their legislative context.

The legislative context of section 40-880 indicates that the closeness of the association or connection must objectively support the conclusion that the expenditure is a business expense of the particular business.

Determining whether the expenditure has the character of a business expense can be approached by asking what the expenditure is for, in the sense of identifying the need or object that the expenditure serves. If the facts show that the expenditure satisfies the ends of the relevant business then it will have the character of a business expense.

You have incurred expenditure as a company director under a DOCA which was entered into to enable the company to continue trading during a period of administration. There is a clear connection between the expenditure incurred and the business carried.

Your business

The question as to whether the business conducted by the trust of which the trustee company (which has been the subject of voluntary administration, liquidation proceedings and under a DOCA) is 'your business' needs to be addressed. The trust owns all of the shares in the trustee company. The business is conducted by the discretionary trust and you are a beneficiary of the trust as well as an employee of the trust.

Taxation Ruling TR 2011/6 Income tax: business related capital expenditure- section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6) states at paragraphs 98 and 99:

Paragraph 40-880(2)(a) gives an entitlement to a deduction for capital expenditure the taxpayer incurs in relation to their business. The expenditure must relate to an existing business the taxpayer is carrying on at the time they incur the expenditure.

Under paragraph 40-880(2)(a), only the taxpayer carrying on the business, and no other taxpayer, is entitled to a deduction. If the business is carried on through a company or trust structure then that entity must incur the expenditure to be entitled to a deduction under this paragraph.

In accordance with that ruling the business conducted through the trust cannot be described as 'your business' for the purposes of allowing a deduction under paragraph 40-880(2)(a) of the ITAA 1997.

In accordance with paragraph 40-880(2)(d) of the ITAA 1997, a deduction may also be possible for capital expenditure incurred 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. You have incurred some expenditure in relation to liquidation processes involving your company. However TR 2011/6 explains at paragraph 133 that expenditure incurred by a shareholder, partner or beneficiary prior to making the decision to liquidate or wind up an entity does not have the relevant connection under paragraph 40-880(2)(d) because it is not incurred directly in the process of bringing the entity to an end. The directors' contribution expenses incurred in relation to the DOCA were incurred in order to enable the business to continue trading and saving the business which was being conducted. Therefore paragraph 48-880(2)(d) does not apply to allow a deduction for the expenditure incurred.

It has been established that you do not satisfy the basic eligibility to claim a deduction under subsection 40-880(2) of the ITAA 1997. However further consideration can be given to a possible deduction under an exception listed under subsection 40-880(4) of the ITAA 1997.

Subsection 40-880(4) of the ITAA 1997 states that you can only deduct the expenditure, for a business that another entity used to carry on or proposes to carry on, to the extent that:

(a) the business was carried on or is proposed to be carried on for a taxable purpose; and

(b) the expenditure is in connection with:

(i) your deriving assessable income from the business; and

(ii) the business that was carried on or is proposed to be carried on.

The Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.1) Bill 2006 provides an insight into the intended application of the law and it states:

The deduction is limited to qualifying expenditure in relation to either a former business or a prospective business where the taxpayer that carried on the former business or proposes to carry on the new business (the 'operating entity') is not the same taxpayer who incurred the expenditure (the 'incurring entity'). In both cases, only the incurring entity is entitled to a deduction. For example, pre-business costs such as incorporation fees may be incurred (by an incurring entity) in relation to a business proposed to be carried on by the entity the individual incorporated (the operating entity).

The expenditure incurred by you as directors of the company that is currently carrying on a business is excluded from this section by the contemporaneous nature of the business. It neither 'used to be carried on' nor is 'proposed to be carried on' because it has always been carried on. Therefore, even though the business was carried on for a taxable purpose you are ineligible to claim a deduction under paragraph 40-880(4)(a) of the ITAA 1997.

The other factor to be considered in conjunction with paragraph 40-880(4)(a) of the ITAA 1997 is paragraph 40-880(4)(b) of the ITAA1997. That paragraph considers whether the expenditure is in connection with your deriving assessable income from the current business and the business that was carried on or is proposed to be carried on.

Once again the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.1) Bill 2006 has been consulted in order to gain clarity regarding the application of the legislation. The memorandum states that deriving assessable income refers to the entitlement to a share in the profits from the business. This means that the expenditure must have some connection with the income so derived, or that is proposed to be derived from the business. The relationship between the taxpayer and the business is relevant. For exampled a company employee does not have the requisite connection with the company as they derive their income as a consequence of their employment. Put another way, the taxpayer would expect a return on that expenditure in the form of profits from the business. The expenditure need not of itself be directly productive of the taxpayer's assessable income.

The salary which you received from the trust was received as a consequence of employment. In accordance with TR 2011/6, a beneficiary of a discretionary trust has no entitlement to derive assessable income from the business of the trust and therefore cannot satisfy subparagraph 40-880(4)(b)(i) of the ITAA 1997. The trust distributions which you receive are a discretionary payment made by the trustee in your favour. However you do not have an entitlement to receive income from the trust which carries on the business.

The limitations and exceptions contained in subsection 40-880(4) of the ITAA 1997 do not allow a deduction for the payments made by you as directors under the DOCA.

Issue 1 Question 2

Summary

A capital loss may not be claimed under section 100-20 of the ITAA 1997 because there was no capital gains tax (CGT) asset therefore a CGT event has not occurred.

Detailed reasoning

You make a capital gain or a capital loss if a CGT event happens to a CGT asset. Under section 108-5 of the ITAA 1997, a CGT asset can include any kind of property, or a legal or equitable right that is not property such as a debt owed to a taxpayer or a right to enforce a contractual obligation.

In your case, you were a director of a company which went into voluntary administration. The company was placed in the hands of liquidators and the directors entered a DOCA.

As directors you made financial contributions to the administration fund. The amounts were paid to ensure that the fund contained sufficient money to make various payments as determined by the administrators.

Payments made under the DOCA were made without any expectation of repayment of those funds. The information which you have provided in relation to the DOCA states; 'There was no intention between the relevant parties that the Directors' Contribution was to be repaid…'

Because there was no expectation of repayment, there was no enforceable debt against the company. The payments therefore did not create a right to be indemnified by the company in relation to which a CGT event could take place. You are therefore not entitled to claim a capital loss with respect to the payments made.

If the DOCA indicated that there was an obligation in place for the company to reimburse amounts paid by the company directors, and that obligation was finalised, there would be a CGT event at that time and a capital gain or loss could be recorded by the directors.

Issue 2 Question 1

Summary

Expenses incurred by the company for its own business are eligible for a deduction in equal amounts over a period of five years from the date on which the capital expenditure was incurred.

Detailed reasoning

Subject to the limitations and exceptions contained in subsections 40-880(3) to (9) of the ITAA 1997, subsection 40-880(2) of the ITAA 1997 provides that you can deduct, in equal proportions over a period of 5 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.

The business carried on whilst the company was in administration and under the DOCA is still being carried on. Therefore, there is no need for consideration of factors relating to a business that used to be carried on or proposed to be carried on. There has also been no capital expenditure incurred in order to deregister a company or wind up a trust of which you were a beneficiary.

Accordingly, consideration is confined to whether paragraph 40-880(2)(a) of the ITAA 1997 is satisfied and whether any of the limitations and exceptions in subsections 40-880(3) to 40-880(9) of the ITAA 1997 apply.

Paragraph 40-880(2)(a) of the ITAA 1997 gives an entitlement to a deduction in equal proportions over a period of five years for capital expenditure you incur in relation to your business. Under that paragraph the expenditure must relate to an existing business carried on at the time you incur the expenditure.

Under paragraph 40-880(2)(a) of the ITAA 1997, only the taxpayer carrying on the business, and no other taxpayer, is entitled to a deduction. If the business is carried on through a company or trust structure then that entity must incur the expenditure to be entitled to a deduction under that paragraph.

Capital expenditure

In order to establish the basic eligibility under paragraph 40-880(2)(a) of the ITAA 1997 we need to consider the application of the term 'capital expenditure' you incur in relation to your business.

In order to judge whether expenditure is capital in nature we have to consider legal precedents. The judgment of Dixon J in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation [1938] ALR 498;[1939] ALR 10;(1938) 12 ALJ 411;(1938) 5 ATD 23;5 ATD 87;61 CLR 337;(1938) 61 CLR 337 at 351 (Sun Newspapers) is the leading authority on the distinction between revenue and capital expenditure. In Sun Newspapers, Dixon J referred to what are now considered guidelines in determining whether a loss or outgoing is of a capital or revenue nature:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) 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.

The character of the advantage sought provides important direction as it says most about the essential character of the expenditure itself.

In relation to the character of the advantage sought by the expenditure, it is necessary to examine whether the expenditure secures an enduring benefit for the business.

Expenses have been incurred in the nature of payments to liquidators and company administrators. The purpose of the expenditure has been to enable the business which has been carried on for a number of years to continue to be carried on. The business has successfully traded through the period of administration.

The company has also incurred legal expenses in relation to the administration procedures against the company and for the termination of the liquidation. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses.

Where the expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature.

The advantage sought in preserving the business is capital in nature. Accordingly, the legal expenses incurred in relation to terminating the liquidation and other legal expenses incurred in relation to the administration of the company are considered capital expenditure. The payments secured a permanent advantage.

You incur

There is no statutory definition of the term 'incurred'. However the principles established by case law regarding the meaning of the word 'incurred' can be applied. The accepted definition of incurred means that a taxpayer incurs expenditure at the time they owe a present money debt that they cannot avoid paying.

Information supplied by you indicates that expenditure has been incurred by the company in the nature of payments to an organisation in their initial role as liquidators which then changed to that of company administrators and DOCA administrators. You have also supplied information indicating that legal fees were incurred in relation to the administration of the company and to terminate the liquidation. The debt was incurred and paid by the company.

In relation to

The legislation does not define the expression 'in relation to' and so it takes its ordinary meaning. The Macquarie Dictionary Online defines 'related' as 'associated; connected'. Accordingly, the expenditure and the business need to be associated or connected for the expenditure to be described as being 'in relation to' the business. Although the phrase 'in relation to' uses wide words of connection, the intended width of the relationship between the two connected subjects must be considered against their legislative context.

The legislative context of section 40-880 indicates that the closeness of the association or connection must objectively support the conclusion that the expenditure is a business expense of the particular business.

Determining whether the expenditure has the character of a business expense can be approached by asking what the expenditure is for, in the sense of identifying the need or object that the expenditure serves. If the facts show that the expenditure satisfies the ends of the relevant business then it will have the character of a business expense.

The goal for the expenditure incurred was to enable the company's business to continue trading through the trust. There is a clear connection between the expenditure and the business carried.

Your business

Under paragraph 40-880(2)(a) of the ITAA 1997, only the taxpayer carrying on the business, and no other taxpayer, is entitled to a deduction. If the business is carried on through a company or trust structure then that entity must incur the expenditure to be entitled to a deduction under that paragraph.

Therefore the question as to whether the business conducted by the trust of which the trustee company (which has alternatively been the subject of voluntary administration, liquidation proceedings and under a DOCA) is 'your business' needs to be addressed.

'Business' is defined broadly at subsection 995-1(1) of the ITAA 1997 and includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. Paragraph 40-880(2)(a) of the ITAA 1997 refers to 'your business' being the taxpayer's overall business. The trust owns all of the shares in the trustee company and the business is conducted by the discretionary trust.

The business was run through a trust. However the trustee company is the legal entity which conducts the business. Therefore expenditure incurred by the company regarding the liquidation procedures and administration of the company has been incurred in relation to 'your business'. The expenditure incurred satisfies the basic eligibility tests set out in section 40-880(2) of the ITAA 1997.

Limitations

Because it has been determined that you are eligible for a deduction under subsection 40-880(2) of the ITAA 1997, the limitations and exceptions contained in subsections 40-880(3) to (9) of the ITAA 1997 must be considered.

Subsections 40-880(3) to (9) of the ITAA 1997 sets out limitations and exclusions to deductibility under section 40-880 of the ITAA 1997. As your business is carried on for a taxable purpose, subsection 40-880(3) of the ITAA 1997 does not apply to limit the amount the company can deduct under section 40-880 for this expenditure. On the facts of this case, only paragraphs 40-880(5)(b) and (f) of the ITAA 1997 need to be relevantly considered.

Paragraph 40-880(5)(b) 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 you can deduct an amount for it under a provision of 'this Act' other than section 40-880. In this case it is necessary to consider section 8-1 of the ITAA 1997.

As the expenditure incurred is capital expenditure, the expenditure is not deductible under section 8-1 of the ITAA 1997. That section would allow a loss or outgoing to the extent that it was necessarily incurred in carrying on a business to the extent that the expenditure was not of a capital nature. As the expenditure has been determined to be capital in nature, section 8-1 does not apply. Therefore, paragraph 40-880(5)(b) of the ITAA 1997 does not limit to any extent the deduction for the expenditure.

Paragraph 40-880(5)(f) 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 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. A CGT event is an event which occurs involving a CGT asset.

The business itself is not a CGT asset as that is defined as any kind of property or legal or equitable right. Examples of CGT assets are land and buildings, shares in a company, options, debts owed to you, a right to enforce a legal obligation and foreign currency.

Subsection 110-25(5) of the ITAA 1997 states that the fourth element of the cost base of a CGT asset includes expenditure incurred for the purpose or the expected effect of which is to increase or preserve the CGT asset's value. Although it could be said that the expenditure incurred has preserved the value of the shares in the company because it is not a liquidated company, that outcome is secondary to the desired consequence of the expenditure which is the ability to continue to carry on the business.

As the expenditure incurred on the administration process of the company is not considered to be a cost incurred in increasing or preserving the value of a CGT asset, it does not form part of the cost base (or reduced cost base) of a CGT asset and will not be taken into account in working out the amount of a capital gain or capital loss from a CGT event. Therefore, the exception in paragraph 40-880(5)(f) of the ITAA 1997 will not apply.

Accordingly, the company can deduct its capital expenditure over five years under section 40-880 of the ITAA 1997 commencing in the year in which the expenditure was incurred and for the subsequent four years.