Edited version of your written advice

Authorisation Number: 1051332153980

Date of advice: 22 February 2018

Ruling

Subject: Income tax - deductions - general deductions - section 8-1 - other

Question

Is the loss incurred by the taxpayer on the disposal of its Equity Interest in the Consortium deductible to it under section 8-1 of the Income Tax Assessment Act (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 2018

Relevant facts and circumstances

1. The taxpayer is an Australia tax resident.

2. A Consortium was established to bid for a Project. The taxpayer was an equity member of the Consortium.

3. The taxpayer’s business included being a contractor to provide products and services of the type required for the Project.

4. The Consortium was the successful tenderer for the Project.

5. The taxpayer acquired an equity interest in the Consortium (the ‘Equity Interest’).

6. The taxpayer became a contractor to the Consortium. The contracts were expected to generate revenue for the taxpayer.

7. The acquisition of the Equity Interest was consistent with the taxpayer’s business strategy.

8. The taxpayer expected to sell down its Equity Interest shortly after completion of key components of the contracts.

9. The taxpayer made a net loss on disposal of its Equity Interests in the Consortium.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Summary

The loss incurred by the taxpayer on the disposal of its Equity Interest originally acquired for the purposes of its interest in the Consortium are deductible under section 8-1 of the ITAA 1997. The Equity Interest acquired by the taxpayer was acquired as an ordinary incident of its business activity and in this circumstance were held on revenue account.

Detailed reasoning

Section 8-1 relates to general deductions and provides:

8-1(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.

8-1(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 your *non-assessable non-exempt income; or

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

8-1(3)

A loss or outgoing that you can deduct under this section is called a general deduction.

The courts have held that for there to be a deduction under section 8-1 there must be a sufficient connection between the loss or outgoing and the production of assessable income. The loss or outgoing must be incidental and relevant to the earning of assessable income (Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236).

In Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199 (‘Myer’), the High Court considered the concepts of ‘capital’ and ‘revenue’ in reference to charactering a profit or gain from an isolated transaction outside the ordinary course of a taxpayers business. The High Court also considered the characterisation of a profit or gain made in the ordinary course of a business.

Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income (‘TR 92/3’) sets out the Commissioner’s view as to the application of the decision of the High Court in Myer.

Taxation Ruling TR 92/4 Income Tax: whether losses on isolated transactions are deductible (‘TR 92/4’) provides the Commissioner’s view on whether losses from isolated transactions are deductible under section 8-1 of the ITAA 1997. TR 92/4 should be read in conjunction with TR 92/3 (see paragraph 3 of TR 92/4).

Paragraph 15 of TR 92/3 sets out that where a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction or operation:

(a) is in the ordinary course of the taxpayer's business (see paragraph 32 for an explanation of the circumstances in which a transaction is in the ordinary course of business) - provided that any gross receipt from the transaction or operation is not income; or

(b) is in the course of the taxpayer's business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit; or

(c) is not in the course of the taxpayer's business, but

(i) the intention or purpose of the taxpayer in entering into the transaction or operation was to make a profit or gain; and

(ii) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Profits or gains in the ordinary course of the taxpayer’s business

Paragraphs 31 and 32 of TR 92/3 consider the High Court’s view in Myer that profits or gains made in the ordinary course of carrying on a business are income. Paragraph 31 states that:

The Court went on to say that, because a business is carried on with a view to profit, such profits or gains are invested with a profit-making purpose and are thereby stamped with the character of income.

Paragraph 32 of TR 92/3 states that it is not completely clear what the High Court meant in referring to ‘profits or gains made in the ordinary course of carrying on a business’. However, the ATO considers that there are two types of profits or gains which come within that description, namely:

(i) a profit or gain arising from a transaction which is itself a part of the ordinary business of a taxpayer (judged by reference to the transactions in which the taxpayer usually engages) - provided that the gross receipts from the transaction lack the character of income (Commercial and General Acceptance Ltd v. FC of T (1977) 137 CLR 373 at 381; 77 ATC 4375 at 4380; 7 ATR 716 at 722); and

(ii) a profit or gain arising from a transaction which is an ordinary incident of the business activity of the taxpayer, although not a transaction entered into directly in its main business activity e.g. profits of insurance companies and banks on the sale of investments are generally income (Chamber of Manufactures Insurance Ltd v. FC of T (1984) 2 FCR 455; 84 ATC 4315; 15 ATR 599 and C of T v. Commercial Banking Co. of Sydney (1927) 27 SR(NSW) 231).

In Westfield Limited v FC of T 91 ATC 4234 the Full Federal Court considered ‘profits made in the ordinary course of business’ and a situation where the transaction which gives rise to the profit is an ordinary incident of the business activity of the taxpayer. At 4242 Justice Hill observed:

When in Myer the High Court spoke of profits made in the ordinary course of business, their Honours were not speaking in a temporal sense. Rather, as the judgment of the Full Court of this court in FC of T v Spedley Securities Limited 88 ATC 4126 at 4130 points out, it is necessary that the purpose of profit-making must exist in relation to the particular operation. In a case where the transaction, which gives rise to the profit, is itself a part of the ordinary business (eg a profit on the sale of shares made by a share trader), the identification of the business activity itself will stamp the transaction as one having a profit-making purpose. Similarly, where the transaction is an ordinary incident of the business activity of the taxpayer, albeit not directly its main business activity, the same can be said. The profit-making purpose can be inferred from the association of the transaction of purchase and sale with that business activity.

An examination of the taxpayer’s ordinary business transactions and activities is necessary to determine whether the loss arising from the disposal of its Equity Interest was a part of the taxpayer’s ordinary business or an ordinary incident of its business activity, and therefore incurred in the ordinary course of carrying on its business. The taxpayer’s business includes being a contractor to provide products and services of the type required for the Project. As a contractor to the Consortium, the taxpayer was responsible for delivery of products and services as part of the Project. The taxpayer was also an equity member of the Consortium.

The taxpayer’s acquisition of its Equity Interest in the Consortium was an integral element in the wider business activity of the taxpayer.

It is considered that the acquisition and disposal of the taxpayer’s Equity Interest in the Consortium were not transactions entered into in its ordinary business as required by paragraph 32(i) of TR 92/3. However, consistent with paragraph 32(ii) of TR 92/3, the acquisition and disposal of the taxpayer’s Equity Interest were ordinary incidents of the taxpayer’s business activity to secure contracts to provide products and services. In these circumstances, it is considered that the principles in paragraph 15(a) and paragraph 32(ii) of TR 92/3 apply and the taxpayer’s loss on disposal of its Equity Interest was incurred in the ordinary course of carrying on its business and will be revenue in nature.

Accordingly, it is considered that the taxpayer necessarily incurred the loss on disposal of its Equity Interest in carrying on a business for the purpose of gaining or producing its assessable income and therefore subsection 8-1(1) is satisfied. As the Equity Interest on which the loss was incurred is revenue in nature and none of the circumstances in subsection 8-1(2) apply, the loss incurred by the taxpayer on disposal of its Equity Interest will be deductible under section 8-1 of the ITAA 1997.