Edited version of your written advice

Authorisation Number: 1051381682434

Date of advice: 5 June 2018

Ruling

Subject: Company under administration – Income Tax and GST implications of payments to creditors

Issue 1

GST

Question 1

For GST purposes, are amounts attributed (reported on the Business Activity Statement (BAS)) pursuant to section 29-10 of the A New Tax System (Goods and Services Tax Act) 1999 (GST Act) when you make contributions to a Fund established under a DOCA?

Answer

No, you will attribute your input tax credits in the tax period the Deed Administrators make a distribution to the creditors.

Issue 2

Deductibility of expenses included in the DOCA

Question 1

Are expenses for which invoices have been received prior to the date on which the Administrators were appointed and which were provided for in the DOCA deductible under Section 8-1 of the ITAA 1997 in the income year in which the invoices in relation to these expenses were issued to the Company?

Answer

Yes

Question 2

If the answer to Question 1 is yes, is the Company required to make adjustments pursuant to the "Commercial Debt Forgiveness" provisions in Div 245 of ITAA 1997?

Answer

Yes

Issue 3

Deductibility of Administrator’s remuneration

Question 1

Is Administrator’s remuneration payable under the DOCA deductible under Section 8-1 of the ITAA 1997 when it is incurred?

Answer

No. The expenditure on administrator's fees is capital expenditure incurred 'in relation to your business' for the purpose of paragraph 40-880(2)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) and deductible over five years.

This ruling applies for the following period(s)

1 July 20xx to 30 June 20xx

Relevant facts and circumstances

The Company is registered for GST purposes effective from xx.

The Company reports on an accruals basis for Income Tax purposes and reports GST on a cash basis using quarterly tax periods.

Due to the instability of the industry in which the Company operates significant debtors of the Company went into liquidation and the Company had to write off their debt. It subsequently had difficulty paying wages, material costs and other overheads and was also unable to meet taxation and superannuation liabilities. The director attempted to enter into payment plans with the Company’s affected creditors, but it became apparent that it would be impossible for the Company to continue to trade as well as pay the legacy debt that had been incurred. It was decided that the only way the Company would be able to recover would be to enter into a voluntary administration with the intention of offering the creditors a portion of the debt under a Deed of Company Arrangement under Part 5.3A of the Corporations Act 2001.

The Creditors of the Company resolved under section 439C(a) of the Corporations Act that the Company execute a DOCA. This followed acceptance of a proposal by the director for the Company to enter into the DOCA which provided for the payment of a pool of funds over the period of twenty-four months for a total sum. The pool of funds was expected to provide for the payment of a distribution to creditors.

The DOCA was executed.

When the DOCA was entered into, the period of Administration ended, the Administrators ceased being the administrators of the Company and became the Deed Administrators under the DOCA.

The DOCA specified that the Deed Administrators would act as agents of the Company.

The rights of Secured Creditors and of Owners and Lessors who did not vote in favour for the resolution to execute the DOCA are unaffected.

Each DOCA Creditor accepted the right to prove and the Entitlements under the DOCA and distribution of the Fund in full discharge and satisfaction of any claim against the Company that it would have been entitled to prove for in a winding up of the Company had it been wound up on the Appointment Date.

The DOCA Creditors agreed that when the Deed Administrators have paid to DOCA Creditors their full entitlements under the DOCA and the DOCA terminates upon the issuing of a Certificate of Termination by the Administrators, the claims they would have been entitled to prove for in a winding up of the Company had it been wound up on the Appointment Date, are released in full and extinguished.

Upon the execution of the DOCA, control of the Company and its business returned to the Director.

It was intended that the Deed Administrators would distribute payments from the Fund to creditors on a six monthly basis.

The Company had to pay an Initial Contribution Amount which was unspecified, but defined as an amount sufficient to pay the remuneration, costs, disbursements, trading liabilities in respect of the Company, or expenses of the Administrators, acting in their capacity as the Administrators of the Company including their partners and staff, during the Voluntary Administration Period, as well as any other claims of the Administrators under the DOCA and the Corporations Act as well as 24 monthly contributions.

(hereafter referred to as the Fund)

The Deed Administrators would control the Fund with the Fund being an asset of the Deed Administrators to be used in accordance with the DOCA and for no other purpose.

These amounts that constitute the Fund are pooled until paid in the following order of priority:

a) Payment of the remuneration, costs, disbursement, trading liabilities or expenses of the Administrators, acting as the Administrators of the Company during the Voluntary Administration Period

b) Payment of the remuneration, costs, disbursements and expenses of the Deed Administrators of the Company

c) Employee Superannuation Claims

d) Other claims by Priority Creditors

e) Claims by the ATO and the SRO

f) Other claims by other participating creditors, pro rata

Payments to the Administrators are approved by the DOCA Creditors.

Included in the Creditor claims under the DOCA are claims for numerous unpaid tax invoices in relation to two financial years.

For GST purposes the Company did not make any payment or claim an input tax credit in respect to the invoices/acquisitions prior to the date Administrators were appointed.

Secured creditors that choose not to participate in the DOCA may be paid amounts owing by the Company by way of the personal guarantees that they hold over the Director of the Company. Once this process has been completed, the DOCA will be amended to re-assess the value of the DOCA in regards to unsecured creditors. Apart from this, the terms of the DOCA will remain unchanged.

No termination date is specified in the DOCA. However the DOCA will terminate in respect of the Company when the Deed Administrators issue a Certificate of Termination.

A Certificate of Termination will be issued once the Administrators have applied all of the proceeds of the Fund available for the payment of Participating Creditors. Administrators must then certify to that effect in writing and must within 28 days lodge with ASIC a notice of termination of the DOCA.

The DOCA can also terminate where ordered by the court under section 445D of the Corporations Act or where the creditors of the Company with a Claim pass a resolution terminating the DOCA in respect of the Company at a meeting convened under section 445C(b) of the Corporations Act.

The Deed Administrators can at their discretion convene a meeting of the DOCA Creditors by written notice to consider the termination of the DOCA, variation of the DOCA or enforcement of the terms of the DOCA, if they consider doing so is in the interests of DOCA Creditors and the DOCA, upon the happening of any one of the following events:

a) The Company is unable to comply with any fundamental provision of

the DOCA including payment of monies due under the DOCA and/or

b) the Administrators form the view that the Company is unlikely to be able

to comply with the terms of the DOCA.

If any part of the DOCA is or becomes illegal, ineffective, invalid or unenforceable, that part shall be severed from the DOCA and that severance shall not affect the effectiveness, validity or enforceability of the remaining part of the DOCA.

The termination or avoidance, in whole or in part, of the DOCA does not affect the previous operation of the DOCA.

Relevant legislative provisions

Subsection 29-10(2) A New Tax System (Goods and Services Tax Act) 1999

Subsection 29-10(3) A New Tax System (Goods and Services Tax Act) 1999

Section 8-1 of Income Tax Assessment Act 1997

Division 245 of Income Tax Assessment Act 1997

Section 245-1 of Income Tax Assessment Act 1997

Section 245-2 of Income Assessment Tax Act 1997

Section 245-10 of Income Assessment Tax Act 1997

Section 245-35 of Income Assessment Tax Act 1997

Section 245-40 of Income Assessment Tax Act 1997

Section 245-45 of Income Assessment Tax Act 1997

Section 245-48 of Income Assessment Tax Act 1997

Subdivision 245-C of Income Assessment Tax Act 1997

Subdivision 245-D of Income Assessment Tax Act 1997

Section 245-105 of Income Assessment Tax Act 1997

Sections 245-115 to 245-195 of Income Assessment Tax Act 1997

Reasons for decision

Issue 1

GST

Question 1

For GST purposes, are amounts attributed (reported on the BAS) pursuant to section 29-10 of the GST Act when you make contributions to a Fund established under a DOCA?

Summary

The Company will attribute your input tax credits in the tax period the DOCA Administrators make a distribution to the creditors.

Detailed reasoning

Note: In this reasoning, unless otherwise stated,

● all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

● reference material(s) referred to are available on the Australian Taxation Office (ATO) website www.ato.gov.au

Subsection 29-10(2) contains the basic rules in regard to attributing an input tax credit (ITC) for creditable acquisitions that have been made in cases where the company accounts for GST on a cash basis.

In summary, if a company accounts for GST on a cash basis, they attribute the ITC for a creditable acquisition to the tax period in which they provide consideration for that acquisition, but only to the extent that they provided the consideration in that tax period.

In this case:

● the Company acquired goods and services during the 20xx and 20xx financial years

● the Company accounts for GST on a cash basis

● the Company did not make payments in regard to the acquisitions prior to entering into a DOCA

● under the DOCA, the Company will make periodic payments into a Fund

● the Deed Administrators will distribute the payments made to the Fund to parties including creditors (suppliers of the acquisitions the Company made in the 20xx and 20xx financial years).

The Deed Administrators, in exercising the powers conferred by the DOCA, are acting as an agent for and on the Company’s behalf. Under the general law of agency, an agent is said to stand in the shoes of the Principal where acts done by an agent are considered to be acts of the Principal.

Furthermore, in this case, at the time the Company makes payments into the Fund, as required under the terms of the DOCA, those payments will be distributed to various creditors including those from which the Company haves not made a creditable acquisition (and as such not entitled to an ITC - for example, payments made in respect to superannuation and to the ATO). As such, at the time the Company make the payments to the Fund, they are unaware of the amount/s to be allocated to creditors in respect of their creditable acquisitions.

Given the above, the Company will attribute ITCs for their creditable acquisitions in the tax period they become aware of the amounts and details of the distributions made by the Deed Administrators to the creditors.

Subsection 29-10(3) requires that the Company holds a valid tax invoice in order to claim an ITC for creditable acquisitions. On this point, the tax invoice/s required to be held for the purposes of claiming ITCs, are in respect of creditable acquisitions the Company has made. This includes acquisitions from suppliers/creditors made prior to the Company having an Administrator appointed. Also any goods and/or services supplied by/acquired from the Administrators (such as services provided to the Company by the Administrators).

For GST purposes, the payment by the Company of monthly contributions into the DOCA Fund would not constitute consideration for a supply from the Administrators. The monthly amounts paid into the Fund, are outside of the scope of GST and would not trigger an entitlement to an ITC. The payments are made to the Administrator (as agent) to be held on Trust until the Administrators make a distribution.

To be entitled to an ITC, one of the requirements of making a creditable acquisition is that the Company ‘provide, or are liable to provide, consideration for the supply’. For GST purposes, it does not matter whether the payment of the consideration is made by the recipient of the supply.

Issue 2

Deductibility of expenses included in the DOCA

Note that, from here on, unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997.

Question 1

Are expenses for which invoices have been received prior to the date on which the Administrators have been appointed and which will be paid by the Administrators under the terms of the DOCA, deductible under Section 8-1 of the ITAA 1997 in the income year in which the invoices in relation to these expenses were issued to the Company?

Detailed Reasoning

Note: The answer to this question does not consider whether expenses are in fact deductible under Section 8-1, but only the timing of when deductible expenses, for which the payment will be made under the terms of the DOCA, should be claimed.

When is an expense incurred?

In order to be able to claim a deduction under section 8-1, a taxpayer must have incurred an expense.

The word 'incurred' is not defined in the legislation; therefore in determining whether an amount will have been incurred for income tax purposes, regard must be had to the ordinary meaning determined by the courts.

Federal Commissioner of Taxation v. James Flood (1953) 88 CLR 492 establishes that a loss or outgoing is incurred where the taxpayer has 'completely subjected itself' to the loss or outgoing. Further, in the case of Nilsen Development Laboratories Pty Ltd v. Federal Commissioner of Taxation (1981) 144 CLR 616, the word incurred was taken to mean when the taxpayer has a 'presently existing liability'.

Therefore the expense would be incurred when the invoices for the materials or services provided were issued to the Company and should be claimed in the year of income in which this occurred.

Question 2

If the answer to Question 1 is yes, is the Company required to make adjustments pursuant to the "Commercial Debt Forgiveness" provisions in Division 245 of ITAA 1997?

Summary

In the year in which the DOCA terminates as a result of the Administrators issuing a Certificate of Termination after having applied all the proceeds of the Fund available for the payment of participating creditors, you must determine the extent to which the Company’s debts to the creditors were forgiven and apply the net forgiven amounts in that year in the following order:

(a) to your tax losses from previous income years;

(b) to your net capital losses from previous income years;

(c) to the deductions you would otherwise get in the income year, or in a later income year, because of expenditure from a previous year (for example, the capital allowance deductions you would get for expenditure on acquiring a depreciating asset);

(d) to the cost bases of your CGT assets.

Detailed reasoning

Division 245 sets out the rules regarding the forgiveness of commercial debts. Section 245-1 states:

When a creditor forgives a commercial debt you owe, you make a gain. This is usually not included in your assessable income. Instead, this Division offsets the forgiven amount against amounts that could otherwise reduce your taxable income in the same or a later income year. Those amounts are:

(a) your tax losses and net capital losses; and

(b) capital allowances and some similar deductions; and

(c) the cost bases of your CGT assets.

Section 245-2 states that Division 245 applies to any commercial debt or part thereof that is forgiven.

Debt

The debts to the creditors dealt with under the DOCA are a legally enforceable obligation for Company or its agent to pay the creditors.

Commercial debt

Under section 245-10 a debt is a commercial debt if interest on the debt was or could have been deducted from the debtor's assessable income. Where invoices are issued for the provision of goods or services and the expenses are deductible under Section 8-1, interest on late payment of these debts will also be deductible and therefore the debts are commercial debts

Forgiveness of a debt

Under section 245-35 a debt is forgiven if and when:

(a) the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full; or

(b) the period within which the creditor is entitled to sue for recovery of the debt ends, because of the operation of a statute of limitations, without the debt having been paid.

The DOCA states that the DOCA Creditors (other than Secured Creditors and Owners and Lessors) will not otherwise seek to recover their claims. The DOCA Creditors accept the right to prove and the entitlements under the DOCA and distribution of the DOCA Fund in full discharge and satisfaction of their claims. After Creditors have been paid their full entitlements under the terms of the DOCA and the DOCA terminates, their claims are released in full and extinguished.

However the DOCA may also be terminated in other ways if the Company is unable to meet its payment obligations under the DOCA. In this case the Creditors’ ability to otherwise seek to recover their claims will no longer be limited by the DOCA. The forgiveness of the debt only becomes unconditional once the DOCA is terminated by the Administrators issuing a certificate of termination following the application of all the proceeds of the Fund available for the payment of Participating creditors.

It is also at this stage that it would be possible to determine how much of the debts will be forgiven. The estimate provided by the Director in his proposal was that ordinary unsecured creditors would receive XX cents in the dollar. However this percentage is an estimate only and would be affected by the amount of Administrator’s Remuneration paid from the Fund.

Therefore the forgiveness of the debts or part thereof only becomes unconditional upon the issue of a Certificate of Termination by the Administrators.

Circumstances in which Div 245 does not apply

Subdivision 245-40 states that Division 245 does not apply if:

(a) the debt is waived and the waiver constitutes a fringe benefit; or

(b) the amount of the debt has been, or will be, included in your assessable income in any income year; or

(c) the debt is forgiven under an Act relating to bankruptcy; or

(d) the debt is forgiven by will; or

(e) the debt is forgiven for reasons of natural love and affection; or

(f) the debt is a tax-related liability.

In your case none of these apply.

Determining if the forgiveness involved an arrangement for the purposes of Section 245-45

Section 245-45 determines the application of the operative rules if forgiveness involves an arrangement. This section states that where the debtor and creditor in relation to a debt enter into an arrangement and under the arrangement, the debtor’s obligation to pay the debt is to cease at a particular time, the debt forgiveness rules apply as if the debt were forgiven when the arrangement is entered into. However Section 245-45 only applies if the cessation of the obligation to pay the debt is to occur without the debtor incurring any financial or other obligation (other than one that is nominal or insignificant.)

In this case, under the DOCA, the Company has the obligation to make specified payments to the Administrators on a monthly basis and to adhere by the terms of the DOCA. Therefore this section will not apply to deem the debt forgiven at the time of execution of the DOCA.

The amount of the forgiveness

Section 245-48 states:

The amount of forgiveness (called the gross forgiven amount) for the debtor reflects the loss that the creditor makes for tax purposes. It is worked out in 2 steps:

(a) the value of the debt when it was forgiven is worked out on the basis that you were solvent both then and when you incurred the debt; and

(b) the value of the debt is then offset by any consideration given for the forgiveness of the debt.

The difference between the value of the debt and the amount offset is the gross forgiven amount.

It will only be possible to calculate the amount of forgiveness at the time when a certificate of Termination of the DOCA is issued by the Administrators.

At that stage Subdivisions 245-C and 245-D should be applied to work out the gross and net forgiven amounts of a debt.

Applying the total net forgiven amount

Section 245-105 states that the total net forgiven amount in a forgiveness income year (the income year in which the debt is forgiven) is the net forgiven amounts of all your debts forgiven in that year.

As discussed above, if the DOCA is taken to its conclusion as intended this will be the year in which the Certificate of Termination is issued by the Administrators.

The total net forgiven amount will then be applied, in accordance with sections 245-115 to 245-195 in the following order:

(a) to your tax losses from previous income years;

(b) to your net capital losses from previous income years;

(c) to the deductions you would otherwise get in the income year, or in a later income year, because of expenditure from a previous year (for example, the capital allowance deductions you would get for expenditure on acquiring a depreciating asset);

(d) to the cost bases of your CGT assets.

Issue 3

Deductibility of Administrator’s remuneration

Question 1

Is Administrator’s remuneration payable under the DOCA deductible under Section 8-1 of the ITAA 1997 when it is incurred?

Summary

The Company is not entitled to an immediate deduction for the total amount of administrator's fees relating to the period of Voluntary Administration or the administration of the DOCA under Section. However, the expenditure on administrator's fees is capital expenditure incurred 'in relation to your business' for the purpose of paragraph 40-880(2)(a) and deductible over five years.

Detailed reasoning

Section 8-1 allows a deduction for losses and outgoings to the extent they are incurred in gaining or producing assessable income (the 'first limb'), or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income (the 'second limb'). However, a deduction is not allowed under section 8-1 if the loss or outgoing is of a capital, private or domestic nature, or is incurred in producing exempt income or where another provision of the ITAA 1997 prevents a deduction.

For an outgoing to be deductible, it must be incidental or relevant to the production of the taxpayer's assessable income or business operations: Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

With regards to the second limb, the High Court in John Fairfax & Sons Pty Ltd v. FC of T (1959) 101 CLR 30 at 48; 11 ATD 510 at 519 said that an outlay must be part of the cost of trading operations to produce income, that is, it must have the character of a working expense.

However, even if an expense met one of the two positive limbs of section 8-1, a deduction under that section would not be allowable if the capital exclusion would apply.

The Company considered that it would only be able to recover from its legacy debt by entering into a voluntary administration with the intention of offering the creditors a portion of the debt under a DOCA arrangement and this was the reason for originally approaching the Administrators.

The expense incurred in paying the Administrators’ remuneration is considered to be capital in nature as:

a) it is a 'one-off' type expenditure rather than a recurrent business expense;

b) it was incurred in order to provide an enduring benefit, that is, to secure the continued existence of the company; and

c) it was expenditure directed to the profit-yielding subject rather than the operation of the business.

Section 40-880

Subject to the limitations and exceptions contained in subsections 40-880(3) to 40-880(9), subsection 40-880(2) 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, which carried on a 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 the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 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. FC of T 95 ATC 4145; (1995) 30 ATR 207, Hill J. considered the phrase 'in relation to' within the context of paragraph 26(g) of the Income Tax Assessment Act 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) in order to determine whether there is a sufficient and relevant connection between the incurrence of the expenditure and the Company's business.

In discussing the types of business capital expenditure to which subsection 40-880(2) applies, the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states:

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). 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 administration of the company during the period of Voluntary Administration as well as the DOCA Period affect whether the structure by which the Company carried on its business continued, the profit yielding structure of that business and the business's trading operations. On the facts, there is a sufficient and relevant connection between the taxpayer's incurrence of the capital expenditure on administration and the Company's business.

Accordingly, the capital expenditure was incurred by the Company in relation to its business for the purposes of paragraph 40-880(2)(a). None of the limitations and exceptions contained in subsections 40-880(3) to 40-880(9) apply. Therefore the capital expenditure is deductible over a period of five years.