Edited version of private advice

Authorisation Number: 1051571929248

Date of advice: 24 June 2021

Ruling

Subject: Costs associated with the establishment of an employee share scheme

Question 1a

Is Parent Company eligible for a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for expenses incurred in establishing an Employee Share Trust (EST)?

Answer 1a

No.

Question 1b

If the answer to Question 1a is no, will Parent Company be eligible for a deduction under section 40-880 of the ITAA 1997 for expenses incurred in establishing the EST?

Answer 1b

No.

Question 2

Will the amount received by Parent from a wholly owned subsidiary as reimbursement for the expenses incurred in establishing the EST be included in its assessable income under sections 6-5, 6-10 or 20-20 of the ITAA 1997?

Answer 2

No.

Question 3

Is Parent Company eligible for a deduction under section 8-1 of the ITAA 1997 for the expenses incurred in the ongoing administration of the EST (Ongoing EST Administration Expenses)?

Answer 3

No.

Question 4

Is Parent Company eligible for a deduction under section 25-5 or section 8-1 of the ITAA 1997 for the expenses incurred in managing the tax affairs of the EST (EST Tax Affairs Expenses)?

Answer 4

No.

Question 5

Will the amount received by Parent Company from Subsidiary Company as reimbursement for the expenses incurred in the ongoing administration of the EST, and managing the tax affairs of the EST (Ongoing Expense Recharge Amount) be included in its assessable income under sections 6-5, 6-10 or 20-20 of the ITAA 1997?

Answer 5

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1) Parent Company is a public company, listed on the Australian Securities Exchange (ASX). Parent Company is a holding company, and the Parent Company Group comprises legal entities in Australia, and overseas (the Parent Company Group).

2) Parent Company's 100% owned Australian subsidiary, Subsidiary Company, conducts the business operations for Parent Company and the Parent Company Group in Australia. Parent Company and Subsidiary Company are not members of a tax consolidated group.

3) Subsidiary Company employs all Australian resident employees of the Parent Company Group which includes members of Parent Company's Board of Directors (Subsidiary Company Employees). Parent Company has no employees.

4) The business of the Parent Company Group is a consumable good.

5) Parent Company owns several patents and trademarks which it licenses to its subsidiaries (which includes Subsidiary Company). These entities pay Parent Company a license fee, which Parent Company returns as assessable income in Australia.

6) Parent Company incurs additional expenses on behalf of its various Parent Company Group members. These expenses include (amongst other amounts) auditing fees, accounting fees and professional advice fees in relation to the taxation affairs of the various Parent Company Group members. These amounts are recharged to the relevant Parent Company Group subsidiary without an additional 'mark-up' percentage.

7) Parent Company and Subsidiary Company have a standing loan agreement in place, whereby Subsidiary Company as the operating entity 'loans' Parent Company the funds to meet the expenses as they are incurred by Parent Company.

8) Amounts owed between the entities are invoiced as they become due and payable, and the appropriate entry is made to the loan account between the parties to reflect payment of the amount due and payable.

9) Whilst Subsidiary Company is generally the creditor and Parent Company the debtor, the balance of that 'loan facility' can fluctuate, such that Subsidiary Company can periodically become the debtor and Parent Company the creditor - for example when Subsidiary Company has an amount due and payable to Parent Company for a license fee to use Parent Company's intellectual property.

10) As an incentive, Parent Company has implemented the Parent Company Long-Term Plan (an employee share plan) (Plan), which provides certain Australian employees of the Parent Company Group the opportunity to become participants and receive rights to fully paid shares in Parent Company.

11) Parent Company decided to establish the Parent Company Employee Share Trust (EST), which was settled via a Deed to facilitate the provision of shares in Parent Company under the Plan to eligible Subsidiary Company Employees.

12) Parent Company makes contributions to the Trustee of the (EST). These contributions are used by the Trustee to subscribe for shares in Parent Company (or acquire Parent Company shares on-market). These contributions are recharged to Subsidiary Company.

13) The scheme resulting from the operation of the Plan, the invitations to Subsidiary Company Employees to participate in the Plan, and the Deed which establishes the EST, all comprise an Employee Share Scheme (ESS) for the purposes of Division 83A of the Income Tax Assessment Act 1997.

14) Parent Company incurred various expenses associated with establishing the EST (Establishment Expenses). These expenses included legal fees associated with drafting the Deed and other professional fees relating to commercial and legal advice with the EST's implementation. Parent Company also incurred stamp duty and other ancillary 'one-off' expenses. The total Establishment Expenses incurred by Parent Company for the years ending:

•                    30 June 20XX was $XX,XXX, and for

•                    30 June 202XX was $XX,XXX.

15) The Establishment Expenses have been recharged to Subsidiary Company on a 'dollar for dollar' basis, without any margin being applied (the Establishment Recharge Amount).

16) The Establishment Recharge Amounts for the income years ending 30 June 20XX and 30 June 20XX was $XX,XXX (GST exclusive) and was recharged to Subsidiary Company under a single invoice.

17) As identified above, in addition to Establishment Expenses, Parent Company also incurs expenses in relation to the EST such as auditing fees, accounting fees and professional advice fees in relation to the taxation affairs (EST Tax Affairs Expenses) of the EST.

18) Further, Parent Company also incurs ongoing administration and maintenance costs for the EST (collectively referred to as Ongoing EST Administration Expenses). These amounts are principally the fees charged by the Trustee of the EST to Parent Company as well as regulatory fees (such as ASIC charges). The total of Ongoing EST Expenses charged to Parent Company for the year ending:

•                    30 June 20XX was $X,XXX, and for

•                    30 June 20XX was $XX,XXX.

19) The EST Tax Affairs Expenses and Ongoing EST Administration Expenses are recharged to Subsidiary Company on a cost incurred basis, without an additional corporate margin (the Ongoing Expense Recharge Amount).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

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

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

Income Tax Assessment Act 1997 paragraph 8-1(1)(b)

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 subsection 20-20(1)

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 subsection 20-20(3)

Income Tax Assessment Act 1997 section 25-5

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 subsection 40-880(2)

Income Tax Assessment Act 1997 subsection 40-880(3)

Income Tax Assessment Act 1997 subsection 40-880(9)

Income Tax Assessment Act 1997 section 995-1

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

Reasons for decision

All legislative references in these reasons are to the Income Tax Assessment Act 1997 unless otherwise indicated.

Question 1a

Section 8-1 provides, relevantly, that:

(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.

Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.

Was the outgoing incurred in gaining or producing Parent Company's assessable income under paragraph 8-1(1)(a)?

The phrase 'incurred in gaining or producing your assessable income' was considered in the High Court decision of Commissioner of Taxation v Payne [2001] HCA 3 (Payne) (at [9]). The majority concluded that 'incurred in gaining or producing' assessable income means incurred 'in the course of gaining or producing that income' - it does not mean outgoings incurred 'in connection with' or 'for the purposes of' deriving assessable income. The High Court stated that the question that requires consideration is (at [11]);

... is the occasion of the outgoing found in whatever is productive of actual or expected income?

In Healy and FC of T [2013] AATA 281, the AAT suggested (at [92] to [95]) that the following may assist in determining whether a loss or outgoing was incurred 'in the course of' gaining or producing actual or expected income:

What is required is an objective:

(i)            identification of the "occasion" for the loss or outgoing;

(ii)           identification of the "activity" that is "productive" of the assessable income in question; and

(iii)         a determination whether the loss or outgoing can be properly regarded as having been incurred in the course of that activity: see Federal Commissioner of Taxation v Anstis [2010] HCA 40 and Federal Commissioner of Taxation v Visy Industries USA Pty Ltd [2012] FCAFC 106; (2012) 205 FCR 317.

What makes the outgoing deductible under s 8-1 is the existence of a sufficient connection, a 'link' or 'nexus', between the loss or outgoing and the production of assessable income. A taxpayer's subjective purpose in incurring a loss or outgoing is not normally relevant to whether a sufficient connection exists.

In Watson as Trustee for the Murrindini Bushfire Class Action Settlement Fund v Commissioner of Taxation [2020] FCAFC 92 (Watson), the full Federal Court held (at [33]):

While the connection with activities which more directly gained or produced the assessable income need not be direct (Day at [21]), the occasion of the outgoing must be found in what is productive of the assessable income; there must be a sufficient nexus between the outgoing and "the activities which more directly gain or produce the assessable income".

The Establishment Expenses which Parent Company has incurred relate to establishing an EST for Subsidiary Company's employees. Accordingly, the Establishment Expenses are not productive of Parent Company's assessable income and are not incidental and relevant to any income earning activity of Parent Company. There is not a sufficient nexus between the outgoing and the activities which more directly produce Parent Company's assessable income. Therefore, the Establishment Expenses incurred by Parent Company are not deductible under paragraph 8-1(1)(a).

Was the outgoing necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income under paragraph 8-1(1)(b)?

Parent Company is a public company, listed on the ASX, while its subsidiary, Subsidiary Company, employs all employees and conducts the business operations in Australia. Given the wide definition of 'business' and 'carrying on an enterprise' in subsection 995-1(1) it is accepted that Parent Company is 'carrying on' a business.

Determining whether the expenses were necessarily incurred for the purpose of gaining or producing assessable income involves:

•                    characterising the outgoing and looking 'to the relationship between the outgoing and the carrying on of business' (Essenbourne Pty Ltd v Commissioner of Taxation [2002] FCA 1577 at [24], per Kiefel J); and

•                    considering the purpose or motivation for the making of the outgoing, that is:

whether the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of that business and, if so, whether those responsible for carrying on the business so saw it (Magna Alloys & Research Pty Ltd v FC of T [1980] FCA 150).

The Commissioner's view on how to satisfy the requirements of subsection 8-1(1)(b) can be found in Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 (TR 2011/6). Paragraphs 73 and 74 of TR 2011/6 contain a comparison of the use of the expression 'in relation to' in subsection 40-880(2), and the expression 'in carrying on' in subsection 8-1(1). It relevantly states:

73. In contrast, for expenditure to be deducted under the second positive limb of section 8-1, it must be incurred in carrying on a business. To satisfy this requirement, the outgoing must have the character of a working or operating expense of the entity's business or be an essential part of the cost of its business operations. In John Fairfax & Sons Pty Ltd v. FC of T (1958-9) 101 CLR 30 Menzies J stated at page 49:

...there must, if an outgoing is going to fall within its terms, be found (i) that it was necessarily incurred in carrying on a business; and (ii) that the carrying on of the business was for the purpose of gaining assessable income. The element that I think is necessary to emphasise here is that the outlay must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations.

74. The test under the second positive limb of section 8-1 is therefore a more demanding test requiring a more immediate or direct link between the expenditure and the process of operating the business than a connection that qualifies the expenditure as being 'in relation to' a business.' (emphasis added)

The Establishment Expenses at issue relate to establishing an EST for Subsidiary Company's employees. The relationship between the expenses incurred and the carrying on of a business would, at best, be that Parent Company may receive income by way of dividends from Subsidiary Company. This connection is considered too remote - the relevant expense is not part of the cost of Parent Company's trading operations and as such it does not satisfy paragraph 8-1(1)(b).

Conclusion

In conclusion, Parent Company is not entitled to a deduction under section 8-1 for the Establishment Expenses, as they were not:

•                    incurred in gaining or producing its assessable income; or

•                    necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income.

Question 1b

Establishment Expenses and section 40-880

As explained in Commissioner of Taxation v Sharpcan Pty Ltd [2019] HCA 36 (Sharpcan), section 40-880 covers deductions that are allowed for business related expenses, its purpose being to target (at [46]):

"black hole" expenditure, namely business expenses incurred by taxpayers that fall outside the scope of deduction provisions of income tax law. Thus, as s 40-880(1) provides, a deduction under s 40-880 is "only allowed to the extent that the expenditure is not taken into account in some way elsewhere in the income tax law".

Section 40-880 provides that:

(1) The object of this section is to make certain *business capital expenditure deductible over 5 years, or immediately in the case of some start-up expenses for small businesses, if:

(a) the expenditure is not otherwise taken into account; and

(b) a deduction is not denied by some other provision; and

(c) the business is, was or is proposed to be carried on for a *taxable purpose.

Note: If Division 250 applies to you and an asset:

(a) if section 250-150 applies-you cannot deduct an amount for capital expenditure you incur in relation to the asset to the extent specified under subsection 250-150(3); or

(b) otherwise-you cannot deduct an amount for such expenditure.

Deduction

(2) 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) ...

The threshold test for an expense to be deductible under section 40-880 is therefore that it is capital in nature.

Are the Establishment Expenses capital in nature?

In Sun Newspapers Ltd v Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337 at 363 (Sun Newspapers), Dixon J outlined three matters to be considered when determining whether an outgoing is capital or revenue in 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 to be 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.' [Emphasis added]

Justice Dixon went on to distinguish capital and revenue expenses by saying that an expense is capital in nature if it relates to the business entity, structure, or organisation established for the earning of profit, as opposed to the process by which the organisation operates to obtain its income (see, Sun Newspapers Ltd at 359).

In GP International Pipecoaters Pty Ltd v FCT [1990] HCA 25 the High Court stated (at [13]):

The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by making 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.

Subsequently, in Sharpcan the High Court cited Sun Newspapers as support for the proposition that in identifying the advantage sought, it is ordinarily necessary to consider (at [18]):

...the manner in which it is to be used, and whether the means of acquisition is a once-and-for-all outgoing for the acquisition of something of enduring advantage or a periodical outlay to cover the use and enjoyment of something for periods commensurate with those payments.

These principles have been summarised in Origin Energy Ltd v Federal Commissioner of Taxation (No 2) [1990] HCA 25 by Thawley J (at [13]):

85. In AusNet, the majority emphasised the importance of the "advantage sought by the taxpayer by making the payments"... Fullagar J [in Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation [1953] HCA 68; (1953) 89 CLR 428 at 454] identified the questions commonly arising as (emphasis in original):

(1) What is the money really paid for?: - and

(2) Is what it is really paid for, in truth and in substance, a capital asset?

86. The answer to the question what the money is "for" is not necessarily answered solely by reference to a "juristic classification of legal rights": Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 at 648. The answer "depends on what the outgoing is calculated to effect from a practical and business point of view": Sharpcan at [18]; Hallstroms at 648. The primary question is the character of the advantage sought by the taxpayer in incurring the expenditure:...'

The nature of the establishment costs of trusts was considered in Fanmac Limited v FCT [1991] FCA 490. In that case the taxpayer was 'carrying on a business of establishing, marketing, managing, administering trusts which issued fixed rate securities'. It was held that on the facts, the expenses took on the character from the processes of the operations of the business rather than a part of the structure of the business and were held to be on revenue account. The Court went on to say that (at [32]):

if the only relevant activity of the taxpayer was the instant trust, there would be much to be said for the view that this item of expenditure was an affair of capital.

Parent Company incurred the Establishment Expenses in order to set up the EST. The Establishment Expenses incurred by Parent Company were a one-off payment used in setting up a single trust as part of the remuneration structure for Subsidiary Company's employees. The character of the advantage sought was the enduring benefit of having the EST in Subsidiary Company's business structure. This leads to the conclusion that the once and for all payment was a capital outlay. There are no special circumstances that indicate to the contrary.

Were the Establishment Expenditure incurred in relation to Parent Company's business?

Assuming the Establishment Expenses incurred by Parent Company meet the other requirements of subsection 40-880(1), the next consideration is whether they meet the requirements of subsection 40-880(2). It provides:

Deduction

(2) 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) ...

The term 'business' is defined in subsection 995-1(1) as:

business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Paragraphs 21, 98 and 99 of TR 2011/6 provide guidance on the meaning of the phrase 'your business':

21. The reference in paragraph 40-880(2)(a) to 'your business' is a reference to the taxpayer's overall business rather than a particular undertaking or enterprise within the overall business. Similarly, where the taxpayer is the head company of a consolidated group, "your business" refers to the overall business of the head company.

...

98. Paragraph 40-880(2)(a) gives 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.

99. 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.'

As Parent Company and Subsidiary Company are not part of an income tax consolidated group, the reference in the law to 'your business', is that of Parent Company's business.

The Establishment Expenses were incurred by Parent Company for the benefit of Subsidiary Company Employees. Whilst the ESS (and by inference the EST) may produce economic benefits, these are economic benefits that will arise to Subsidiary Company. Such economic benefits as 'positive working relationships', 'boosting productivity', 'reducing staff turnover' and 'encouraging good corporate governance' that may arise to Subsidiary Company through implementation of the ESS, do not produce a direct benefit to Parent Company.

It cannot be concluded that the expenditure incurred by Parent Company in establishing an EST for the sole benefit of Subsidiary Company Employees is expenditure incurred by Parent Company, 'in relation to' the business being carried on by Parent Company (see, TR 2011/16 at paragraph 75).

Consequently, Parent Company is not entitled to claim a deduction under subsection 40-880(2) for the Establishment Expenses, and there is no need to consider subsections 40-880(3) to (9).

Question 2

Is the Establishment Recharge Amount ordinary income?

The expression 'ordinary income' is defined in s 995-1 and s 6-5 as 'income according to ordinary concepts'. There is a long line of authorities that consider the question as to whether an amount is 'ordinary income'. Deputy President Forgie in Confidential v Commissioner of Taxation [2013] AATA 112 listed propositions that are useful in determining whether an amount is ordinary income. Relevantly, she stated (at [833] and [844]):

(1) Although income is not defined by the Act, its provisions give some indication of its meaning....

(2)... Whether a receipt is to be treated as income or not is determined according to 'the ordinary concepts and usages of mankind'... except where [the] statute sweeps in particular receipts or amounts which would not ordinarily be taken to fall within the concept.

(3)... Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form....

... The word 'gains' is not here used in the sense of net profits of the business for the topic under discussion is assessable income, that is to say gross income. But neither is it synonymous with 'receipts'. It refers to amounts which have not only been received but have 'come home' to the taxpayer' and that must surely involve, if the word 'income' is to convey the notion it expresses in the practical affairs of business life, not only that the amounts received are unaffected by legal restrictions, as by reason of a trust or charge in favour of the payer - not only that they have been received beneficially - but that the situation has been reached in which they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived.

The ultimate inquiry in either kind of case, of course, must be whether that which has taken place, be it the earning or the receipt, is enough to satisfy the general understanding among practical business people of what constitutes a derivation of income....

(5)... The question in each particular case is as to the character of the receipt in the hands of the recipient.... The test to be applied is an objective, not a subjective, test....

(6)... It does not depend upon whether it was a payment or provision that the payer or provider was lawfully obliged to make.... The motives of the donor do not determine the answer. They are, however, a relevant circumstance....

(8)... whether a particular receipt has the character of the derivation of income depends upon its quality in the hands of the recipient, not the character of the expenditure by the other party...

(11)... To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose if engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.

(12) There is a difficulty in making good absolute propositions in this field. In Federal Commissioner of Taxation v Montgomery..., Gaudron, Gummow, Kirby and Hayne JJ recognised that:

income is often (but not always) a product of exploitation of capital; income is often (but not always) recurrent or periodical; receipts from carrying on a business are mostly (but not always) income.

In Federal Commissioner of Taxation v The Myer Emporium [1987] HCA 18 (Myer Emporium) the High Court observed (at [14]) that 'ordinary income' can include income derived from a transaction which was 'extraordinary when judged by reference to the ordinary course of the taxpayers business:'

Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income.

Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterised as income.

In relation to reimbursements that are received, it has been held in Batchelor and Federal Commissioner of Taxation [2013] AATA 93 (Batchelor) that (at [34]):

There is no general principle of Australian tax law to the effect that amounts received by way of reimbursement or compensation for deductible expenses are assessable. The receipt must be otherwise income, according to ordinary concepts, to be assessable, and an amount is not income simply because it is a recoupment of a deductible expense: Federal Commissioner of Taxation v Rowe [1997] HCA 16.

Thus, it may be that in some instances a reimbursement may be assessable in nature, for example in HR Sinclair and Son Pty Ltd v Federal Commissioner of Taxation [1966] HCA 39 (HR Sinclair) a recoupment/reimbursement of a royalty to a State body was considered to be ordinary income. Whereas in Batchelor the AATA concluded that a refund of a deposit on an unsuccessful property purchase was not ordinary income of the partnership. It was not a 'gain or profit' to the business being carried on by the partnership.

In determining whether the amount Parent Company received from Subsidiary Company is ordinary income, the character of the receipt in the hands of Parent Company must be considered. On the facts:

•                    Parent Company is not carrying on a business of establishing, managing and/or selling ESTs.

•                    It appears that Parent Company's intention or purpose of establishing the EST was undertaken on behalf of Subsidiary Company and that Subsidiary Company would reimburse Parent Company for the expenses Parent Company incurred, and

•                    Parent Company had no intention of making a profit or gain from the transaction, and it did not charge Subsidiary Company any service fee/mark-up.

Looking at the totality of events, objectively the better view is that the Establishment Recharge Amount received by Parent Company is not an amount that was incurred in the ordinary course of carrying on its business. There was no intention to make a gain from the transaction. Further, as mentioned in Victoria Power Networks Pty Ltd v Federal Commissioner of Taxation [2020] FCAFC 169 in applying GP International Pipecoaters (at [74]):

The mere fact that a taxpayer is engaged in a business at the time of receiving a payment and the payment bears some connection to that business will not be sufficient to stamp the receipt with a revenue character.

Further still, this was not a one-off transaction that was undertaken to make a gain or profit. Consequently, the reimbursement Parent Company is to receive from Subsidiary Company is not income according to ordinary concepts and is therefore not included in Parent Company's assessable income under subsection 6-5(1).

Is the Establishment Recharge Amount statutory income?

The expression 'statutory income' is defined in section 995-1 by reference to section 6-10 as follows.

(1) Your assessable income also includes some amounts that are not *ordinary income.

Note: These are included by provisions about assessable income.

For a summary list of these provisions, see section 10-5.

(2) Amounts that are not *ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

Note 1: Although an amount is statutory income because it has been included in assessable income under a provision of this Act, it may be made exempt income or non-assessable non-exempt income under another provision: see sections 6-20 and 6-23.

Note 2: Many provisions in the summary list in section 10-5 contain rules about ordinary income. These rules do not change its character as ordinary income.

Section 10-5 provides that certain reimbursements and recoupments can be assessable income (it not being ordinary income), as follows.

In working out whether an amount is an assessable recoupment (and therefore included in a taxpayer's assessable income), a three-step process is required:

Step 1

Pursuant to subsection 20-20(1), the Establishment Recharge Amount will not be an assessable recoupment as it is not ordinary income as concluded above and neither is it statutory income under section 6-10.

Step 2

The Establishment Recharge Amount is not an insurance or indemnity amount so therefore subsection 20-20(2) is not satisfied.

Step 3

The final possibility is that the Establishment Recharge Amount is an assessable recoupment pursuant to subsection 20-20(3).

Subsection 20-20(3) provides that an amount received as recoupment of a loss or outgoing is an assessable recoupment if:

Other recoupment

(3) An amount you have received as *recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if:

(a) you can deduct an amount for the loss or outgoing for the *current year; or

(b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year;

under a provision listed in section 20-30.

Parent Company cannot deduct the expenses it incurred establishing the EST on behalf of Subsidiary Company under a provision contained in section 20-30. Accordingly, the Establishment Recharge Amount that Parent Company received from Subsidiary Company for those expenses are not an assessable recoupment under subsection 20-20(3).

Consequently, there is no requirement for Parent Company to include the Establishment Recharge Amount in its assessable income under sections 6-10 and section 20-20.

Question 3

Ongoing EST Administration Expenses

The operation of section 8-1 in the context of these reasons was explained at questions 1a and 1b (above). In accordance with what was explained there, the first step to consider in determining whether section 8-1 applies to the Ongoing EST Administration Expenses is the application of paragraph 8-1(1)(a).

Were the Ongoing EST Administration Expenses incurred in gaining or producing assessable income under paragraph 8-1(1)(a)?

Consistent with what was explained at questions 1a and 1b (above), the phrase 'incurred in gaining or producing' assessable income means incurred 'in the course of gaining or producing'. It does not mean 'in connection with' (see, Payne at [9]).

On the facts, Parent Company has invoiced Subsidiary Company for the Ongoing EST Administration Expenses it has incurred in operating the EST.

Parent Company incurs various expenses on behalf of the Parent Company Group, an example being the Ongoing EST Administration Expenses it incurs on behalf of Subsidiary Company. These expenses are generally ongoing regulatory fees (such as ASIC charges), and monthly expenses charged by the Trustee of the EST.

Consistent with the reasoning in question 1a (above), Parent Company will not be entitled to a deduction under section 8-1 for the Ongoing EST Administration Expenses, as they were not:

•                    incurred in gaining or producing Parent Company's assessable income; or

•                    necessarily incurred in carrying on Parent Company's business for the purposes of gaining or producing assessable income.

Question 4

EST Tax Affairs Expenses

Section 25-5 states:

(1) You can deduct expenditure you incur to the extent that it is for:

(a) managing your *tax affairs; or

(b) complying with an obligation imposed on you by a *Commonwealth law, insofar as that obligation relates to the *tax affairs of an entity; or

(c) ...

The EST Tax Affairs Expenses that Parent Company incurs cannot be deducted under section 25-5 as they were not incurred by Parent Company in:

1. managing its tax affairs, or

2. in complying with an obligation imposed on Parent Company which relates to an entity.

Deduction under section 8-1

Consistent with the reasoning in question 1a (above), Parent Company will not be entitled to a deduction under section 8-1 for the EST Tax Affairs Expenses, as they were not:

•                    incurred in gaining or producing Parent Company's assessable income; or

•                    necessarily incurred in carrying on Parent Company's business for the purposes of gaining or producing assessable income.

Question 5

Consistent with the reasoning outlined in Question 2 (above), in determining whether the Ongoing Expense Recharge Amount received from Subsidiary Company is ordinary income, the character of the receipt in the hands of Parent Company must be considered. On the facts:

•                    Parent Company is not carrying on a business of establishing, managing and/or selling ESTs.

•                    It appears that Parent Company's intention or purpose of establishing the EST was undertaken on behalf of Subsidiary Company. It was always intended that Subsidiary Company would reimburse Parent Company for the expenses incurred, and

•                    Parent Company had no intention of making a profit or gain from the transaction. Parent Company did not add any margin to the expenses recharged to Subsidiary Company - it simply recoups what it expends.

Based on the above facts, objectively the Ongoing Expense Recharge Amount is not an amount that was incurred in the ordinary course of carrying on Parent Company's business. Consequently, the Ongoing Expense Recharge Amount is not income according to ordinary concepts, and therefore does not need to be included in Parent Company's assessable income under section 6-5.

As is also explained in Question 2, an amount that is not ordinary income may still be included in your assessable income if it is statutory income. Relevant to this question is whether the Ongoing Expense Recharge Amount is an assessable recoupment under section 20-20. Subsection 20-20(3) provides that an amount received as a recoupment of an outgoing is an assessable recoupment if:

(a) you can deduct an amount for the loss or outgoing for the *current year; or

(b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year;

under a provision listed in section 20-30.

As Parent Company cannot deduct the underlying expenses it on charged to Subsidiary Company which make up the Ongoing Expense Recharge Amount under a provision contained in section 20-30, the Ongoing Expense Recharge Amount is not an assessable recoupment and therefor does not need to be included in its assessable income under subsection 20-20(3).