Edited version of private advice

Authorisation Number: 1051571929313

Date of advice: 25 June 2021

Ruling

Subject: Establishment of an employee share trust

Question 1a

Is Subsidiary Company eligible for a deduction under section 8-1 for expenses charged by the parent entity for establishing the Employee Share Trust (EST)?

Answer 1a

No.

Question 1b

If the answer to Question 1a is no, is Subsidiary Company eligible for a deduction under section 40-880 for expenses charged by its parent entity for establishing the EST?

Answer 1b

Yes.

Question 2

Is Subsidiary Company eligible for a deduction under section 8-1 for the expenses charged by its parent entity for the ongoing administration of the EST?

Answer 2

Yes.

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

1) Subsidiary Company is a wholly owned subsidiary of its Australian ASX listed parent entity.

2) Subsidiary Company conducts the business operations for the parent entity in Australia. The parent entity and Subsidiary Company are not members of a tax consolidated group.

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

4) The business of Subsidiary Company is a consumption product.

5) The parent entity owns several patents and trademarks which it licenses to Subsidiary Company. Subsidiary Company pays the parent entity a license fee to use the parent entity's intellectual property (IP).

6) Expenses incurred by the parent entity on behalf of Subsidiary Company are charged to Subsidiary Company on a 'dollar for dollar' basis. That is, the parent entity does not apply any additional mark up. These expenses include (amongst other amounts) auditing fees, accounting fees and professional advice fees in relation to the taxation affairs of Subsidiary Company.

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

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 the parent entity the debtor, the balance of that 'loan facility' can fluctuate, such that Subsidiary Company can periodically become the debtor and the parent entity the creditor - for example when Subsidiary Company has an amount due and payable to the parent entity for a license fee to use the parent entity's IP.

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

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

12) The parent entity makes contributions to the Trustee of the EST. These contributions are used by the Trustee to subscribe for shares in the parent entity (or acquire those shares on-market). These contributions are also recharged to Subsidiary Company on a 'dollar-for-dollar' basis.

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 (ITAA 1997).

14) The parent entity 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. The parent entity also incurred stamp duty and other ancillary 'one-off' expenses. The total Establishment Expenses incurred by the parent entity for the years ending:

•         31 July 20XX was $XX,XXX, and for

•         31 July 20XX 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 31 July 20XX and 31 July 20XX was $XX,XXX (GST exclusive) and was recharged to Subsidiary Company in the income year ending in 20XX under a single invoice.

17) As identified above, in addition to Establishment Expenses, the parent entity also incurs expenses in relation to the EST such as auditing fees, accounting fees and professional advice fees in relation to the taxation affairs of the EST. Further, the parent entity also incurs ongoing administration and maintenance costs for the EST.

18) All of these expenses associated with the EST (other than Establishment Expenses) are collectively referred to as Ongoing EST Administration Expenses).

19) The Ongoing EST Administration Expenses are principally the fees charged by the Trustee EST to the parent entity as well as regulatory fees (such as ASIC charges). The total of Ongoing EST Administration Expenses charged to the parent entity for the year ending:

•         31 July 20XX was $X,XXX, and for

•         31 July 20XX was $XX,XXX.

19) The EST Tax Affairs Expenses and Ongoing EST Administration Expenses are recharged by the parent entity to Subsidiary Company on a cost incurred basis ('dollar for dollar') (the Ongoing EST Administration Expense Recharge Amount).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

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

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

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

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

Subsection 8-1(1) provides 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.

Were the expenses incurred in establishing the EST and oncharged to Subsidiary Company an outgoing incurred in gaining or producing Subsidiary 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; (2010) 241 CLR 443 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 of the ITAA 1997 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 the Subsidiary Company has incurred relate to establishing an EST for its employees. The generation of its assessable income comes from the sale of its products in the Australian market. It is considered therefore, that the Establishment Expenses are neither productive of, nor have sufficient nexus to, the generation of Subsidiary Company's assessable income. Accordingly, the Establishment Expenses 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)?

Subsidiary Company employs all employees and conducts the business operations of the parent entity in Australia. Given the wide definition of 'business' and 'carrying on of an enterprise' in subsection 995-1(1) it is accepted that Subsidiary 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).

Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 (TR 2011/6) states at paragraphs 73 and 74:

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 payment the Subsidiary Company makes to the parent entity for the establishment costs of the EST relates to how Subsidiary Company remunerates its employees. In this instance, the expenditure has a more immediate or direct link with the process of operating the business of Subsidiary Company. As such, it is a business expense which is necessarily incurred by Subsidiary Company in the course of carrying on a business for the purpose of gaining or producing its assessable income, and therefore satisfies paragraph 8-1(1)(b).

Is the expenditure capital or of a capital nature under paragraph 8-1(2)(a)?

In Steele v Deputy Commissioner of Taxation [1999] HCA 7, the High Court of Australia said (at [24]):

... it only becomes necessary to consider the exceptions [i.e. negative limbs in section 8-1] if it has already been concluded, or accepted by hypothesis, that one or other of the positive limbs applies.

The negative limbs are contained in subsection 8-1(2). Of relevance here is paragraph 8-1(2)(a), which states:

(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

...

In Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 73 (Sun Newspapers), Dixon J outlined 3 matters to be considered for determining whether an outgoing is capital or revenue in nature (see, (1938) 61 CLR 337 at 363):

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 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 FC of T v Sharpcan Pty Ltd [2019] HCA 36 (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) [2020] FCA 409 by Thawley J (at [85] and [86]):

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] identified the questions commonly arising as (emphasis in original):

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:...

Support for the proposition that the establishment costs of the trust should be treated as capital in nature can also be found 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 (at 91 ATC 4703 at 4709) that:

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.

The relevant costs were incurred to establish an EST. They were a one-off payment used in setting up a trust as part of the remuneration structure for Subsidiary Company's employees. The Character of the advantage sough was the enduring benefit of having the EST in the Subsidiary Company's business structure. The EST was established in order to add to the essential business structure of Subsidiary Company and to hold and deliver ESS interests to employees of Subsidiary Company. Further, the EST is a permanent element of the legal structure established to deliver benefits to Subsidiary Company's employees.

Counterfactual

In working out whether an outgoing is capital in nature, it is helpful to identify an appropriate counterfactual proposition. The High Court in Sharpcan opined (at [33]) that:

...specifically, whether the outgoing is calculated to effect the acquisition of an enduring advantage to the business. And the identification of what (if anything) is to be acquired by an outgoing ultimately requires a counterfactual, not an historical, analysis: specifically, a comparison of the expected structure of the business after the outgoing with the expected structure but for the outgoing, not with the structure before the outgoing. (emphasis added)

The relevant costs were incurred to establish an EST. They were a one-off payment used in setting up a trust as part of the remuneration structure for Subsidiary Company's employees. In comparing Subsidiary Company's business structure after the payment of the costs by the parent entity with the expected structure but for the outgoing, Subsidiary Company would not have been able to offer its employees an ESS interest, or an ESS interest held within the EST structure.

In AusNet Transmission Group Pty Ltd v Commissioner of Taxation [2015] HCA 25 (AusNet), in relation to the manner in which payment was made, the High Court approved the following principles:

Lord Dunedin suggested in 1910 that a distinction between a once and for all payment and a recurrent payment may be "in a rough way....not a bad criterion of what is capital expenditure...as against what is income expenditure". Viscount Cave LC in British Insulated and Helsby Cables Ltd v Atherton cautioned that this criterion is not decisive in every case. In that case, the "once and for all" character of an expenditure was treated as an indicator that it was in the nature of a capital outlay, a fortiori, when made "with a view to bringing into existence an asset or advantage for the enduring benefit of a trade". Even then there may be special circumstances leading to an opposite conclusion.

Here, the advantage sought was the establishment of an EST, which Subsidiary Company planned would be of enduring benefit to it. This is because it wanted to provide incentives to its employees so as to attract and retain high quality staff, which it believed would ensure its future success. 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. As such, the reimbursement of these establishment expenses by the Subsidiary Company are capital, or of a capital nature.

Conclusion - is Subsidiary Company eligible for a deduction under section 8-1 for expenses charged by the parent entity for establishing the EST?

The purpose of setting up the EST (it being a one-off), was for it to be part of Subsidiary Company's business structure; the advantage sought being the reasons listed above (see, AusNet at [17]). As such, the expenditure incurred by:

•         the parent entity in establishing the EST for Subsidiary Company; and therefore, ultimately for

•         Subsidiary Company as a result of being invoiced by the parent entity for these costs;

are capital, or of a capital nature.

Subsidiary Company is therefore not entitled to a deduction under section 8-1 for the reimbursement of the expenses incurred in establishing the EST, as these expenses are capital, or of a capital nature, and are not deductible under section 8-1.

Question 1b

Establishment expenses and section 40-880

As explained in 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 (in part) 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.

...

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

...

However, there are limits to the deductions that are allowed under section 40-880. This is discussed below.

Application of section 40-880 to the expenses incurred by Subsidiary Company

In the present case, Subsidiary Company has been invoiced by the parent entity for the expenses it incurred to establish the EST for employees of Subsidiary Company. In order for the expenses incurred by Subsidiary Company to be deductible under subsection 40-880(2), they must not only be in relation to a business, but they must be in relation to the business being carried on by Subsidiary Company.

When considering what is meant by 'in relation to' in paragraph 40-880(2)(a), paragraph 2.25 of the Explanatory Memorandum (EM) to 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.

Taxation Ruling TR 2011/6 provides guidance on the nature of the connection required between the expense and the business being carried on. Paragraphs 73 and 75 state:

73. The use of the expression 'in relation to' in subsection 40-880(2) rather than 'in carrying on' or the preposition 'on' to qualify the closeness of the required connection indicates that Parliament intended there to be greater latitude in the connection that needs to exist.

...

75. The words 'in relation to', whilst positing a test that is not as strict as 'in carrying on' however indicate that the expenditure in question is sufficiently relevant to the business to impress on it the character of a business expense of that business.

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] HCA 36, whereBrennan CJ, Gaudron and McHugh JJ observed, in considering the application of the Commercial Arbitration Act 1985 (NT), at [26]:

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.

Toohey and Gummow JJ also observed:

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)

Expenditure that relates to remuneration of employees who work within that business, can be said to be incurred in relation to that business. As explained by the High Court in W Nevill & Co Ltd v Federal Commissioner of Taxation [1937] HCA 9 (W Nevill), all such expenses are:

part of the necessary expenses of conducting the business... connected with the ever recurring question of personnel.

Whilst voluntary and indirect remunerative expenses will usually be sufficiently connected to the business being carried on, there will be some instances where the connection is not established (see, Benstead Services Pty Ltd v FC of T [2006] AATA 976).However, this will usually only occur where the purpose (or benefit) of the expense can be attributed to someone or something other than a genuine employee.

In relation to the present case, it is not suggested that the establishment of the EST in the context of the ESS arrangement and the costs related thereto can be attributed to something other than a need to remunerate genuine employees of the business. In the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 which introduced the Bill for Division 83A, the benefits of employee share schemes as a remuneration vehicle to businesses were observed:

1.25 However, the rules also specifically aim to improve the alignment of employee and employer interests. In recognition of the economic benefits derived from employee share scheme arrangements, the rules provide for tax concessions for employees participating in employee share schemes.

1.26 Tax support is provided on the grounds that aligning the interests of employees and employers encourages positive working relationships, boosts productivity through greater employee involvement in the business, reduces staff turnover and encourages good corporate governance.

Therefore, it is accepted that where an expense is incurred by an employing entity in relation to the establishment of an EST to which Division 83A applies and the employees who are to be provided the ESS interest are the employees of that employing entity, such expenses have the requisite connection with the business being carried on. They are, as was described in W Nevill, an expense connected with the ever-recurring question of personnel.

Before being entitled to a deduction under section 40-880, it is necessary to consider whether any limits or exceptions may apply. The subsections that may be relevant to the Subsidiary Company are:

(5) You cannot deduct anything under this section for an amount of expenditure you incur to the extent that:

(a) it forms part of the *cost of a *depreciating asset that you *hold, used to hold or will hold; or

(b) you can deduct an amount for it under a provision of this Act other than this section; or

(c) it forms part of the cost of land; or

(d) it is in relation to a lease or other legal or equitable right; or

(e) it would, apart from this section, be taken into account in working out:

(i) a profit that is included in your assessable income (for example, under section 6-5 or 15-15); or

(ii) a loss that you can deduct (for example, under section 8-1 or 25-40); or

(f) it could, apart from this section, be taken into account in working out the amount of a *capital gain or *capital loss from a *CGT event; or

(g) a provision of this Act other than this section would expressly make the expenditure non-deductible if it were not of a capital nature; or

(h) a provision of this Act other than this section expressly prevents the expenditure being taken into account as described in paragraphs (a) to (f) for a reason other than the expenditure being of a capital nature; or

(i) it is expenditure of a private or domestic nature; or

(j) it is incurred in relation to gaining or producing *exempt income or *non-assessable non-exempt income.

(6) The exceptions in paragraphs (5)(d) and (f) do not apply to expenditure you incur to preserve (but not enhance) the value of goodwill if the expenditure you incur is in relation to a legal or equitable right and the value to you of the right is solely attributable to the effect that the right has on goodwill.

The only possible relevant paragraph that may have application is paragraph 40-880(5)(f), which provides that if you cannot deduct an amount to the extent it could (apart from this section), be taken into account in working out a capital gain or loss from a CGT event. However, there is an exception to this paragraph, it being contained in subsection 40-880(6).

The expenses in question are not taken into account in working out any capital gain or capital loss in relation to the CGT assets of the EST, Subsidiary Company or the parent entity.

It is noted that the Trustees of the EST hold the ESS interests on behalf of the employees who have a beneficial interest in the ESS interests (being shares or rights). The expenses incurred in establishing the EST would not be taken into account in working out any capital gain or capital loss to the employees in relation to the ESS interests. In addition, the Trustees of the EST hold the ESS interests on behalf of the employees who have a beneficial interest in the ESS interests (being shares or rights). The expenses incurred in establishing the EST would not be taken into account in working out any capital gain or capital loss to the employees in relation to the ESS interests

As a consequence, paragraph 40-880(5)(f) does not apply and there is no need to consider the application of subsection 40-880(6).

Conclusion - section 40-880

It is accepted that the EST was established for the benefit of its employees. The reimbursement made by Subsidiary Company (to the parent entity) is deductible to Subsidiary Company under section 40-880.

This is because:

•         there is a direct correlation between the reimbursed amount and the expense incurred by the parent entity, having regard to quantum and timeliness; and

•         the expense is not referable to anything other than the direct reimbursement of the expense incurred by the other party (the parent entity).

Question 2

As stated previously, subsection 8-1(1) provides as follows:

(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 its assessable income under paragraph 8-1(1)(a)?

For the same reasons as discussed in question 1a (above), the expense paid by the Subsidiary Company to its parent entity is not incurred in gaining or producing its assessable income.

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)?

As mentioned above at question 1, Subsidiary Company employs all employees and conducts the business operations of the Parent Company in Australia. Given the wide definition of 'business' and 'carrying on of an enterprise' in subsection 995-1(1), it is accepted that Subsidiary Company is 'carrying on' a business.

Taxation Ruling TR 2011/6 states at paragraphs 73 and 74:

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 reimbursement Subsidiary Company paid to the parent entity in the form of the Ongoing EST Administration Expense Recharge Amount (which is calculated by reference to the EST Tax Affairs Expenses and Ongoing EST Administration Expenses), relates to Subsidiary Company's costs of undertaking its business, including how it remunerates its employees. In this instance, the expenditure has a more immediate or direct link with the process of operating the business.

For the sake of completeness, the so called 'negative limb' (subsection 8-1(2)) does not apply.

As such, the Ongoing EST Administration Expense Recharge Amount is a business expense necessarily incurred by Subsidiary Company in the course of carrying on its business and therefore satisfies paragraph 8-1(1)(b) and is deductible.