Edited version of private advice

Authorisation Number: 1051801591072

Date of advice: 21 April 2021

Ruling

Subject: Application of section 8-1 of the Income Tax Assessment Act 1997

Determination whether payment is of a capital or revenue nature.

Question 1

Will the Taxpayer be entitled to a deduction in the income year ended 30 June 20XX under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the payment to Party A as consideration for entering a Heads of Agreement (HoA) in the income year ended 30 June 20XX?

Answer

Yes

Question 2

Will section 82KZMD of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the payment?

Answer

No

This ruling applies for the following periods:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Taxpayer is a company that provides a variety of services to a large customer base.

The Taxpayer and Party A are currently in an agreement for the Taxpayer to provide Y services. Taxpayer currently provides Y services to Party A and other customers.

The current agreement will expire in the year ended 30 June 20XY.

In the year ended 30 June 20XX the Taxpayer and Party A entered into a Heads of Agreement (HoA).

Both parties have agreed to negotiate the New Agreement in good faith.

During the negotiations Party A warrants to the Taxpayer that they will exclusively negotiate with them until the New Agreement is executed.

If a New Agreement is executed, the Taxpayer will receive exclusivity in providing Y services to Party A.

Failure to adhere to the terms of the HoA allows either party to terminate the HoA.

In the year ended 30 June 20XX, the Taxpayer made a payment to Party A as consideration to enter the HoA.

In the event of termination, Party A must promptly refund the payment to the Taxpayer.

Summary

Question 1

The payment is deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 8-1

Section 8-1 of the ITAA 1997 allows a deduction for certain losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income or a provision of the taxation legislation excludes it.

Section 8-1 of the ITAA 1997 provides:

(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.

(collectively referred to as the "positive limbs")

(2)             However, you cannot deduct a loss or outgoing under this section to the extent that:

(a)             it is a loss or outgoing of capital, or of a capital nature; or

(b)             it is a loss or outgoing of a private or domestic nature; or

(c)             it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

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

(collectively referred to as the "negative limbs")

After examining all the relevant factors, the Commissioner considers that the payment to enter into the HoA is not of a capital nature such that subsection 8-1(2)(a) would apply. As such, the Taxpayer is entitled an income tax deduction for this payment in the income year ended 30 June 20XX under section 8-1 of the ITAA 1997.

Summary

Question 2

The payment was made in the year ended 30 June 20XX as consideration to enter into a HoA and will therefore be recorded as a deduction for that period.

Detailed reasoning

Subdivision H of Part III of the ITAA 1936 provides rules for the period of deductibility of certain advance expenditure and applies in certain circumstances to change the timing of a deduction for expenses incurred under section 8-1 of the ITAA 1997. Under section 82KZMA and section 82KZMD of the ITAA 1936 certain expenditure that would otherwise be fully deductible under section 8-1 of the ITAA 1997 is instead deducted over a specified period.

Subsection 82KZMA(3) of the ITAA 1936 provides that the expenditure must be incurred:

a)               in carrying on a business or incurred otherwise than in carrying on a business by a taxpayer that is not an individual,

b)               under an agreement (as defined in subsection 82KZL(1) of the ITAA 1936), and

c)               in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year.

Where all the elements of subsection 82KZMA(3) are satisfied, subsection 82KZMD(2) of the ITAA 1936 provides for the expenditure to be deductible pro-rata across the eligible service period.

The Taxpayer incurred expenditure in carrying on business and under the HoA which is the relevant agreement, for the purposes of subsection 82KZL(1) of the ITAA 1936.

The final issue is therefore whether this expenditure is in return for the 'doing of a thing' that is not to be wholly done within the expenditure year.

The HoA provides that the Payment is in consideration of Party A entering into the HoA. The payment was made exclusively to enter into a HoA. As such, the payment is made for a single point in time obligation, rather than an ongoing obligation or as a prepayment for goods or services.

Therefore, the payment incurred by the Taxpayer would not be pro-rated over a specified period under section 82KZMD of the ITAA 1936.