Edited version of private advice

Authorisation Number: 1051840692703

Date of advice: 1 June 2021

Ruling

Subject: Business - deductions

Question

Can you treat the expenditure to purchase control units as a general deduction for tax purposes under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

Financial year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased a business from entity X.

Entity X designed and manufactured the control units for a specific purpose related to perishable food transportation.

Entity X also developed central server software as well as the software within the control units.

The server software communicates with the software within the control units to monitor and control the climatic conditions inside the perishable food transportation containers.

The software is also used to track the control units and invoice customers.

You supply the control units to your customers and charge a fee for their use.

The control units are a small plastic box, containing various components with varying effective life of more than one year.

The control units are powered by batteries which are replaced several times per year.

The total direct cost of the controllers is $XXX.

After XX days, the software within the control units automatically shuts down rendering the control unit redundant until the software is updated during the servicing of the units.

You request customers return the control units by leaving in certain collection points after use however, currently you lose about XX% of your controllers per year.

The returned control units are then serviced by you.

Servicing involves updating the software and replacing parts as needed before returning the units to service.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Section 70-10 of the Income Tax Assessment Act 1997

Division 40 of the Income Tax Assessment Act 1997

Reasons for decision

Trading stock

Section 70-10 of the ITAA 1997 defines " trading stock " as including anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of business, and livestock.

Taxation ruling IT 81 Trading stock: hire and rental business, provides that stocks of goods purchased for hire/rental are not to be regarded as trading stock, applying to hirers of all descriptions.

In your case, the control units are not held by you for the purposes of manufacture, sale or exchange. The title for the control units is retained by you rather that passing to your clients. The fee charged for the use of the items would be akin to a hiring fee. On this basis the Commissioner does not consider the control units to be trading stock.

General deduction or depreciating asset.

Section 8-1 of the ITAA 1997 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.

(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.

Subsection 40-30(1) of the ITAA 1997 provides that a depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

In your case the expenditure on controllers is necessarily incurred in carrying on your business for the purpose of gaining or producing assessable income. It satisfied the second positive limb of the section 8-1 of the ITAA 1997. However, the expenditure may be capital in nature.

The leading case on whether an outgoing is of a capital nature, is the Sun Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 5 ATD 87; (1938) 61 CLR 337. Dixon J referred to three matters which were to be examined. He said:

"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 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."

Application to your circumstances

The expenditure to acquire the control units is a one-off expenditure. If regularly maintained, the control units will potentially last for several years providing an enduring benefit through hire fees for usage during their service life. On this basis it is the Commissioner's view that the controllers are capital in nature.

As the controllers are capital in nature, the first negative limb (paragraph 8-1(2)(a) of the ITAA 1997) is failed. You cannot claim the cost of the control units as a general deduction for tax purposes.

Apart from the cost of batteries, the acquisition cost of a control unit will need to be treated as a depreciating asset. However, the service costs, including the initial and replacement cost of the batteries will be deductible under section 8-1 of the ITAA 1997.