Edited version of private advice

Authorisation Number: 1051891270557

Date of advice: 25 August 2021

Ruling

Subject: Deductions - general deductions

Question

Is the loss incurred by Company A on the disposal of its interest in Company C acquired under the Transaction deductible to Company A under section 8-1 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

XX/month/XXXX

Relevant facts and circumstances

Company A is an Australian tax resident.

Company A and Company B announced an intention to acquire 100% of Company C.

Company A and Company B effected the takeover of Company C.

Following the takeover, Company A and Company B each held a certain percentage in Company C.

Company A had not entered into this type of transaction in the past.

Company A's business included providing products and services of the type produced by a project (the Project) that was being undertaken by Company C.

The Transaction was expected to generate revenue for the taxpayer.

It was not Company A's intention to be a long-term holder in Company C.

Company A significantly impaired its investment in Company C due to poor market conditions and the uncertainty of the timing of the development of the Project. Company A later further impaired its investment in Company C, writing down its investment to $Nil.

Company A disposed of its shares in Company C resulting in a tax loss.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Summary

The loss incurred by Company A on the disposal of its interest in Company C acquired under the Transaction is deductible to Company A under section 8-1 of the Income Tax Assessment Act 1997.

Detailed reasoning

Section 8-1 relates to general deductions and provides:

8-1(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.

8-1(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.

8-1(3) A loss or outgoing that you can deduct under this section is called a general deduction.

The courts have held that for there to be a deduction under section 8-1 there must be a sufficient connection between the loss or outgoing and the production of assessable income. The loss or outgoing must be incidental and relevant to the earning of assessable income (Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236).

In Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer), the High Court considered the concepts of 'capital' and 'revenue' in reference to a characterisation of a profit or gain from an isolated transaction outside the ordinary course of a taxpayers business.

The Commissioner has considered the principles outlined in the Myer decision in Taxation Ruling TR92/3 Income Tax: whether profits on isolated transactions are income (TR92/3)and Taxation Ruling TR92/4 Income Tax: whether losses on isolated transactions are deductible (TR 92/4)and provided guidance in determining whether profits from isolated transactions are assessable as ordinary income or losses on isolated transactions are deductible. TR 92/3 should be read in conjunction with TR 92/4.

Isolated Transactions

Taxation Ruling TR92/3provides guidance on the Commissioner's views in regard to isolated transactions. Paragraph 1 of TR 92/3 provides that the term 'isolated transactions' refers to:

...

(a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

(b) those transactions entered into by non-business taxpayers.

In this case, it is accepted that the purchase of the shares in Company C is outside the ordinary course of Company A's business and therefore considered to be an isolated transaction.

Profits or losses on isolated transactions

In reference to the Myer decision, paragraph 3 of TR 92/3 provides:

.... The Court relied on two strands of reasoning in holding that the amount received by the taxpayer was income:

(a) The amount in issue was a profit from a transaction which, although not within the ordinary course of the taxpayer's business, was entered into with the purpose of making a profit and in the course of the taxpayer's business.

(b) The taxpayer sold a mere right to interest for a lump sum, that lump sum being received in exchange for, and as the present value of, the future interest it would have received. The taxpayer simply converted future income into present income.

More recently, the elements established in the Myer decision were considered in Visy Packaging Holdings Pty Ltd v Commissioner of Taxation [2012] FCA 1195 (Visy). In Visy, Justice Middleton stipulated at paragraph 9 that:

As is the subject of further analysis later in these reasons for judgment, these proceedings do not raise any novel or overly complex principles of law. The determination of these proceedings principally turns on the facts. ....

Middleton J further elaborated at paragraphs 185 to 187 that:

185. The principle of law which is at the centre of this case is clear: if the intention or purpose of the relevant entity in entering into a transaction or upon acquiring an asset was to make a profit or gain, that profit or gain will be income, even if the transaction was extraordinary by reference to the ordinary course of that entity's business: see Westfield Ltd v Commissioner of Taxation (1991) 28 FCR 333; Commissioner of Taxation v Cooling (1990) 22 FCR 42; Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199; Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355; and Visy Industries USA Pty Ltd [2012] FCAFC 106. Similarly, if the intention or purpose was to make a profit or gain but a loss was ultimately in fact sustained, then a deduction in the amount of that loss would be permitted.

186. It is not necessary that the sole or dominant purpose of entering into the relevant transaction is to make a gain or profit. It is enough if a "not insignificant purpose" of the relevant transaction was to obtain a profit or gain: see eg Cooling (1990) 22 FCR 42 at 56-57.

187. Accordingly, in these proceedings, if the intention or purpose of acquiring the relevant shares (in the context in which that occurred), was to make a profit or gain, then the losses ultimately incurred are deductible. If that intention or purpose did not exist, then in the circumstances of these proceedings the losses incurred would be of a capital nature for the purpose of s 8-1 of the 1997 Act, and no losses could be deducted as sought by the taxpayers.

Paragraph 6 of TR 92/3 provides the Commissioner's view regarding profit on isolated transactions:

Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In conjunction, paragraph 4 of TR 92/4 provides the Commissioner's view regarding losses on isolated transactions:

A loss from an isolated transaction is generally deductible under subsection 51(1) if:

(a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income; and

(b) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Accordingly, to determine whether the loss on an isolated transaction will be deductible under section 8-1 of the ITAA 1997, Company A must have had an intention or purpose to make a profit at the time of acquisition of the Company C shares and the acquisition must have been in the course of carrying on a business or carrying out a business operation or commercial transaction.

Intention or purpose to make a profit

As established in the Myer case, and repeated in paragraph 6(a) of TR 92/3, a profit from an isolated transaction will generally be income when the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

Relevantly, paragraphs 7 to 10 of TR 92/3 provide:

7. The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

8. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

10. If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

As further elaborated in Visy, when trying to determine the intention to make a profit, Middleton J provided at paragraphs 200 to 203 that the minds of the directors who are in control are relevant as to whether they represented that of the taxpaying entity. Therefore, the fact that a taxpayer made a loss from a particular transaction is not important to the characterisation or assessment of the profit making intention. Rather, what matters most is whether the taxpayer, based on the directing minds of the company, had an opportunity for profit.

Also in Visy, Middleton J at paragraphs 195 and 196 did not accept that the proper characterisation of the divestment assets were part of wider scheme for the acquisition of a synergistic business. This view provides that rather than looking at the acquisition of a company as a whole forming part of a wider scheme of capital acquisition, those assets that were acquired for the purpose of divestment at a profit, would be regarded as doing more than realising an asset in an enterprising way.

Therefore, a taxpayer's sole purpose does not need to be the making of a profit in order for the taxpayer to have the requisite profit making intention. A taxpayer may have a dual purpose for the acquisition of the asset. In the case of Visy, this dual purpose was to acquire and control a business with synergistic benefits while also seeking to gain a profit on the divestment of unwanted assets.

Provided that the taxpayer can establish that one of those purposes is achieving a profit, this will be sufficient to render that profit as ordinary income. Accordingly, it stands that should a loss in fact be realised, the loss obtained will be deductible.

When looking at the business context of the transaction, Middleton J, in Visy, stipulated at paragraph 238 that, "it is necessary to look at the whole factual matrix in which the transaction occurs".

In the current circumstances, the factual matrix to be considered is those listed in the Relevant facts and circumstances. It is this factual matrix that has been utilised to determine whether Company A had the requisite intention or purpose when entering into the Transaction.

On consideration of the 'Relevant facts and circumstances' of this ruling, the Commissioner is satisfied that Company A had the relevant intention of making a profit at the time of entering the Transaction. Although Company A's acquisition of the shares in Company C was not in the ordinary course of Company A's business dealings, it had the requisite intention to generate a profit from this acquisition under the Transaction. Correspondingly, Company A's resultant loss from the isolated transaction will be deductible under section 8-1 of the ITAA 1997 if the Transaction was entered into in the course of carrying on a business or in carrying out a business operation or commercial transaction.

As provided in paragraph 6(b) of TR 92/3, the other key element for a profit on an isolated transaction to be generally considered income is that the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Company A's business included providing products and services of the type produced by the Project that was being undertaken by Company C. In considering this factor, plus the profit making intention for the Transaction as provided in the 'Relevant facts and circumstances' of this Ruling, it is accepted that the purchase of shares in Company C was in the course of carrying on a business operation or commercial transaction. The shares are held on revenue account and any gain or loss from the sale of them may be treated as ordinary income under section 6-5 of the ITAA 1997 or deductible under section 8-1 of the ITAA 1997.

It is considered that Company A necessarily incurred the loss on disposal of its interest in carrying on a business for the purpose of gaining or producing its assessable income and therefore subsection 8-1(1) of the ITAA 1997 is satisfied. As the interest on which the loss was incurred is revenue in nature and none of the circumstances in subsection 8-1(2) of the ITAA 1997 apply, the loss incurred by Company A on disposal of its interest will be deductible under section 8-1 of the ITAA 1997.

Conclusion

Company A objectively had a profit making purpose in relation to the Transaction, even though that purpose was not its dominant intention or purpose. Furthermore, the Transaction undertaken by Company A was in the course of carrying on a commercial business operation.

Taking into consideration the Commissioner's views expressed in TR 92/3 and TR 92/4, and the application of the principles set out in Myer and Visy, the loss incurred by Company A on the sale of its shares in Company C acquired under the Transaction will be deductible under section 8-1 of the ITAA 1997.