ATO ID 2007/124: Capital Allowances: business related costs - limitation of deduction - business of another entity
Date of decision: 31 May 2007
Year of income: Year ended 30 June 2006
Business line: Public Groups and International

Issue
Is the taxpayer's deduction under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997), for capital expenditure they incurred in relation to a business that used to be carried on, limited by subsection 40-880(4) of the ITAA 1997?

Decision
Yes. The taxpayer's deduction under section 40-880 of the ITAA 1997 for capital expenditure they incurred in relation to a business that used to be carried on is limited by subsection 40-880(4) of the ITAA 1997, because the capital expenditure is not to any extent in connection with the taxpayer deriving assessable income from that business.

Facts
The taxpayer is a company that carries on business entirely for a taxable purpose. The taxpayer incurred, after 30 June 2005, capital expenditure to settle certain legal proceedings brought against it by the liquidator of another company (the company in liquidation). It was alleged that the taxpayer had wrongfully received money that belonged to the company in liquidation arising from that company's business activities and that deprivation of that money led to an inability of the company in liquidation to pay its trade debts. In this case there is a sufficient and relevant connection between the taxpayer's incurrence of the capital expenditure and the business that used to be carried on by the company in liquidation, and that business is most relevant to that expenditure. Accordingly, the taxpayer's capital expenditure was incurred in relation to that business. The business that used to be carried on by the company in liquidation was carried on entirely for a taxable purpose. The taxpayer was not a shareholder of the company in liquidation nor was it otherwise in a position to derive any assessable income from the company in liquidation.

Reasons for decision
Summary: All legislative references in this Interpretative Decision are to the ITAA 1997 unless otherwise noted Subsection 40-880(4) provides that: you can only deduct the expenditure, for a business that another entity used to carry on or proposes to carry on, to the extent that: the business was carried on or is proposed to be carried on for a taxable purpose; and the expenditure is in connection with: (i) your deriving assessable income from the business; and (ii) the business that was carried on or is proposed to be carried on. The relevant business for the purposes of subsection 40-880(4) - the business that used to be carried on by the company in liquidation - was carried on entirely for a taxable purpose. However, the capital expenditure incurred by the taxpayer is not, for the purposes of subparagraph 40-880(4)(b)(i), to any extent in connection with the taxpayer deriving assessable income from the business that used to be carried on by the company in liquidation. Relevantly, paragraphs 2.54 and 2.55 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 state: The expenditure must be in connection with the taxpayer deriving their assessable income from the business. [Schedule 2, item 30, paragraph 40-880(4)(b)] This is to provide a proxy for the relationship between the taxpayer and 'their' (ie, the taxpayer) business, where the taxpayer that incurs the expenditure is not the same as the taxpayer that carries on the business. Deriving assessable income refers to the entitlement to a share in the profits from the business. The way in which the profit is derived can be direct or indirect. The expenditure also needs to be 'in connection with' the business that was carried on or is proposed to be carried on. The taxpayer was not a shareholder in the company in liquidation. The taxpayer was never in a position to derive assessable income, being an entitlement to a share in the profits (derived either directly or indirectly) from the business that used to be carried on by the company in liquidation. Accordingly, there is a 100 per cent limitation imposed by paragraph 40-880(4)(b) on deductibility by the taxpayer of the capital expenditure it incurred. In other words, the taxpayer cannot deduct any amount under section 40-880 for the capital expenditure it incurred.

Legislative references: Income Tax Assessment Act 1997 section 40-880 subsection 40-880(2) paragraph 40-880(4) paragraph 40-880(4)(a) paragraph 40-880(4)(b) paragraph 40-880(4)(b)(i) paragraph 40-880(4)(b)(ii)
Related ATO interpretative decisions: ATO ID 2007/123
Other references: Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.1) Bill 2006
Subject references: Blackhole expenditure Capital Allowances CoE