ATO ID 2003/827: Deductibility of long service leave payments after sale of business
Date of decision: 25 July 2003
Year of income: Year ended 30 June 2002
Business line: Private Groups and High Wealth Individuals

Issue
Is a taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for payments made to the purchaser of the taxpayer's business in relation to long service leave amounts paid by the purchaser to the taxpayer's previous employees?

Decision
No. A taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for payments made to the purchaser of the taxpayer's business in relation to long service leave amounts paid by the purchaser to the taxpayer's previous employees.

Facts
The taxpayer had previously carried on a business. The taxpayer sold the business to another party (the purchaser). The taxpayer had no legal liability to make long service payments to their former employees after the sale of their business. The purchaser, as the current employer, was legally liable for the payment of long service leave. The long service leave entitlement was calculated taking into account the employees' previous period of service with the taxpayer. When the business was sold the sale agreement required the taxpayer to deposit a sum of money, equal to the notionally accrued long service leave entitlements of their employees, into their solicitor's trust account. These funds were remitted, from the trust account, to the purchaser if and when the purchaser was obliged to make long service leave payments to the taxpayer's former employees. Payments to the purchaser were made out of the solicitor's trust account a number of years after the business was sold.

Reasons for decision
Summary: Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent that they are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature. The issue to be considered is whether these payments were incurred by the taxpayer in carrying on their previous business income earning activities. The issue of the deductibility of payments for long service leave made after the sale of a business was considered by the High Court in Federal Commissioner of Taxation v. Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278; 11 ATR 859; (1981) 81 ATC 4261 ( Foxwood Tolga) . In that case the purchaser of a business agreed to take over all the employees from the vendor (the taxpayer) and became liable to pay all their holiday and long service leave payments. Under the Industrial Conciliation and Arbitration Act 1961 (Qld) none of the employees were entitled to be paid for their accrued long service leave on the transfer of the business but each employee's period of service with the vendor would be taken into account in calculating their leave entitlement. The vendor made a payment to the purchaser representing the accrued entitlements of each employee for long service leave and claimed a deduction for this payment. In dealing with the issue of this deduction Gibbs CJ said (at CLR p 286, ATR p 863 ATC p 4264): The effect of the contract for the sale of the business, and the transfer of the services of the employees to the purchaser, was that the taxpayer was not liable, and never could become liable, to pay anything to his former employees in respect of long service leave. ... By this part of the payment the taxpayer made a contribution to assist the purchaser of the business to discharge obligations which would be expected to bind the purchaser in the future. It was not an unreasonable provision to make in a contract for sale of the business. A payment of that kind was not incidental or relevant to the gaining or producing of the taxpayer's income or clearly appropriate to or adapted for that purpose; it was incidental and relevant to the sale of the business. The High Court therefore disallowed the deduction for the payment for accrued long service leave on the basis that the vendor had no liability to pay anything to their former employees. As such, the payment was not incidental or relevant to the carrying on of its business but rather was incidental and relevant to the sale of the business. The taxpayer's circumstances here are similar to those of the vendor's in Foxwood Tolga. The taxpayer had no legal liability to pay long service leave to their former employees. The taxpayer made payments, under the terms of the sale agreement, to assist the purchaser with their liability for long service leave. The payments made were not incidental or relevant to carrying on the taxpayer's previous business activities. Rather they were an incident of, and arose out of the agreement for, the sale of the taxpayer's business. Therefore the payments were not incurred in gaining or producing their assessable income and therefore were not deductible under section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: Federal Commissioner of Taxation v. Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278 (1981) 11 ATR 859 81 ATC 4261
Subject references: Long Service Leave