ATO ID 2008/163: Capital Allowances: business related costs - taxable purpose
Date of decision: 8 September 2008
Year of income: Year ended 30 June 2007
Business line: Public Groups and International

Issue
Is the taxpayer's business carried on wholly for a taxable purpose for the purposes of subsection 40-880(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. The taxpayer's business is not carried on wholly for a taxable purpose for the purposes of subsection 40-880(3) of the ITAA 1997 because, at the time the relevant capital expenditure was incurred, there was no evidence that the part of the taxpayer's business that was represented by its holding of shares in offshore subsidiaries was carried on for a taxable purpose.

Facts
The taxpayer, a company, incurred capital expenditure in soliciting and evaluating bids for the acquisition of the shares in the taxpayer and in implementing a Scheme of Arrangement for the acquisition of the shares. The shares in the taxpayer were subsequently acquired by an unrelated entity. At the time the expenditure was incurred, the business carried on by the taxpayer included the business of being a holding company. An integral part of that holding company business is the taxpayer's holding of shares in a significant number of wholly-owned offshore subsidiaries. At the time the expenditure was incurred, there was no evidence of a policy for the payment of dividends to the taxpayer. In addition, the taxpayer was unable to predict whether there would ever be a declaration of dividend in its favour from any of the subsidiaries. The taxpayer expected that all other activities of its business would be carried on for the purpose of gaining or producing assessable income. The capital expenditure was incurred by the taxpayer in relation to its business for the purposes of paragraph 40-880(2)(a) of the ITAA 1997. For the purposes applying that paragraph, the relevant business is the combined business of the taxpayer and not merely its business of being a holding company.

Reasons for decision
Summary: All legislative references are to the ITAA 1997 unless otherwise stated Subsection 40-880(3) provides that you can only deduct the expenditure, for a business that you carry on, used to carry on or propose to carry on, to the extent that the business is carried on, was carried on or is proposed to be carried on for a taxable purpose. In this case, the relevant business for the purposes of the application of subsection 40-880(3) is the combined business of the taxpayer to which paragraph 40-880(2)(a) applies. Paragraphs 2.46 and 2.47 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 relevantly state: The definition of 'taxable purpose' is provided by subsection 40-25(7) of the ITAA 1997 and covers various purposes, including the purpose of producing assessable income. The term purpose of producing assessable income is further defined in subsection 995-1(1) of the ITAA 1997 as being something done: • for the purpose of gaining or producing assessable income; or • in carrying on a business for the purpose of gaining or producing assessable income. A taxpayer whose business is not carried on for a taxable purpose cannot deduct expenditure to that extent. This limitation is not an annual test: that is, it is not to limit deductions to only the income years in which the business is carried on for a taxable purpose. The test as to the taxable purpose of the business is applied - as at the time the expenditure is incurred - to the taxable purpose of the business by reference to all known and predictable facts in all years. The application of subsection 40-880(3) requires that the taxpayer determine, as at the time the capital expenditure was incurred, the extent to which the taxpayer's business is carried on for a taxable purpose by reference to all known and predictable facts in all years. In considering the taxable purpose of the taxpayer's business in this case, it is necessary to look at all of the activities of the taxpayer, including its holding of shares in offshore subsidiaries as part of the business of being a holding company. At the time the capital expenditure was incurred, there was no evidence of a policy for the payment of dividends to the taxpayer. In addition, the taxpayer was unable to predict whether there would ever be a declaration of dividend in its favour from any of the subsidiaries. The taxpayer engaged an independent expert to evaluate the amount of the offer by the unrelated entity for the shares in the taxpayer. The expert's report, which was provided to the former shareholders as part of the acquisition process, analysed the underlying value of the taxpayer's business operations to work out whether the offer for the shares represented fair value for shareholders. The report was prepared on the basis of known circumstances affecting the taxpayer's business at that time. It, therefore, provides objective evidence as to the known and predictable facts and expectations of the taxpayer in respect of the taxpayer's business as at the time the capital expenditure was incurred. The expert's report does not make any reference to the receipt of dividends from offshore subsidiaries. Therefore, taking into account all known and predictable facts as at the time the expenditure was incurred, it cannot be concluded that the taxpayer held its investments in the offshore subsidiaries for the purpose of producing assessable dividend income. To the extent that the business of being a holding company is not carried on for the purpose of gaining or producing assessable income, it is not carried on for a taxable purpose in applying subsection 40-880(3). As the taxpayer's business of being a holding company is not carried on wholly for a taxable purpose, it follows that the combined business of the taxpayer is not carried on wholly for a taxable purpose. As a result, any deduction under section 40-880 needs to be reduced to reflect the extent to which the taxpayer's combined business is not carried on for a taxable purpose. The extent to which that business is not carried on for a taxable purpose is the extent to which the taxpayer's combined business relates to the part of the business of being a holding company that is not carried on for a taxable purpose.

Legislative references: Income Tax Assessment Act 1997 subsection 40-25(7) section 40-880 subsection 40-880(2) paragraph 40-880(2)(a) subsection 40-880(3) subsection 995-1(1)
Related ATO interpretative decisions: ATO ID 2007/110
Other references: Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.1) Bill 2006
Subject references: Blackhole expenditure Capital Allowances CoE Taxable purpose Centres of Expertise