ATO ID 2007/111: Capital Allowances: business related costs - limitation of deduction - lease or other legal or equitable right
Date of decision: 27 April 2007
Year of income: Year ended 30 June 2006
Business line: Public Groups and International

Issue
Does paragraph 40-880(5)(d) of the Income Tax Assessment Act 1997 (ITAA 1997) apply so as to reduce the taxpayer's deduction under section 40-880 of the ITAA 1997 for capital expenditure it incurred 'in relation to your business'?

Decision
No. Paragraph 40-880(5)(d) of the ITAA 1997 does not apply so as to reduce the taxpayer's deduction under section 40-880 of the ITAA 1997 for capital expenditure it incurred in relation to its business.

Facts
The taxpayer, a public company limited by shares that carried on business for a taxable purpose, was approached by an unrelated entity with a proposal for the two companies to merge. The taxpayer had not been actively seeking any such offers at the time the offer was made but decided to proceed with the merger. The merger was implemented by a scheme of arrangement in accordance with Part 5.1 of the Corporations Act 2001 . The scheme of arrangement involved the existing shares in the taxpayer being transferred from the taxpayer's members to the unrelated entity in exchange for the taxpayer's members being issued shares in the unrelated entity. The result of the arrangement was the taxpayer becoming a wholly owned subsidiary of the unrelated entity. The taxpayer incurred capital expenditure on or after 1 July 2005 in respect of evaluating the merger proposal, changing its constitution to facilitate the merger, and implementing the scheme of arrangement. The capital expenditure was incurred in relation to its business for the purposes of paragraph 40-880(2)(a) of the ITAA 1997.

Reasons for decision
Summary: Paragraph 40-880(5)(d) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 of the ITAA 1997 for an amount of expenditure you incur to the extent that 'it is in relation to a lease or other legal or equitable right'. In respect of paragraph 40-880(5)(d) of the ITAA 1997, paragraph 2.68 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states: This exclusion replicates that found in the repealed section 40-880, having been added in 2002 in the context of the Government's review of the treatment of expenditure incurred on leases or other legal or equitable rights. The 2005-06 Budget announced that the Government would take a case-by-case approach in relation to the taxation of rights. Since that paragraph states that the exclusion contained in paragraph 40-880(5)(d) of the ITAA 1997 replicates that found in the repealed section 40-880 of the ITAA 1997, it is relevant to consider the repealed paragraph 40-880(3)(d) of the ITAA 1997. In discussing that exclusion, paragraph 3.67 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 stated: The Government is reviewing the treatment of expenditure incurred in relation to leases or other legal or equitable rights as part of the consideration of the recommendations of the Review of Business Taxation. The appropriate income tax treatment of capital expenditure incurred in relation to these leases and rights will be determined as part of that review. Consequently, capital expenditure on leases or other legal or equitable rights will be excluded from deduction under section 40-880. For example, expenditure representing lease surrender payments incurred in closing down your business will not be deductible under section 40-880. It is therefore relevant to consider what 'leases and rights' were considered in the recommendations of the Review of Business Taxation in order to determine the intended scope of the phrase 'in relation to a lease or other legal or equitable right' in paragraph 40-880(5)(d) of the ITAA 1997 and former paragraph 40-880(3)(d) of the ITAA 1997. The proposed review of the taxation of 'leases and rights' was discussed at pages 213-280 of the Review of Business Taxation, A Platform for Consultation , Discussion Paper 2 Volume I, February 1999. Specifically, at paragraph 8.1 on page 217, the following is stated: What is a lease or right? Leases and rights are essentially arrangements for transferring some or all of the benefits of ownership of an asset from the owner to the recipient of the lease or right. The following kinds of rights contracts are covered by the discussion: • leasing and similar contracts which provide rights over physical assets, for example, leases of equipment • contracts giving rights over intangible assets, such as spectrum licences and rights in films, patents, copyright, and industrial designs • indefeasible rights of use over assets, such as telecommunication cables • profits á prendre, that is, a right to take a product such as standing timber from another person's land • contracts for services • restrictive covenants; and • rights to receivables arising from 'rights' contracts, for example, lease receivables. There is also a reference at paragraph 9.4 on page 233 of that document that 'service contracts that are, in substance, broadly similar to leases' were part of the review. Further, there is a reference at paragraph 10.1 on page 269 of that document to the effect that rights under franchise agreements were also part of the review. Section 10 of the Review of Business Taxation, A Tax System Redesigned , Report, July 1999, made recommendations in relation to the taxation of leases and rights. While that report did not explain what was encompassed by the expression 'leases and rights', it can reasonably be inferred that it was referring to the sorts of 'leases and rights' outlined in the Review of Business Taxation, A Platform for Consultation , Discussion Paper 2 Volume 1, February 1999, referred to above. On the facts, there are no leases or other legal or equitable rights of the types considered by the Review of Business Taxation (in the context of its review of the taxation of leases and rights) in relation to which the expenditure referred to in the facts could reasonably be said to have been incurred. The Review of Business Taxation was concerned with the proper taxation treatment of 'receipts and expenditure associated with leases and rights on a consistent basis' (see paragraph 8.3 on page 217). What receipts and expenditure are so associated with leases and rights as to call for consistent treatment? That depends on what the overall framework is within which treatment should be consistent. Division 40 of the ITAA 1997 does not apply in the context of a generalised 'tax value method' treatment, and that generalised treatment was the context of the Review of Business Taxation's discussion of receipts and expenditures associated with leases and rights. In the context of the income tax law, what receipts and expenditures are so associated with leases and rights as to be within the scope of paragraph 40-880(5)(d) of the ITAA 1997 may therefore require a closer connection than the connection contemplated in the publications of the Review. Although it could be said that the expenditure as stated in the facts above was incurred in a sense in relation to the shares in the taxpayer held by members of the taxpayer and that a share is a bundle of rights (albeit the bundle of rights forms one piece of property - see paragraphs 20 to 26 of Taxation Ruling TR 94/30 and section 1070A of the Corporations Act), shares do not appear to be among the type of rights that the Review of Business Taxation considered in the context of its review of the taxation of leases and rights. Further, the application of paragraph 40-880(5)(d) of the ITAA 1997 to expenditure incurred in relation to shares only in the same way as the expenditure being considered in facts set out above would defeat the apparent Parliamentary intention to allow a deduction under section 40-880 of the ITAA 1997 as it formerly stood, an intention clearly meant to continue in relation to the present revised version of the section, for certain types of capital expenditure that are clearly incurred in relation to shares in that sense. In discussing the capital expenditure which may be deductible under subsection 40-880(2) of the ITAA 1997, paragraph 2.22 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states: Taxpayers can deduct the following specific types of capital expenditure: • expenditure to establish your business structure • expenditure to convert your business structure to a different structure • expenditure to raise equity for your business • expenditure to defend your business against a takeover • costs to your business of unsuccessfully attempting a takeover; and • costs to stop carrying on your business, The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 provides further guidance as to expenditure that previously fell within these specific types of capital expenditure. In particular, it states: Paragraph 40-880(1)(d) - expenditure to defend against a takeover 3.54 Paragraph 40-880(1)(d) allows deductions for capital expenditure incurred by a taxpayer to defend their business against a takeover. The use of the words defend and against in paragraph 40-880(1)(d) means that there must be resistance of the attempted takeover for paragraph 40-880(1)(d) to apply. 3.55 Item 44 inserts an example immediately after the paragraph. It deals with a situation in which a public limited company launches a hostile takeover bid for another public limited company. The target company must take certain steps prescribed by the Corporations Act 2001. The capital expenditure it incurs in following those steps is covered by this paragraph. 3.56 The following types of expenditure incurred in defending a takeover under the Corporations Act 2001 could come within paragraph 40-880(1)(d) to the extent to which they are capital expenditure: • legal and accounting costs • stockbrokers fees • compliance fees under the Corporations (Fees) Regulations 2001 • consultancy fees paid for public relations, merchant bankers and the media • printing, advertising and mailing of documents produced for shareholders • costs of independent evaluations of the takeover offer • the salary or wages of individuals employed specifically to undertake takeover defence activities; and • the preparation of and issuing of Part B statements or Part D statements. If paragraph 40-880(5)(d) of the ITAA 1997 were to apply to expenditure incurred in relation to shares only in the same way as the expenditures stated in the facts above, that would defeat the apparent Parliamentary intention to allow a deduction under section 40-880 of the ITAA 1997 in respect of the expenditure of the sort referred to in paragraphs 3.56 and 3.58 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 as examples of expenditure to defend your business against a takeover and costs to your business of unsuccessfully attempting a takeover. Where your business is threatened with takeover, or where you attempt a takeover of a business, it must be by way of an attempt to acquire the equity in the business. So capital expenditure on those topics will relate to the equity in the sense that it relates to the acquisition of the equity. Much of the expenditure as stated in the facts above is of the nature referred to in paragraph 3.56 referred to above. But this cannot be intended to be in relation to the legal or equitable rights which the equity embodies, for the purpose of the operation of paragraph 40-880(5)(d) of the ITAA 1997. For the foregoing reasons, paragraph 40-880(5)(d) of the ITAA 1997 does not apply so as to reduce the taxpayer's deduction under section 40-880 of the ITAA 1997 in respect of capital expenditure it incurred as set out in the facts.

Legislative references: Income Tax Assessment Act 1997 Division 40 section 40-880 subsection 40-880(2) paragraph 40-880(2)(a) subsection 40-880(3) subsection 40-880(5) paragraph 40-880(5)(d) former paragraph 40-880(1)(d) former paragraph 40-880(1)(e) former paragraph 40-880(3)(d)
Case references: First Provincial Building Society Ltd v. Federal Commissioner of Taxation (1995) 56 FCR 320 (1995) 30 ATR 207 95 ATC 4145
Related public rulings and determinations: Taxation Ruling TR 94/30
Related ATO interpretative decisions: ATO ID 2007/109 | ATO ID 2007/110 | ATO ID 2007/112
Other references: Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2002 Review of Business Taxation, A Platform for Consultation, Discussion Paper 2 Volume I, February 1999 Review of Business Taxation, A Tax System Redesigned, Report, July 1999
Subject references: Black hole expenditure Capital Allowances CoE Capital expenditure Taxable purpose Uniform capital allowances system