ATO ID 2003/271: Reimbursement of redundancy payments under contract for sale of a business
Date of decision: 12 December 2002
Year of income: Period from 1 January 2001 to 31 December 2001 Period from 1 January 2002 to 31 December 2002
Business line: Private Groups and High Wealth Individuals

Issue
Is an amount paid by the taxpayer to the former owner of a business to reimburse the cost of redundancy payments made by the former owner an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. An amount paid by the taxpayer to the former owner of a business to reimburse the cost of redundancy payments made by the former owner is not an allowable deduction under section 8-1 of the ITAA 1997.

Facts
The taxpayer and related companies acquired a business from its former owner. Under the terms of the contract of sale and in order to ensure the smooth transition of the operation of the business to the taxpayer and related companies, the former owner of the business agreed to provide the services of their employees to the taxpayer on an interim basis. The taxpayer did not enter into a contract of employment with the employees of the former owner. Under the contract of sale both the taxpayer and the former owner were required to take all reasonable steps to convince those employees to accept an offer of permanent employment with the taxpayer. The former owner was also required to provide work, as far as practical, to those employees who did not accept the offer of permanent employment with the taxpayer. Where employees did not accept the offer of permanent employment with the taxpayer and were unable to be placed in other areas of the former owner's business they were entitled to receive a redundancy payment. Under the terms of the contract of sale the taxpayer agreed to reimburse the former owner for the cost of those redundancies, up to an agreed monetary limit. The taxpayer agreed to this term in order to facilitate securing the services of the former owner's employees for the interim period. This payment (the redundancy amount) had no direct connection with, and was not a payment for, the provision of the services provided by the employees of the previous owner. The taxpayer paid the redundancy amount to the former owner.

Reasons for decision
Summary: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. The taxpayer and related companies acquired a business from the former owner and any costs associated with the acquisition of that business or the restructure of that business would generally be considered capital in nature rather than costs of running or operating that business ( Associated Newspapers Ltd & Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403). The redundancy amount paid by the taxpayer to the former owner was to subsidise the previous owner's costs in transferring the business to the taxpayer. The taxpayer at no time assumed the liability to make the redundancy payments to the former owner's employees. Nor did the former owner assign such liability to the taxpayer. The payment of the redundancy amount to the former owner does not constitute a payment made in the course of carrying on the taxpayer's new business. The decision to provide reimbursement of employee redundancy payments to the former owner was made and carried out as part of the purchase and restructure of the business which the taxpayer and related companies proposed to carry on. The decision to implement the acquisition of the business in this particular manner, and to pay the redundancy amount to the former owner, was part of the restructure of the business acquired by the taxpayer and related companies rather than an ongoing expense incurred in running that business ( British Insulated & Helsby Cables v. Atherton [1926] AC 205). The payment is not an allowable deduction as there is no nexus between the payment of the redundancy amount and the ongoing business activities of the taxpayer. The redundancy amount was a payment made with regard to the restructure of the former owner's business activities and the new business structure of the taxpayer and related companies. This payment was in the nature of a capital expense. Accordingly it is not an allowable deduction under section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: Associated Newspapers Ltd & Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 (1938) 5 ATD 87
Subject references: Capital expenditure Eligible termination payment Redundancy and retrenchment