ATO ID 2008/146: Capital allowances: business related costs - capital expenditure incurred - non-contractual customer relationships
Date of decision: 29 August 2008
Year of income: Year ended 31 December 2007
Business line: Public Groups and International

Issue
Is that part of the contract purchase price of depreciating assets that the taxpayer attributed, for accounting purposes, to non-contractual customer relationships, deductible under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. Section 40-880 of the ITAA 1997 has no application to that part of the contract purchase price of depreciating assets that the taxpayer attributed, for accounting purposes, to non-contractual customer relationships because the taxpayer did not incur any capital expenditure on such relationships.

Facts
The taxpayer is the holder of a large number of physically similar depreciating assets. Each asset is attached to land in different but strategically important locations. The taxpayer carries on a business of leasing the use of the depreciating assets to multiple customers. In order to expand their income producing capacity, the taxpayer contracted to acquire more of this type of depreciating asset. The subject matter of the purchase contract was the acquisition of multiple depreciating assets in different locations for a single contract price. The transaction did not represent the acquisition of the vendor's business. The purchase contract required the assignment to the taxpayer of the existing lease agreements in relation to the assets acquired. A nominal value was placed on the existing leases but payment of that value was contingent on the vendor making a call for the payment. Customers with existing leases in relation to the assets acquired were under no obligation to renew those leases on expiry. For accounting purposes, the taxpayer attributed part of the contract purchase price of the depreciating assets to an asset titled 'non-contractual customer relationships'. The term 'non-contractual customer relationships' was used to describe the anticipated economic benefit which may arise for the taxpayer in the event that the existing leases are renewed. The amount the taxpayer attributed to this asset was derived from a discounted value of the estimated excess earnings from the future leases.

Reasons for decision
Summary: Section 40-880 of the ITAA 1997 provides a deduction over five income years for certain capital expenditure incurred in relation to a business. It is, therefore, a prerequisite requirement that capital expenditure be incurred for the provision to be capable of applying to the expenditure. The subject matter of the purchase contract in this case is clearly enunciated as the acquisition of the depreciating assets. It is equally clear that the consideration provided by the taxpayer for those assets was the entire contract price. The assignment of existing leases was not a subject matter of the contract. Rather, the assignment of existing leases was a condition only of the contract. The placement of a nominal value (and its contingent payment) on the existing leases reflected the incidental or ancillary nature of their assignment in relation to the depreciating assets themselves. The contract makes no separate or other identifiable reference to non-contractual customer relationships. That is not unexpected because the purchase contract does not create any rights in the taxpayer in relation to those relationships. On the contrary, there is no obligation on the part of an existing customer to renew their lease upon expiry of the current one. The economic benefit that was identified by the taxpayer for accounting purposes was derived from the discounted value of excess earnings from new leases that are anticipated will be entered into upon the expiry of an existing lease. This anticipation is based primarily on the qualities of the depreciating asset being leased, particularly its strategic location. It is also based, but to a lesser extent, on the quality of the management of that asset by the taxpayer over the term of the existing lease. In other words, the anticipation of attracting the renewal of existing leases substantially derives from the primary feature of strategic location of the depreciating assets themselves and cannot be detached from them. This also means that any value of that expectation is more appropriately vested in the depreciating asset itself. For all of these reasons, no part of the contract purchase price of the depreciating assets is attributable to the non-contractual customer relationships identified by the taxpayer for accounting purposes. It follows that no capital expenditure has been incurred by the taxpayer on such relationships and section 40-880 of the ITAA 1997 is not capable of applying.

Legislative references: Income Tax Assessment Act 1997 section 40-880 paragraph 40-880(5)(a)
Subject references: Blackhole expenditure Capital expenditure Depreciating assets Uniform capital allowances system