Private ruling: "Black hole" expenditure
Published: July 2013
Date scheme commenced: After the 2005 financial year

Ruling: Q1: Does the landscaping expenditure incurred by the Applicant qualify for deduction over 5 years pursuant to the "black hole" expenditure provisions in section 40-880 of the ITAA 1997? | A1: Yes.

Relevant facts and circumstances: The Applicant is a resident Australian company and head of a tax consolidated group. The Applicant holds two leases related to its business operations. The Applicant incurred what was broadly described as 'landscaping expenditure', comprised of: · landscape concept and design · rehabilitation services · plants. As well, the expenditure involved recreating gardens, including the supply and installation of turf and soil, planting mature trees and introducing new plant species. The Applicant stated that any depreciating asset was separately identified and did not form part of the relevant landscaping expenditure. Also, the Applicant stated in its ruling application that the expenditure incurred and the subject of the application would not be taken into account in working out its assessable income, under section 6-5 or section 15-15, or any loss otherwise deductible under section 8-1 or section 25-40. In the application there is an assurance that: the relevant expenditure incurred did not result in any variation to the existing leases, or any addition, deletion or change of the rights or obligations under them. Furthermore, there have been no variations to the original lease terms and rights. The Applicant contends the relevant expenditure is attributable to enhancing or preserving the overall business and in particular the value of goodwill.

Relevant legislative provisions: Income Tax Assessment Act 1997, section 6-5 | Income Tax Assessment Act 1997, section 8-1 | Income Tax Assessment Act 1997, section 15-5 | Income Tax Assessment Act 1997, section 25-10 | Income Tax Assessment Act 1997, section 25-40 | Income Tax Assessment Act 1997, Division 40 | Income Tax Assessment Act 1997 , subsection 40 - 25(7) | Income Tax Assessment Act 1997, paragraph 40-25(7)(a) | Income Tax Assessment Act 1997, subsection 40-25(8) | Income Tax Assessment Act 1997, subsection 40-30(1) | Income Tax Assessment Act 1997, paragraph 40-30(1)(a) | Income Tax Assessment Act 1997, paragraph 40-30(1)(b) | Income Tax Assessment Act 1997, paragraph 40-30(1)(c) | Income Tax Assessment Act 1997, section 40-880 | Income Tax Assessment Act 1997, subsection 40-880(1) | Income Tax Assessment Act 1997, paragraph 40-880(1)(a) | Income Tax Assessment Act 1997, paragraph 40-880(1)(b) | Income Tax Assessment Act 1997, paragraph 40-880(1)(c) | Income Tax Assessment Act 1997, subsection 40-880(2) | Income Tax Assessment Act 1997, paragraph 40-880(2)(a) | Income Tax Assessment Act 1997, paragraph 40-880(2)(b) | Income Tax Assessment Act 1997, paragraph 40-880(2)(c) | Income Tax Assessment Act 1997, paragraph 40-880(2)(d) | Income Tax Assessment Act 1997, subsection 40-880(3) | Income Tax Assessment Act 1997, subsection 40-880(4) | Income Tax Assessment Act 1997, subsection 40-880(5) | Income Tax Assessment Act 1997, paragraph 40-880(5)(a) | Income Tax Assessment Act 1997, paragraph 40-880(5)(b) | Income Tax Assessment Act 1997, paragraph 40-880(5)(c) | Income Tax Assessment Act 1997, paragraph 40-880(5)(d) | Income Tax Assessment Act 1997, paragraph 40-880(5)(e) | Income Tax Assessment Act 1997 , paragraph 40-880(5)(f) | Income Tax Assessment Act 1997, paragraph 40-880(5)(g) | Income Tax Assessment Act 1997, paragraph 40-880(5)(h) | Income Tax Assessment Act 1997, paragraph 40-880(5)(i) | Income Tax Assessment Act 1997, paragraph 40-880(5)(j) | Income Tax Assessment Act 1997, subsection 40-880(6) | Income Tax Assessment Act 1997, subsection 40-880(7) | Income Tax Assessment Act 1997, subsection 40-880(8) | Income Tax Assessment Act 1997 , subsection 40-880(9) | Income Tax Assessment Act 1997, paragraph 40-880(9)(a) | Income Tax Assessment Act 1997, paragraph 40-880(9)(b) | Income Tax Assessment Act 1997, subparagraph 40-880(9)(b)(i) | Income Tax Assessment Act 1997, subparagraph 40-880(9)(b)(ii) | Income Tax Assessment Act 1997, section 43-10 | Income Tax Assessment Act 1997, Division 110 | Income Tax Assessment Act 1997, subsection 110-25(5) | Income Tax Assessment Act 1997, Division 727 | Income Tax Assessment Act 1997, section 995-1 | Unless otherwise specified, all references in this Ruling are to the Income Tax Assessment Act 1997 (ITAA 1997).

Reasons for decision: Detailed Reasoning - Section 40-880 - Business related costs: The object of the applicable legislation is set out as follows: Object 40-880(1) The object of this section is to make certain *business capital expenditure deductible over 5 years if: (a) the expenditure is not otherwise taken into account; and (b) a deduction is not denied by some other provision; and (c) the business is, was or is proposed to be *carried on for a *taxable purpose. The requirements for deductions are set out in subsection 40-880(2), as follows: Deduction 40-880(2) You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur: (a) in relation to your *business; or (b) in relation to a business that used to be *carried on; or (c) in relation to a business proposed to be carried on; or (d) to liquidate or deregister a company of which you were a *member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business. The initial consideration is that in order to claim a deduction under this section, the expenditure must be incurred in relation to a business carried on by a taxpayer. Section 995-1 defines the term business to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. The term 'carried on' is not specifically defined by section 995-1, however the term 'carrying on' in relation to an enterprise is defined to include 'doing anything in the course of the commencement or termination of the enterprise'. The Applicant's business activities are such that the relevant expenditure was incurred in the course of carrying on an existing business pursuant to the requirements in subsection 40-880(2). | Detailed Reasoning - Limitations and exceptions: Subsection 40-880(3) and Subsection 40-880(4) - Taxable Purpose A deduction can only be claimed under section 40-880 for expenditure of a business that is, used to be or proposes to be carried on for a taxable purpose (subsection 40-880(3) and subsection 40-880(4)). The term, 'taxable purpose', is defined in subsection 40-25(7) to include the following: 40-25(7) Subject to subsection (8), a taxable purpose is: (a) the *purpose of producing assessable income; or … As the Applicant is the entity that incurred the relevant expenditure and its business is being carried on for a taxable purpose, subsections 40-880(3) and 40-880(4) are satisfied. Subsection 40-880(5) and Subsection 40-880(6) Subsection 40-880(5) and subsection 40-880(6) contain certain limitations or restrictions on the general application of section 40-880. In particular, these limitations or restrictions may impact on the tax treatment of expenditure under section 40-880, as follows: 40-880(5) You cannot deduct anything under this section for an amount of expenditure you incur to the extent that: (a) it forms part of the *cost of a *depreciating asset that you *hold, used to hold or will hold; or (b) you can deduct an amount for it under a provision of this Act other than this section; or (c) it forms part of the cost of land; or (d) it is in relation to a lease or other legal or equitable right; or (e) it would, apart from this section, be taken into account in working out: (i) a profit that is included in your assessable income (for example, under section 6-5 or 15-15); or (ii) a loss that you can deduct (for example, under section 8-1 or 25-40); or (f) it could, apart from this section, be taken into account in working out the amount of a *capital gain or *capital loss from a *CGT event; or (g) a provision of this Act other than this section would expressly make the expenditure non-deductible if it were not of a capital nature; or (h) a provision of this Act other than this section expressly prevents the expenditure being taken into account as described in paragraphs (a) to (f) for a reason other than the expenditure being of a capital nature; or (i) it is expenditure of a private or domestic nature; or (j) it is incurred in relation to gaining or producing *exempt income or *non-assessable non-exempt income. These limitations and restrictions are considered in detail below in relation to the relevant expenditure incurred. (a) Cost of a Depreciating Asset 'Depreciating asset' is defined in section 40-30 as: 40-30(1) A depreciating asset is an asset that has a limited * effective life and can reasonably be expected to decline in value over the time it is used, except: (a) land; or (b) an item of * trading stock; or (c) an intangible asset, unless it is mentioned in subsection (2). As has been contended by the Applicant in its application, the relevant items are more in the nature of part of the setting for its business. Further, the relevant items can be maintained (at a cost to it) and therefore, in themselves are unlikely to decline in value over time. In addition, any depreciating assets arising in relation to the landscaping have been separately identified and do not form part of the relevant expenditure. Therefore subsection 40-880(5)(a) does not apply. (b) Other Deductible Amounts Subsection 40-880(5)(b) excludes an amount from the scope of section 40-880 if the amount can be deducted under a provision of the income tax legislation other than section 40-880. If it were not capital in nature, the landscaping expense could be deducted as losses or outgoing in gaining or producing assessable income under section 8-1; if it were a rental property and a repair then section 25-10 would be an option; and if it were a structural improvement then section 43-10 would be considered. But none of these options is applicable and therefore the landscaping is not excluded by subsection 40-880(5)(b). (c) It forms part of the cost of the land In Taxation Ruling TR 2011/6 Income Tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6) at paragraph 218, the following is stated as to the meaning of 'the cost of land': … the Commissioner considers that the more natural reading of the full expression in the context in which it appears is that it covers only the cost of acquiring land. The cost of acquiring land, in this context, includes stamp duty and conveyance costs. In view of the above, the landscaping expenditure is not consideration to acquire the land. This is on the basis that expenditure incurred in relation to landscaping garden surrounds is not consideration provided to acquire the land. (d) lease or other equitable right In addition, TR 2011/6 notes at paragraph 239 that expenditure 'in relation to a lease or other legal or equitable right' must be relevantly related to a lease or right. To be relevantly related, TR 2011/6 states that: there must be an objective connection between the expenditure and the acquisition, creation, alteration or termination of the lease or right. The landscaping expenditure did not result in any acquisition, creation, alteration or termination of the leases and hence subsection 40-880(5)(d) would not apply. (e) assessable profit or deductible loss As stated in TR 2011/6, at paragraph 246, this paragraph (40-880(5)(e)): … gives effect to the policy intention that section 40-880 is a provision of last resort. Accordingly, if expenditure is already dealt with by the income tax law because it is reflected in either a profit or a loss calculation then it is outside the scope of section 40-880. The relevant expenditure incurred will not be taken into account in working out an amount included in the Applicant's assessable income, under section 6-5 or section 15-15, or as a loss deductible under section 8-1 or section 25-40. In sum, this exclusion does not apply. (f) capital gain or capital loss from a CGT event Paragraph 40-880(5)(f) provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that it could, apart from that section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event. The cost base of a CGT asset is made up of five elements (section 110-25): 1. money or property given for the asset 2. incidental costs of acquiring the CGT asset or that relate to the CGT asset 3. cost of owning the asset 4. capital costs to increase or preserve the value of it or to install or move it 5. capital costs of preserving or defending your ownership of or rights to it. In the circumstances of this Ruling, the relevant assets for consideration are leases, sub-leases and goodwill. As stated in ATO ID 2012/46 Income Tax Capital Gains Tax: cost base: fourth element of cost base (ATO ID 2012/46): For expenditure to be included in the fourth element of the cost base of an asset under subsection 110-25(5) of the ITAA 1997, it must be incurred 'to' enhance the value of the asset, that is, for the purpose of enhancing the value of an asset. It is immaterial whether or not the expenditure in fact enhances the value of the asset. In ATO ID 2009/36 Income Tax Capital Allowances: business related costs - limitation of deduction - in relation to a lease or other legal or equitable right (ATO ID 2009/36) in consideration of circumstances very similar to those in this Ruling, it is stated at page 3: … whether capital expenditure is incurred to any extent 'in relation to' a lease or other legal or equitable right will depend on whether there is a sufficient and relevant connection between the incurrence of the expenditure and … the sub-leases or the head lease. The Applicant has contended that the relevant expenditure is attributable to enhancing or preserving the overall business; i.e. in relation to enhancing or preserving the value of goodwill, and therefore is not attributable to the leases. The facts indicate that the landscaping is broadly described as: landscape concept and design; rehabilitation services; and planting in the general vicinity of the Applicant's business operations. The expenditure incurred has not resulted in any variation to the existing leases, or any changes of the rights, obligations or terms of them. As stated above, the relevant expenditure has been for the purpose of enhancing the overall business operations. In consideration of the outlays and any effect they may have had specific to the leases, there is a lack of a 'sufficient and relevant connection between the incurrence of the expenditure' and the leases. | Detailed Reasoning - Goodwill: A significant CGT asset held by the Applicant is goodwill. It is contended that the expenditure incurred in relation to the landscaping was incurred in respect of increasing or preserving the value of the goodwill. In this regard, pursuant to paragraph 110-25(5A), expenditure incurred in relation to preserving or enhancing the value of goodwill does not add to the cost base of that goodwill. Therefore, the expenditure incurred falls outside the scope of Division 110. (g) expenditure non-deductible if it were not of a capital nature Paragraph 40-880(5)(g) of the ITAA 1997 states that: (g) a provision of this Act other than this section would expressly make the expenditure non-deductible if it were not of a capital nature; or If it were not capital in nature, the expense could be deducted as losses or outgoing in gaining or producing assessable income under section 8-1 of the ITAA 1997. There may even be an issue as to whether section 25-10 might be considered, other than that subsection 25-10(3) precludes a deduction for capital expenditure. There is no other provision of the Act that would expressly make the expenditure non-deductible if it were not of a capital nature. (h) a reason other than the expenditure being of a capital nature Further, paragraph 40-880(h) of the ITAA 1997 states that: (h) a provision of this Act other than this section expressly prevents the expenditure being taken into account as described in paragraphs (a) to (f) for a reason other than the expenditure being of a capital nature; or No other provision of the Act prevents the landscaping expenditure from being taken into account, as described in paragraphs (a) to (f), for a reason other than the expenditure being of a capital nature. (i) private or domestic nature Paragraph 40-880(5)(i) states that: (i) it is expenditure of a private or domestic nature; or The landscaping expenditure is not of a private or domestic nature. (j) exempt income or non-assessable non-exempt income. Paragraph 40-880(5)(j) of the ITAA 1997 states as: (j) it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income. The landscaping expenditure is not incurred in gaining or producing exempt or non-assessable non-exempt income. Subsection 40-880(6) to subsection 40-880(9) Subsection 40-880(6) is an elaboration of the exceptions described in paragraphs 40-880(5)(d) and (f) and since those exceptions do not apply neither does 40-880(6). Subsection 40-880(7) applies in relation to subsection 40-880(2)(c), business proposed to be carried on. In this Ruling, the Applicant is already carrying on a business and therefore subsection 40-880(7) does not apply. Subsection 40-880(8) precludes deduction of expenditure excluded from the cost of a depreciating asset or the cost base or reduced cost base of a CGT asset, due to it being subject to a market value substitution rule (Division 727). Market value substitution rules enable the Commissioner to substitute market value in circumstances where the consideration is questionable or the dealing is not at arm's length. In the Applicant's circumstances the landscaping expenditure was: · brought to account · specified · undertaken at arms' length with independent providers. In view of the above, subsection 40-880(8) does not apply. Subsection 40-880(9) relates to an amount of an expenditure that is incurred: (a) by way of returning an amount you have received …; or (b) to the extent that, for another entity, the amount is a return on or of: (i) an equity interest; or (ii) a debt interest that is an obligation of yours. None of these is applicable to the landscape expenditure. | Detailed Reasoning - Conclusion: After consideration of the limitations and exceptions under subsections 40-880(3) to (9) it is apparent that they do not apply in relation to the capital (landscaping) expenditure at issue. Accordingly, the landscaping expenditure has not otherwise been taken into account and the deduction sought is not denied by any other provision of the Act. In conclusion, the Applicant is eligible to claim a deduction pursuant to section 40-880.