Private ruling: Business-related capital expenses
Date of advice: 19 March 2019
Published: May 2019
Ruling period: Year ended 30 June 2019 | Year ended 30 June 2020 | Year ended 30 June 2021 | Year ended 30 June 2022 | Year ended 30 June 2023
Date scheme commenced: 1 July 2018

Ruling: Q1: Are the advisor costs incurred by the taxpayer deductible over five years under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The taxpayer was established in the early 2000s and is a supplier of beverage products. As a result of strong growth, the taxpayer engaged a strategic adviser to find a partner that would assist the group’s business to realise that potential. The taxpayer incurred professional advisor costs in relation to the investment in the group (the Transaction) by a new strategic partner (the Preferred Investor). The group engaged a strategic advisor as well as legal and other professional advisors to provide advice with respect to the Transaction. The taxpayer incurred various advisor costs in relation to the Transaction. The Transaction Costs are summarised as follows: Service provider Description of services Strategic advisor ● Provide advice in preparation for the sale process as contemplated by the transaction ● Provide recommendations (in conjunction with other advisers) in relation to the structure under which particular assets should be sold ● Developing a sale strategy and timetable ● Identifying potential purchasers and an approach strategy in relation to purchasers ● If appropriate, explore the possibility of an IPO ● Assisting in the preparation of and provision of a flyer or information memorandum and other information as required. ● Assisting financial advisers in the preparation of a financial model ● Assisting in the preparation of management presentations ● Assisting in the assessment of initial expressions of interest ● Provide advice in relation to exclusivity ● Assist with the maintenance of a data room and responses to queries raised in the data room ● Assisting in the selection of shortlisted parties ● Reviewing sale documentation ● Assisting with completion of a transaction Legal advisor Legal services in relation to the Transaction such as drafting of confidentiality agreements, term sheets, legal due diligence, drafting sale and subscription documents and negotiations. Professional services firm Financial due diligence and tax advice with respect to the sale of disposal of shares in the group. The taxpayer has carried on business in Australia and does not derive any exempt income or non-assessable non-exempt income.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 40-880. | Income Tax Assessment Act 1997 Subsection 40-880(2) | Income Tax Assessment Act 1997 Paragraph 40-880(2)(a) | Income Tax Assessment Act 1997 Subsection 40-880(3) | Income Tax Assessment Act 1997 subsection 40-25(7) | Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision: Summary: The advisor costs incurred by the taxpayer are deductible over five years under section 40-880 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 40-880 of the ITAA 1997 applies to certain business expenditure of a capital nature incurred on or after 1 July 2005. 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) sets out the Commissioner’s views on the interpretation of the operation and scope of section 40-880 of the ITAA 1997. Capital expenditure Paragraph 66 of TR 2011/6 notes that the classic test for determining whether expenditure is of a capital or revenue nature is explained in the following passage from the judgment of Dixon J in Sun Newspapers Ltd v FC of T (1936) 61 CLR 337: There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay... In that case, Dixon J held that: The distinction between expenditure and outgoings on revenue account and capital account corresponds with the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. The advisor costs relate to the process of finding a strategic partner for the operation and growth of the group. These expenses relate to the taxpayer’s business structure and the ownership of that structure as well as the profit-yielding structure of the business and were not incurred as part of the taxpayer’s normal business operations or the continuous process by which the taxpayer derives its income. Therefore, the advisor costs are capital expenses. Business related capital expenditure Subject to the limitations and exceptions contained in subsections 40-880(3) to (9), subsection 40-880(2)(a) provides that you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure you incur in relation to your business In identifying the business that is most relevant to the expenditure, TR 2011/6 provides that it is necessary to look at the taxpayer’s overall business rather than a particular undertaking or enterprise within the overall business. In this case, the supply of beverages is considered the relevant business for the purposes of subsection 40-880(2). For a deduction to be allowable under paragraph 40-880(2)(a) you must incur capital expenditure ‘in relation to’ your business. ATO Interpretative Decision ATO ID 2007/109 Income Tax Capital Allowances: business related costs – in relation to your business (ATO ID 2007/109) notes that there needs to be a sufficient and relevant connection between the taxpayer’s incurrence of the expenditure and the taxpayer’s business. In interpreting the phrase ‘in relation to’ in paragraph 40-880(2)(a) and subsection 40-880(2) generally, paragraph 2.25 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states: The provision is concerned with expenditure that has the character of a business expense because it is relevantly related to the business. The phrase ‘in relation to’ was considered by the High Court in PMT Partners Pty Ltd (In Liquidation) v Australian National Parks & Wildlife Service (1995) 184 CLR 301. Brennan CJ, Gaudron and McHugh JJ observed, in considering the application of the Commercial Arbitration Act 1985 (NT), at 313: Inevitably, the closeness of the relation required by the expression ‘in or in relation to’ … must be ascertained by reference to the nature and purpose of the provision in question and the context in which it appears. Paragraph 82 of TR 2011/6 provides that expenditure on converting an existing business structure to a different structure which is to carry on that business in future, demonstrates a relevant connection with the existing business being carried on. The taxpayer incurred capital expenditure in engaging advisors to provide strategic advice in relation to the future direction of the business. The advisor costs were incurred by the taxpayer in order to identify potential growth opportunities including the consideration of various proposals. The decision to bring on the Preferred Investor meant that there would be structural changes to the business. The taxpayer engaged strategic advisors, legal advisors and other professional advisors to assist in connection with the restructure/Transaction. The advisor costs were incurred in relation to changing the structure by which the taxpayer’s business will be carried on; that is, in relation to the profit-yielding structure of the business. On the facts of this case, there is a sufficient connection between the expenditure and the taxpayer’s business because establishing the structure by which the business will be owned and operated is an essential prerequisite to the conduct of the business itself. Accordingly, the advisor costs have a sufficient and relevant connection with the taxpayer’s business for the purposes of paragraph 40-880(2)(a). Any deduction the taxpayer is entitled to under section 40-880 is subject to the limitations set out in subsection 40-880(3). Taxable purpose 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. The business referred to in this subsection is the business to which the relevant paragraph in subsection 40-880(2) applies. In this case paragraph 40-880(2)(a) applies and therefore the issue is the extent to which the business that the taxpayer carries on is carried on for a taxable purpose. The definition of ‘taxable purpose’ is provided in subsection 40-25(7) of the ITAA 1997 to include 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 either: ● for the purpose of gaining or producing assessable income ● in carrying on a business for the purpose of gaining or producing assessable income. The application of subsection 40-880(3) requires that you determine, as at the time the capital expenditure was incurred, the extent to which your business will be carried on for a taxable purpose by reference to all known and predictable facts in all years. Paragraph 27 of TR 2011/6 notes that if the expenditure relates to the whole of the business but part of the business is carried on to derive exempt income or non-assessable non-exempt income then to that extent the expenditure will not be deductible. All income derived by the taxpayer is assessable. The taxpayer does not derive any exempt income or any non-assessable non-exempt income. Considering all the facts, at the time the taxpayer incurred the advisor costs, the taxpayer was carrying on their business for a taxable purpose. As such, subsection 40-880(3) will not apply to limit the taxpayer’s deduction under section 40-880. Other limitations Subsections 40-880(5) to (9) set out other limitations and exclusions to claiming a deduction under section 40-880. On the facts of this case, subsections 40-880(5) to (9) do not apply to limit or exclude deductibility of the advisor costs incurred by the taxpayer under section 40-880. Therefore, the taxpayer is entitled to deduct the advisor costs in equal proportions over five income years from the time the expenses were incurred pursuant to subsection 40-880(2).