Private ruling: Treatment of construction revenue and expenses relating to the Project Plant
Published: January 2012
Ruling period: 1 January 2008 - 31 December 2008 | 1 January 2009 - 31 December 2009 | 1 January 2010 - 31 December 2010 | 1 January 2011 - 31 December 2011
Date scheme commenced: 1 January 2008 - 31 December 2008

Ruling: Q1: Is the expenditure incurred by the Taxpayer to construct the Asset (asset construction expenditure) deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the Monthly Payments derived by the Taxpayer in relation to the Asset be included in the assessable income of the Taxpayer under section 6-5 of the ITAA 1997 at the time a legally recoverable debt comes into existence? | A2: Yes

Relevant facts and circumstances: The Taxpayer operates a number of projects for the provision of services to a third party. The Taxpayer was engaged by the Head Contractor, under the Asset Agreement, to construct and then operate the Asset. The cost of constructing the Asset (the asset construction expenditure) was incurred by the Taxpayer. The Taxpayer is not entitled to receive any separate payment for the construction of the Asset. The Taxpayer owns and has responsibility for specific items of property which form part of the Asset. Operation of the Asset commenced after construction was completed and continues for the Asset Term. The Taxpayer operates the Asset to produce the Product which is supplied to the Head Contractor. After the completion of the Asset and for the duration of the Asset Term, the Head Contractor pays the Monthly Payment to the Taxpayer. The Monthly Payment is calculated pursuant to the Asset Agreement by reference to the quantity and quality of Product supplied by the Taxpayer to the Head Contractor. No part of the Monthly Payment that relates to the construction of the Asset is severable. At the end of the Asset Term, the Asset is transferred to the Head Contractor for nil consideration.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5. | Income Tax Assessment Act 1997 subsection 6-5(4). | Income Tax Assessment Act 1997 section 8-1. | Income Tax Assessment Act 1997 subsection 8-1(1). | Income Tax Assessment Act 1997 subsection 8-1(2).

Reasons for decision: Summary: The expenditure incurred in relation to the construction of the Asset is capital in nature as it establishes a profit yielding asset. The construction expenditure is therefore not deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 8-1(1) of the ITAA 1997 provides that you can deduct from your assessable income any loss or outgoing to the extent that: · it is incurred in gaining or producing your assessable income; or · it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. · However, subsection 8-1(2) of the ITAA 1997 provides that you cannot deduct a loss or outgoing to the extent that: · it is a loss or outgoing of capital, or of a capital nature; or · it is a loss or outgoing of a private or domestic nature; or · it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or · a provision of this Act prevents you from deducting it. The first exclusion in paragraph 8-1(2)(a) of the ITAA 1997 prevents an amount from being deducted if it is capital or of a capital nature. The established principles on the distinction between capital and income are well known; see for example, Dixon J's judgement in Sun Newspapers Ltd & Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87, and the Full Federal Court decision in FC of T v. Email (1999) 99 ATC 4868 at 4873; 42 ATR 698 at 704). The character of the advantage sought provides important direction. It provides the best guidance as to the nature of the expenditure as it says most about the essential character of the expenditure itself. The nature or character of the expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. On the facts, the asset construction expenditure was incurred by the Taxpayer to establish the Asset for the purpose of generating assessable income from the operation of the Asset. Viewed this way, the business purpose of the construction was to secure or establish a profit yielding asset. As such, the construction expenditure is considered to be capital in nature. Accordingly, while the construction expenditure was necessarily incurred in the ordinary course of the Taxpayer carrying on its business for the purpose of gaining or producing assessable income, the expenditure incurred in relation to the construction of the Asset is capital under subsection 8-1(2) of the ITAA 1997 and therefore is not deductible under section 8-1 of the ITAA 1997. | Summary: The Monthly Payments received by the Taxpayer in relation to the Asset must be included in the assessable income of the Taxpayer under section 6-5 of the ITAA 1997 at the time a legally recoverable debt comes into existence. | Detailed Reasoning - Detailed reasoning: Section 6-5 of the ITAA 1997 provides that your assessable income includes the ordinary income you derived during the income year. Subsection 6-5(4) of the ITAA 1997 states that you derived ordinary income when it is applied or dealt with in any way on your behalf. Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings (TR 98/1) provides guidance on the factors that are relevant in determining the appropriate method to bring income to account for tax purposes. On the facts, the earnings method is most appropriate to determine business income derived from a trading or manufacturing business. Accordingly, the Monthly Payments received by the Taxpayer in relation to the Asset must be included in the assessable income of the Taxpayer under section 6-5 of the ITAA 1997 at the time a legally recoverable debt comes into existence.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.