Private ruling: deductibility of expenditure
Published: January 2012
Ruling period: Year ended 30 June 2007 | Year ended 30 June 2008 | Year ended 30 June 2009 | Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: 1 July 2006

Ruling: Q1: Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for fees incurred pursuant to the agreement? | A1: Yes | Q2: Is the taxpayer entitled to deductions under section 8-1 of the ITAA 1997 for project costs incurred pursuant to the agreement? | A2: Yes | Q3: If the answer to questions 1 or 2 is 'No', is the taxpayer entitled to deductions for the expenditure pursuant to: Division 70 of the ITAA 1997 Section 82KZM of the Income Tax Assessment Act 1936, or Section 40-880 of the ITAA 1997? | A3: Not applicable

Relevant facts and circumstances: The taxpayer carries on a business. The taxpayer's business includes completion of projects and the trade of its own stock. The taxpayer derives fee income for projects completed. During the 2006-07 income year the taxpayer entered an agreement (the agreement) with another entity to complete a project whereby: The other entity is to grant the taxpayer access and possession of assets necessary to carry out the project The taxpayer is required to pay certain fees and project costs to the other entity and to other entities Upon successful completion of the project, and for coordinating marketing and sales activities, the taxpayer is entitled to receive certain fee income The estimated project completion date was during the 2009-10 income year but has been extended by three to four years. The project constitutes approximately three percent of total project activity by the taxpayer for the 2009-10 and 2010-11 income years (less so for earlier income years).

Relevant legislative provisions: Income Tax Assessment Act 1997 - section 8-1

Reasons for decision: Summary: The Commissioner is of the view that the payments are outgoings of a revenue nature. In the context of the taxpayer's business, the expenditure incurred is seen to be part of the ordinary process by which the taxpayer operates to obtain regular returns. The taxpayer is entitled to a general deduction pursuant to section 8-1 of the ITAA 1997 in the year each outgoing was incurred. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the ITAA 1997 allows a deduction for any loss or outgoing incurred in gaining or producing assessable income, or that is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except to the extent that such loss or outgoing is, inter alia, of capital, or of a capital nature. For losses and outgoings incurred in carrying on a business, the term 'necessarily incurred in' is taken to mean 'clearly appropriate or adapted for' ( Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 326). The taxpayer conducts a business in which it regularly acquires stock, or it completes projects for others for a fee. This ruling considers expenditure incurred on a project. Successful completion of various aspects of the project will entitle the taxpayer to certain fee income. The outgoings incurred by the taxpayer under the agreement include certain fees and project costs. The assessable income of the taxpayer will include certain fees to be charged to the other entity. The expenditures on fees and project costs incurred are integral to the production of the taxpayer's business income and therefore the expenditure is considered to be 'necessarily incurred in' the course of carrying on that business. However, it must also be determined whether or not that expenditure is excluded from deductibility on the basis that it is capital, or of a capital nature. | Detailed Reasoning - Capital or of a capital nature: The decision in Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 ( Sun Newspapers ) is a leading authority on the distinction between revenue and capital expenditure, where his Honour said at 363: 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 to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. The Sun Newspapers test is described as being based on a conceptual approach to the distinction between the business structure or entity and the process of operating the business. To express it in another way, a distinction is made between the profit-yielding subject and the profit yielding process of a business: The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay... Subsequently, in Hallstroms Pty. Ltd. v. FC of T (1946) 72 CLR 634, Dixon J. reaffirmed his approach: [T]he contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it. More recently in GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 21 ATR 1; 90 ATC 4413 the High Court pointed out that the character of expenditure is ordinarily determined by reference to the nature of the asset acquired and that the character of the advantage sought by the making of the expenditure is a critical factor in determining the character of what is paid. | Detailed Reasoning - Character of advantage sought: In considering the character of the advantage sought and the light it sheds on the character of the expenditure, it is necessary to take into account numerous factors including the taxpayer's intentions and the form and manner of the transactions. Dixon J in Hallstroms Pty Ltd v F.C. of T. (1946) 72 CLR 634 at 648 highlighted the need to consider: ...what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. The practical effect of participating in the project is that the taxpayer anticipates deriving business income in the form of fees. The payments ultimately enable the taxpayer to derive fees from the project for the subsequent three to seven years (three years according to the agreement). The project constitutes approximately three percent of the taxpayer's activity for the 2009-10 and 2010-11 income years. The project represents a much smaller proportion of the taxpayer's activity in earlier years. It is considered that the rights obtained from the agreement do not alter the way in which the taxpayer carries on its business. The taxpayer is an established business undertaking large scale activity. The agreement did not alter the framework or structure in which the taxpayer carries on its business. Rather, it presented the taxpayer with access to additional opportunities to carry out its activities. | Detailed Reasoning - The manner in which the advantage is to be used, relied upon or enjoyed: All business expenditure is likely to be made with the intention of securing some commercial advantage. What is necessary to establish is the effect of the expenditure and how long it will likely endure. Where the expenditure results in an intangible benefit or advantage, it is necessary to establish whether the asset is sufficiently substantial and enduring to count as capital. The 'enduring benefit test' suggests that if a loss or outgoing gives rise to a benefit of an enduring nature, the loss or outgoing is more likely to be capital in nature. The test arose to prominence in British Insulated and Helsby Cables Ltd v. Atherton [1926] AC 205 where it was held that an employer contribution to establish a staff pension fund was capital in nature on the basis that it brought into existence an asset of 'enduring benefit". Viscount Cave LC at 192 made the following statement on the characteristics of capital expenditure: When an expenditure is made, not only once and for all, but with a view to bring into existence an asset or advantage for the enduring benefit of a trade, l think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital. It has been established that the advantage sought by the taxpayer from payment of the fees was the derivation of business income. This income and the rights under the agreement will cease on the project completion date. The estimated project completion date in the agreement was during the 2009-10 income year, approximately three years from commencement. It is now likely that completion will not take place until around six or seven years from commencement. In this case the term over which the taxpayer expected the rights under the agreement to endure and the term over which the rights actually endure vary between three and seven years. It is considered that in this case the enduring nature of the rights are not determinative of the nature of the expenditure. | Detailed Reasoning - The means adopted to obtain it: In the present case, to obtain the right to participate and in turn to derive the income, the taxpayer was required under the agreement to incur certain fees and project costs. In National Australia Bank v. Federal Commissioner of Taxation (1997) 80 FCR 352; 97 ATC 5153; (1997) 37 ATR 378 ( NAB ), the bank was required to pay a lump sum (but further amounts were payable if loan quotas were exceeded) to the Commonwealth in order to have the exclusive right to make advances to Australian Defence Force personnel for a 15 year period. The Full Federal Court held that the payment was of a revenue nature as it did not enlarge the framework within which the Bank carried on its activities. Rather, it was incurred as part of the process by which the Bank operated to obtain regular returns by means of regular outlay. The Full Court determined that the payment was in the nature of a marketing expense and had a revenue rather than capital aspect. The lump sum in NAB was $42 million and was a once and for all payment. The absence of recurrence suggests that an outgoing is of a capital nature, but it is not conclusive. In Sun Newspapers Dixon J. referred to the Anglo Persian Oil Co v. Dale (1932) 16 TC 253 as a case being an example of a one-off payment that was nevertheless deductible. Three features of the NAB case diluted the significance of the $42 million once and for all payment. In the taxpayer's case it is considered there are also features which have a dilution effect on the presumption that a lump sum has a capital nature.

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