Private ruling: Deductibility of expenses
Published: April 2013
Ruling period: 1 July 2009 to 30 June 2012
Date scheme commenced: During the 2010 income year

Ruling: Q1: Are costs incurred by the taxpayer in providing trustee services to the Trust relevant to the proposed, but then aborted merger with another trust and which were on-charged to the Trust by way of increased trustee fees, deductible to the taxpayer under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: The taxpayer is an Australian proprietary company limited by shares and operates as the trustee of the Trust. In this capacity it acts on behalf of the Trust. By virtue of their respective activities as described in the Rules of the Trust, the Trust and the taxpayer are separate entities for income tax and goods and services tax (GST) purposes. The taxpayer provides the trustee services to the Trust and receives remuneration by way of a trustee fee. The taxpayer may not directly perform all the administrative, operational and investment functions but in various cases it arranges for them to be provided by engaging various third parties. In carrying out its trustee duties, the taxpayer incurs expenses in dealing with a range of entities. The taxpayer invoices the Trust for a single amount each month to represent the estimated amount that it requires to pay the anticipated expenses. These trustee fees received by the taxpayer are returned as assessable income by the taxpayer. As estimation is involved the amount invoiced to the Trust does not always equate to the amount paid out by the taxpayer, sometimes resulting in a mismatch between the amounts received and the amounts outlaid by the taxpayer. The taxpayer also maintains a cash reserve to ensure that it has sufficient funds in the event that the amount invoiced by it is less than the amount subsequently paid. Proposed Merger and Costs In a previous income year, the Trust proposed to merge with another similar trust. It was announced that a new company had been established to be the intended trustee of the merged trust. However, after more than X years of planning for the merger, the board of the Trust voted to withdraw from the merger. During this period the taxpayer had incurred significant costs to consider various issues relating to the merger, particularly legal and consulting fees. In accordance with the Rules of the Trust, these costs were on-charged to the Trust as part of the monthly trustee fee. Invoices from service-providers for all of the merger related costs for merger project were issued to the taxpayer and not to the Trust. All of the expenses in respect of the merger project have been recovered from the Trust by way of additional trustee fees charged to the Trust. However, no margin has been charged by the taxpayer on the merger expenses because this is not permitted under the terms of the Rules of the Trust. As at the time of the withdrawal from the merger, no particular decision had been made regarding the future operations of the taxpayer in the event that the merger actually proceeded.

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

Reasons for decision: Summary: The general deduction provision of the ITAA 1997 is section 8-1, which is set out below: 8-1(1 ) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. Note: Division 35 prevents losses or outgoings from non-commercial business activities that may contribute to a tax loss being offset against other assessable income. | Detailed Reasoning - 8-1(2): However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. For a summary list of provisions about deductions, see section 12-5. 8-1(3) A loss or outgoing that you can deduct under this section is called a general deduction. For the effect of the GST in working out deductions, see Division 27. Note: If you receive an amount as insurance, indemnity or other recoupment of a loss or outgoing that you can deduct under this section, the amount may be included in your assessable income: see Subdivision 20-A. | Detailed Reasoning - Subsection 8-1(1): In the circumstances of this case there are two distinct entities - the Trust and its trustee, the taxpayer. In its day to day operations the taxpayer invoices the Trust each month for an amount that it expects to outlay for the running costs of the Trust that it has incurred. The taxpayer includes in its assessable income the fees it charges to the Trust for carrying out the trustee function. The taxpayer claims deductions for the expenses it incurs in carrying out the trustee function which are indirectly charged to the Trust via the monthly trustee fee. Under the Rules of the Trust, the taxpayer was and is obliged to provide services to the Trust as trustee and as such, if the Trust wanted to explore the possibility of a merger the taxpayer was obliged to undertake that exploration. For the duration of the merger project the taxpayer engaged various consultants and advisers to investigate the feasibility of the merger. In doing so, the taxpayer incurred expenses that were over and above the usual level of monthly expenses which were invoiced to the Trust as a higher monthly fee without a mark-up. The merger expenses can be regarded as being incurred in gaining or producing the assessable income of the taxpayer, which satisfies the general requirements of paragraph 8-1(1)(a) of the ITAA 1997. | Detailed Reasoning - Subsection 8-1(2): It is necessary to consider whether the expenses of the merger project would not be deductible because of any of the 'negative' limbs of section 8-1 of the ITAA 1997, particularly paragraph 8-1(2)(a) of the ITAA 1997. This provision denies a deduction for losses or outgoings that are of capital or of a capital nature. To determine the character of a particular loss or outgoing the facts of each case needs to be examined having regard to principles established by the courts. The leading Australian case setting out principles to help determine the capital/revenue distinction is Sun Newspapers Ltd v FC of T (1938) 61 CLR 337. In that case Dixon J set out three indicators which help in determining this issue, which can be summarized in the following questions: (1) What is the character of the advantage sought by incurring the expenditure? (2) What is the manner in which the advantage is to be used, relied on or enjoyed? (3) What is the means adopted to obtain the advantage? The answer to the first question is the main factor and is often the decisive factor, per FCT v Citylink Melbourne Ltd [2006] HCA 35. To ascertain the answer to the first question it is helpful to consider some further factors in the light of the circumstances of the taxpayer: § The object of the expenditure What was the advantage the taxpayer received for its outlays? The taxpayer obtained legal and other advice concerning the merger which was provided to the Trust for it to make use of or not. Such information was only useable by the Trust because it dealt with the unique circumstances of the Trust. It was not directly useable by the taxpayer. § The recurrence of the expenditure or the advantage sought The expenditure was quite regular during the merger consideration period but ceased once the decision was made to not pursue the merger. § The lasting qualities of the advantage obtained by the expenditure, often referred to as the enduring benefit During the period of the merger consideration the additional expenditure incurred by the taxpayer in respect of the merger project resulted in increased fees (assessable income) paid to it by the Trust because of the policy of on-billing expenses incurred by the taxpayer. The additional expenditure for the project was over and above the usual expected level of expenses during that time and resulted in additional assessable income for the taxpayer for that time only. The taxpayer did not obtain any enduring or lasting benefit from the expenditure because the merger did not proceed and it seems that even if the merger was implemented, the taxpayer may not have obtained any further benefit because another company had been incorporated to take on the trustee duties for the merged trust. § What is the practical and business effect of the expenditure? The expenditure was made to explore the feasibility of the merger of the Trust with another trust. Had the merger been implemented it is arguable that the trustee fees pertaining to the merged larger trust would be increased but as stated above it was not certain whether the taxpayer would have received any of these fees in the future. The second question above is similar to the first. The advantage obtained by the additional expenditure on the merger project was the additional assessable income for the taxpayer for the duration of the merger consideration period and only for that period. Once it was decided that the merger was not to proceed the taxpayer did not incur further expenditure for the project and was unable to on-charge expenses to the Trust that were over and above the usual level of fees. The third question concerns the means adopted to obtain the advantage. The advantage was the increased trustee fees paid to the taxpayer for the duration of the merger consideration period and which was the direct result of the increased expenditure incurred in respect of the merger project. The increased expenditure consisted of a large number of invoices for varying amounts, paying for advice in respect of the project. The above factors point to a conclusion that the expenses of merger project incurred by the taxpayer could not be regarded as being capital expenditure of the taxpayer and therefore the negative test of paragraph 8-1(2)(a) of the ITAA 1997 has not been satisfied. Therefore, the costs incurred by the taxpayer in providing trustee services to the Trust relevant to the proposed, but then aborted merger which were on-charged to the Trust by way of increased trustee fees, are deductible to the taxpayer under section 8-1 of the ITAA 1997.