Private ruling: Expenditure incurred in connection with a lease
Date of advice: 15 July 2020
Published: August 2020
Ruling period: xx xx 20xx to xx xx 20xx
Date scheme commenced: xx xx 20xx

Ruling: Q1: Is the Contribution paid by Subsidiary Company B to Company D under the Side Deed deductible for Head Company A pursuant to section 25-110 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Is the fee paid to Consulting Firm E for advising on the transfer of the lease, together with related legal fees, deductible for Head Company A pursuant to section 25-110 of the ITAA 1997? | A2: Yes. | Q3: If the answer to question 1 and 2 is yes, is the income year in which Head Company A terminates the lease for the purposes of paragraph 25-110(2)(a) of the ITAA 1997 the income year in which all the ongoing rights under the sublease have been assigned and all ongoing obligations transferred to Company D? | A3: Yes.

Relevant facts and circumstances: The Head Company A Group Head Company A is a company incorporated in Australia and the head company of a consolidated group for the purposes of the Income Tax Assessment Act 1997 . The Head Company A consolidated group has an income tax year ending on xx xx. Subsidiary Company B is an indirectly wholly owned subsidiary of Head Company A and is a member of the Head Company A consolidated group. Subsidiary Company C was wholly owned by Subsidiary Company B and was a member of the Head Company A consolidated group prior to xx xx 20xx. Subsidiary Company B entered into an agreement on xx xx 20xx to sell 100% of its interest in Subsidiary Company C to an unrelated third party (Acquisition Trustee F as trustee for the Acquisition Trust G) as part of a strategic management plan to divest certain businesses in the Head Company A portfolio. The sale completed on xx xx 20xx, at which time Subsidiary Company C left the Head Company A tax consolidated group. Subsidiary Company C is in the business of offering Services. However, the Subsidiary Company C Services are considered expensive in the market. This, and other factors, has led to a substantial drop in customer numbers. As a result of the fall in customer numbers, the management of Subsidiary Company C decided to exit the lease over an existing premises in Australia (referred as the 'Sublease' below) through a deed of assignment (referred to as the 'Deed of Assignment' below). Subsidiary Company B agreed to a one-off payment to the new tenant (through the 'Side Deed' referred to below) in connection with the deed of assignment. However, the 'Deed of Assignment' and 'Side Deed' were not part of a broader arrangement that included the sale of Subsidiary Company C. Those two agreements were instead independent of the sale of Subsidiary Company C. The Head Lease of the Premises Landholding Entity H made an agreement (Head Lease) with Head Lessor I for the Premises to be leased to Head Lessor I. The Sublease of the Premises Head Lessor I entered an agreement with Subsidiary Company C (Sublease), dated xx xx 20xx, for the Premises to be subleased to Subsidiary Company C. Head Lessor I is not a related party to Head Company A or its subsidiaries. The Sublease runs for a term of xx years, commencing xx xx 20xx and ending on xx xx 20xx. The rent was $xx per annum which was to be paid in monthly instalments. The Sublease allows for the transfer of the Sublease or sub-sublease of the Premises in certain circumstances. Bank guarantees also had to be obtained and delivered to Head Lessor I as part of the Sublease. The Sublease is not required to be treated as a finance lease in accordance with accounting standards, or statements of accounting concepts made by the Australian Accounting Standards Board. Deed of Assignment Head Lessor I, Subsidiary Company C and Company D entered into a Deed of assignment (Deed of Assignment) on xx xx 20xx. Company D is not a related party to Head Company A or its subsidiaries and all dealings between the parties were conducted at arm's length. The Deed of Assignment provided for an assignment of all interest in the Sublease and the Premises to Company D on xx xx 20xx. Company D also promised to Subsidiary Company C and Head Lessor I that it would meet all the obligations to Head Lessor I under the Sublease, including the payment of rent. As from the assignment date, Subsidiary Company C released Head Lessor I from any claim arising under or in connection with the Sublease or in respect of the Premises. However, Subsidiary Company C will only be released from all obligations and liabilities under the Sublease from the date that it physically vacates the Premises due to the expiry or earlier determination of any sub-sublease. The Deed of Consent and Sub-Sublease Head Lessor I, Company D, Subsidiary Company C and Subsidiary Company B entered into a Deed of consent (Deed of Consent) dated xx xx 20xx. This agreement involved Head Lessor I consenting to a sub-sublease of the Premises, and the creation of certain obligations that Subsidiary Company C would have to Head Lessor I. The Deed of Consent also provided that the sub-sublease would end automatically if the Sublease were to come to an end. The sub-sublease between Company D as lessor and Subsidiary Company C as lessee (Sub-Sublease) itself was only in respect of xx% of the Premises covered by the Sublease. The Sub-Sublease began in xx xx 20xx and ended in xx xx 20xx, with no option for an extension. The rent was $xx per annum plus GST. This rent is the same rent payable on a per square metre basis as under the Sublease (being $xx per square metre plus GST). The other terms of the Sub-Sublease were adopted from the terms of the Sublease, with some minor variations. The Side Deed and Side Letter Company D, Guarantor Company J and Subsidiary Company B entered an undated Side Deed (Side Deed) on or before xx xx 20xx. The terms of this Side Deed were being negotiated from xx 20xx. Under the Side Deed, Subsidiary Company B agreed to pay Company D a 'Contribution' amount of $xx inclusive of GST. The obligation to pay this Contribution amount under the Side Deed was a prerequisite for Company D to enter into the Deed of Assignment. The Side Deed provides that the Contribution is in consideration of entry by the parties into the Deed of Assignment, transfer of Sublease and the Sub-Sublease. The Contribution was payable in two instalments. The first instalment of the Contribution was specifically to facilitate the obtaining of Bank Guarantees required to be provided by Company D under the Deed of Assignment and Sublease. The Side Deed also provided that if the Deed of Assignment, transfer of Sublease and Sub-Sublease were not entered into by the relevant parties on or before the Assignment Date then there would be not obligations for Subsidiary Company B to pay the Contribution (unless an extension of time was agreed to by Subsidiary Company B). The Contribution amount of $xx was broadly negotiated, and calculated, to represent a xx% incentive of the total outstanding lease commitment at the date of assignment. Subsidiary Company C was willing to pay this amount given that the leased premises were excess to its business needs and it wished to completely vacate the Premises from xx xx 20xx. At the time of negotiating and entering into the Side Deed, the Contribution was consistent with market termination fees on properties in the area. The Contribution amount was calculated as follows: Remaining Term xx Years Remaining Lease Liability $xx Termination Incentive xx% Termination Incentive $xx Savings on rent liability $xx The first instalment of $xx was made on xx xx 20xx. The second instalment was made on xx xx 20xx and was reduced from $xx to $xx in line with the 'Side Letter' described below. After the execution of the Side Deed, Subsidiary Company B and Company D entered into an additional agreement via letter (Side Letter) dated xx xx 20xx. Under the Side Letter, Company D and Subsidiary Company B agreed to an adjustment to the second instalment of the Contribution. The adjustment was necessary due to a rental invoice being issued by Head Lessor I to Subsidiary Company C (instead of Company D) after the assignment date specified in the Deed of Assignment. Subsidiary Company B agreed to pay the rental invoice in full to Head Lessor I in exchange for an amount being credited against the second instalment of the Contribution. Consequently, the second instalment reduced from $xx (inclusive of GST) to $xx (inclusive of GST). Fees to Consulting Firm E Subsidiary Company B engaged Consulting Firm E to advise on and facilitate the above arrangement, including through identifying an assignee. The fee paid for this service was $xx (plus GST) in xx 20xx. Legal fees of approximately $xx (plus GST) were also paid for preparing the various agreements. The advice provided by Consulting Firm E related solely to the various agreements described in the relevant facts and circumstances. The advice from Consulting Firm E was not legal advice and did not relate to the sale of Subsidiary Company C. Consulting Firm E publicly advertised the Premises, as well as sourcing potentially interested parties from its contact list. Consulting Firm E introduced Subsidiary Company C to multiple potentially interested parties, some of whom took the opportunity to tour the property.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 25-110(1) | Income Tax Assessment Act 1997 Subsection 25-110(2) | Income Tax Assessment Act 1997 Subsection 25-110(3) | Income Tax Assessment Act 1997 Subsection 25-110(4) | Income Tax Assessment Act 1997 Subsection 25-110(5) | Income Tax Assessment Act 1997 Subsection 25-110(6) | Income Tax Assessment Act 1997 Subsection 701-1(1)

Reasons for decision: Summary: Yes. The Contribution paid by Subsidiary Company B to Company D under the Side Deed is deductible for Head Company A pursuant to section 25-110. | Detailed Reasoning - Detailed reasoning: Capital expenditure incurred to terminate a lease may be deductible under section 25-110 in some circumstances. Subsection 25-110(1) states: (1) You can deduct an amount for capital expenditure you incur to terminate a lease or licence (including an authority, permit or quota) that results in the termination of the lease or licence if the expenditure is incurred: (a) in the course of carrying on a *business; or (b) in connection with ceasing to carry on a business. Subsection 25-110(1) requires the following: 1. The amount is capital expenditure; 2. The amount is incurred to terminate a lease or licence; 3. The amount results in the termination of the lease or licence; 4. The amount is incurred in the course of carrying on a business, or in connection with ceasing to carry on a business. However, there are also some types of expenditure that cannot be deducted because of the exceptions in subsections 25-110(3) to 25-110(6). 1. The amount is capital expenditure In Sun Newspapers Ltd & Anor v FC of T , 61 CLR 337, 5 ATD 87, Dixon J, as he then was, stated that in determining whether an outgoing is capital or capital in nature there are 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. ... In this case, the Contribution amount paid by Subsidiary Company B under the Side Deed was in consideration of the entry by Company D into the Deed of Assignment, the transfer of the Sublease and entry into the Sub-Sublease. The Contribution amount agreed to was $xx. The first instalment of $xx was made on xx xx 20xx. The second instalment was made on xx xx 20xx and was reduced from $xx to $xx in line with the Side Letter, making the Contribution amount to be $xx (inclusive of GST). The predominant advantage sought by Subsidiary Company B through paying the Contribution was a saving of approximately $xx to its wholly owned subsidiary at the time of the Contribution, Subsidiary Company C. In particular, Subsidiary Company C would have otherwise had to make regular payments pursuant to the Sublease for a period of xx years. The entry by Company D into the Deed of Assignment and the transfer of the Sublease eliminated these reoccurring obligations. There was also an advantage gained through Company D entering into the Sub-Sublease. However, it is clear in the circumstances that the Contribution amount was primarily intended to compensate Company D for taking on the obligations associated with the remaining xx years of the Sublease. As a result, the Contribution amount was a one-off payment to end a reoccurring obligation and thereby secure a permanent and enduring advantage. The Contribution is therefore capital expenditure. 2. The amount is incurred to terminate a lease or licence The Contribution amount was paid by Subsidiary Company B under the Side Deed in consideration of the entry by Company D into the Deed of Assignment, the transfer of the Sublease and entry into the Sub-Sublease. The Deed of Assignment provides that Subsidiary Company C will be released from all obligations and liabilities under the Sublease (except for any antecedent breaches) from the date that the company physically vacates the Premises due to the expiry or earlier determination of any sub-sublease. Likewise, Subsidiary Company C released Head Lessor I from any claim arising under the Sublease, or in respect of the Premises, from xx xx 20xx pursuant to the Deed of Assignment. Consequently, the Sublease between Head Lessor I and Subsidiary Company C will terminate on the day Subsidiary Company C vacates the Premises as the parties will have performed all obligations owed to each other. As referred to above, the predominant advantage sought by Subsidiary Company B through paying the Contribution was to end obligations associated with the Sublease through the entry by Company D into the Deed of Assignment and the transfer of the Sublease. The Deed of Assignment ends any remaining obligations imposed on Subsidiary Company C by the Sublease and, as a result, brings about the termination of the Sublease between Head Lessor I and Subsidiary Company C. As such, the Contribution was incurred to terminate a lease. 3. The amount results in the termination of the lease or licence Company D, Guarantor Company J and Subsidiary Company B entered the Side Deed on or before xx xx 20xx. Head Lessor I, Subsidiary Company C and Company D entered into the Deed of Assignment on xx xx 20xx (after the Side Deed was entered into). The obligation to pay the Contribution amount under the Side Deed was a prerequisite for Company D to enter into the Deed of Assignment (which terminated the lease between Head Lessor I and Subsidiary Company C). As such, the Contribution resulted in the termination of the lease. 4. The amount is incurred in the course of carrying on a business, or in connection with ceasing to carry on a business Subsidiary Company C carries on a business of providing Services. The Contribution was incurred in the course of carrying on this business. | Detailed Reasoning - Subsection 25-110(3): Subsection 25-110(3) states: (3) You cannot deduct any amount for expenditure you incur to terminate a lease that, in accordance with *accounting standards, or statements of accounting concepts made by the Australian Accounting Standards Board, is classified as a finance lease. The Sublease is not required to be treated as a finance lease in accordance with accounting standards, or statements of accounting concepts made by the Australian Accounting Standards Board. As such, subsection 25-110(3) has no application. | Detailed Reasoning - Subsection 25-110(4): Subsection 25-110(4) states: (4) If you incurred the expenditure under an *arrangement and: (a) there is at least one other party to the arrangement with whom you did not deal at *arm's length; and (b) apart from this subsection, the amount of the expenditure would be more than the *market value of what it was for (assuming the termination did not occur and was never proposed to occur); the amount of expenditure you take into account is that market value. Company D and Head Lessor I are not related parties to Head Company A or its subsidiaries, and all dealings with those parties were conducted at arm's length. Furthermore, the Contribution was consistent with market termination fees on properties in the area (at the time of Side Deed). Consequently, subsection 25-110(4) has no application. Subsection 25-110(5) Subsection 25-110(5) states: (5) You cannot deduct any amount for expenditure you incur to terminate a lease or licence if: (a) after the termination, you or an *associate of yours enters into another lease or licence with the same party or an associate of that party; and (b) the other lease or licence is of the same kind as the original one. The Deed of Assignment provides that Subsidiary Company C will be released from all obligations and liabilities under the Sublease (except for any antecedent breaches) from the date that the company physically vacates the Premises due to the expiry or earlier determination of any sub-sublease. As such, termination of the Sublease between Head Lessor I and Subsidiary Company C will not occur until the termination date of the Sub-Sublease, being xx xx 20xx. There is no evidence that the Head Company A consolidated group or any of its 'associates' will enter into a lease with Head Lessor I, or any of Head Lessor I's associates, after xx xx 20xx that is of the same kind as the Sublease. Consequently, subsection 25-110(5) has no application. | Detailed Reasoning - Subsection 25-110(6): Subsection 25-110(6) states: (6) You cannot deduct any amount for expenditure you incur to terminate a lease or licence to the extent that the expenditure is for the granting or receipt of another lease or licence in relation to the asset that was the subject of the original lease or licence. In relation to section 25-110(6), the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 ('Explanatory Memorandum') states: 2.122 Where capital expenditure is incurred to terminate a lease or licence for the granting of another lease or licence in relation to the asset that was the subject of the original lease or licence, it will be specifically excluded from this provision. This is because, rather than the removal of an onerous obligation, the payment is to acquire a new lease. The expenditure may form part of the cost base of the new lease, a CGT asset. [Schedule 2, item 2, subsection 25-110(6)] Example 2.22 Nicholas holds a lease over a suburban office space with the office building manager, Tim. James has been looking for a suitable office in that area, and approaches Tim to negotiate taking over the lease. Tim agrees, subject to the payment of a lease surrender payment. James makes the payment. As the payment is for the purpose of James taking over the lease and gives rise to a new lease, it is expenditure for the granting of a new lease so is not deductible under this provision. As referred to above, the predominant advantage sought by Subsidiary Company B through payment of the Contribution was to end obligations associated with the Sublease through the entry by Company D into the Deed of Assignment and the transfer of the Sublease. The creation of the Sub-Sublease was part of the wider arrangement but not the reason for the Contribution. As such, the Contribution was not 'for the granting or receipt of' the Sub-Sublease. The Contribution also facilitated the creation of a new sublease between Head Lessor I and Company D, including a direct reference in the Side Deed to facilitating Company D obtaining the relevant 'Bank Guarantees'. Despite the wording of the Side Deed, Subsidiary Company B is incurring the expenditure for 'the removal of an onerous obligation' (consistent with the intent of the law alluded to in paragraph 2.122 of the Explanatory Memorandum), rather than 'for the granting or receipt of' the new sublease between Head Lessor I and Company D. Consequently, subsection 25-110(6) has no application. | Detailed Reasoning - Conclusion: The Contribution paid by Subsidiary Company B to Company D under the Side Deed satisfies all the requirements of subsection 25-110(1) and does not fall within any of the exceptions in subsections 25-110(3) to 25-110(6). However, Subsidiary Company B is a subsidiary member of the Head Company A consolidated group and treated as part of Head Company A rather than a separate entity consistent with subsection 701-1(1). Consequently, the Contribution is deductible for the head company of the consolidated group, Head Company A. | Detailed Reasoning - Question 2: Is the fee paid to Consulting Firm E for advising on the transfer of the lease, together with related legal fees, deductible for Head Company A pursuant to section 25-110 of the ITAA 1997? | Summary: Yes. The fee paid to Consulting Firm E for advising on the transfer of the lease and the related legal fees (collectively 'the Fees') are deductible for Head Company A pursuant to section 25-110 | Detailed Reasoning - The requirements of subsection 25-110(1): 1. The amount is capital expenditure The predominant advantage sought by the Head Company A consolidated group paying the Fees was the creation of the Deed of Assignment and transfer of Sublease, which resulted in a saving of approximately $xx to Subsidiary Company C. Subsidiary Company C would have otherwise had to make regular payments pursuant to the Sublease for a period of xx years. As a result, the Fees were a one-off expense to end a reoccurring obligation and thereby secure a permanent and enduring advantage. The Fees are therefore capital expenditure. 2. The amount is incurred to terminate a lease or licence The predominant advantage sought by the Head Company A consolidated group paying the Fees was to end obligations associated with the Sublease through the creation of the Deed of Assignment and the transfer of the Sublease. The Deed of Assignment provides for the termination of the Sublease between Head Lessor I and Subsidiary Company C. As such, the Fees were incurred to terminate a lease. 3. The amount results in the termination of the lease or licence The Fees were paid to bring about the Deed of Assignment through which the Sublease between Head Lessor I and Subsidiary Company C will be terminated. The Fees were part of a pool of expenses (which also included the Contribution referred to in Question 1) that will result in the termination of the Sublease. 4. The amount is incurred in the course of carrying on a business, or in connection with ceasing to carry on a business Subsidiary Company C carries on a business of providing Services. The Contribution was incurred in the course of carrying on this business. | Detailed Reasoning - Subsection 25-110(3): Subsection 25-110(3) has no application for the same reasons as in Question 1. | Detailed Reasoning - Subsection 25-110(4): Company D and Head Lessor I are not related parties to Head Company A or its subsidiaries, and all dealings with those parties were conducted at arm's length. Furthermore, there is no evidence to suggest that the Fees were not arm's length, or not the market value of the services provided. Consequently, subsection 25-110(4) has no application. | Detailed Reasoning - Subsection 25-110(5): Subsection 25-110(5) has no application for the same reasons as in Question 1. | Detailed Reasoning - Subsection 25-110(6): Subsection 25-110(6) has no application for the same reasons as in Question 1. | Detailed Reasoning - Conclusion: The Fees paid by the Head Company A consolidated group satisfy all the requirements of subsection 25-110(1) and do not fall within any of the exceptions in subsections 25-110(3) to 25-110(6). Consequently, the Fees are deductible for the head company of the consolidated group, Head Company A. | Detailed Reasoning - Question 3: If the answer to question 1 and 2 is yes, is the income year in which Head Company A terminates the lease for the purposes of paragraph 25-110(2)(a) the income year in which all the ongoing rights under the sublease have been assigned and all ongoing obligations transferred to Company D? | Summary: Yes. The income year in which Head Company A terminates the lease for the purposes of paragraph 25-110(2)(a) is the income year in which all the ongoing rights under the Sublease have been assigned and all ongoing obligations transferred to Company D. | Detailed Reasoning - Detailed reasoning: Section 25-110(2) states: (2) The amount you can deduct is 20% of the expenditure: (a) for the income year in which the lease or licence is terminated; and (b) for each of the next 4 income years. The Deed of Assignment provides that Subsidiary Company C will be released from all obligations and liabilities under the Sublease (except for any antecedent breaches) from the date that the company physically vacates the Premises due to the expiry or earlier determination of any sub-sublease. Likewise, Subsidiary Company C released Head Lessor I from any claim arising under the Sublease, or in respect of the Premises, from xx xx 20xx pursuant to the Deed of Assignment. Consequently, the Sublease between Head Lessor I and Subsidiary Company C will terminate in the income year Subsidiary Company C vacates the Premises and is released from all its obligations and liabilities under the Sublease.

Reasons for decision: These reasons for decision accompany the Notice of private ruling for Head Company A. | While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.