Private ruling: Method of apportionment of business expenses
Published: December 2013
Ruling period: Income year ended 30 June 2008 | Income year ended 30 June 2009 | Income year ended 30 June 2010 | Income year ended 30 June 2011 | Income year ended 30 June 2012 | Income year ended 30 June 2013 | Income year ending 30 June 2014
Date scheme commenced: The scheme has commenced.

Ruling: Q1: For the purposes of determining the extent to which Company X can claim deductions for corporate expenses and administrative expenses under section 8-1 of the Income Tax Assessment Act 1997 , shall the taxpayer's proposed method of apportionment as described in the Private Ruling be acceptable? | A1: Yes. | Q2: For the purposes of determining the extent to which Company X can claim deductions for business capital costs under section 40-880 of the Income Tax Assessment Act 1997 , shall the taxpayer's proposed method of apportionment as described in the Private Ruling be acceptable? | A2: Yes.

Relevant facts and circumstances: Company X is an Australian resident company with a goal of acquiring a suite of businesses in Country Z. Since incorporation Company X has raised funds, predominately from Australian based investors which has been utilised by the company; · to acquire 100% of the shares in a number of Country Z incorporated companies; · loan funds to its Country Z incorporated subsidiaries to fund their operations (loans denominated in Country Z dollars); and · fund Company X's operational costs. The funds were raised through the issue of convertible notes, promissory notes and ordinary shares in Company X. Company X utilised part of the funds raised to purchase all the shares in the Country Z entities: Consideration for the shares in the Country Z entities was paid partly from the capital raised through the convertible notes and the issue of shares in Company X. At various times during the relevant income years Company X has held substantial amounts of cash in Country Z dollars. Company X made the investments in the Country Z subsidiaries with the hope and expectation that their production activities will be profitable and allow a return on those investments by way of substantial dividends. However, at no point since its inception have any of Company X's subsidiaries in Country Z paid any dividends. Further, the timing of and ability for these subsidiaries to maintain their current business operations and pay dividends to Company X has not yet been determined. During the relevant income years Company X has generated assessable interest income from bank deposits. Additionally Company X made Foreign Exchange (FOREX) realisation gains/losses from Foreign Exchange Realisation Events 2 (FRE2) under section 775-45 of the ITAA 1997 from Country Z dollar currency deposits, Country Z dollar denominated loans to subsidiaries and other Country Z dollar denominated receivables and payables. Company X also made FOREX realisation gains/losses from Foreign Exchange Realisation Events 4 (FRE4) under section 775-55 of the ITAA 1997 from borrowings in Country Z dollars from the issue of promissory notes and convertible notes. During this period Company X has not received any dividend income from its Country Z subsidiaries. Company X claims that due to the type income received during the relevant income years, establishing the extent to which the Company X business is carried on for a taxable purpose by comparing the amount of any assessable income to total income results in a high taxable percentage which does not represent the use of capital raised. Further, the extent to which future income will be classified as assessable, exempt or NANE will be driven by the level of funds maintained in cash by Company X, the level of funds loaned to subsidiaries, the movement in the Australian/Country Z exchange rate and the success of Company X's subsidiaries current business strategies in generating net income from their assets. The inherent uncertainty around these future income sources prohibits a reasonable basis to be established under which an income based allocation of taxable purpose can be arrived. For the income years in question, Company X incurred general corporate and administrative expenses and business capital cost in relation to its business operation. General and administrative costs General corporate and administrative expenses comprised of bank fees, stationery, telephone expenses, insurance, ongoing ASX listing costs, accounting fees, legal fees, auditor's fees, director's fees and travel expenses. Legal costs were incurred in drafting confidentiality deeds in relation to various transactions entered into between Company X and other entities subsequent to the acquisition of its Country Z subsidiaries. Audit fees were incurred in relation to the ongoing audits of the company such as that undertaken on the Annual Reports. Accounting and management fee expenses relate to consultants used to keep the company's internal books and management of accounts. Director's fees were incurred to remunerate the two non-executive directors of Company X. The directors are working to maximise the value of the Country Z subsidiaries and as a result increase the value of Company X for its shareholders. The majority of general and administrative costs have been incurred in maintaining Company X, as the Australian head entity, including its compliance and activities to increase the value of its Country Z investments. Business capital costs Company X incurred capital raising costs consisting of accounting and audit fees, consultant fees, legal fees, ASX listing costs and travel expenses to acquire shares in its Country Z subsidiaries. Legal costs, accounting and auditing fees were incurred in relation to participation in meetings related to Company X's initial public offering and prospectus. The issue of shares in Company X under the terms of the convertible notes subscription agreement was subject to Company X's listing in the ASX and this gave rise to ASX listing costs. Company X received a prior private ruling in relation to the nature of the dividends from Country Z subsidiaries, tax treatment of FOREX gains or losses and the deductibility of the relevant business expenditure as raised in the current ruling application. That ruling is considered relevant to the current ruling application and is summarised as follow. i. Any dividends received by Company X from its wholly owned Country Z subsidiaries will be non-assessable non-exempt (NANE) income under section 23AJ of the Income Tax Assessment Act 1936 ('ITAA 1936'). ii. General corporate and administrative expenses incurred by Company X that are considered to be otherwise deductible under paragraph 8-1(1)(b) of the ITAA 1997 are however denied deductibility pursuant to paragraph 8-1(2)(c) of the ITAA 1997 to the extent to which they are incurred in gaining or producing NANE income. iii. Business related capital costs otherwise deductible under section 40-880 of the ITAA 1997 are not deductible under paragraph 40-880(5)(j) of the ITAA 1997 to the extent to which they were incurred by Company X in acquiring shares in Country Z subsidiaries and in relation to deriving NANE income, iv. Where Foreign ReaIisation Event 4 (FRE4) applies, realised gains or losses are excluded from being assessable or deductible to Company X under section 775-25 or section 775-35 with this exclusion restricted to the extent to which the foreign exchange gain or loss results from the discharge in whole or in part of an obligation by Company X to repay foreign currency borrowed to acquire shares in its Country Z subsidiaries to generate NANE income. v. Foreign exchange realisation events resulting in a gain made or loss incurred by Company X will be considered to be deductible or assessable respectively where: · An obligation of Company X's Country Z subsidiaries to repay monies lent by Company X is discharged in whole or in part by actual payment by the subsidiaries. · There are fluctuations in the value of the Australian dollar against the Country Z dollar in respect of funds in Country Z currency held by Company X in bank accounts, between the time of depositing the funds into the accounts and subsequent transfer of those funds to the Country Z subsidiaries. In this application, Company X is seeking a ruling to ascertain whether the allocation of capital between assessable income generating, exempt income generating and NANE income generating net assets is an acceptable basis to calculate proportionate deductions for general corporate and administrative expenses and business capital costs. In arriving at deductible percentage of the expenditure, Company X proposes that the following methodology be used: i. The total net assets that are generating assessable income in the form of interest or an assessable FRE2 gain or deductible FRE2 loss from foreign exchange event on realisation. ii. Dividing this amount by total net assets to arrive at a taxable purpose percentage. iii. This taxable purpose percentage would be calculated for each relevant financial year based on the average net asset balances during the year. iv. The taxable purpose percentage would be applied to total deductible general corporate and administrative expenses and business related capital costs for the relevant financial year.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 8-1(1) | paragraph 8-1(2)(c) | subsection 40-880(1) | paragraph 40-880(2)(a) | paragraph 40-880(5)(j) | subsection 40-880(3)

Reasons for decision: Summary: Summary The proposed methodology of apportionment of expenses on a net assets basis is considered appropriate in determining the relevant amounts of deductions relating to corporate and administrative expenses and business capital cost for the purposes of section 8-1 and section 40-880 of the Income Tax Assessment Act 1997 ('ITAA 1997'). Detailed reasoning General corporate and administrative expenses Subsection 8-1(1) of the ITAA 1997 allows deductions for losses and outgoings to the extent that they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, paragraph 8-1(2)(c) denies deductions for losses or outgoings to the extent that they are incurred in gaining or producing exempt income or non-assessable non-exempt income. Business capital costs Section 40-880 of the ITAA 1997 applies to business related capital expenditure incurred on or after 1 July 2005. Subsection 40-880(1) of the ITAA 1997 describes the object of section 40-880 which is to make certain business capital expenditure deductible over five years. Paragraph 40-880(2)(a) of the ITAA 1997 gives an entitlement to a deduction for capital expenditure the taxpayer incurs in relation to an existing business. Subsection 40-880(3) of the ITAA 1997 limits the deduction for the expenditure to the extent that the business is carried on for a taxable purpose. Paragraph 40-880(5)(j) of the ITAA 1997 provides that the taxpayer cannot deduct anything under section 40-880 of the ITAA 1997 for an amount of expenditure they incur to the extent that it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income. Apportionment The Commissioner's view in relation to apportionment of expenses can be found in a number of taxation rulings. Paragraph 14 of TR 95/33 provides that where an outgoing is not incurred entirely for the purposes specified in subsection 8-1(1), the portion of the outgoing for which a deduction is allowable under section 8-1 is calculated on a basis that is fair and reasonable in the particular circumstances ( Ronpibon Tin NL v. FCT (1949) 78 CLR 47 at 59). Paragraph 40 of TR 95/25 states: "Under the reasoning in Roberts and Smith, interest on borrowed funds will be fully deductible provided the amount of 'capital' attributable to the borrower at the time of the borrowing is equal to or greater than the amount borrowed. If the amount of capital attributable to the borrower is less than the amount borrowed it will be necessary to apportion the interest expense. Generally the proportion of interest deductible will be equal to the proportion of capital that had been used to derive assessable income. " Paragraph 140 of TR 2011/6 states: "….., expenditure incurred on a thing or service as an undivided amount where distinct and severable parts of the thing or service relate to different businesses or objects needs to be apportioned against the relevant paragraphs of subsection 40-880(2) on some fair and reasonable basis: see Ronpibon Tin at page 59. " In paragraphs 35 and 40, it is respectively stated: "35. As a general rule, the extent to which a business is, was or is proposed to be, carried on for a taxable purpose is determined by comparing the amount of any exempt income and non-assessable non-exempt income the business has derived or will derive with total income (that is, assessable income plus exempt income plus non-assessable non-exempt income). This percentage is then applied to the amount of expenditure to reduce the deduction. 40. However, a comparison of non-assessable non-exempt and exempt income with total income may not always be the most relevant method of apportionment - particularly, if an integral part of the business activities is not for the purpose of gaining or producing any income, assessable or otherwise." In the present case, during the relevant income years Company X has incurred corporate expenses, administrative expenses and business capital costs in relation to Company X's business operations. The deductibility of these expenses has been determined by the Commissioner in a previous private ruling. In the ruling, the Commissioner determined that general corporate and administrative expenses incurred by Company X that are considered to be otherwise deductible under paragraph 8-1(1)(b) of the ITAA 1997 are however denied deductibility pursuant to paragraph 8-1(2)(c) of the ITAA 1997 to the extent to which they are incurred in gaining or producing NANE income. Further, business related capital costs otherwise deductible under section 40-880 of the ITAA 1997 are not deductible under paragraph 40-880(5)(j) of the ITAA 1997 to the extent to which they were incurred by Company X in acquiring shares in Country Z subsidiaries and in relation to deriving NANE income. The business of Company X comprises of investment in Country Z subsidiaries, loan to its Country Z subsidiaries, depositing funds in bank accounts. The funding of these business activities was raised through the issue of convertible notes, promissory notes and shares in Company X and has been utilised and applied in these various business activities. Income of Company X's business is generated by the various assets in which the funds were utilised and may include assessable income in the form of interest from bank deposits and FRE2 gains and non-assessable non-exempt income in the form of dividends from Country Z subsidiaries and FRE4 gains. The expenditure at issue relates to the production of both assessable income and exempt/NANE income, therefore it is necessary to apportion the relevant expenditure in determining the proportionate deductions of the expenditure that can be claimed against Company X's assessable income for the purposes of section 8-1 and section 40-880 of the ITAA 1997. As considered in various taxation rulings (TR 95/25, TR 95/33 and TR 2011/6), the Commissioner's view is that a particular item of expenditure may have to be apportioned into its deductible and non-deductible components. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be "fair and reasonable" in all the circumstances. In particular, paragraph 40 of TR 95/25 discusses the principle of apportionment of deduction of interest on the basis of the amount of capital 'attributable to the borrower at the time of the borrowing'. Further, it states that generally the proportion of interest deductible will be equal to the proportion of capital that had been used to derive assessable income. As the income from a business is generated by the assets of that business, it is considered reasonable that a mixed expenditure ought to be characterised and apportioned according to the nature and in the proportion of the assets of the business and the nature of the income they may be expected to produce. In this regard and in consideration of the principle discussed in the relevant taxation rulings, it is considered that the proposed net assets basis methodology to be used in calculating the proportionate deductions for the general corporate and administrative expenses and business capital cost is fair and reasonable taking into account: · Company X has not derived any dividends from its Country Z subsidiaries during the relevant income years. · The timing of and ability for the Country Z subsidiaries to maintain their current business operations and pay dividends to Company X has yet been determined. · The funds raised have been utilised by Company X in both assessable income and NANE income generating assets. Accordingly, the proposed methodology of apportionment of expenses on a net assets basis is considered appropriate for the purposes of, · determining the extent to which Company X can claim deductions for corporate expenses and administrative expenses under section 8-1 of the Income Tax Assessment Act 1997 . · determining the extent to which Company X can claim deductions for business capital costs under section 40-880 of the Income Tax Assessment Act 1997 .