Private ruling: Unsuccessful bidding costs
Date of advice: 21 December 2015
Published: March 2016
Date scheme commenced: The scheme has commenced.

Ruling: Q1: Are unsuccessful bidding costs an allowable deduction in terms of section 8-1 of the Income Tax Assessment Act 1997 ? | A1: Yes. | Q2: Are unsuccessful bidding costs an allowable deduction in terms of section 40-880 of the Income Tax Assessment Act 1997 ? | A2: No.

Relevant facts and circumstances: The Company, a foreign based company, has been carrying on business in Australia in two main geographical areas namely X and Y. The Company opened an office in Australia. The office is located in X and its primary activity is to conduct various bidding processes. The Company also carries on business in Y. This activity commenced when the Company was appointed. A taxable income was generated. The Company incurred expenditure in an unsuccessful bid for a contract. The nature of the activities conducted at the office in X with respect to bids was described as follows: The office primarily conducts all marketing and business development activities. The activities of the office involve: • Meetings with clients, partners, consultants and suppliers within the industry to identify opportunities for collaboration and to market the Company's capabilities to the wider market; • Reporting to Head Office in Z to exchange market information; • Development of business cases; • Attendance at conferences etc to develop networking and relationships with clients, partners etc; • Develop strategies; • Provide back office support and accounting; • Establish governance on projects or ventures; • Assist in supporting team on outsourcing personnel for awarded project; • Provide advice on local market practices and trends; and • General corporate headquarters role (accounting, finance and human resource support, etc.)

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 6-5(3) | Section 8-1 | Section 40-880 | Paragraph 40-880(5)(b)

Reasons for decision: Summary: A deduction is considered in terms of subsection 8-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the costs of unsuccessful bids for contracts. The activities of the Company are examined against the indicators of a business in Taxation Ruling TR 97/11. The result of that examination is that the Company is found to be carrying on a business in Australia. The income derived by the Company from carrying on business in Australia is ordinary income from an Australian source and as the Company is a foreign resident that income is assessable income in terms of subsection 6-5(3) of the ITAA 1997. Whether the costs of an unsuccessful bid for a contract is non-deductible capital expenditure is then examined with respect to the criteria for identifying capital expenditure as set out in the judgement of Dixon J in Sun Newspapers Ltd v FC of T (1938) 61 CLR 337; 5 ATD 87. A comparison with the criteria results in the finding that the costs of an unsuccessful bid for a contract are not an outgoing of capital or of a capital nature but instead are of a revenue nature. The expenditure is thereby deductible in terms of subsection 8-1(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 8-1(1) of the ITAA 1997 provides that a deduction is allowable to an entity for expenditure incurred in gaining or producing assessable income or for expenditure necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, the deduction is subject to the qualifying conditions in subsection 8-1(2) that it is not an outgoing of capital or of a capital nature; or that it is not of a private or domestic nature; that it is not incurred in gaining or producing exempt income or non-assessable non-exempt income; or that a deduction is denied by some other provision. In the present case the disqualifying conditions as to private or domestic expenditure do not apply. Nor is the expenditure incurred in gaining or producing exempt income or non-assessable non-exempt income. Further the deduction is not denied by any other provision of the legislation. However, the question of capital expenditure is considered below. Accordingly, first it is necessary to consider whether the expenditure incurred by the Company upon an unsuccessful bid for a contract falls within the terms of either limb of subsection 8-1(1) of the ITAA 1997. The Company has provided details of bids submitted for the years in question. It is necessary to determine whether the expenditure on the unsuccessful bids was incurred by the Company in carrying on business. In this regard it is useful to consider the indicators of a business as identified in Taxation Ruling TR 97/11 titled "Income tax: am I carrying on a business of primary production?" (TR 97/11). In TR 97/11 at paragraph 13 it is stated: 13 The courts have held that the following indicators are relevant: • whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators; • whether the taxpayer has more than just an intention to engage in business; • whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity; • whether there is repetition and regularity of the activity; • whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business; • whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit; • the size, scale and permanency of the activity; All of those indicators are present in the operations of the Company such that it is clearly evident that the Company is carrying on a business. It is worthwhile considering the business structure the Company has put in place in Australia and the way it operates its business through that structure. The office in X is at the heart of the Company's business operations. The office in X conducts meetings with potential and existing clients, partners and suppliers within the industry to identify opportunities for collaboration and to market the Company's capabilities. Thus it is at the office in X that the projects are identified, the bids for contracts on those projects are developed, prepared and ultimately they are submitted from and by the office in X. When a bid is successful and a contract is won it means that the Company will carry on business at the project location, as well as at the office in X. However, the duration of the contract is relatively short-lived by comparison with the operation of the office in X. A contract could be for up to 2 years, whereas the office in X is permanent and enduring. In addition the office in X has an ongoing role in the contract beyond the bid process. This is because the office in X recruits employees, provides payroll services and performs other human resource functions in respect of the contract. In addition the office in X has the general corporate office roles of accounting and finance for the contract. Therefore, the Company carries on one business in Australia through its office in X. From time to time the business also operates at other places in Australia being the location of the projects for which it has a contract. The income derived by the Company from its business in Australia is ordinary income from an Australian source and as the Company is a foreign resident that income is assessable income in terms of subsection 6-5(3) of the ITAA 1997. As it is recognised that a business is being carried on in Australia the expenditure upon an unsuccessful bid must be examined within that context. The preparation and submission of bids for contracts is an integral part of the business in which the Company is engaged. The submission of a bid in order to win a contract and thereby derive assessable income is an essential and unavoidable component of doing business. Therefore the cost of preparing and lodging a bid for a contract is necessarily incurred by the Company in carrying on its business. However, further examination of the character of the expenditure is required to ascertain whether it is denied as a deduction because it is an outgoing of capital or of a capital nature. First there is no provision of the Income Tax Assessment Act 1936 or the ITAA 1997 which specifically classifies the expenditure as being of a non-deductible capital nature. Therefore it is necessary to turn to consideration of decisions of the courts for guidance. Sun Newspapers Ltd v FC of T (1938) 61 CLR 337; 5 ATD 87 ( Sun Newspapers ) is a leading case which considered the question of capital expenditure and it is discussed below. In Sun Newspapers Dixon J examined the distinction between revenue and capital expenditure where his honour said: 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, the difference between the outlay and returns representing profit or loss. The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested. … But in spite of the entirely different forms, material and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a "profit-yielding subject" the phrase of Lord Blackburn in United Collieries Ltd. v. Inland Revenue Commissioners 1930 SC 215, at p 220; (1929) 12 Tax Cas 1248. As general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of operating it. …. For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose. Later Dixon J said: In the attempt, by no means successful, to find some test or standard by the application of which expenditure or outgoings may be referred to capital account or to revenue account the courts have relied to some extent upon the difference between an outlay which is recurrent, repeated or continual and that which is final or made 'once for all', and to a still greater extent upon a distinction to be discovered in the nature of the asset or advantage obtained by the outlay. … But the idea of recurrence and the idea of endurance or continuance over a duration of time both depend on degree and comparison. As to the first it has been said it is not a question of recurring every year or every accounting period but 'the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once for all' (per Rowlett J., Ounsworth v Vickers Ltd (1915) 3 KB 267). By this I understand that the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely. … 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 payments or by making a final provision or payment so as to secure future use or enjoyment. At issue in the present case is expenditure on unsuccessful bids for contracts where the expenditure was incurred in each of the income years in question. The expenditure was not directed towards establishing or adding to the "profit yielding subject" of the Company so in that sense it was not capital expenditure. Nor did the expenditure give rise to the creation or acquisition of any asset for the company. There was no ongoing or enduring benefit that came out of the expenditure; on the contrary, the expenditure on the unsuccessful bid meant that the amount outlaid represented a loss of that sum in that year. It is necessary to consider the expenditure in terms of the examination by Dixon J in Sun Newspapers of the distinction between expenditure on capital account and expenditure on revenue account. Dixon J identified three matters which need to be considered when determining whether the expenditure is of a capital or revenue nature. With respect to the cost of the unsuccessful bids those matters are: (a) the character of the advantage sought - this was the winning of a contract and as such that would have conferred a benefit upon the Company for the duration of the contract; (b) the manner in which it is to be used, relied upon or enjoyed - the winning of the contract would mean the Company would receive assessable income for the life of the contract; and (c) the means adopted to obtain it - because the expenditure on each bid is specific to that bid and does not extend into any other area of the Company's general operations it is effectively a final payment made in an effort to secure the benefits of a future income stream under the contract. Some elements of the above analysis suggest that the expenditure is of a capital nature. However, it is considered that the expenditure does not relate to the structure of the enterprise and does not provide an enduring benefit of a capital nature. The expenditure is part of the routine and regular business operations of the Company. This situation was recognised by Dixon J when referring to "expenditure which is made to meet a continuous demand". This can be understood from an examination of the way in which the Company carried on business. In order to gain a comprehensive view of the Company's business it is necessary to look at the Company's activities in the period from the establishment of the office in X. In that period the Company submitted bids for contracts. Having regard to the Company's activities in the period it is accepted that the submission of bids for contracts is an element of the way in which business is conducted by the Company. In other words it is simply a feature of the way in which business is done in that industry in which the Company operates. Doing business requires that submissions for contracts must be made in order to win a contract and hence derive income. Therefore, it is concluded that the expenditure on an unsuccessful bid is necessarily incurred in carrying on the Company's business in order to gain its assessable income; a deduction is not denied by any other provision. Consequently it is an allowable deduction in terms of section 8-1 of the ITAA 1997. | Summary: Section 40-880 of the ITAA 1997 relates to a deduction for certain business capital expenditure. However, it has been found in answer to Question 1 above that the expenditure incurred on the unsuccessful bid for a contract is business expenditure on revenue account and is deductible in terms of section 8-1 of the ITAA 1997. Accordingly, the expenditure is not capital expenditure and thus section 40-880 does not apply. Further paragraph 40-880(5)(b) denies a deduction under section 40-880 where a deduction is available under another provision, which is the case here. | Detailed Reasoning - Detailed reasoning: Section 40-880 of Subdivision 40-I in Part 2-10 of the ITAA 1997 concerns the deductibility of capital expenditure over time. Briefly stated the object of this section is to make certain business capital expenditure deductible over 5 years subject to a number of conditions being met. Therefore, at the outset it is necessary to consider the term "business" which subsection 995-1(1) defines as "includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee". The nature and degree of the activities in which the Company engages are such that they constitute the carrying on of a business. In addition the expenditure is incurred on the unsuccessful bid for a contract and is thereby business related. The business income of the Company, a foreign resident, is assessable in terms of subsection 6-5((3) of the ITAA 1997. However, the expenditure is not considered to be capital expenditure. This opinion is based upon the view formed in answer to question 1 above that the expenditure is on revenue account as part of the carrying on of the business. Therefore as the cost of the unsuccessful bid is not capital expenditure it does not qualify for deduction in terms of section 40-880 of the ITAA 1997. Further paragraph 40-880(5)(b) denies a deduction under section 40-880 where a deduction is available under another provision which is the case here.