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Is the capital expenditure incurred by the taxpayer to terminate major operational contracts with another party expenditure 'to convert your business structure to a different structure' for the purpose of paragraph 40-880(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The capital expenditure incurred by the taxpayer to terminate major operational contracts was not expenditure 'to convert your business structure to a different structure' for the purpose of paragraph 40-880(1)(b) of the ITAA 1997 because it was not directed and integral to the conversion of the taxpayer's business structure.

The taxpayer entered into a merger arrangement with an unrelated company. For the purposes of paragraph 40-880(1)(b) of the ITAA 1997, this new legal relationship created the framework within which the taxpayer operates and represents the conversion of the taxpayer's business structure to another business structure. The taxpayer, through the new structure, carries on business for a taxable purpose.

In conjunction with the merger process, the taxpayer incurred capital expenditure in consideration for an external service provider terminating major operational contracts between the taxpayer and the external service provider.

Subject to the exclusions in subsection 40-880(3) of the ITAA 1997, paragraph 40-880(1)(b) provides a deduction for capital expenditure you incur to convert your business structure to a different structure, to the extent your business is, was or will be carried on for a taxable purpose.

Broadly speaking, capital expenditure is incurred for the purpose of converting your business structure to a different structure, if the expenditure can be attributed to tasks and activities which are directed and integral to that purpose.

This is an objective test: each case must be viewed on the basis of its own facts and circumstances to determine whether the expenditure can objectively be demonstrated as having as its purpose the conversion of your business structure to a different business structure. The substance of what was the occasion of, and what was provided from, the capital expenditure, must be taken into account. Examining the purpose for which an amount is expended involves both a consideration of the character of the expenditure and an examination of the business structure and the operation of the business of the taxpayer, in the course of which the capital expenditure has been incurred.

There is a distinction between, on the one hand, a business structure comprised of legal relationships and containing such features as ownership, control, profit distribution and liability and, on the other hand, the profit yielding subject that is operated to earn the profits of the business. This is emphasised by paragraph 3.46 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No.5) 2002 which provides that the type of structural change intended by paragraph 40-880(1)(b) of the ITAA 1997 is about how something was held and not what was held.

The capital expenditure incurred by the taxpayer as consideration to terminate major operational contracts was not incurred 'to convert your business structure to a different structure'. The taxpayer's business structure is the legal relationship through which the business is carried on for a taxable purpose.

The major operational contracts between the taxpayer and the external service provider did not form part of the taxpayer's business structure that was converted to another structure. They represented the way in which the taxpayer obtained necessary services to carry on its business activities.

Accordingly, the capital expenditure was not incurred to convert the taxpayer's business structure to a different structure for the purpose of paragraph 40-880(1)(b) of the ITAA 1997.