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1 Are the cash payments made to option holders in respect of the cancellation of pre-IPO options (Option Cancellation Payments) deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

1 No. Question 2 Are the Option Cancellation Payments deductible under section 40-880 of the ITAA 1997? Answer 2 Yes. This ruling applies for the following periods : Year ended 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX The scheme commenced on: 1 July 20XX

Initial Public Offering and Options 1.              The Company was an Australian tax resident proprietary company. 2.              The Company sought an Initial Public Offering (IPO) on the Australian Securities Exchange (ASX). 3.              The Company pursued an IPO to, among other reasons, provide a liquid market for its shares and provide securityholders with an opportunity to realise a portion of their investment in the Company. 4.              Prior to the IPO, the Company had various options on issue, including option issued under Employee Share Option Plans and outside such plans. Cancellation of Options 5.              In preparing for the IPO, the Board of the Company determined pursuant to the options terms of the options or by Option Cancellation Agreement, to cancel options on or about the completion of the IPO in return for cash consideration to be provided to optionholders.

6.              This decision reflected the desire of the Company to provide optionholders with a liquidity event on the occurrence of an IPO, to wind up the existing options which were issued when the Company was a private company and to provide a simpler capital structure for the Company on IPO. The Company considered that a simpler capital structure would help attract investors and result in a simpler approval process with the ASX. 7.              The Company cancelled a number of options and made Option Cancellation Payments to its existing optionholders. 8.              Option Cancellation Amounts for each of the optionholders was based upon the difference between the IPO Price, and the Exercise Price, multiplied by the number of options held by each optionholder. 9.              The options on issue had varying vesting schedules and varying exercise prices, but were predominantly issued under similar terms. 10.          For accounting purposes, the Option Cancellation Payments were recognised through adjustments in equity reserve. Other

11.          The Company did not carry on its business (including in part) to derive any exempt income or non-assessable non-exempt income during the relevant period. 12.          As at the relevant time, no known and predictable facts existed which would have altered the taxable purpose of the Company in subsequent years. 13.          It is the Company's understanding that there were not any business plans that would affect the taxable purpose of the Company's business during any relevant time. 14.          The Option Cancellation Payments were incurred exclusively in relation to the IPO. 15.          The Company did not derive any exempt income or non-assessable income during the relevant income years. 16.          The Option Cancellation Payments: a.              do not form part of the cost of a depreciating asset b.              do not form part of the cost base or reduced cost base of any CGT or depreciating asset c.              cannot be included in the cost base of any CGT asset, or in working out the amount of a capital gain or loss from a CGT event d.              did not form part of the cost of land

e.              do not constitute expenditure incurred in relation to a lease or other legal or equitable right f.               are not amounts which can otherwise be taken into account in working out a profit or loss for the Company. 17.          There is no other provision of the Act (i.e. ITAA 1997 or the Income Tax Assessment Act 1936 (ITAA 1936)) under which deductions for the Option Cancellation Payments are available to the Company. 18.          There is no provision of the ITAA 1997 or ITAA 1936 which would expressly make the Option Cancellation Payments non-deductible if not of a capital nature. 19.          There was no consideration received in respect of the original issuance of options to optionholders to which the Option Cancellation Payments relate.

Income Tax Assessment Act 1997 section 8-1 Income Tax Assessment Act 1997 section 40-880 Does IVA apply to this private ruling? Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement. If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax. We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to ru

Issue 1 Question 1 Are the Option Cancellation Payments deductible under section 8-1 of the ITAA 1997? Summary The Option Cancellation Payments do not satisfy either positive limb of section 8-1 of the ITAA 1997 as they were neither incurred in gaining or producing assessable income, nor were they necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Further, the Option Cancellation Payments were a loss or outgoing of capital, or of a capital nature, satisfying the negative limb in paragraph 8-1(2)(a) of the ITAA 1997. As such, the Option Cancellation Payments are not deductible under section 8-1 of the ITAA 1997. Detailed reasoning Section 8-1 Section 8-1 of the ITAA 1997 is the general deductibility provision that allows taxpayers to deduct losses or outgoings they incur as part of their income producing activities.

Subsection 8-1(1) of the ITAA 1997 allows a deduction for a loss or outgoing of a taxpayer to the extent it is incurred in the course of gaining or producing assessable income or it is necessarily incurred in carrying on a business for that purpose. Even where an outgoing satisfies the requirements of subsection 8-1(1), it will not be deductible if it is capital or of a capital nature under subsection 8-1(2). Positive limbs of section 8-1 Section 8-1 of the ITAA 1997 requires an examination of the connection between the expense and the process of derivation of income: •                The first positive limb, paragraph 8-1(1)(a), directs attention to whether the expenditure was 'incurred in' gaining or producing assessable income. •                The second positive limb, paragraph 8-1(1)(b), directs attention to whether the expenditure was 'necessarily incurred in' carrying on a business for the purpose of gaining or producing assessable income. Under both limbs, the expenditure must have some relevant connection to producing assessable income. Additionally, the expenditure must also be incurred "in" either (see Clough Ltd v Federal Commissioner of Taxation [2021] FCAFC 197 (

Clough )): (a) gaining or producing assessable income, or (b) carrying on a business for the purpose of gaining or producing assessable income. Paragraph 8-1(1)(a): the first positive limb For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. It is both sufficient and necessary that the occasion of the loss or outgoing be found in whatever is productive of the assessable income or, if none produced, would be expected to produce assessable income ( Ronpibon Tin NL v Commissioner of Taxation (Cth) [1949] HCA 15 ( Ronpibon Tin )). To identify or find the occasion of the loss or outgoing, it is necessary to examine all relevant circumstances giving rise to the outgoing. It will be relevant to ask what the outgoing was incurred to effect from a practical or business point of view ( Clough, at [50]).

The "occasion of the loss or outgoing" is not necessarily temporally restricted to the immediate causes for the payment, albeit contemporaneous events will be directly relevant and of significant, and on occasion decisive, weight. Questions of causation (including for example whether a payment would have been made were it not for the existence of a particular circumstance) and purpose are relevant, but the ultimate object is one of characterisation having regard to all of the relevant circumstances ( Clough , at [51]). However, as the High Court has observed, the word "purpose" is not employed in paragraph 8-1(1)(a) of the ITAA 1997 ( Clough, at [51]). Paragraph 8-1(1)(b): the second positive limb

To satisfy the second positive limb, a nexus must exist between the outgoing and a business carried on for the purpose of gaining or producing assessable income. Two things must be established: firstly, the expense was necessarily incurred in carrying on a business; and secondly, that the carrying on of the business was for the purposes of gaining or producing assessable income. The outlay must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations ( John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1959) 101 CLR 30). An outgoing will be "necessarily incurred in carrying on a business" if it is clearly appropriate or adapted for the carrying on of the business or, in other words, reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business. If the expense meets this definition, it will not be denied deductibility if it was not strictly necessary ( Ronpibon Tin ; Clough at [56]-[62]).

To understand whether the expense is appropriate and adapted involves an examination of the business operations carried on over time and the whole course of events relevant to the particular expenditure ( Clough at [59]. Application of the positive limbs Prior to the IPO, the Company had various options on issue. In preparing for the IPO, the Board determined to cancel the options on or about the completion of the IPO. The reasons for this decision were to provide a provide a liquid market for its shares and provide securityholders with an opportunity to realise a portion of their investment in the Company and to provide a simpler capital structure for IPO. The IPO was the proximate causal event requiring that the payments be made, that is, the payments would not have been made, but for the IPO. The Option Cancellation Payments were made to cancel entitlements and were not made as payment for some form of performance recognition. As a matter of legal form and practical reality, the Option Cancellation Payments were made to bring the Company's obligations to its optionholders to an end.

Therefore, the payments were not incurred by the Company in gaining or producing assessable income within the meaning of paragraph 8-1(1)(a) of the ITAA 1997 on the basis that the occasion of them lay in the IPO and not in gaining or producing assessable income. The Option Cancellation Payments were not in the nature of a working expense in the carrying on of the Company's business. Rather, the incurrence of the expense resulted in order for the Company to achieve its IPO. The payments were therefore not necessarily incurred in carrying on a business for the purpose of gaining or producing the Company's assessable income within the meaning of paragraph 8-1(1)(b) of the ITAA 1997. Paragraph 8-1(2)(a) - the first negative limb Even if the Option Cancellation Payments satisfy the nexus required by one of the positive limbs, they will still not be deductible to the extent they are "a loss or outgoing of capital, or of a capital nature" within the meaning of paragraph 8-1(2)(a) of the ITAA 1997.

The meaning of 'capital, or of a capital nature' is not defined for the purposes of the ITAA 1997 and as such, draws its meaning from the ordinary meaning of the concept which is considered in an extensive body of case law. Under case law, the distinction between expenditure of a revenue or capital nature turns on what the expenditure is intended to effect from a practical and business point of view, rather than what legal rights are created or exhausted in the process ( Commissioner of Taxation v Sharpcan Pty Ltd [2019] HCA 36 (Sharpcan); Hallstroms Pty Ltd v FCT [1946] HCA 34). This test essentially asks what the expenditure was designed to produce, as distinct from what it actually produced. In Sun Newspapers Ltd & Anor v. Federal Commissioner of Taxation (1938)[1938] HCA 73( Sun Newspapers ) Dixon J formulated the 'classic test' for determining whether expenditure is of a capital or revenue nature at [363]:

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 payment or by making a final provision or payment so as to secure future use or enjoyment. The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid ( GP International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) [1990] HCA 25; Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35).

When an outgoing is made, not only once and for all, but with a view to bringing into existence an asset or an advantage of an enduring benefit, it is more likely to be considered as capital in nature ( British Insulated and Helsby Cables v. Atherton [1926] AC 205; AusNet Transmission Group Pty Ltd v Federal Commissioner of Taxation (2015) 255 CLR 439). When the words 'permanent' or 'enduring' are used it is not meant that the advantage which will be obtained will last forever. The distinction which is drawn is that between recurrent expenses involved in running a business and an expenditure for the benefit of the business as a whole ( Sun Newspapers Ltd ). Further, in Sharpcan , the High Court stated at 18:

Authority is clear that the test of whether an outgoing is incurred on revenue account or capital account primarily depends on what the outgoing is calculated to effect from a practical and business point of view. Identification of the advantage sought to be obtained ordinarily involves consideration of the manner in which it is to be used and whether the means of acquisition is a once-and-for-all outgoing for the acquisition of something of enduring advantage or a periodical outlay to cover the use and enjoyment of something for periods commensurate with those payments. Once identified, the advantage sought is to be characterised by reference to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; and between an enterprise itself and the sustained effort of those engaged in it. Thus, an indicator that an outgoing is incurred on capital account is that what it secures is necessary for the structure of the business .

The immediate advantage which the Company sought by making the Option Cancellation Payments was to bring the various options to an end permanently. The object of making the payments was to allow the Company to provide a liquidity event to optionholders prior to the IPO, and to achieve a more simplified capital structure on IPO. While multiple payments were made to the various optionholders, the payments were, from the Company's perspective, made at once to secure the one enduring change, namely that the Company would permanently modify its capital structure to allow it to undertake the IPO effectively. The amounts of the payments were calculated by reference to the share price, not by reference to time served by particular employees or by reference to performance criteria achieved. Payment of the amounts was conditional on the IPO occurring. The payments were unusual and not in the nature of an ordinary working expense. The payments were predominantly connected with facilitating a change in the underlying shareholding of the company and the bringing of the options to an end had an effect on the capital structure of the Company by removal of the options as securities on issue.

The above factors give a clear indication that the Option Cancellation Payments were on capital account and therefore, the Option Cancellation Payments were a loss or outgoing of capital, or of a capital nature, satisfying the negative limb in paragraph 8-1(2)(a). As such, the Option Cancellation Payments are not deductible under section 8-1 of the ITAA 1997. Question 2 Are the Option Cancellation Payments deductible under section 40-880 of the ITAA 1997? Summary The Option Cancellation Payments are business-related capital expenditure deductible over a period of 5 income years starting in the year in which the expenditure is incurred. Detailed reasoning Section 40-880 Section 40-880 of the ITAA 1997 operates to make certain business capital expenditure deductible over 5 years in circumstances where: •                the expenditure is not otherwise taken into account; and •                a deduction is not denied by some other provision; •                and the business is, was or is proposed to be carried on for a taxable purpose. Taxation Ruling TR 2011/6 - Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues

sets out the Commissioner's views on the interpretation of the operation and scope of section 40-880. As outlined in paragraphs 23 and 197 of TR 2011/6, determining the amount allowable as a deduction under section 40-880 of the ITAA 1997is a multi-step process. The first step is to determine initial entitlement under subsection 40-880(2). Once entitlement is established, the limitations in subsections 40-880(3) and 40-880(4) and the exceptions in subsection 40-880(5)-(9) must be considered. In Sharpcan , the High Court noted that [footnotes omitted]: Further, s 40-880 is a provision of last resort. It targets "blackhole expenditure", namely business expenses incurred by taxpayers that fall outside the scope of deduction provisions of income tax law. Thus, as s 40-880(1) provides, a **399 deduction under s 40-880 is "only allowed to the extent that the expenditure is not taken into account in some way elsewhere in the income tax law".

The core operative provision within section 40-880 of the ITAA 1997 is subsection 40-880(2) (relevantly in this case, paragraph (a)), which states that you can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur in relation to your business. Broadly, for a deduction to arise for the Company under section 40-880 of the ITAA 1997, for the full amount of the Option Cancellation Payments: •                The expenditure must be capital expenditure (subsection 40-880(2)) •                the expenditure must be incurred in relation to the Company's business (subsection 40-880(2)) •                the expenditure must relate to a business carried on for a taxable purpose and (subsection 40-880(3)-(4)), and •                the carve out provisions must not apply (subsections 40-880(5)-(9)). The expenditure must be capital expenditure (subsection 40-880(2)) 'Capital expenditure' is not a defined term in the ITAA 1997 or the ITAA 1936. The Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 at paragraph 2.19 discusses subsection 40-880(2) and states:

The provision only applies to business capital expenditure...This includes expenditure that fails the general deduction provision of section 8-1 by reason only of being capital or of a capital nature. For the reasons outlined above in Question 1, the Option Cancellation Payments are capital expenditure. Therefore, this first element of subsection 40-880(2) of the ITAA 1997 is satisfied. The expenditure must be incurred in relation to the Company's business (subsection 40-880(2)) As noted in paragraph 10 of TR 2011/6, section 40-880 only applies to business related capital expenditure which is incurred on or after 1 July 2005. Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out principles developed by case law to help determine whether and when expenditure has been incurred. These principles are reproduced in paragraph 63 of TR 2011/6 and are equally applicable in determining if an amount has been incurred for the purposes of section 40-880 of the ITAA 1997.

The Commissioner accepts, based on the principles outlined in paragraph 63 of TR 2011/6, that the Company incurred the Option Cancellation Payments during the income year ended 30 June 2021. As noted above, the expenditure must be incurred in relation to the Company's business. TR 2011/6 provides the following regarding the phrase 'in relation to': 15. The expression 'in relation to' denotes the proximity required between the expenditure on the one hand and the former, current or proposed business on the other. For capital expenditure to be 'in relation to' a business, there must be a sufficient and relevant connection between the expenditure and the business. 16. The closeness of the association or connection must objectively support the conclusion that the capital expenditure is a business expense of the particular business. 17. Whether capital expenditure is truly business expenditure is determined by the facts. If the facts show that the expenditure satisfies the ends of the relevant business, it will have the character of business expenditure. Further, at paragraphs 82-84, TR 2011/6 provides:

82. In many cases, the description of what the expenditure is for will be enough to demonstrate the relationship with the former, proposed or existing business. The connection will be readily evident. For example, capital expenditure incurred to establish the structure (that is, the entity) that is to carry on a proposed business has a clear connection with that proposed business. Likewise, expenditure on converting an existing business structure to a different structure which is to carry on that business in future, for example, from a sole trader or partnership to a company, demonstrates a relevant connection with the existing business being carried on (as well as with the carrying on of that business in the future).

83. There is an immediate connection between expenditure of this type and the relevant business because establishing the structure by which the business will be owned and operated is an essential prerequisite to the conduct of the business itself. The occasion of the outgoing can only be explained by reference to the business. Of course, expenditure to establish a structure, such as a company, will only be deductible under section 40-880 if there is in fact a business that is proposed to be carried on in that structure. If there is no proposal to carry on a particular business within a reasonable time then it follows that the requisite relationship between the expenditure and a business cannot be satisfied. 84. In contrast, expenditure relating to the ownership of the entity carrying on the business is not business related capital expenditure unless it can be demonstrated that the change of ownership serves an objective of the business. Example 8 of TR 2011/6 is relevant in this context. The Company carried on the same business both before and after the IPO, albeit with a different business structure. This is the relevant business which must be identified.

The Company pursued an IPO to among other reasons, provide a liquid market for its shares and provide securityholders with an opportunity to realise a portion of their investment in the Company. The Option Cancellation Payments facilitated the IPO by simplifying the Company's capital structure. The Option Cancellation Payments rendered a significant enduring benefit to the Company relating to its change in capital structure. The Company's circumstances, and the relationship between the Option Cancellation Payments and the Company's business are similar to those outlined in Example 8 of TR 2011/6 in that the ownership of the company was restructured to provide an enduring benefit to the business and to meet business objectives. While the Option Cancellation Payments are not considered to be a cost incurred by the Company 'in carrying on' a business for the purpose of gaining or producing assessable income, it is considered that the Option Cancellation Payments were nevertheless made 'in relation to' its business and therefore a business-related expense.

The Commissioner is therefore satisfied that the Option Cancellation Payments were made in relation to the Company's business, satisfying the second element to establish initial entitlement. Taxable purpose - subsection 40-880(3)-(4) Subsection 40-880(3) of the ITAA 1997 contains a 'taxable purpose test' and states that expenditure to which subsection 40-880(2) applies can only be deducted to the extent that the business is carried on for a taxable purpose. The 'taxable purpose test' is also present in subsection 40-880(4) of the ITAA 1997 which limits the deductibility of expenditure for a business that another entity used to carry on or proposes to carry on. Subsection 40-880(4) is not relevant for the current purposes and will therefore not be considered further. Subsection 995-1(1) of the ITAA 1997 notes that the term 'taxable purpose' has the meaning given by section 40-25 of the ITAA 1997. Paragraph 40-25(7)(a) of the ITAA 1997 defines a 'taxable purpose' to include the purpose of producing assessable income. The term 'purpose of producing assessable income' is defined at subsection 995-1(1) of the ITAA 1997 as being something done:

(a) for the purpose of gaining assessable income; or (b) in carrying on a *business for the purpose of gaining or producing assessable income. Assessable income means ordinary income and statutory income that is not exempt income or non-assessable non-exempt income. Paragraphs 26 and 27 of TR 2011/6 outlines what is meant by the phrase 'to the extent' for the purpose of determining whether there should be an apportionment of the capital expenditure incurred and states: 26. Subsections 40-880(3) and 40-880(4) both contain a 'taxable purpose test' which applies to the expenditure identified in subsection 40-880(2) by reference to the extent to which it related to carrying on the business for a taxable purpose. In other words, the expenditure identified in subsection 40-880(2) is deductible only to the extent that it relates to so much of the business that is, was or will be, carried on for a taxable purpose.

27. If the expenditure relates to the whole of the business but part of the business is carried on to derive exempt income or non-assessable non-exempt income then to that extent the expenditure will not be deductible. If the expenditure relates to that part of the business carried on to derive assessable income, however, the whole of the expenditure will be deductible. On the other hand, if the business is carried on to derive exempt income or non-assessable non-exempt income only then none of the expenditure is deductible under subsection 40-880(2). Appendix 1 to TR 2011/6, although not binding, provides further commentary that is useful in understanding how the Commissioner's view has been reached. In respect of the 'taxable purpose test' paragraphs 157 and 159 of TR 2011/6 states: 157. The taxable purpose of the business is tested as at the time the expenditure is incurred. Where expenditure is incurred for an existing or proposed business, the test takes into account all known and predictable facts about the taxable purpose of the business in future years - not just in the year the expenditure is incurred or the years for which a deduction under section 40-880 is sought. ...

159. If, at the time the taxpayer incurs the expenditure, the business in relation to which the expenditure is incurred is carried on wholly for a taxable purpose and there are no proposals or plans for activities from which exempt income or non-assessable non-exempt income could be derived, then no apportionment will be required under subsection 40-880(3) or paragraph 40-880(4)(a). The Company did not carry on its business (in whole or in part) to derive any exempt income or non-assessable non-exempt income during relevant time (reflected in the fact the Company did not derive any exempt income or non-assessable non-exempt income during the relevant period). The Company has confirmed that there were no proposals, plans or activities from which exempt income or non-exempt income could be derived. As at year ended 30 June 2021, no known and predictable facts existed which would have altered the taxable purpose of the Company. As such, the Company's business was carried on wholly for a taxable purpose and no apportionment is required under section 40-880(3). Carve out provisions do not apply - subsections 40-880(5)-(9 )

Subsections 40-880(5) to (9) provide a list of exceptions under which an amount will not be deductible under section 40-880. On the facts of this case, subsections 40-880(5) to (9) of the ITAA 1997do not apply to limit or exclude deductibility of the Option Cancellation Payments incurred by the Company under section 40-880. Conclusion As the requirements of section 40-880 of the ITAA 1997 are met, and none of the carve out provisions apply, the Option Cancellation Payments will be deductible under section 40-880.