Deductibility: Purchase price of Cleaning Contract

Is the cost of acquiring a cleaning contract which was subsequently lost, deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The cost of acquiring a cleaning contract is not deductible under section 8-1 of the ITAA 1997. The expenditure is capital in nature and the subsequent loss of the contract does not alter the nature of the payment.

The taxpayer operates a cleaning business as a sole trader. The taxpayer approached a broker through whom the taxpayer acquired a number of cleaning contracts.

The taxpayer was required to make an upfront payment to acquire each contract. The contracts gave the taxpayer the right to clean customer's offices or shops for a pre-determined fee. The contracts were for guaranteed minimum periods of up to two years and if any contract was terminated before the expiry of the guaranteed minimum period, through no fault of the taxpayer, then a replacement contract was to be provided to the taxpayer.

The taxpayer lost one contract and a replacement contract was not provided.

Section 8-1 of the ITAA 1997 allows a deduction for any losses or outgoings to the extent to which 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, no deduction is allowed under section 8-1 of the ITAA 1997 for expenses to the extent that they are of a capital, private or domestic nature.

The judgment of Dixon J in Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337 (the Sun Newspapers Case ) is a leading exposition of the matters that must be examined in order to differentiate whether an amount is capital or revenue in nature.

Accordingly the following indicators, consistent with the matters raised by Dixon J, in the Sun Newspapers Case point towards an expense being capital in nature: 'The expenditure is related to the business structure itself. This includes the establishment, replacement or enlargement of the profit yielding structure of business rather than the money earning process. The nature of the asset has lasting and enduring benefit to the business. The payment is made 'once and for all' being a single final provision for the future use or enjoyment of the asset or advantage rather than on a regular basis, such as weekly, monthly or yearly or for a specific period.'

It must be borne in mind that the statements made by Dixon J are not exhaustive or ultimately definitive of the relevant matters to be considered in each case.

The courts have held, in the absence of special circumstances, that expenditure is capital in nature where it is made with the view to bring into existence an asset or an advantage whether tangible or intangible for enduring benefit of the business: British Insulated & Helsby Cables v. Atherton (1926) AC 205.

The term enduring was referred to by Rich J at page 547 in Herring v. FCT (1946) 72 CLR 543, who stated that 'by enduring it is not meant that the asset or advantage should last forever. It is a matter of degree and only one element to be considered.'

In determining the essential character of the cleaning contract, it is necessary to clarify what the payment actually represents.

Applying the indicators consistent with the Sun Newspapers Case, the following factors indicate that the expenditure incurred by the taxpayer in acquiring cleaning contracts are capital in nature: • The purchase price of each contract is a 'once and for all' payment • The expenditure incurred in respect of payment for cleaning contracts is made with a view to acquiring an income-producing asset that has an enduring benefit for the business • The expenditure relates to enlarging the profit yielding structure of the taxpayer's business. That is, it relates to the structure within which profits from cleaning will be derived.

Accordingly, the cost of purchasing the cleaning contract is not deductible under section 8-1 of the ITAA 1997. The fact that the taxpayer lost the contract does not alter the fact that the cost of acquiring each contract is capital in nature.