Capital allowances: business related costs - in relation to a business proposed to be carried on

Was the taxpayer's capital expenditure incurred 'in relation to a business proposed to be carried on' for the purpose of paragraph 40-880(2)(c) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. All the taxpayer's capital expenditure was incurred 'in relation to a business proposed to be carried on' for the purpose of paragraph 40-880(2)(c) of the ITAA 1997 because that business was the most relevant to the expenditure.

The taxpayer is an Australian resident company that carries on its business solely for a taxable purpose. As part of their growth strategies for the taxpayer, the taxpayer's Board of Directors decided to insert an overseas resident holding company above the taxpayer to hold 100% of the taxpayer's issued shares and seek to have shares in the overseas holding company listed on an overseas stock exchange. This process was colloquially referred to as the overseas 'listing strategy'. The Board considered that the overseas listing strategy would, for example, provide access to a larger pool of equity capital which, ultimately, could be used to acquire assets for the taxpayer and to grow the business of the taxpayer.

The proposed steps to insert the overseas holding company above the taxpayer involved: - incorporating the overseas resident holding company; and - by a proposed Scheme of Arrangement, having all the issued shares in the taxpayer held by the overseas holding company and issuing shares in the overseas holding company to the taxpayer's existing shareholders.

The taxpayer incurred capital expenditure on legal, accounting and independent expert fees on or after 1 July 2005. For this expenditure, the taxpayer was provided with services and advice to assist in progressing and executing the overseas listing strategy. In particular, the services and advice were directed to developing and implementing the steps necessary to insert the overseas holding company above the taxpayer (including the proposed Scheme of Arrangement) and list the company on that overseas stock exchange.

During this process, the taxpayer received an unsolicited takeover bid from an unrelated entity and decided not to proceed with the implementation of the overseas listing strategy. The Scheme of Arrangement and listing prospectus documentation necessary to give effect to that strategy were consequently not completed.

Subject to the limitations and exceptions contained in subsections 40-880(3) to 40-880(9) of the ITAA 1997, subsection 40-880(2) of the ITAA 1997 provides that you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure you incur: (a) in relation to your business; or (b) in relation to a business that used to be carried on; or (c) in relation to a business proposed to be carried on; or (d) to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.

In considering the phrase 'in relation to' contained within subsection 40-880(2) of the ITAA 1997, paragraph 2.25 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 (the EM) states: The provision is concerned with expenditure that has the character of a business expense because it is relevantly related to the business. The concept used to establish this character or requisite relationship between the expenditure incurred by the taxpayer and the business carried on (current, past or prospective) is 'in relation to'. The connector 'in relation to' allows the appropriate latitude to enable the deductibility of qualifying capital expenditure incurred before the business commences or after it has ceased.

The phrase 'in relation to' was considered by the High Court in PMT Partners Pty Ltd (In Liquidation) v. Australian National Parks & Wildlife Service (1995) 184 CLR 301. Brennan CJ, Gaudron and McHugh JJ observed, in considering the application of the Commercial Arbitration Act 1985 (NT), at 313: Inevitably, the closeness of the relation required by the expression 'in or in relation to' in s 48 of the Act, indeed, in any instrument - must be ascertained by reference to the nature and purpose of the provision in question and the context in which it appears.

In that case Toohey and Gummow JJ also observed: It is apparent that the words 'in or in relation to' are particularly wide. ... Cases concerning the interpretation of this phrase in other statutory contexts are of limited assistance. However, the cases do show that the words are prima facie broad and designed to catch things which have sufficient nexus to the subject. The question of sufficiency of nexus is, of course, dependent on the statutory context. (at 330) ... The connection which is required by the phrase 'in relation to' is a question of degree. There must be some "association" which is "relevant" or "appropriate". The question of the relevance or appropriateness of the connection is a question which cannot be divorced from the particular statutory context. (at 331)

In First Provincial Building Society Limited v. Federal Commissioner of Taxation (1995) 56 FCR 320; (1995) 95 ATC 4145; (1995) 30 ATR 207, Hill J considered the phrase 'in relation to' within the context of paragraph 26(g) of the Income Tax Assessment Act 1936 . He considered the words 'in relation to' in that context included a relationship that may either be direct or indirect, provided that the relationship consisted of a real connection, but that a merely remote relationship is insufficient.

It is therefore necessary to consider the legislative context of subsection 40-880(2) of the ITAA 1997 in order to determine whether there is a sufficient and relevant connection between the expenditure incurred and a particular business. In discussing the types of business capital expenditure to which subsection 40-880(2) applies, the EM states at paragraphs 2.19 and 2.20 respectively: Expenditure on the structure by which an entity carries on (or used to or proposes to carry on) their business and on the profit yielding structure of the business would ordinarily be expected to be of a capital nature. Capital expenditure can also relate to a business's trading operations or the entity that will carry on the business. The structure covers the legal entity (such as a company) or the legal relationship (such as a partnership or trust) that is the entity that carries on the business for a taxable purpose and that holds the business assets.

These paragraphs indicate that capital expenditure incurred on the structure by which an entity carries on, or used to or proposes to carry on their business, on the profit yielding structure of the business, or relating to the business's trading operations, are capable of being described as capital expenditure incurred 'in relation to' that business for the purposes of subsection 40-880(2) of the ITAA 1997. Whether such capital expenditure is incurred 'in relation to' the particular business will depend on whether there is a sufficient and relevant connection between the incurring of the expenditure and that business on the facts of the particular case.

The statement in paragraph 2.48 of the EM - '[t]he business to which the expenditure relates is that most relevant to the expenditure' - indicates that when there is such a connection between the incurring of the expenditure and more than one business, the expenditure is treated for the purposes of subsection 40-880(2) of the ITAA 1997 as incurred in relation to the business that is most relevant to the expenditure.

In identifying for the purposes of subsection 40-880(2) of the ITAA 1997 the business that is most relevant to the expenditure, it is necessary to look to the character of the expenditure rather than simply the broad intent of its incurrence. The broad intent in this case was the Board's thinking as to the benefits intended or expected to ultimately flow to the taxpayer that directed their decision towards the object of the listing strategy.

The capital expenditure the taxpayer incurred was legal fees, accounting fees and independent expert's fees. For this expenditure the taxpayer was provided with a variety of services and advice to assist in progressing and executing the overseas listing strategy. In particular, the expenditure was incurred on a variety of services and advice directed to developing and implementing the steps necessary to insert the overseas holding company above the taxpayer (including the proposed Scheme of Arrangement) and list the overseas holding company on the overseas stock exchange. The character of this expenditure is as part of establishing the structure by which the overseas holding company proposed to carry on its holding company business.

In these circumstances, there is a sufficient and relevant connection between the taxpayer's incurrence of the capital expenditure and the business proposed to be carried on by the overseas holding company, and that business is the most relevant to that expenditure. Accordingly, the capital expenditure is incurred in relation to the business proposed to be carried on by the overseas holding company, and therefore paragraph 40-880(2)(c) of the ITAA 1997 applies.