Issue
Is business capital expenditure which is included in the second element of the cost base or reduced cost base of a share in an entity (joining entity) that becomes a subsidiary member of a consolidated group, prevented from being deducted under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997), by paragraph 40-880(5)(f) of the ITAA 1997, where the share's cost base or reduced cost base is included in the allocable cost amount for the joining entity?
Decision
Yes. Where business capital expenditure is included in the second element of the cost base or reduced cost base of a share in a joining entity, and the share's cost base or reduced cost base is included in the allocable cost amount for the joining entity, the expenditure is prevented from being deducted under section 40-880 of the ITAA 1997 by paragraph 40-880(5)(f) of the ITAA 1997.
Facts
On 1 February 2008 Head Co incurred a liability to pay legal and accounting fees of $100,000 in negotiating and drawing up a contract for the acquisition of all of the shares in A Co. The fees are business capital expenditure of Head Co.
On 1 May 2008 Head Co acquired all of the shares in A Co.
Head Co chose to form a consolidated group, effective from 1 July 2008, with Head Co as the head company of the group and A Co a subsidiary member of the group.
At the time of consolidation, the second element of the cost base of the shares in A Co included the $100,000 legal and accounting fees Head Co incurred in negotiating and drawing up the contract for the acquisition of the shares.
The cost base of each of the shares in A Co was included at step 1 in the allocable cost amount calculation for A Co when it joined the group.
Reasons for Decision
Section 40-880 of the ITAA 1997 allows certain business capital expenditure to be deducted in equal proportions over five income years. Paragraph 40-880(5)(f) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that 'it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event'.
In most cases, capital proceeds and cost base (or reduced cost base) are taken into account in working out the amount of a capital gain or capital loss from a CGT event. Therefore, capital expenditure which reduces capital proceeds from a CGT event or forms part of the cost base (or reduced cost base) of a CGT asset could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f) of the ITAA 1997.
Paragraph 40-880(5)(f) of the ITAA 1997 is not prevented from applying to capital expenditure that: • forms part of the cost base or reduced cost base of shares in an entity (joining entity) that becomes a subsidiary member of a consolidated group; and • is included in the entry allocable cost amount for the joining entity because that cost base or reduced cost base is included by step 1 of the allocable cost amount calculation for that entity, under section 705-65 of the ITAA 1997.
It is the inclusion of the capital expenditure in the cost base or reduced cost base of the shares in the joining entity that brings the expenditure within the scope of paragraph 40-880(5)(f) of the ITAA 1997.
Paragraph 40-880(5)(f) of the ITAA 1997 has no regard to whether the capital expenditure is included in calculating a capital gain or capital loss when later a CGT event happens.
The legal and accounting fees are business capital expenditure incurred by Head Co and are included in the second element of the cost base of each of the shares in A Co. The expenditure, therefore, will be something that could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f) of the ITAA 1997.