Capital Allowances: business related costs - amount incurred indifferently - most relevant business

If the capital expenditure the taxpayer incurred relates indifferently both to their business pursuant to paragraph 40-880(2)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) and to a business that used to be carried on pursuant to paragraph 40-880(2)(b) of the ITAA 1997, does section 40-880 of the ITAA 1997 apply by reference only to the business that is most relevantly related to the taxpayer's capital expenditure?

Yes. Where the taxpayer's capital expenditure relates indifferently both to their business pursuant to paragraph 40-880(2)(a) of the ITAA 1997 and to a business that used to be carried on pursuant to paragraph 40-880(2)(b) of the ITAA 1997, section 40-880 of the ITAA 1997 applies by reference only to the business that is most relevantly related to the taxpayer's capital expenditure.

The taxpayer, a company, incurred capital expenditure on legal fees to resolve and defend several matters brought against it and its two director/shareholders.

One of the directors/shareholders of the taxpayer (shareholder X) previously carried on a business in partnership (the partnership business) with two other parties. The other director/shareholder (shareholder Y) was an employee of the partnership business. Shareholder X was alleged to have breached the partnership agreement by leaving the partnership business without giving adequate notice. In addition, prior to the termination of the partnership, shareholder X and shareholder Y were alleged to have established a company which carried on a business in direct competition with the partnership business.

The other two partners of the former partnership (the plaintiffs) took legal action against the taxpayer and its directors/shareholders on several matters. One of these matters involved the establishment of the termination date of the former partnership. This date was relevant to determining both: • the date from which the taxpayer was free to carry on its business without claims by the plaintiffs (the legal fees incurred by the taxpayer on this matter constitute expenditure in relation to the taxpayer's business for the purposes of paragraph 40-880(2)(a) of the ITAA 1997), and • the extent of any breach of contract and fiduciary duty by shareholder A (the same legal fees were also incurred by the taxpayer on this matter and constitute expenditure in relation to the business that used to be carried on by the partnership for the purposes of paragraph 40-880(2)(b) of the ITAA 1997).

The establishment of the termination date of the former partnership served to determine both of these issues indifferently.

All legislative references are to the ITAA 1997 unless otherwise stated.

Subject to the limitations and exceptions contained in subsection 40-880(3) to subsection 40-880(9), subsection 40-880(2) 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 the present case, the legal fees were incurred to resolve a single legal matter that relevantly related to both the taxpayer's business and the business that used to be carried on by the partnership. That is, the expenditure is in relation to both the taxpayer's business pursuant to paragraph 40-880(2)(a) and the business that used to be carried on by the partnership pursuant to paragraph 40-880(2)(b). The expenditure therefore satisfies both paragraph 40-880(2)(a) and paragraph 40-880(2)(b).

For the purposes of applying section 40-880, an issue arises as to whether the expenditure should be apportioned as between paragraph 40-880(2)(a) and paragraph 40-880(2)(b) or whether the same expenditure is deductible pursuant to both paragraphs or whether all of the expenditure is deductible pursuant to only one of the paragraphs.

Subsection 40-880(2) is silent on whether expenditure on a single object that indifferently satisfies more than one of its paragraphs can be apportioned as between the relevant paragraphs. As there is no express rule which permits apportionment in these particular circumstances, the better view is that expenditure incurred in these particular circumstances cannot be apportioned.

The same expenditure in this case potentially qualifies for deduction twice under section 40-880 because it satisfies both paragraph 40-880(2)(a) and paragraph 40-880(2)(b). However, section 8-10 prevents a double deduction for the same expenditure. Section 8-10 provides, in effect, that the deduction be allowed under the provision that is most appropriate.

Pursuant to section 8-10, it is necessary to identify the most appropriate paragraph, paragraph 40-880(2)(a) or paragraph 40-880(2)(b).

In identifying the most appropriate paragraph, it is necessary to determine to which business the expenditure is the most relevant. This is supported by paragraph 2.48 of the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 1) Bill 2006 which states 'the business to which the expenditure relates is that most relevant to the expenditure'.

In identifying, for the purposes of subsection 40-880(2), the business that is most relevant to the expenditure, it is necessary to look to the character of the expenditure and what it achieved rather than simply the broad intent of its incurrence.

It is considered that the expenditure on determining the termination date of the former partnership is most relevant to the business that used to be carried on by the partnership because the incurrence of the expenditure was primarily about determining the existence/continuance of the partnership. The result of determining this date was only secondary for the taxpayer's business in the sense that it also established a date from when it was free to carry on its business without the claims from the plaintiffs.

Therefore, the taxpayer's capital expenditure is most relevantly related to the business that used to be carried on by the partnership and that business is taken into account for the purpose of working out any deduction for that expenditure that may be available under section 40-880.