1 Will Company A obtain an income tax deduction pursuant to section 8-1 of the Income Tax Assessment Act 1997 for payments made by the Group to Company B under clause XX of the Deed and the Annual Leave Component of the Employee Entitlements?
1 Yes Question 2 Will Company A obtain an income tax deduction pursuant to section 40-880 of the Income Tax Assessment Act 1997 for the payment made by the Group to Company B for the Remaining Employee Entitlements Component under clause YY the Deed? Answer 2 Yes This ruling applies for the following periods : Year ending 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX Year ended 30 June 20XX
1. The Group is a provider of services in Australia. 2. Company A is the parent company of the Group, comprising Company A and its controlled entities. It is also the head company of the income tax consolidated group (the Group ). 3. Company C, a wholly owned subsidiary of Company A and member of the Group, is undertaking a programme to outsource certain service and administration functions (Outsource Programme). 4. Company B is a business process outsource provider specialising in providing business process outsource services. 5. As part of the Outsource Programme, Company C and Company B entered into agreements (including the Deed), which cover: (a) the provision of business process outsource services from Company B to Company C; (b) the provision of certain transitional support services from Company C to Company B and (c) the transfer of certain contracts, information, employees and contingent personnel (and contractors) from Company C and Company D to Company B for the purpose of outsourcing certain activities to Company B. 6. The objectives of the Outsource Programme, include to:
(a) reduce ongoing operating costs and risk; (b) automate processes; (c) deliver reduced costs for the Group over time with reduced fees from Company B; and (d) initially maintain, and then enhance over time, the customer service and performance of the outsourced operations. 7. The transfer of resources to Company B via the Deed is intended to facilitate Company B's performance of the business process outsourcing services under the Outsource Programme. 8. Under the Deed, Company B must make an offer of employment to certain individuals employed by Company C or Company D specified in the Deed on substantially the same terms as their existing employment, subject to the completion of the transfer taking place under the Deed, and the employee continuing to be an employee of Company C or Company D until completion. Where an employee accepts an offer ( Transferring Employee ), then on completion under the Deed the Transferring Employee's employment with Company C or Company D will be taken to have ended, and Company C must release, and procure that Company D releases the Transferring Employee from their employment with Company C or Company D.
9. Upon completion of the Deed, Company C or Company D are required to pay all amounts to the Transferring Employees that they would be entitled to by virtue of their employment with Company C or Company D before completion, other than accrued entitlements to annual leave, long service leave and personal / carer's leave accrued as at completion (which includes such entitlements accrued with any previous employers of the respective Transferring Employees where those previous entitlements have been treated as continuous service (and accrued as such) by Company C or Company D). These other amounts are referred to as Employee Entitlements and are treated differently.
10. In relation to the Employee Entitlements, no amount will be paid by Company C or Company D to the Transferring Employees in relation to these amounts and instead Company B will assume the liability for these payments on and from completion on a continuing basis. That is, the Transferring Employees will continue to accrue annual leave and long service leave with Company B recognising their prior continuous service with the Group and any previous employers of the respective Transferring Employees where those previous entitlements have been treated as continuous service (and accrued as such) by Company C or Company D. On and from completion, when the Transferring Employees: (a) cease to be an employee, Company B will pay them an amount equal to any accrued but untaken long service leave (to the extent that they are entitled under applicable long service leave legislation) and accrued but untaken annual leave entitlements; (b) take annual leave or long service leave, Company B will pay they their annual leave or long service leave entitlement in respect of the leave taken.
11. The leave entitlements are governed by provisions of the Fair Work Act 2009 (Cth) (FWA) (in respect of annual leave) and various State-based acts (in respect of long service leave), which invariably require the period of service of an employee with one employer to be recognised when such employee is transferred to a second employer in certain circumstances. These various provisions are summarised below. 12. In recognition of Company B assuming the liability to pay the Employee Entitlements of the Transferring Employees, the Deed requires Company C to pay to Company B an amount regarding Employee Entitlements: 13. For the purposes of this Ruling the Employee Entitlements are broken down into the Annual Leave Component of the Employee Entitlements and the Remaining Employee Entitlements Component of the Employee Entitlements. 14. The Annual Leave Component of the Employee Entitlements refers to that part of any payment that is equal to the amount that would have been paid to the Transferring Employees for their accrued annual leave if their employment had been terminated at the date of Completion and not transferred to Company B.
15. The Remaining Employee Entitlements Component of the Employee Entitlements refers to all other amounts payable other than the Annual Leave Component of the Employee Entitlements. 16. Company C is not required to pay any amount to Company B or otherwise compensate Company B for any liabilities related to the Transferring Employees for any sick, personal or carer's leave. 17. Under the Deed, with effect from completion, Company B must pay to or in respect of each Transferring Employee as and when they fall due: (a) all amounts to which the Transferring Employee is entitled by virtue of their employment with Company B after completion (including remuneration, allowances, superannuation contributions, commissions and performance bonus payments and all annual leave, long service leave and personal/carer's leave); and (b) the Employee Entitlements of that Transferring Employee.
18. Under the Deed, Company C must pay to Company B an amount of redundancy costs where that Transferring Employee is made redundant by Company B during the XX year period from the date of completion (taking into account any extensions granted), provided that a number of conditions are met. Employment terms 19. The Transferring Employees are covered by the Enterprise Agreement 20XX ( EA ), which was approved pursuant to the FWA. Annual leave and personal leave entitlements 20. The FWA governs each of Company C, Company D and Company B as employers of the Transferring Employees at the relevant time. 21. The Transferring Employees' annual leave entitlements are as follows: (a) for each year of service with an employer an employee is entitled to four weeks of annual leave (subsection 87(1) of the FWA, clause XXX of the EA); and (b) an employee's entitlement to paid annual leave accrues progressively during a year of service according to the employee's ordinary hours of work, and accumulates from year to year (subsection 87(2) of the FWA).
22. For the purpose of calculating an employee's leave entitlements, subsection 22(5) of the FWA applies to the Transferring Employees to require that any period of service of the employee with the first employer (i.e. Company C or Company D as relevant) counts as service of the employee with the second employer (i.e. Company B) and the period between the termination of the employment with the first employer and the start of the employment with the second employer does not break the employee's continuous service with the second employer, but does not count towards the length of the employee's continuous service with the second employer. 23. However, section 91(1) of the FWA states: Subsection 22(5) does not apply (for the purpose of this Division) to a transfer of employment between non - associated entities in relation to an employee, if the second employer decides not to recognise the employee's service with the first employer (for the purpose of this Division).
That is, an employer may decide not to recognise the employee's service with the first employer for untaken paid annual leave purposes. If an employer were to make such decision, the "first employer" (here, Company C or Company D as relevant) would be liable to pay the relevant employee their accrued annual leave under section 90(2) of the FWA. 24. As Company B did not make such decision per section 91(1), section 90(2) does not apply to Company C or Company D and instead, section 22(5) of the FWA applies to require Company B to recognise the service of the Transferring Employees with their prior employer for the purpose of calculating their annual leave entitlements. 25. Subsection 22(5) applies because there will be a "transfer of employment" as defined in subsection 22(7) of the FWA, which states: " (7) There is a transfer of employment of a national system employee from one national system employer (the first employer) to another national system employer (the second employer) if: (a) the following conditions are satisfied:
(i) the employee becomes employed by the second employer not more than 3 months after the termination of the employee's employment with the first employer; (ii) the first employer and the second employer are associated entities when the employee becomes employed by the second employer; or (b) the following conditions are satisfied: (i) the employee is a transferring employee in relation to a transfer of business from the first employer to the second employer; (ii) the first employer and the second employer are not associated entities when the employee becomes employed by the second employer. Note: Paragraph (a) applies whether or not there is a transfer of business from the first employer to the second employer. " 26. A "transfer of business" occurs under section 311 of the FWA if the following requirements are satisfied: (a) the employment of an employee of the old employer has terminated; (b) within 3 months after the termination, the employee becomes employed by the new employer; (c) the work (the "transferring work") the employee performs for the new employer is the same, or substantially the same, as the work the employee performed for the old employer; and
(d) there is a connection between the old employer and the new employer as described in any of subsection 311(3) to 311(6) of the FWA. 27. Relevantly, under subsection 311(4), there is a connection between the old employer and the new employer if the transferring work is performed by one or more Transferring Employees, as employees of the new employer, because the old employer, or an associated entity of the old employer, has outsourced the transferring work to the new employer an associated entity of the new employer. 28. In the present case, paragraph (b) of subsection 22(7) of the FWA should be satisfied, as the Transferring Employees are being transferred as part of an outsourcing project, and their roles and responsibilities are not changed as a result of their change in employer.
29. The Transferring Employees will satisfy the definition of a "national system employee" as employees of a "national system employer" which is defined in section 14 of the FWA as a "constitutional corporation" so far as it employs, or usually employs, an individual. Each of Company C and Company D and Company B are "constitutional corporations" as defined in paragraph 51(xx) of the Constitution, being trading or financial corporations formed within the limits of the Commonwealth. 30. This means that Company B is required by law to take into account the service of a Transferring Employee with Company C or Company D, as relevant, when calculating that employee's annual leave entitlements for each year that employee is employed with Company B. Long service leave entitlements 31. The Transferring Employees are located in Australia. The Transferring Employees' long service leave entitlements are governed by state based law, collectively being the Long Service Leave Laws .
32. Long Service Leave Laws contain provisions that require a new employer to take into account the service of an employee with an old employer for the purpose of calculating the long service leave entitlements of that employee. 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 rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. For more information on Part IVA, go to our website ato.gov.au/gaar .
Legislative references in the following are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997), unless otherwise indicated. The consolidation provisions in Part 3-90 allow certain groups of entities to be treated as a single entity for income tax purposes. Under the single entity rule (SER) in section 701-1 the subsidiary members of an income tax consolidated group are taken to be parts of the head company. As a consequence, the subsidiary members cease to be recognised as separate entities during the period that they are members of the income tax consolidated group with the head company of the group being the only entity recognised for income tax purposes. The meaning and application of the SER is explained in Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997 . As a consequence of the SER, the actions and transactions of the members of the Company A income tax consolidated group are treated, for income tax purposes, as having been undertaken by Company A as the head company of the tax consolidated group.
This means that references to Company A in the reasoning below are effectively regarding the Company A income tax consolidated group. Question 1 Summary The Annual Leave Component of the Employee Entitlements payment is deductible under section 8-1 as a payment to extinguish the accrued annual leave liability that is not disallowed under section 26-10. The payments to be made under clause XX of the Deed are deductible under section 8-1 as an ongoing payment for gains in efficiency. Detailed reasoning Company A can deduct a loss or outgoing under section 8-1 if it satisfies either of the following positive limbs in subsection 8-1(1) of the ITAA 1997: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income. However, it will not be deductible if it is capital, private or domestic in nature, or is incurred in relation to exempt or non-assessable non-exempt income in accordance with subsection 8-1(2) of the ITAA 1997.
The following considers the payments made for the Annual Leave Component of the Employee Entitlements and those made under clause XX separately. Annual Leave Component of the Employee Entitlements Generally, a payment of annual leave to an employee will meet the requirements of 8-1 where the employee was employed in a business carried on for the purpose of gaining or producing assessable income, as the payment arose because of the employment of the employees in the business, and is therefore relevant to that purpose and of a revenue character (see Justice Gibbs comments in FCT v Foxwood(Tolga) Pty Ltd 81 ATC 4261;(1981) 81 ATC 4261 case (Foxwood) at page 4263:
"There can be no doubt that a payment by a taxpayer to an employee of an amount due in respect of long service leave or holiday pay will fall within both categories of sec. 51(1), provided of course that the employee is employed in a business of the taxpayer which is carried on for the purpose of gaining or producing assessable income. The obligation to make such a payment will have arisen by reason of the employment of the employees in the business and a payment in fulfilment of the obligation will plainly be made in the course of gaining or producing the assessable income, and will be incidental and relevant to that end, and will be of a revenue character. Such a payment will be deductible in the year in which it is made.") The Commissioner accepts that the accrued annual leave was accumulated for the employee's providing administration services to Company A in the course of gaining or producing its assessable income. However, as the payment was not made to the employee but to Company B further consideration is required.
The case considered payments purported to be for accrued leave made to an entity other than the employee. Specifically, they were made under a contract of sale of a business and were calculated as the accrued holiday leave, accrued long service leave and sick leave of transferring employees that would have been paid if the employees had been terminated. It found that the payment made by the seller to the buyer for accrued holiday leave of employees was deductible under section 51(1) of the ITAA 1936 (section 8-1 equivalent that applied at that time) and maintained the same character as if the payment had been made to employees. It distinguished these payments from the long service and sick leave amounts which would not be deductible and were incidental and relevant to the sale of the business. The difference was that there was no legal liability (except for the sale agreement) for the seller to pay amounts for accrued long service leave and sick leave and these amounts would therefore not be deductible. The payments for long service leave and sick leave were not to discharge an obligation, but instead were incidental and relevant to the sale of business and therefore capital in nature. Specifically Justice Gibbs at Foxwood pages 4264-4265 stated:
"...the payment [regarding annual leave] discharged the obligation of the taxpayer to the employees. It would be too narrow a view to hold that the object of the payment was to enable the purchaser to pay the employees; the object, revealed by cl. 25 of the contract, was to discharge the obligation of the taxpayer to the employees by paying the requisite amount to the purchaser and obliging him to pay the employees. The payment therefore had the same character as a payment made directly to the employees would have had. ....
The position with regard to the payment of the amount said to be in respect of long service leave is however different. The effect of the contract for the sale of the business, and the transfer of the services of the employees to the purchaser, was that the taxpayer was not liable, and never could become liable, to pay anything to his former employees in respect of long service leave. It is impossible to say that the object of the payment of $2,913 was to discharge a liability which did not and never could exist. By this part of the payment the taxpayer made a contribution to assist the purchaser of the business to discharge obligations which would be expected to bind the purchaser in the future. It was not an unreasonable provision to make in a contract for the sale of the business. A payment of that kind was not incidental or relevant to the gaining or producing of the taxpayer's income or clearly appropriate to or adapted for that purpose; it was incidental and relevant to the sale of the business. The amount of $2,913 paid in respect of long service leave is therefore not deductible within sec. 51(1)."
For the current situation, where the new employer is not a related entity (Company B and Company A are not related) the new employer has a choice to recognise the employees accrued annual leave. If this choice is not made then Company A has the legal liability to pay its employees their accrued annual leave directly when they end their employment with Company A even though their employment is transferred to Company B. The Deed shows that as part of the commercial transaction to outsource functions to Company B, Company B has made the choice to recognise the employees accrued annual leave and that Company A will pay (amongst other things) the Annual Leave Component of the Employee Entitlements to Company B. This is a liability of Company A that is being discharged via payment to Company B (rather than payment to the employees themselves) - a liability that has crystalised but that, due to the arrangement with Company B, Company B has agreed to takeover the annual leave liability and is compensated for doing so. On that basis, it is a discharge of Company A's liability and therefore has the same character as accrued annual leave and is deductible under 8-1.
Additionally, we need to consider whether section 26-10 will deny the deduction under section 8-1. Broadly, this section will disallow a deduction for the annual leave amount that is paid to an entity other than the employee unless it is an accrued leave transfer payment. Specifically, 26-10(1) states: You cannot deduct under this Act a loss or outgoing for long service leave, annual leave, sick leave or other leave except: (a) an amount paid in the income year to the individual to whom the leave relates (or, if that individual has died, to that individual's dependant or legal personal representative); or (b) an accrued leave transfer payment that is made in the income year. The term 'accrued leave transfer payment' is defined in subsection 26-10(2) as: An accrued leave transfer payment is a payment that an entity makes: (a) in respect of an individual's leave (some or all of which accrued while the entity was required to make payments in respect of the individual's leave, or leave the individual might take); and (b) when the entity is no longer required (or is about to stop being required) to make payments in respect of such leave; and
(c) to another entity when the other entity has begun (or is about to begin) to be required to make payments in respect of such leave; and (d) under (or for the purposes of facilitating the provisions of) an Australian law, or an award, order, determination or industrial agreement under an Australian law. The first three requirements to be an accrued leave transfer payment are clearly satisfied as: • the payment was made by an entity, Company A, in respect of leave that had accrued to its employees, satisfying paragraph 26-10(2)(a), • the Company A Group was no longer required to make payments in respect of that leave on the basis these employees were transferred to and subsequently employed by Company B and Company B agreed to take over this liability, satisfying paragraph 26-10(2)(b), and • the payment was made by the Company A to Company B, who had begun or was about to begin being required to make payments in respect of this leave for each respective employee, satisfying paragraph 26-10(2)(c).
The last requirement in paragraph 26-10(2)(d) requires the payment made by Company A to have been made under - or for the purposes of facilitating the provisions of - an Australian law, or an award, order, determination or industrial agreement under an Australian law. Subsection 995-1(1) defines 'Australian law' to mean a Commonwealth law, a State law or a Territory law. The Deed establishes that Company A will pay Company B an Annual Leave Component of Employee Entitlements and that Company B will take over the annual leave accrued by the transferred employees during employment in the Company A Group. The FWA allows for a new unrelated employer - Company B to choose not to recognise this accrued annual leave and, if they make this choice, then Company A Group would then be responsible for paying the accrued annual leave to employees directly. The Deed therefore provides a direct nexus linking the payment to Company B with the relevant awards and Australian law governing the relevant leave arrangements.
Therefore, the payment can be said to be made 'under' an Australian law/award or facilitating the provisions of such. All the requirements in subsection 26-10(2) are satisfied and section 26-10 does not act to deny a deduction for the Annual Leave Component of the Employee Entitlements. On this basis the Annual Leave Component of the Employee Entitlements is deductible under 8-1. Clause XX Payments Under clause XX Company A is liable to pay Company B an amount when Company B makes an employee (that had left the Group and joined Company B as part of the Outsource Programme) redundant within a XX-year period. These payments form part of the agreement which transfers the services that were previously provided in-house to Company B in order to obtain efficiency gains etc. for the Company A's ongoing business. It is clear this expenditure meets the positive limbs of 8-1 as Company A needs these administrative services to produce its assessable income through its ongoing business.
As discussed in more detail below in the reasoning for Question 2, determining whether something is capital in nature or not, requires consideration of the nature of the advantage sort, the manner it will be enjoyed and the means adopted to obtain it.
The obligations for which the payments are made under clause XX are ongoing in nature in that Company A is bound to them for at least XX years after the agreement is completed, with each payment to Company B triggered when it is identified and agreed that personnel are no-longer required. The advantage sought in incurring the cost is to increase efficiency in the provision of services to Company A's business by agreeing to provide for the redundancy of excess employees. The Outsource Programme provides for a reduction in costs over time and redundancies funded by Company A (instead of Company B) factor into these calculations. This is not a once and for all payment to allow for the restructure of services but ongoing in nature and reflective of the ongoing efficiencies that this project is aiming to achieve. The advantages of reduced employees of Company B needed to provide services to Company A are part of the ongoing efficiency gains. Additionally, in the case of Buckley & Young Ltd. v. Commissioner of Inland Revenue 78 ATC 6019 Woodhouse J stated:
A payment made as a matter of commercial necessity or expediency to secure the removal of an unsatisfactory director or employee is referable only to the current business operations of the taxpayer in gaining its assessable income and that also stamps it with the character of a revenue and not a capital disbursement. This shows the revenue nature of payments made to reduce workforces for efficiency of the current ongoing business operations. The character of the advantage gained is for the reduction in costs associated with the administrative services provided by Company B to Company A. Therefore, the payments under clause XX are deductible under 8-1 as they meet the positive limbs and are not capital in nature. Question 2 Summary The payments for the Remaining Employee Entitlements Component under clause YY are not payments to discharge liabilities of Company A. They are a once and for all payment made to Company B in order to facilitate Company B taking on Company A's employees to provide administration services to Company A in a more efficient/cost effective manner. They are capital in nature and meet the criteria to be deducted under 40-880. Detailed reasoning
Section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997) applies to certain business expenditure of a capital nature from 1 July 2005. Subsection 40-880(1) indicates the object of section 40-880 is to make certain business capital expenditure deductible in equal proportions over five years if: (a) the expenditure is not otherwise taken into account; and (b) a deduction is not denied by some other provision; and (c) 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 (TR 2011/6) sets out the Commissioner's views on the interpretation of the operation and scope of section 40-880. Paragraph 23 of TR 2011/6 states that determining the amount allowable as a deduction under section 40-880 is a multi-step process: • first it is necessary to determine initial entitlement under subsection 40-880(2); and • then the limitations and exceptions in the subsequent subsections must be considered. Initial entitlement
Relevantly, 40-880(2) and 40-880(2)(a) indicate 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. The facts of this case show that the payment for Remaining Employee Entitlements Component is actually made to Company B and thereby actually incurred after 1 July 2005. Therefore, this is satisfied and consideration must be given to (a) whether it is capital in nature and (b) in relation to Company A's business. (a) Capital in nature The expression 'capital expenditure' is not a defined term. Whether expenditure is capital in nature is determined on the facts of each particular case having regard to the principles established by the case law the classic test of which is described in the judgment of Dixon J in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 23; (1938) AITR 403 ( Sun Newspapers ):
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... The payment for the Remaining Employee Entitlements Component is a payment made as part of the Outsource Programme and calculated in reference to long service leave, along with an estimate of payroll tax that would be paid if annual leave was paid to employees.
As discussed in answering Question 1 above regarding the Annual Leave Component of the Employee Entitlements, the case concluded that the character of the payment for accrued annual leave was to discharge the seller's liability for this leave, but that the component in reference to long service leave could not be characterised the same way as the seller was not liable and could never become liable to pay anything to these employees. Any liability for this leave was passed on to the new employer simply because of the laws that governed long service leave and not due to the agreement or any election of the parties to the agreement. Specifically, in the case, Justice Mason stated at page 4269:
"As we have seen, the liability, if any, to arise in respect of long service leave was a liability of the purchaser, the inchoate liability of the taxpayer having terminated in consequence of the disposition of the business for which provision was made by the contract and the termination of the employees' services as contemplated by the contract. The payment made to the purchaser in respect of long service leave was therefore a contribution made in respect of its liability to accrue in the future. In no sense can it accurately be described as a payment made for the purpose of discharging a liability of the taxpayer. Consequently, the payment in respect of long service leave is not an allowable deduction"
The Long Service Leave Laws are similar to those that were in place at the time of the case in that any liability for long service leave is passed to the new employer. There is no choice available to the new employing entity to avoid becoming responsible for long service leave if an employee is considered transferred. On this basis, the character of the payment calculated in reference to accrued long service leave is not to discharge Company A's liability to pay its employees long service leave, as such liability could not exist once employees transferred. Further support is found in the calculation methodology of the amount to be paid to Company B by Company A. Additionally, the payroll tax component of any annual leave that is paid is not a liability of Company A. It is a liability that is levied when annual leave is paid and will therefore be a liability of Company B. No liability exists prior to this payment and due to the Deed, Company B has agreed to take over any payment of annual leave. It therefore cannot be a payment to discharge a liability as this liability did not and never could exist, similar to payments regarding accrued long service leave.
We can therefore conclude the character of these payments is not to discharge a liability of Company A. The case, after concluding this, determined that the payment was incidental and relevant to the sale of the business and therefore on capital account. There is no such sale in this case. Accordingly, further analysis is required. The Remaining Employee Entitlements Component is a payment that is part of the Outsourcing Programme which aims to outsource certain service and administration functions currently completed by Company A to Company B. The objectives of the program include reducing the operating costs.
As part of this programme Company B offered employment to the existing Company A staff. The payment is made in reference to the employees transferring to Company B. It is a payment agreed upon when the two parties agreed to transfer this function to Company B in recognition of the financial burden that Company B will be taking on by employing these specific people. This is a structural change of Company A's business such that it no-longer performs these administrative services in-house but they are provided by Company B. Given the structural nature of the change the advantage sought provides an enduring benefit to Company A through its change to its business process. The Remaining Employee Entitlements Component payment is 'once and for all' in nature and is not an ongoing agreement to pay for the transferred employees leave. For the reasons above the Remaining Employee Entitlements Component payment is capital in nature. (b) in relation to your business For capital expenditure to be 'in relation to' a business, there must be a sufficient and relevant connection between the expenditure and the business.
As discussed above, the payment is in relation to the outsourcing project which enables the business to continue to have the necessary administration functions performed to support the on-going business but via Company B providing the services. The outsourcing project's aim is to increase efficiencies of the current business. It is clear that the expenditure is in relation to the taxpayer's ongoing business. We note subsection 40-880(2A) does not apply as the business is not proposed but ongoing and Company A and subsection 40-880(2B) would apply as Company A would not meet the criteria of a small business provided in that section. Therefore, the payment meets the initial entitlement requirements in 40-880 and we need to consider the exceptions. Limitations and exceptions to allowing a deduction
The first limitation for deductibility under section 40-880 is regarding the extent it is incurred for a taxable purpose. Given the nature of the outsourcing - providing administration and technology services - the Commissioner accepts that these will support the taxable purpose of the business and that 40-880(3) applies such that the payment is for a taxable purpose. (We note subsection 40-880(4) does not need to be considered as this is an ongoing business). Further restrictions may be placed on the amount of expenditure which is deductible under section 40-880 specifically those in subsection 40-880(5), 40-880(8) and 40-880(9) outlined below: • Expenditure which forms part of the cost of a depreciating asset - paragraph 40-880(5)(a) • Expenditure is deductible under another provision - paragraph 40-880(5)(b) • Expenditure that forms part of the cost of land - paragraph 40-880(5)(c) • Expenditure in relation to a lease or other legal or equitable right - paragraph 40-880(5)(d)
• The expenditure would otherwise be taken into account in working out a profit including in the taxpayer's assessable income, or a loss that they can deduct - paragraph 40-880(5)(e) • The expenditure could be taken into account in working out the amount of a capital gain or capital loss from a CGT event - paragraph 40-880(5)(f) • Another provision would make the expenditure non-deductible if it was not of a capital nature -paragraph 40-880(5)(g) • Another provision expressly prevents the expenditure being taken into account as described in paragraphs 40-880(5)(a) to (f) for a reason other than the expenditure being of a capital nature - paragraph 40-880(5)(h) • The expenditure is of a private or domestic nature - paragraph 40-880(5)(i) • The expenditure is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income - paragraph 40-880(5)(j) • The expenditure is excluded from the cost of a depreciating asset or the cost base or the reduced cost base of a CGT asset because of a market value substitution rule - subsection 40-880(8)
• The expenditure is a return of an amount previously received or a return on or of debt or equity - subsection 40-880(9). Given the facts and discussion above, it is clear the majority of the above exceptions do not apply to this payment. However, 40-880(5)(f) and 40-880(5)(g) warrant further discussion. 40-880(5)(f) The Commissioner considers that the expenditure will not be taken into account when working out a capital gain or loss for Company A. The agreement does not constitute a sale of a part of Company A's business to Company B. Additionally, the agreement is executed such that Company B makes offers of employment to the current Company A workforce involved in the administration functions capital assets of Company A are not effectively sold to Company B. There is therefore no capital asset to which this payment can apply and 40-880(5)(f) exclusion does not apply to the Remaining Employee Entitlements Component under clause YY of the Deed. 40-880(5)(g)
Broadly, as discussed in answer to Question 1 above section 26-10 excludes losses/outgoings regarding employees leave from being deductible if not paid to the employee and therefore warrants consideration as to whether, if this payment was revenue in nature, 26-10 would deny Company A a deduction and thus 40-880(5)(g) exclusion applies. For section 26-10 to deny a deduction, the payment must be for long service leave, annual leave or sick leave. As discussed above regarding the character of the payment, it is to compensate Company B for employing Company A's employees to allow for the outsourcing project to occur. It is not a payment for leave. It does not discharge any of Company A's liabilities regarding its employees leave. The amount paid to Company B for the Remaining Employee Entitlements Component under clause YY of the Deed was calculated in reference to leave balances of employees, but it was not a payment to Company B for accrued leave. As it is not for leave described in section 26-10, this section has no application.
We note that similar principles are expressed in ATO ID 2004/489 which found that, although payments made to a worker entitlement fund were calculated in reference to worker's future leave entitlements, the cause was to discharge the employer's immediate legal obligations (in respect to worker entitlements) and not an outgoing for leave. As such, it found that these payments were unaffected by section 26-10. Therefore 26-10 would have no application to deny the deduction if the payment was not capital in nature and the 40-880(5)(g) exclusion does not apply. In conclusion all the criteria for 40-880 to apply is met and the Remaining Employee Entitlements Component under clause YY of the Deed is deductible under this provision.