ATO Interpretative Decision

ATO ID 2007/87

Income Tax

Issue

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

Decision

Yes. The taxpayer's capital expenditure was incurred 'in relation to your business' for the purpose of paragraph 40-880(2)(a) of the ITAA 1997 because there was a sufficient and relevant connection between the taxpayer's incurrence of the expenditure and the taxpayer's business.

Facts

The taxpayer conducts a bus charter business as a sole trader. They carry on that business wholly for a taxable purpose.

Based on photographs and information provided by the seller, the taxpayer paid a holding deposit on a second-hand bus to replace an older bus being used in the taxpayer's business. The second-hand bus was located in another State.

The taxpayer incurred capital expenditure on an airfare to travel to where that bus was located so as to take delivery of the bus and drive it back to where their business is carried on. The taxpayer also incurred capital expenditure on having new tyres fitted to the bus in anticipation of driving it back to their place of business.

After inspecting the bus, the taxpayer decided not to continue with the purchase.

While the taxpayer had their deposit refunded, they decided to leave the new tyres fitted to the second hand bus because it was not worth their time, effort and cost of removing and returning the new tyres and finding other replacement tyres. The original tyres had been discarded when the new tyres were fitted.

The taxpayer incurred further capital expenditure on an airfare to return to their place of business.

The expenditure was incurred on or after 1 July 2005.

Reasons for Decision

Section 40-880 of the ITAA 1997 potentially applies to the expenditure because the expenditure was incurred on or after 1 July 2005: see section 3 and Schedule 2 Item 51(1) to the Tax Laws Amendment (2006 Measures No.1) Act 2006.

Subject to the limitations and exceptions contained in subsections 40-880(3) to (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 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 incurrence of the expenditure and the taxpayer's business. In discussing the types of business capital expenditure to which subsection 40-880(2) of the ITAA 1997 applies, the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 states:

2.19.

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.

2.20.

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.

A necessary part of the taxpayer's trading operations of a bus charter business is having buses which are suitable for charter. The acquisition of buses for use in the taxpayer's bus charter business is an integral part of that business. The taxpayer's incurrence of capital expenditure on an airfare to the location of the second-hand bus and the bus tyres were an integral step in the process of purchasing another bus to replace an older bus that the taxpayer was using in their business. The taxpayer incurred expenditure on the airfare solely in order to inspect such a bus and take delivery of it. The taxpayer incurred expenditure on tyres so the bus they intended to purchase was in a suitable condition to undertake the drive back to the State where they carried on their business. Although the purchase of the bus did not eventuate, in a practical sense the taxpayer incurred expenditure in order to purchase a bus for use in their bus charter business.

As a consequence of the taxpayer's decision (after inspecting the bus) not to continue with the purchase of the bus, the taxpayer incurred further capital expenditure on a return airfare. The taxpayer was required to purchase this airfare to return to their place of business solely and directly because they did not proceed with the purchase of the bus they had flown to inspect and take delivery of for use in their business.

In the circumstances, there is a sufficient and relevant connection between the taxpayer's incurrence of the expenditure on both airfares and bus tyres and their business. Accordingly, the capital expenditure incurred on the airfares and bus tyres is capital expenditure the taxpayer incurred in relation to their business for the purposes of paragraph 40-880(2)(a) of the ITAA 1997.

Year of income:  Year ended 30 June 2007

Legislative References:
Income Tax Assessment Act 1997
   subsection 40-880(2)
   subsection 40-880(3)
   subsection 40-880(4)
   subsection 40-880(5)
   subsection 40-880(6)
   subsection 40-880(7)
   subsection 40-880(8)
   subsection 40-880(9)
   paragraph 40-880(2)(a)
   paragraph 40-880(2)(b)
   paragraph 40-880(2)(c)
   paragraph 40-880(2)(d)

Case References:
First Provincial Building Society Ltd v. Federal Commissioner of Taxation
   (1995) 56 FCR 320
   (1995) 95 ATC 4145
   (1995) 30 ATR 207

Related ATO Interpretative Decisions
ATO ID 2007/88
ATO ID 2007/89

Other References:
Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006

Keywords
Blackhole expenditure
Capital Allowances CoE
Capital expenditure
Depreciating assets

Siebel/TDMS Reference Number:  5475920

Business Line:  Public Groups and International

Date of publication:  4 May 2007

ISSN: 1445-2782