Edited version of your private ruling

Authorisation Number: 1011972358512

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Income Tax: Deductions

Question 1

Is the estimated fee for injury management services to treated as a prepayment under section 82KZL of the Income Tax Assessment Act 1936 (ITAA 1936) as the estimated fee is to be topped up as soon as the estimated fee has been utilised at any point of time before the expiration of the insurance policy?

Answer

No

Question 2

Is the expense for soft drinks and beers constitute entertainment expenses under section 32-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period

Financial year ended 30 June 2008

Financial year ended 30 June 2009

Financial year ended 30 June 2010

Financial year ended 30 June 2011

The scheme commenced on

1 July 2007

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

X Co (the company) is a private company providing services to the building industry.

The company is required to take the workers compensation insurance and public liability insurance for their employees.

Also, the company is required to pay the injury management fee. This fee is for the repatriation, trauma management, initiation of injury management and all other matters required to get the injured contractor back into the workforce as soon as possible.

The amount of the cover is estimated by the service provider in April based on the amount of work done in the previous twelve months. If at any time in the next calendar year, the expenses to date exceed their estimate, the company is required to pay the difference. In other words, there is no adjustment done at calendar year end but is done at any time once the estimated service is

exceeded.

Further, the company's employees work at the building worksites and they do not work on the company's business premises. On occasion, the operations manager holds meetings with the employees on the client's worksite after hours to discuss the employees' concerns on safety issues. He provides them with soft drink and beer.

Relevant legislative provisions

Income Tax Assessment Act 1936, subsection 82KZL(1)

Income Tax Assessment Act 1936, subsection 82KZL(2)

Income Tax Assessment Act 1997, section 8-1

Income Tax Assessment Act 1997, section 32-5

Income Tax Assessment Act 1997, subsection 32-10(1)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

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 first 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 www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Summary

The injury management excess payment is not considered as prepayment under subsection 82KZL(1) of the ITAA 1936.

However, it is considered as allowable deduction under section 8-1 of the ITAA 1997.

Detailed reasoning

Prepaid expense is expenditure incurred in one year for things to be done (in whole or in part) in a later year of income.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or are necessarily incurred in carrying on a business for the purposes of gaining or producing such income, except where the outgoings are of a capital, private or domestic nature, or relate to the gaining or producing of exempt income.

The prepayment rules affect the timing of deductions for prepaid expenditure where, inter alia, that expenditure would ordinarily be immediately deductible under section 8-1 of the ITAA 1997 and it is not excluded expenditure.

Subsection 82KZL(1) of the ITAA 1936 provides that the 'eligible service period' in relation to an amount of expenditure incurred under an agreement is the period during which the thing is to be done under the agreement in return for the expenditure. It begins on the day the thing under the agreement commences to be done or on the day the expenditure is incurred, whichever is later. It continues until the last day the thing under the agreement ceases to be done or 10 years, whichever is earlier.

Paragraph 82KZL(2)(c) of the ITAA 1936 further provides that :

where expenditure incurred under an agreement consists of a payment of an insurance premium or a payment of a similar kind, the expenditure shall, for the purposes of this Subdivision, be taken to be incurred in return for the provision or continued provision, as the case requires, of insurance against the risk concerned, or of a thing of a similar kind, under the agreement during the period to which the payment relates.

In this case, the 'eligible service period' commences on 1 April of each year. This is the later of the day the thing under the agreement commenced being done and the day the expenditure was incurred. Any prepaid expenditure incurred on that day for premium relating to a later income year will be subject to the prepayment rules.

However, paragraphs 1 - 4 of the Taxation Determination TD 97/14 states that:

1. In ANZ Banking Group Ltd v. FC of T 94 ATC 4026; (1994) 27 ATR 559 ('the ANZ case'), the taxpayer was a 'self-insurer' under the Accident Compensation Act 1985 (Vic). As such, it was required to make payments to injured employees in accordance with the provisions of that Act. In its 1986 income tax return, the taxpayer claimed a deduction in respect of its estimated workers' compensation liabilities for:

(a) accident claims which had been reported but not paid ('RBNP'); and

(b) accident claims which had been incurred but not reported by injured employees ('IBNR').

2. The Commissioner's practice (as set out in Taxation Ruling IT 2098) had been to deny deductions for such provisions and allow deductions in the year of income when the payments were actually made to the injured employees.

3. The Full Federal Court considered that the Accident Compensation Act 1985 (Vic) creates a presently existing liability to make payments in the future from the moment an employee suffers an injury at work. Such a liability, though perhaps ultimately defeasible, is still a liability 'incurred' within the meaning of section 8-1 of the ITAA 1997 (formerly section 51(1) of the Income Tax Assessment Act 1936 ('the ITAA'). Accordingly, the Court held that a deduction is allowable in the year in which the liability arises notwithstanding that the actual payments are not made until a later year. The Court also held that the provisions for such deductions should be bona fide , capable of reasonable estimation and acceptable to the company's auditors to enable certification as a true and fair view of the company's accounts.

4. In view of the decision of the Court (as it applies to workers' compensation claims) the Commissioner will allow similar claims by self-insurers for workers' compensation liabilities under section 8-1 of the ITAA 1997 in the following circumstances:

(a) where employers are entitled to self-insure under their relevant workers' compensation / workcare legislation; and

(b) the relevant workers' compensation / workcare legislation operates so as to fix the liability on an employer at the time the accident occurs; and

(c) the calculation of the provision is made with regard to the relevant principles set out in Taxation Ruling IT 2663 (Basis of Assessment of General Insurance activities) and Taxation Ruling TR 95/5 (Basis of Assessment of Reinsurance Activities).

In this case the taxpayer has the workers compensation insurance and the Public liability insurance. The taxpayer has to pay the injury management fees when the expense exceeds their estimate.

In Ronpibon Tin NL and Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431, the Court established that, for a loss or outgoing to be an allowable deduction, there must be a nexus between the outgoing and the assessable income so that the expenditure is incidental and relevant to the taxpayer's income-producing or business operations.

The Full High Court in Federal Commissioner of Taxation v. Smith (1981) 147 CLR 578; (1981) 11 ATR 538; 81 ATC 4114, allowed a deduction for premiums paid to secure a monthly indemnity against the income loss arising from the inability to earn. It was held that there was sufficient connection between the purchase of the insurance cover against the loss of the ability to earn and the consequent earning of assessable income, and the outgoing was not of a capital, private or domestic nature. The deduction was allowed under subsection 51(1) of the ITAA 1936 (the equivalent of section 8-1 of the ITAA 1997).

Accordingly, the taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for the injury management excess payments when it is incurred.

Question 2

Summary

The provision of soft drinks and beers during after hours meetings are not considered as entertainment expenses under section 32-10 of the ITAA 1997.

However, it is considered as necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income under paragraph 8-1(1)(b) of the ITAA 1997.

Detailed reasoning

Subsection 32-10(1) of the ITAA 1997 defines ''entertainment''. Unless the contrary intention appears, ''entertainment'' means:

(a) entertainment by way of food, drink or recreation, or

(b) accommodation or travel to do with providing entertainment by way of food drink or recreation.

A loss or outgoing is not deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in respect of providing entertainment under section 32-5 of the ITAA 1997.

Example of items that are entertainment are business lunches and social functions these examples enforce that activities that would generally be considered to be entertainment will be treated as such despite any actual or claimed relationship with business activities.

However, although subsection 32-10(2) of the ITAA 1997 provides examples of what is and what is not considered to be entertainment, the question of whether an event is primarily entertainment or business in other cases is a question of fact to be determined from the circumstances. For example, in FC of T v Amway of Australia Ltd 2004 ATC 4893;(2004) 57 ATR 339; the Full Federal Court considered in relation to ITAA 1936 section 51AE (equivalent to Division 32 of the ITAA 1997) that the provision of food and drink (other than a gala dinner) to Amway distributors at a leadership seminar, which as held at a quality holiday resort, was not the ''provision of entertainment", as the seminars were primarily concerned with business matters. The court also said that the provision of accommodation and travel to distributors to attend the seminar were not for the purposes of facilitating the provision of entertainment by way of food and drink. Accordingly, all the relevant expenses were not precluded from deduction.

The principal issues to be considered in this case is whether the provision of soft drinks and beer to the workers when after hours the meetings are conducted by the operation manger at the clients work site to discuss the employees' concerns issues etc considered as entertainment expenses under section 32-5 of the ITAA 1997.

Taxation Ruling TR 97/17 (TR 97/17) applies four criteria to determine whether food or drink constitutes meal entertainment at paragraph 7:

· why the food or drink is provided;

· what type of food or drink is being provided;

· when the food or drink is being provided; and

· where the food or drink is being provided

Applying the above factors to this case:

· the soft drinks and beer are provided as refreshment and sustenance. As per paragraph 23(a) of TR 97/17, refreshment and sustenance do not have the character of entertainment.

· soft drinks and beer as such are not considered as entertainment as per paragraph 23(b) of TR 97/17.     

· the soft drinks and beers are provided during the work related after hour's meetings. It is considered that the provision of soft drinks and beers has a work related purpose of providing sustenance rather than an entertainment purpose: paragraph 23 of TR 97/17.

Further paragraph 19 of the TR97/17 states that:

19. We have expressed this view previously, for example, in Taxation Ruling IT 2675. That Ruling considers that the provision of morning and afternoon tea to employees (and associates of employees) on a working day, either on the employer's premises or at a worksite of the employer, is not entertainment. The provision of light meals (finger food, etc.), for example in the context of providing a working lunch, is not considered to be entertainment. The provision of food or drink in these circumstances does not confer entertainment on the recipient.

However, Taxation Ruling IT 2675 (IT 2675) deals specifically with these issues. Paragraphs 2 -3 of IT 2675 states:

2. Providing morning and afternoon tea to employees (and associates of employees) on a working day either on the employers premises or at a worksite of the employer is not the provision of entertainment. The cost of providing these refreshments is therefore not excluded as a deduction by subsection 51AE(4) of the ITAA 1936 (section 32-5 of the ITAA 1997).

3. However, it is necessary that the requirements of subsection 51(1) (8-1 of the ITAA 1997) be met in each particular case for the cost of providing the morning and afternoon tea to be deductible. Broadly stated, the requirements are that the expenditure be incurred in the course of gaining assessable income (or carrying on business for this purpose) and that is not of a capital, private or domestic nature.

Further, Paragraph 7 of the IT 2675 states that:

Light meals are treated the same way as morning and afternoon tea. It is not

(a) the provision of entertainment to provide sandwiches and other hand food

(b) salads, orange juice, etc.., that are intended to be consumed on the taxpayers

(c) premises or worksite.

Therefore, it is considered that the provision of soft drinks and beers to the employees during the after hours meetings constitute the provision of a light meal as described in paragraph 7 of IT 2675.

Applying these criteria to the facts provided, as soft drinks and beers are provided during the working day in the course of carrying on business, they are not entertainment expenses and will be deductible pursuant to section 8-1 of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).