Is Company X entitled to claim a deduction for costs associated with an initiation related to the COVID-19 pandemic (the Costs) under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Yes. This ruling applies for the following periods : A number of income years. The scheme commences on: During an income year.
Company X is an Australian incorporated company, conducting business that derives assessable income in Australia for many years. During the relevant income years, Company X's sales revenue was affected by the COVID-19 pandemic. Consequently, Company X incurred the Costs to support the broader industry in which it operates, protect its reputation with consumers, and engender loyalty and pride in its employees.
Income Tax Assessment Act 1997 subsection 8-1
All legislative references are to the ITAA 1997 unless stated otherwise. Under the second positive limb of section 8-1, a deduction is allowed for losses or outgoings to the extent that the loss or outgoing is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. The Costs satisfy the second positive limb because Company X carries on a business for the purpose of gaining or producing assessable income and the Costs are appropriate and adapted for its business ends Ronpibon Tin NL v Commissioner of Taxation (Cth) [1949]HCA 15). It is for Company X to determine that the Costs were necessarily to be incurred to sustain its business during the COVID-19 pandemic by supporting the broader industry in which it operates Magna Alloys & Research Pty Ltd v. Commissioner of Taxation of the Commonwealth of Australia [1980] FCA 180 ( Magna Alloys ). However, a deduction is not allowed under section 8-1 where, relevantly, the loss or outgoing is capital or of a capital nature (subsection 8-1(2)). In considering the factors highlighted in Sun Newspapers Limited v Federal Commissioner of Taxation
[1938] HCA 73 for distinguishing between revenue and capital expenditure, the character of the advantage sought is the chief, if not the critical, factor in determining the character of what is paid ( G P International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) [1990] HCA 25). Further, what determines the issue is the business purpose for which the outgoing was incurred from Company X's point of view ( Commissioner of Taxation (Cth) v Midland Railway Co of Western Australia Ltd [1952] HCA 5). From Company X's point of view, the character of the advantage sought to be gained by incurring the Costs was to support the wider industry in which it operates, to protect its reputation with consumers and to engender loyalty and pride in its employees.
Company X needs the wider industry to survive the COVID-19 pandemic in order to maintain, sustain and grow its client base and the Costs aligned with the needs of the industry during the pandemic. Supporting the broader industry also strengthens Company X's relationship within the industry generally, with its customers and with its employees. Having engaged and proud employees reduces staff turnover, meaning Company X is able to retain knowledge and experience within the business to enable Company X to make better business decisions. Company X also benefits from the relationships that the employees develop with its customers. Therefore, taking the whole business context of what was done by Company X into account, the nature of the Costs incurred is akin to a marketing or advertising expense to increase the flow of its ordinary business activities, as in the cases of National Australia Bank Ltd v The Commissioner of Taxation of the Commonwealth of Australia [1997] FCA 1394 and B.P. Australia Ltd. v Federal Commissioner of Taxation [1965] HCA 35. The Costs did not enlarge the framework within which Company X carried on its business.
Whilst the incurrence of the Costs may protect or enhance Company X's relationship with its employees and consumers, the costs formed part of Company X's day-to-day operations and therefore are a source of goodwill of the type described by Brennan J in Magna Alloys , and not in itself goodwill. Further, the Costs are not expenditure in respect of acquiring internally generated goodwill, rather, they are incurred by Company X in the course of carrying on its business (Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business ). Having regard to all the circumstances, it is concluded that the Costs are an outgoing of revenue (rather than capital), and Company X will be entitled to claim a deduction for the Costs under section 8-1.