A whole new range of business expenditure has become tax deductable under amendments to the Income Tax Assessment Act 1997 (Cth) (Act). The expenditure is intriguingly called "blackhole expenditure". This article overviews the new blackhole expenditure tax deduction provisions, particularly for expenses relating to intellectual property and its commercialisation.
1. What is blackhole expenditure?
One Australian Government website defines the phrase this way: "Blackholes occur when business expenses are not recognised under the income tax laws." The formal name of the new law is Tax Laws Amendment (2006 Measures No. 1) Act 2006.
Blackhole expenditure is made up primarily of business start-up costs. For example, for the commercialisation of intellectual property, a spin-off or start-up company might be formed. The new blackhole provisions may provide tax deductions for commercialisation costs incurred by the intellectual property originator, provided they are not claimable elsewhere.
2. When did the deductions become available?
The blackhole expenditure provisions became effective for expenditure incurred on or after 1 July 2005. Under the earlier law (section 40-880 of the Act), blackhole expenditure was expenditure that was not deductible or depreciable and did not form part of the cost base for capital gains tax purposes. The earlier law provided a five year write off for seven specified types of business capital expenditure.
Under the new law in order to deduct the expenditure, the business was, is or will be carried on for a "taxable purpose". This is defined as the "purpose of producing assessable income or in carrying on a business for the purpose of gaining or producing assessable income".
3. Effect of the blackhole expenditure provisions
On announcement of the blackhole expenditure provisions the Treasurer's press release put it this way:
The systematic treatment [available under the new tax law] comprises:
- permitting deductions for capital expenditures incurred by businesses that are carried on for a taxable purpose;
- providing deductions for certain pre-business expenditures incurred by existing businesses; and
- recognising these expenditures in a new provision that will only apply where the expenditures do not have tax treatment, or are denied a deduction, elsewhere in the tax laws. Therefore, the new provision will be a provision of last resort.
The blackhole expenditure provisions will apply not only to capital expenditure incurred by the intellectual property originator in its own business but also in respect of business carried on by another entity in which the originator has an interest, such as in a subsidiary, spin-off or start-up company.
4. Types of available blackhole taxation deductions
Under the blackhole expenditure provisions, deductions are allowed on a straight line basis for five years from the year in which the expenditure is incurred. Allowed types of deductible expenditure are set out below.
- Expenditure to establish a business structure. This applies to companies, partnerships and trusts established to carry on a business. Legal expenses for the establishment of a business entity or enterprise (eg company incorporation and partnership formation) will generally be deductible. Franchise fees and lease payments will not be deductible.
- Expenditure to convert an existing business structure to another. An example will be professional fees to obtain advice about modifying the constitution of a company.
- Expenditure to raise equity for the business. This applies when there is raising of equity by a company or a fixed unit trust through either a private placement, public issue of shares or a rights issue. It includes expenditure for preparation of disclosure documents.
- Expenditure to defend a business against a takeover.
- Expenditure incurred in an unsuccessful takeover attempt.
- Expenditure by a shareholder in liquidating a company with that carried on a business.
- Expenditure in ceasing to carry on the taxpayer's business. This will include legal costs, including fees in connection with terminating the services of employees.
5. Other conditions
With the example again of IP, there are other conditions that need to be satisfied before the intellectual property originator can claim deductions under the new blackhole provisions. The expenditure must be in connection with the originator deriving assessable income from the commercialisation entity. The originator having shares in the commercilisation entity and deriving dividend income from it are sufficient for this purpose.
To obtain a deduction under the new blackhole expenditure tax law provisions the taxpayer must demonstrate a commitment to commence the business and sufficiently identify the business that is proposed to be carried on. The following may provide the relevant evidence of commitment by the taxpayer:
- a business plan;
- establishment of a business premises;
- research into likely markets or profitability of the business; and
- capital investment in assets of the business.
Expenditure will not be deductible if it is included in the cost of either a depreciable asset or land. A lease surrender payment incurred in closing down a business will not be deductible.
Entitlement under the new provisions to deduct blackhole expenditure is significant when one considers acquisition of intellectual property by a business. Deduction will rarely be available as a revenue expenditure since intellectual property is of an enduring benefit to the acquiring business and therefore will be considered as capital. If the intellectual property acquired does not fall within the definition of intellectual property in the Act, then no depreciation will be available to the business in respect of the acquisition expenditure.
6. Other tax law options
Other instances where the cost of acquisition of intellectual property may be deductible for tax purposes are:
- depreciation in respect of "intellectual property" as defined in the Act;
- "core technology" deductions under the Act;
- "in-house software" depreciation; and
- cost base for capital gains tax considerations.
This short article is of general nature. To benefit from any of the tax deductions overviewed in this article seek professional advice to review your specific circumstances.
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