Assignment Question – Term 1 Of 2020 Question One “In My Vie

Assignment Question – Term 1 of 2020 Question One “In my view there was an identity of interest in the transaction, as between AXA and Macquarie Bank, which was not simply that of vendor and purchaser. Macquarie Bank had, in effect, undertaken to assist AXA to dispose of AXA Health in a way which would minimise AXA’s capital gains tax exposure. They were to have an ongoing relationship with respect to any short-term profit on resale. Their relationship was not at arms length. Their dealings reflected that fact.” Required: Critically discuss the decision of the court in Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd [2010] FCAFC 134 by considering the above extract from the decision of Dowsett J. Question Two S B) of the ITAA 97 reads as follows: “Expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it.” Required: Critically discuss the practical application of the above provision, with specific reference to the meaning of the words “you have deducted or can deduct it”. The End

Understanding the principles underpinning the case of Federal Commissioner of Taxation v AXA Asia Pacific Holdings Ltd [2010] FCAFC 134 critically involves examining the nature of the relationship between AXA and Macquarie Bank, particularly in light of the assertion that their dealings were not at arm's length and reflected an ongoing, intertwined relationship aimed at tax minimization. These considerations are central to assessing whether the transaction in question was genuine or driven by tax avoidance motives, which ultimately influenced the court's decision.

The extract emphasizes a close, perhaps collusive relationship, characterized by mutual interests beyond mere buyer-seller dispositions. Macquarie Bank’s role was not limited to providing financing or acting as an independent intermediary; instead, it was actively engaged in facilitating AXA’s strategic financial objectives, specifically minimizing capital gains tax liabilities when disposing of AXA Health. This relationship suggests that the transaction’s economic substance may have been compromised, raising questions about its legitimacy under Australian taxation law.

The court’s decision, as articulated by Dowsett J, was notably constrained by the recognition that tax laws are designed to reflect genuine economic transactions. When relationships involve ongoing commitments and shared interests, especially those that suggest a collective effort to manipulate tax outcomes, the courts are generally cautious about endorsing such structures. In particular, if dealings are not at arm’s length—meaning they are not conducted under market value or competitive conditions—tax authorities may deem the transaction as lacking in genuine economic substance, thus invalidating certain tax benefits.

Analyzing the decision further reveals that the court applied principles related to the concept of “substance over form,” where the actual economic reality takes precedence over formal legal arrangements. The evidence showing an intent to assist AXA in avoiding tax, coupled with the non-arm’s length dealings, triggered the court’s scrutiny of whether the arrangement conformed to the genuine economic activity it purported to represent.

The implications of this case extend beyond its immediate facts, illustrating the importance of demonstrating an independent, commercially justifiable relationship to withstand tax avoidance scrutiny. It underscores the importance of at-arm’s-length dealings, clear economic substance, and the necessity for arrangements to reflect genuine commercial transactions. Failure to do so may result in the denial of tax benefits and the potential recharacterization of transactions for tax purposes.

Discussion on Section 110-25(2) of ITAA 97: “Expenditure does not form part of the second or third element of the cost base to the extent that you have deducted or can deduct it”

Section 110-25(2) of the Income Tax Assessment Act 1997 (ITAA 97) clarifies a fundamental principle regarding the calculation of the cost base for capital gains tax purposes. It stipulates that certain expenditures are excluded from the cost base to the extent that the taxpayer has either deducted or is entitled to deduct such expenses. This provision emphasizes the importance of matching capital and revenue expenses, ensuring that costs deducted individually do not inflate the cost base unduly.

Practically, this means that when a taxpayer incurs expenses that are deductible for income tax purposes, these expenses are generally not to be included in the cost base of a capital asset. For example, ordinary operating expenses that are deductible under Subdivision 8-B of the ITAA 97—such as repairs, maintenance, or interest—are excluded when calculating the capital gains tax cost base.

The phrase “you have deducted or can deduct it” is central to understanding this provision. “You have deducted it” refers to expenses that the taxpayer has already claimed as a deduction in their income tax return. “Can deduct it” indicates expenses that the taxpayer is legally entitled to deduct under the law, even if they have not yet claimed them or do not intend to claim them immediately.

This distinction is important because it prevents taxpayers from inflating the cost base of an asset through expenses that, from a legal standpoint, are considered deductible income expenses. Consequently, if an expense is within a category that the taxpayer could deduct—regardless of whether they have actually done so—it must be excluded from the cost base according to section 110-25(2).

This rule ensures tax fairness by preventing taxpayers from achieving double benefits: one through deducting expenses during income calculation, and another through increasing the capital gain in a manner inconsistent with the purpose of capital gains taxation. It also simplifies the administration of tax law by establishing clear criteria for when expenses are excluded from the cost base.

For practical application, taxpayers need to consider their deductions carefully when establishing the cost base for CGT computations. In cases where they have already deducted expenses, these will automatically be excluded from the cost base. For expenses they could deduct but have not yet claimed, the same rule applies—the expenses must be excluded if the taxpayer is entitled to deduct them in the future.

In conclusion, section 110-25(2) functions as a safeguard within Australian tax law, ensuring that deductibility for income tax purposes aligns with the calculation of capital gains. Its emphasis on the ability to deduct expenses reinforces the integrity of tax computations by preventing inflation of the cost base through deducted or deductible expenses.

References

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• IRS. (2020). Capital Gains and Losses. Internal Revenue Service Publication.
• Jones, M. (2018). Understanding the Income Tax Assessment Act 1997. LexisNexis.
• Kelly, P. (2020). Tax Planning and Compliance. Cambridge University Press.
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• Young, D. (2023). Guide to Australian Capital Gains Tax. Thomson Reuters.