Clough and s 40-880 expenditure

Published: 8 Dec 2021



In its recent decision in Clough Limited v Commissioner of Taxation [2021] FCA 108 (Clough), the Full Federal Court added to the long-running history of revenue versus capital cases by dismissing the taxpayer’s appeal and ruling that amounts incurred to cancel employee share rights and options were not deductible under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). Although Clough is by no means a landmark case, the decision raises the importance of s 40-880 of the ITAA 1997 in allowing the gradual deduction of business-related costs which are not immediately deductible under s 8-1 of the ITAA 1997.

Summary of Clough


Clough Ltd (the Taxpayer) was the head entity of a tax consolidated group, specialising in engineering and construction and previously listed on the Australian Stock Exchange. Prior to the transactions that gave rise to the case, it was 60% owned by Murray & Roberts, a group based in South Africa.

Between 2012 and 2013, the Taxpayer and Murray & Roberts entered into discussions about the latter acquiring all the remaining shares in the Taxpayer. At this stage, both parties were concerned about how the employee share rights and options should be discharged and the appropriate tax treatment of these transactions.

The Taxpayer had two employee share schemes in place at the time:

  • Employee Option Plan — employees were given options which entitled them to subscribe for shares in the Taxpayer at a specified exercise price. The board of directors could determine that these options could vest immediately if they deemed that a ‘change in control’ event had occurred.
  • Employee Incentive Scheme — employees would be issued with performance rights after three years (or earlier if a ‘change of control’ event occurred). On vesting, each performance right entitled the employee to one share in the Taxpayer or cash equal to the market value of one share at the Taxpayer’s discretion. 

In late 2013, the Taxpayer made offers to all participating employees to cancel the share options and rights under the above schemes. On 11 December 2013, one of the Taxpayer’s subsidiaries paid $15,050,487 in respect of these cancellations.


In a deemed assessment in respect of the 2013–14 income year, the costs of cancelling the share rights and options were treated as being non-deductible by the Commissioner of Taxation (the Commissioner).

Taxpayer’s argument

The Taxpayer objected to the Commissioner’s assessment, contending that these payments were deductible under both positive limbs of s 8-1(1) of the ITAA 1997. They argued that these payments satisfied both limbs of s 8-1(1) and were not precluded from deduction by the negative limbs under s 8-1(2).

In their view, the Employee Options Plan and Employee Incentive Scheme were intended to incentivise and reward senior employees for their performance and tenure. It followed that the payments to cancel the related share options and rights were incurred or necessarily incurred in the course of producing assessable income because they discharged the Taxpayer’s obligation to remunerate eligible employees under these schemes.

Commissioner’s argument

The Commissioner maintained that these payments were not deductible under s 8-1, dismissing the Taxpayer’s objection. In his view, the occasion of the cancellation payments was in the change of ownership structure and not the Taxpayer’s ordinary course of business. The Commissioner further contended that, as these outgoings were incurred as part of a capital restructure in preparation for a takeover of the Taxpayer, they were capital or capital in nature and therefore not deductible pursuant to s 8-1(2)(a).

This prompted the taxpayer to appeal this decision to the Federal Court.

Federal Court decision

The primary judge agreed with the Commissioner’s view that the payments were not deductible under the positive limbs of s 8-1(1), dismissing the Taxpayer’s appeal. The Taxpayer appealed this decision to the Full Federal Court.


The Full Federal Court unanimously upheld the primary judge’s decision, agreeing that the payments were not immediately deductible under s 8-1.

Subsection 8-1(1)(a): ‘incurred in gaining or producing assessable income’

The Full Federal Court held that there was an insufficient connection between the payments to cancel the employees’ share options and rights and the production of the Taxpayer’s assessable income pursuant to s 8-1(1)(a).

In reaching this conclusion, their Honours pointed to the fact that the immediate cause for these payments was to implement the agreed takeover of the Taxpayer by Murray & Roberts. In other words, the payments were incurred to facilitate the change in control over the Taxpayer, and not to gain or produce its assessable income.1

Subsection 8-1(1)(b): ‘necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income’

The Full Federal Court also held that these payments were not incurred in the course of carrying on a business to gain or produce assessable income under s 8-1(1)(b) of the ITAA 1997. This was on the basis that the Taxpayer did not incur these payments to remunerate its employees, but rather to secure the desired capital structure to effectuate the takeover of the Taxpayer.2 The Court pointed out that the amounts paid to employees were not based on their time served or fulfillment of performance measures and were unusual and not ordinary working expenses by nature.3

The Full Federal Court also indicated that the payments to cancel the share options and rights would not have reduced the Taxpayer’s future revenue expenses. As these employees were entitled to shares in the Taxpayer had the change in control of the Taxpayer not occurred, the issuance of these shares would not have been an expense, but rather result in the dilution of its capital structure.4

Section 40-880 of the ITAA 1997: Blackhole expenditure

Brief overview of s 40-880

By way of background, s 40-880 of the ITAA 1997 provides an avenue for business expenditure of a capital nature to be deducted across a period of five years. This provision is a means of last resort for deducting business expenses, as it only allows taxpayers to claim a deduction for business capital expenditure that is not otherwise deductible or not otherwise taken into account under any other section of the Act as prescribed by s 40-880(1).

This allows business capital expenditure that does not form part of the cost base of a CGT asset to be written-off over a five-year period. These types of expenses have been dubbed ‘blackhole expenditure’ since they would not have been deductible under any other provision and would therefore be lost even though they had some connection with the taxpayer’s business.

There are various exclusions in ss 40-880(6) to (9) that prevent a deduction being claimed under s 40-880. These should be considered when working through s 40-880.

Application of s 40-880 in Clough

As the Commissioner conceded that the payments could be deductible over a period of five years shortly before the trial commenced5, the Full Federal Court simply agreed with this assessment and did not make any further comments on the merits of this position.6 As the original amended assessment was made on the basis that the cancellation payments were wholly non-deductible, the Full Federal Court allowed the Taxpayer’s appeal to the extent that they were deductible under s 40-880.7

From a purely technical perspective, it would have been interesting to see the Full Federal Court’s analysis of these payments in the context of s 40-880 had the Commissioner not made this concession. 

Relevance of the Clough decision

The role of s 40-880

The decision in Clough highlights the importance of the role of s 40-880 in allowing the deduction of business-related expenditure that may not be allowable deductions under s 8-1 of the ITAA 1997 or reflected in the cost base of a CGT asset. Although the outgoings in Clough were found to be not deductible under s 8-1, the Taxpayer and the Commissioner reached an agreement that they were deductible under s 40-880.

As businesses may incur a range of expenses, some of which do not have an immediate connection with producing their assessable income, taxpayers and advisers should keep in mind that s 40-880 may be the most appropriate avenue for deducting these amounts. It is preferable for taxpayers to be able to deduct these costs over a five-year period under s 40-880 rather than losing them altogether to a ‘black hole’ had this provision not been introduced.

Comparing s 8-1 and s 40-880

The key difference between being eligible to deduct an amount of expenditure under s 8-1 versus s 40-880 is the degree of connection between the outgoing and the production of assessable income — i.e. whether the outgoing itself gave rise to the taxpayer’s assessable income.

The two positive limbs of s 8-1 require that the outgoings be ‘incurred in gaining or producing assessable income’ or ‘necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income’. This contrasts with ss 40-880(2)(a) to (c) which require only that the outgoing be incurred ‘in relation to’ a new, existing or wound-up business.

There is a long lineage of decisions emphasising the need for a sufficient link or nexus between the incurring of a loss or an outgoing and the gaining or producing of assessable income — i.e. that the expenditure gave rise to assessable income.8 Taking its ordinary meaning, the phrase ‘in relation to’ in s 40-880(2) allows for more general business expenses that are not deductible under s 8-1 to be claimed as a capital allowance over five years.

Some examples of such expenses may include:

  • Costs of incorporating a company, registering a business name or establishing a trust
  • Costs to internally restructure a business9
  • Costs of evaluating a merger proposal10
  • Demerger costs incurred before and after a demerger11
  • Costs of raising equity such as legal fees or preparing required documentation
  • Costs incurred in making an unsuccessful takeover attempt or in defending against a takeover (but not the cost of acquiring shares)
  • Costs incurred in liquidating and winding-up a business
  • Costs incurred in preparation for commencement of a business (such as undertaking feasibility studies or preparing business plans).

Note that the above list is intended only to serve as an illustration of the types of expenses that may be deductible under s 40-880 and not any other provision of the ITAA 1997. Taxpayers and their advisers need to determine whether the requirements of s 40-880 are met before claiming a deduction under this provision.

ATO views

The Commissioner has taken a similar view in TR 2011/6 Income tax: business related capital expenditure – section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6), stating as follows:12

The test under the second positive limb of section 8-1 is therefore a more demanding test requiring a more immediate or direct link between the expenditure and the process of operating the business than a connection that qualifies the expenditure as being ‘in relation to’ a business.

The words ‘in relation to’, whilst positing a test that is not as strict as ‘in carrying on’ however indicate that the expenditure in question is sufficiently relevant to the business to impress on it the character of a business expense of that business.

The legislative context of section 40-880 indicates that the closeness of the association or connection must objectively support the conclusion that the expenditure is a business expense of the particular business …

The Commissioner’s comments in TR 2011/6 affirm the notion that the threshold for whether an amount is deductible under s 40-880 is lower than the tests under the two positive limbs of s 8-1(1). This means that capital expenditure may still be deductible where there is no direct connection or causal relationship with the assessable income derived by the business. In other words, the relevant issue shifts from whether there is a sufficient connection or nexus between the expense and assessable income of the business to whether the expenditure relates to the business itself.

However, taxpayers and their advisers must still look to the facts and circumstances of the expenses to confirm that the amounts are relevant to the business. They will not be eligible to claim deductions under s 40-880 where they are unable to demonstrate that they were incurred in relation to the business for a taxable purpose.

Section 40-880 only covers capital expenditure

It should be noted that s 40-880 only covers business expenditure that is capital or capital in nature, pursuant to ss 40-880(2) and (2A). Further, business expenditure is not automatically capital in nature (and therefore deductible under s 40-880) simply because it failed the positive limbs of s 8-1.13 Taxpayers will need to apply the relevant case law principles to determine whether their business expenditure should properly be characterised as capital or capital in nature.

This can be challenging in practice. The countless cases that have come before the courts over many years, including the High Court of Australia, to consider the characterisation of expenditure as being on revenue or capital account illustrate how difficult this characterisation can be.

Expenses incurred in dealing with employees are not always deductible under s 8-1

Taxpayers should be mindful that expenditure is not automatically deductible under s 8-1(1)(b) (i.e. incurred in carrying on a business) merely because it was incurred in dealing with their employees.

In Clough, Thawley J (Kenny and Davies JJ agreeing) made the following comments about the above point:14

The important point is that the occasion of the outgoing, and identification of what the outgoing is for (Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428 at 454 (Fullagar J); GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 at 136-137), is not as simple as merely observing that the outgoing relates to employees or that one of the reasons the payments were made was the existence of rights or expectations arising from dealings between employer and employee.

Thus, the key question that should be asked when determining whether a loss or an outgoing is deductible under s 8-1(1)(b) is whether the expenditure was sufficiently proximate to the derivation of assessable income, regardless of whether it relates to its employees.

Next steps

Taxpayers and their advisers should consider the following when determining the tax treatment of business expenditure:

  1. Is the expenditure deductible under the either of the positive limbs of s 8-1?
  2. Is the expenditure then treated as non-deductible under any of the negative limbs of s 8-1?
  3. If Yes to Q1 and No to Q2 — claim the deduction under s 8-1.
  4. If Yes to Q1 and Yes to Q2 (the amount is not not-deductible under s 8-1) — is the expenditure deductible under a specific provision?
  5. If No to Question 1 and Question 4 (the expenditure is not immediately deductible under 
    s 8-1 or another specific provision) — is the expenditure deductible over time under the capital allowance provisions, excluding s 40-880?
  6. If No to Question 5 (expenditure is not deductible over time under the capital allowance provisions, excluding s 40-880) — is the expenditure included in the cost base of a CGT asset?
  7. If No to Question 6 (the expenditure is not otherwise deductible or included in the cost base of a CGT asset, and a deduction is not denied by some other provision) — the expenditure may be deductible over five years under s 40-880.
  8. If, as a last resort, the expenditure is not deductible over five years under s 40-880, it is true blackhole expenditure and there is no tax recognition of the amount incurred or outlaid.

See Clough Limited v Commissioner of Taxation [2021] FCA 108 (Clough), per Thawley J at  [83]—[84].
Ibid, per Thawley J at [86].
Ibid, per Thawley J at [91].
Ibid, per Thawley J at [125].
Ibid, per Thawley J at [14].
Ibid, per Thawley J at [125].
Ibid, per Thawley J at [129].
See, for example, Federal Commissioner of Taxation v Payne [2001] HCA 3, per Gleeson CJ at [9]; Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation [1956] HCA 77 at [7]; Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation [1949]  HCA 15 at 57.
See TR 2011/6 Income tax: business related capital expenditure – section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6), Examples 8 and 9.
10 See ATO ID 2007/109 Capital Allowances: business related costsin relation to your business.
11 See ATO ID 2007/91 Capital Allowances: business related costs – in relation to your business and ATO ID 2007/92 Capital Allowances: business related costs – in relation to a business that used to be carried on.
12 TR 2011/6 Income tax: business related capital expenditure – section 40-880 of the Income Tax Assessment Act 1997 core issues (TR 2011/6), at [74], [75] and [78].
13 Ibid at [13].
14 Clough, op cit, per Thawley J at [98].

Further guidance and information 

Further guidance and information are available from the ATO website’s page on deductions for depreciating assets and other capital expenditure.

If you have any specific concerns that have not been outlined above, please email


DISCLAIMER: The material and opinions in this article should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

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