In this edition of Talking Tax, we discuss the Full Federal Court appeal of Clough v The Commissioner of Taxation over whether the cancellation of employment share schemes is income tax deductible. We also look at the meaning of employment agency contract and NSW payroll tax in E Group Security Pty Ltd v Chief Commissioner of State Revenue.

Lastly, we examine research and development expenditure through a trust in XQDX and Commissioner of Taxation.

Case law

Cancellation of employee rights under a share scheme not deductible – Full Federal Court confirms

The Full Federal Court in Clough Limited v Commissioner of Taxation [2021] FCAFC 197 has upheld the Federal Court’s decision in Clough Ltd v Commissioner of Taxation [2021] FCA 108 that a payment in consideration for the cancellation of entitlements under an employee option plan and incentive scheme is not deductible under s 8-1 of the Income Tax Assessment Act 1997.

Instead, the Court found that because the payments were made in conjunction with the takeover and delisting of the Taxpayer from the ASX, they were capital in nature.

The Taxpayer had set up an employee option plan and incentive scheme intended to retain employees in order to increase and maintain the Taxpayer’s revenue and profitability.

The majority (60%) shareholder of the Taxpayer sought to acquire the remaining (40%) shares in the Taxpayer and delist it from the ASX. This required the Taxpayer to convert or cancel the entitlements under the option plan and employee incentive scheme. If the option holders agreed to cancel their entitlement, the Taxpayer would pay them a fee. Alternatively, if the options were exercised, the shares obtained would be acquired by the majority shareholder.

The Taxpayer argued that these payments were deductible under section 8-1 of the 1997 Act.

The Full Federal Court decision

The Full Federal Court considered the two limbs of section 8-1 of the 1997 Act, noting that:

  • s 8-1(1)(a) directs attention to whether the expenditure was ‘incurred in’ gaining or producing assessable income (First Limb); or
  • s 8-1(1)(b) directs attention to whether the expenditure was ‘necessarily incurred in’ carrying on a business for the purpose of gaining or producing assessable income (Second Limb).

The Full Federal Court, agreeing with the decision at first instance, rejected that the nature of the payments complied with the First Limb. The Court stated that ‘the payments would not have been made but for the fact that Clough had agreed to facilitate a takeover…’ such that the expenses were not incurred in gaining or producing assessable income.

The Court also rejected the proposition that the costs were deducible under the Second Limb, concluding that the payments were not incurred in carrying on a business. The payments were not in the nature of a working expense, rather they were incurred as part of the activities required to acquire the minority shareholding.

Also relevant to the Court’s conclusion were the following:

  • the cancellation of the options had an effect on the capital structure of Clough;
  • the payments were all made at once to secure the one enduring change; and
  • the payments were made by reference to the share price.

This meant that the payments were on capital account and not deductible pursuant to s 8-1(2)(a) of the 1997 Act.

The ATO did, however, concede that a portion of the payments were deductible, pursuant to the business-related costs provisions set out in section 40-880 of the 1997 Act. Accordingly, the Taxpayer was able to deduct one fifth of the costs in the year they were incurred.

For further background on the facts and decision at first instance of this case, please read Talking Tax ­­– Issue 195.

Security company business model not subject to NSW payroll tax

The NSW Supreme Court in E Group Security Pty Ltd v Chief Commissioner of State Revenue [2021] NSWSC 1190 has held the arrangements between the Taxpayer (a security company) and their client was not an employment agency contract as defined in s 37(1) of the Payroll Tax Act 2007 (NSW) and were therefore not taxable wages subject to payroll tax.


The Taxpayer is the main operating company in a group of companies involved in the security industry across Australia. The Taxpayer’s business model involved employing some security guards directly while obtaining the balance of the security guarding labour force from third-party contractors.

The main issue in dispute in this case was whether the procurement of security guards from third-party contractors and the subsequent supply of those security guards to the Taxpayer’s client was an employment agency contract pursuant to section 37(1) of the Act.

The Supreme Court’s decision

Section 37(1) of the Payroll Tax Act provides that: ‘for the purposes of this Act, an employment agency contract is a contract, whether formal or informal and whether express or implied, under which a person (an employment agent) procures the services of another person (a service provider) for a client of the employment agent.

The Supreme Court referred to the decision in UNSW Global Pty Ltd v Chief Commissioner of State Revenue [2016] NSWSC 1852 where Justice White construed the word ‘for’ in s 37(1) in a manner such that a contract is only an employment agency contract if the asserted employment agent procures the services of another person ‘in and for the conduct of the business of’ the asserted employment agent’s client.

The Supreme Court, applying this reasoning, held that the correct test for was whether the workers in question were sufficiently integrated into the client’s business to be seen as an addition to the client’s workforce, and work in much the same way as the client’s employees.

In applying the test, the Court considered:

  • the location at which the services were provided by the workers;
  • the regularity with which the workers provided the services to the clients;
  • the level of interaction between the works and the client’s customers and contractors;
  • the level of direction or instruction the client can exert over the workers;
  • the workers access to and use of the client staff facilities; and
  • the significance and/or necessity of the work provided to the client.

Balancing the above factors, the Court found that there was insufficient integration of the Taxpayer’s workers with the clients’ for the arrangements to be considered an employment agency contract.

AAT deems R&D expenditure not incurred by the taxpayer, but by the trust

In XQDX and Commissioner of Taxation (Taxation) [2021] AATA 4070, the Taxpayer was the trustee of a trust that was unsuccessful in claiming research and development (R&D) expenditure. Here, the Administrative Appeals Tribunal (AAT) was not satisfied that the Taxpayer had ‘incurred’ the relevant expenses due to a number of contingencies that existed.  The Taxpayer was able to receive a partial remission of penalties due to the AAT finding that they had relied on professional advice in making the relevant claim.


The taxpayer carried on a business in its capacity as a trustee. The taxpayer claimed notional deductions for R&D expenses during the financial years ending in 30 June 2012 and 30 June 2013.

The Commissioner rejected the deduction claims resulting in the Taxpayer’s appeal. The issue before the AAT was whether the Taxpayer had ‘incurred’ the R&D expenditure entitling them to claim the notional deductions.

AAT decision

The AAT rejected the taxpayer’s arguments that it had incurred the R&D expenditure. This was due to two main reasons.

  1. The obligation to pay the R&D expenditure was contingent on receipt of a tax refund. Therefore, at the time the deduction claim was made, the expense had not been incurred as the taxpayer was not definitively ready to pay for the obligation.
  2. The expenditure was incurred in the taxpayer’s capacity as trustee of a trust and not by the taxpayer in its own right (notwithstanding there was a reimbursement of the relevant expenditure through an inter-entity loan account). The trust controlled the bulk of the business, purchased, owned, and operated the business as well as employed and supervised staff who undertook the R&D work.

Luckily for the Taxpayer, the AAT partially remitted their penalties from 25% to 15%, on the basis that the Taxpayer relied on professional advice.

Overall, the AAT found that the Taxpayer should have taken more reasonable care to ensure that it had validly incurred the R&D expenditure.

ATO updates

TR 2021/8 – Income tax – value of goods taken from stock for private use for the 2021–22 income year

This ruling provides an update of amounts that the Commissioner will accept as estimates of the value of goods taken from trading stock for private use by taxpayers of specific industries.

Recognising that accurate records of goods taken from stock can be difficult to attain, the Commissioner had previously issued ‘Goods Own Use’ amounts for prior years to provide estimates, which have now been updated below for 2021.

Different amounts that are more accurate for certain taxpayers may be used. However, if different amounts are used, the taxpayer should ensure they are able to demonstrate why the value used is reasonable in their circumstances.

This schedule is relevant for industries that:

  • have a transformation process of trading stock items;
  • have a range of small items or ingredients as trading stock, usually of low value;
  • are not suited for inventory systems; and
  • have a high turnover of items, often for cash.

Legislation and government policy

Remake of Public Ancillary Fund Guidelines

With the current Public Ancillary Fund Guidelines 2011 (2011 Guidelines) scheduled to sunset on 1 April 2022, the Treasurer has released submissions for the remake of the Public Ancillary Fund Guidelines 2022 (2022 Guidelines).

The majority of the 2022 Guidelines are proposed to remain the same as the 2011 Guidelines aside from a few changes to reflect current drafting practice. The important proposed changes are:

  • Section 9: a public ancillary fund must now be established and maintained as a valid trust under common law, State law, Territory law, Commonwealth law and foreign law – not just under State or Territory law.
  • Section 15 and Schedule 1: public ancillary funds that are seeking a reduction in their annual distribution rate and are dissatisfied with the Commissioner’s rejection of their request can now seek a merits review of the decision.
  • Section 24: introduces a specific administrative penalty amount.
  • Section 29: provides guidance regarding the rules referring to the establishment and maintenance of public ancillary funds as deductible gift recipients transition from the 2011 to 2022 guidelines.
  • Section 30: introduces a reduced minimum annual distribution rate in the 2021-22 financial years (and potentially also for the later years) for donations that sufficiently exceed the minimum required distributions during the 2019-20 and 2020-21 financial years.

This article was written with the assistance of Michelle Benington and Gabrielle Terliatan, paralegals.