In summary

The judgment in Clough Limited v Commissioner of Taxation [2021] FCA 108 rules out claiming a deduction under ordinary principles for payments to cancel employee entitlements made to facilitate an acquisition of the company. More concerning was the Commissioner’s apparent willingness to deny tax recognition of the payments altogether under section 40-880. The Commissioner only conceded that a deduction should be allowed over 5 years under 40-880 shortly before trial, allowing the Court to avoid considering the issue. The Commissioner's approach and the lack of judicial guidance on section 40-880 may signal more uncertainty to come.

In detail

Commercial impact

  • Businesses considering paying out employee incentive plans or bonuses as part of a sale process should carefully consider the tax recognition of the payments.

  • Taxpayers typically (in our view, correctly) treat payments to cancel employee incentives as part of capital transactions as being deductible over 5 years under section 40-880. However, the ATO has signalled an aggressive approach to denying access to the “last resort” provisions, so taxpayers cannot simply assume that a section 40-880 deduction is available over 5 years where a section 8-1 deduction is not available.

The decision Clough Limited v Commissioner of Taxation [2021] FCA 108 (Clough) involved a question as to the correct tax treatment of payments to employees to satisfy their rights under a share option scheme (Option Plan) and employee incentive scheme (Incentive Scheme) in the context of an impending sale transaction. While the Commissioner initially challenged the deductibility of the payments under sections 8-1 and 40-880, the section 40-880 position was conceded before trial.

In the years prior to the sale the taxpayer had issued options and equivalent cash rights to key employees. Under the Option Plan and Incentive Scheme the grants were subject to vesting and the board held a discretion to accelerate vesting of the options or rights in the case of a “Change of Control Event”, such as a takeover.

Clough’s majority shareholder (the Purchaser) offered to purchase all of the Clough shares, with a stipulation that Clough should cancel and pay out the Option Plan and Incentive Scheme, which Clough did.

Clough argued that the payments to cancel the rights under the Option Plan and Incentive Scheme were incurred to reward its employees for their past service and to incentivise their future efforts, despite the change in ownership. In essence, the taxpayer argued the expenditure had the flavour of salary and wages and should be deductible under section 8-1.

Colvin J rejected that argument, noting that the effect of terminating the Option Plan and Incentive Scheme was to neutralise the employees’ incentives to stay on until vesting. Further, a new incentive scheme was promptly put in place. The schemes may have had the purpose of motivating employees while operational, but this was not the reason for ending them. They were terminated only because of the change of ownership. Therefore, the payments to cancel the Option Plan and Incentive Scheme were not made with a view to Clough gaining or producing income.

The capital or revenue nature of the payments was not considered in light of the Commissioner’s concession on section 40-880.


It is unusual for any business expense to lack the requisite nexus to the production of income, except where payments relate to the cessation of business or are found to be a distribution of profits. However, in Clough the nexus was found to be broken simply because the taxpayers’ motive for closing out and replacing the schemes was to facilitate a share sale. This may bring into question the immediate deductibility of any non-recurrent expenditure that is undertaken as part of a sale transaction, although in many cases such expenditure is likely to be on capital account.

More generally, Clough marks a refusal to “look through” to the source of an obligation when characterising a payment is made to meet that obligation. In particular, Colvin J gave very little weight to the fact that rights under the schemes had been issued to incentivise employees to work to generate income for the business. Instead, his Honour focussed on the manner in which Clough performed its obligations under the schemes, by electing to make payments in cash prior to the scheduled vesting dates (i.e. closing out the scheme early). This focus led to the conclusion that it was the takeover, not the employees’ service, that resulted in the payments.

This refusal to “look through” to the purpose of the Option Plan and Incentive Scheme was made because the payments did not satisfy accrued entitlements; there was no certainty that the performance conditions for the options and rights would be met or that they would be “in the money” upon exercise. However, it is a timely reminder that the Commissioner is willing to challenge the immediate deductibility of payments made to employees (see, for example, draft TR 2019/D6 in relation to capitalised wages).

The Court was not required to consider whether the payments should be deductible over 5 years under section 40-880 as business capital expenditure because the Commissioner conceded this issue. Given the Commissioner’s willingness to challenge the section 40-880 position until shortly before trial, it is disappointing that the Court was not required to decide the issue as the lack of judicial guidance foreshadows further disputes ahead. At the time of publication of this article, it was not known if the taxpayer had lodged an appeal to the Full Federal Court.