DENMARK'S CONTENTIONS
26 A taxpayer can deduct from assessable income any loss or outgoing to the extent that it is incurred in gaining or producing assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income: s 8-1(1) of the 1997 Act. However, certain deductions are precluded under s 8-1(2) of the 1997 Act which provides as follows:
8-1 General deductions
…
(2) However, you cannot deduct a loss or outgoing under this section to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature; or
(b) it is a loss or outgoing of a private or domestic nature; or
(c) it is incurred in relation to gaining or producing your *exempt income or your *non assessable non-exempt income; or
(d) a provision of this Act prevents you from deducting it.
For a summary list of provisions about deductions, see section 12-5.
(emphasis added)
27 Denmark's position is that none of the amounts incurred in respect of Eligible Project Costs of constructing the windfarm are amounts which it can deduct either as a loss or as an outgoing as they were expenditure incurred on capital account for Plant, Property and Equipment. The deductibility of the entire amount is therefore precluded by the provisions of s 8-1(2)(a) of the 1997 Act.
28 As noted, it is common ground that the Grant was not assessable income under either s 6-5 or s 15-10 of the 1997 Act. Rather, the question is whether the Grant constitutes a 'recoupment' as defined. Again, it appears to be common ground that the Grant, being a portion of the Eligible Project Costs, falls within the meaning of 'recoupment' and 'reimbursement' of an outgoing as envisaged in s 20-25(1)(a) of the 1997, albeit that it is an outgoing on capital account. There is also no doubt that the Grant was not paid by way of insurance. However, Denmark's position is that the Grant is not a 'refund, insurance, indemnity or recovery, however described'.
29 As to the second limb of the definition in s 20-25(1), it is also common ground that the Grant is in respect of a loss or outgoing within the meaning of s 20-25(1)(b) of the 1997 Act, being 'a grant in respect of the loss or outgoing'.
30 Consequently, two alternative questions arise:
(a) was the payment of the Grant an 'indemnity' and therefore assessable under s 20-20(2)?; and
(b) could the depreciation have been claimed under Div 40 of the 1997 Act?
31 Denmark argues that it did not receive the Grant as recoupment of a deductible outgoing by way of indemnity within the meaning of s 20-20(2) for the following reasons:
(a) the Grant was funding Denmark received (via the State) from the Commonwealth, paid to it by the Coordinator. The Grant was paid in respect of a portion of Eligible Project Costs as defined, in respect of the capital costs of land, equipment and services to implement, design, construct and install the Denmark Community Windfarm and to provide for ancillary services to enable the windfarm to supply power to the electricity grid;
(b) the Grant was not paid or received 'by way of indemnity', within the meaning of indemnity in ordinary parlance, the amount not having the quality of a payment 'by way of indemnity'. Nor is it a payment to indemnify a deductible loss or outgoing for the current year or an earlier income year within the meaning of the section of the Note to s 8-1. The amount paid was merely a refund of the expenses of construction which in turn was non-deductible;
(c) the expression 'by way of indemnity' imposes a characterisation test which requires consideration of the character of the amount received. In this instance the amount was paid on account of, and to recoup, non-deductible capital expenditure;
(d) as such, the Grant was not a payment to indemnify or otherwise compensate Denmark in respect of a deductible loss or outgoing for the current year or an earlier income year, the Eligible Project Costs not being deductible to Denmark having been incurred on capital account and accounted for as such. The Grant was not paid to offset a prior or current year deduction.
(e) none of the provisions of the RRPGP Agreement contemplate that the Grant approved by the Commonwealth would be or is paid by way of indemnity. Rather, it is funding provided by the Commonwealth to Denmark to implement the construction of Denmark Community Windfarm in respect of capital costs of equipment and services;
(f) when properly characterised by reference to the RRPGP Agreement under which the Grant was paid, the amounts paid were paid on capital account on account of Eligible Project Costs, and were not paid or received by way of indemnity in respect of a deductible outgoing, this being consistent with the basis on which the Commissioner determined that the Grant was not assessable as ordinary income under s 6-5 or as statutory income under s 15-10;
(g) under s 20-20(2)(b) it is necessary that the taxpayer can deduct 'an amount for the loss or outgoing' under any provision of the 1997 Act. The use of the definite article in the term 'the loss or outgoing' is a reference to the amount of the capital expenditure, which is the outgoing. It does not envisage, as the Commissioner contends, that the term includes depreciable expenses, even though the deduction claimed in any one year may not be for the original loss or outgoing expended to purchase a capital asset, but rather a component of that expense reflecting the declining value of that asset in a given year;
(h) the introductory words to s 20-20(2) and (3) refer to 'an amount you have received as recoupment of a loss or outgoing' which is a reference to the capital expenditure and is not a reference to a deduction; and
(i) in any event, the deduction of an amount representing a decline in value is not a 'loss or outgoing', but rather, is an allowance.
32 As to 'indemnity', Denmark argues that an indemnity can be used in one of two senses. One connotes that there is a contractual relationship by which the indemnifier agrees to insure another party against a contingent loss. In that sense, there would be little difference between a contract of indemnity and a contract of insurance. In the second sense, the term refers to the undertaking to make good a contingent loss, whether or not there is a contractual relationship between the parties to the undertaking.
33 In Batchelor v Federal Commissioner of Taxation (2014) 219 FCR 453, Edmonds, Pagone and Wigney JJ made clear that the words 'insurance or indemnity' are to be given a wide meaning. While in a narrow sense 'indemnity' is a payment in respect of loss or damage, there is a broader meaning identified in Yallop C (ed), Macquarie Dictionary (4th ed, Macquarie, 2005) (at 722) which includes:
protection or security, as by insurance, against damage or loss;
compensation for damage or loss sustained;
something paid by way of such compensation;
legal protection as by insurance from liabilities or penalties incurred by one's actions; and
legal exemption from penalties attached to unconstitutional or illegal actions granted to public officers and other persons.
34 Denmark contends that the general principle is that an amount received by way of insurance or indemnity is treated as income on the basis that it is intended to 'fill a hole' created by a loss of income or profits. This is reflected by the fact that the predecessor to subdiv 20-A, s 26(j), largely replicated this principle. In Federal Commissioner of Taxation v Wade (1951) 84 CLR 105 (at 115), Kitto J noted that 'indemnity' includes a receipt in the nature of compensation by way of a statutory right as well as a receipt under a contract of indemnity. There, the taxpayer received statutory compensation in respect of an actual loss caused by destruction of cattle. Denmark contends that its expenditure was not a loss, but a capital investment.
35 In Batchelor, the Full Court considered the status of an amount described as a return of a deposit, the question being whether the amount of the refunded deposit was an assessable recoupment under s 20-20 or a taxable capital gain. In that case, the taxpayer had acquired an interest in the business and assets of the Cresthaven Village Partnership Agreement for the purchase and development of a property as a retirement village. The taxpayer's share of the deposit was $55,500, being part of an amount she claimed as a deduction for her share in a partnership loss distribution. She had been allowed a deduction for that amount as her share of the deposit paid through the partnership. The venture did not proceed, ultimately resulting in a settlement deed from which the taxpayer received an amount of $47,927. Edmonds and Pagone JJ (with whom Wigney J agreed) observed (at [12]-[15]):
12 Neither s 26(j) of the 1936 Act nor s 20-20 of the 1997 Act is designed to bring to tax every payment received by a taxpayer of an amount for which the taxpayer previously obtained a deduction. In Federal Commissioner of Taxation v Rowe (1997) 187 CLR 266 (Rowe) the High Court by majority rejected the existence of any general principle in taxation law bringing to tax an amount received by a taxpayer which compensates the taxpayer for an item that had previously been allowed as a deduction. The majority pointed at 277 to the existence of s 26(j) as telling against the existence of a general principle of the kind which had been advanced in Rowe. It should not be thought, however, that s 26(j) is as wide as the principle otherwise rejected in Rowe. It may be accepted, therefore, that a payment which has the practical effect of compensating a taxpayer for an amount previously claimed as a deduction will not necessarily make the amount assessable as income.
13 The "recoupment" of a loss or outgoing is one of the conditions for the operation of s 20-20(2). Recoupment is defined broadly (as may be seen by the definition in s 20-25(1)) but, however broad "recoupment" may be, a receipt will only be an "assessable recoupment" if it satisfies the additional conditions in s 20-20(2)(a) and (b). One of those conditions is that the recoupment be capable of bearing the description of being received "by way of insurance or indemnity". An amount will not satisfy that requirement merely by satisfying the definition of recoupment. It may be accepted that the words "by way of insurance or indemnity" are, and are intended to be, wide, but they must be applied as intended. Generally speaking a payment will not be regarded as an indemnity (whether the word is taken alone or in combination in the composite phrase "by way of insurance or indemnity") unless the entitlement to its receipt precedes the event in respect of which it is paid. An ex gratia payment, for example, is not apt to be regarded as indemnification of a loss or outgoing notwithstanding that its receipt may be said, from the point of view of economic equivalence, to compensate the recipient for a loss which had been suffered or an outgoing which had been incurred. Similarly, a refund would not ordinarily be regarded as an indemnification notwithstanding that its receipt may be said to have rendered a taxpayer harmless, from an economic point of view, for an antecedent loss or outgoing.
14 The issue in dispute was raised sharply in this case because the deduction was allowed, probably incorrectly, by the Commissioner at the time that the taxpayer entered the partnership. Section 20-20(2)(b) would not have been satisfied (on any view) if the wrongful deduction had not been allowed, but the question of construing the condition in s 20-20(2)(a) is not to be determined by reference to the mistake (if it was a mistake) of an amount having been allowed. Section 20-20(2) does not provide that an amount received as a recoupment will be an assessable recoupment if it is received and the taxpayer could or did deduct an amount that was recouped. Section 20-20(2)(a) cannot be read as if the words "the amount by way of insurance or indemnity" simply said "an amount". There must be something about the quality of the received amount which may be regarded as being "by way of insurance or indemnity". A mere refund or reimbursement will not ordinarily fit those words because its receipt will not have a quality of the receipt being by way of insurance or indemnity.
15 It is, therefore, to the character of the receipt that one must turn to determine whether what the taxpayer received may relevantly bear the description as being "by way of insurance or indemnity". In Goldsbrough Walters J held that a contract between the purchaser and vendor had obliged one party "to be kept secured against, or compensated for, the expense of rates and taxes". His Honour said at 598:
In the present case, each contract for sale and purchase resulted in the assumption by the purchaser of certain obligations which, but for the transaction, would have rested upon the taxpayer. In terms of the contract, the taxpayer was to be kept secured against, or compensated for, the expense of rates and taxes on the subject property, in so far as the taxpayer might become liable in future to discharge that expense, or in so far as it had already been discharged it: the taxpayer was to be held indemnis. In my view, the language of s 26(j) may be treated as contemplating an indemnification in respect of loss already incurred.
In the present case the payment to the taxpayer was not of an amount from a person who was obliged to make good a loss occasioned by another. What the taxpayer received was a return of the deposit from the person to whom it had been paid by her through the partnership. Clause 10.4 of the contract provided:
If the Purchaser rescinds the Contract as a result of a default by the Vendor, the Purchaser shall be immediately entitled to be paid by the Vendor an amount equal to so much of the Deposit as has then been paid.
What the taxpayer received, in light of the way the case was conducted before the Tribunal, was the return of her deposit pursuant to an entitlement arising under cl 10.4 (whether as a claim for damages or a claim in restitution) plus interest. The latter is plainly assessable as income but the former is not apt to be described as received "by way of insurance or indemnity". It was not an amount paid to compensate a loss but received by her as a return of what she had contributed to the venture. It is a payment unlike that considered in Goldsbrough because it lacked the quality of payment to compensate for some other event rather than because the obligation to be repaid the deposit was in existence before a loss had been suffered or had occurred.
(emphasis added)
36 In relation to the payment of capital argument, the contention for Denmark is that the Grant was not one of indemnity, either within the ambit of the term as set out in s 20-20(2) of the 1997 Act or within the context of the decisions referred to in the Commissioner's Private Ruling or in Batchelor. Denmark submits that the true character of the Grant was that of a payment to reimburse a portion of capital expenditure and that is not within the ordinary meaning of the word 'indemnity'. Therefore, Denmark submits, the Grant was not an 'assessable recoupment' within the meaning of s 20-20(2).
37 Importantly, however, Denmark goes onto argue that even if this is wrong and the Grant should be regarded as being an indemnity in a wide sense, it is still necessary under s 20-20(2)(b) of the 1997 Act that a taxpayer can deduct an amount for the loss or outgoing which has been recouped for the current year, or an earlier income year, under any provision of the 1997 Act. An allowance for depreciation could only ever relate to the year in which the asset is held ready for use or for a later year. This fact underscores Denmark's contention that the assessable recoupment provisions are designed to reverse the effect of past deductions and do not apply to cases such as the present where, Denmark submits, no 'deduction' was allowed for the outgoing.
38 The Commissioner asserts that a fundamental requirement for an amount to be an assessable recoupment is that the taxpayer has deducted or can deduct an amount 'for the outgoing'. That is, there is a connection between the deduction and the outgoing. That connection, the Commissioner submits, is that the outgoing that the taxpayer has subjected itself to is the asset's cost, and the amount that is being deducted is calculated by reference to the decline in value of the asset. The deduction envisaged in s 20-20(2)(b) is for the outgoing under any provision of the 1997 Act. Denmark asserts that this misconstrues the tests in s 20-20(2) and s 20-20(3), the proper test being, 'was the amount received as reimbursement of a deductible loss or outgoing?' Denmark says, in this case, the character of the receipt determines that it was not an assessable recoupment.
39 Denmark also argues that the Commissioner is mistaken in stating that the outgoing was deductible under Div 40, so satisfying one of the requirements of s 20-20(3), as the outgoing was never deductible. The capital allowance in respect of the depreciating asset is a provision or allowance and is not an 'outgoing'. It is simply a deductible allowance designed to reflect an assumed reduction in the value of the depreciating asset through age, use or altered technology.
40 The other question to consider is that of 'other recoupment'. An amount received as recoupment of a loss or outgoing (except by way of indemnity or insurance) is assessable under s 20-20(3) of the 1997 Act if the taxpayer can deduct an amount for the loss or outgoing for the current year, or it has deducted or can deduct an amount for the loss or outgoing for an earlier income year under a provision listed in the tables to s 20-30. If, as the Commissioner contends, 'indemnity' is to be interpreted widely to include the Grant which was paid on capital account, Denmark contends that it would not be necessary to include s 20-20(3) of the 1997 Act because 'indemnity' would include every form of payment. Rather, Denmark argues, the amount of the Grant is not an 'assessable recoupment' of a loss or an outgoing because it cannot deduct an amount for the outgoing for the current year under a provision listed in s 20-30, nor had it deducted nor could it deduct an amount for the outgoing for an earlier income year under a provision listed in s 20-30 or under another provision of the 1997 Act. Denmark argues that the deductibility of the outgoing, being the Eligible Project Costs, is actually precluded under s 8-1(2)(a) of the 1997 Act. Accordingly, Denmark submits, the Grant is not an assessable recoupment within the meaning of s 20-20(3) as the amount of capital expenditure in respect of an Eligible Project Cost is not a deductible loss or outgoing, but rather, an expenditure on capital account. Section 20-20(2)(b) and s 20-20(3)(a) or (b) are both predicated on the deductibility of the loss or outgoing in the current year or an earlier income year. The outgoing is the expenditure on Eligible Project Costs, which is not deductible, and therefore neither subsection has room to operate, according to Denmark.
41 Section 20-20(3) of the 1997 Act applies on its terms to the deduction of 'an amount for the loss or outgoing' in respect of which the recoupment is received for the current or an earlier year. Denmark argues that the outgoing posited by use of the definite article in the expression 'the loss or outgoing' is a reference to the amount paid on an account of Eligible Project Costs. This is not the amount which may be an allowable deduction under Div 40, which relates to a decline in value of a depreciating asset held by a taxpayer. Division 40 does not relate to a deduction for the amount of the 'outgoing'. 'The decline in value' is not 'the outgoing' predicated in s 20-20(3) and, in any event, the 'decline in value' is not an outgoing but is an allowance or provision.
42 For those reasons, Denmark argues that an assessment under s 20-20(3) is incorrect. There is conceptual confusion in treating 'the amount of the outgoing' with the 'amount of the decline in value' as meaning the same thing when they do not.
43 Both for the purpose of s 20-20(2) and s 20-20(3) of the 1997 Act, Denmark contends it is necessary that it 'received' the amount of the Grant 'as recoupment of the loss or outgoing' on one or another of the conditions posited in those sections. Denmark submits that these provisions import a characterisation test as to the nature and quality of the amount received. The correct characterisation of the amount Denmark received, it says, is that it was paid on account of non-deductible capital expenditure, defined as Eligible Project Costs, for which Denmark is not entitled to a deduction for an earlier year or for a current year under Div 8 or Div 40 or under any other provision of the 1997 Act.
44 On that basis, Denmark again asserts that the amount of the Grant is not an assessable recoupment of a loss or an outgoing because it cannot deduct an amount for the outgoing for the current year under a provision listed in s 20-30, nor did it deduct nor could it deduct an amount for the outgoing for an earlier income year under a provision listed in s 20-30 or any other provision of the 1997 Act. While depreciation is deductible by way of a capital allowance under either Div 40 or subdiv 328-D, Denmark submits that the Grant was not paid to refund a capital allowance or depreciation, nor could it be so characterised. Rather, the Grant was an amount paid to fund one half of the capital costs of construction by way of reimbursement of the cost of the Eligible Project Costs. Again, Denmark asserts the amounts expended on construction were not deductible costs, but capital costs.
45 As an alternative construction pertaining to subdiv 328-D, Denmark contends that because subdiv 328-D is not listed in the table set out in s 20-30, the amount of the Grant is not an assessable recoupment for the purpose of s 20-20(2) or s 20-20(3). As a further alternative, it is contended by Denmark that if the allowable depreciation under Div 328 is a deductible amount for the purpose of s 20-20(2)(b), it is submitted that the assessable recoupment is limited to the amount of the deductible depreciation in the current year (2014) or in prior years. It would not extend to the full amount of the Grant.