Email Ltd v Commissioner of Taxation

"To make a payment to acquire or to defend the acquisition of a favourable position from which to earn income or to enter into arrangements that will yield income is not in general an outlay incurred either in gaining or in carrying on business for the purpose of gaining assessable income; such a payment in the case of a trading company, occurs at a stage too remote from the receipt of income to be so regarded."(47-48)

3 To come within the scope of the second limb, Menzies J said:

"… there must, if an outgoing is to fall within its terms, be found (i) that it was necessarily incurred in carrying on a business; and (ii) that the carrying on of the business was for the purpose of gaining assessable income. The element that I think it necessary to emphasise here is that the outlay must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations."

4 The word "necessarily" in the second limb means "clearly appropriate or adapted for": Federal Commissioner of Taxation v Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278 at 284 per Gibbs CJ. In Foxwood (Tolga) Gibbs CJ also made the point that the two limbs are not mutually exclusive. 5 The effect of the applicant's argument in the present case is that the relevant payments are deductible under both limbs of the subsection. The respondent, the Commissioner for Taxation ("the Commissioner"), submits that the payments were payments of capital or of a capital nature and, hence, that they are not deductible under either limb (at 283).

The Facts 6 Email is a listed public company. It has numerous subsidiary companies who undertake a diverse range of businesses. Email's business activities include acting as a service provider for the companies that constitute the Email Group and maintaining the head office for the group. Email also involves itself in the operations of one of its groups - the Industries Products Group - and conducts administrative activities for another group. 7 Prior to 4 May 1988, Dowell Australia Limited ("Dowell") was a company that was 50 per cent owned by Alcoa of Australia Limited ("Alcoa") and, as to the remaining 50 per cent, by Overseas Corporation (Australia) Limited ("OCAL"). OCAL was a wholly owned subsidiary of McIlwraith Davey Industries Pty Limited ("MDI") which, in turn, was wholly owned by Email. Dowell's business consisted of selling fully fabricated windows and other extruded systems together with associated timber window facilities.

By Deeds of Sale dated 4 May 1988, Alcoa and OCAL agreed to sell their shares in Dowell to Boral Cyclone Limited ("Boral Cyclone") for $20,775,000 each.

8 As part of the terms and conditions of the Deeds of Sale, Email and OCAL on the one hand, and Alcoa on the other, gave certain warranties and indemnified Boral Cyclone against any losses that it might suffer as a result of a breach occurring of any of the warranties. I will refer to these warranties and indemnities compendiously as "the indemnity" 9 The warranties that Email gave under the Deed of Sale, so far as they are relevant to these proceedings, were as follows: "4.3 The vendors make the following representations and warranties, each of which is true on the Settlement Date and each of which shall survive the Settlement Date and the completion of the sale and purchase hereby agreed to be made and each of which is an independent, separate and severable representation and warranty: (a) … (b) … (c) the Company (ie Dowell) has since 30 June 1987 carried on its business in a proper and businesslike manner and is not in breach of any of the Current Contracts in any material respect and the Company is not aware of any breach in any material respect of any of the Current Contracts by any of the other parties thereto and the Vendors are not aware of any grounds upon which any of such contracts may be rescinded or terminated; (d) … …

(w) the Company has not incurred or will not incur at any time in the future any liability whatsoever arising out of any contract (other than any of the Current Contracts) entered into with, work done for, materials provided to or advice given to any customer or other person or otherwise arising out of the conduct by the Company of its business (in all of its aspects) at any time prior to the Settlement Date except to the extent to which such liability is provided for in the April Accounts;"

10 The indemnity that Email gave to Boral Concrete was contained in sub-cl 5.1 of the Deed of Sale: "OCAL and Email jointly and severally covenant and agree with the Purchaser to indemnify and keep indemnified the Purchaser against: (a) half of any losses, damages, claims and demands arising out of any breach or breaches by the Vendors of the warranties in clause 4.3 hereof; and

11 In the seven accounting periods to which these proceedings relate (i.e., the period ending 31 March 1990 up to and inclusive of the period ending 31 March 1996) Email paid out $5,207,752.89 as a consequence of the indemnity. The payments so made were, for the most part, reimbursement of moneys paid by Dowell in settlement of claims that had been made against it by its dissatisfied customers; there were also some related legal costs. 12 The total consideration for the sale of the shares in Dowell exceeded the amount at which the investment in Dowell had been recorded in the balance sheet of OCAL and in the consolidated balance sheet of the Email group. Consequently, a profit was recorded in the profit and loss account of OCAL. The profit also appears in the consolidated profit and loss account for the Email group. This profit was reported in OCAL's financial statements as an "extraordinary item" in an amount in excess of $5.6m and was treated as a capital profit for taxation purposes. At the time of the sale by OCAL of its shares in Dowell, a provision of $5m was established in Email's accounts relating to the indemnity that it had given to Boral Cyclone in the Deed of Sale; that $5m was reflected in Email's profit and loss account (but not for taxation purposes) as an expense in the year of sale. As a consequence, Email's profits from its general activities in the year of sale were reduced by $5m. In the seven years following the sale, Email was obliged to make payments in each year under the indemnity and, by objections first lodged in December 1996, claimed deductions for income tax purposes in respect of the payments so made. In that same seven year period, the provision in the accounts was reduced by the amounts of the payments. There was no impact on Email's profit and loss account until the 1996 accounting period when the amount of the last of the claims, when added to the earlier claims, took the total of all claims just past the $5m mark. 13 The Commissioner refused Email's claims that the indemnity payments that it made in each of the seven accounting periods in question were losses or outgoings that were deductible under either limb of subs 51(1) of the Act. Email objected against the Commissioner's subsequent assessments, but the Commissioner disallowed those objections. Email now appeals to the Court against each of the appealable objection decisions.

The Nature of Email's Business 14 The total of the amounts initially claimed by Email as deductions was $5,207,752.89. However, the parties have agreed that an amount of $152,445.96 in respect of the period ending 31 March 1996 is not to be pressed at this stage. Hence, the total of the amounts involved is presently fixed at $5,055,306.93. 15 Mr Edward Brink, who filed an affidavit in these proceedings as part of the applicant's case, was made available for cross-examination. Although now retired, he had been, since 1988, the Finance Director of Email; previously he had been the company's Group General Manager - Finance and Administration. In that capacity he had been responsible for all the accounting and finance functions as well as many of the commercial aspects of Email and its "controlled entities." I take that expression to mean conventional subsidiary companies together with joint venture operations of which Dowell would be an example. Mr Brink's duties did not materially alter with his appointment to the Board of Email. 16 Mr Brink explained that Email's activities as a holding company were productive of assessable income in the form of dividends from its controlled entities. He said that it was the ordinary practice of Email to ensure that the profits (including capital profits) of its controlled entities were available for and ultimately returned to Email by way of dividends. Whilst the dividend history of OCAL does not support this statement, the dividend history of MDI does. OCAL's profit on the sale of the shares in Dowell occurred in the accounting period that ended on 31 March 1989. Hence the profit on the sale could have been the subject of a dividend flowing through to Email in that accounting period. This did not occur however. The dividend declared by OCAL was only $262,794 and its subsequent dividends were only $1,116,338, $822,405 and $30,691 for the 1990, 1991 and 1992 accounting periods. OCAL has not declared any dividends since then. 17 On the other hand, the information that is contained in par 31 of Mr Brink's affidavit showing dividends received by MDI and declared and paid by MDI in the same accounting period, supports Mr Brink's general proposition. In the thirteen accounting periods from 31 March 1985 to 31 March 1997, the dividends received and paid by MDI were identical in nine cases; no dividends were received or paid in two periods and the information for the accounting period that ended on 31 March 1987 was not available. It was only in respect of the 1993 period that the dividend paid by MDI was less than the dividend that it received . MDI received $7,295,375 but only declared and paid a dividend of $5,895,921. 18 In par 35 of his affidavit, Mr Brink pointed out that if OCAL had not sold its shares in Dowell to Boral Concrete, the liabilities that ultimately matured (and which were the subject of the indemnity) would have had the effect of depressing Dowell's future profits, thereby reducing the dividend stream that would otherwise have been available to Email. That statement is seemingly correct but, during his cross-examination, Mr Brink had to agree that Email had made provision in its profit and loss account for a contingent liability of $5m in respect of the indemnity. Although this sum was not claimed as a deduction for income tax purposes, Email's published accounts included this provision and so its reported profits were accordingly reduced. The action in making this provision seems therefore to negate the proposition that Mr Brink was advancing in paragraph 35 of his affidavit. It seems to me to be of more significance to note that if OCAL had not sold its shares in Dowell, Dowell would have, in due course, accepted and paid out all claims of about $5.2m but would have thereby been entitled to claim the greater part of those payments as deductions for income tax purposes - probably under the second limb under subs 51(1) of the Act. 19 To bring itself within one or other of the two limbs of subs 51(1) Email must satisfy the Court either that the indemnity payments were losses or outgoings that were incurred in gaining or producing assessable income or that they were necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. A key issue in this case, therefore, is to identify the business of Email. Identification of the business will help in determining whether the indemnity payments were incurred in gaining or producing the assessable income of the business. It will also be an aid in determining whether they were necessarily incurred in carrying on the business. 20 In my opinion, the evidence in this matter is sufficient to support a finding that Email was, at all material times, carrying on a business that may be described as acting as the holding company of a group of companies. But it was not a mere passive holding company doing nothing other than receiving and distributing a dividend flow. It was active in the numerous ways that Mr Brink listed in par 12 of his affidavit; it was responsible for providing a variety of services to its controlled entities; those services included such matters as the management of cash flows, currency fluctuations, and interest rate exposures, the provision of legal, taxation, internal auditing and accounting services, training, information technology and recruitment and human resources. Of particular interest to this case was Mr Brink's assertion that the services that Email provided, and hence, an aspect of its business activities, included the provision of warranties and indemnities on the sale of shares in or the sale of businesses by controlled entities. On the other hand, if, as I believe, the correct description of that business is to act as the holding company of a group of companies then, when any of the companies in the group is sold, that is not a sale in the ordinary course of any business that is being conducted by the holding company - it is the sale of a capital asset. It produces an enduring benefit to the holding company and the group in the sense that it liberates the sale proceeds for the use of the group. 21 The advice of the Privy council in American Leaf Blending Co. Sdn. Bhd. v Director-General of Inland Revenue [1979] AC 676 shows how little a company need do to be classified as carrying on a business. In that case, the company had abandoned its tobacco business; it leased out its warehouse and factory and brought to account the rents that it received as assessable income. Its claim to set-off earlier losses against its assessable income was disallowed on the ground that its leasings did not amount to carrying on a business. The advice of their Lordships was given by Lord Diplock. In concluding that rents could constitute income from a business source his Lordship said at 684: "In the case of a private individual it may well be that the mere receipt of rents from property that he owns raises no presumption that he is carrying on a business. In contrast, in their Lordships' view, in the case of a company incorporated for the purpose of making profits for its shareholders any gainful use to which it puts any of its assets prima facie amounts to the carrying on of a business. Where the gainful use to which a company's property is put is letting it out for rent, their Lordships do not find it easy to envisage circumstances that are likely to arise in practice which would displace the prima facie inference that in doing so it was carrying on a business.

The carrying on of "business," no doubt, usually calls for some activity on the part of whoever carries it on, though, depending on the nature of the business, the activity may be intermittent with long intervals of quiescence in between. In the instant case, however, there was evidence before the special commissioners of activity in and about the letting of its premises by the company during each of the five years that had elapsed since it closed down its former tobacco business."

22 Mr Gzell QC, counsel for Email, submitted, and I agree, that the action of Email in giving Boral Concrete the indemnity was not an isolated transaction; it fell within a pattern of activity. Furthermore, it was not merely for the benefit of the vendor of the shares (ie OCAL) that Email gave the indemnity; it was also for the benefit of Email, which as the ultimate holding company, stood to benefit from the price achieved by OCAL on the sale of the shares. Email stood to gain an advantage in that its indemnity would encourage a prospective purchaser to pay a higher price for the shares and a higher price would mean a greater dividend in the hands of Email.

Capital or Revenue 23 The members of the High Court (Brennan, Dawson, Toohey, Gaudron & McHugh JJ) in their joint judgment in GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1989-1990) 170 CLR 124 at 137 said that: "The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid". 24 Two years later the same members of the High Court sat with Mason CJ and Deane J in Mount Isa Mines Ltd v Federal Commissioner of Taxation (1992-1993) 176 CLR 141 and reaffirmed that statement (at 149n45)). 25 In the present case no asset was acquired but certain liabilities were discharged. When it is recognised that the relevant liabilities were incurred as a consequence of the sale by a subsidiary company of income earning assets, there is, at the very least, a prima facie case for arguing that the liabilities were of a capital nature. As Menzies J described the situation in John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (see above) these would be payments to defend "the acquisition of a favourable position" and as such would not normally be deductible under the first limb and they would not be deductible under the second limb unless they were necessarily incurred in carrying on a business for the purpose of gaining assessable income. 26 The context in which a taxpayer makes a particular payment is of importance in determining whether it is a payment of a capital or a revenue nature. But as Burchett J said in Commissioner of Taxation v Ampol Exploration Ltd (1986) 13 FCR 545 at 573: "The difficulty of cases concerned with the question of whether an outgoing is of capital or of a capital nature or whether it is a revenue outgoing is not a difficulty of comprehension of the principle involved, but of its application to the infinite variety of business circumstances." 27 His Honour then went on to quote from the well known judgment of Dixon J in Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 at 646:

"The truth is that, in excluding as deductions losses and outgoings of capital or of a capital nature, the income tax law took for its purposes a very general conception of accountancy, perhaps of economics, and left the particular application to be worked out, a thing which it thus became the business of the courts of law to do."

28 Dixon J had also discussed this same problem much earlier in the equally well-known case of Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 363. On that occasion his Honour said: "There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment." 29 In terms of the factors enunciated by Dixon J in Sun Newspapers, Mr Gzell QC for Email advanced the following propositions: (a) the character of the advantage to Email was the protection of its commercial reputation and the enhancement and protection of its dividend stream; (b) the manner in which that advantage was to be used or enjoyed by Email was by maintaining the level of profit generated by its operating businesses and by the receipt of dividends from its subsidiaries as their enhanced profits filtered through to the holding company and by the adoption of a policy of repatriating the profits of subsidiary companies to the holding company as dividend income;

(c) the means adopted by Email to obtain the advantage was by meeting warranty claims against the Email Group and by granting indemnities as the need arose in relation to the sale by subsidiaries as an ordinary incident of its business operations, both as a holding company and as a member of operating groups.

30 Examples of the application of the principles laid down by Dixon J are numerous. Thus in Commissioner of Taxation v Ampol Exploration (see above) Lockhart & Burchett JJ (Beaumont J dissenting) came to the conclusion that payments made by a company that was engaged in exploring for hydrocarbons off the China coast pursuant to an agreement with an agency of the Chinese Government were payments made on account of revenue and deductible under both limbs of subs 51(1). 31 Lockhart J described the outgoings this way at 562: "The true legal character of the expenditure was that of the ordinary business activity of the taxpayer as a petroleum exploration company. From a practical and business point of view the taxpayer sought to adopt one of a number of possible methods in which it engaged for the purpose of its exploration business to obtain, if all went well, the possibility of a right to bid to undertake further seismic and exploration work. The expenditure could not lead to the establishment of an income-producing asset for it to exploit and it was recurrent and in the nature of operating expenses of the taxpayer's prospecting and exploration business. Recurrence is, however, merely one matter to consider. … … The payments in question were in truth part of the outgoings of the taxpayer in the course of carrying on its ordinary business activities. It was not expenditure incurred for the purpose of creating or enlarging a business structure or profit-yielding or income-producing asset." 32 Burchett J, after noting that an assignment of an expense to capital or revenue account cannot be determined by assessing whether the transaction was successful said at 574-5: "It seems to me the test can only be sensibly applied, in such a case as the present, on the basis that, the enterprise being the exploration company itself, the relevant business organisation, implement, or means of production, is its exploration arm (including all its skilled employees and sophisticated equipment), and not any one project undertaken by that arm. A project is a part of the regular performance and sustained effort being carried on by the enterprise, all the activities of which are directed to the finding and commercial exploitation of undiscovered oil. But once the matter is so regarded, there is no longer any question: the expenditure is a quite ordinary incident of the company's operations." 33 The facts in Commissioner of Taxation v E A Marr & Sons (Sales) Ltd (1984) 2 FCR 326 bear some resemblance to the facts of this case in that the taxpayer made payments for the benefit of related companies; the particular facts established that the receivers and liquidators of a company had made payments of amounts owing to leasing financiers in respect of plant and equipment which the company had made available to its related companies without charge. In a joint judgment (Bowen CJ, Toohey and Lockhart JJ), the Court held that such payments were payments made in the course of carrying on the company's business by reason of the fact that the company's activities as a whole included the provision of management and administrative services to related companies; the provision by it of the plant and equipment was part of those services. At 331 the Court said: "The taxpayer's leasing activities have a commercial explanation. Indeed, if they were not part of the carrying on of the taxpayer's business it is difficult to see how else they could be properly described." 34 There is also a commercial explanation in this case. There is evidence to support the finding that it was in the interests of Email as the ultimate holding company to give Boral Concrete the indemnity; the inference can be drawn that Email thereby offered Boral Concrete a measure of security that it would not otherwise have enjoyed. In return, the absence of such an indemnity could have meant that an intending purchaser might have decided against purchasing or might have made a reduced offer. By this means one can recognise the existence of the advantage that was obtained by Email in return for its promise to indemnify the purchaser of the shares in Dowell. 35 In Federal Commissioner of Taxation v Total Holdings (Australia) Pty Ltd (1979) 24 ALR 401, the taxpayer was a wholly owned subsidiary of a French company; it acted as a holding company in Australia for its French parent's interests. From 1963 to 1968 the taxpayer owned the whole of the shares in an operating company which sold in Australia the products of the French company; in 1968 the taxpayer reduced its shareholding in the operating company to 50 percent. Between 1963 and 1968, the financing of operations in Australia was carried out by the French company lending money to the taxpayer at 3 per cent per annum for varying periods up to ten years. The taxpayer would then on-lend money to the operating company or take up further shares in it. In these periods, loans from the taxpayer to the operating company were interest free but repayable on demand. From 1968, after the operating company ceased to be a wholly owned subsidiary, the taxpayer charged interest at the rate of 7 per cent. For the year ended 30 June 1972, the Commissioner allowed the taxpayer, as a deduction, that part of prior losses which represented interest paid by the taxpayer to the French company on the money used to acquire shares in the operating company and on the money that was lent at interest to the operating company. The Commissioner disallowed so much of the losses as represented interest paid by the taxpayer to the French company on the money that the taxpayer had lent interest free to the operating company. 36 The taxpayer objected successfully to the Supreme Court of New South Wales and the Commissioner's appeal to the Full Court of this Court was dismissed. The leading judgment was given by Lockhart J (with whom Northrop and Fisher JJ agreed). He concluded that the payment of all interest by the taxpayer satisfied the tests required in respect of each limb of subs 51(1). His Honour was of the opinion that the liability of the taxpayer for interest to the French parent was incidental and relevant to the derivation of its income and was part of its business activities. In formulating these conclusions, Lockhart J said: "The moneys advanced by [the French company] to the taxpayer were required, by the terms of the loan agreements, to be allocated by the taxpayer to investments in Australia approved by [the French company]. The loans were all long-term loans so structured that the taxpayer had the use of the money for a long period of time. In my opinion, it is clear from the evidence that the moneys borrowed by the taxpayer from [the French company] were to be used by it for financing [the operating company] in whatever way was regarded as appropriate from time to time, whether this be by taking up shares in [the operating company] or making advances to it with or without interest and, if with interest, at whatever rate of interest might be thought appropriate. It was regarded as appropriate to fund [the operating company] primarily by interest-free loans, not only to place it in the best light so far as its accounts were concerned, but to minimize the tax consequences that would flow from the acquisition of further shares by the taxpayer in [the operating company] and the consequent payment of dividends by [the operating company] to it, assuming there were sufficient profits. Those dividends would not be deductible to [the operating company]. The loans by the taxpayer to [the operating company] were repayable on demand. Thus it was within the power of the taxpayer, at any time it wished, to restructure the financing of [the operating company] by calling up the loans and using the funds in some other way, whether by taking up further shares in [the operating company] or the making of loans at an appropriate rate of interest. Also, there was no guarantee that the many millions of dollars which the taxpayer had invested in [the operating company] would ultimately produce a profitable trading entity. The activities of the taxpayer were designed to render [the operating company] profitable as soon as commercially feasible and to promote the generation of income by [the operating company] and its subsequent derivation by the taxpayer and thence [the French company]." 37 The essential element in this decision, in its application to the present case, is that the generation of profits by the operating company and the intended flow-on benefits to the taxpayer was a sufficient connection to enable the taxpayer to claim all interest payments as deductions. The decision in Total Holdings also makes it clear that one must assess the situation by identifying what it is that Email has achieved. The fact that the profit that OCAL made on the sale of the shares was a capital profit is not to the point and is irrelevant for the purpose of characterising the nature of the outgoing that was incurred and paid by Email: see Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 where by Gibbs ACJ said at 656-657: "I have said that in deciding whether outgoings made by a taxpayer are of a revenue or of a capital nature, it is necessary to consider "the character of the advantage sought". In my opinion, in principle, that must mean the character of the advantage sought by the taxpayer for himself by making the outgoings. Of course, as I have already indicated, a taxpayer may derive an advantage if someone else, such as a subsidiary, acquires an asset. But the fact that someone else incidentally derives an advantage of a capital kind in which the taxpayer does not share is not enough to give the outgoings the character of capital." 38 Stephen and Aikin JJ made the same point at 662: "That others obtained, to its knowledge, a collateral advantage, even if it were of a capital nature, was not the advantage that it either sought or obtained." 39 In Europa Oil (NZ) Ltd (No 2) v Commissioner of Inland Revenue [1976] 1 WLR 464 (PC) Lord Diplock said that: "… it is not the economic results sought to be obtained by making the expenditure that is determinative of whether the expenditure is deductible or not; it is the legal rights enforceable by the taxpayer that he acquires in return for making it." 40 But in Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183 Brennan J said that he thought that the principle laid down by Lord Diplock "may be too widely stated to be applied in s 51(1) in every case." (190). Further on, at the same page, his Honour continued: "But there are cases where expenditure is not incurred solely to acquire an asset or legal right under a contract or to discharge a legal obligation, and there are cases where there is dispute as to the scope and nature of activities and operations by which assessable income is or is intended to be gained or produced, or by which a business is carried on. In cases of these kinds, the Europa approach does not give adequate guidance to a court in finding whether the expenditure is deductible under sec 51(1)." 41 NMRSB Limited v Federal Commissioner of Taxation 98 ATC 4188 is another example of the difficulty in determining whether outgoings are of a capital or a revenue nature. In that case the taxpayer, then a building society, entered into merger negotiations with a disassociated entity. In order to gain support for the merger from its members and depositors, the taxpayer made them a "Special Interest Offer". The merger proceeded with the support of the members and depositors. Over a period of five years, the implementation of the "Special Interest Offer" meant that the taxpayer paid out over $20m in additional interest to its depositors. The Commissioner treated those additional payments as payments on account of capital, arguing that the reason for the payment of the additional interest was the agreement that had been made between the merging parties or the offer that the taxpayer had made in the documents that it had submitted to its depositors. Sackville J, however, rejected these arguments, finding in favour of the taxpayer. His Honour held that the additional interest was paid by the taxpayer to continuing depositors pursuant to legally binding arrangements and that it had an obvious relationship with the conduct of the taxpayer's business. Those two factors are, in my opinion present in the instant case - namely, the payments were made pursuant to legally binding arrangements and the payments had, as I have found, an obvious connection with the conduct of Email's business. 42 Carapark Holdings Ltd v The Commissioner of Taxation of the Commonwealth of Australia (1965-1966) 115 CLR 653 is an example of the reverse situation, that is, it is an example of a taxpayer's receipts being assessable income notwithstanding that the relevant sum was sourced out of an event in a subsidiary company. The taxpayer, a holding company, had insured the lives of certain employees of subsidiary companies. In holding that the amount received by the holding company was assessable, the members of the High Court in their joint judgment said at 663: "True, in a case like the present the insurance money was not received by the appellant to take the place of what Lord Greene described as "those benefits on revenue account which it would have received if it had continued to enjoy (the employee's) services", for the appellant was not itself in enjoyment of those services. But it was in enjoyment, through the medium of dividends from the employing companies, of some or all of the profits of those companies which, on the one view of the purpose of the insurance, the services of the employees were helping to produce and which, on the other view of that purpose, the payments to injured employees or to dependants of deceased employees would necessarily reduce. So whichever of the purposes was the true purpose, the situation simply is that the appellant, rather than leave the employing companies to take out separate insurances designed to bring in money in place of profits which would be lost to them if any of the events insured against should occur, itself took out a single policy in its own name to provide directly against such loss of dividend income as it might itself suffer, really, though indirectly, in consequence of the death or disablement of any of the employees. Accordingly the insurance moneys which the appellant received in respect of the death of Williams must be considered as having been gained in the course of its business, using "business" in the broad sense which makes it relevant to the tax problem …" 43 This passage identifies the importance of the relationship between dividends that flow through to the holding company and the expenditure that the holding company is seeking to deduct from its assessable income. 44 Three cases from the United Kingdom that dealt with payments made under guarantees were cited by Mr Gzell QC for the taxpayer as having persuasive value in this case. The first of them was Morley v Lawford and Company (1928) 14 TC 229. The taxpayers, a firm of contractors, were guarantors for 500 pounds to the British Empire Exhibition; they claimed a deduction of 375 pounds being the amount paid by them under the guarantee. The taxpayers established that they had been told by a representative of the Exhibition that guarantors would be given preference in the allotment of contracts for work at the Exhibition. The taxpayers gave the guarantee with the sole object of obtaining a contract to carry out works for the Exhibition but, in fact, were unsuccessful in obtaining one. The General Commissioners decided that the amount paid under the guarantee was money expended wholly and exclusively for the purpose of the taxpayer's trade and was therefore deductible. The Court of Appeal, holding that the matter was primarily a question of fact, declined to intervene. 45 The next case was Hunt v Wellesly (1945) 27 TC 78. In that case the taxpayer lent money to a company and also guaranteed its overdraft account with its bank. The company had been formed for the express purpose of making a film and the taxpayer was the artistic film producer. The film was produced, but at a loss. No moneys were repaid to the taxpayer who also had to pay money to the bank under the guarantee. The taxpayer was successful in contending that the sums advanced by him to the company and the sum paid by him to the bank were expenditure incurred by him wholly and exclusively for the purpose of his profession and were therefore deductible. 46 The last of these three cases was Jennings v Barfield (1962) 40 TC 365. The taxpayers, a firm of solicitors paid out money under a guarantee that they had given to a client's banker. The taxpayers convinced the General Commissioners that the practice of solicitors acting as a guarantor for a client was so common that it was to be regarded as part of the usual business of a practicing solicitor and that the payment made under the guarantee was, on ordinary principles of accounting, a revenue payment. Whilst that case might be distinguished on its facts in Australia, the principle for which it is authority, along with the decisions in Morley v Lawford and Hunt v Wellesley lend support to the taxpayer's arguments in the present case. 47 A similar result was obtained by the taxpayer in 15 CTBR(NS) Case 33. The taxpayer was a property owning company which had a number of operating subsidiaries from whom it derived dividends. Its only other income was from interest and rents. The taxpayer guaranteed the repayment of the overdraft account of a customer of one of its subsidiaries in anticipation that the customer would continue to purchase goods from that subsidiary. The taxpayer sought a deduction for the amount that it was required to pay under the guarantee. The Board of Review decided, by a majority, in favour of the taxpayer. In their joint decision Mr JD Davies (later Davies J of this Court) and Mr GR Thompson said, quoting Hunt v Wellesley as authority: "It has never been doubted that an outgoing is allowable as a deduction though it, or the occasion for it, affects the income of another person or body as well as that of the taxpayer."(at 217) 48 Giving the indemnity to Boral Concrete assisted Email in various ways. It aided in getting the best price and making the best use out of an asset of a controlled entity. It thereby preserved and enhanced its future dividend stream.

The Case for the Crown 49 But did the indemnity, and the due performance of the obligations under the indemnity, also enhance Email's commercial reputation and that of its subsidiaries? Counsel for the Commissioner, Mr Durack S.C., disputed that the indemnity and the payments under the indemnity can somehow be related to the preservation of the reputation of Email and the Email group. He pointed to the evidence of Mr Brink who conceded that some of the payments that had been made by Email were only made after Dowell had been sued to judgment by dissatisfied customers. He also pointed out that, in his affidavit, Mr Brink had nowhere referred to the subject of the reputation of Email and the Email group. Mr Brink's evidence was that "without a holding company guarantee" in respect of the rectification costs of a number of major projects that had been undertaken by Dowell, "the shares would not have been saleable at a satisfactory price" and the indemnity was given "in order to ensure the most profitable sale". Mr Durack submitted that this statement identified the true purpose of the advantage that was sought by the giving of the indemnity and the making of the subsequent payments, and that there was no evidence to justify a finding that the indemnity was given and the payments were made to meet allegations of faulty workmanship which, if not met, would have reflected upon Email and its reputation. In my opinion, the submissions that were made on behalf of the Commissioner in respect of this issue of commercial reputation are correct. However the evidence is not sufficient to sustain a finding that the payments under the indemnity enhanced the commercial reputation of Email. 50 Counsel for the Commissioner submitted that the decision in Total Holdings was distinguishable on three grounds. First he put forward the proposition that Dowell was not a subsidiary of Email: it was a company in which Email's subsidiary owned 50 per cent of the issued share capital, whereas in Total Holdings the taxpayer had made payments for the benefit of a wholly owned subsidiary. I do not see that this difference would have any effect on the principle that is to be found in the decision of the Full Court. Next it was claimed that, in the present case, the payments that were made under the indemnity were not made to customers who were claiming against Email - the payments that were made had been made in order to discharge an obligation to a purchaser of the shares. With respect, I do not see that the identity of the payee is important; the issue of importance is Email's purpose in making the payment. Finally it was claimed that the obligation to the purchaser was one that was undertaken at the time of the disposal of the shares pursuant to the terms of a specific clause in the Deed of Sale. It was the case for the Commissioner, therefore, that the sale of the shares in Dowell could not be treated as a sale of an asset that occurred in the ordinary course of the business of OCAL or of Email. In other words, the sale of the shares was not an integral part of the activities of Email or of the Group of which it was the holding company: c.f. the contrary position in London Australia Investment Co Ltd v Federal Commissioner of Taxation (1977) 138 CLR 106. 51 The Commissioner accepts that, in addition to its primary role as a holding company, Email was involved in business activities in that it was involved in activities other than the restricted activities of a conventional holding company. However, so the Commissioner maintained, Email was not carrying on a business in which the payments made pursuant to the indemnity could be regarded as an ordinary incident of or an integral part of the business. The case for the Commissioner rested upon the premise that the indemnity that Email gave, and the payments that it made in pursuance of that indemnity, were given and made by reference to OCAL's sale of its shares in Dowell or, in other words, by reference to the sale of a capital asset. And, so it was submitted, it is only in rare circumstances that expenses incurred in connection with the sale of a capital assets will be on revenue account. Mr Durack sought to distinguish the decisions in Marr and Total Holdings, arguing that each of those cases involved payments that had been made to strengthen the position of a subsidiary company (which company would continue to form part of the taxpayer's group) whereas, so he submitted, the payments that had been made in the present case were not made for that purpose but were made only for the purpose of disposing of a capital asset. Mr Durack submitted that whilst the giving of the indemnity and the payments that were made under the indemnity amounted to business activities, they were not activities that took place in the ordinary course of carrying on a business; he submitted that this was a case of a holding company participating in the disposal of a capital asset in the group of which it was the holding company by providing support for that disposal; it was not for the purpose of supporting the continuing operations of a company which was to continue as a member of the group.

Conclusion 52 The sale by OCAL was the sale by it of a capital asset. Had the investment in Dowell been owned directly by Email, the sale would also have been of a capital asset. The sale therefore represented the disposal of OCAL and, indirectly by Email, of portion of its profit earning structure. Be that as it may, I am of the opinion that, in the circumstances of this case, the giving of the indemnity by Email had the potential to allow its subsidiary company (OCAL) to achieve a greater capital profit (which would in due course be available for the declaration of a dividend in favour of Email). Thus, payments made as a consequence of that indemnity were payments on account of revenue and therefore deductible under both limbs of subs 51(1) of the Act. Factually, this conclusion can be based on this evidence of Mr Brink who, in par 37 of his affidavit of 16 April 1998 said:

"Throughout my commercial experience, it has been normal commercial practice for the purchaser of an existing business or corporate entity to seek security such as a warranty or guarantee from a responsible commercial entity by way of indemnity against unascertained liabilities of the entity being purchased. In the case of entities being acquired from a substantial corporate group, it was normal practice for purchasers to require security from the holding company of the group. The Email Group, when acquiring new corporate assets, followed this practice itself."

53 In support of his evidence - that the giving of an indemnity of the kind that is presently under consideration was part of the normal business activities of Email - Mr Brink exhibited to his affidavit four Deeds of Sale. Three of them related to the sales by a subsidiary company of businesses and the fourth dealt with the sale of a subsidiary's Plumbing Supply Division. In each case Email provided an indemnity to the purchaser. The earliest of these sales occurred in November 1985, two occurred in late 1986 and the fourth was in October 1989. These Deeds were tendered by counsel for Email to make good the proposition that the giving of an indemnity by Email with respect to the sales of businesses, divisions or (as in this case) shares in controlled entities was part of the ordinary business activities of Email. 54 I accept Mr Brink's evidence as an accurate statement of Email's business practice. I find, in terms of the first and second limb of subs 51(1) that the payments made by Email under the indemnity were incurred in gaining or producing assessable income and were necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. It should be noted for completeness that the Commissioner did not seek to argue that a dividend received by Email and sourced from the sale of the shares in Dowell would not have been assessable income. 55 Even though it may be said that the decision by Email to give the indemnity was a voluntary act, in the sense that it was under no legal obligation (as distinct from commercial prudence) that will not necessarily deprive it of the right to claim the subsequent outgoings as deductions under subs 51(1) of the Act. In Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (see above) the taxpayer company had paid the legal expenses incurred by some of its directors in defending criminal charges. The Full Court was unanimous in holding for the taxpayer. In their joint judgment Deane and Fisher JJ said:

"An outgoing can, in the relevant sense, be necessarily incurred in carrying on a business notwithstanding that it flows from a sense of moral obligation to those involved in the business. In particular, the fact that the needs of some directors and agents provided the occasion of an outgoing and that the resulting benefit to directors of agents constituted the dominant motive of a taxpayer for incurring it does not, of itself, preclude the outgoing from being necessarily incurred in carrying on the taxpayer's business for the purposes of s 51(1). Whether a voluntary outgoing was so incurred depends upon the answer to the composite question which we have indicated, namely, whether the outgoing was reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of that business and, if so, whether those responsible for carrying on the business so saw it."

56 There was, it must be acknowledged, a reason for the taxpayer undertaking the costs of the directors' defence that is absent in the present case. The charges of criminal conspiracy that had been brought against the directors and others had a direct relationship to the taxpayer's business and its reputation. Thus it was considered to be in the best interests of the taxpayer to do what it could to protect its good name. Despite this distinguishing feature, I do not consider that the passage from the joint judgment of Deane and Fisher JJ is to be read down as one limited to the particular facts of that case. 57 As I have said, it is necessary to characterise the outgoings that are represented by the indemnity payments by having regard to the circumstances of the party who made the payments - that party was Email, not OCAL. 58 The essential question is what was the advantage that Email was seeking? As to this, the evidence points, in my opinion, in only one direction: Email sought to advantage itself by increasing the likely flow of dividends that it would ultimately receive. The decisions in Total Holdings and Marr are cases in which the holding company sought to advantage itself by improving the profitability of a subsidiary and the size of its ultimate dividends. The indemnity in the present case was given to promote and preserve the size of future dividends from its subsidiary. 59 The evidence has satisfied me that the conduct of Email in giving the indemnity was not an isolated transaction; on the contrary, it accorded with an established practice that Email had adopted as part of its corporate policy. As counsel for the applicant submitted, the element of repetition strengthens the revenue character of the outgoings: Fanmac Ltd v Federal Commissioner of Taxation 91 ATC 4703. That case is an example of expenditure which, but for the repetitive conduct of the taxpayer, might otherwise have been classified as expenditure of a capital nature. The taxpayer company carried on a business of establishing, marketing and managing mortgage trusts. Since the commencement of its business it had established twenty-two such trusts. The taxpayer claimed a deduction for expenses incurred in the course of establishing a particular trust; those costs included legal fees, printing costs, an underwriter's fee and a rating establishment fee. In holding that the expenses were deductions under both limbs of subs 51(1) Beaumont J said that if the only relevant activity of the taxpayer had been the instant trust: "… there would be much to be said for the view that this item if expenditure was an affair of capital."(p4709) 60 The issue of repetitive expenditure had also been discussed by Hill J in Goodman Fielder Wattie Ltd v Commissioner of Taxation (1991) 29 FCR 376, where his Honour said: "A pharmaceutical company, the business of which includes continuing research and development as part of the continuous or constant demand for expenditure in its business, does not each time that expenditure is incurred make an outlay of capital or of a capital nature. Its business, when properly analysed, includes its research and development, at least in the ordinary case. No doubt there are matters of degree involved, and in a particular case the research and development may be concentrated on a product so far removed from the day-to-day products of the taxpayer, that the expenditure cannot be properly seen as part of its working expenditure." 61 Although the facts in Fanmac and Goodman Fielder Wattie do not bear any relationship to the present facts, the principle of law remains constant: expenditure having the hallmarks of capital expenditure, can, in appropriate cases, because of the repetitive nature of the expenditure, assume the character of revenue expenditure. 62 The payments that Email made under the indemnity were made because of the contractual obligations that it had accepted under the Deed of Sale - and Email had given that indemnity so that its wholly owned subsidiary, OCAL, could achieve a sale of and enhance the sale price of the shares in Dowell. 63 The objection decisions made by the Commissioner should be set aside. Neither party's submissions addressed the form of order that should be made if the applicant were to succeed. I think the appropriate course is to stand the matter over and to direct Email to bring in short minutes of order. My present view is that there is no reason why the Commissioner should not pay Email's costs. However, I shall give the parties an opportunity on the adjourned date to make submissions on costs, should they wish to do so. Either party is at liberty to relist the matter on seven days notice. I certify that the preceding sixty-three (63) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice O'Loughlin.

Associate: Dated: 24 February 1999 Counsel for the Applicant: Mr I V Gzell QC and Mr M L Brabason

Counsel for the Respondent: Mr J W Durack SC and Mr R Hamilton

Solicitor for the Respondent: Australian Government Solicitor