whether a deduction
17 The Commissioner's reason for the decision was that the contribution made by Essenbourne to the Trust was capital in nature and therefore not deductible under s 51(1) of the Income Tax Assessment Act. Alternatively, the contribution was an expense incurred in connexion with its involvement in a scheme to avoid tax and was therefore not incurred in gaining or producing assessable income or carrying on a business under sub-s 51(1). Part IVA of the Act was said to apply to the arrangement.
18 Essenbourne based the deductibility of the contribution on its need to provide Sam Marino with an incentive to remain in the dealership, as it had done in 1994 by the creation of the Employer Share Plan. The situation with respect to him had remained the same. Mr Mario Marino and Mr Catanzaro gave evidence about statements said to have been made by Sam Marino, to the effect that he was dissatisfied with his employment in the dealership. Mr Sam Marino did not give evidence, although he was able to do so, the Court was informed. Evidence of statements made by him was tendered by Essenbourne on a limited basis, namely to establish the belief, on the part of those two witnesses, that something needed to be done to ensure that Sam Marino remained an employee. I shall return to the question of the relevance of this evidence to the issue of the nature of the payment.
19 Mr Mario Marino said that prior to the creation of the Employee Share Plan in 1994 Sam Marino had said to him on a number of occasions, and he had believed, that he was considering undertaking other types of work. He was considering running the family farm on a full time basis and planting a vineyard. When asked whether his brother provided a reason, Mario Marino said that Sam Marino had a lot of stress in his position. He had to deal with irate customers, although he agreed that this situation had prevailed for some time.
20 Mr Catanzaro was also aware of Sam's dissatisfaction, he said. The prospect of his leaving was of concern to his brothers who would have to employ a person outside the family and who was not likely to share the same level of commitment to the dealership. Mr Catanzaro was asked to find a solution. The solution he devised was to condition Sam's entitlement to Essenbourne's contribution to the Employee Share Plan to his remaining for a further three years.
21 Another aspect of the reason for the establishment of the Plan, and for the equal sharing of the employer contributions as between the three brothers, was also provided. It was said that Sam Marino might be concerned that he was not, in effect, receiving the same share in the profits of the dealership as his brothers. He might have this view of the superannuation contribution made on behalf of them and their wives. The only evidence of a concern that the brothers should share equally, was that of Mr Catanzaro. It was not suggested that Sam Marino had made a direct reference to any disparity of this kind, but rather that Mr Catanzaro thought that he might view the matter in this way. The statements initially attributed to Sam Marino did not include reference to the question of the sharing of superannuation contributions. Although it was said that Sam Marino thought that he was not well paid, by way of salary, Mr Catanzaro did not consider that increasing his salary was likely to be effective in tying him to the business. The receipt of more money does not appear to have featured very strongly in Sam Marino's complaints, if it did at all.
22 In May 1997, Mr Catanzaro was told that Sam Marino's position had not changed. Mr Catanzaro was told by him that he maintained his desire to leave the business. The brothers spoke to Mr Catanzaro about tying everyone together and providing a "better benefit" for Sam Marino than the superannuation contributions allowed. There is nothing to suggest that Sam Marino was concerned about the division of profits by way of superannuation contributions at this point. Although Mr Catanzaro said that Sam Marino might think that his two brothers' households received a greater share of the profits of the company, there is nothing to suggest Sam Marino in fact held such a view and there would seem to be little factual foundation for it. The greater disparity in income was produced by the wives' salaries, not the small amount of superannuation contribution. In the years prior to 1997 Sam Marino had not been disadvantaged by the sharing of the superannuation contribution and in the years subsequent to it the brothers shared equally. There is nothing to suggest Sam Marino had any belief that he would be disadvantaged in the future, if that was in fact to be the case.
23 Another aspect of the sharing of profits by means of the Employee Incentive Trust was referred to in evidence by Mr Catanzaro. On this topic the focus was upon all brothers sharing equally rather than upon improving the position of Sam Marino as was suggested at other points in the evidence. Mr Catanzaro said at a later point in his evidence that the Scheme would have allowed them to achieve an "asset base" and to leave the dealership at the same time. The implication was that it might be sold at the end of the period. It is not necessary to consider whether this was in fact planned.
24 The second limb of s 51(1) of the Income Tax Assessment Act provides that outgoings which are "necessarily incurred in carrying on a business for the purpose of gaining or producing … income" are allowable deductions "except to the extent to which, they are losses or outgoings of capital or of a capital … nature". The question whether the outgoing was incurred for the requisite purpose involves characterising the outgoing and looking to the relationship between the outgoing and the carrying on of business: Fletcher v Federal Commissioner of Taxation (1991) 173 CLR 1, 17; Hart v Federal Commissioner of Taxation [2002] ATC 4608, 4615; [2002] FCAFC 222. The relationship between them must be such as to import the character of an outgoing of the relevant kind. It is usually possible therefore, to characterise an outgoing as of this kind without recourse to the taxpayer's subjective thought processes: Fletcher, 17, 18. The example there given was of an outgoing which gives rise to the receipt of a large amount of assessable income. In such a case those facts would be sufficient to characterise the outgoing. The Court accepted, however, that it may be different where no relevant assessable income can be identified.
25 It may be necessary in some cases to consider, to an extent, the purpose or motivation for an outgoing, particularly where the outgoing is voluntary: Fletcher 17, Hart [32]. The end which the taxpayer subjectively had in view may be an element in characterising the outgoing: Fletcher, 17. Even so, it has been held that the test to be applied comprises both objective and subjective elements:
"…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."
(Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183, 208). Deane and Fisher JJ had earlier observed that, to the extent that the subjective element is relevant to a voluntary payment, it is in the identification of the advantage which it was intended to achieve, not whether the advantage was the direct or indirect result of it or whether there was a motive to pursue it. Their Honours also expressed the view that the fact that the legitimate ends of a business might encompass what is in the personal interests of directors does not prevent the outgoing being of the necessary character.
26 In the present case the business purpose in making the payment to the Trust was said to be in retaining Sam Marino. An incentive was provided, as had previously been arranged through the Employee Share Plan. It was submitted for Essenbourne that the provision of retirement benefits, so as to keep Sam Marino in the dealership, was both properly connected to its business ends and reasonably appropriate. Consistent with the basis upon which it had put forward its evidence on this point, Essenbourne contended that the question was not whether Sam Marino in fact had the intention referred to, but whether Essenbourne and the other directors believed that there was a need to address how to retain him in the business.
27 The Commissioner submitted that the character of the outgoing was to be ascertained by reference to the brothers' desires to invest for the long term, to divide up profits and to obtain a deduction instead of paying tax on the contribution. The Commissioner also submitted that the evidence of Sam Marino's intention to leave, and the view that it needed to be addressed, were not credible. It is submitted that an inference available to the Commissioner from the evidence is that it was the objectives just referred to, in the context of long term investment of profits, which were being pursued. Sam Marino might have given evidence on that question and as to whether he was in fact dissatisfied and contemplating leaving the dealership. His evidence could resolve the question whether statements had been made by him to his brothers and Mr Catanzaro so as to provide a basis for their belief in what needed to be done.
28 The Commissioner seeks to rely upon the rule in Jones v Dunkel (1959) 101 CLR 298. The application of that rule requires that there be an inference available which favours the other party. In those circumstances the failure to call a witness who might reasonably be thought to be able to give evidence on the point leaves the Court in a position where opposing inferences can more confidently be drawn because they stand uncontradicted by someone who could say something about the true state of the facts (at 308).
29 A reference in this case to the payment to the Employee Incentive Trust as an outgoing does not provide an answer to the question whether it was reasonably incurred by Essenbourne in carrying on its business. It is equally possible, on those bare facts, that it be seen as a transfer of the profits of the company to the Trust so that they might be shared and, at the same time the taxation advantages obtained. Essenbourne relies upon its need to provide incentives for Sam Marino to stay with the business for another five years as the link to its business requirements. Such an objective could be considered as both reasonable and business-related, if it was the objective being pursued. The question which then remains is whether the brothers in truth viewed the outgoing in this way. That is the question to which the evidence is relevant.
30 It was submitted for Essenbourne that it is necessary for the Court to accept the evidence of Mario Marino and Mr Catanzaro as to their belief about Sam Marino's position because their evidence was not contradicted. Certainly their evidence could not be rejected out of hand, but it does not follow that it must be accepted.
31 Apart from the evidence of statements attributed to Sam Marino, there is nothing to indicate that he was considering leaving. He had held his position for a long time. The business was very much a family concern and one which was of benefit to them all. The fact that the parents received a substantial portion of the profits by way of superannuation contributions was not apparently a matter of concern to the brothers. The Commissioner placed some reliance upon there being other means to keep Sam Marino, more particularly to pay him more or provide more by way of superannuation contribution. I do not think much can be drawn from the method chosen as indicative of the true purpose of the brothers and therefore Essenbourne. Of some relevance however, is the fact that three brothers were to participate. Whether through bonus issues, or vesting of the funds in Lynrose after termination of the Trust, it was clearly intended that the brothers were to share some of the profits of Essenbourne. It was intended on this occasion, as it had been with the earlier Employee Share Plan, that the brothers share equally.
32 If there was a change to the position so as to give more to Sam Marino than before one might infer that some complaint was being addressed. The position was however that the brothers were sharing equally. Whilst that is not necessarily inconsistent with there being another purpose, to tie him to the dealership, it does not assist in proof of it. The fact that they are all unable to access the funds for a period conveys little about Sam Marino. It may simply be the period they all considered as the first time they might wish to access the funds. The provision of benefits to them at an early point was never a realistic option if they were to obtain the taxation advantages they sought.
33 As against the prospect that Essenbourne's purpose was to tie Sam to the business, is that the brothers sought to share profits in a tax effective way. I tend to the view that Sam Marino's position was not really a reason for the payment of the contribution. I do not accept as likely that he referred to there being an imbalance in the superannuation contributions. So far as concerns whether he was dissatisfied and wanted to leave the dealership, these are matters about which he could have given evidence. In these circumstances I conclude that his evidence in this regard would not have assisted Essenbourne. A conclusion that the payment was simply to provide for the three brothers and at the same time to obtain the advantages outlined is more confidently arrived at. A sharing of profits by the three brothers does not have the necessary connexion to Essenbourne's business. The outgoing is not deductible.
34 The Commissioner's alternative contention was that the payment was also of a capital expenditure, even if its purpose was to provide an incentive, especially to Sam Marino. In British Insulated & Helsby Cables Ltd v Atherton (1926) AC 205, at issue was the payment by a company into a pension fund for its employees. On the winding up of the fund the whole amount was to be distributed among the members. In the judgment ofViscount Cave (213-214) when an expenditure is made both "once and for all" and "with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade …" there is good reason to treat the expenditure as attributable not to revenue, but to capital. The lasting advantage to be obtained was the company retaining the services of a "contented and efficient staff" (214). Lord Atkins was of a similar view, holding that a payment not to meet a liability but having a purpose, in a general way, of improving the position of staff is a capital outlay (222). Earlier his Lordship had observed that the fund was not treated as part of the assets of the company. It had parted with its rights to it and the trustees had absolute power over the fund (220-221).
35 Essenbourne submitted that there was no clear majority view expressed in British Insulated. The Commissioner submits that Viscount Caves' reasoning has been cited with clear approval in Australia. In Sun Newspapers Ltd v Federal Commissioner of Taxation (1939) 61 CLR 337, 360-361, Dixon J was concerned with the difficulty of distinguishing capital outlays and working expenses. His Honour considered that, as a general rule, establishing, replacing or enlarging a profit-yielding subject may appear to be quite different from the continual flow of working expenses. The factual context of that case is different from the present but some observations in it may be useful. His Honour considered that a great initial outlay towards establishing goodwill to be a payment of a capital nature. On the other hand where goodwill is gradually established over the years by continual advertisement, the expenses associated with the advertisements are of an ordinary business type. As to the test of recurrence or once and for all payments, the result may be to procure "some asset or advantage of a lasting character which will enure for the benefit of the organisation or system or 'profit-earning subject'" (at 361). In that regard his Honour accepted the phrase coined by Viscount Cave and implicitly, its application. The test of recurrent expenditure is not just the fact that it is made every year or accounting period. The real test, his Honour held (362), is between expenditures to meet a continuous demand, as opposed to an expenditure which is made once-and-for-all. His Honour concluded that recurrence is not a test, only a consideration the weight of which depends on the nature of the expenditure. Further, the lasting character of the advantage is not necessarily a determining factor. His Honour concluded (363) that there were three considerations: the character of the advantage sought, in which its lasting qualities may play a part; and thirdly, the manner in which it is to be used or enjoyed in which recurrence may play a part; the means adopted to obtain it. "That is, by providing a periodical reward or outlay to cover its use or enjoyment for period commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment" (363).
36 In the present case the payment in question is of the surplus profits out of the company. The payment is not referrable to the conduct of its income-producing business. The advantage or benefit sought to be secured from it, from Essenbourne's point of view, is the improvement of the position of the three principals in the business. It has produced a benefit to be derived by them at some point in the future and the intangible benefit of job satisfaction in the interim. The payment is not made in such a way as to be seen as an operating expense. The fact that in most years Essenbourne made superannuation contributions does not assist in characterising this payment. In my view the payment is of a capital nature and, for that reason, not deductible.