Lamont v Commissioner of Taxation

Federal Court of Australia|2005-04-29|Before: Hill J

REASONS FOR JUDGMENT HILL J 1 The applicant, Mr Lamont, is a member of what he describes as a "partnership". He, and other members of that partnership, on 7 October 2002 sought a binding private ruling in respect of the application of the income tax law for the years of income ending 30 June 2002 to 30 June 2006. The letter forwarding the application for ruling, however, stated that the application related to the years of income ending 30 June 2002 to 30 June 2005. The letter was written on behalf of the applicant by Corporate Business Centres International Pty Ltd ("CBCI") and made the following comment concerning the subject matter of the ruling: "The client is a partner of the above-named partnership (the partnership was referred to in the letter as the 'Shamrock Partnership'). The client has a share of partnership loss of $AUD 100,000 representing that partners (sic) share of irrevocably committed $AUD 100,000 in expenses of the partnership for the 2002 financial year (that is, ended 30 June 2002). The client is committed for a period of at least 4 years to see that the business plan mandate is carried out. As such the client understands that the client will be called upon to meet any outstanding commitments from deposits put down on any purchases of warrants and make such further commitments as the client see (sic) as expedient… The client is a partner of the partnership that is in the business of being an agency for legal services. Its business includes the sourcing of clients and legal service providers, negotiating and tailoring services that can be provided and required and ultimately endorsing those services to clients. It does so under an agency/sub-agency channel system designed and operated by Pre-Paid professional that seeks to maximize purchasing/negotiating power with legal service providers and tailoring the provision of services for minimal cost to the consumer. For the 2002 financial year, the activities of the partnership are reflected in the running minute book. For the 2003 year and beyond, the partnership business is intended to be that of executing the business plan." 2 A number of documents were attached to the letter including an outline of what is said to be the business structure of the partnership, a business plan, a partnership deed and a "running minute sheet" for the period ended 30 June 2002. That running minute sheet recorded minutes not only of the particular partnership of which the applicant was a member but other partnerships involved in similar activities. The letter set out what were said to be the issues to be ruled upon. These issues differ in form although less in substance from the questions that the respondent Commissioner of Taxation ("the Commissioner") in fact relied upon. 3 Thereafter there was correspondence between CBCI and the Commissioner in which, inter alia, more information was sought and at least to some extent, supplied. 4 The Commissioner did not rule on the application for a ruling and ultimately an application was made to the Court for an order in the nature of a mandamus requiring the Commissioner to consider the application and respond to it. It is not clear to me on the information I now have whether the applicant was a party to that application, although it can be assumed he was. 5 The application for mandamus and other issues that arose between the Commissioner and the representative for the applicant, CBCI, were the subject of litigation which culminated in judgment being delivered on 20 April 2004 ("the previous judgment"). As I then said, the Commissioner, on the last day of hearing of those proceedings (31 March 2004), indicated that rulings had in fact been issued. There was a dispute as to whether the rulings had been served. I did not resolve that dispute but ordered that the Commissioner comply with s 14ZAR of the Taxation Administration Act 1953 (Cth)("the Administration Act") to the extent that rulings had not, in fact, issued in respect of applicants who were parties to the then proceedings. It would seem to be the case that the present ruling was not in fact issued until 20 May 2004, that is to say, a month after judgment had in fact been delivered. 6 One of the issues between the parties to the earlier proceeding was whether the ruling application together with other documents and correspondence provided a sufficient description of the "arrangement" that was the subject of the ruling. I said in my reasons that the application, as supplemented by the other material to which reference was made in the previous judgment, sufficiently described the arrangement. Indeed, I summarised what I thought to be the arrangement as it appeared in the application and supplementary material. 7 The ruling, when it issued, set out a series of questions and answers relating to the years of income ending 30 June 2002 to 30 June 2005. Not all the questions reflected what the Commissioner was asked to rule upon. In particular, the last question related to the application of Part IVA. The applicant did not wish this question to be answered. The submissions of the Commissioner pointed out the difficulty of responding in a ruling on the application of Part IVA and he appeared equally unhappy to rule upon that question. I will return to that matter later. The questions asked and the answers to them were as follows: 1 Is the purchase price paid by the partnership for the acquisition of each warrant or block of warrants in the income year ended 30 June 2002 an allowable deduction of the partnership for the income year ended 30 June 2002 under section 8-1 of the Income Tax Assessment Act 1997 ("ITAA 1997")?

2 Is a partner's share of a partnership loss an allowable deduction of the partner under subsection 92(2) of the Income Tax Assessment Act 1936 ("ITAA 1936") for the year ended 30 June 2002?

3 Is the purchase price paid by the partnership for the acquisition of each warrant or block of warrants in the income years ended 30 June 2003, 2004, and 2005 an allowable deduction of the partnership for the income years ended 30 June 2003, 2004, and 2005 respectively, under section 8-1 of the ITAA 1997?

4 Are the proceeds received on the endorsement of a warrant assessable income of the partnership under section 6-5 of the ITAA 1997?

5 Is the assignment of a share of a right to sue assessable income of the partnership under section 6-5 of the ITAA 1997?

6 Is the assignment of a share of a right to sue assessable income of the partnership under section 15-15 of the ITAA 1997?

7 Does section 82KZME of the ITAA 1936 apply to deny any deductions otherwise allowable to the partnership for the purchase price paid by the partnership for the acquisition of each warrant or block of warrants?

8 Does Part IVA of the ITAA 1936 apply to deny any deductions otherwise allowable to the partnership under section 8-1 of the ITAA 1997 and/or to the partner under subsection 92(2) of the ITAA 1936?

8 On the third page of the ruling there was set out what the "subject" of the ruling was. The document said that the ruling concerned the "arrangement as described and commented upon in" the ruling application, the documents which were included with the ruling application and listed correspondence and attached documents. What were said to be the "key features of the arrangement" were then outlined in the following terms: "The Partnership Deed

On 29 June 2002 you entered into an agreement to carry on a business of acquiring and marketing wealth creation, financial services, financial systems, concepts and strategies to the public and the business of designing wealth enhancing business models for the public using technologies systems. The terms of the agreement state that the partnership commenced on that day. The Deed was signed by CBCI on behalf of the relevant partners. The Business Agreement

The partnership entered into the agreement with Pre-Paid Professional Inc (PPP) on 3 March 2002. The main features of the agreement are:

· The partnership is a business agent providing legal and professional services either personally or by arranging, through the PPP business agent model ('Pre-Paid Professionals Business Agent Plan'), for others to provide the services.

· The effect of the Business Agreement is that the partnership is committed to purchasing a given level of service warrants from PPP.

· The price, discounts and commencement dates were not detailed in the agreement however reference was made to the attached Schedule.

· Any deposits payable by the partnership to PPP on service warrants acquired were to be paid within seven days from the order of the warrants.

· The Business Agreement was signed by the director of PPP and the director of CBCI under power of attorney for the partnership.

This contract was attached to the Business Agreement and is between PPP and the partnership. The main features of the contract are:

· That PPP grants to the partnership the right to endorse the number of warrants specified in the schedule to clients.

· Under the terms of the warrants a 'client … shall not be required to pay PPP any consideration for the service performed pursuant to the warrant and PPP undertakes unconditionally to the purchaser that it shall not seek to recover from the client any consideration in respect of the service performed under the terms of the warrant' (clause 2.1 of the contract). The warrants have an eligible service period of 13 months.

· The purchase price of the warrants to be paid by the partnership was not detailed in the contract or in the attached Schedule. Furthermore, the quantities of warrants purchased by the partnership and the terms of payments to PPP are not stated in the documents.

· The Schedule details a commencement date of 1 June 2002 but does not name the purchaser, the number of warrants or any description or identification of the service to be provided.

On 1 May 2002 the partnership entered into an Administration Agreement with CBCI. Under the terms of the Agreement, signed by the director of CBCI on behalf of both CBCI and also the partnership:

· CBCI is appointed as administrator and agent for the partnership to undertake the administrative issues in the conduct of its business; · The partnership is required to pay the following amounts to CBCI:

o Administration Fee to the amount of 17.5% of the value of all of the service warrants/rights committed to PPP for the following year; and o Either:

s 20.5% of the value of all service warrants/rights committed to PPP for the following year (clause 6.1); or s 30% of the gross business income from the proceeds of the endorsement of the service warrants (clause 6.4); and

o An amount of at least 17.5% of the value of all service warrants committed to PPP for the following year. This amount is payable by the end of the financial year. On receipt of this amount, CBCI pays the full amount as part payment for the entire amount of pre-paid services committed by the partnership to PPP (clause 5.1). Any excess will reduce the outstanding liability incurred to PPP.

The warrants purchased by the partnership from PPP were endorsed by way of a Client Service Agreement between the partnership and the relevant client(s).

· The copy of the undated Client Service Agreement contains no specific details as to the name of the client to which the warrants were endorsed, the quantity of warrants endorsed, the price paid by the client, the payment requirement to the partnership (Advance Fee), or the termination date of the agreement. · The agreement does detail that in the event that another entity is to provide the service, no additional consideration is required by the client. Furthermore, the agreement states that the client's entitlement to the performance of any services will lapse on the termination date.

According to the Minutes of the partnership meeting supplied as part of your Ruling request, CBCI operates the partnership account on a 'trust account style' basis, thus there is no separate bank account for the partnership. CBCI keeps journal entries for the partnership (your letters of 7 November 2002 and 13 May 2003 confirm).

The meetings in respect of the partnership are run by CBCI who apply a 'consortium approach' so that they deal with several other partnerships' issues as well as the matters relating to the partnership. The relationship between the partnership and PPP is not a relationship of agent and principal." 9 The applicant was dissatisfied with the ruling and objected. His objection was disallowed and the applicant then, being dissatisfied with the objection decision, appealed to the Court under s 14ZZ of the Administration Act. Although called "an appeal" the matter is an application to the Court in its original jurisdiction.

Was there a valid ruling? 10 There is a real question whether the ruling was a valid ruling. It was not a question which the parties specifically agitated. However, the submissions of the Commissioner were so framed as to make clear that the Commissioner regarded the description of the relevant "arrangement", presumably as detailed by the applicant in the application and supplementary documents, to be incomplete and contain inaccurate statements and it was said that there were changes to the form of the arrangement as initially implemented. However, the problems to which these submissions were addressed arise from the manner in which the Commissioner described the subject matter of the ruling. 11 It is clear that a purported "ruling" would not be a valid ruling if it failed to set out the arrangement ruled upon: National Speakers Association of Australia Inc v Federal Commissioner of Taxation (1997) 97 ATC 5131. It is an essential part of the scheme of Part IVAA of the Administration Act that a ruling identify the arrangement to which the ruling relates. Obviously, if it is not possible to identify the arrangement it would not be possible for the Commissioner to give a ruling. The Commissioner, clearly, is not enabled to make good any deficiencies in that description of the arrangement. He is confined to the facts said to constitute the arrangement: Federal Commissioner of Taxation v McMahon (1997) 79 FCR 127. He is, however, entitled to make assumptions, where assumptions are, in his view, necessary in order to determine how the taxation law applies to the arrangement, but must state the assumptions made in the ruling itself. 12 The Commissioner apparently was unable or unwilling to set out in his own words what the arrangement was. Instead, the present ruling sought to identify the arrangement by reference to the collection of documents and correspondence which is listed. 13 Ordinarily it would suffice to describe the arrangement by incorporating a description of it contained in some other document. Usually, this will be the ruling application itself. Indeed the incorporation by reference of a description provided by the applicant for the ruling will often be the most convenient method of setting out the arrangement ruled upon. That this is so is reflected in s 14ZAS(3) of the Administration Act which permits arrangements to be identified by reference to matters set out in a document identified in the ruling. The problem in the present case, which arises by virtue of the arrangement being described as that contained in a number of documents, is brought about by the rather diffuse and indeed, confusing nature of some of the documents and correspondence to which reference has been made. 14 A number of the documents seem to have been derived from American precedents. Whether this is the case, I do not know. However the comment of George Bernard Shaw to the effect that the United States and the United Kingdom are two countries divided by a common language could not be more apt than in the drafting of legal or commercial documents. It is equally apt if Australia is substituted for the United Kingdom. 15 Language is not the only problem. Senior counsel for the Commissioner submitted that there was internal conflict within the documents. However, the examples of such conflict which were given were, it must be said, immaterial to the subject matter of the ruling. So, by way of example, the point was made that some documents claimed that warrants would be endorsed by the partnership either for cash or a share of the proceeds of litigation whereas it appeared that one transaction actually entered into involved warrants being endorsed in consideration of an issue of units. It sufficed that the arrangement contemplated that warrants would be endorsed for either cash or other consideration. The nature of the consideration had no consequence for the matter ruled upon. 16 It was said that accounting entries contained in the supplementary material suggested that an amount owing by the partnership for the acquisition of warrants had been eliminated from the accounts without payment having been received. Queen's counsel for the applicant disputed this. The application for ruling made it clear that the arrangement contemplated that the partnership would make payment for warrants acquired. It is hard to see that the accounting entry could be taken to contradict the way the arrangement was said to operate even if it was accurate that it should be interpreted as involving a liability being eliminated without any explanation being given for the elimination. I am satisfied that the entries did not have the consequences suggested. 17 There was said also to be a difficulty in that the documents submitted to the Commissioner did not show the form of contract that was entered into between the provider of services and the initial contracting party nor whether those services were of a legal or an accounting nature. This is so. However, it is clear enough from the proposal just what is envisaged to happen. It can hardly be correct that an applicant for a ruling on an arrangement not yet entered into (which the Administration Act describes in s 14ZAI(c) as a "proposed arrangement") is required to give to the Commissioner the documents proposed to be used in the proposed arrangement. It will be sufficient if the material given to the Commissioner describes the arrangement in such a way as permits the Commissioner to set out his understanding of how the income tax law relates to the arrangement. Likewise it suffices if the ruling itself describes the arrangement (whether expressly or by reference to other material) in such a way as enables the reader to understand what the proposed arrangement is, so that it is possible to know what the application of the income tax law to the applicant for the ruling will be in a nominated year of income in the event that the arrangement is entered into. 18 It should be noted here that an assessment has issued to Mr Lamont in respect of the year of income ended 30 June 2002 and in consequence, the parties agree that the Court no longer has jurisdiction to consider the ruling in respect of that year: s 14ZAN(b) or (e) relate. 19 There is another difficulty which should be mentioned. The so-called "running minute sheet" contains material from which it might be argued that the initial partnership terminated when some partners indicated that they would no longer contribute amounts to the partnership that they had previously agreed to contribute. It may well be the case that the remaining partners thereupon agreed to continue the partnership activity. Indeed, this is the way the continuing partners appear to have acted in their relations to one another and to CBCI. More importantly, however, it can be said that the minutes, such as they are (they cease in January 2003) do raise a question whether the so-called partnership did in fact carry on a business either before the indication by some partners that they would not make the contributions they had previously agreed upon or thereafter. The question whether business is carried on is critical to the answers that should be given to the questions ruled upon. Indeed, it can be said that absent a business being carried on by the "partnership", no deduction would be available for amounts incurred in acquiring warrants, although it may be that the cost of the warrants might be taken into account in calculating net profit. 20 As already indicated it is open to the Commissioner under s 14ZAQ to give a ruling setting out any assumptions he makes such, for example, as to whether the partnership is carrying on a business. The Commissioner did not do this. Had he made any assumptions he would have been required by s 14ZAS(2) of the Administration Act to identify those assumptions in the ruling itself. 21 It would have been better had the Commissioner made an assumption and then ruled upon it. The Court has no jurisdiction itself to make assumptions. The Court's jurisdiction is confined to determining whether the ruling is or is not correct and if not correct, to indicate what the correct ruling is. 22 However, it is submitted that the course the Commissioner took in giving a ruling without making any assumption as to whether the partnership carried on or would continue to carry on a business is correct because the application for ruling stated specifically that the partnership was carrying on a business and would continue to do so in the years of income which had not yet commenced. The application as stated earlier specifically narrates that the partnership was "in the business of being an agency for legal services". While the concept of "agency for legal services" might seem to many unintelligible, what it means becomes clear upon a reading of the documents accompanying the application. 23 It follows in my view that where an applicant asks the Commissioner to rule upon an arrangement where one of the facts are that the partnership of which the applicant is a member in fact carries on a particular kind of business, the Commissioner may proceed to rule upon that application on the basis that the facts as stated are correct. Of course, should it turn out that the facts were incorrect, the applicant for the ruling will get no protection from the ruling. That however, is not a matter which need concern the Commissioner who is required to rule upon a stated arrangement having the factual parameters which the applicant sets out. 24 Thus it is quite possible in the present case that the ruling will have no utility at all to the applicant or those others who have made similar applications. But it does not follow from this that the Commissioner should not have been required to give the ruling if that is the point which senior counsel for the Commissioner intended to make. 25 I am, therefore, of the view that the ruling as issued is a valid ruling and does describe the arrangement in respect of which the ruling sets out the stated consequences. It follows, therefore, that there is properly before the Court an appeal against the Commissioner's objection decision which disallowed the applicant's objection to the ruling.

A summary of the arrangement ruled upon 26 As must be clear from what I have already written, it is not for the Court to formulate a description of the arrangement the subject of the ruling. That is a matter for the Commissioner. However, the present reasons for judgment will necessarily be unintelligible unless there is set out here, in summary form, a brief description of the arrangement which is discussed in the application for ruling and supplementary documents to which reference has already been made. However, in doing so, I must emphasise that my description of the arrangement is not determinative of what the arrangement is in the event that there develops a dispute between the parties on that matter. Any such dispute would need then to be resolved. However, I trust that the description which follows suffices to describe what is contemplated and makes intelligible the discussion of law which follows. 27 Briefly, therefore, it can be said that it is contemplated that there is a partnership of which the applicant is a member which carries on a business. The activities which the partnership proposed to engage in and says that it did engage in, in years already passed, involves the following steps. First, an agreement is entered into between a barrister, solicitor or accountant ("the advisor") and an entity called Pre Paid Professionals ("the promoter") whereby, in consideration of the payment of a sum of money or the agreement to pay that sum, the advisor agrees to provide professional services up to a stipulated number of hours or days to the promoter or such person as the promoter or person nominated by the promoter should direct. The services normally have to be performed within the space of 13 months. Longer periods may be nominated. The document recording this agreement is referred to as a warrant. A nomination is to be made upon "endorsement" of the warrant. The partnership then enters into an agreement with the promoter to purchase from the promoter the right to direct the advisor to perform services. The partnership is committed to purchasing a given number of warrants from the promoter in each year. Purchase of these warrants does not entail payment upon acquisition. It seems that the promoter is prepared to accept part payment of the purchase price (called a "deposit") with the balance payable thereafter. The part payment is 17.5 per cent for the years covered now by the ruling, ie the years 2003 to 2005 inclusive. The balance is payable (or so the Commissioner said in the ruling), when the service is in fact redeemed by performance or earlier if the warrant is not endorsed by the expiration of the time within which the services have to be performed. I say "so the Commissioner said" as there was a suggestion by Queen's counsel for the applicant that what is said by the Commissioner is incorrect. Originally, the promoter agreed to purchase back the "warrants" at a discount but that agreement was subsequently withdrawn, with the consequence that all warrants to which the ruling related, not endorsed by the end of the 13 month period (assuming the warrants related to that period), would expire and have no value to the partnership. The partnership then seeks purchasers for the warrants, that is to say, persons with a need for the legal or accounting services in question. That purchaser might pay cash, or assign or mortgage the whole or part of the proceeds of litigation the purchaser is engaged in or transfer other property such as units in a unit trust to the partnership. The warrants are then endorsed in favour of the end purchaser. In other words, the end purchaser becomes the person entitled, by direction of the promoter and the partnership, to the services of the advisor. The purchaser would have no claim against the promoter that the promoter actually perform the contracted services. 28 The partnership was to be administered by CBCI. It was required to pay to CBCI an administration fee of 17.5 per cent of the value of all of the service warrants which the partnership is committed to purchasing from the promoter for the following year and other amounts. The basis of remuneration of the promoter is set out in the Commissioner's summary given earlier and need not be here repeated. 29 The partnership administration was to be conducted in common with other similar partnerships although it was possible for the partnerships to terminate the arrangements with CBCI and administer their own affairs separately. Initially at least, there were no separate bank accounts maintained by each partnership but separate journal entries and other accounting records were to be kept by CBCI. It is said that all warrants acquired by the partnership (and presumably other similar partnerships) in the first year of income had been endorsed to a "fighting fund client" who is said to have required the legal services acquired for a legal campaign. This endorsement occurred in the first year of income in respect of which the present proceedings relate. 30 There may be thought to be a number of legal, commercial and ethical problems associated with the proposal. It is not for the Court to comment upon any lack of commerciality which may appear to arise, although those matters may have relevance to the operation of Part IVA of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act"). 31 Assuming that it is legally and ethically possible for a barrister or solicitor to contract in the way which the arrangement envisages, there are some issues which may have relevance to the taxation consequences. The initial contract between the advisor and the promoter is a contract for personal services. In the event of breach of that contract by the advisor, the promoter would be limited in its remedy to damages only. The contract would not be specifically enforceable (see, Fry on Specific Performance, 6th ed, secs 49-60; Jones and Goodhart on Specific Performance, 1st ed pp 135-139; Meagher, Gummow and Lehane on Equity: Doctrines and Remedies, 3rd ed, p 502; Williamson v Lukey (1931) 45 CLR 282 where Dixon J, as he then was, makes the observation: "Specific performance is inapplicable when the continued supervision of the Court is necessary in order to ensure the fulfilment of the contract. It is not a form of relief which can be granted if the contract involves the performance by one party of the conditions upon which those obligations depended, and could only leave him to his action of damages at law in the event of the conditions being unperformed"). There would be a question whether the chose in action created by the agreement between the advisor and the promoter was, in the circumstances, capable of assignment (see, Meagher, Gummow and Lehane on Equity: Doctrines and Remedies, 3rd ed, p 200 where the learned authors note that although the benefit of a contract is a chose in action and generally can be assigned, the benefit of a contract involving personal skill or confidence may not be assigned, at least "where the identity of the person for whom it is to be discharged is of importance to the party on whom the obligation rests" cf: Smith v ANL Limited (2000) 204 CLR 493. The identity of the lawyer or accountant would be evident in the present contracts. In Smith v ANL Limited at 504[20] the Court, however, recognised that any chose in action could be turned to account immediately by assigning the damages which might later be recovered by instituting an action). There is a real question whether the assignment could be effected by endorsement of a warrant. A legal assignment of a chose in action would require, to be effective, to comply with s 12 of the Conveyancing Act 1919 (NSW). However, as there is consideration for the endorsement, equity would enforce an agreement to assign the right to damages. To this extent, endorsement of the warrant might sufficiently evidence the agreement. Hence, the partnership's only remedy for non performance by the advisor would be against the promoter in damages. The same would be true in the case of the client who would have no direct relationship with the advisor but would have a right of action against the partnership in the event that the advisor not perform the contracted number of hours. The partnership would have a right of action in damages against the promoter who in turn would have a right of action in damages against the advisor. 32 It was common ground that the arrangement did not involve trading stock. The contractual relationship involved in the warrants and the endorsement of them were not trading stock either in a commercial sense, or in the sense that "trading stock" is defined in s 6(1) of the 1936 Act. 33 The question whether amounts paid for the acquisition of each warrant or block of warrants will be allowable deductions in determining the net income of the partnership will depend upon whether the amounts in question are deductible under the provisions of s 8-1 of the Income Tax Assessment Act 1997 (Cth)("the 1997 Act"). That section provides as follows: "8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. (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." 34 The first question for determination will be whether the partnership has incurred a loss or outgoing. The second question is whether any loss or outgoing so incurred is an outgoing of capital or of a capital nature.

Are there amounts incurred for the purposes of s 8-1 of the 1997 Act? 35 There is no doubt that an outgoing will be incurred, at the latest, at the time the outgoing has been paid. This is subject to the qualification that there will be cases where, while the outgoing (ie, payment) itself is not deductible because, for example it is on capital account, the taxpayer may, nevertheless, be entitled to a deduction for a loss which the taxpayer incurs when the relevant time of incurring will be the year of income in which the loss has been incurred. In such a case the taxpayer will be assessable to tax on any income gain in the year of income in which the gain is made. 36 However, an outgoing may be incurred prior to the time when the outgoing has been paid. In City Link Melbourne Limited v Federal Commissioner of Taxation 2004 ATC 4945 at 4954-4055 a full court of this Court (Hill, Stone and Allsop JJ) set out a series of well settled principles on the question of when an outgoing may be incurred by reference to the principles that I had earlier set out in Ogilvy and Mather Pty Limited v Federal Commissioner of Taxation (1990) 90 ATC 4836. It is unnecessary to set out here those principles. 37 Thus, where a taxpayer has definitively committed itself to a liability in the year of income the taxpayer may be entitled to a deduction for the outgoing. In such a case the outgoing will be more than just pending, threatened or expected (where no deduction would be available). Indeed, a deduction may be available for a present or accrued liability to make payment in the future so long as the taxpayer has, in the sense used in the cases referred to, subjected itself to the liability. 38 On the facts of the present case it is said in the material before the Commissioner that the partnerships have committed themselves to expenditure on the warrants. Only some part of the amount will actually have been paid. The balance would be payable at the latest when the "warrant" expired. So long as the facts are such that the partners have committed to payment for the warrants as is stated, then, so long as it is the outgoing itself which is deductible and not a net loss, the outgoing will have been incurred in the year of income in which that commitment took place.

Was the amount of the outgoing committed an outgoing of capital or on capital account? 39 The classic formulation of when a loss or outgoing is capital is to be found in Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337. Before setting that formulation out it is useful to set out an earlier passage which must be read with it. At 359, Dixon J (as he then was) said: The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. The business structure or entity or oranization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested. In a trade or pursuit where little or no plant is required, it may be represented by no more than the intangible elements constituting what is commonly called goodwill, that is, widespread or general reputation, habitual patronage by clients or customers and an organized method of serving their needs. At the other extreme it may consist in a great aggregate of buildings, machinery and plant all assembled and systematized as the material means by which an organized body of men produce and distribute commodities or perform services. But in spite of the entirely different forms, material and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a 'profit-yielding subject', the phrase of Lord Blackburn in United Collieries Ltd. v Inland Revenue Commissioners [(1930) SC 215 at 220]." 40 At 363, his Honour continued by setting out the three-fold test which has become the classic formulation for distinguishing capital and income. 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." 41 Earlier in the judgment his Honour had made reference to the idea of recurrence. Recurrence does not mean that the expenditure is made every year or indeed in every accounting period. The distinction to be drawn is between expenditure made to meet a continuous demand (recurrent expenditure) and expenditure which is made once and for all: Ounsworth v Vickers Ltd [1915] 3 KB 267 at 273. 42 Likewise, his Honour discussed at 362 what was meant by lasting character, while pointing out that this was not necessarily a determining factor. His Honour referred to John Smith & Son v Moore (1921) 2 AC 13 at 20 where a taxpayer had acquired the assets of a business formerly conducted by his father, which assets included forward coal contracts for relatively short terms. The contracts enabled the taxpayer to purchase coal from colliery owners at an advantageous price. The taxpayer made his profits, not by selling the coal contracts, but by selling the coal acquired under them. What was paid for the contracts was fixed capital and not circulating capital in accordance with the now rather outmoded distinction drawn by Adam Smith. By retaining the coal contracts he was, as Dixon J observed, able to employ his circulating capital in buying under them. The expenditure on the coal contracts was thus capital expenditure. 43 Reference may be made also to the judgment of the High Court in GP International Pipecoaters Pty Ltd v Commissioner of Taxation (1989) 170 CLR 124 at 137 where Brennan, Dawson, Toohey, Gaudron and McHugh JJ, discussing whether an amount paid by a customer of the taxpayer to fund the building of a plant to coat pipes was assessable income, having regard to the character of the outgoing on building that plant, said: "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." 44 Ordinarily where a taxpayer expends funds to acquire an asset the outgoing will be on capital account as the price of a capital asset. This can be said, generally, to flow from the character of the advantage obtained. Where, on the other hand, a taxpayer employs funds to acquire an asset for sale as part of the business, the outgoing will be on revenue account where the asset itself is a revenue asset. An asset which is trading stock is clearly on revenue account without the necessity of calling in aid the provisions of s 51(2) of the 1936 Act or its equivalent s 70-25 of the 1997 Act. In terms of the classic Adam Smith distinction, expenditure on trading stock will be circulating capital. 45 Except for expenditure on trading stock there are few, if any, examples where expenditure on assets has been said to be on revenue account. Rather, in cases where the expenditure is not expenditure on trading stock what is brought to account is the net profit or net loss as the case may be of the business. Professor Parsons in his work Income Taxation in Australia (Law Book Company, 1985) says at [7.17]: "Where assets are turned over in the carrying on of a business but are not trading stock - the investments of a life insurance company or a banking company, or the investments in London Australia Investment Co Ltd (1977) 138 CLR 106 - the cost of an asset it not deductible though it will enter the calculation of loss or profit on realisation." 46 However, in deciding the character of the advantage obtained it is necessary to approach the question in what has been described as a practical and business like way (cf Hallstroms Pty Ltd v Commissioner of Taxation (1946) 72 CLR 634 at 648 per Dixon J). In a practical sense the partnership will not be paying for an asset ("the warrants"), notwithstanding that the transaction is said to involve the purchase of the warrants for endorsement to clients. The monies expended by the partnership do no more than give the partnership the ability to take advantage of what can be said to be the right to nominate the person or persons who will become entitled to the services of the advisor. Given the difficulties of enforcement, which would arise should the advisor refuse to perform the professional services for which he or she has contracted with the promoter, it would be unwise to regard the monies expended by the partnership as paid for the acquisition of an asset except perhaps in a strict juristic sense. 47 In my view, where the partnership is carrying on business as it is said to be in the relevant years of income, the amounts paid were not outlaid for the purchase of a capital asset of an enduring nature but should be seen as recurrent outgoings incurred in the course of carrying on that business and thus on revenue account. 48 It follows that a deduction would be available for monies outlaid in the acquisition of the warrants and correspondingly that amounts derived by turning these warrants to account whether in exchange for money, a share of the proceeds of litigation or otherwise (including the issue of units in a unit trust) would be assessable income. 49 The ruling contains, as noted, a question as to the application of Part IVA of the 1936 Act to deny any deductions otherwise allowable. 50 In Bellinz v Commissioner of Taxation (1998) 84 FCR 154 at 170, I pointed out the practical difficulty which would be faced by the Commissioner in giving a private ruling as to whether Part IVA applied to a particular arrangement. The difficulty arises because of the need to consider the whole factual matrix in determining, for the purposes of s 177D(b), whether the eight factors there set out would lead to a conclusion that a person or persons who entered into or carried out the relevant scheme did so for the dominant purpose of obtaining a tax benefit in the defined sense of that expression (see s 177A). 51 Senior counsel for the Commissioner relies upon these comments and what he refers to as the inaccurate statements in the material supplied by or on behalf of the applicant or its incompleteness. 52 Queen's counsel for the applicant submits for other reasons that the Court should not consider the question but rather the Commissioner should be ordered to amend the ruling so as to exclude from it the question and answer relating to Part IVA. It is submitted that Part IVA does not operate to bring about the result that an amount otherwise deductible should not be an allowable deduction, unless and until there has been a determination by the Commissioner. No such determination has in fact been made. In the result, as at the time the ruling speaks, there could be no application of Part IVA. The submission emphasises also that the Commissioner was not asked to rule upon the application of Part IVA and for that reason too, this part of the ruling should be excised. 53 There is much to be said for both of the arguments advanced by Queen's counsel for the applicant. In the circumstances, I am of the view that there should be excised from the ruling, both the questions and answers to the application of Part IVA. However, because it is possible that the Commissioner might in any year of income make a determination under s 177F(1) and because in light of the facts, that determination may be correctly made, the answers to the question of deductibility and the question of whether income is assessable should be qualified by words to the effect that the answers could be altered if a determination were made under the provisions of Part IVA which operated to disallow the deductions otherwise allowable. 54 I would thus allow the appeal and set aside the objection decision and, in lieu thereof, I would order that the objection be allowed and that the matter be remitted to the Commissioner to amend the ruling in accordance with law. I certify that the preceding fifty-four (54) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Hill.

Associate: Dated: 29 April 2005 Counsel for the Applicant: Mr A H Slater QC and Mr M L Robertson

Counsel for the Respondent: Mr B J Sullivan SC and Mr J H Momsen

Solicitor for the Respondent: Australian Government Solicitor

At a glance

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Before

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Judgment (37 paragraphs)

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Legislation Cited (4)

Cases Cited (8)

Cited By (4)