Malouf v Commissioner of Taxation [2008] FCA 497 | Case summary

The facts 7 The taxpayer had a 2.2% share as a partner in the TPC Retirement Village (No 1) Partnership (the TPC Partnership), which was itself a partner in another partnership, the Cresthaven Village Partnership (the Cresthaven Partnership) to the extent of 52.9066298%. The two partnerships were established by agreements dated 20 June 1999 (in respect of the TPC Partnership) and 24 June 1999 (in respect of the Cresthaven Partnership). These agreements were part of a tax scheme (using the term non-pejoratively and non-technically in the context of an absence of any assertion of the applicability of Part IVA of the 1936 Act) in which taxpayers sought to take advantage of Taxation Ruling TR94/24, in which the Commissioner stated that outgoings representing the purchase price for land in connection with the development of a retirement village would be viewed on revenue, not capital, account. Relevantly for the issues in this appeal, however, was the following statement in the ruling: …expenditure incurred by the owner in acquiring or developing the village is considered to be expenditure of a revenue nature. Accordingly, a deduction will be allowed for that expenditure in the year in which it is incurred. … (emphasis added) 8 The Cresthaven Partnership returned a partnership loss in the 1999 year of income, claiming deductions of $39,750,000 for the purchase price of a property at 124 Clegg Road, Mt Evelyn in Victoria and other deductions totalling $1,080,260. These other deductions are now not relevant to the controversy before the Court. 9 The structure of the scheme was that Prime Life Corporation Limited (Prime Life), through two subsidiaries (a management company and a development company), entered arrangements with the Cresthaven Partnership for the building, development and commercial exploitation of a retirement village. The relevant agreements were entered with a company as nominee for the four partnerships (including the TPC Partnership) which formed the Cresthaven Partnership. Each constituent partnership had a number of investors (personal and corporate). 10 In due course, on 17 February 2006, a Judge of this Court (Goldberg J) made a declaration that the scheme was a managed investment scheme that was required to be registered under the Corporations Law and the Corporations Act 2001 (Cth), but was not registered. The Court ordered that the scheme be wound up pursuant to s 601EE(1) of the Corporations Act. The Court also ordered that an independent accountant's report be filed. The consequence of the failure to register the scheme was that a contract entered into by a person other than the offeror for the scheme to subscribe for an interest was voidable at the option of that person by notice in writing: s 601MB(1) of the Corporations Law (as at June 1999); Ibrahim v Pham [2007] NSWCA 215; Karl Suleman Enterprizes Pty Limited (in liq) v Babanour (2004) 49 ACSR 612; and Mier v FN Management Pty Limited [2006] 1 Qd R 339 at 345-346 [10]. 11 I will come to the requisite provisions of the constituent documents directly, but Prime Life produced a "property report" that was distributed to investors and which contained an explanation of the investment and its workings as follows: 2. THE INVESTMENT 2.1 Investment Key Features The Investment has a number of special features: · Acquisition of a substantial property and ongoing business in a growth industry. · Potential for high yields and capital appreciation resulting from the growth of the Business. · Expected to realise revenue of not less than $39.75 million over a five year period from Licence Fees paid for Residential Licences, followed by EBIT of approximately $950,000 per annum upon the Village reaching "maturity" - ie 5-6 years after first occupancy. · Purchaser is not required to provide his personal guarantee to support construction finance. · Opportunity to benefit from taxation allowances applicable to retirement accommodation. These allowances could provide the Purchaser with a pre-interest tax deduction of $39,750,000 in the tax year ending 30th June 1999. 2.2 How the Investment Works (a) The Purchaser will acquire the land and completed building from PLC for a consideration of $39,750,000 on the basis of an unconditional contract of sale. A deposit of $6,500,000 is required no later than 15th May 1999 with the residue payable 14 days after receipt of a certificate of practical completion for the community centre and the Units in the first unit construction stage ('Settlement Date'). Title to the Village will be transferred to the Purchaser on the Settlement Date. (b) The Purchaser may be entitled to claim a tax deduction of around $39.75 million (exclusive of interest and other costs which the Purchaser may himself incur) in the 1999 income tax year. If this deduction is not fully utilised, it may be carried forward. (c) On the Settlement Date, the residue of $33.25 million remaining under the Contract will be advanced to the Purchaser by PLC, secured by a registered mortgage granted by the Purchaser over the retirement village. PLC will not charge interest on this advance. (d) The Purchaser will repay PLC's advance from proceeds of sale of Residential Licences. (e) Prior to the Settlement Date, PLC will borrow the funds required to complete the building works, secured by a first mortgage over the property. (f) On the Settlement Date, the first mortgage granted by PLC will be replaced by a third party mortgage granted by the Purchaser, but there will be no requirement for the Purchaser to provide his personal guarantee to support PLC's borrowing. The mortgage granted by the Purchaser to PLC (refer item (c) above) will rank behind that granted to PLC's lender. (g) It is envisaged that the preliminary roadworks and site preparation will commence in September 1999, with construction of the village infrastructure and first 40-50 Units to commence in September 2000. Units in this first stage are expected to be ready for occupancy around May 2001. The rest of the village will be constructed in stages of 20-30 Units, with work on each stage commencing when 65% of the Units in prior stages are sold on an unconditional basis. Serviced apartments will be constructed as a stand-alone stage part way through or at the end of the unit development. (h) PLC will undertake the initial marketing (first-time sale) of Units at its cost, to a limit of $2 million. Marketing expenses in excess of this level will be to the account of the Purchaser, to be funded, if so requested by the Purchaser, by advances from PLC and repaid from sales proceeds. (i) As stated above, settlement proceeds will be applied in reduction of the advance made by PLC to the Purchaser and, in turn, PLC will redirect those proceeds in reduction of PLC's construction loan. (j) The Adjusted Surplus, if any, will be shared equally by the Purchaser and PLC, however distribution of the Adjusted Surplus will not occur until the advance made by PLC to the Purchaser has been repaid in full. (k) The Purchaser will enter into a management agreement with PLC, effective from the Settlement Date. Under the terms of the management agreement, PLC will be responsible for supervision of the day-to-day operation of the Business and the continued marketing of the Village. The management agreement will stipulate that all operating income and expenses of the Business will be to the account of PLC until the Completion Date, after which PLC will be paid a management/consulting fee commensurate with the duties performed. (l) The Purchaser will also enter into a profit share agreement with PLC, effective from the day following the Completion Date, whereby the Purchaser and the PLC will share the EBIT on an equal basis. 2.3 Financial Results and Forecasts It is envisaged that the construction of the Village will be completed by 31st December 2004, and that all of the Licences will be sold within one year thereafter. … 12 The independent accountant's report ordered by the Court contained the following information about the project. (The reference to Prime Life (Mt Evelyn) Pty Ltd (PLME) is to the development subsidiary of Prime Life; the reference to Cresthaven is to the nominee of the Cresthaven Partnership which was previously called, at the date of the execution of the documents, GDK Retirement Nominees Pty Limited; and the references to ICGAS, Myra, TPC1 and TPC2 are to the four constituent partners of the Cresthaven Partnership.) …[T]he completed works in respect of the Facility (at the date of my report [17 May 2006]) are as follows: Stage 1 - completed (but not operating), and Stage 2 - infrastructure commenced … As at the date of this report [17 May 2006], settlement of the Sale Contract has not been completed and PLME remains the registered proprietor of the Property. Various matters are disputed between PLME and Cresthaven in respect of the Sale Contract and the development of the Facility on the Property. In or about July 2004, I understand Cresthaven notified PLME that it considered PLME had repudiated the Sale Contract and sought repayment of the deposit of $6.5 million plus interest. Cresthaven initiated proceedings against PLME in the Supreme Court of Victoria proceedings no. 2087 of 2004 (Proceedings). As at the date of my report, I understand that the parties have agreed to settle their dispute in accordance with terms set out in a Deed of Settlement dated 2 February 2006 between PLME, Primelife, PLMS, Cresthaven, ICGAS, Myra, TPC1 and TPC2 (the Settlement Deed). I understand that the parties have notified the Court that the proceedings have been settled, but have not taken the formal steps to dispose of the Proceedings. … 13 The contract for the sale of the subject property was entered into on 25 June 1999. A deposit of $6,500,000 was paid on exchange of contracts. No issue arises about the legitimacy of the deductibility of this sum in the 1999 year of income. The issue concerns what was described in the "Particulars of Sale" as the "Residue" of $33,250,000. Adjacent to the heading "Payment of Residue" under the Particulars of Sale was: "On the date determined in accordance with special condition 11." 14 Special condition 11, headed "Payment of Residue" was in the following terms: The Residue must be paid by the Purchaser to the Vendor on the day being fourteen (14) days after the Stage 1 Completion Date. 15 The definition of "Settlement Date" was as provided for in the "Particulars of Sale" as follows: The date upon which vacant possession of the Land must be provided subject to the remaining provisions of this Contract, and namely, upon acceptance of title and payment of the whole of the Residue. 16 The contract contemplated three completion dates after three stages of building. The three stages were defined as follows: "Stage 1" means the construction of that portion of the Buildings comprised by the Infrastructure, the Residents' Recreation & Community Facilities and the Units denoted on Plans A and Plans B with the letters "S1" and "S2 subject to variation or amendment of the Plans pursuant to the terms of this Contract; "Stage 2" means the construction of that portion of the Buildings comprised by the Units denoted on Plans A and Plans B with the letters "S3" and "S4" and any remaining components of the Infrastructure relating thereto as reasonably determined by the Vendor, subject to variation or amendment of the Plans pursuant to the terms of this Contract. "Stage 3" means the construction of that portion of the Buildings comprised by the Units denoted on Plans A with the letters "S5" and any remaining components of the Infrastructure relating thereto as reasonably determined by the Vendor, subject to variation or amendment of the Plans pursuant to the terms of this Contract. 17 The phrase "Stage 1 Completion Date" was defined as: …the date upon which a Certificate of Completion is issued in respect of Stage 1; 18 The phrase "Certificate of Completion" was defined as: …the Certificate of Completion issued by the Architects confirming that:- a. a particular Stage has, in the Architects' opinion generally been completed in accordance with the Plans and the Fixtures, Fittings and Finishes; and b. an Occupancy Permit has been issued by a registered Building Surveyor in respect of all of the Works relating to a particular Stage; 19 The "Plans A" and "Plans B" referred to in the definitions of Stage 1, Stage 2 and Stage 3 were defined as the plans so marked and annexed to the contract. The evidence revealed that they were not annexed, but were present at the time of execution of the contract and were themselves signed as Plans A and Plans B. 20 The relevant planning permit was dealt with in special condition 6. Special condition 6.1 acknowledged that there was an Existing Permit issued in accordance with Plans B and contained an obligation on the vendor to apply for a new permit in accordance with Plans A. Special condition 6.2 required the vendor to exercise its best endeavours to procure the new permit at its own cost as soon as possible and to prosecute any relevant appeal. If the new permit were granted, the construction would be in accordance with Plans A; if not, it would be in accordance with Plans B (special condition 6.4). The vendor's obligation to build under one or other of Plans B or Plans A or any agreed variation was unconditional. 21 The building contract was to be let by 1 September 1999 (special condition 7.2(a)). The building work was to proceed in three stages - stage 1 to be commenced by 1 September 1999, stage 2 to be commenced by the sooner of 1 March 2001 or 30 days after signing by residents of unconditional loan licence agreements for at least 65% in number of the units in stage 1, and stage 3 to be commenced by the sooner of 1 March 2002 or 30 days after signing by residents of unconditional loan licence agreements for at least 65% in number of the units in stage 2, such commencement times being capable of variation (special condition 7.2(b)). 22 If the Existing Permit (based on Plans B) formed the basis of the operative planning permit, the price was to be reduced by $6 million to $33,750,000 and the Residue to $27,250,000 (special condition 9.1). The parties to the contract agreed that of the price, $2,500,000 was to be attributed as the value of the land at the date of exchange, that is, in its undeveloped form. 23 The existing permit was attached to the contract and contained 24 conditions dealing with the requirement for approved plans, excavations, top soil, external finishes, lighting, landscaping, the nearby ring road, access, footpaths, parking, drainage, a maintenance bond, and other aspects related to the carrying out of the work. 24 The payment of the residue of the purchase price upon settlement was to be financed by a loan from the vendor supported by a mortgage called the "V. Mortgage", the terms of which were annexed. The terms of the V. Mortgage provided for repayment of the loan by reference to the receipt of amounts of loan licence fees by the purchaser/mortgagor. The repayment of the loan (with one qualification) was limited to the funds accruing from residents taking up loan licence agreements and paying loan licence fees and the land: special conditions 2 and 6. The qualification was that if the purchaser failed to pass on loan licence fees in reduction of the outstanding loan, the balance of the loan of the Residue would fall in and would be repayable personally: special conditions 2.4 and 6.1. 25 The priority of the V. Mortgage was recognised to be subordinate to securities provided by the vendor to the financiers of the building work. These securities were dealt with in special condition 13. 26 The contract expressly recognised that settlement would occur prior to completion of all the building works. The terms of the contract were therefore to continue to govern the relationship between the parties and were not to merge on settlement. 27 The deposit was provided for in special condition 10 of the contract, which included provisions dealing with the consequences for the deposit of "rescission" as a result of the default by vendor and by purchaser. 28 There was no provision providing for termination by either party without default, on the happening or not happening of any circumstance. In that sense, the contract can be legitimately described in traditional conveyancing terms as unconditional.

The issue of "incurred" 35 I have truncated the submissions of the parties into summary form. The subtle and difficult issue addressed in those submissions as to the application of the words of s 8-1 to the facts here (and whether an outgoing had been "incurred" here) is addressed below. Before dealing with this central issue a number of arguments can be cleared away. 36 First, the voidable nature of the contract by reason of the failure to register the scheme does not affect the question of incurrence. No party, including the taxpayer, sought to avoid the contract. The scheme has been wound up, but the terms of the winding up were premised on the non-avoidance of the scheme. The scheme was not illegal and there was no taint of illegality to strike at deductibility. 37 Secondly, the limited recourse nature of the vendor loan to fund the residue of the purchase price does not affect the issue of incurrence. Whilst the terms of the contract and the V. Mortgage gave a degree of personal protection to the investors, the funding of repayments from loan licence fees from residents meant that funds that would otherwise be assessable income of the taxpayer would be diverted to the vendor. It would be a real payment by the investors. 38 Thirdly, any effect of the Retirement Villages Act did not affect the nature or character of the obligation incurred to pay the purchase price. It is far from clear that the dual mortgage structure (the V. Mortgage and the Financiers Mortgages) could not deal with the requirements of the Retirement Villages Act to give residents unencumbered title. It would very much depend upon the ability to release lots of land referable to licence from the V. Mortgage and the Financiers Mortgages. 39 Fourthly, the contract was not void for uncertainty. The evidence discloses that Plans A and Plans B were signed contemporaneously with the contract. The submission, in the end, was barely put. 40 The most difficult question arises from what the Commissioner called the conditionality of the payment (that is, payment at settlement on tender of a transfer in the proper form after the successful completion of the building work) and the relationship between that and the tests for incurring for the purposes of s 8-1. 41 Before turning to the cases on incurred in relation to s 51(1) of the 1936 Act and s 8-1 of the 1997 Act, it is first necessary to analyse, with some more precision, the nature of the obligation to pay the purchase price. This is necessary because the legal character of the outgoing must be the subject of focus: Coles Myer Finance Limited v Commissioner of Taxation (1993) 176 CLR 640. 42 Special condition 11 of the contract, when read with relevant definitions and the Particulars of Sale, contains an express promise to pay the residue of the purchase price on the Settlement Date, that is, a day 14 days after the Stage 1 Completion Date. 43 The proper identification of this promise and its relationship to the payment of the purchase price is to be found in a number of cases of the highest authority. In McDonald v Dennys Lascelles Ltd (1933) 48 CLR 457 at 475-476, Dixon J (as he then was) quoted Sir John Salmond in Ruddenklau v Charlesworth [1925] NZLR 161 at 164-165 in expressing the relevant principle: If the purchaser refuses to complete the executory contract to buy the land, the vendor is not entitled to sue for the purchase money as a debt. He is entitled to sue for specific performance or for damages for the loss of his bargain. [emphasis added] Sir John Salmond continued: It is only when the contract has been completed by the execution and acceptance of a conveyance that unpaid purchase money may become a debt and can be recovered accordingly. [emphasis added] This general rule could be rebutted by clear intention in the contract for the payment of the purchase price, or part of it, on a fixed day, other than the day for completion. 44 That the obligation, subject to a revealed contrary intention, to pay the purchase price accrues fully only on settlement was reiterated in Sunbird Plaza Pty Limited v Maloney (1988) 166 CLR 245. In that case, the vendors sought recovery against guarantors of a contract for the sale of land in respect of which an order for specific performance had been made consequent upon repudiation by the purchaser. The proper construction of the guarantee was held not to support a conclusion that the guarantors were liable. Mason CJ (with whom Deane, Dawson and Toohey JJ agreed) said the following at 253-254: The general rule, stated by Dixon J in McDonald v Dennys Lascelles Ltd (1933) 48 CLR 457, at p 476, is that a vendor of land cannot sue for the price before the contract is completed by conveyance, unless the price is expressed to be payable on a fixed day, not being the day fixed for completion. Here the balance of the purchase price was payable "upon settlement". Settlement has not taken place and there has been no conveyance of the property sold. Once this is accepted, the appellant is faced with a daunting task in making good the submission that the respondent guarantors are liable under their joint and several guarantee to pay the balance of the purchase price and interest thereon, notwithstanding the absence of an accrued liability on the part of the purchaser to make the payment. [emphasis added] In the same case, Gaudron J (with whose reasons in this respect Mason CJ (and so also the other members of the Court) agreed) at 267-268 also referred to McDonald v Dennys Lascelles 48 CLR 457. 45 Thus, whilst there is a promise in an executory contract to pay the balance of the purchase price on settlement, there is no "debt" (McDonald v Dennys Lascelles) and no "accrued liability on the part of the purchaser to make the payment" (see Mason CJ in Sunbird Plaza 166 CLR at 254), until completion. This is not to deny, however, that the purchaser's interests will be protected in equity consistent with the nature and extent of the terms of the contract of sale: Stern v McArthur (1988) 165 CLR 489 at 522-23, and that the promise can be otherwise seen as unqualified. 46 These cases were applied by von Doussa J (with whose reasons Jenkinson and Spender JJ agreed) in Gasparin v Commissioner of Taxation (1954) 50 FCR 73. That case concerned the question as to when income was derived from the sale of allotments of land. It was held that each allotment remained trading stock on hand until settlement. After referring to McDonald v Dennys Lascelles, Sunbird Plaza and Automatic Fire Sprinklers Pty Limited v Watson (1946) 72 CLR 435 at 463-464 (as to which case, see below), von Doussa J said at 77 that these cases reflected a general rule about unsettled contracts of sale. His Honours said that at the end of the year of income in question: …there were no debts owing by the purchasers to the joint venturers. In each case the promise to pay the balance of the purchase price "at settlement" remained executory until settlement occurred at which time a conveyance was executed, accepted and delivered to the purchaser. Until these events there was no accrued liability on the part of the purchaser to pay the balance of the purchase price. [emphasis added] 47 These comments were made in the context of derivation of income on an accruals basis, a different though obviously cognate subject matter from the notion of incurring in s 51(1) or s 8-1. In the context of Carden's Case (Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108) and J Rowe and Son Pty Limited v Commissioner of Taxation (Cth) (1971) 124 CLR 421 and in the absence of evidence about business or accounting practice, von Doussa J said (at 79) that stress should be placed on the prominence given in both Carden and Rowe to there being a debt in existence. von Doussa J rejected the approach of the Administrative Appeals Tribunal which had seen no distinction between a sale and delivery and giving time to pay by way of credit, on the one hand, and a contract such as the one there to buy land to be paid for at settlement on the other. von Doussa J said at 79-80: With respect to the Tribunal, I am unable to agree that there is no difference in the present case from a Department store sale of articles on 30 days terms. In that example there has been a delivery of the articles sold. The contract of sale is no longer executory. A debt has accrued due; the debtor has become subject to an obligation to pay a sum certain in money even though the debt may not be payable forthwith: cf Cardenat 127. [emphasis added] Notions of loss of dispositive power over the goods were also important: see Gasparin 50 FCR at 81. 48 Gasparin and the cases referred to therein are not determinative of the question as to what "incurred" means for the purposes of 8-1 of the 1997 Act. They do reveal, however, the use, in a cognate area, of the distinction between a promise in an executory contract, and the debt (that is the present obligation to pay the purchase money) accruing on settlement, whether payable then or after some agreed time if credit be given. In this context, it is important to note that von Doussa J, though dealing with the contract for the sale of land, referred to Automatic Fire Sprinklers 72 CLR 435. That case concerned a question of wrongful dismissal under wartime regulations. Nevertheless, despite this context, what was said by Dixon J at 463-464 remains important for understanding the relationship between the executory contract and the entitlement to the price of the property or services contracted for: In certain forms of executory contract where the promise of one party is to pay the other money in consideration of his transferring property, of his doing work, of his serving the former as his master, and, perhaps, of his providing other tangible things or definite services, the money to be paid is regarded as the price of or reward for the property or service when and so often as the transfer of the one or the performance of the other affords an executed consideration. In these contracts the promise to pay the price or reward is not construed as a simple obligation to pay a sum or sums at a future date supported solely by a consideration consisting in the corresponding promise to transfer the property, do the work, serve, or provide the things or services by the other party, so that a mere readiness and willingness on the one side of the latter to perform his part is enough to entitle him to the payments, notwithstanding that, whether owing to the fault of the former, or without fault on either side, the property is not transferred, the work is not done, the relation of master and servant ceases, or the things or services are not provided. The most familiar example is that of the sale of goods. There the common understanding of an agreement to sell is that it is the goods and not the promises to deliver that are to be paid for. The result is that, if the seller tenders goods in accordance with his contract but the buyer rejects them in breach of his contract, the seller cannot sue for the price; his remedy is for unliquidated damages for non-acceptance. … 49 The Commissioner submitted that in the context of the authorities on "incurred" for the purposes of s 51(1) of the 1936 Act and s 8-1 of the 1997 Act (to which authorities I will presently turn), this jurisprudential approach is sufficient to recognise that there is no accrued obligation to pay the purchase price until settlement, so that the promise to pay the balance of the purchase price does not give rise to a debt or accrued obligation until settlement occurs and a transfer is tendered. Until settlement, it was said, the obligation to pay the balance of the purchase money (whether immediately or later, as here, on credit) does not accrue and is conditional or contingent. It is the property (the goods or land) that is to be paid for, not the promise to deliver the property. 50 The above said, there was nothing qualified or inchoate about the promise in special condition 11 of the contract. There was no condition precedent to the coming into existence of the promise there stated. It was, from exchange of contracts, a legal obligation intended to have effect; but it is to be construed (as its words make plain) as an obligation to pay a certain time after tender of the transfer on settlement. After the contract was made, it was a promise that was part of an executory contract, but, of course, it could not be withdrawn. The point of the above authorities is that until delivery (here, of the transfer) there is no accrued obligation to pay, no debt. What exists beforehand is a promise to pay, but in one sense dependent or conditional upon delivery. Delivery can, perhaps, be seen as the condition precedent to performance (cf Perri v Coolangatta Investments Pty Limited (1982) 149 CLR 537). The use, however, of the words "conditional" or "unconditional" in this context is apt to cause confusion. A better way of expressing the analysis from the above cases is that the mutual promises (here, to build and transfer, on the one hand, and to pay, on the other) are unconditional, but dependent, and calling for concurrent performance. Neither promise was conditional on a contingency; they were mutually dependent: see generally Carter JW and Harland DJ, Contract Law in Australia (4th ed, Butterworths, 2002) at [742], [1807] and [1808]. 51 It is necessary to seek to place this analysis into the context of the words of s 8-1 and their surrounding jurisprudence. 52 Section 8-1(1) of the 1997 Act is, relevantly, in the following terms: 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. [emphasis added] 53 There is no suggestion in the terms or history of s 8-1 that the issues or questions of when an outgoing is incurred were different to those raised in s 51(1) of the 1936 Act. 54 The circumstances in which outgoings or losses will be seen as incurred in any year of income have been discussed in numerous cases. Recently, Lindgren J in Merrill Lynch International (Australia) Limited v Commissioner of Taxation (2001) 47 ATR 611 undertook a careful analysis of the course of authority from New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 to Commissioner of Taxation v Mercantile Mutual Insurance (Workers' Compensation) Ltd (1999) 87 FCR 536. Since 2001, the Full Court of this Court and the High Court has each undertaken an analysis of the relevant authorities in CityLink Melbourne Limited v Commissioner of Taxation (2004) 141 FCR 69 and Commissioner of Taxation v CityLink Melbourne Limited (2006) 228 CLR 1. 55 In Ogilvy & Mather Pty Limited v Commissioner of Taxation (1990) 21 ATR 841 at 873-874 Hill J sought to summarise the principles from the authorities. This summary was adopted by the Full Court in CityLink 141 FCR at 79-80. It was as follows: · It is unsafe to attempt an exhaustive definition of a term such as "incurred": New Zealand Flax Investments Ltd at 297 per Dixon J; Hooker Rex Pty Ltd v Commissioner of Taxation (Cth) (1988) 19 ATR 1241 at 1249-1250; · In considering whether a loss or outgoing is incurred the Courts in Australia have adopted what is described as a "legal" or "jurisprudential approach" and not what may be described as a "commercial approach": Coles Myer Finance Ltd v Commissioner of Taxation (Cth) [(1993) 176 CLR 640]; · An outgoing may be incurred notwithstanding that the amount is not paid in the year of income: Commissioner of Taxation (Cth) v James Flood Pty Ltd (1953) 88 CLR 492 at 507; · An outgoing may be incurred notwithstanding that at the end of the year of income it represents a present liability then due although payable in the future: Commissioner of Taxation (Cth) v Australian Guarantee Corporation Ltd (1984) 2 FCR 483. However, it will be important that the liability is "presently existing" during the year of income; · It will be necessary that the taxpayer has completely subjected itself to the loss or outgoing, that is to say definitively committed itself to it in the year of income: Merrill Lynch International (Australia) Ltd v Commissioner of Taxation (Cth) (2001) 113 FCR 79 per Lindgren J. It will not be sufficient if the loss or outgoing is no more than pending, threatened or expected, no matter that it may be certain that the loss or outgoing will occur in the future: Flood at 5-7-508; Hooker Rex at 1249-1250; and · However, a loss or outgoing may be incurred in the year of income notwithstanding that the obligation to pay it is theoretically defeasible: Flood at 506-507; Coles Myer at 670 or, perhaps, even contingent: Coles Myer at 670 per Deane J, citing Commercial Union Assurance Co of Australia Ltd v Commissioner of Taxation (Cth) (1977) 32 FLR 32 at 42-43, but see, however, Flood at 507-508. 56 At about the time of this first instance judgment in Ogilvy & Mather 21 ATR 841, the Full Court in Raymor 24 FCR at 97 (Davies, Gummow and Hill JJ) expressed the relevant principles as follows: A loss or outgoing to be deductible under s 51(1) must be incurred in the year of income. What is meant by the word "incurred" in this context has been the subject of considerable discussion in the cases. Central to that discussion is the classic statement of Dixon J in New Zealand Flax Investments Ltd v Commissioner of Taxation (Cth) (1938) 61 CLR 179 at 207, referred to with approval by the court in Commissioner of Taxation (Cth) v James Flood Pty Ltd (1953) 88 CLR 492 at 507. His Honour there said: "To come within that provision there must be a loss or outgoing actually incurred. Incurred' does not mean only defrayed, discharged or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened or expected." Some propositions are now well established. Outgoings may be incurred though the sum in question has not been paid or the liability discharged: New Zealand Flax Investments Ltd (supra) and James Flood Pty Ltd (supra). An outgoing may be incurred notwithstanding that it may be defeasible: Commonwealth Aluminium Corp Ltd v Commissioner of Taxation (Cth) (1977) 32 FLR 210 at 223-224, cited with approval in Commissioner of Taxation (Cth) v Australian Guarantee Corp Ltd (1984) 2 FCR 483, per Toohey J (at 487); RACV Insurance Pty Ltd v Commissioner of Taxation (Cth) [1974] VR 1 and Commercial Union Assurance Co of Australia Ltd v Commissioner of Taxation (Cth) (1977) 32 FLR 32. An outgoing may be incurred notwithstanding that the amount of that outgoing is payable in the future. It is not necessary that the outgoing be one both due and owing at the time it is "encountered": James Flood Pty Ltd at 507; Commissioner of Taxation (Cth) v Australian Guarantee Corp Ltd (supra). However, "a liability which has not come home' in the year of income, in the sense of a pecuniary obligation which has become due" will not have been incurred until the year of income in which there is a presently existing liability: Nilsen Development Laboratories Pty Ltd v Commissioner of Taxation (Cth) (1981) 144 CLR 616, per Barwick CJ (at 623) and per Gibbs J (at 627). As the Australian Guarantee Corp case demonstrates, evidence of commercial and accountancy practice may be relevant in determining whether an outgoing is referable to the accounting period in which it is claimed although such evidence will not be a substitute for the words of s 51(1) itself: per Toohey J (at 492-493), per McGregor J (at 501-503); see also Hooker Rex Pty Ltd v Commissioner of Taxation (Cth) (1988) 79 ALR 181 at 189, 203. It may be noted that in the present case no evidence of this kind was adduced by the Commissioner. 57 By and large this expression of principle is consistent with Ogilvy & Mather, though the propositions in the sixth bullet point in Ogilvy & Mather can be seen to be somewhat more qualified than as expounded in Raymor. 58 It is also important to bear in mind, as the Full Court said in Woolcombers 47 FCR at 575, that much depends on the circumstances of the case at hand. Whilst a legal or jurisprudential approach is to be taken, the precise circumstances of the contract and surrounding circumstances in question are what must be assessed, not generalities and wide categories of cases. 59 In the High Court in CityLink 228 CLR 1,Crennan J (with whose reasons Gleeson CJ, Gummow, Callinan and Heydon JJ agreed) referred at 38 [127], without disapproval, to the synthesis essayed by Hill J in Ogilvy & Mather. In her Honour's reasons (at [122]-[126]) some analysis of the jurisprudence was made upon which the respondent here relied. After referring in [122] to New Zealand Flax 61 CLR 179 and James Flood 88 CLR 492 and, in particular, to the notions of "definitely committed" and "completely subjected", her Honour referred to the reasons of Barwick CJ in Nilsen Development Laboratories Pty Limited v Federal Commissioner of Taxation (1981) 144 CLR 616. The reference to that decision is important in that the Chief Justice (with whose reasons Mason J agreed generally, and Aickin and Wilson JJ agreed (together with the reasons of Mason J)) said at 623 that the language of Dixon J in New Zealand Flax "need[ed] to be carefully perused and applied" and then went on to say the following: …Granted that exhaustive definition of what may be denoted by the word "incurred" in s 51 (1) may not be possible, there can be no warrant for treating a liability which has not "come home" in the year of income, in the sense of a pecuniary obligation which has become due, as having been incurred in that year. Sir John Latham's language in Emu Bay Railway Co Ltd v Federal Commissioner of Taxation (1944) 71 CLR 596 at p 606 clearly enough indicates that to satisfy the word "incurred" in s 51 (1) the liability must be "presently incurred and due though not yet discharged". The "liability" of which Sir John speaks is of necessity a pecuniary liability and the word "presently" refers to the year of income in respect of which a deduction is claimed. It may not disqualify the liability as a deduction that, though due, it may be paid in a later year. That part of Sir Owen Dixon's statement in New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR, at p 207 which presently needs emphasis is that the word "incurred" in s 51 (1) "does not include a loss or expenditure which is no more than pending, threatened or expected": and I would for myself add "no matter how certain it is in the year of income that that loss or expenditure will occur in the future". The language of Crennan J in [123] can be seen to revivify this passage from Nilsen Developments 144 CLR 616 which did not form an express part of Hill J's synthesis in Ogilvy & Mather, though it was referred to in Raymor. It can be seen as a reiteration, perhaps, of the fourth proposition in Ogilvy & Mather supported by reference to Federal Commissioner of Taxation v Australian Guarantee Corporation Limited (1984) 2 FCR 483, a case in which Nilsen Developments and Emu Bay Railway Co Ltd v Federal Commissioner of Taxation (1944) 71 CLR 596 were distinguished. Though Nilsen Developments was in respect of long service leave obligations in a specific statutory context, it is clear that the lack of a liability to make a paymentuntil leave was taken or cessation of employment meant that there was no incurring of the outgoing. 60 After this reference to Nilsen Development in [123], Crennan J at [124] referred to Deane J in Coles Myer 176 CLR 640, quoting the following passage of Deane J's reasons at 176 CLR at 670: [T]he weight of authority supports the conclusion that, depending upon the circumstances, a liability to pay money can constitute, or give rise to, a "loss or outgoing" which is "incurred" within the meaning of that subsection notwithstanding that the money is not payable until a future time and that the obligation to pay it is theoretically defeasible or contingent in that it is subject to a condition which remains unfulfilled. (Footnotes omitted.) Crennan J continued at [125] Deane J considered that the critical question was whether the taxpayer was, as a practical matter, definitively committed or completely subjected to discharge of the liability in the future (1993) 176 CLR 640 at 670-671. His Honour recognised that on some facts it would be apparent that a condition giving rise to a theoretical contingency could be treated, for practical purposes, as certain to be satisfied (1993) 176 CLR 640 at 670-671. 61 Two (related) elements of these passages were relied upon by the Commissioner. First, the use of the adjective "theoretical" as qualifying "defeasible or contingent"; and, secondly, the reference to the assessment of definitively committed or completely subjected to discharge of the liability as a "practical matter". The Commissioner submitted: Save for merely theoretical contingencies which can, for practical purposes, be treated as certain to be discharged the liability must not be subject to contingencies. 62 The Commissioner submitted that, here, the conditionality of settlement occurring was more than theoretical, involving practical considerations that were far from certain. Further, the Commissioner submitted that the liability to pay the outgoing was not merely conditional upon settlement, but rather was not due or accrued and would not be so until settlement and the delivery of a transfer and title to the land. 63 Subject to one qualification, and subject to the examination of certain of the authorities, there is significant force in these submissions. 64 The qualification is that I do not think that the authorities require a detailed factual enquiry as to the practicality and likelihood of the condition being met or the defeasance not occurring. In Woolcombers 47 FCR at 575, the Full Court said: In James Flood, the High Court said (at 506): "It is probably going too far to say that the obligation must be indefeasible." In our view, much will depend upon the particular circumstances of the case at hand. If the defeasibility takes the form of a contingency such as drought or a similar frustrating event which ordinarily would be implied as a matter of business efficacy, it is difficult to argue that by reason of the existence of this contingency, no liability to pay the price has accrued. An enquiry may well be necessary as to the understanding of the parties as to the likelihood or expectation of the contingency or defeasance occurring, but so as to understand the context of the contract, not to make a detailed assessment of the fact of the likelihood of the contingency or defeasance occurring. 65 That said, the words of Barwick CJ in Nilsen Development 144 CLR at 623-624 using the phrase of Latham CJ in Emu Bay Railway Co 71 CLR at 606, applied by Crennan J in CityLink 228 CLR 1that the liability must be "presently incurred and due" in the context of the liability to pay the purchase moneys for the acquisition of land are a powerful basis to conclude that the outgoing (being the payment of the purchase moneys) has not been incurred at exchange and will not be incurred until settlement. To apply McDonald v Dennys Lascelles, Automatic Fire Sprinklers, Sunbird Plaza and Gasparin, a distinction could be made between the promise to pay the purchase price as part of an executory contract and the liability to pay the purchase price which accrues, and can be seen to be due, only at settlement. Thus, it could be said that the liability to pay the outgoing is not "incurred and due"; just as the income for the seller is not derived: Gasparin 50 FCR 73. 66 This argument and conclusion must contend, however, with a number of authorities. The first is Raymor 24 FCR 90. The taxpayer sold and distributed plumbing goods, including copper tubing. It purchased most of its supplies of copper tubing from a company (MML) for resale. The managing director of the taxpayer agreed with an officer of MML in the last days of each of three years of income. Each agreement was concerned with the purchase of a significant amount of copper tubing with payment being made in advance of delivery. It was in effect a forward purchase agreement with a discounted price and rise and fall clause. The contract was entered and payment was made before the end of June, with delivery in the next financial year. 67 In Raymor, the Commissioner argued that where an outgoing was incurred for trading stock, the stock must be on hand at the end of the year of income. This mirrored when the income was derived from disposal of trading stock: J Rowe and Son 124 CLR 421. The Commissioner argued that the outgoings were properly to be regarded as characterised as having been incurred in the year of income not for trading stock or in the purchase of trading stock, but for the right to acquire trading stock - on capital account. Having referred to the principles dealing with "incurred" (see above), the Court concluded that the outgoing was incurred in the year of income, saying at 97: It follows, therefore, that at the point of time at which the respondent bound itself as a party to each of the contracts, and so became committed to pay the amount shown in each contract to MML, it incurred the respective amount, notwithstanding that its obligation could be increased or reduced under the rise and fall provisions of the contract: cl 8. Payment thereafter was strictly irrelevant to the time at which the outgoing was incurred. It merely operated to discharge in the year of income the outgoing already incurred in that year. In this sense it is strictly incorrect to speak of the payment here in question as a prepayment. A presently existing obligation had arisen and had been discharged. [emphasis added] 68 Though payment was made it was irrelevant to the Court's reasoning. The contractual binding to pay the price on delivery was sufficient. Then, after dealing with the effect of the rise and fall clause, the Court said at 101: Once, however, it is appreciated that an outgoing may be deductible notwithstanding that it may be defeasible, there can be no logical reason why an outgoing pursuant to a contract may not be deductible notwithstanding that the ultimate price payable upon delivery of the goods the subject of a contract may be varied upwards or downwards to reflect the increased cost of the goods. … 69 The above approach of the Full Court was to view the promise to pay the price, on delivery, as a sufficiently present obligation to amount to the incurring of the obligation to pay the price. 70 A similar approach was taken in Woolcombers. 71 In Woolcombers the taxpayer, in the year of income, entered forward contracts for the purchase of wool that had been shorn or was yet to be shorn. The standard form contracts provided for property in the wool to pass from the woolgrower to the taxpayer upon payment, being 14 days after delivery. The contract provided expressly for the possibility of the grower needing to dispose of the sheep because of drought, flood or disease. In such circumstances, failing agreement as to how many sheep to sell, the matter of disposal would be the subject of arbitration. Thus, the promise to pay for wool to be delivered in the future was made in the year of income (1988). The wool was delivered and paid for in the following year of income. An indemnity as to delivery and quality was given by the grower. In the previous 12 years, all such forward contracts, with one exception, had been completed by the growers. The contracts were to meet contracts by way of on-sales for export entered by companies related to the taxpayer. (It is to be recalled, at this point, that the principle dealt with in Gasparin and Sunbird Plaza was not limited to contracts for the sale of land. The discussion by Dixon J in Automatic Fire Sprinklers 72 CLR at 463-464 made that clear.) 72 At first instance, Lee J concluded that the obligation to pay the purchase price of all the wool on the forward contracts had been incurred in the year of income. The argument of the Commissioner was not that the estimate made of the sums meant that there was no incurrence. Rather, it was argued that the liability to pay had not "come home". Expert accounting evidence was led by both sides (something which did not occur here). The point of difference between the accountants was the truth and fairness of the accounts treating the payments as incurred or not. The expert called by the Commissioner relied heavily on the matching principle. Lee J put this evidence into context at 114 ALR at 653: Evidence from expert accountants does not supply the proper construction of s 51(1) of the Act but the evidence may assist the court to identify, and to understand the commercial significance of, the facts to which the subsection, duly construed, is to be applied: Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia Ltd (Carden's case) (1938) 63 CLR 108 per Dixon J at 153-4; QBE Insurance Group Ltd v Australian Securities Commission (1992) 110 ALR 301; 38 FCR 270 per Lockhart J at 289; Coles Myer Finance Ltd v FCT (1993) 112 ALR 322 ; 93 ATC 4,214 per Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ at 4,221. The construction of s 51(1) is a jurisprudential analysis and not a construction assisted by the application of commercial principles (see Coles Myer per Mason CJ, Brennan, Toohey, Gaudron JJ at ATC 4,221, per McHugh J at ATC 4,227-8) but commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item claimed as a loss or outgoing under s 51(1): see FCT v James Flood Pty Ltd (1953) 88 CLR 492 at 506-7; Carden's case per Dixon J at 152-3. Furthermore, the manner of application of s 51(1) will depend upon the particular facts of each case. 73 Very relevant for the present argument is the recognition by Lee J at 653-654 that the Commissioner's argument that an outgoing had not been incurred was put as encapsulated in the reasons of Barwick CJ in Nilsen Developments 144 CLR at 623-624 (as to the terms of which, see above). Lee J saw James Flood and Nilsen Developments as concerned with a payment akin to wages, not accrued and due until work was performed. That said, the analysis by Lee J at 114 ALR 654-655 is directly contrary to the argument of the Commissioner here (as it was in Woolcombers). Those passages make clear that Lee J saw the undertaking of the obligation to pay upon delivery of the goods in the future, in circumstances where the woolgrower's right to dispose of the sheep without the taxpayer's consent was restricted, reflected a mutual intention that the taxpayer obtain enforceable contractual rights upon execution of the contract and undertake a commensurate liability. At 114 ALR 165 Lee J said: The result of the contractual provisions was the imposition of a clear liability on the taxpayer to pay for the wool grower's woolclip. Although it may be said that the effective time for payment did not arise until the wool had been shorn and the quantum of payment decided by the weight of wool shorn, neither circumstance made the obligation a mere "theoretical contingent liability". The liability of the woolgrower to indemnify the taxpayer upon formation of the contract made it clear that it was intended that a correlative liability be imposed upon the taxpayer at the same time to pay the woolgrower for the woolclip. There was an accrued obligation or present liability imposed on the taxpayer by a definite contractual commitment. It was more than "an impending, threatened or expected expenditure not then grounded in a commitment in the form of a liability to pay"… … [T]he mutual contractual commitments of the taxpayer and the woolgrower made the contract itself an item of value in commerce. In any event, as a matter of jurisprudential analysis the taxpayer's present contractual commitment to buy and pay for the woolclip was a liability to pay an ascertainable sum at a later date undertaken by the taxpayer in the course of the conduct of and for the purpose of its business and the binding nature of that commitment satisfied the meaning of the word "incurred" as used in s 51(1) of the Act… 74 Lee J then dealt with the meaning of "referable", to which I will come later. 75 In the Full Court, the Commissioner once again argued that there was no presently existing liability to pay until delivery, which was a condition precedent to the performance of the taxpayer's obligation to make payment with the contract. Thus, there was no present liability accrued until after the wool was delivered, which did not occur in the year of income. This can be seen as the same argument propounded before me. 76 The Full Court rejected the argument. In so doing, it referred to and relied on the two passages from Raymor 24 FCR at 97 and 101, cited earlier. This was to support the conclusion that the entry into the obligation to pay for future goods was sufficient for there to be an incurring of the liability to pay for them, even if the obligation was defeasible. Coles Myer 176 CLR 640 was then referred to. At 47 FCR at 573-575 the Full Court expressed its reasons fully for coming to the view that there was an accrued obligation or present liability imposed by definite contractual commitment. The Court said that it was not necessary for the taxpayer to have an interest in the wool, though it was recognised that equity would give protection to the taxpayer's interests. Stern v McArthur 165 CLR 489 was referred to. The Court rejected the argument of the Commissioner based on the requirement of delivery to create a present and accrued liability to pay. It agreed with Lee J's analysis. The Full Court did conclude, however, with the following passage at 47 FCR at 575: In our view, much will depend upon the particular circumstances of the case at hand. If the defeasibility takes the form of a contingency such as drought or a similar frustrating event which ordinarily would be implied as a matter of business efficacy, it is difficult to argue that by reason of the existence of this contingency, no liability to pay the price has accrued. 77 As I have said earlier, the application of the principles in Sunbird Plaza to the question of "incurred" has force, unconstrained by authority. So to conclude would lead to a certain harmony in timing between recognition of derivation of income and the incurring of an outgoing. It would give expression to the long-recognised underlying legal analysis in cases such as McDonald v Dennys Lascelles, Automatic Fire Sprinklers, and Sunbird Plaza. It would conform more clearly with the views of Barwick CJ in Nilsen Developments 144 CLR 616. Nevertheless as a single judge, I am clearly bound by Raymor and Woolcombers. The essence of the argument, as I apprehend it, that was put to the Full Court in Woolcombers, was put to me, though, perhaps, in a somewhat more developed form. Unless the last passage that I have quoted above entitles me to find differently, on the authority of both Raymor and Woolcombers, I should find that the obligation to pay the purchase price on settlement was incurred at the time of the exchange of contracts. 78 I do not think that the defeasibility or contingency of drought, flood or disease in Western Australian sheep country in the late 1980s should be viewed qualitatively differently from commercial building in Victoria in the late 1990s. Both undertakings have their risks and imponderables, and it is clear that natural or commercial exigencies may intrude to defeat or delay the future event upon which payment would be made. Importantly for present purposes, the obligation on the vendor to undertake the building work to a point of completion at which settlement would take place was unconditional. If building work could not be completed to a stage for completion that would be a product of either force majeure or frustration or default. There was no allegation of sham. Whilst the contract can be said to have been made available with its tax advantages made prominent, it was a real commercial undertaking. The obligations of the vendor were, amongst other things, to bring the project to Stage 1 completion under a permit based either on Plans A (a new permit) or Plans B (the existing permit). The purchaser was obliged to pay the residue on settlement. 79 In my view, I am bound to apply the analysis found in Raymor and Woolcombers. Doing so by reference to the particular contract here, I conclude that the obligation to pay the residue was incurred in the 1999 year of income.

Malouf v Commissioner of Taxation

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Judgment (19 paragraphs)

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Legislation Cited (5)

Cases Cited (27)

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