Introduction

[11.1] In [2.10]–[2.37] above, the integral relationship between the income character of an item and the derivation of that item was emphasised. Proposition 3, considered in [2.34]–[2.37] above, asserts that the character of an item as income must be judged in the circumstances of its derivation by the taxpayer, and without regard to the character it would have had if it had been derived by another person. While the Assessment Act in s. 25(1) refers to “income derived”, derivation is itself an aspect of income character. The same observation may be made in another way. Derivation is concerned with the time at which an item is income, so that it falls to be included in a return of income for a year of income or comes to be subject to tax by withholding. But the time at which an item is to be judged for its income character will affect the judgment that is made. In Abbott v. Philbin [1961] A.C. 352, a decision that there was a derivation on the acceptance by the taxpayer of the options offered to him was the basis of a conclusion that there was an item of an income character. A decision that the only derivation occurred on the exercise of the options would have required a conclusion that there was no item of an income character. The shares acquired on exercise came to the taxpayer as a consequence of the exercise of a valuable right, and not in circumstances which gave them an income character. In Constable (1952) 86 C.L.R. 402 the employer’s contributions to a superannuation fund were, in the view expressed by the majority of the court, not derived by the employee at the time they were contributed to the fund in respect of the employee. They were derived on payment out from the fund to the employee, at which time they had ceased to have an income character as rewards for services he had performed.

[11.2] None the less it is necessary in any discussion of tax accounting to follow the language of s. 25, so as to sever the notion of derivation from the income character of an item. So too it is necessary to follow the language of s. 51 so as to sever the incurring of an item from the character that makes it a deductible item.

[11.3] The problems of tax accounting are thus seen as problems of when an item is “derived” or “incurred”. Problems of derivation may in all circumstances be regarded as problems of interpretation of the word “derived” in s. 25, if the central provision and single meaning analyses of the structure of the Assessment Act, propounded in [1.30]–[1.44] above, are adopted. That interpretation will be assisted by the language that is used in specific provisions which may direct a particular basis of tax accounting, for example s. 44(1) which refers to a dividend “paid to” the taxpayer, or may provide a particular basis of accounting for an item, for example s. 36 which brings in the value of an item of trading stock disposed of otherwise than in the course of carrying on a business.

[11.4] Problems of incurring will for the most part be problems of interpretation of the word “incurred” in s. 51(1). Sometimes, however, deductibility depends on some provision which cannot be seen as simply explaining the operation of s. 51(1). In which case the timing of incurring must depend on the interpretation of that provision. Section 59(1), in regard to the deduction that may be available on disposition, loss or destruction of property in respect of which depreciation has been allowed, is an illustration.

Tax Accounting and Financial Accounting

[11.5] It will be seen that tax law, in asserting principles determining the time of derivation of a receipt of income that is not a profit item, and in determining the time of incurring of an outgoing (as distinct from a loss), has adopted language borrowed from financial accounting which distinguishes between “accruals” or “earnings” or “credit” accounting, and “cash” accounting. It should not, however, be assumed that financial accounting is part of tax law. Accruals financial accounting will, for example, treat as an expense a provision for long service leave. Accruals tax accounting will not allow a deduction of such a provision (Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 and s. 51(3)). Financial accounting may treat a “pre-payment” as an expense only to the extent that the benefit from the payment is enjoyed in the year in which it is treated as an expense. Tax accounting will, it seems, treat the outlay as a deductible outgoing in the year in which it is in other respects incurred. The matter was the subject of some comment in [6.119]–[6.136] above. B.P. Australia Ltd (1965) 112 C.L.R. 386 supports deductibility in advance of the enjoyment of the benefit, though Alliance Holdings Ltd (1981) 81 A.T.C. 4637 and Australian Guarantee Corp. (1984) 84 A.T.C. 4642 may be seen as bringing tax accounting nearer to financial accounting.

[11.6] Tax accounting has none the less imported some principles from financial accounting. The principal illustration is the principle in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 that an item of income otherwise derived will be treated as derived only to the extent that it has been “earned”. The principle may have a scope narrower than its scope in its application in financial accounting, but it is none the less imported. The consequence, it will be seen, is a curious asymmetry between tax accounting for income items and tax accounting for deduction items.

The Basic Distinction: Accounting for Receipts and Outgoings and Accounting for Specific Profit or Loss

[11.7] Though somewhat grudgingly, tax accounting has come to recognise a basic distinction between accounting for receipts and outgoings and accounting for specific profit or loss. Assertions that were commonly made to the effect that tax accounting under the Assessment Act was a matter of accounting for receipts and outgoings except where the Assessment Act specifically provided otherwise are no longer heard, though assertions continue to be made which would regard accounting for profit or loss as exceptional and accounting for receipts and outgoings as the general rule. Specific provisions of the Assessment Act, the most significant being s. 26(a) (the predecessor of s. 25A(1)) had always required profit or loss accounting. International Nickel Aust. Ltd (1977) 137 C.L.R. 347 involved a recognition that items which are income by ordinary usage might be accounted for on a specific profit basis, though there had been such a recognition as far back as New Zealand Flax Investments Ltd (1938) 61 C.L.R. 179 as a matter of observation by Dixon J. And there had been recognition in the decisions in Australasian Catholic Assurance Co. Ltd (1959) 100 C.L.R. 502 and, though implicitly, in Investment & Merchant Finance Corp. Ltd (1971) 125 C.L.R. 249 and in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106 and the so-called banking and life insurance cases concerned with profits on investments. The most recent recognition is by the High Court in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355, though it is again implicit: the court was not asked to consider questions of tax accounting. The recognition is in the conclusion that the item of income by ordinary usage arising from the isolated business venture carried out by the taxpayer was of the same kind as the item of income that might arise under s. 26(a).

[11.8] At a number of points in Pts I and II of this Volume situations are identified where the appropriate accounting is concerned with what might be called a specific profit or loss. A number are listed in [5.15] above, and some of these are the subject of further comment in other paragraphs, more especially those concerned with losses in relation to receivables and liabilities ([6.308]ff. above). An addition to the list would be an isolated business venture, as in Whitfords Beach. All these situations are “instances of special businesses and transactions … where nothing but the net profit could be regarded as a revenue item”, which Dixon J. in New Zealand Flax Investments Ltd (1938) 61 C.L.R. 179 at 206 anticipated might be found. They do not include the situation of dealing in trading stock as defined in s. 6. It was explained in [5.23]ff. and [7.17]ff. above that a code of accounting for dealings in trading stock has been adopted by express provisions in ss 28ff. That code in its terms adopts receipts and outgoings accounting, but adapts that accounting so that it achieves much the same as would be achieved if specific profit or loss accounting had been left to apply.

[11.9] There is one common feature of the listed situations. There has been a cost in the form of an outlay in the acquisition of a revenue asset, or in the discharge of a liability on revenue account, and the asset is realised to yield proceeds or there have been proceeds from the assumption of the liability. Profit or loss which is the item of income or deduction is the positive or negative balance of proceeds over cost. This common feature yields a principle which will go to determine the boundary between the regimes of specific profit or loss accounting and receipts and outgoings accounting. The principle would assert that the cost of acquiring a non-wasting revenue asset, or of discharging a revenue liability, is not an outgoing deductible under s. 51(1). It is not an outgoing: it is no more than an outlay. And the proceeds of a non-wasting revenue asset or of a liability on revenue account are not a receipt that is income. The relevant item of income or loss will be the balance—positive or negative—of proceeds over cost. The principle is thus expressed in terms of a non-wasting asset. A non-wasting asset, for this purpose, is an asset whose value is not consumed in some process of derivation of income which is not simply the acquisition and realisation of the asset. The assets in London Australia Investment were clearly non-wasting. Receivables on revenue account are non-wasting. The land in Whitfords Beach is non-wasting.

[11.10] Specific profit or loss accounting may have a wider regime than the regime set by the principle considered in the last paragraph. A like principle might be framed applicable to wasting assets—assets whose value is consumed in a process of income derivation that is not simply the acquisition and realisation of the asset. The principle would need to accept that at least some part of the cost of a wasting revenue asset is an outgoing that is deductible. The outlay in B.P. Australia Ltd (1965) 112 C.L.R. 386 was for the acquisition of a wasting revenue asset—a tie agreement whose value would diminish over the period that goods were supplied under the tie. The conclusion in B.P. Australia was that the whole outlay in the acquisition of the tie was an outlay deductible immediately. In a number of contexts in Pt II, it was argued that an outlay on a wasting revenue asset should be treated as a deductible outgoing only as and to the extent that the value of the asset is consumed in the process of income derivation ([6.119]–[6.136] above). The argument was there made in relation to the facts of B.P. Australia itself, and in relation to the facts in Ilbery (1981) 81 A.T.C. 4661, that interest paid in advance should be treated as a deductible outgoing only as and to the extent that the use of the money for which the interest is a payment is enjoyed. An outlay in acquiring an import quota or an agency should be treated as a deductible outgoing only as and to the extent that the period to which the quota or agency relates has elapsed. An outlay for insurance cover extending over a number of years should be treated as a deductible outgoing only as and to the extent that the cover has elapsed. If the argument is accepted there will be a wider regime for profit and loss accounting. A taxpayer who is bought out of an agency agreement that is a revenue asset will receive proceeds of realisation which are income only to the extent that they exceed so much of the cost of the agency agreement as has not been a deductible outgoing.

[11.11] This extended regime for specific profit or loss accounting will of course only operate where the outlay is to acquire a wasting revenue asset. It was argued in relation to Ilbery, in [6.116] above, that the advance payment of interest secured a lasting advantage that was a structural asset, and the payment was a non-working expense. A payment for long term insurance cover may be characterised in the same way. The payment in Strick v. Regent Oil Ltd [1966] A.C. 295 was held to be a structural expense. In all these instances any proceeds of realisation of the asset which is the lasting advantage will be proceeds of realisation of a non-revenue asset and, unless some specific provision of the Assessment Act applies, a profit that is income or a loss that is deductible cannot arise.

[11.12] Specific profit accounting achieves a matching of expenses and receipts by deferring any allowance for the cost of an asset until a calculation of specific profit or loss falls to be made. It may require in some circumstances that an anticipated receipt be brought into the calculation of a profit or loss though the receipt would not yet be brought to account if receipts and outgoings accounting were applicable. The matter of bringing in an anticipated receipt in specific profit accounting is the subject of later discussion in relation to building contracts. Bringing in an anticipated receipt and the allowance of costs at that time will have the effect of advancing the time of realisation of a profit. In another aspect specific profit accounting may be flexible in delaying the time of realisation by requiring that receipts be brought to account and a profit or loss determined only when there are actual cash receipts—as distinct from the arising of receivables. There may be held to be a realisation to the extent of the proportion that cash receipts are of the amount of the receivable, or to the extent that total cash receipts have come to exceed cost. It will be apparent that the timing and extent of realisation will be different depending on which method of specific profit accounting is adopted, though each method may be described as a method of determining “profit emerging” or “profit arising”. Indeed the same phrases may be used to describe the method of specific profit accounting referred to above, which may be applied to a building contract. Specific profit accounting is thus flexible, though it may be indeterminate.

[11.13] Receipts and outgoings accounting may claim some achievement in matching receipts and outgoings. Any achievement within its general field of operation is the outcome of the decision in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314. In its special application, by ss 28ff., in trading stock accounting, its achievement also depends on what is in effect the deferral of the deduction for a deemed outgoing of the cost of trading stock (s. 51(2)) by the operation of s. 28, so that the outgoing is allowed when the item of trading stock ceases to be on hand and there is, at least generally, a matching receipt of the proceeds of realisation. The achievement of receipts and outgoings accounting in its general field of operation will be limited while recognition is refused of a principle that will treat an outgoing as incurred only as and when it is consumed—as and when a benefit that results from the outgoing is consumed in the income producing operation.

[11.14] Receipts and outgoings accounting does not have the flexibility of specific profit accounting. Where accruals accounting is applicable there will, subject to the Arthur Murray principle, be a derivation of income when there comes to be a right to receive an ascertained amount and there is no element of contingency. The amount, it seems, need not be presently receivable. There is no room for a method of accounting which would parallel profit-emerging in specific profit accounting. Any such method was rejected for Australian law in J. Rowe & Son Pty Ltd (1971) 124 C.L.R. 421, a case that has been followed for New Zealand law in Farmers’ Trading Co. Ltd v. C.I.R. (N.Z.) (1982) 82 A.T.C. 6001. Rowe concerned trading stock accounting, where a special statutory regime has displaced specific profit accounting by receipts and outgoings accounting. It might be taken to have established the law even more firmly for receipts and outgoings accounting in its general field of operation.

[11.15] The matching of receipts and outgoings that results from the Arthur Murray principle had not been recognised at the time of the High Court decision in New Zealand Flax Investments Ltd (1938) 61 C.L.R. 179. The latter case offered a stark demonstration of the rogue operation of receipts and outgoings accounting in the absence of an Arthur Murray principle. Dixon J. observed (at 199):

The High Court was not asked in New Zealand Flax Investments to consider the recognition of a principle that would have deferred the derivation of receipts for the “bonds”, so that there would have been derivation of those receipts as the work which the taxpayer had undertaken to carry out under the agreement expressed in the bonds progressed. Starke J. (at 197) observed that the court “inquired whether the sum … received from the sale of bonds was income.… The only answer the court received was that the Act taxes the gross income of the taxpayer—all that comes in—subject to certain statutory deductions and, in any case, that the matter was not raised by the objections to the assessment.” His comment on that answer is significant. He said: “The former answer overlooks the fact that the [Act] imposes a tax upon income. It is not a tax upon everything that comes in whether an income receipt or a capital receipt.” That comment may suggest a willingness to consider an Arthur Murray principle. On the other hand, it is framed in terms of “capital” receipt, and may only indicate the possibility that some of the receipts by the taxpayer were not income because they were contributions to capital. As that principle is explained in [2.113]ff. above, it might have denied an income character to the receipts so far as they were to be used in paying for the land that was to be vested in the bondholder. The taxpayer would, in turn, have been denied any deduction for what it paid for the land. But the contribution to capital principle would not have denied an income character to other receipts under the bonds.

[11.16] There is a reservation about the income character of receipts under the bonds in the words “assuming the proceeds of the bonds to be a revenue item” in the judgment of Dixon J. (at 204). But the reservation is not explained. Instead, Dixon J. concentrated on extracting from receipts and outgoings accounting as much as he could that would achieve some measure of matching of receipts and outgoings. The achievement was very little, and at some cost to the coherence of receipts and outgoings accounting. Accruals was presumably appropriate. Yet Dixon J. treated only cash receipts as derived. At the same time he allowed deduction of so-called “interest” on money received under the bonds, though that interest had not been paid and liability to pay was clearly still contingent.

[11.17] In New Zealand Flax Investments receipts ran very much ahead of outgoings, and the problem of matching was a problem of deferring receipts. There will be other circumstances where matching requires a deferral of outgoings. The scope that the law may allow to achieve matching by deferral of outgoings remains unresolved. In yet other circumstances matching may require the advancing of an income derivation or the advancing of an outgoing. Receipts and outgoings accounting admits of neither: Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616. In these respects receipts and outgoings accounting may simply share an incompetence with specific profit accounting. In the New Zealand case, H. W. Coyle Ltd v. C.I.R. (N.Z.) (1980) 80 A.T.C. 6012 the taxpayer sought the application of specific profit accounting to a building contract, asserting that no profit emerged until he had completed work under the contract. The New Zealand Revenue sought another method of specific profit accounting—a percentage of completion method—that would have required bringing to account receipts which were as yet only contingent. To bring those receipts to account would have involved some affront to a financial accounting convention that an unrealised profit should not be recognised. The New Zealand court rejected both methods of specific profit accounting put to it, and applied receipts and outgoings accounting tempered by the Arthur Murray principle.

[11.18] The advancement of costs in specific profit tax accounting would not offend financial accounting. It might be assumed that in the facts of Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 development costs had been incurred in the form of wages of employees engaged in the development work. Those wages were a cost to be brought to account in the determination of the profit emerging on the sale of the developed land. Presumably a provision for long service leave to which those employees had acquired an entitlement would also be a cost to be brought to account. Nilsen Development Laboratories and s. 51(3) do not stand in the way. They are concerned only with receipts and outgoings accounting.

[11.19] Tax accounting for profit or loss is concerned with specific profit or loss, and not with the overall consequence of operations during a year of income which will be reflected in taxable income, or in financial accounting, in a balance of a profit and loss account. Reference has already been made ([6.296] above) to the confusion in some expositions of the Australian income tax law which would assert that the law differs from the United Kingdom law which is concerned with the “profits of a trade”. One view of the United Kingdom law equates profits of a trade with the balance of a profit and loss account. Out of this view there is drawn a conclusion that much of the United Kingdom law is irrelevant if it is sought to use it as persuasive authority in Australian law. The United Kingdom law, it is said, accepts a figure determined by accounting conventions save where some specific provision of the law requires a correction. It will already be apparent that a great deal of United Kingdom income tax law has been imported into the Australian law. And where there is no specific provision of statute, the United Kingdom law has been created by judicial decision, with what assistance judges might choose to take from accounting conventions. The ultimate question is always whether an item is income, or as it will often be put where a business is involved, a profit of a trade. The fact that an item may have entered the calculation of a balance of profit or loss for purposes of financial accounting does not determine any consequence for United Kingdom income tax.

[11.20] Another view of the United Kingdom law places emphasis on the express reference to “profits” in the phrase “profits of a trade” and in like phrases used in the United Kingdom legislation, and would assert that there is a basis in United Kingdom law for treating a profit in the sense of a balance of proceeds over cost of some asset as an item of income, and no such basis in Australian law, save in some specific provisions such as s. 25A(1). The word “profits” in the phrase “profits of a trade” in the United Kingdom law and in other contexts is intended to cover all income items. It will cover a simple receipt and a balance of proceeds over cost. It affords no basis for a view that the United Kingdom law is concerned with income by ordinary usage, and distinct items called profits.

[11.21] It is true that the view of Australian law that it taxes only simple receipts except where some specific provision provides for taxing a profit, has lost some support. The loss of support became very evident in International Nickel Aust. Ltd (1977) 137 C.L.R. 347. The view none the less lingers: a frank recognition that the view is unsound would allow an open development of the law defining the regimes of receipts and outgoings and specific profit or loss accounting.

[11.22] Accounting for receipts and outgoings and accounting for specific profit or loss are two distinct regimes. The law in relation to receipts and outgoings is concerned with the timing of a receipt, which will involve issues as to receivability if accruals accounting is held to govern, or actual receipt if cash is held to govern, and as to a requirement of earning which may cause derivation, otherwise complete, to be deferred. And it is concerned with the timing of an outgoing which will involve parallel issues, save that there may not be a requirement of consumption parallel with the requirement of earning.

[11.23] The law in relation to specific profit or loss is concerned with the time of realisation and the calculation of a profit as it emerges from some isolated business venture, or from some particular transaction which may or may not be an aspect of some continuing business operation. The law as to derivation of a receipt and incurring of an outgoing applicable where a receipts and outgoings regime is applicable, has no direct bearing on the recognition of costs and proceeds in the calculation of a specific profit or loss. Indeed specific profit or loss accounting may need different rules to determine the time of realisation of a loss, from those applicable to the time of realisation of a profit. Where a taxpayer has sold an asset for less than he paid for it, but has not yet received payment, he will wish to assert that he has realised a loss, even though, had he sold for more, he might have asserted that the realisation of his profit must wait on actual receipt of the proceeds of sale. It is possible that he will be successful in his submission. Where profit or loss may arise from the discharge of a liability, a taxpayer may be anxious to assert that he has realised a loss when the time for repayment has arrived.

The Distinction between Accruals and Cash Tax Accounting

[11.24] The law in relation to receipts and outgoings accounting generally concerns the appropriateness of one or other of accruals and cash accounting and the principles which express each basis. Broadly, accruals tax accounting and cash tax accounting correspond with methods of accounting under the like descriptions in financial accounting. There are, however, important differences. Accruals tax accounting is much less ready than accruals financial accounting to find that an outgoing has been incurred. Financial accounting may hold an expense has been incurred in the form of an obligation to provide long service leave to an employee, an obligation which will be expressed in a provision in the taxpayer’s accounts. Tax accounting, on the authority of Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 and s. 51(3), will say that no outgoing has been incurred until actual payment is made for leave taken, or actual payment is made in lieu of leave not taken. Cash financial accounting may not always be concerned to deny that a cash receipt has been derived because it has not yet been earned, in a sense of that word drawn from Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314. But deferral till the receipt is earned is arguably the correct method of cash tax accounting. Arthur Murray involved a taxpayer obliged to account on an accruals basis, but the elaboration of the principle in the case, in particular the relevance of a prospect that money received may have to be returned if only in the form of damages for breach of contract, suggests that it is equally applicable to a receipt that is accounted for on a cash basis.

[11.25] An item of receipt that is to be accounted for on an accruals basis is derived when it becomes “due”, though not necessarily presently receivable, and an item of outgoing is incurred when there arises a “definitive commitment to pay” (James Flood Pty Ltd (1953) 88 C.L.R. 492) though it need not be presently payable. An item of receipt that is to be accounted for on a cash basis is derived when it is actually received, though there is a notion of “constructive receipt”, and an item of outgoing is incurred when it is actually paid. Questions such as whether “due” involves legal recoverability, whether “definitive commitment to pay” involves legal liability and as to the scope of “constructive receipt”, are deferred for the present. The immediate concern is with the law that will determine which basis of accounting is applicable to an item.

The Appropriateness of each basis of Accounting

[11.26] Where the Assessment Act does not in express terms indicate the appropriate basis of tax accounting in regard to any receipt or outgoing, the choice of basis must depend on judicially established principles. The leading case is C. of T. (S.A.) v. Executor Trustee & Agency Co. of S.A. Ltd (Carden’s case) (1938) 63 C.L.R. 108. So far as any single governing principle emerges from Carden’s case, it is that the basis of accounting must be chosen by reference to its “actual appropriateness”: it is a question of which basis of accounting most “truly reflects income”. On a more determinate level, Carden’s case offers the rule that the cash basis is appropriate in regard to the proceeds of “professional skill and personal work”. Thus a wage-earner or salary-earner will bring his wages or salary to account on a bash basis. The case also suggests a rule that the accruals basis is generally appropriate whenever taxable income falls to be ascertained in relation to a period less than a full year of income. Dicta of Dixon J. in Carden’s case support a rule that the accruals basis is appropriate wherever the computation of profits from manufacture or trading is called for, that is where there is “a stock of vendible articles to be acquired or produced and carried by the taxpayer, where outstandings on the expenditure side … correspond to, and are … naturally connected with, the outstandings on the earning side, and where there is … [a] fund of circulating capital from which income or profit must be detached for actual enjoyment” (at 158).

[11.27] It will be seen in Chapter 14 below that the trading stock provisions of the Assessment Act allow a deduction of what will normally be the cost of the item when the item ceases to be on hand. This is the manner of operation of s. 28. Where an item of trading stock is sold on credit terms there will be distortion of the taxable income of the year of sale if the proceeds of sale are accounted for on a cash basis (cf. J. Rowe & Sons Pty Ltd (1971) 124 C.L.R. 421). Accruals is thus the appropriate basis of accounting.

[11.28] The principle expressed in Carden’s case (1938) 63 C.L.R. 108 is that a cash basis forms a fair and appropriate foundation for the estimating of professional income where “the receipts represent in substance a reward for professional skill and personal work to which the expediture on the other side of the account contributes only in a subsidiary or minor degree” (at 158). The principle may however be qualified by the observation later in the judgment of Dixon J. that “If in a given medical practice there is but little certainty about the payment of fees, I should have thought that a receipts basis of accounting would alone reflect truly the income and for most professional incomes it is the more appropriate” (at 159). This observation about bad debts experience is not referred to in the judgment of Barwick C.J. in Henderson (1970) 119 C.L.R. 612, though he does refer to the figure for bad debts, a relatively small figure, in the accounts of the partnership of accountants in that case. Barwick C.J. was content to assert the “sharp contrast” between the operation of the partnership of accountants in Henderson and the operations of the medical practitioner in Carden’s case and, by inference, to assert that the operations of the partnership in Henderson did not amount to a “professional practice carried on by the taxpayer[s] personally” while the operations of the doctor in Carden’s case did amount to a professional practice carried on personally. The Commissioner, in an announcement subsequent to Henderson, (CCH, Federal Tax Reporter, para. 12–130) expressed the Department’s view in this way:

[11.29] There is an indication in the reference to the situation of a barrister that the probable bad debts experience of the taxpayer may continue to be relevant. The announcement otherwise assumes that the outcome in Henderson is that accruals will be appropriate if the professional practice is carried on as a business. The clue to the distinction may be in the extent to which the professional practice makes use of the services of employees. In Henderson a very substantial part of the disbursements of the practice must have been made up of salaries to employees and the total disbursements, for example in the 1965 year, were $1,045,358 while the fees earned for that year were $1,181,166.

[11.30] One can suggest a reason why cash rather than accruals may be the more appropriate when the taxpayer is likely to have substantial bad debts. If he were on an accruals basis, the deduction under s. 63 for bad debts written off may not afford sufficient scope to correct the distortion of taxable income which might result. It is not however readily apparent why accruals rather than cash is the more appropriate when a professional practice is carried on as a business in the sense suggested by the facts of Henderson. The reason may be that a professional practice so carried on may be expected to have substantial outgoings which, whether accounted for on a cash or accruals basis, will run ahead of the derivation of income. If the taxpayer is on an accruals basis the derivation of income will be sooner than if he is on cash, and is thus more likely to be accounted for in the year matching outgoings were incurred.

[11.31] Henderson (1970) 119 C.L.R. 612 is not authority that every solicitor must account in relation to his professional practice on an accruals basis. In Firstenberg (1976) 76 A.T.C. 4141 at 4152 McInerney J. concluded “that in the case of a one-man professional practitioner the essential feature of income ‘derived’ is receipt”. His reasons for reaching that conclusion go very little further than an assertion of the inappropriateness of accruals in the circumstances of the taxpayer’s practice. “I am of the view that the ‘accruals basis’ is, in the case of a practice such as the taxpayer’s, an artificial, unreal and unreasonably burdensome method of arriving at the income derived” (at 4155).

[11.32] Carden’s case asserted a general principle that the accruals basis of accounting is appropriate where the accounting is for a “broken period”, in that case the period from the end of the last complete year of income until the taxpayer’s death. No reason is suggested in the judgment why accruals is more appropriate in that situation. Indeed, an insistence by a personal representative that accruals is appropriate to the broken period to the date of death, may secure a tax advantage. Section 101A discussed in [11.150]ff. and [11.188] below would not bring in accruals of the last complete period which were received as cash in the broken period, and may not bring in accruals of the last complete period received in cash after death. The latter may not be “amount[s] which would have been assessable income in the hands of the deceased person if [they] had been received by him during his lifetime”. They are amounts that would have been assessable income if received in the last complete period.

[11.33] Judicial statements on the appropriateness of a basis of acounting, made in Carden’s case appeared to leave it open to the Commissioner to argue that the choice by him of a basis of accounting must be accepted if it is an appropriate basis, even though it is not the more appropriate basis. It would now appear from Henderson that there is only one appropriate basis of accounting, and this is determined by the law. However the law, both in this determination and when defining the principles of accounting attracted by the determination, is ready to look to established principles of financial accounting.

[11.34] The Commissioner, it appears from the announcement referred to above, will allow a small retailer to account on a cash basis. Having regard to Carden’s case (1938) 63 C.L.R. 108 and J. Rowe & Sons Pty Ltd (1971) 124 C.L.R. 421 and to the trading stock provisions of the Assessment Act, it is not easy to see how this is justified.

[11.35] There are no Australian authorities as to the appropriate basis of accounting when services, other than professional services, are provided. Presumably, if there are substantial outgoings involved, more especially if these are wages of employees, an accruals basis is appropriate. The authorities in regard to professional services all concern services provided in an independent contractor relationship. The cash basis of accounting is, presumably, always applicable when services, professional or otherwise, are provided in an employment relationship.

[11.36] Farnsworth (1949) 78 C.L.R. 504 is a decision that in regard to some activities of primary production, cash is the appropriate basis. Dawson v. Botten (1952) 10 A.T.D. 252 is perhaps sufficiently explained on the ground that there had not been an accrual: the price receivable from the marketing authority for wool submitted for appraisal had not yet been ascertained. But Crisp J. appears at one point to contemplate that cash is the appropriate basis whenever goods are sold through a marketing authority. The case demonstrates how the trading stock provisions, in their object of bringing about a matching of costs and proceeds of sale, are subject to defeat even when accruals apply, if goods are no longer on hand and the price is not yet ascertained. If cash is the appropriate basis of accounting, the prospects of defeat are so much greater.

[11.37] A taxpayer may in regard to some items be on a cash basis notwithstanding that generally he is on an accruals basis. Thus it seems that interest, even though it is, for example, on an overdue account for goods supplied, is to be brought to account on a cash basis. And other items of passive income, including rent and royalties, will generally be brought to account on a cash basis. Where however there can be said to be a business of deriving interest, rent or royalties, accruals will be appropriate: National Bank of N.Z. Ltd v. C.I.R. (N.Z.) (1977) 77 A.T.C. 6001. Dividends will, presumably, always be accounted for on the special statutory basis, equivalent to cash, provided for by s. 44(1).

[11.38] A taxpayer may be on a cash basis in regard to the derivation of an income item, for example interest received, even though another taxpayer in regard to the corresponding deduction item, for example, interest paid, is on an accruals basis.

[11.39] An annuity receipt will generally be brought to account on a cash basis. Where however the amount is received from the trustee of a trust estate, there may be problems arising from the special tax accounting basis which is applied by s. 97 of the Assessment Act to a beneficiary in a trust estate. Where the annuity involves a present entitlement to income of a trust estate, s. 97 will presumably be applicable to the exclusion of any general principle of tax accounting.

[11.40] The suggestion was made in [11.30] above that the appropriateness of accruals basis, where a taxpayer providing services has substantial outgoings for salaries of employees, rests on the fact that accruals may achieve some degree of matching. The extent of matching is very limited. A substantial degree of matchings would require the deferral of outgoings that concern work in progress until there are receipts resulting from that work. Accruals accounting could only bring about matching of this kind if the trading stock provisions were held applicable: there would appear little possibility of this. Even if a principle were accepted that an outgoing is not deductible until it is consumed, there does not seem to be any room for the application of such a principle. Like the trading stock provisions, specific profit or loss accounting, if held applicable, would achieve a substantial degree of matching. But there would need to be an extension of the present regime of profit or loss accounting. It could not be said that the costs of work in progress are in any sense outlays in the acquisition of assets.

[11.41] In Henderson (1970) 119 C.L.R. 612 the Commissioner argued that there should be an amount shown at the end of the first accrual year, and, indeed, of subsequent years, reflecting a deferral of costs of work in progress. The Commissioner was concerned to find some offset to counter the “fall-out” of items of income, which had accrued in earlier cash basis years, but were not derived in those years because they were not the subject of actual receipts. The “fall-out” consequences of a change in basis of accounting are examined in [11.71]–[11.72] and [11.213]–[11.215] below. The bringing in of work in progress at the end of the first accrual year in the manner of closing trading stock under s. 28 of the Act would have achieved the offset, provided no opening stock entry had been allowed to the taxpayer. Barwick C.J. saw the Commissioner’s submission as an attempt to insist on accounting for items of income that had not yet been derived, and in rejecting it asserted principles about derivation of an item on an accruals basis. Those principles are the subject of observations in [11.52] below. The significance of the Commissioner’s submission, in asserting a principle of deferring costs of work in progress where services are performed, was passed over.

[11.42] It will be apparent from preceding paragraphs that there is no principle that one basis of accounting must be held applicable to all the items derived or incurred by a taxpayer in the same year of income. The point becomes evident enough when the taxpayer is required to account on an accruals basis for items that are aspects of the conduct of a business, and to account on a cash basis for items, whether or not connected in some way with the business, that are items of passive income.

[11.43] Interest derived from investments will generally be subject to accounting on a cash basis. Where the lending of money is an aspect of a taxpayer’s business, such that the loans are revenue assets, interest on those loans will it seems be subject to accounting on an accruals basis. This may be the consequence of the New Zealand Court of Appeal decision in National Bank of N.Z. Ltd v. C.I.R. (N.Z.) (1977) 77 A.T.C. 6001. The principle of that case may extend to a taxpayer who trades in debts, to a life insurance company that invests in debts, and to a taxpayer that engages in a business of investing involving the switching of investments. The last situation was the facts, as understood by Gibbs J., in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106.

[11.44] Where a taxpayer carries on a business, one judgment will be made as to the appropriate basis of accounting in regard to all items that are active income of that business. But a taxpayer may carry on more than one business, and the appropriate basis of accounting must be separately determined for each business. The question whether business activity may include more than one business has been referred to on a number of occasions in earlier paragraphs, and the suggestion has been made that geographical separation, separate accounting or separate management may require a conclusion that there are several businesses, even though the activities of all the businesses are of the same general kind. A conclusion that there is a separate business is significant not only in relation to the appropriateness of a basis of accounting, but also in regard to the operation of the principle of contemporaneity in the interpretation of s. 51(1) as demonstrated in Ronpibon Tin N.L. & Tongkah Compound N.L. (1949) 78 C.L.R. 47, in regard to the operation of the principle that a receipt for a substantial detraction from pre-existing rights is not income and in regard to the principle that a receipt for giving up a structural asset of a business is not income.

[11.45] If a taxpayer is held to conduct one business of selling and repairing motor cars, he will account on one basis, almost certainly on an accruals basis, for all items of active income of that business. If he carries on two businesses— a selling business and a repairing business—he might account in respect of one on an accruals basis and in respect of the other on a cash basis. If he is conducting only one business and discontinues the selling activity, the new circumstances may require a conclusion that he should cease to account on an accruals basis and hereafter account on a cash basis. In the result the consequences of a change in basis of accounting considered in [11.71]–[11.72] and [11.213]–[11.215] below will follow. A change from accruals to cash may involve what will appear to be a double inclusion in income of the same item. There is another possible analysis. The discontinuance of the selling activity, more especially if the repair activity is now carried on at a new location, may justify a conclusion that the business has ceased and that a new business has commenced. The tax accounting consequences of discontinuance of a business, considered in [12.99]–[12.108] below, will be attracted, but not the consequences of a change in basis of accounting.

The Meaning of Derivation of a Receipt when an Accruals basis is Appropriate

[11.46] A receipt will be derived where the taxpayer is on an accruals basis in regard to the item, if an amount of money has become “due” to the taxpayer. It is not necessary that there should have been an actual receipt. An amount is clearly due if the taxpayer has a right to receive that amount presently, and there is no element of defeasibility or contingency affecting his right. There may be thought to be some element of doubt as to whether an amount has become due, if the right is not to receive presently but to receive at some future time. Crisp J. in Dawson v. Botten (1952) 10 A.T.D. 252 reserved the question whether the 95 per cent of the appraised value of the wool payable to the taxpayer on 1 July could be said to have been derived in the year of income in which the right arose. In Henderson (1970) 119 C.L.R. 612, Barwick C.J. did not commit himself to a general proposition that an amount is derived though the right is a right to receive at a future time. He said (at 650–651):

[11.47] The reference to “special arrangements” may suggest that derivation must wait until an amount is presently recoverable, if the taxpayer as a matter of general practice does business on terms that allow some time after completion of the work before the amount becomes presently recoverable. J. Rowe & Sons Pty Ltd (1971) 124 C.L.R. 421 may appear to be authority for the general proposition to which Barwick C.J. did not commit himself. But the case concerned the sale of trading stock on credit terms, and may have established a general proposition only in relation to receivables in respect of the sale of trading stock. Receipts and outgoings accounting applies to trading stock, because of express provisions in s. 51(2) and ss 28ff. Treating the proceeds of sale as derived even though not presently receivable, will generally avoid a failure to match costs and proceeds which would otherwise result from the fact that the costs of stock in effect become deductible outgoings when the stock ceases to be “on hand”, and that may be a time when the proceeds of sale are not yet presently receivable. The High Court held that the element of the “cash price” reflected in each instalment to be received in the future was derived at the time of sale of the goods. The elements of interest in the instalments were derived, presumably, when each instalment was in fact received. Rowe has been followed by the New Zealand Court of Appeal in Farmers’ Trading v. C.I.R. (N.Z.) (1982) 82 A.T.C. 6001, which reversed a decision that sought to defer derivation of amounts receivable in the future so far as they exceeded an amount that would equal the costs that, in effect, became deductible when the goods were sold. Neither case offers any support for a view that would treat the present value of amounts receivable in the future as derived at the time of sale, and would treat amounts beyond the present value as derived when they become presently receivable, or are actually received. A present value approach might be thought appropriate where no interest is expressly provided for in the terms of sale. It would not be appropriate where such provision is made, and where the transaction may then be seen as a sale for a price presently receivable which is received and lent to the purchaser at interest: the interest will be derived, a cash basis being applicable to it, as it is actually received.

[11.48] The effect on derivation of the fact that the right to receive is defeasible is not the subject of any decision. In one sense, every right to receive is defeasible as the result of some new agreement between the parties. This circumstance cannot prevent derivation. A contract for the sale of land may be voidable, and the right of the vendor to be paid may be defeasible for this reason. If defeasibility is regarded as precluding derivation, there will be no derivation until the ground for avoidance is no longer available, or the contract is completed. If defeasibility does not prevent derivation, there will be problems if the sale is in fact avoided. There is need to find an outgoing available to the vendor that will reverse the earlier inclusion of the amount receivable. The matter is the subject of further comment in [11.222]–[11.243] below.

[11.49] Where a taxpayer’s right to payment is contingent, there is no derivation until the contingency occurs. In Ballarat Brewing Co. Ltd (1951) 82 C.L.R. 364, the debtor was entitled to a discount if he paid within 30 days. There was no derivation of the amount of the discount, until the 30 days had expired and the debtor had not made payment. It is true that Fullagar J. based his conclusion on accounting conventions allowing as an expense a provision for the discount that might be claimed. But an explanation of the case in terms that the amount of the discount was not income until the expiration of the time within which the discount was available to the debtor, supports a principle that at least has an affinity with Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314. The notion of “earning” in that case should not require active steps to be taken by the taxpayer. The view is taken in [11.111]–[11.112] and [11.203] below that Arthur Murray is applicable, for example, to interest on money lent, so that the interest is not derived until there has been a use of the money borrowed for the period to which the interest relates. A like rule would apply in regard to rent and other passive income.

[11.50] The taxpayer’s right to a receivable may be indefeasible and not subject to any contingency. There will not however be a derivation by an accruals basis taxpayer so long as the amount of the receivable is not ascertained or presently ascertainable. This is one basis of the decision in Dawson v. Botten (1952) 10 A.T.D. 252 and of the decision of those judges in Farnsworth (1949) 78 C.L.R. 504 (Latham C.J. and Webb J.) who considered that the taxpayer was properly to be assessed on an earnings basis. In Dawson v. Botten, Crisp J. insisted that it was necessary that the whole amount due to the taxpayer should be ascertained. It was not enough that part of the “whole debt” of £4,472.16s.1d (being 95 per cent of the appraised value), was due. It is not easy to see why it should be insisted that the “whole debt” should be ascertained, or to see exactly what is meant by the “whole debt”. Crisp J. referred to the case of Dailuaine-Talisker Distilleries Ltd v. I.R.C. (1930) 15 T.C. 613 where the amount payable depended upon adjustments which, it was provided in the contract, would have to be made before the sum due could be finally determined. In the circumstances no part of the amount receivable could be said to be ascertained. A conclusion that the amount is ascertained should not be precluded by the circumstance that the debtor is contemplating or has commenced an action for damages against the taxpayer arising out of the transaction from which the debt arose, or indeed has recovered damages. The incurring of an outgoing in the amount of the liability in damages is a distinct issue.

[11.51] A receipt may be derived if the amount is ascertained or ascertainable at the time it is said to be derived. In Farnsworth an amount receivable from a marketing authority, which at the time could only be estimated, was held not to be derived. Australian Gas Light Co. (1983) 83 A.T.C. 4220 may support a view that the amount must be physically ascertainable. The taxpayer supplying gas could not read every gas meter at midnight on 30 June to determine how much gas had been consumed by customers. There was therefore no derivation in respect of gas used but not the subject of a meter reading prior to 30 June. So explained, the case is hardly consistent with Commercial Union Assurance Co. Ltd (1977) 77 A.T.C. 4186. That case is concerned, it is true, with incurring of outgoings on an accruals basis. Deductions were allowed in respect of claims on a taxpayer insurer in respect of liabilities not yet reported to the insurer. Another ground of decision in Australian Gas Light is more appropriate. The rate scale for gas supplied depended on the amount of gas supplied over a quarter. Whatever the quantity of gas consumed shown by a meter at 30 June, the amount payable in respect of that gas could not be determined until the next quarterly reading of the particular customer’s meter, when the total gas consumed during the quarter could be known. Quarterly meter readings were staggered among consumers. So explained, the case is an application of Farnsworth and is consistent with the view taken in Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 ([11.80]ff. below) in regard to the incurring of outgoings.

[11.52] The language of “right to a receivable” in describing derivation by an accruals basis taxpayer has been adopted so far in this discussion. It is not intended, however, that right to recover should be confined to legal recoverability. It is true that in the passage quoted above ([11.46]) from the judgment in Henderson (1970) 119 C.L.R. 612, there is a dictum that “only fees which have matured into recoverable debts should be included in income”. From this dictum a conclusion has been drawn that legal recoverability is necessary if an amount receivable that is to be accounted for on an accruals basis is to be treated as derived. No doubt an amount that is legally recoverable will generally be an amount derived. But tax accounting should not be linked to a factor that may need to be finally determined by litigation, perhaps litigation extending over years. The Papua-New Guinea Supreme Court in Commonwealth-New Guinea Timbers Ltd v. Chief Collector of Taxes (1972) 72 A.T.C. 4048 applied the dictum of Barwick C.J. with disastrous consequences for the sensible operation of the New Guinea law. A view is taken in [11.222]-[11.236] below that Australian law should follow United States’ law by adopting a claim of right principle. Whether or not an amount is legally recoverable, it will be taken to be derived by a taxpayer who must account for it on an accruals basis, if other conditions are satisfied, when the taxpayer asserts a claim of right to recover the amount. If in a later year the taxpayer acknowledges that his claim was mistaken, or repays an amount he has in fact received, he will be entitled in that year to a deduction of the amount he acknowledges not to be recoverable or the amount he has in fact repaid.

[11.53] A doubt that a claim to a receipt will be followed by an actual receipt does not prevent or qualify derivation. The New Zealand Court of Appeal so held in National Bank of N.Z. Ltd (1977) 77 A.T.C. 6001. The taxpayer’s doubts may be expressed by writing-off under s. 63 the whole or some part of the amount derived as a bad debt, and a failure to obtain payment may give rise to a deduction for a loss under s. 51(1). National Bank resulted in a change in bankers’ practice. Prior to that case the practice was that so much of an amount of interest receivable whose actual receipt was doubted would not be treated as income derived. Since the case the practice has become to include the full amount of interest receivable. Commercial Banking Co. of Sydney Ltd (1983) 83 A.T.C. 4208 at first instance demonstrates what might be thought an unexpected consequence: a loss experienced by the taxpayer in a failure to receive the full amount of interest receivable was held deductible even though that amount had never in fact been included as income derived in a return of income, the amount having become receivable before the decision in The National Bank of N.Z. Ltd. The decision is, in effect an application of the principle in Country Magazine Pty Ltd (1968) 117 C.L.R. 162. The amount was income derived in the earlier year, and the receivable was a revenue asset in relation to which a s. 51(1) loss deduction was available. The circumstance that the amount had not been included in assessable income of the earlier year could only be corrected, if the Commissioner had the necessary power, by amendment to the assessment of the earlier year.

[11.54] It has been observed that a taxpayer may be on an accruals basis of returns in regard to some items but on a cash basis in regard to others. He may not be partly on accruals and partly on cash in regard to the same item: National Bank of N.Z. may be seen as authority for this proposition. And he may not be on accruals in regard to receipts and on cash in regard to matching outgoings, or vice versa. This last proposition may be thought to be at odds with New Zealand Flax Investments (1938) 61 C.L.R. 179. The endeavour by all members of the court to do what they could within receipts and outgoings accounting to bring about a result which was something less than dramatically unfair, produced a variety of views. The principle in Arthur Murray (1965) 114 C.L.R. 314 was not yet recognised at the time of New Zealand Flax Investments Ltd and recognition of that principle in the latter case was discouraged by an agreement between the parties that may have prevented any application of the principle if it had been recognised. In general the direction of the court was that the taxpayer should account for receipts on a cash basis. Though Dixon J. thought at one point in his judgment that amounts presently receivable in respect of the sale of “bonds” should be brought in, his final conclusion favoured the bringing in of receipts on a cash basis. In this he was supported by Rich and McTiernan JJ. That same three judges considered that an accruals basis should apply in regard to outgoings for “interest” and deferred commissions. This basis was more generous to the taxpayer than would be thought consistent with the later decisions in James Flood Pty Ltd (1953) 88 C.L.R. 492 and Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 considered in [11.76]–[11.83] below. It contemplated the allowance of deductions for interest and deferred commissions which were at the time only contingently payable. New Zealand Flax Investments should not be taken to support a view that a taxpayer on a cash basis in regard to derivation of receipts may adopt an accruals basis in regard to the incurring of an outgoing. The case is special in the respect that there was limited room for development of the law open to the court because of the agreement between the parties, and should not be taken as authority for any principle of tax accounting.

[11.55] Accruals accounting for a receipt can only be applicable in advance of actual receipt where the taxpayer asserts a claim of right to a receipt. A taxpayer who provides services may be on an accruals basis in regard to rewards for services. If services are performed and the taxpayer asserts a claim of right to a reward there will be an immediate derivation. If a reward is in fact received that may have been anticipated but was not the subject of an assertion of right by the taxpayer, there will be a derivation on actual receipt. In Squatting Investment Co. Ltd (1954) 88 C.L.R. 413 the taxpayer, presumably, derived a receipt in the distribution of the surplus of proceeds of wool submitted for appraisal, when he actually received, though there could be an argument made that he derived a receipt when the legislation had been passed which gave him a right to the receipt. Where there is a derivation of an amount on the assertion of a claim of right to a receipt, there will not be a further derivation on actual receipt of that amount. The actual receipt is not an occasion of a derivation. It produces no tax consequences save that it will preclude a bad debt write-off under s. 63 or a loss deduction under s. 51(1).

[11.56] It was seen in [5.37]–[5.48] above that a principle requiring contemporaneity may deny the deduction of an outgoing that is incurred after the cessation of a business. It has been assumed that there is no similar principle that would deny the income character of a receipt that is derived after a business has ceased. A question as to the existence of such a principle is unlikely to arise when the taxpayer is on an accruals basis. An amount is most likely to become receivable before cessation of the business. But it may not. And the receipt may not have been the subject of any claim of right so that it will be derived only when actually received. The possible application of a contemporaneity principle cannot be entirely excluded. In setting the scope of any such principle it will be necessary to have regard to A.G.C. (Advances) Ltd (1975) 132 C.L.R. 175, and the view expressed in that case that the incurring of a loss that is a direct outcome of an operation of the business during the time it was carried on is not subject to denial under the contemporaneity principle. It may follow that a receipt which is a direct outcome of a business operation, such as the supply of goods, is income notwithstanding that the business has ceased to be carried on. If the taxpayer in Squatting Investment Co. Ltd had ceased to carry on business at the time of the derivation of the benefit in respect of wool submitted for appraisal some years before, the receipt would none the less have been an income receipt.

Derivation by an accruals basis taxpayer where the receipt is an item other than cash

[11.57] Section 21 of the Assessment Act provides that “where, upon any transaction, any consideration is paid or given otherwise than in cash, the money value of that consideration shall, for purposes of [the] Act, be deemed to have been paid or given”. The section may suggest that an item other than cash must always be accounted for on a basis equivalent to the cash basis, so that there is no derivation of income until actual receipt. The alternative is to apply an adapted accruals basis where the item is not a right to a sum of money but the taxpayer would account on an accruals basis if the item were a right to a sum of money. A land developer sells land that is trading stock to a company for cash, and for shares to be issued by the company. An adapted accruals basis would treat the arising of the right to the shares as a derivation. The amount of income derived might be the present value of equivalent shares in the company at the time the right arises, discounted so as to take account of the effect of the prospective issue on the present value of shares in the company. It would not be appropriate to treat the item derived as the present value of the right to the share issue. If the right to the share issue is a right not to a present issue but an issue in the future, there will be questions of the accruals accounting applicable to a right to cash receivable in the future, and the manner in which that accounting might be adapted to a right to a receipt other than cash.

[11.58] A view that derivation must wait on actual receipt of an item other than cash is the more convenient, save where the event that gave rise to the right to a receipt other than cash was the realisation of trading stock. Delaying derivation until actual receipt in that case involves the prospect that the trading stock—possibly shares of a share trader that have been disposed of in response to a share exchange take-over bid—will have-ceased to be on hand so that there is a failure to match receipts and outgoings.

[11.59] There is a question as to what is an actual receipt where the item receivable is itself a chose in action. In Abbott v. Philbin [1961] A.C. 352 and Donaldson (1974) 74 A.T.C. 4192, in both of which the taxpayer was, presumably, on a cash basis in relation to the item, there was held to be a derivation when options over shares were issued to him. One must distinguish the arising of a right to the issue of options, which would not be a derivation, and the arising of the rights given by the options when they are issued, which would be a derivation.

[11.60] Abbott v. Philbin and Donaldson are authority that there is an actual receipt of a chose in action, notwithstanding that the chose in action is defeasible (Abbott v. Philbin) or contingent (Donaldson). There is thus a distinction between derivation where an accruals basis taxpayer comes to have a right to receive—contingency, at least, will prevent derivation—and derivation by actual receipt of a chose in action.

[11.61] Insisting that there is no derivation of an item other than cash until the item is actually received would answer the reasoning of Lord Denning in Abbott v. Philbin, who saw the majority decision as involving the conclusion that a taxpayer who becomes entitled to some benefit which he may not choose to take must be taxed on the right to the benefit. The conclusion would extend to a taxpayer on a cash basis in relation to that item and to a taxpayer on an accruals basis. A taxpayer in circumstances such as those in Cooke and Sherden (1980) 80 A.T.C. 4140 may be entitled, because of the quantity of purchases he has made from his supplier, to an expense paid holiday. There would be no suggestion, whether he be regarded as on an accruals or a cash basis in regard to his trading receipts, that he has derived an item of income if he has chosen not to take up his entitlement.

The operation of section 19

[11.62] Where an amount is receivable, there may be a derivation by a cash basis taxpayer on some event which is not an actual receipt of the cash receivable. The event may be one covered by s. 19 of the Assessment Act, which deals expressly with a number of circumstances which will give rise to a derivation, though there has not been an actual receipt and the taxpayer is on a cash basis in regard to the item. Section 19, it will be suggested, is a partial expression of a principle, which might be called a constructive receipt principle, which gives meaning to the word “derived” in s. 25(1).

[11.63] Where an amount is receivable, but there is as yet no derivation by an accruals basis taxpayer—the amount may not yet be ascertained or ascertainable, or it may not be presently receivable and present receivability is held in the circumstances to be assential to a derivation—s. 19 may, in some events, bring about a constructive derivation. And again there may be a constructive derivation within the meaning of the word “derived” in s. 25(1), a meaning wider than s. 19. It is true that s. 19 in its terms—“not actually paid over to him”—may appear to be concerned only with derivation where the item is to be accounted for on a cash basis, but it is none the less capable of application in relation to an item accounted for on an accruals basis, and a wider principle of constructive receipt may extend to items accounted for on an accruals basis.

[11.64] A taxpayer, or another person acting on his behalf, may deal with a receivable so that it is “reinvested, accumulated, capitalised, carried to any reserve, sinking fund or insurance fund however designated”. The language is that of s. 19. The section has been held, in Brent (1971) 125 C.L.R. 418 (where the issue was receipt of an item to be accounted for on a cash basis), not to be attracted where the taxpayer simply does not seek to obtain payment of the amount of a receivable, and there is a dictum of Gibbs J. in the case that s. 19 would not have been attracted had the taxpayer expressly asked the debtor not to pay him. Permanent Trustee Co. (Executor of Estate of F. H. Prior, dec’d) (1940) 6 A.T.D. 5 is authority that s. 19 is not attracted where a taxpayer who has no prospect of obtaining payment of interest receivable agrees to a proposal that the interest be capitalised. The case may be thought to gloss the section so as to limit its scope. In any case, these authorities have no bearing on the operation of s. 19 in relation to an item to be accounted for on an accruals basis. In all of them there would already have been a derivation if accruals had applied. Gair (1944) 71 C.L.R. 388 is concerned with the operation of s. 19 in relation to derivation on a cash basis in circumstances where there may not as yet have been a derivation on an accruals basis. At least in the view of Latham C.J., the assignment of a receivable involves a receipt, though the item is to be accounted for on a cash basis. It might be said that, a fortiori, it is a receipt where the item is to be accounted for on an accruals basis. Assuming that an amount that is not presently receivable is for this reason to be regarded as not yet derived, the assignment of it should give rise to a derivation. There is a question in these circumstances of the amount so derived. The view is taken in [13.22] below, in dealing with assignment of income, that the amount derived is the amount realised in a commercial transaction of which the assignment is part. If the assignment is wholly or partly by way of gift, the amount derived is the value of the receivable at the time of the assignment. In the result, there will be an equivalence with the accounting applicable where there is a derivation of the amount receivable at the time the receivable arises, and thereafter there is an assignment of the receivable in circumstances that give rise to a loss deduction under s. 51(1).

[11.65] If s. 19 is not sufficient to support these conclusions they may be supported by general law yet to be developed from the interpretation of the word “derived” in s. 25.

The operation of section 101A

[11.66] C. of T. (N.S.W.) v. Lawford (1937) 56 C.L.R. 774 expresses a logical implication of the cash method of accounting. At the time of his death a substantial sum was owing to a professional man in respect of fees. It was held that when these fees were paid to his estate there was no income of the deceased upon which the estate was liable to tax. Nor was there income of the estate: the fees were received by the estate as capital. The principle in Lawford would apply not only to salary for work done to the date of death, but also to interest or rent in respect of the use of money or property to the date of death.

[11.67] The effect of Lawford, so far as it concluded that the fees when received were not income of the estate, has been reversed by s. 101A of the Assessment Act and the application of the section has been clarified to some extent by the High Court in Single (1964) 110 C.L.R. 177. The majority held that s. 101A could apply to a receipt which was not receivable and not ascertained at the time of death. Section 101A may thus have some application to an accruals basis taxpayer.

[11.68] Single may support a view that an amount received by a trustee after death which is for services performed prior to death, or for the use of money or property up to the time of death, will be income of the trust estate where the deceased was on an accruals basis in regard to the item, but there had not been a derivation by the deceased up to the time of his death. The amount may not have been ascertained at the time of death, or its receivability may have depended on other services being performed, or the lapse of further periods of time. There may be thought to be some difficulty in reading the words of s. 101A—“if it had been received by him during his lifetime”—as extending to the arising of a receivable that would have been a derivation by a taxpayer on an accruals basis of return in relation to the item. But s. 101A was in effect read in such a way in Single. An actual receipt by the deceased of a share of the proceeds of work done prior to his death would not have been significant. A derivation by him during his lifetime would have depended on a partnership account having been taken, and the arising in him of an individual interest in the net income of the partnership as determined by s. 90.

[11.69] Kitto J. in Single would have limited the operation of s. 101A so that it is hard to see how it could have any application to a deceased who was on an accruals basis of return in relation to the item. Kitto J. would have confined its operation to circumstances where an amount was presently receivable by the deceased at the time of his death. Menzies and Owen JJ. refused to limit the operation of the section in this way. Owen J. said: “There is, in my opinion, no justification for treating the section as requiring the introduction of a further assumption that the amount which the deceased is to be regarded as having received during his life was an amount which was then due and payable” ((1964) 110 C.L.R. 177 at 191).

[11.70] It may express the effect of Single to say that there is a derivation of income under s. 101A by the estate of a deceased person where there is a receipt of an amount that reflects a return for work performed by or on behalf of the deceased, or reflects a return for the use of money lent or property let by the deceased, or which is a dividend on shares which were owned by the deceased for some period prior to his death. The amount of income derived by force of s. 101A will be limited to that part of the receipt that reflects the return for work performed by the deceased, for the period of the loan or letting prior to death, or the period to which the dividend relates that elapsed during the lifetime of the deceased. This part of the receipt will be income of the deceased estate notwithstanding that a derivation of the amount by the deceased would have depended on the amount becoming due to him and not on its actual receipt by him. If the amount of the receipt by the estate reflects in part work done by the trustee after the death of the deceased, or is in respect of a period of time after the death of the deceased, the receipt may to this extent be income of the deceased estate by the operation of s. 95.

[11.71] The absence of a provision such as s. 101A in the South Australian Taxation Act is the explanation of the Commissioner’s action in Carden’s case (1938) 63 C.L.R. 108 in asserting that an accruals basis was appropriate for the broken period to the date of death and for the 1934 and 1935 years of income. An accruals basis for these years would, presumably, have enabled him to bring in those items, as accruals, though they had not been received at the date of death. But the effect of substituting accruals for any of the broken period, the 1934 or the 1935 year, would be to allow items to escape tax which had accrued in the last year assessed on a cash basis. It would only have been possible to ensure that all items were brought to tax if the taxpayer could have been required to account on an accruals basis for every year he had carried on the professional practice. The Commissioner’s powers of amendment did not go so far. A change from cash to accruals will always involve some items escaping inclusion in assessable income, and some items being denied deduction. In Henderson (1970) 119 C.L.R. 612, it was the taxpayer who sought the change in accounting basis. Windeyer J. attempted to prevent the escape by insisting that in the first year of accruals accounting the accruals of the last year of cash accounting were also to be brought to account. This, he considered, was necessary to ensure that the basis of accounting in the year of change truly reflected the income of that year. The Full Court, however, rejected this attempt to prevent the escape, insisting that there is no warrant “for combining the results of more than one year in order to obtain the assessable income for a particular year of tax” (per Barwick C.J. at 649).

[11.72] Where there is a change from cash to accruals, as in Henderson, s. 101A does not prevent the escape. The accruals of the last year of return on a cash basis will very likely have matured into actual receipts before death and are not for this reason affected by s. 101A. If any of these accruals do become receipts after death they will not be amounts which would have been assessable income if received by the deceased during his lifetime because at most times of all possible times of receipt the taxpayer was on an accruals basis. If s. 101A is to achieve anything in preventing the escape, it must be read as “which would have been assessable income if received by the deceased, in the year of income in which it became receivable”.

The Meaning of Incurring of an Outgoing on an Accruals Basis of Tax Accounting

[11.73] One would expect that principles in regard to the moment of incurring of an outgoing would be symmetrical with principles examined under the last heading in regard to derivation of a receipt. Such a symmetry, in general, obtains. Where a principle is unsettled it is possible to argue, in terms of the need for symmetry, for a principle which reflects a settled principle in regard to the derivation of a receipt. A settled principle in regard to the incurring of an outgoing may serve to supply a principle in regard to the derivation of a receipt. The law that follows in respect to the incurring of an outgoing may serve to resolve questions as to the meaning of derivation raised in earlier paragraphs. Thus it would appear to be settled by Commonwealth Aluminium Corp. Ltd (1977) 77 A.T.C. 4151 and Commercial Union Assurance Co. Ltd (1977) 77 A.T.C. 4186 than an outgoing may be incurred though there is no legal liability to pay. In Commercial Union it was enough that the taxpayer acknowledged liability to indemnify the insured, even though a failure by the insured to notify the taxpayer within time precluded any legal liability. Commercial Union in this way would supply a principle argued for in [11.52] above that a receipt is derived if there is a claim of right to that receipt, whether or not the receipt is legally recoverable. The dictum in regard to a requirement of legal recoverability in the judgment of Barwick C.J. in Henderson, referred to in [11.46] above, presents some difficulty, but it should not stand in the way. There is a necessary corollary of the principle adopted in Commercial Union: a withdrawal of an acknowledgement of liability that was an outgoing incurred is a derivation of income. A like corollary would apply in regard to a derivation of a receipt: the abandonment of a claim of right that is a derivation of income is the incurring of an outgoing. The ultimate discharge of a liability for less than the amount at which it stands acknowledged will generate an item of income, following principles examined in [12.181]–[12.191] above. If the discharge involves payment of a greater amount, there will be a loss that is deductible.

[11.74] Commonwealth Aluminium supports the view that incurring of an outgoing may arise from the acknowledgement of a liability. The acknowledgement concerned a liability that was defeasible in the event of the taxpayer’s success in an appeal to the Privy Council challenging the validity of the legislation under which the liability arose. This element of defeasibility, in the view of Newton J., did not prevent the incurring of an outgoing. The taxpayer acknowledged that subject to such defeasance he was liable to pay an amount determined under the legislation. Newton J. relied on James Flood Pty Ltd (1953) 88 C.L.R. 492 considered in this aspect in [11.78] below, for a view that the defeasibility of a liability does not preclude the incurring of an outgoing. If the defeasance occurred, the taxpayer’s acknowledgement would, presumably, be withdrawn, and there would at that time be a derivation of income equivalent to the outgoing incurred. Newton J. was conscious of the difficulty posed by the High Court decision in H. R. Sinclair & Son Pty Ltd (1966) 114 C.L.R. 537 considered in [2.547]–[2.552] above, and the subject of further consideration in [11.243] below.

[11.75] The law on incurring of an outgoing on an accruals basis adopts principles in regard to the relevance of a present liability to pay, the contingent nature of a liability, the defeasibility of a liability and the ascertainability of the amount of a liability that parallel equivalent principles in regard to derivation of a receipt.

[11.76] There is a dictum in James Flood Pty Ltd (1953) 88 C.L.R. 492 at 507 that a “debitum in praesenti solvendum in futuro” may be an outgoing incurred. The principle is applied in Alliance Holdings Ltd (1981) 81 A.T.C. 4637 and Australian Guarantee Corp. Ltd (1984) 84 A.T.C. 4642 so as to allow a deduction of interest in respect of the past use of money though the interest is not payable until the money borrowed is repaid. It is true that the dictum in James Flood seems inconsistent with an observation made by the court in W. Nevill & Co. Ltd (1937) 56 C.L.R. 290 at 302-3 per Latham C.J. and at 307 per Dixon J. The court in James Flood (at 507) explained the observation in Nevill by saying: “nothing that was decided in Nevill … was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable.” The dictum in James Flood was approached with some caution by Barwick C.J. in Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 at 624 where he said: “It may not disqualify the liability as a deduction that, though due, it may be paid in a later year.” It will be recalled that Barwick C.J. showed a similar cautious approach in Henderson (1970) 119 C.L.R. 612 to a principle that there may be a derivation of income though an amount is not presently receivable ([11.46] above). The caution could only have been intended to relate to items other than receivables for trading stock supplied. J. Rowe & Son Pty Ltd (1971) 124 C.L.R. 421 is clear authority that in regard to the latter there can be a derivation of income notwithstanding that the amount is not presently receivable. If an outgoing is treated as incurred on the arising of a liability to pay in the future, the amount of the outgoing will, presumably, be the amount payable in the future. It will be the amount payable notwithstanding that there is no obligation on the taxpayer to pay interest on the debt. A principle which would assert that the present value of the liability is the amount of the deduction may be seen as rejected by Rowe in its decision in regard to derivation of an income item.

[11.77] James Flood Pty Ltd (1953) 88 C.L.R. 492 is authority that a liability that will arise only on the happening of a contingent event is not before that event an outgoing incurred. A liability on a taxpayer to pay interest owed by another, contingent on a demand by the lender, is not yet an outgoing incurred (Marbren Pty Ltd (1984) 84 A.T.C. 4783). James Flood involved liabilities to pay employees while on holiday, liabilities that were contingent on periods of service that could be completed only in the following year of income. The case might equally have been decided on the ground that the amounts of the liabilities were not yet ascertained or ascertainable, which is a way of expressing the ground of decision in the later case of Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616. But James Flood offers authority for a principle as to the relevance of an element of contingency, equivalent to the principle considered in [11.49] above in relation to the derivation of an income item.

[11.78] There is an observation in James Flood which will support a view that the defeasible character of a liability will not prevent it being an outgoing incurred by an accruals basis taxpayer. The court said:

If a defeasible liability is treated as an outgoing incurred there must be a derivation of income equivalent to the amount allowed as a deduction if the defeasance occurs and the liability ceases. The view is taken above that an acknowledgement of a liability may be an outgoing incurred, and that a subsequent acknowledgement that the liability has ceased will involve a derivation of income. That view expresses a principle that is to be preferred to a principle that is cast in terms of the arising of a legal liability and cessation of liability. But a principle cast in terms of legal liability stands in equal need of a recognition that cessation of liability may be a derivation of income.

[11.79] In James Flood the taxpayer’s liabilities in regard to holiday pay were contingent. In Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 the liabilities in regard to long service leave pay were no longer contingent. Qualifying periods of service had been completed. But there was a factor common to James Flood and Nilsen that will explain the decision in Nilsen, and could also have been relied on to support the denial that an outgoing had been incurred in James Flood. The amount of the liability was neither ascertained nor ascertainable, since it was dependent on the rate of pay of the employee at the time he took leave, or resigned from his employment and became entitled to an amount equivalent to what he would have received if he had remained in service and taken his holiday. In judgments of the Federal Court and of the High Court in Nilsen the denial of a deduction is put on the ground that the taxpayer had not come to be under a “pecuniary liability”. The liability was to allow a paid holiday, and not to pay the employee while on holiday. This ground, it is now suggested, is no more than an assertion that there is no outgoing incurred until the amount of it is ascertained or ascertainable. Financial accounting may treat as an expense an estimate of the amount of a liability reflected in a provision made in accounts. But tax accounting, when the accounting is for receipt and outgoings, does not admit of an estimate of that kind. The estimate contemplates a procedure for correcting the amount of the estimate, by compensating items in subsequent years, or by reopening of assessments, to ensure that the amount of the liability ultimately ascertained is the amount for which deduction is allowed. There is a procedure for corrections of this kind in s. 170(9) which will ensure that the correct amount of profit or loss is brought in or allowed where specific profit accounting is appropriate. But no such procedures are available where receipts and outgoings accounting is applicable.

[11.80] Nilsen, as a decision on the incurring of outgoings in respect of long service leave, holiday leave and other leave of employees, has been deprived of significance by the enactment of s. 51(3) which establishes a specific rule of tax accounting that a deduction is not allowable in respect of “long service leave, annual leave, sick leave or other leave except in respect of an amount paid to the person to whom the leave relates or, where that person is deceased, to a dependant or personal representative of that person and, for the purposes of [subs. (1)], the amount paid shall be deemed to be a loss or outgoing incurred at the time when the payment is made”. The case remains significant as a decision on general principles of tax accounting. As a decision which would distinguish a liability to provide paid leave from a liability to pay on the occurrence of an event that must occur, the case is not helpful. The distinction, with respect, is verbal only. As a decision that an outgoing is not incurred until the amount of a liability is ascertained or becomes ascertainable the case leaves unresolved a question of the continuing significance of three decisions of the Victorian Supreme Court in R.A.C.V. Insurance Pty Ltd (1974) 74 A.T.C. 4169, Commonwealth Aluminium Corp. Ltd (1977) 77 A.T.C. 4151 and Commercial Union Assurance Co. of Aust. Ltd (1977) 77 A.T.C. 4186.

[11.81] Commonwealth Aluminium supports a principle that there may be an outgoing incurred if some estimate can be made of the amount of an acknowledged liability, even though the amount is not even theoretically ascertainable because the formula by which it will be ascertained has not yet been established so that the estimate is only a prediction. If symmetry is to be preserved between the law as to derivation of a receipt and the law as to incurring of an outgoing, the decisions in Australian Gas Light Co. referred to in [11.51] above, and in Commonwealth Aluminium cannot both stand as good law. R.A.C.V. Insurance and Commercial Union can be explained on the basis that the amounts of the acknowledged liabilities were theoretically ascertainable. The law of damages assumes that there is a sum which is the correct amount of a liability to compensate another for damage to his property or for personal injury, so that the amount of the liability of an insurance company to indemnify an insured person in respect of events that have occurred before the end of a year of income is theoretically ascertainable, even though the insurer at year end does not know that those events have occurred.

[11.82] The distinction thus drawn between R.A.C.V. Insurance and Commercial Union on the one hand and Commonwealth Aluminium on the other, is perhaps too fine to be useful and all three cases might be taken as supporting a principle that an estimate of the amount of a liability that does not purport to be any more than a prediction may be an outgoing incurred. A consequence is recognised in all three cases that as the estimate proves to be wrong, or, indeed, is displaced by a new estimate in a later year of income, there will be an incurring of a further outgoing if the actual liability proves to be more or the estimate increases, or a derivation of income if the actual liability proves to be less or the estimate decreases. Flexibility of this order may be beyond the capacity of the income tax law, though, it must be conceded, the law argued for in this Volume in regard to derivation by claim of right and incurring of an outgoing by acknowledgement of liability requires a substantial measure of flexibility.

[11.83] Mason J. was the only judge in Nilsen Development Laboratories (1981) 144 C.L.R. 616 to refer to R.A.C.V. Insurance, Commercial Union and Commonwealth Aluminium. He did not reject them, presumably because they were concerned with pecuniary liabilities while Nilsen was not. He said (at 632):

The Chief Justice’s comment referred to by Mason J. was the following (at 623):

[11.84] The implied approval by Mason J. of R.A.C.V. Insurance, Commercial Union and Commonwealth Aluminium is reinforced by the final words of the passage quoted from his judgment that the taxpayer in Commonwealth Aluminium “had completely subjected itself to liability to pay royalties”.

[11.85] R.A.C.V. Insurance, Commercial Union and Commonwealth Aluminium make a substantial contribution to the scope within receipts and outgoings accounting for matching of receipts and outgoings. In all three cases attention is drawn to the need to recognise expenses of the estimated amounts of liabilities in order to ensure that the profit shown in the financial accounts of a taxpayer are not distorted. There is an assumption that it is equally important to recognise outgoings of estimated amounts of liabilities in order that taxable income should not be distorted.

[11.86] Commercial Union (1977) 77 A.T.C. 4186 and R.A.C.V. Insurance (1974) 74 A.T.C. 4169 may be thought to cast doubt on the earlier decision in Herald & Weekly Times Ltd (1932) 48 C.L.R. 113, so far as that case may be taken to have decided that a liability in defamation is an outgoing incurred when the amount of the liability is ascertained by verdict in an action. The issue of time of derivation was not in fact raised in the case. There is this difference however between Herald & Weekly Times and the later cases: the taxpayer in Herald & Weekly Times did not acknowledge any liability until that liability was finally determined by action. The view has been taken above that the moment of acknowledgement of liability is the moment of incurring an outgoing by an accruals basis taxpayer, not when a legal liability arises—a legal liability that may not be confirmed until a court decision is given.

[11.87] The most significant development in tax accounting in the cause of matching receipts and outgoings is the decision in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 more closely considered in [11.89]ff. below. The method of the Arthur Murray decision is to defer the recognition of a receipt as an item of income derived until the item is earned, in the sense that the taxpayer has performed the acts which are the consideration for the receipt. The receipt is treated as derived as performance proceeds, and in proportion to that performance. Performance and the incurring of outgoings will generally run together. To the extent, however, that outgoings are treated as incurred in advance of performance, the achievement of Arthur Murray in matching receipts and outgoings is frustrated. A too enthusiastic application of a principle that will treat the estimated amount of a liability as deductible though the liability relates to a future supply of goods or services, will involve such frustration. It is true that frustration is in any case involved if outgoings that are not yet fully consumed are treated as outgoings incurred. But the advancing of the time of incurring that may result from treating estimated amounts of liability as incurred will increase the possible frustration. Arthur Murray is no more than a partial recognition of a matching principle. A more thoroughgoing recognition would seek to relate derivation of a receipt to the incurring of related expenses, rather than to performance of the acts that are the consideration for the receipt. This would to a degree overcome the distortion that results from the principle in Nilsen, and s. 51(3). The more thoroughgoing principle would require reconsideration of the Arthur Murray principle. A more realistic prospect is the recognition of a principle argued for in this Volume, that an outgoing is not incurred until it is consumed. There is no decision directly in the way of such a recognition, and the principle has the support of the Federal Court in Australian Guarantee Corp. Ltd (1984) 84 A.T.C. 4642. A combination of Arthur Murray and such a principle would go a considerable distance towards an acceptable matching, though distortion would continue where income does not arise until after matching outgoings are fully consumed, or outgoings do not arise until matching income has been fully earned. Matching in these circumstances requires the advancing of the arising of income or the advancing of the arising of outgoings, which is probably beyond the capacity to be flexible of any system of tax accounting.

[11.88] On the view taken in this Volume a taxpayer on an accruals basis in relation to an item, who acknowledges a liability to pay may incur an outgoing, notwithstanding that he doubts that he is legally liable to pay, and will pay under protest anticipating that he might in due course recover what he has paid after successfully challenging the validity of the law under which it is said his liability arises. Commonwealth Aluminium was a case of this kind. The time of incurring of the outgoing is the time of acknowledgment. Payment in fact will support the acknowledgement but the payment is not the incurring of an outgoing. Where there has been no acknowledgement of a liability to pay, the incurring of an outgoing must wait on actual payment. The common situation will be a voluntary payment by the taxpayer. The concept of actual payment will, presumably, be the same as actual payment where the taxpayer is on a cash basis in relation to the item.

Tax Accounting for Receipts “in Advance” and for Outgoings “in Advance” Under Accruals Accounting

[11.89] Reference has already been made ([11.87] above) to the role of the principle in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 in promoting a matching of receipts and outgoings. The possible achievement of the principle is limited. The spreading forward of a receipt so that it is derived over a number of years of income is appropriate only so long as the receipt retains the inherent characteristic that it, or its equivalent, may have to be returned, in whole or in some part, to the person from whom it was received. Such spreading will in many cases have the effect that derivation occurs over the years in which there are matching outgoings. But the method of spreading is not designed to achieve this result. The expenses of the performance of services which are the quid pro quo for a receipt will very likely be outgoings incurred in the years of performance—years in which there will continue to be the prospect for the taxpayer that he may have to return, perhaps by way of damages for failure to perform, some part of the amount of the receipt. But some expenses of performance may not be incurred until after performance is complete, for example the expense of a payment to an employee taking holidays or long service leave, or a payment in lieu of such made to an employee who retires, or to the estate of an employee who has died.

[11.90] Arthur Murray does not allow the anticipation of a derivation of income so that there might be income derived in years in which related outgoings have been incurred.

[11.91] The case involved receipts. It may suggest a parallel principle in regard to outgoings, but the case does not decide that there is a parallel principle which would direct that an outgoing is incurred only as it is consumed—the whole of it is not incurred until there is no remaining benefit from the outgoing that may affect income derivation. A parallel principle would in any case be confined to outgoings that are in other respects incurred: it would not allow the anticipation of an outgoing. Nilsen Development Laboratories and s. 51(3) do not conflict with a principle in regard to outgoings parallel with that in Arthur Murray.

[11.92] Arthur Murray and any parallel principle in regard to outgoings work with receipts and outgoings tax accounting. Specific profit tax accounting may allow greater flexibility in matching costs and proceeds, but, it will be seen, there are limits also on its possible achievement.

[11.93] The judgment in the High Court in Arthur Murray makes some reference to the background of practice by the Commissioner prior to the decision:

The Commissioner might be pardoned for thinking that the denial of the deductibility of the provision for leave yet to be taken in James Flood required the denial of the deductibility of a provision for income yet to be earned. The effect of the Arthur Murray decision in financial accounting terms is to allow deduction of the latter provision. But in tax accounting the two provisions are distinguishable. A provision for leave yet to be taken seeks to anticipate the incurring of an outgoing. A provision for unearned income seeks to defer income that is otherwise derived. Which is not to say that a provision for unearned income may not bring about the same result in some circumstances as a provision for an expense yet to be incurred. It will have the same effect where the expense when incurred will be incurred in the performance of the acts which are the quid pro quo for the receipt.

[11.94] The Commissioner’s practice prior to James Flood Pty Ltd (1953) 88 C.L.R. 492 apparently recognised that an actual receipt in respect of the supply of goods or the provision of services was not income derived until the tender of delivery of the goods or the performance of the services. The Arthur Murray principle aside, it may be assumed that an actual receipt in these circumstances is a derivation of income. It is a derivation, notwithstanding that there would as yet be no derivation by an accruals basis taxpayer of an amount receivable in the same circumstances, unless all contingency in regard to the receivable has been removed by an agreement that the amount was receivable irrespective of delivery or performance of the services. One may assume that the Commissioner’s practice in regard to an actual receipt would have extended to an item receivable by an accruals basis taxpayer irrespective of delivery or performance. The Commissioner’s practice would appear however to have been different at the time of New Zealand Flax Investments (1938) 61 C.L.R. 179. There is no indication in that case that the Commissioner was prepared to treat the derivation of the bond receipts as deferred until the performance of the work that the taxpayer had undertaken to perform as the quid pro quo for the receipts.

[11.95] There are some observations by members of the court in New Zealand Flax Investments (1938) 61 C.L.R. 179 that could perhaps be seen as searching for an Arthur Murray principle, but the search was readily abandoned. Starke J. (at 197) related that during argument “the court inquired whether the sum … received from the sale of bonds was income … The only answer the court received was that the Act taxes the gross income of the taxpayer—all that comes in—subject to certain statutory deductions …”. He then observed: “The … answer overlooks the fact that the [Act] imposes a tax upon income. It is not a tax upon everything that comes in whether an income receipt or a capital receipt.” The concluding words in the passage quoted may indicate that Starke J. had in mind the possibility, not of an Arthur Murray principle, going to the time of derivation, but a principle identified in [2.113]ff. above as the contribution to capital principle. The latter principle would justify a conclusion that the bond receipts were not income to the extent that New Zealand Flax Investments was required to use them in the purchase of land the title to which would be vested in the bondholder. Views expressed by Dixon J. in regard to the operation of receipts and outgoings tax accounting describe a system (at 199): “…. under the Income Tax Assessment Act 1922–1930, [by which] the assessment must begin by taking, under the name of assessable income, the full receipts on revenue account, and only such deductions must be made as the statute in terms allows.” This approach suggests a rigidity that would have no place for an Arthur Murray principle. It is true that Dixon J. sought some flexibility in regard to outgoings, and did allow deductions that would now be denied under James Flood. But he saw the scope for anticipating outgoing as a means of achieving some matching with receipts that had to be treated as income derived, as very limited.

[11.96] The specific effect of the Arthur Murray decision is that a receipt which would otherwise be income derived by the taxpayer, depending on his appropriate basis of accounting, will not be income until the services to which it relates have been performed or it becomes apparent that the taxpayer will not be called on to perform those services. The statements of principle in Arthur Murray are not, however, in terms confined to services-to-be-performed situations. The joint judgment of Barwick C.J., Kitto and Taylor JJ. supports a general principle that income will be derived only if gains have “come home” beneficially to the taxpayer in circumstances in which “they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived” ((1965) 114 C.L.R. 314 at 318). The judgment asserts that:

[11.97] Neither the words of the Assessment Act nor any judicial decision stood in the way of the relevant general understanding among practical business people. James Flood Pty Ltd (1953) 88 C.L.R. 492 was to be regarded as a decision on the meaning of the word “incurred” in s. 51(1), and thus had no application. It should be noted that the matter was before the High Court on a case stated in which, by agreement, business and accounting principles relevant to the facts were set out as being established principles. It may be asked whether it would now be open to the Commissioner to assert a general understanding among practical business people different from that reflected in the agreed principles in the case stated.

[11.98] The court’s perception of the “general understanding among practical business people of what constitutes a derivation of income”, relevant to the facts of Arthur Murray, is explained in the following passage:

The scope of the decision in its effect on receipts and outgoings tax accounting, and in its application to the circumstances of the case and to other circumstances, requires examination.

[11.99] Arthur Murray (1965) 114 C.L.R. 314 was concerned with fees for dancing lessons yet to be given. The fees had already been the subject of actual receipt by the taxpayer. Some statements in the judgment may suggest that the law established in the case is confined to actual receipt. There can be no basis in principle, where the item is accounted for on an accruals basis, for drawing a distinction that would exclude the application of the case to a receivable where that receivable is otherwise derived—the amount is ascertained or ascertainable, and there is no element of contingency affecting the taxpayer’s right to receive. If a customer in the circumstances of the Arthur Murray case has agreed to pay for lessons and his agreement is not in its express or implied terms conditional on lessons having been given, there is a derivation by the person providing the lessons, which will be governed by the Arthur Murray principle.

[11.100] If the taxpayer is on a cash basis in relation to the item of receipt, there can be no room for the law established in Arthur Murray until there has been an actual receipt.

[11.101] In the view of the court the general understanding among practical business people would have deferred the derivation of the fees received until there had been performance of the obligations the taxpayer had undertaken. The judgment is not definitive on the question whether there must have been complete performance of the obligations to which the receipt relates before there is a derivation. It would be assumed, however, that derivation occurs as performance proceeds, which raises the question of how the stage of performance is to be measured. On the facts of Arthur Murray, a measure in terms of the number of lessons given of the total number promised to be given is suggested, a measure which would generally correspond in its effect with a measure that judges performance in terms of the expenses incurred as a fraction of the estimated total expenses that will be incurred in giving the lessons promised. In other facts, for example an advance receipt for the maintenance of new machinery for a period, it may be expected that the obligation will become the more onerous as the period elapses, and a simple formula by which to assess the measure of performance is not readily found. If a time lapse formula is adopted, there will be a limited achievement in matching receipts and outgoings. Whatever formula is adopted, it will, presumably, be concerned with a measure of performance and not with a measure of expenses incurred. The point has already been made that Arthur Murray does not offer a method of overcoming the defeat of a matching of receipts and outgoings that is implicit in Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 and in s. 51 (3) of the Assessment Act.

[11.102] In a statement subsequent to the decision in Arthur Murray, the Commissioner gave some indication of his views on the scope of the decision. In one paragraph of that statement the suggestion is that the decision has no application to a contract to perform services unless “a specific number of … services … are to be provided” or “services are to be rendered as required over a fixed period of time”. In these instances there is a ready measure of degree of performance, but there is no basis in the Arthur Murray decision for limiting the decision to circumstances in which a ready measure is available. In fact a broader view seems to be contemplated in another paragraph of the Commissioner’s statement where it is said:

[11.103] The same statement by the Commissioner insists that the taxpayer should have kept his financial accounts in accordance with the accounting practices accepted by the High Court to be the general rule. If he has not, the Arthur Murray principle will not be applied though its application has been claimed in the taxpayer’s return. The statement reads:

However, it is not proposed to make any distinction between taxpayers who prepare their books of account and published accounts on the basis that advance payments are not income until ‘earned’ (as in the Arthur Murray case) and those who credit the advance payments to the same account as other gross revenue received but make a balance day adjustment, at the close of the year of income, to exclude unearned income from the profit and loss account. These alternative methods use different bookkeeping techniques, but both methods achieve the same practical result in excluding ‘unearned income’ from the net profit for the current year, as revealed by the taxpayer’s financial accounts” (CCH, Federal Tax Reporter, para. 12-005.). It is true that the High Court drew on financial accounting conventions in formulating a principle of tax accounting. But financial accounting and tax accounting are distinct regimes. What the taxpayer is entitled to do in his tax return in order that his return should correctly reflect the derivation of income, should not depend on what he may have done in his financial accounts in following conventions concerned with ensuring that accounts correctly reflect the annual profits of his enterprise.

[11.104] Reference has already been made to New Zealand Flax Investments (1938) 61 C.L.R. 179 as a decision prior to Arthur Murray in which the Arthur Murray principle might have been recognised, at least if the Commissioner and taxpayer had not reached an agreement about the law that was inconsistent with the principle, and the taxpayer had not failed to raise by his objection a question whether some part of the receipts was not income. The case affords an illustration of how receipts and outgoings accounting, in the absence of an Arthur Murray principle, can bring about a failure to match receipts and outgoings and a consequent stark injustice. The injustice in this instance was to the bondholders whose subscriptions, so far as they had not yet been spent in performing the services promised by the taxpayer, would go in payment of tax by the taxpayer company. That tax was imposed on an amount which, despite the warping of other principles by the High Court so as to mitigate the failure of matching, could not be said to reflect any overall gain by the taxpayer company. A proposition is asserted in Pt I (Proposition 4, [2.38]ff. above) that an item, to have the character of income, must be a gain by the taxpayer who derived it. In that context the concern is with the individual item derived, and the need to put out of any tax account an item that has not been derived beneficially, or has been derived subject to obligations to apply the amount in the interest of a person from whom it was received or in reimbursing a loss or outgoing incurred in the interests of the person from whom the item was received. The principle now asserted is that the balance of receipts and outgoings which is identified as taxable income should reflect an overall gain, in the sense that there is a balance of the amount of income items over matching expenses. It is true that receipts and outgoings accounting, without an Arthur Murray principle, will ultimately, in the sum of experiences of several years, bring out a balance that is an overall gain. But a failure to match receipts and outgoings in any of those years will preclude a balance that is an overall gain in that year. It is small comfort to a bondholder in a New Zealand Flax situation that the taxpayer will in subsequent years very likely show negative taxable income (losses in the s. 80 sense), more especially since there is no carry back of that negative taxable income. It will be of no comfort at all if the moneys he has subscribed for bonds are consumed in the payment of tax on positive taxable incomes of the taxpayer in early years, so that the taxpayer is denied the funds that would have been used in carrying out its obligations to bondholders, and the taxpayer is forced into liquidation.

[11.105] The tax accounting in New Zealand Flax should have reflected both Proposition 4 (as it is more particularly expressed in Proposition 7—the contribution to capital principle) and the principle later established in Arthur Murray. The receipts from bondholders, so far as they were to be used in buying land to be vested in the bondholders, were not income of the taxpayer, and the use of the receipts in this way did not give rise to deductible outgoings. The receipts in other respects were income, but income derived only as and to the extent that the services of clearing, ploughing, planting and tending the bondholder’s land proceeded over the years of income until harvesting of flax commenced. The expenses of clearing, ploughing, sowing, planting and tending would be deductible as they were incurred.

[11.106] The assumption in the last paragraph that the principle in Arthur Murray would be attracted by the facts of New Zealand Flax involves a wider view of the principle than that reflected in the Commissioner’s statement referred to in [11.102]–[11.103] above. It is true that the progress of performance could only be a matter of estimate, but the uncertainty of estimate is the price of escape from a rigidity in the operation of receipts and outgoings that is simply unacceptable. That price is properly paid.

[11.107] The application of the Arthur Murray principle in circumstances beyond Arthur Murray and New Zealand Flax calls for some comment. Clearly there must be some limits on the scope of the principle. Almost any occasion of the derivation of income will carry a prospect that the taxpayer who derives may be called on to take some action—either to make good what he has provided or to pay money—in the event of a contingency that may occur. Where goods or services are provided there are prospects of liability in tort, liability under consumer credit law and liability in contract on the happening of an event—either a defect arising or becoming apparent, or damage being caused either to the person for whom the goods or services were provided, or another. The deferring of some part of income otherwise derived while there remains any prospect of a liability arising is not required by the Arthur Murray principle.

[11.108] It is arguable that there is room for the Arthur Murray principle where an express promise has been given to make good within a specified period. The promise would be recognised in financial accounting by a provision for unexpired warranties. But a promise to make good in the event of a contingency—a defect arising or becoming apparent—is different from a promise to give service for a period, that is not dependent on a contingency occurring, and it may be that the Arthur Murray principle is appropriate only in the latter situation. The obvious illustration is “free” service for a period promised on the sale of a motor vehicle or other consumer durable.

[11.109] Where a contract relates to the sale of goods an amount received that is not contingent on delivery of the goods will, apart from the Arthur Murray principle, be income derived at the moment the receivable arises. Where the receivable is contingent on delivery there will be a derivation apart from Arthur Murray, when there is an actual receipt, for example the receipt of a deposit, and the amount received is not held in trust. In these circumstances the Arthur Murray principle will defer derivation until performance. In this instance only one act of performance, the giving of delivery, is contemplated, and derivation will be deferred of the whole amount receivable or received until delivery is given. This operation of the Arthur Murray principle is recognised in the Commissioner’s statement referred to in [11.102] above.

[11.110] A taxpayer who is entitled to an amount payable as a subscription to a periodical publication for a stated period has derived income, apart from Arthur Murray, if his right to receive is not contingent on actual delivery of some or all of the issues of the periodical to which the subscription relates. Arthur Murray will however require a deferral of derivation so that only so much of the receivable as may be regarded as relating to issues of the periodical delivered in the year of income will be regarded as income derived. Country Magazine Pty Ltd (1968) 117 C.L.R. 162 is authority for this operation of the Arthur Murray principle.

[11.111] An amount receivable under an insurance policy that gives cover for an agreed period will be income derived under the Arthur Murray principle to the extent that the period of cover falls within the year of income. It is a short step from this operation of the Arthur Murray principle in relation to insurance, to an operation that will defer derivation of a passive income receivable, otherwise held to be derived, so that it is income derived only to the extent that it is in respect of a period that falls within the year of income. It would be asserted that interest accounted for on an accruals basis, as in National Bank of N.Z. Ltd v. C.I.R. (N.Z.) (1977) 77 A.T.C. 6001, is income derived in tandem with the running of the period of the lending to which it relates. Generally an entitlement to receive interest will be contingent on a period of the lending having elapsed, in which event there will be no room for the operation of the Arthur Murray principle. There will be no derivation until the period has elapsed because the entitlement to receive is until that time contingent. When the contingency is satisfied, the interest receivable will have been fully “earned” in the sense in which that word is used in Arthur Murray.

[11.112] If Arthur Murray (1965) 114 C.L.R. 314 may operate to defer derivation of interest income, it may equally operate to defer rent and royalty income. The Commissioner’s statement referred to in [11.102] above denies the relevance of the Arthur Murray principle: “… nothing that was said in the judgment (in the case) appears to have any bearing on the point of time at which rents, rentals of plant or machinery or investment income should be regarded as being derived.” It is true that the language used in the statement of principle in Arthur Murray contemplates the kind of future performance with which the case was concerned—what might be called active performance as distinct from forbearance. A distinction in terms of action and non-action, assuming it can always be drawn, would distort the operation of the principle. A receipt of interest or rent in advance under an agreement will require an implication that the receiver will not exercise any power he may have to terminate the tenancy or recall the loan during the period to which the receipt relates. And where he has no power, there are duties to forbear from wrongful interference. Duties to forbear should be held sufficient to attract the operation of the principle.

[11.113] The decision in Arthur Murray is concerned with the deferring of receipts otherwise derived. It does not authorise the anticipation of a receipt that will not otherwise be derived until a later year of income. It would not authorise a conclusion that the income item in Squatting Investment Co. Ltd (1954) 88 C.L.R. 413—a receipt in respect of wool submitted for appraisal years before—was income of the year in which it was submitted, though it may be thought that it was fully earned, in the Arthur Murray sense, in that year. At the time of the submission of the wool there was no entitlement to receive or claim of right to receive an ascertained or ascertainable amount. An entitlement and a claim to receive arose years later, when legislation was enacted providing for a distribution of the surplus realised on the sale of wool that had been submitted. Any principle that would bring back the derivation of the item in Squatting Investment to the year in which the wool was submitted would, in any event, be unacceptable as a matter of tax procedure. There would be nothing in the Commissioner’s powers to amend an assessment to enable him to reopen an assessment and include the item of income as an item derived in the year in which wool was submitted for appraisal.

[11.114] In confirming the operation of the Arthur Murray principle in the context of receipts in respect of subscriptions to periodicals, Country Magazine Pty Ltd (1968) 117 C.L.R. 162 may have revealed difficulties posed by tax procedure where the principle operates. There will always be difficulties arising from the very limited powers the Commissioner has to reopen assessments, if a new statement of principle conflicts with assumptions that had previously been made. There will, more especially, be difficulties for the taxpayer if an item of a kind that had been assumed to be and had been returned as income of an earlier year is now held, in the affairs of some other taxpayer, not to have been an income item at all. Country Magazine concerned an item— a receipt of a subscription for a periodical some numbers of which would appear in later years of income—that was undoubtedly of an income nature. It had however been treated as income derived as to the whole of its amount in the year of receipt. The decision in Arthur Murray (1965) 114 C.L.R. 314 thereafter revealed that it was only in part income derived in the year of receipt. In other parts it was income derived in subsequent years. Country Magazine confirmed that the amounts derived in those subsequent years must be returned and assessed in those subsequent years. There is some reference in the case to the possibility of an amendment of the assessment of the year of receipt. It is not easy to see what power the Commissioner would have to reopen that assessment: the including of the whole amount of the receipt as income in that year is not an error in calculation or a mistake of fact (s. 170(4)). In the statement to which reference is made in [11.102] above, the Commissioner foresaw the circumstances of Country Magazine and asserted that an assessment made in an earlier year when the whole amount of the receipt had been included could not be amended “unless the taxpayer’s rights are protected by an undetermined objection or appeal”.

[11.115] Country Magazine suggests a question about the operation of the Arthur Murray principle that requires an answer. The method of spreading forward the amount of a receipt over the years of “earning” may not produce an accurate distribution. The Commissioner’s statement referred to in [11.102] above, seeks to deal with this matter:

In this and other paragraphs of the Commissioner’s statement there is an assumption that spreading is a matter of estimate and that a new estimate may be made in a year subsequent to the initial estimate. The Commissioner’s concern is with underestimate in earlier years and the need for an exaggerated estimate of the amount earned in a later year to ensure that the whole amount is brought to account over a span of years. It should follow that it is proper to redress an overestimate in an earlier year, perhaps the first year, by an underestimate in later years. There might thus be a way of overcoming the unfairness of Country Magazine, and of allowing a flexibility within the Arthur Murray principle comparable with the flexibility contemplated, in another context, by the decisions in Commercial Union Assurance Co. Ltd (1977) 77 A.T.C. 4186 and R.A.C.V. Insurance Pty Ltd (1974) 74 A.T.C. 4169. Those cases assume that an estimate of a liability incurred in one year may, in effect, be corrected by new estimates in subsequent years.

[11.116] The possibility of a principle of tax acounting applicable to outgoings, that would be symmetrical with the principle in Arthur Murray in relation to income items, has been explored in a number of places in Pt II of this Volume. Apart from some observations in the House of Lords in Strick v. Regent Oil Co. Ltd [1966] A.C. 295, no overt consideration has been given in the cases to this possibility, though it might be thought now to be tacitly recognised by the Federal Court in Australian Guarantee Corp. Ltd (1984) 84 A.T.C. 4642. The taxpayer in Arthur Murray deferred items of income—fees in advance for lessons—not yet earned, and at the same time deferred expenses—commissions payable to agents who sold the lessons—referable to the items of income not yet earned. No reference is made to this circumstance in the judgment in Arthur Murray.

[11.117] Such a principle would have afforded a simple and fair solution to the issue of the deductibility of the payment of interest in advance in Ilbery (1981) 81 A.T.C. 4661. If the advantage obtained by the payment is not of such significance as to be treated as structural, so that any deduction for the interest paid in advance is denied, the advantage is to be seen as a wasting revenue asset, and the payment should be treated as incurred as the benefit arising from the payment is consumed. The benefit will be consumed as the period of use of the money borrowed elapses. Payment of the interest will not be a moment of incurring. Incurring will arise when the outgoing is consumed by the use of the benefit that results from the outgoing. An outgoing thus incurred will be deductible if it is relevant to the derivation of income. It will be relevant, in the case of an interest outgoing, if the money borrowed is, at the time of consumption of the interest, used in a process of income derivation.

[11.118] On such a principle interest paid in advance will not be deductible if in the year of consumption the money borrowed is not used in a process of income derivation. It will not be deductible because it will not be relevant to a process of income derivation. In Ilbery consumption and relevance in the year of income could have been shown as to only a small fraction of the interest paid in advance. Consumption and relevance might have been shown in subsequent years if the money borrowed had continued to be used in a process of income derivation. The reasons given by Toohey J. for denying any deduction put at the forefront a failure to satisfy the contemporaneity requirements. The payment of interest came too soon—some minutes, presumably, before the money borrowed came to be invested in an interest bearing account. Contemporaneity in such circumstances is a bizarre basis of decision. It is simply a trap for the unwary. Contemporaneity may be a useful enough guide to relevance of an outgoing incurred that relates to a benefit already consumed, or that is consumed immediately. It has no role in relation to a benefit that will be consumed in the future.

[11.119] If a principle which relates incurring to the consumption of resulting benefit is adopted, the payment of interest may give rise to some deductibility, notwithstanding that the payment occurred at a time when there was as yet no process of income derivation, actual or even intended. If the money borrowed comes to be used in a process of income derivation, there will be an incurring by consumption and an allowable deduction of so much of the interest paid as relates to the period of such use.

[11.120] The observations in the immediately preceding paragraphs concern interest paid in advance by a taxpayer on a cash basis in relation to the item. Where the taxpayer is on an accruals basis in relation to an item of interest, the principle that an outgoing is not incurred until the benefit arising from it is consumed will be applicable to the arising of a liability to pay interest that would in other respects be an incurring of an outgoing. A taxpayer will have undertaken a liability to pay interest in the contract of loan. That liability to pay, if it is in other respects the incurring of an outgoing—it is ascertained and not contingent—will attract the operation of the principle. The principle will have little apparent room for operation where interest is payable in arrears and an outgoing is not yet incurred because the liability to pay is contingent on the continued running of the loan. Another principle, that there is no incurring while a liability remains contingent, in these circumstances has an overlapping operation with the principle that an outgoing is not incurred until the benefit arising from the liability is consumed. Where, however, there is no right to repay in advance of a specified time and no right in the lender to demand repayment before that time, and the taxpayer is obliged to pay interest on repayment at that time, there is need of the operation of the principle. The liability to pay interest on repayment of the loan should not give rise to a deductible outgoing on the receipt of the loan moneys by the borrower. The principle requiring consumption of the benefit of use of the money would ensure that the liability to pay interest is a deductible outgoing as and to the extent that the period of the loan runs. The principle found such application in Alliance Holdings (1981) 81 A.T.C. 4637 and in Australian Guarantee Corp. Ltd (1984) 84 A.T.C. 4642. These cases express the principle in relation to a liability to pay interest at the end of a fixed period of borrowing where there is no right to repay in advance or to demand repayment in advance. The liability to pay that arises at the time of the borrowing is not contingent and its amount is ascertained. The benefit arising from the liability to pay interest is the use of the money borrowed. If that use is in a process of income derivation, the principle will allow deduction of the interest to the extent of the amount that relates to the use of the money in the year of income. Australian Guarantee Corp. Ltd also endorses the principle where the liability to pay interest is defeasible because the contract of loan provides for an option in the borrower to repay the loan before the end of the fixed period, or an option in the lender to demand repayment of the loan before the end of the fixed period. James Flood Pty Ltd (1953) 88 C.L.R. 492 recognises that a liability to pay that is defeasible may be an outgoing incurred. If the outgoing is immediately deductible there is the prospect of the recognition of an item of income if the defeasance occurs. That point is made in [11.78] above. The application of the principle that there is no incurring of an outgoing until the benefit arising from it is consumed, precludes any need to recognise income on the defeasance occurring. The outgoing otherwise incurred will only be deductible as the running of the loan proceeds, and the liability to pay becomes pro tanto absolute. If the repayment of the loan in advance of the end of the fixed term has a consequence that the liability to pay interest for the remainder of the term is discharged, there will never be an incurring of the liability to pay interest in respect of the remainder of the term. These observations are relevant only to a loan under which the liability to pay interest in respect of a fixed term is absolute or defeasible. If the liability to pay is contingent there will not be any incurring of a liability until the contingency occurs and Australian Guarantee Corp. Ltd will not be applicable. If there is a clause in the loan agreement that the lender will not be entitled to interest for any part of the term if he exercises an option to claim repayment before the expiration of the term, the borrower’s liability to pay interest is contingent, and there will be an outgoing incurred only as interest is paid.

[11.121] The principle argued for, like the Arthur Murray principle, brings about a matching of receipts and outgoings, though the total achievement of both principles must always be less than may result from specific profit accounting. Profit accounting will bring about matching of all costs and proceeds at the time a profit or loss is to be struck. Arthur Murray (1965) 114 C.L.R. 314 cannot assist matching when income is fully earned prior to any incurring of an outgoing, for example outgoings that are the making of payments for long service leave (Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 and s. 51(3)). And the symmetrical principle applicable to outgoings will not assist matching if the benefit arising from an outgoing is fully consumed before there is any related income derivation. An insurance premium for cover of factory premises may be fully consumed before the factory has yet produced any goods, or before those goods are sold. In such circumstances there is some prospect that deduction may be denied altogether by the contemporaneity principle, but in the view of this Volume, wrongly. The contemporaneity principle makes no contribution to the achievement of matching.

Accounting for Receipts on a Cash basis

[11.122] There is no general principle that will answer all questions as to when there is a derivation by a taxpayer on a cash basis in relation to an item. Rules are required for particular situations.

[11.123] The question whether there is a receipt that is a derivation of income when an item is to be accounted for on a cash basis may arise in circumstances which concern only the taxpayer and the person from whom the receipt by the taxpayer proceeds. Or it may arise where action by the taxpayer in relation to his expectation of a receipt or a right to a receipt, will bring about an expectation of a receipt or a right to receive in another person or an actual receipt by that other person. The emphasis in present discussions is on the question as it arises in the first situation. The question in the second situation is the subject of a closer examination, in connection with the assignment of income, in Chapter 13 below and in [11.140]–[11.143] below.

[11.124] The present discussions are concerned with derivation in its meaning in ordinary usage, and with possible extension of this meaning of derivation by s. 19 of the Assessment Act. They deal in turn with derivation where the item is money and then with derivation where the item is something other than money. A distinction is drawn between derivation that involves an actual receipt—where everything has been done to vest the item in the taxpayer as completely as the nature of the item will allow—and derivation that involves a constructive receipt. An actual receipt, in the case of an item of money, will involve the taxpayer acquiring money in hand. A constructive receipt that may be a derivation will involve something more than the arising of a receivable in money. How much more calls for examination.

[11.125] Section 19 reflects the distinction between an actual receipt, in the sense adopted above, and a constructive receipt. It distinguishes a situation where an item of an income character has been “actually paid over” to a taxpayer and a situation where the item has been “reinvested, accumulated, capitalised, carried to any reserve, sinking fund or insurance fund however designated, or otherwise dealt with on his behalf or as he directs”. It will be noted that the language of the section suggests concern only with items of money income, leaving derivation in the case of other items to be governed by the ordinary usage meaning of derivation.

[11.126] The judicial consideration of the scope of constructive receipt has concentrated on s. 19 of the Assessment Act, and the question whether s. 19 extends or limits the ordinary usage meaning of derivation has been given little attention. The words of s. 19 referring to constructive receipt situations are so broad that the section on its face can only extend the ordinary usage meaning of derivation in its application to items of money, and in its application to circumstances not involving assignment of income. There is some prospect however that s. 19 might be held to have limited the ordinary usage meaning of derivation in its application to assignment of income situations. That prospect is rejected in the discussion that follows in Chapter 13 below.

[11.127] One thing would appear to be clearly established: s. 19 leaves the ordinary usage meaning of derivation untouched, in the respect that the ordinary usage meaning would insist that “to see whether income has been derived one must look to realities”. The quotation is from the judgment of Rich J. in Permanent Trustee Co. (1940) 6 A.T.D. 5. The context of the quotation is this (at 12–13):

[11.128] The judgment of Rich J. is relied on by Gibbs J. in Brent (1971) 125 C.L.R. 418 for a conclusion that a taxpayer on a cash basis who is owed money for services rendered does not derive the money by not asking to be paid. Such a conclusion could not be doubted without abandoning any distinction between accruals and cash tax accounting. However, Gibbs J. made an observation that may be thought to draw from the judgment of Rich J. more than could have been intended. He said (at 430–431): “In the present case, even if the money had been retained at the request of the [taxpayer], her position would have remained exactly as it was; the income would not have been used on her behalf and the company would have remained under an obligation to pay it to her. There is not the slightest ground in the present case for applying the provisions of s. 19.” The dictum places emphasis on the action of the taxpayer, and whether it is within the precise words of s. 19. It overlooks the reasoning in the judgment of Rich J. that expresses an overall limitation on any words in s. 19. An event will not be a derivation if there is no reality behind the event: an event that may in other circumstances be a constructive receipt that is a derivation will not be such if in reality the taxpayer was “no nearer getting his money or of transferring it into anything of any value”. It may be that a request not to be paid is not in any circumstances a constructive receipt that will amount to derivation by a taxpayer on a cash basis, but the judgment of Rich J. in Permanent Trustee affords no authority for such a proposition. Nor is authority to be found in St Lucia Usines & Estates Co. Ltd v. Colonial Treasurer of St Lucia [1924] A.C. 508, which decides no more than was decided by Rich J.

[11.129] Permanent Trustee (1940) 6 A.T.D. 5 is authority that an event involving only the taxpayer and the person from whom an item of money is receivable will not be a derivation if there is no commercial prospect of an actual handing over of money to the taxpayer. If there is such a commercial prospect, the question remains whether the event is one that either the ordinary usage meaning of derivation or s. 19 would regard as a derivation.

[11.130] The event that is the subject of the observation by Gibbs J. in Brent —a request not to be paid—may not be of sufficient significance to be recognised as a derivation, though failure to recognise it as such opens opportunities for postponing the derivation of income. At the same time a request by a taxpayer creditor not to be paid is different in legal significance from a tender of payment by the debtor. A tender does have an effect on the legal relations between debtor and creditor. It would be possible to hold that a tender refused involves a derivation, though a request by the creditor that the debtor should not tender does not.

[11.131] It may be argued that there is an event of sufficient significance if the debtor acknowledges his liability by a credit to the account of the taxpayer in the debtor’s books of account. It has gone unquestioned since the inception of the income tax that a taxpayer on a cash basis in relation to the item derives interest that is credited to his current or savings account by his bank. In these circumstances the crediting is done with the actual or implied assent of the taxpayer, the implied assent arising from the practice of banks. And the crediting brings about a change in the relationship of debtor and creditor, in that the amount of interest becomes subject to the methods of obtaining payment—a cheque or withdrawal notice— applicable to a current or savings account. Crediting in other circumstances—where no change in legal relations will result—even with the assent of the taxpayer may not be sufficient.

[11.132] Treating a crediting as a derivation of an item to be accounted for on a cash basis does not raise any conflict with the words of the Assessment Act. In a number of instances the Assessment Act by express provision treats an item as derived when it is “paid” to a taxpayer (for example s. 26(eb). In other situations it is enough to constitute a derivation that an item is “paid or credited” to the taxpayer (s. 109, s. 44(1) and the definition of “paid” in s. 6). It might be inferred that “paid” reflects the meaning of ordinary usage derivation where the item is to be accounted for on a cash basis and “crediting” is an extension beyond ordinary usage derivation. There is, however, nothing in the authorities that supports an equating of ordinary usage derivation and “paid”. The fact that an item is held to have been “paid” might suggest that it has been derived within the ordinary usage meaning. But “paid” may have different meanings in different contexts, and is thus an uncertain guide to the ordinary usage meaning of income. It should not be taken to determine exclusively the ordinary usage meaning.

[11.133] As explained in [11.128] above, Permanent Trustee (1940) 6 A.T.D. 5 and St Lucia [1924] A.C. 508 are not authority that a “capitalising” of a receivable is never a derivation of an item accounted for on a cash basis. “Capitalising” is of course a term of several meanings. The capitalising in Permanent Trustee was no more than an acknowledgement that an amount was owing to the taxpayer that had its origin in an obligation to pay interest, and the addition of a security over certain property in respect of the amount owing. Such an acknowledgment ought not to have greater significance than a crediting which brings about no change in legal relations. The giving of security does not of itself change the nature of the indebtedness, though it does bring about additional legal relations between the parties. A change in legal relations going to indebtedness itself may be the appropriate test of a constructive receipt that will be a derivation. It will follow that an agreement that an amount owing by a debtor should be treated as a loan made by the taxpayer to the debtor will be a derivation, more especially if it is agreed that the loan will bear interest. Such a “capitalising” is effected by the crediting by a banker of interest to a savings account, and may be another reason why such a crediting should be treated as a derivation. There is an observation by Mason J. in Brookton Co-operative Soc. Ltd (1981) 147 C.L.R. 441 at 455-6:

[11.134] The case involved a notion of payment for purposes of a power under Articles of Association of a company to “pay” an interim dividend, and has no direct bearing on what is a derivation of income. The observations of Mason J. may none the less suggest a conclusion that a capitalising by an agreement that a receivable shall be treated as moneys lent by the taxpayer to a debtor is a derivation of the amount receivable by the taxpayer. It may be noted that Mason J. did not regard a crediting, even with the assent of the taxpayer, as a payment save where it had the effect of bringing about a loan of money by the taxpayer.

[11.135] The reference to payment by the making of a loan arrangement, in the passage quoted from the judgment of Mason J., concerned an arrangement made in relation to a debt that had already arisen. There is a question whether a loan arrangement operating on a debt will bring about a derivation where the arrangement was made before the debt arose. An agreement may be made that interest to become receivable in the future will be treated as capital and itself bear interest. It is arguable that there is no derivation in the circumstances, though a conclusion which adopts that argument may have unacceptable implications. The prior agreement will be operative to bring about a change in legal relations, such that interest receivable becomes loan money receivable. There is room then for an argument suggested by the conclusions in Constable (1952) 86 C.L.R. 402, that the ultimate handing over of cash to the taxpayer is not a derivation of income by him. What he receives is the repayment of a loan. Such an argument, it must be admitted, may equally be available on the ultimate receipt in the circumstances of Permanent Trustee and St Lucia, though a continued insistence on the need to look to “realities” may rebut the argument.

[11.136] A taxpayer may be entitled to receive payment from a debtor, and the debtor may have a claim against the taxpayer. If the effect of an appropriation by either party, or by the agreement of the parties, or by the operation of a rule of law applicable in the absence of appropriation, is that the taxpayer’s entitlement to receive payment ceases, there will be a derivation by the taxpayer of the amount he is entitled to receive. There are no words in s. 19 that would extend to such circumstances, at least where the appropriation is by the debtor, or by operation of law. But there must in such circumstances be an ordinary usage derivation. If interest becomes owing by a bank to its taxpayer customer on a fixed deposit, and that interest is credited to the taxpayer’s overdrawn current account there will be a derivation of interest by the taxpayer. And there may also be a payment of interest by the taxpayer on the overdrawn account if the crediting of interest to the overdrawn account, having regard to any agreement of the parties or the operation of a rule of law, brings about a discharge of the interest liability. If there is no ordinary usage derivation by a taxpayer where an entitlement to receive ceases because of some action in relation to an entitlement of the debtor to a payment by the taxpayer, the possibilities of what might be called income swallows by both parties will indicate an unacceptable failure of legal principle. There will be an unacceptable failure if a taxpayer entitled to a receipt of interest is held not to have derived that interest if he buys goods from his debtor, and it is agreed that the debts for interest and for the supply of goods shall be set-off against one another.

[11.137] These possible income swallows have affinity with those that are sometimes said to arise from barter transactions. A taxpayer who is a plumber carries out work on the house of an electrician under an agreement whereby the electrician will do electrical work on the house of the taxpayer. There are derivations of income by both parties. In the illustration given the amount of income will in each case be determined by the “value to the taxpayer” in accordance with s. 26(e). In other circumstances s. 26(e) may not be available to determine the amount of income. Owners exchange houses so that each lives in the other’s house. The fact that the principle in Tennant v. Smith [1892] A.C. 150 may require a conclusion that there is no amount of income derived by either owner is an indication only of the inadequacies of the law in regard to the valuation of items of income. It does not bear on the conclusion that there are derivations of income by both parties.

[11.138] The practice of “handing over of cash”—bank notes and coin— which has been taken to be an undoubted derivation by a taxpayer on a cash basis in relation to an item, has been to a substantial extent displaced by the handing over of a cheque, or a direct credit to the taxpayer’s account with a bank or some other financial institution. A cash cheque that has been in fact cashed by the taxpayer will involve a derivation. There may be a derivation before that time if the taxpayer has chosen to delay cashing the cheque. In these circumstances, the choice to delay might be thought to justify the same treatment as the refusal of a tender. Where the cheque requires collection by a bank, derivation should wait on actual collection by the taxpayer’s bank, unless the taxpayer has chosen to delay submitting the cheque for collection.

[11.139] Where a debtor directs a transfer of credit from his own acount with a bank to an account of the taxpayer with the same or another bank, there will be a derivation by the taxpayer immediately the transfer is irrevocable. Such a rule is directed by the rules in regard to a payment by way of a cheque.

[11.140] Questions of derivation of an item of income by a taxpayer on a cash basis arise where a receivable is assigned by the taxpayer to another. The questions are the subject of more general treatment in Chapter 13 below. The rules that apply follow the rules underlying the answers to questions examined in relation to circumstances where the events concern only the taxpayer and the person from whom the receipt proceeds. A disposition by the taxpayer of a right to receive which is involved in an effective assignment, brings about a change in legal relations between debtor and the creditor taxpayer, such that no debt is thereafter owed to the taxpayer. Section 19 does not include words that are obviously appropriate to describe an assignment, but this, it has been argued, does not justify a conclusion that the assignment cannot be a derivation by ordinary usage. There is no reason to treat s. 19 as a code. Indeed observations by Rich J. in Permanent Trustee (1940) 6 A.T.D. 5 quoted in [11.127] above might be interpreted so that the section has no operation at all. If emphasis is placed on the word “income” in the opening phrase of s. 19—“income shall be deemed to be derived”—there might be room to suggest that the section has no operation unless an item is already derived, since derivation is an essential quality of an item being income of a taxpayer. The suggestion would leave s. 19 with no operation. It would read, in effect: “Income that is derived shall be deemed to be derived”. The suggestion must obviously be rejected, but the fact that it can be made justifies an assertion that the section should not be treated as a code governing derivation in circumstances other than the actual handing over of money.

[11.141] Action by a taxpayer that brings an end to his right to receive is a constructive receipt that is a derivation. There may be room for debate concerning the amount of the receipt. Where a taxpayer who is on an accruals basis has already derived an item that is a receivable, he may suffer a loss by the failure of the receivable to realise the amount of the receivable when it is assigned to another. An objective to equate the consequences of assignment for accruals and cash basis taxpayers, would direct that an assignment by a cash basis taxpayer should be treated as a derivation, not of the amount of the receivable, but of the amount of its value at the time of the assignment. Treating it in this way would be consistent with the principle established in Permanent Trustee that an event should be judged in terms of realities. It would not accord with realities to treat the taxpayer as having derived the amount of a receivable when the financial responsibility of the debtor leaves a doubt that he will ever be able to pay that amount.

[11.142] It is of vital importance to a fair and coherent operation of tax law that the assignment of a receivable should be treated as a derivation by a cash basis taxpayer. The decision in Federal Coke Co. Pty Ltd (1977) 77 A.T.C. 4255 confirms a basic principle of income tax law that the character of an item as income must be judged as it comes to the taxpayer. A receivable that has been assigned will not generally be capable of being an income item in the hands of the assignee. A receivable that would have been interest income if it had been derived by the assignor, may not be interest income of the assignee. The assignee may not have taken an assignment of the debt to which the interest relates, so that the item cannot be income in his hands as a gain derived from property. Even if he has taken an assignment of the principal debt as well as of the debt for interest, the receipt of the interest by him as assignee will not be income derived from property. The interest has not arisen from property held by him at the time to which the interest relates. What he receives is simply the payment of a debt that he has acquired. The law ought not to contemplate the possibility that an item is not income of the assignor because the receivable has been assigned, and is not income of the assignee because in the circumstances of receipt by him the item does not have an income character. The possibility is an unacceptable income swallow.

[11.143] An assignment needs to be seen differently from an instruction—a mandate—by a person entitled to a receivable, requiring the debtor to pay to another. The mandate remains revocable unless the taxpayer who gave the mandate is bound not to revoke. Even if he is so bound, the mandate does not terminate the obligation of the debtor to pay the taxpayer, in the way that is characteristic of an effective assignment. Action taken by the debtor in pursuance of the mandate, so that payment is made to another, will bring about a derivation by the taxpayer who gave the mandate. The amount of the derivation will be the amount of the receipt by the person to whom payment is made.

Derivation on a cash basis where a right to receive cash is applied so that the taxpayer becomes entitled to a benefit other than money, or where the item of income is something other than money

[11.144] Three situations may be distinguished:

1. A taxpayer agrees, in advance of a right to receive money arising, that his right to receive will be applied in a specified way by the person otherwise obliged to make the payment and the agreement is not revocable by the taxpayer. Thus it may be agreed that, on the right to receive arising, it will be applied as a subscription to a debenture to be issued by the person otherwise obliged to make payment.
2. A taxpayer who has a right to receive money agrees, after the right to receive arises, that his right will be applied in a certain way; or fails to revoke a revocable agreement that his right will be applied in this way. A taxpayer may have given a revocable instruction that his right to a distribution of income by a unit trust will be applied in a subscription for new units in that trust.
3. A taxpayer has at all times a right, not to money, but to some other form of property.

[11.145] In situation (2) there will, generally, be a derivation by a cash basis taxpayer when the agreement is acted on. He will derive the amount of money he was entitled to receive, not the value of any benefit or property he received as a result of the application of the money. There is a constructive receipt of the money that is a derivation by the ordinary usage meaning of derivation and by s. 19. The time of derivation will be the time when his agreement is acted on so that any property that is to be vested in him is so vested to the full extent that vesting is possible. The general rule would, presumably, not apply if a handing over of money was not a real commercial prospect and the taxpayer has been offered some other property in substitution for his entitlement to receive money. In these circumstances it is arguable that he has derived so much of the amount receivable as is reflected in the value of the benefit or the property he has received. And an approach in terms of realities might require a conclusion that there is a derivation to the extent of the value of any benefit or property he receives as a result of the application of the money receivable, when that value exceeds the amount of the money receivable.

[11.146] In situation (1)—where there is an irrevocable consent by the taxpayer to the debtor applying the receivable in a specified way, the consent being given before the receivable arises—the most likely conclusion is that there is a derivation of the value of any benefit or property received as a result of the application of the money. Permanent Trustee Co. (1940) 6 A.T.D. 5 may be thought to stand in the way of such a conclusion, at least when the property that results is a new debt arising from a loan by the taxpayer to the debtor. But Permanent Trustee did not consider the question of a derivation of the value of the debt owed to the taxpayer which arose from the capitalising of the interest. And, in any event, the case can have no application where the property that results from the application of the receivable involves rights against persons other than the debtor. The case would have no application, for example, where the arrangement is that money due by a debtor to the taxpayer shall be applied in subscription for debentures in a company in which the debtor is interested.

[11.147] The decisions in W. E. Fuller Pty Ltd (1959) 101 C.L.R. 403, and in I.R.C. v. Fisher’s Executors [1926] A.C. 395 in regard to shares and debentures issued as a result of the application of dividends are not inconsistent with the conclusion in the last paragraph. Any principle that those cases establish is concerned with the income character of “bonus” issues and they have no wider application.

[11.148] In situation (3)—where the taxpayer cannot be said to have had at any time even a notional right to money—there will be a derivation of the value of any benefit or property received by the taxpayer. The derivation will arise, generally, where the debtor has done all that can be done to vest the benefit or the property in the taxpayer. Where the item of income is options to be issued by a company to its employee to acquire shares in the company, there will be a derivation when an offer of options is made by the company and the employee accepts the offer by paying the amount specified in the offer as the amount payable to secure the issue. Neither Abbott v. Philbin [1961] A.C. 352 nor Donaldson (1974) 74 A.T.C. 4192 resolves expressly the question whether derivation occurs at this time or at the time of the offer, but derivation at the time of acceptance is the more appropriate. A taxpayer should not be taken to have derived a benefit or property when it remains open to him to reject it.

[11.149] Where the item of income derived will be a benefit given or the vesting of property—situation (3), or situation (1) on the view taken in [11.146] above—there is a possibility that the taxpayer may assign the right to the benefit or property to another or direct the debtor to provide the benefit or property to another. In the latter case there will be a derivation by the taxpayer when action is taken on his direction. In the former case there will be a derivation at the time of the assignment. There must be a principle by which a constructive receipt of a benefit or property is a derivation, parallel with a principle by which a constructive receipt of money is a derivation. There will, of course, be problems of valuation of the benefit or the property in determining the amount of the derivation. Proposition 2 ([2.30]ff. above) and s. 26(e) will be operative, with some special nuances when the benefit or property will be or has been conferred on or vested in another.

The operation of section 101A

[11.150] Where an item is income of a person in all respects save derivation, and he is on a cash basis in relation to the item, his death before a receipt that would have been a derivation will preclude the item ever being derived by that person. And a receipt of the item by his personal representative could not on general principles be income derived by his estate. In the hands of the personal representative the item does not have an income character. So much was decided in Lawford (1937) 56 C.L.R. 774, and confirmed in Carden’s case (1938) 63 C.L.R. 108. Section 101A was added to the Assessment Act in 1941. It makes a receipt by the personal representative a derivation of an item of income by the estate of the deceased, if the item “would have been assessable income in the hands of the deceased person if it had been received by him during his lifetime”.

[11.151] The operation of s. 101A where the deceased would have accounted for the item on an accruals basis, was the subject of some comment in [11.66]-[11.72] above. A deceased partner would have accounted during his lifetime on a basis of receivability under s. 92, a basis akin to accruals. Single (1964) 110 C.L.R. 177 may be taken to be authority that s. 101A operates if it can be said of an item that it would have been income derived by the partnership—the hypothetical taxpayer under s. 90—and would have given rise to an individual interest in a deceased partner, even though the partnership was on an accruals basis in relation to the item so that an actual or constructive receipt would have been of no consequence. And it may be taken to be authority that the section will operate notwithstanding that the deceased would have derived income under s. 92 on the arising of his individual interest, an actual or constructive receipt by him being of no consequence. The word “received” in the phrase “if it had been received by [the deceased] in his lifetime” must be given a wide meaning, so that it covers an event that would have been a derivation, having regard to the basis of accounting appropriate to the item.

[11.152] This interpretation of s. 101A may be thought to have implications in the circumstances of Carden’s case where there has been a change in basis of accounting from cash to accruals prior to the death of the deceased. It will be seen that an item which became receivable during a year of cash tax accounting will escape inclusion in assessable income of the deceased if it is the subject of an actual or constructive receipt during a subsequent year of accruals tax accounting. It cannot be included in the assessable income of the deceased estate, since it will not be received by the deceased estate. Where the item remains receivable until death and is received by the deceased estate, s. 101A will not operate. It will not operate because a receipt for purposes of a cash basis accounting—the basis appropriate to the item—would not have been a derivation during the lifetime of the deceased, unless it had occurred in the year in which the receivable arose. The interpretation of s. 101A in Single will not, therefore, enable the Commissioner to overcome the “fall-out” that results from the change from cash to accruals.

[11.153] Single is consistent with a conclusion that s. 101A will operate only where the income character of the item in the hands of the deceased, save for the element of derivation, was completely established prior to the death. Menzies J. observed (at 190):

The word “received” in the words quoted, on its face, suggests a misunderstanding of tax accounting applicable to derivation of income through a partnership intermediary. If the word is read as “derived” the difficulty disappears. And the significance of the statement then rests with the reference to “work done by the firm while he was a member of it”. Income character will not presumably be established prior to death where derivation has been deferred by the operation of the principle in Arthur Murray (1965) 114 C.L.R. 314.

[11.154] Where the income character of an item reflects action taken after death, for example the realisation of an asset, whether it is taken by the former partners of the deceased or by the deceased’s personal representative, s. 101A will not operate (Spence (1969) 121 C.L.R. 273). There may be need to draw a distinction between work done by or on behalf of the deceased before his death under an entire contract—so that there is no item of income until the work is completed—and work done under a contract for which there would be at least a right to a quantum meruit. It is arguable that s. 101A can have no operation in the former situation, though this might be thought to give undue significance to the technicalities of the general law in the interpretation of the Assessment Act.

[11.155] Where s. 101A operates in other respects, there will be a derivation by the estate of the deceased for purposes of s. 95. At least that is the inference to be drawn from the deeming of the amount to be income to which no beneficiary is presently entitled, which has significance only in relation to net income as determined by s. 95. The reference to “receipt” by the trustee in this instance may be taken to require a receipt that would be a derivation by a taxpayer on a cash basis in relation to the item.

Other specific provisions

[11.156] The Assessment Act contains a number of provisions in regard to the derivation of items which have, or are given, an income character. Some of these provisions give an income character to items that are specific profits, and the words used in relation to derivation are apt to refer to the ordinary usage meaning of derivation in relation to such profit. Thus s. 25A(1) and s. 26AAA refer to “profit arising”.

[11.157] In some instances the provision deals only with income character in respects other than derivation. The intention is clearly that derivation is left to be determined by the ordinary usage notions of derivation. Section 27H is an example. It provides that the “assessable income of a taxpayer shall include the amount of any annuity derived by the taxpayer”.

[11.158] In other instances words are used in relation to derivation that may adopt a meaning that is in some respect different from ordinary usage derivation. The word “received” is very generally used. Thus it appears in s. 26(f)—“any amount received as or by way of royalty”; in s. 26(g)—“any bounty or subsidy received”; in s. 26(h)—“any fee or commission received”; in s. 26(j)—“any amount received by way of insurance or indemnity”; in s. 26AB(2)—“receives a premium”; in s. 26AF—“receives or obtains a benefit”; and in s. 26B—“receives”. The word “received” in all the illustrations listed should be taken to refer to ordinary usage derivation. Generally the appropriate basis of tax accounting will be cash, and it is derivation on this basis that will be required. There will, however, be occasions when the basis of accounting otherwise appropriate to the item is accruals, and the word “received” should be taken to require accruals accounting.

[11.159] Where more specific words are used, the inference may be that some notion of derivation other than derivation by ordinary usage was intended, and it becomes necessary to identify that notion. The word “obtains” in the phrase “receives or obtains” in s. 26AF(1), used in relation to a “benefit of any kind” may have been intended to extend the ordinary usage notion of derivation in relation to a benefit other than money. It is not however easy to imagine circumstances which are described by the word “obtains” which would not be within the ordinary usage notion of a vesting in the taxpayer to the full extent that vesting of the benefit is possible. Some argument might be made that the use of the phrase “receives or obtains” indicates a more limited meaning of the word “receives” than the meaning suggested in the last paragraph. The argument would be both forced and unfortunate.

[11.160] Subsections (5) and (15) of s. 26AAC impose in a number of respects special tests of derivation where the item in question is a share in a company acquired under a scheme for the acquisition of shares by employees. These have been the subject of some comment in [2.25]ff., [2.35], [4.20], [4.82], [4.85] and [4.134] above. There is, however, a question of the significance to be given to the word “acquired” or “acquires” which describes a pre-condition of the application of these special tests.

[11.161] The word “acquired” is also used in s. 26AAC in the context of an option acquired and disposed of so that the amount received, less certain costs, is income derived (subss (7) and (8)). It was suggested in [11.57]–[11.61] and [11.148] above that an option is derived when a person accepts the offer of options, not when a right to options arises. Only then is there a vesting of the benefit to the full extent that the nature of the benefit admits. A like meaning should be given to the word “acquired” in its use in relation to options in s. 26AAC. The word “acquired” as an aspect of derivation in relation to shares under subss (5) and (15), may require a similar interpretation, so that at least an actual allotment of shares by the company is necessary. It may be argued that in addition there must have been a registration of the taxpayer, or of a trustee for him, as shareholder. The principle suggested above governing ordinary usage derivation—all must be done to vest the item in the taxpayer that the character of the item admits—might be thought to require registration. However, this may be to press the suggested ordinary usage notion of derivation too far. Unacceptable opportunities to defer the derivation of income would become open.

[11.162] Section 27 is concerned with interest on loans raised in Australia by the government of a country outside Australia. It provides that such interest “received directly or indirectly by a resident of Australia, shall be deemed to be derived by him from a source in Australia, and shall be included in his assessable income”. The intention is clearly that an item “received directly or indirectly” by a resident shall be deemed to be derived, and to be derived from a source in Australia. The word “received” has been assumed in previous paragraphs, when used alone, to be equivalent to derivation by ordinary usage. The reference to “directly or indirectly” might base an argument that the word received standing alone is not sufficient to describe ordinary usage derivation. Such an argument should be rejected. It is however possible that an “indirect” receipt will describe situations that are not within derivation by ordinary usage. It is not easy to imagine what they might be, if, as it has been asserted in [11.144]–[11.149] above, derivation by ordinary usage will embrace payment on the instruction of the taxpayer, and assignment by the taxpayer of a right to receive. One possibility is that an indirect receipt will include a receipt that has moved through the hands of a third party in the manner of the receipt in Constable (1952) 86 C.L.R. 402, considered in [11.171]–[11.172] below.

[11.163] A number of provisions adopt the word “paid” in expressing the test of derivation. These include s. 26(eb) (“paid to the taxpayer”), s. 26AC(1) and s. 26AD(1) (“paid … to a taxpayer in a lump sum”) and s. 44(1) (“paid to [a shareholder]”). Presumably the context of s. 44 requires that the reference to shareholder is a reference to a shareholder who is the taxpayer. These provisions and s. 26(e) yet to be considered, are unique in framing the test of derivation in terms which look to action by a person other than the taxpayer. At least this is so if we read the words “the assessable income shall include” as providing that there shall be a derivation of assessable income. There is a remotely possible construction of the provisions that they are directed to the income quality of an item in respects other than derivation, leaving the question of derivation to be resolved by ordinary usage principles.

[11.164] While it might be accepted that a payment to a person will always involve an ordinary usage derivation by that person, it is unlikely that a payment to a person is a wide enough notion to embrace all circumstances that would be derivations by ordinary usage. Which raises the question whether these provisions exclude ordinary usage derivation, so that, for example, a dividend may be derived so as to be income of a person only if it is paid to him, or, treating the exclusive operation of s. 44 more narrowly, a dividend may be derived so as to be income of a shareholder only if it is paid to him. The implications of the words added to s. 25(1) in 1984 are again raised.

[11.165] The respects in which “paid” to a person may have a more limited meaning than ordinary usage derivation concern:

1. the possible limitation of “paid” to items which are money sums;
2. the possible limitation of “paid” so that it does not include any occasions of constructive receipt; and
3. the possible limitation of “paid” so that it does not include constructive receipts that arise from the assignment by a taxpayer of a right to receive, or an instruction given by a taxpayer that payment be made to another.

[11.166] The possible limitations may be considered in reverse order. The words “paid to” a taxpayer do not easily describe the assignment by the taxpayer of a right to receive. Nor do they easily describe payments made to a person other than the taxpayer on the instruction of the taxpayer. Perhaps the latter situation is covered: an implication of “by the direction of” after the word “to” is necessary. If that situation is covered, an assignment situation will involve a payment to a taxpayer if the assignment is regarded as an instruction to the debtor to pay to the assignee, and the moment of derivation will be delayed till the instruction is acted on. It would be surprising if derivation under s. 26(eb) of a payment in respect of resumption of work could be avoided by arranging for payment to be made to another.

[11.167] The possibility that “paid to” a taxpayer does not cover any occasion of constructive receipt cannot be excluded. It would follow that a taxpayer could avoid tax or defer tax under s. 26(eb) by agreeing that the amount he is entitled to receive should be treated as having been lent to the party from whom he is entitled to receive. He will avoid tax if the subsequent payment of the debt on the loan is regarded as having lost its character of a payment for resuming work. He will at least have deferred tax if it is regarded as having retained that character. Other illustrations of constructive receipts that are derivations by ordinary usage but would not be within the notion of paid to a taxpayer will be suggested by the treatment of constructive receipts in [11.126]–[11.143] above.

[11.168] It is arguable that “paid” is a word that cannot embrace the transfer of property other than money. The argument is stronger where the word is used, as it was used, in s. 26(d), in conjunction with the phrase “in a lump sum”. It is used with the phrase “in a lump sum” in s. 26AC and s. 26AD. Where the word “paid” is used without reference to a “lump sum”, s. 21 may be thought to deem a transfer in kind to be a payment. Subdivision AA of Div. 2 of Pt III has replaced s. 26(d), but it does not use the language “paid in a lump sum” and it has express provisions both to require that “payment” (the word used in the definition of eligible termination payment in s. 27A(1)) be treated as extending to a transfer in kind (s. 27A(8)) and to provide for what may be its own code as to what is a derivation. The matter is discussed in [4.23] above.

[11.169] In the instance of s. 44(1), however, the argument that paid cannot embrace a transfer of property other than money is at its weakest. A distribution of property other than money is expressly within the definition of a dividend, and the reference to dividends paid in s. 44(1) should be construed in that context.

[11.170] “Paid” as used in s. 44 is used in the meaning defined in s. 6, which provides that “ ‘paid’ in relation to dividends includes credited or distributed”. There is a question of what may be meant by credited in this context, a question which Mason J. declined to answer in Brookton Co-operative Soc. Ltd (1981) 147 C.L.R. 441. A similar question arises in regard to the phrase “paid or credited” in s. 109. The view was suggested in [11.131] above that a simple crediting in the debtor’s books of account is not an ordinary usage derivation, even if it is done with the assent of the taxpayer, though it may be different if the crediting brings about a change in the legal relations of the parties. Where s. 44(1) or s. 109 otherwise applies, a simple crediting, at least if it is with the assent express or implied of the taxpayer, may be a derivation.

[11.171] Section 26(e) uses specific words to identify the circumstances that will amount to derivation for purposes of that provision. The words are “allowed, given or granted [to the taxpayer]”. Like those provisions which make derivation depend on a payment to the taxpayer, s. 26(e) frames the test of derivation in terms which look primarily to action by a person other than the taxpayer. The interpretation of the words “allowed, given or granted” in Constable (1952) 86 C.L.R. 402 limits their meaning, and raises a question as to the scope of the ordinary usage notion of derivation. Constable did not consider whether the receipt by the taxpayer of cash might involve an ordinary usage derivation of what was otherwise an item of income as a reward for services performed by the taxpayer. One explanation would be that the High Court considered s. 26(e) was a code displacing ordinary usage notions of income derived. There is however no express holding that s. 26(e) is a code, and holding s. 26(e) to be a code has become near impossible having regard to the inference to be drawn from the words added to s. 25(1) in 1984. The other explanation is that the High Court considered that the words “allowed given or granted” expressed a wider notion of derivation than the ordinary usage notion, so that it was unnecessary to consider ordinary usage. This second explanation has important implications for the ordinary usage notion. There may be an occasion which would otherwise be an ordinary usage derivation but the occasion is not a derivation of income because it is too remote from the circumstances which could give the item an income character. The matter was the subject of some consideration in [2.17] and [2.22] above. On one reading of the majority judgment in Constable, the occasion is too remote if it was preceded by a “future and contingent or conditional right” which became “a right to present payment” and which in turn gave rise to the occasion of a present payment. Another reading would direct attention to the majority view on the question of a derivation of income on the making of a contribution by the employer to the superannuation fund:

The precise significance of Constable on the question of remoteness must remain a matter of debate. The case does however support a principle that the course of events between point of origin of an item of an income character and the point that would otherwise be a derivation of that item, may disassociate the item and its derivation in a way that precludes a conclusion that there is income derived. The item is swallowed in transit.

[11.172] One observation in relation to the passage quoted might be made. Were it not for the factor of discretion in the administrators, a conclusion that the taxpayer had derived as income a chose in action—an accretion to his interest in the superannuation fund—on the payment by the employer to the fund would have been appropriate. Abbott v. Philbin [1961] A.C. 352 and Donaldson (1974) 74 A.T.C. 4192 would support such a conclusion. In fact Constable has been taken to support a general denial that there is a derivation of income by an employee on payment by an employer to a superannuation fund, even though there is no discretion vested in the administrators.

[11.173] Immediately following the passage quoted, there is a statement in the majority opinion: “We do not think that s. 19 can be used to eke out s. 26(e) and extend its operation or application.” The significance of that statement can only be a matter of speculation. On one reading it implies that s. 26(e) is a code as to the income character of rewards for services and as to derivation of those rewards, so that s. 19—concerned with ordinary usage derivation—has no room for application. On another reading it asserts a view that ordinary usage derivation and s. 19 would not hold there to be a derivation on the facts before the Court. It is this reading that has been assumed in this discussion.

Accounting for Outgoings on a Cash Basis

[11.174] Some argument might be made that no distinction is drawn by the law between accruals basis and cash basis in regard to the deductibility of an outgoing. Reference was made in [11.54] above to the tax accounting adopted by Dixon J. in New Zealand Flax Investments Ltd (1938) 61 C.L.R. 179, which might suggest that a taxpayer on a cash basis in regard to derivation of receipts might be on an accruals basis in regard to the incurring of related outgoings. The case does not however justify any such conclusion. The assumption now made is that there are distinct principles determining when an outgoing is incurred by a taxpayer who, in relation to the item, is on a cash basis.

[11.175] Where the outgoing is a money amount, the word “payment” is an appropriate general description of the occasion that will be an outgoing incurred. It will be evident that payment by a taxpayer on a cash basis in relation to an item will generally be symmetrical with a receipt by a taxpayer on a cash basis in relation to the receipt of that item. Where there is a handing over of cash, there will be symmetry. And there is room for a principle which will in some instances recognise a constructive payment as the incurring of an outgoing. The handing over of a cash cheque will be payment when the receiver cashes the cheque. There should be a constructive payment that is an outgoing incurred if the receiver delays cashing of the cheque. The handing over of a crossed cheque will be an outgoing incurred on the collection of the amount of the cheque. There will be a constructive payment that is an outgoing if the person receiving delays in presenting the cheque for collection.

[11.176] A tender of cash should be seen as the incurring of an outgoing even if the tender is refused. A transfer of credit is the incurring of an outgoing immediately the transfer is complete. Symmetry with the principles in regard to derivation by a cash basis taxpayer would suggest that there is not an outgoing incurred if a debtor delays making a tender of payment at the request of the creditor. In the view of Gibbs J. in Brent (1971) 125 C.L.R. 418 the request of the creditor acted on by the debtor is not a constructive receipt that is a derivation by the creditor.

[11.177] An appropriation by debtor or creditor, or the operation of a rule of law, that brings about an offsetting of claims will give rise to outgoings on a cash basis symmetrical with derivations on a cash basis. There is some discussion of the offsetting of claims in [11.136] above.

[11.178] A crediting by a debtor in his books of account which by express or implied agreement with the creditor brings about a change in legal relations between debtor and creditor will be an incurring of an outgoing by the debtor. The characterisation by Mason J. in Brookton Co-operative Soc. Ltd, quoted in [11.133] above, suggests that the arising of a consequence that an amount otherwise owing by a debtor becomes an amount owing by the debtor under a loan to the debtor is generally an outgoing incurred by the debtor. There would need however to be a qualification to accommodate Permanent Trustee (1940) 6 A.T.D. 5 where, in the “realities” of the matter, there has not been any payment.

[11.179] The notion of a constructive payment that is an outgoing is a matter of the interpretation of the word “incurred” in s. 51(1), just as the notion of a constructive receipt that is a derivation is a matter of the interpretation of the word “derived” in s. 25(1). There is no provision equivalent to s. 19 which may extend the meaning of incurred in the way s. 19 may extend the meaning of derived.

[11.180] In one area there will not be symmetry of incurring of outgoing and derivation of receipt. The assignment of a receivable by a creditor will generally involve a derivation by the creditor. But it will not involve an outgoing by a debtor on a cash basis in relation to the item. An outgoing incurred must await action by the debtor of a kind that amounts to an incurring under principles just considered. In the result, there may be a derivation by a creditor on a cash basis in relation to the item, in advance of the incurring of an outgoing by the debtor. Where the creditor does not assign, but gives a mandate to the debtor to pay to another there will be a derivation by the creditor only when the mandate is acted on, and in this instance symmetry will be achieved.

The incurring of an outgoing where the item is something other than money

[11.181] In [11.144]–[11.149] above, three situations were considered in relation to derivation by a taxpayer on a cash basis where the item is something other than money. Where there is an agreement between debtor and creditor, entered into before any debt arises, that the amount payable will be applied in a specified way by the debtor, there is room to suggest that the creditor derives the value of any benefit or property be receives as a result of the application by the debtor of the amount payable. This approach treats the events as involving only one transaction—the conferring of a benefit or the vesting of property—and the consequences so far as the creditor is concerned are the same as when he has at all times a right, not to money, but to a benefit or to the vesting of property. Symmetry with this analysis would require that the consequences in regard to deductibility by the debtor should be the same as they are when his obligation has always been to provide a benefit or property.

[11.182] Where the creditor, having a right to receive money, agrees that his right will be applied in a certain way, so that he receives a benefit or property is vested in him, there is room for a different analysis. The events may be seen as two transactions: the receipt by the creditor of the money and the application of that money to secure the benefit or property. The debtor will be treated as having made a payment of money which may be the incurring of an outgoing. And he will then be taken to have received an amount equivalent to the amount so paid, in a transaction which may have its own pattern of consequences. The two transactions approach would presumably not be applicable if the creditor has been forced to accept the benefit or property because cash is simply not available to him. In such circumstances there is room to argue, in terms of the “realities” of the matter, as Permanent Trustee (1940) 6 A.T.D. 5 would require, that there is only one transaction being that under which the liability to pay arose, and the conferring of the benefit or vesting of property are actions taken to discharge that liability. In this event the consequence will be the same as when the creditor has at all times a right not to money but to a benefit or to the vesting of property, the situation next considered.

[11.183] The debtor’s liability may at all times be a liability to confer a benefit or to vest property. There will of course be an initial question whether the conferring of the benefit or the vesting of the property is an item that may be an outgoing incurred. If it is, the moment of incurring of the outgoing will be the moment when all steps have been taken to confer the benefit or to vest the property as the benefit or property may allow. There may be problems about the amount of the outgoing. Where the debtor has incurred expenses specifically in providing the benefit—where an employer hires a car specifically for his employee’s private use—or in obtaining the property to vest in another—an employer buys a car specifically for his employee and transfers it to his employee—the amount of the outgoing may be assumed to be the amount of these expenses. Strictly the amount of the outgoing is the value of the benefit or the property. Section 21 would be applicable. Value, presumably, in this context refers to market value.

[11.184] There will not be an outgoing where the debtor provides a benefit or property which it is an aspect of his business to provide and he provides it in the course of his business, or where he provides a benefit or property in the course of an isolated business venture or a transaction within s. 25A(1) or s. 26AAA. A taxpayer who provides a service or supplies goods in these circumstances does not incur an outgoing in the act of providing or supplying. The event will be a realisation of the service or of the goods supplied which may attract other tax consequences. The proceeds of realisation will be income, or will enter the calculation of any specific profit or loss on realisation that is income or deductible. Any deductions by the debtor will have been incurred as costs in providing the service, or in acquiring or manufacturing the goods supplied. There will be problems as to what are proceeds of realisation to be brought to account as income, or to be brought to account in calculating a specific profit that is income. Where the benefit or property is conferred or supplied in return for cash, the cash is clearly proceeds. Where the conferring or supplying is in return for services, the services should not be seen as proceeds in the amounts of their value, unless an offsetting deduction is allowed of that value. Section 21 will have a theoretical but no practical application. Where the conferring or supplying is in return for goods supplied by the creditor, the proceeds will be the value of those goods and the goods acquired will have a cost equivalent to that value. The occasion is not one for the operation of s. 36. The realisation of trading stock in the circumstances envisaged is a realisation in the ordinary course of carrying on the taxpayer’s business.

[11.185] If the item of property is a structural asset of the debtor’s business, there may be an outgoing incurred and the amount of the outgoing will be the value of the item at the time it is vested in the creditor. In this instance s. 21 has both a theoretical and a practical operation. If the item is depreciable, s. 59 may have an operation, in which event the vesting in the creditor may give rise to a balancing charge or allowable deduction. But this will not affect the deductibility of the value of the item as an outgoing incurred.

[11.186] The property to be vested in the creditor may be shares or debentures. Where they are shares or debentures of an entity other than the debtor, the analysis already explained in [11.183]–[11.185] above will be applicable. Where, however, the shares or debentures are shares or debentures of the debtor company, a different analysis is called for. In the case of shares, there cannot be an outgoing incurred in gaining income. The shares may be an income item of the creditor, but they are issued by the debtor in acknowledgment of a subscription of capital. Section 21 has no theoretical or practical application. In this context the distinction between events which may be seen as two transactions—a payment by the debtor and a receipt for property then vested in the creditor—and events which may be seen as only one transaction—the vesting of property in the creditor—is critical. If there are two transactions, the creditor may have a deduction for the amount of the payment in the first transaction. When a company rewards its employees by the issue of its shares or options over its shares, the company is denied any deduction. It is of course true to say that the company has not incurred any expense, though there may be a cost to the shareholders in the decline in the value of their shares resulting from the issue of shares to the employees.

[11.187] What is true in relation to its own shares issued by a company, may be thought equally true in relation to its own debentures issued by a company. The debentures are an acknowledgment of an investment in the company. If the issue of the debentures is seen as the only transaction, the company will be denied any deduction. And there may be no deduction on the redemption of the debentures, though at this point there may be room to say that the reality of the matter is an outgoing now incurred in the transaction out of which the creditor’s right to the debenture issue arose.

The operation of section 101A

[11.188] Section 101A is confined to receipts, and makes no provision for the allowing of deductions of outgoings in determining the income of the trust estate subject to tax by virtue of the section. A payment by the trustee that would have been an outgoing deductible by the deceased had he paid the amount in his lifetime does not, it seems, generate any tax consequences.

Specific provisions allowing the deduction of outgoings

[11.189] The Assessment Act contains a number of provisions, in addition to the general provision in s. 51(1) which allow the deduction of outgoings. The basis of accounting appropriate in the application of these specific provisions is not always clearly specified.

[11.190] Some phrases can be construed as leaving the question to be determined by general principles of tax accounting. Thus s. 53 in allowing a deduction for “expenditure incurred” for repairs will presumably allow a deduction of a liability incurred for repairs if the taxpayer is otherwise on an accruals basis. The same observation may be made in relation to s. 64 (expenditure incurred by way of commission for collecting income); s. 67 (expenditure in borrowing); s. 67A (expenditure in discharging a mortgage); s. 68 (expenditure in connection with lease documents); s. 68A (expenditure related to grant of patents); s. 69(1) (expenses of preparing an income tax return); s. 70(2) (expenditure on telephone line); s. 70A(3) (expenditure on mains electricity connection); s. 74 (election expenses); s. 75(1), s. 75A, s. 75B, s. 75C, s. 75D (expenditure on land used in primary production). Section 76 allows the deduction of an “amount expended” by the taxpayer. It may be asked whether these words call for an interpretation differing from the interpretation of “expenditure incurred”.

[11.191] Section 53F(2), s. 53G and s. 53H adopt language more clearly directed to importing general principles of tax accounting. The phrase used is “costs incurred”.

[11.192] In some instances the language used calls on the word “paid”, and thus adopts cash as the basis of accounting. Those constructive payments that would amount to incurring under s. 51(1) are, presumably, covered. Thus s. 73(1) refers to subscriptions paid by the taxpayer; ss 77B, 77C, 77D, 78(1)(b) and 78(1)(c) refer to moneys, calls, and sums “paid” by the taxpayer.

[11.193] In a number of instances a special form of words has been adopted. Section 53AA refers to an amount “paid to the lessor by, or recovered by the lessor from, the lessee [taxpayer]”. Both phrases would seem to require accounting on a cash basis.

[11.194] Section 63 is unique in allowing a deduction where the occasion is one that is not an outgoing incurred on a cash or an accruals basis. The section relates to a bad debt and will allow a deduction on the occasion that a bad debt is “written off as such”. A deduction is thus allowable in advance of a deduction that might become allowable under s. 51(1) at some later time. The occasion is simply an accounting entry made in the taxpayer’s books of account.

[11.195] Section 65 seeks expressly to cover both the incurring of an outgoing on a cash basis and the incurring of an outgoing on an accruals basis. The language used is “payment made or liability incurred”. Section 73A may be intended to do the same, though the language is different: “payments made, and expenditure incurred”.

[11.196] Section 82AAC has a form of words specifying the manner of incurring of an outgoing which is an employer’s contribution to a superannuation fund. The words are “sets apart or pays … as or to a fund”. The words call for a special exercise in interpretation. Section 78(1)(a) allows a deduction of “gifts made” by the taxpayer. Those words, too, call for a special exercise in interpretation.

[11.197] Section 51(3) is exceptional in that it is framed so as to work a limitation on what would otherwise be the incurring of an outgoing under s. 51(1). It provides that a deduction is not allowable under subs. (1) in respect of long service leave, annual leave, sick leave or other leave “except in respect of an amount paid to the person to whom the leave relates”, or to his dependant or personal representative where that person is dead. The amount paid is “deemed to be a loss or outgoing incurred at the time when the payment is made”. The deeming ensures that a cash basis applies to the outgoing. The drafting in terms of a negation of s. 51(1) but subject to an exception expressly answers a question that is left open by other specific provisions. There is no concurrent application of s. 51(1). Section 51(3) is restrictive not only in requiring a cash basis but in requiring that the payment be made to the person to whom the leave relates or his dependant or personal representative. Thus s. 51(3) has added another reason why a payment of the kind for which a deduction was claimed in Foxwood (Tolga) Pty Ltd (1981) 147 C.L.R. 278 is not deductible.

[11.198] The assumption would be that, unless it is otherwise expressly provided, a specific provision provides for deductions in addition to any that may be available under s. 51(1). There is a specific provision in s. 82AAQ in relation to employer contributions to a superannuation fund that parallels the operation of s. 51(3) by denying deduction under s. 51(1). The assumption may be the subject of debate in some instances. Comment is made in Pt II in regard to some provisions, including s. 53 ([10.9] above) and s. 63 ([10.65]ff. above). Section 63 is the subject of further comment in [12.181]ff. below.

Accounting on a Cash Basis for Receipts and Outgoings “in Advance”

[11.199] Tax accounting on an accruals basis in relation to an item of receipt otherwise derived, where there is reason to defer recognition of the item as income derived, was examined in [11.89]ff. above. The question now raised is whether deferral allowed by the principle in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 is available where the item is to be accounted for on a cash basis.

[11.200] The taxpayer in Arthur Murray was on an accruals basis in relation to the items, though the items in question were the subject of actual receipts and, the deferral question aside, would have been held derived if a cash basis had been applicable. Indeed a good deal of the judgment of the High Court in the case is in language that would suggest that the question of deferral will arise only in relation to an item that has been actually received. To allow deferral where the item is the subject of an actual receipt, but deny it where the item is a receivable, would make no sense. The principle in Arthur Murray must be applicable to a receivable that would otherwise be held to be derived because it is to be accounted for on an accruals basis. A receivable that is not contingent and is for an ascertained amount may be unusual where the taxpayer has yet to take action that is part of the consideration for the receivable. Thus a receivable in respect of goods to be supplied will normally be contingent on the goods being supplied. But the contract may require payment of a sum certain irrespective of delivery. In which case, the deferral question aside, there will be an item of income derived on the making of the contract. The principle in Arthur Murray will be applicable to that item.

[11.201] The fact that the taxpayer in Arthur Murray was on an accruals basis in relation to the items does not, in itself require that the case be restricted to such a taxpayer. But some of the reasoning in the case may suggest that it is to be restricted in this way. Thus the judgment in Arthur Murray asserts (at 318) that “the ultimate inquiry … must be whether that which has taken place … is enough by itself to satisfy the general understanding among practical business people of what constitutes a derivation of income”. It might be said that the tax accounting applicable to practical business people is accruals and if the taxpayer is on cash there can be no relevant understanding. The judgment continues: “A conclusion as to what the understanding is may be assisted by considering standard accounting methods, for they have been evolved in the business community for the very purpose of reflecting received opinions as to the sound view to take of particular kinds of items.” It is accruals financial accounting that includes a principle requiring deferral in circumstances such as Arthur Murray.

[11.202] When, however, the judgment turns to a detailing of the circumstances that would make it business good sense to defer an income item, a conclusion that the principle is to be confined to a taxpayer on an accruals basis is much less compelling:

These circumstances would make it good sense to any taxpayer, including a taxpayer on a cash basis, to defer income recognition. A dentist on a cash basis of returns who insists on an advance payment from his patient for expensive dental work, a barrister on a cash basis who insists on advance payment before appearing for a client in a criminal trial and an employee who receives pay in advance of performing services would think it a matter of good sense, a quality not confined to business people, to treat the amount of fees or salary as subject to the contingency that the whole or some part of it may have in effect to be paid back, even if only as damages, should the agreed quid pro quo not be rendered in due course.

[11.203] The illustrations in the last paragraph of circumstances where the Arthur Murray principle should extend to a cash basis taxpayer are all concerned with what might be called active income. If the principle extends to such circumstances, there will be a further question whether it extends to what might be called passive income—income derived from property, in the form of interest, rent and royalties received in advance, or a premium received on the letting of property. It would not be easy to draw a conclusion from the judgment in Arthur Murray that the principle requiring deferral extends to such income. But it is fair to say that there is nothing in the judgment in Arthur Murray which would preclude the recognition of a wider principle that would embrace both active and passive income. It is good sense to treat the amount of rent, premium, interest or royalties that relates to the use of property by another in a subsequent year of income as income derived in that subsequent year, and not in the year in which a non-contingent right to receive arises or in which there is an actual receipt. It is good sense not only because the allowing of use by another in that subsequent year is a quid pro quo to be rendered by the taxpayer, but also because there may be expenses, for example for repairs, that may need to be incurred in that subsequent year which ought to be in a matching relationship with the item of income.

[11.204] The scope for operation of an Arthur Murray principle, whether narrow or wide, will be the less in regard to items to be accounted for on a cash basis simply because receipts that are derivations on a cash basis are the more likely to come after any action to which they relate. Receivability is the earlier event, though receipt on a cash basis may be brought closer to receivability if the receivable is assigned by the taxpayer.

[11.205] An Arthur Murray principle does not provide for advancing the derivation of an item. Until there is a derivation in respects other than an Arthur Murray principle, there can be no derivation under an Arthur Murray principle.

[11.206] In [11.156]–[11.173] above a number of specific provisions which deal with derivation in particular circumstances are considered. There is a question whether these specific provisions displace the Arthur Murray principle and any wider principle which would embrace the Arthur Murray principle.

[11.207] Two illustrations may be taken. Section 119 provides, so as to displace the operation of the mutuality principle, that “the assessable income of a co-operative company shall include all sums received by it …”. It is not difficult to preserve the Arthur Murray principle against such drafting. The words used do not require the inclusion of the items in income in the year of receipt. Section 26AB(2) is more awkward. It provides, so far as relevant:

The reference to “the year or income” may be thought to govern the time of inclusion of the premium in income. Such a conclusion is not a necessary one, and it ought not to be adopted to displace the wider Arthur Murray principle. The purpose of s. 26AB(2) is not related to that principle.

[11.208] In [11.116]ff. above the possibility is explored, in relation both to accruals and cash tax accounting, of a principle symmetrical with an Arthur Murray principle that will be applicable to outgoings. An argument may be made that deductibility of a premium paid for insurance cover extending into a later year of income should be deferred in part until that later year. A payment of interest in advance to be accounted for on a cash basis should be deferred and be deductible in the years in which the period of use of the money to which the payment relates occurs. At least that would be the prima facie basis of spreading the interest payment forward. An arrangement can be imagined under which it is provided that interest under a loan for a fixed period is to be at a high rate in early years of the loan, and at a low rate in later years. An advance payment of interest in these circumstances might be spread forward evenly in disregard of the uneven spread of interest under the arrangement. Indeed any principle should be flexible enough, where interest is not expressly paid in advance under such an arrangement, to treat the high interest in early years as paid in part in respect of the use of the money in later years.

[11.209] Where the items of outgoing are to be accounted for on a cash basis the scope for a principle symmetrical with an Arthur Murray principle will be less than will be the case where an accruals basis of accounting is appropriate. Interest payable at the end of a fixed period of borrowing may be prima facie incurred at the time of the borrowing, where the taxpayer is on an accruals basis in regard to the item. A principle that an outgoing is incurred only as any benefit arising from the outgoing is consumed will spread the deductibility of the interest over the period of the borrowing.

[11.210] A principle that will defer the deduction of a payment of a premium or of interest paid in advance will also apply to rent or management charges paid in advance. The principle has implications for the principle of contemporaneity in its application to payments in advance of the commencement of a process of income derivation. Those implications are examined in [11.118]–[11.119] above, and the view is expressed that want of contemporaneity is an unsound reason for denying deduction when a payment that is made before the commencement of a process of income derivation secures a benefit that is subsequently consumed in that process. It would also be asserted that want of contemporaneity is an unsound reason for denying a deduction when a payment is made after a process of income derivation has ceased, and the payment is in respect of a benefit that was consumed in that process.

[11.211] The contemporaneity principle defeats deductibility entirely. Ronpibon Tin N.L. & Tongkah Compound N.L. (1949) 78 C.L.R. 47 and Amalgamated Zinc (De Bavay’s) Ltd (1935) 54 C.L.R. 295 should be seen as treating a want of contemporaneity as only an indication that an outgoing is not relevant. The observations made by Barwick C.J. and Mason J. in A.G.C. (Advances) Ltd (1975) 132 C.L.R. 175 expressing doubts about the scope of the decision in Amalgamated Zinc (De Bavay’s) support the view that a want of contemporaneity is only an indication that an expense is not relevant. Barwick C.J. and Mason J. thought that a loss realised after the cessation of a business may yet be deductible if its relevance to the business operations is established by the fact that the debt arose in the conduct of the business operations.

[11.212] A principle in regard to outgoings that is symmetrical with an Arthur Murray principle in regard to receipts and a reframing of the contemporaneity principle are necessary to preserve the integrity of the income tax. Deductibility where payments precede the commencement of a process of income derivation, or follow its cessation, will not depend on the chance of precise moment of payment. The taxpayer may properly succeed in showing the relevance of an outgoing that is to be treated as incurred in a later year when the outgoing is consumed. He will fail to show relevance if the outgoing must be treated as incurred in the year in which the liability to pay arose or payment was made. A principle symmetrical with Arthur Murray will deny the scope for planning to defer tax by payments between associated entities that will be subject to Arthur Murray in the hands of the receiver, yet be claimed to be presently deductible by the payer. Such planning is now limited by s. 82KK, discussed in [11.289]–[11.292] below, but a symmetrical principle would in any case deny it any success.

The Consequences of a Change in the Basis of Accounting

[11.213] Attention was directed in [11.71] and [11.72] above to the “fall-out” consequences of a change from a cash basis of accounting to an accruals basis. The taxpayer’s business operations may have developed to a point where cash is no longer the appropriate basis and the law requires a change to accruals. There is a question whether that point may be reached at some time in the course of the running of a year of income. Perhaps the question is wrongly put in terms of a point of time. It is arguable that appropriateness must be judged by reference to the business activities of the year of income so that a change in basis may only occur as between one year of income and another. Whichever view is correct, the consequence of a change occurring will be that items of income and deduction which would have been derived or incurred at a time before the change if an accruals basis had been appropriate, but were not derived or incurred on a cash basis before the change, will never be brought to account, save so far as s. 101A may bring them to account. Section 101A is considered in [11.150]ff. and [11.188] above. Where those items would have shown a surplus of assessable income over allowable deductions, the effect of a change in basis of accounting is favourable to the taxpayer. Where there, would have been a surplus of allowable deductions, the effect of the change is unfavourable to the taxpayer.

[11.214] Where the change required by the law is from accruals to cash—a change that had apparently occurred in the early affairs of the taxpayer in Carden’s case (1938) 63 C.L.R. 108, and had occurred in the affairs of the taxpayer in I.R.C. v. Morrison (1932) 17 T.C. 325—there will be a double inclusion of those items that had already been derived or incurred on an accruals basis but now come again to be derived or incurred on the principles governing cash basis of tax accounting. Again the outcome may be favourable or unfavourable to the taxpayer, depending on the nature of the surplus.

[11.215] A change in appropriate basis of accounting will occur within what is seen as continuing business operations. It is to be distinguished from a cessation of operations in one business and the commencement of operations in another. The items of the earlier business may have been subject to one basis of accounting, and the items of the new business may be subject to the other basis of accounting, but in these circumstances there is no prospect of fall-out of items or double inclusion of items. There may, however, be consequences of a different kind on the movement from one business to another, if assets of the earlier business are taken into the new business. Those consequences are the subject of examination in [12.99]ff. below.

The Identification of a Receipt or Outgoing

[11.216] There are problems of identification of a receipt or outgoing, some common both to accruals and to cash accounting, others confined to cash accounting.

[11.217] A taxpayer may receive an amount in such a manner that derivation is satisfied so far as it is necessary that he should have received on a cash basis, but a conclusion that there is income derived requires an identification of the receipt. The taxpayer may be entitled to a receipt from another person in payment for services, and that receipt will be accounted for on a cash basis. At the same time the other person may have sought to make a gift to the taxpayer. Any payment made to the taxpayer will need to be identified as a payment for services or a payment to him by way of gift if it be assumed that a receipt by way of gift in the circumstances is not income of the taxpayer. An appropriation made by either party, and the general law of appropriation, will bear on the identification. A like problem of identification will arise if the taxpayer accounts for the receipt for services on an accruals basis, and the receipt by way of gift is income as a product of his activity in providing services. A receipt of payment for services rendered would not be a derivation of income: the item will have been derived at the time the taxpayer became entitled to receive, and actual receipt is not an occasion of income derivation.

[11.218] The assumption in previous paragraphs is that the whole of one receipt can be identified as having a single character. The question in some circumstances will be whether it is possible to identify within one receipt a part that has an income character, and a part that does not. A payment may have been made to serve two functions, a payment of fees for services due to a taxpayer on a cash basis of return, and the making of a gift to the taxpayer of a kind that does not have the character of income. In this event the question of apportionment of a receipt where some of it relates to an item of an income character and some to an item that does not have that character, is raised. That question was considered in [2.558]ff. above.

[11.219] Allsop (1965) 113 C.L.R. 341 suggests planning to mix a payment in respect of an income item with another, that may be a voluntary payment, so that no part of what is received can be identified as an income item and brought to tax. The possibility of such planning makes the principle in Allsop unacceptable.

[11.220] Allsop was concerned with an actual receipt, but the principle in the case has an application in circumstances involving an amount receivable by an accruals basis taxpayer. A taxpayer may combine the sale of trading stock with the sale of a structural asset—perhaps an item of plant. The principle opens the prospect that no part of the sale price is income derived.

[11.221] Problems of identification of an outgoing parallel those in regard to receipts. There is however one important difference in the law that may be applicable. There is no principle equivalent to that in Allsop applicable to outgoings. At times there are suggestions in judicial opinion of an equivalent principle, for example in the judgment of Fisher J. in Phillips (1978) 78 A.T.C. 4361 such that the whole of an outlay is deductible if any part of it is in respect of a deductible item. But the phrase “to the extent to which” in s. 51(1) provides an authority for identifying an outlay that is not in respect of a deductible item, and the denial of a deduction to that extent.

Receipts Abandoned or Refunded and Outgoings Relieved from or Repaid

[11.222] Save for some observations by Barwick C.J. in Henderson (1970) 119 C.L.R. 612 and the decision of the High Court in H. R. Sinclair Pty Ltd (1966) 114 C.L.R. 537 Australian law lacks authority

• (i) on the consequences of the withdrawal of a claim to a receipt where the taxpayer is on an accruals basis, and of the return to another of an amount received by a taxpayer on an accruals basis; and
• (ii) on the consequences of the withdrawal of an acknowledgment that the taxpayer is under a liability where the taxpayer is on an accruals basis, and of the return to him of an outgoing that he has paid.

[11.223] Equally there is lack of authority on the consequences of a return to another by a taxpayer on a cash basis of an amount received by him, and on the consequences of the return to a taxpayer on a cash basis of an amount paid by him.

[11.224] Some of these matters were considered by the Papua New Guinea Supreme Court in Commonwealth-New Guinea Timbers Ltd v. Chief Collector of Taxes (1972) 72 A.T.C. 4048 which purported to rely on Australian authority. The case is authority for Papua New Guinea law that a claim to recover an amount will not be income derived by an accruals basis taxpayer unless it is legally recoverable by him, and that the abandonment of a claim does not generate a deduction for a loss, under the Papua New Guinea equivalent of s. 51(1) of the Australian Assessment Act, nor will it generate a claim to a deduction under the Papua New Guinea equivalent of s. 63 of the Australian Assessment Act. It will be apparent from the consequences of these principles as they operated in the facts of that case that the principles are quite unacceptable. Legal recoverability should not be a test of the derivation of a receipt by an accruals basis taxpayer. A debt that an accruals basis taxpayer has claimed and now abandons should generate a loss deduction under s. 51. A debt that may be written off under s. 63 should embrace any debt that should be brought to account as assessable income, and debt for this purpose is satisfied by a claim to receive made and still sustained by the taxpayer.

[11.225] Another principle adopted by the Papua New Guinea Supreme Court—actual receipt by an accruals basis taxpayer of an item not legally recoverable is income derived—is unnecessary if the claim to receive is treated as income derived. Actual receipt is not a tax event save so far as it precludes a loss deduction or a s. 63 deduction.

[11.226] The plaintiff in Commonwealth-New Guinea Timbers Ltd v. Chief Collector of Taxes had included in its assessable income amounts it claimed as due to it by the Commonwealth for the years 1962–1968 under an agreement with the Commonwealth that had been approved by the Papua New Guinea Taxation Agreement Act, 1952. None of these amounts was ever received from the Commonwealth. A decision of the High Court in 1969 held that on the view the court took of the agreement there never had been any right to recover the amounts. The plaintiff then claimed, in the 1970 year of income, a deduction of the total of the amounts brought to account as assessable income in the 1962–1968 years. The conclusions of the Papua New Guinea court were that the amounts had been wrongly included in assessable income in the 1962–1968 years since they were never legally recoverable, this having been finally demonstrated by the Australian High Court decision. The Collector of Taxes had no power to amend the assessments in respect of those years so as to exclude the amounts from assessable income since, in including them, he had proceeded on a mistake of law—that the amounts were legally recoverable—and the Papua New Guinea Ordinance, like the Australian Assessment Act s. 170, did not empower the collector in the circumstances to correct the mistake of law. The deduction claimed was not allowable under the Papua New Guinea equivalents of ss 51(1) or 63 of the Australian Assessment Act, since those provisions applied only to legally recoverable debts.

[11.227] In the 1960 year of income the Papua New Guinea collector had included amounts received by the plaintiff in respect of amounts the plaintiff claimed to be recoverable in the 1958–1959 years—years in which no income tax was levied in Papua New Guinea. The Supreme Court of Papua New Guinea held that the actual receipt in 1960 was a derivation of income, presumably because the 1958 and 1959 receivables were not legally recoverable amounts and thus would not have been income derived in the 1958–1959 years, even if there had been an income tax in New Guinea in those years.

[11.228] Logical implications of the judgment of the Papua New Guinea Supreme Court in its application to tax accounting on an accruals basis would appear to be that:

• (i) an outgoing is not incurred unless an amount claimed from a taxpayer is legally recoverable from him, and if an amount not legally recoverable from him is allowed as an outgoing, any subsequent declaration of law that the amount is not recoverable from him will not involve a derivation of income by the taxpayer, and
• (ii) an outgoing will be incurred if a claim not legally recoverable from a taxpayer is actually paid by him, notwithstanding that he may subsequently have the money restored to him.

[11.229] The judgment of the Papua New Guinea Supreme Court does not provide any guidance on the questions whether the repayment by the taxpayer of money which he could not legally have recovered but which he has actually received will be an allowable deduction, and whether the receipt by the taxpayer by way of repayment to him of money which he has paid but which was not legally recoverable from him will be a derivation of income.

[11.230] The plaintiff, who at all times had made full disclosure in its returns, found itself defeated on all possible fronts. Which may be enough to demonstrate that the principles adopted by the Papua New Guinea Supreme Court are unacceptable. A taxpayer may claim an amount, not legally recoverable, in year A, receive it in year B and repay it in year C. He may have been assessed for year A on the assumption that the amount claimed was legally recoverable. He must be assessed for year B because he has actually received the amount. An amendment to the assessment for year A so as to exclude the amount is not within the Revenue’s powers. When the taxpayer pays back the amount in year C he may or may not have a deduction: the court did not consider this situation. The law as stated by the court may be shown to be equally unacceptable by an illustration involving a claim against the taxpayer not legally recoverable from him, the payment of that claim and the recovery back of the money paid.

[11.231] The law as stated by the Papua New Guinea Supreme Court would be inconvenient even under a tax system which gives the Revenue unlimited powers of reopening assessments and unlimited rights to the taxpayer to have assessments reopened. Principles which adopt recoverability at law as a condition of the derivation of income or the incurring of an outgoing will require the determination of general legal issues in relation to the meanest item of alleged income or alleged deduction. The law as to void, voidable and illegal contracts, and the developing body of consumer protection law, which may afford relief to a borrower or purchaser, will plague the administration of the tax laws. The facts must be screened by the law of evidence. The law of evidence may prevent recovery in the absence of a written memorandum.

[11.232] Other implications of the judgment of the Papua New Guinea Supreme Court are that an item accounted for on a cash basis is derived if it is actually received even though the taxpayer had no right to recover the amount and notwithstanding that he subsequently repays the amount. And an item is deductible if it is actually paid though there was no legal liability to pay, and notwithstanding that the taxpayer subsequently recovers the amount he paid. No implication can be drawn as to the deductibility and assessability of the amount repaid or the amount recovered.

[11.233] The Papua New Guinea Supreme Court relied on Henderson (1970) 119 C.L.R. 612. The court quoted the following passage from the judgment of Barwick C.J. in Henderson (at 650), a judgment with which McTiernan and Menzies JJ. agreed:

“In ascertaining such earnings, only fees which have matured into recoverable debts should be included as earnings. In presenting figures before his Honour allowance was made for what was termed ‘work in progress’. But this, in my opinion, is an entirely inappropriate concept in relation to the performance of such professional services as are accorded in an accountancy practice when ascertaining the income derived by the person or persons performing the work. When the service is so far performed that according to the agreement of the parties or in default thereof, according to the general law, a fee or fees have been earned and (sic) it or they will be income derived in the period of time in which it or they have become recoverable.”

[11.234] It is true that this passage appears to assert that legal recoverability is a condition precedent to an amount being income derived. But it must be read in context. The Chief Justice was denying that an amount in respect of work in progress could be said to be income derived. The denial was put on two grounds: that the fee had not been earned and that the fee had not become recoverable. Since the decision in Arthur Murray Pty Ltd (1965) 114 C.L.R. 314 it has been established that an item is not income derived until it has been earned. His Honour, in insisting that, in addition to earning, the item must have matured into a recoverable debt, did no more than assert that the item must have become a non-contingent and ascertained claim.

[11.235] Recognition of an item as income derived in accruals tax accounting requires that there be a claim, unqualified by any contingency, to an ascertained amount. It does not require that it be shown that a court would, if asked, order that the claim is recoverable by the taxpayer and Henderson should not be taken to decide that it does so require. Recovery by a solicitor of the amount of a bill of costs rendered by him may be denied if the client has taken proceedings to have the bill taxed. Henderson, it is submitted, would not be taken as authority that the amount of the bill will not be income derived until the period within which it might be taxed has expired.

[11.236] It would be natural for Australian courts to seek answers in United Kingdom law to the questions raised by Commonwealth-New Guinea Timbers Ltd v. Chief Collector of Taxes (1972) 72 A.T.C. 4048. It is to be noted, however, that the United Kingdom law gives the Revenue a much greater freedom than does the Australian law, in the reopening of assessments. That freedom is necessary to prevent injustice if the principles asserted by the Supreme Court of Papua New Guinea are adopted. Thus it would be possible in the United Kingdom in the Commonwealth-New Guinea Timbers situation to reopen so as to exclude the amounts included in income in the 1962–1968 years. Though the United Kingdom law could thus tolerate the principles of Commonwealth-New Guinea Timbers the United Kingdom authorities do not in fact establish those principles and this must tell strongly against them. The United Kingdom authorities support the proposition asserted by the taxpayer in New Guinea Timbers that an amount claimed to be recoverable will be taxed in the year of claim. So too, the United Kingdom authorities support a proposition that an outgoing acknowledged by the taxpayer to be recoverable from him will be deductible in the year of acknowledgment. If it is later shown that the amount claimed or the outgoing acknowledged was wrongly claimed or acknowledged, the relevant assessment will be reopened. In thus reopening assessments the United Kingdom law does not proceed on the assumption that the earlier derivation or incurring was wrong and that it is now being corrected. Though some of the cases are equivocal, for example, Simpson v. Jones [1968] 1 W.L.R. 1066, they are consistent with the view that to the extent that the amount has been shown not to be recoverable by or from the taxpayer, there is an item of deduction or of income which must be brought to account (Bernhard v. Gahan (1928) 13 T.C. 723; English Dairies Ltd v. Phillips (1927) 11 T.C. 597; Ford & Co. Ltd v. I.R.C. (1926) 12 T.C. 997). This item, being referable to the year of derivation or of incurring of the item now shown not to be recoverable by or from the taxpayer, must be matched with that item and it is for this reason that the earlier assessment is reopened: “Now into what year is this countervailing entry to be put? That is all that arises here” (per Rowlatt J., in English Dairies Ltd v. Phillips (1927) 11 T.C. 597 at 606).

[11.237] A similarity between the basic tax accounting law in the United States and in Australia, and similarity in the law as to reopening of assessments, suggests that the United States may afford a model for the Australian law. Central to the United States law is a doctrine that a claim of right, as distinct from legal recoverability, is enough to give rise to a derivation of income by an accruals basis taxpayer. The United States law, as it bears on the problems that require solution in the Australian law, might be stated thus:

• (1) An item of income will be derived if the taxpayer asserts a claim of right to recover the amount of that item. If in a later year the taxpayer acknowledges that his claim was mistaken, or repays an amount he has in fact received, he will be entitled in that year to a deduction of the amount he acknowledges not to be recoverable or the amount he has in fact repaid;
• (2) An item of income will be derived, even though the taxpayer does not assert a claim to recover the amount of the claim, if he receives the amount. This however will not be so in a case where the taxpayer at no stage asserts a claim to retain the amount and holds himself ready to return it. If the item has been derived in accordance with this principle and the taxpayer later acknowledges that his claim was mistaken and repays the amount, he will be entitled to a deduction in the year in which he repays the amount;
• (3) A deduction will be incurred in the year in which the taxpayer acknowledges that an amount is recoverable from him. If the taxpayer is mistaken and in a later year the claimant gives up his claim to recover from the taxpayer the whole or part of the amount, or repays to the taxpayer the whole or part of an amount in fact received from him, there will, to this extent, be a derivation of income by the taxpayer in that later year; and
• (4) A deduction will be incurred though the taxpayer has not acknowledged that an amount is recoverable from him, if he pays the amount. If the deduction has thus been incurred and the taxpayer in a later year receives an amount repaid by the person receiving the payment, there will, to this extent, be a derivation of assessable income by the taxpayer in that later year.

[11.238] These principles flow from what in the United States tax law is called the “claim of right” doctrine. The authority for principles (1) and (2) is United States v. Lewis 340 U.S. 590 at 591 (1951), a decision of the United States Supreme Court. The Supreme Court referred to a principle, stated in an earlier decision, North American Oil Consolidated v. Burnet 286 U.S. 417 at 424 (1932): “If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.” United States v. Lewis concerned a cash basis taxpayer. However, the application of the same principle to a claim to recover, in the case of an accruals basis taxpayer, is implicit in the following passages in the judgment of the court (at 592):

There is a footnote to the passage quoted which reflects the court’s awareness that the approach in Commonwealth-New Guinea Timbers Ltd v. Chief Collector of Taxes (1972) 72 A.T.C. 4048 is unacceptable:

[11.239] It was conceded by the Revenue in United States v. Lewis that the taxpayer was entitled to a deduction in the year in which he repaid the amount which, it had been adjudged, he was obliged to repay. In the case of an accruals basis taxpayer the deduction will arise in the year in which the taxpayer gives up his claim to recover or, if he has already received, the year in which he repays.

[11.240] The authority for principles (3) and (4) is Baltimore Transfer Co. of Baltimore City v. Commissioner of Internal Revenue 8 T.C. [U.S.] 1 (1947), a decision of the Tax Court of the United States. The taxpayer company claimed a deduction in the 1943 year of income of an amount of unemployment tax which it acknowledged was recoverable from it by the Maryland Unemployment Compensation Board. In the following year of income the Maryland Board, following legal advice, notified the taxpayer that the amount of tax was less than the taxpayer had assumed. The decision of the court was that the amount which the taxpayer had acknowledged in the preceding year to be recoverable from it was a deduction. The difference between that amount and the amount of tax properly payable was income in the later year. In giving judgment, the Tax Court said (at 7–9):

The Supreme Court denied in the Security Flour Mills case that events occurring in a subsequent year may be seized upon as a basis for determining the allowable deductions of an earlier period. The aim of the taxing acts is to determine true income by annual periods, not true income ‘in the light of ultimate gain from a series of transactions over a period of years growing out of, or in some way related to an initial transaction in the taxable year’” (emphasis in original).

[11.241] The decisions of the United States Supreme Court, referred to by the Tax Court, that a controverted obligation is not accruable until the dispute is settled, indicate the limits of the principles making up the claim of right doctrine. Income will be derived only when the taxpayer claims a right to recover or, though he has not claimed, he actually receives an amount and claims to retain what he has received. A deduction will be regarded as incurred only when the taxpayer acknowledges the right of another to recover from him or, though he does not acknowledge, when he actually pays an amount. It may be thought that in these aspects the principles leave an element of uncertainty which mars their convenience. But the Revenue is sufficiently protected by the obligations of disclosure imposed upon the taxpayer. If, in order to avoid or postpone a derivation of income, he asserts that he does not make a claim of right in circumstances where he is taking proceedings to recover the amount he will find it difficult to maintain his assertion. If, in order to attract a deduction, he asserts that he acknowledges that an amount is recoverable from him when in fact he is denying liability, he will equally find it difficult to maintain his assertion.

[11.242] An Australian court has yet to consider facts similar to those in Commonwealth-New Guinea Timbers Ltd v. Chief Collector of Taxes [P.N.G.] (1972) 72 A.T.C. 4048. There is, it is submitted, no reason arising from the Australian authorities why the model of the American law should not be adopted in Australia. There are only two obstacles in the way of adoption by Australia of the American model. These arise in relation to the adoption of what might be called corollaries of the claim of right notion. The first of these corollaries is that where the taxpayer abandons a claim or repays an amount he incurs an allowable deduction. The second corollary is that where the claimant gives up a claim which the taxpayer had acknowledged to be legally recoverable from him, or repays an amount paid to him by the taxpayer, there is an item of assessable income. The obstacle in relation to the first corollary is in the terms of s. 63 of the Assessment Act, which allows a write-off of a bad debt. The requirement that the amount has been brought to account as assessable income is satisfied, but it may be that the word “debt” is to be construed as referable only to an amount which is legally recoverable. This was the view of the Papua New Guinea Supreme Court in Commonwealth-New Guinea Timbers and it is a view which may be thought to have been settled as correct by the decisions in Point (1970) 119 C.L.R. 453 and G. E. Crane Sales Pty Ltd (1971) 126 C.L.R. 177. It should be noted, however, that Point can be explained on the basis that the taxpayer could not write off a claim which he had ceased to assert and that G. E. Crane Sales can be explained on the basis that the taxpayer could not write off a claim which it had assigned to another. In any case, the fact that the corollary cannot operate through the terms of s. 63 does not mean that it cannot operate through s. 51. Once it is accepted that the claim to recover was a derivation of assessable income the reasoning of the Papua New Guinea Supreme Court against the deduction under the equivalent in the New Guinea Income Tax Ordinance of s. 51(1) has no application.

[11.243] The obstacle to the operation of the second corollary might be thought to be the decision of the High Court in H. R. Sinclair & Son Pty Ltd (1966) 114 C.L.R. 537. In that case the High Court denied that there was any general principle that the receipt of a repayment of an amount which had been allowed as a deduction in an earlier year must necessarily be income. None the less it held that the repayment to the taxpayer in the case was assessable income as a trade receipt. In so holding, the High Court took the view that the amounts which had been paid by the taxpayer had been properly paid in the sense that they were amounts which were legally recoverable from him. It might be thought that the court thus raised a suggestion that there is a distinction to be drawn between the repayment of an amount which had been properly paid and the repayment of an amount which had been wrongly paid. The denial of a general principle may be unfortunate in other contexts, but the principle that a trade receipt is income will be sufficient in the context of deductions to which accruals tax accounting applies. The suggestion that some distinct principle might apply to the return of an amount wrongly paid is unfortunate. It lets in issues of general law and fact going to whether an amount was “legally payable”—the phrase is used by Taylor J. in Sinclair (at 543)—which, it is submitted, should have no place in tax accounting. Any such suggestion is hard to explain having regard to the awareness shown, at least by Taylor J., of the very limited powers of reopening assessments given by the Assessment Act.

The Treatment of Interest, Premiums and Discounts on Loans

[11.244] Interest may be distinguished from the amount of a premium which a borrower may be required to pay to the lender on the repayment of a loan. The word premium in this context will generally be used to describe an amount which the borrower agrees to pay on repayment of the loan in excess of an amount expressed by the loan agreement to have been lent to him, and in fact lent to him. Its function is indistinguishable from an amount by which the amount that a borrower acknowledges he is bound to pay to the lender exceeds the amount in fact lent to the borrower. In the latter circumstances, it would be said that an acknowledgement of a debt has been originally issued at a discount, “discount” referring to the amount by which the amount the borrower is obliged to pay to discharge his indebtedness exceeds the amount he received in exchange for his acknowledgement. Both premium and discount are illustrated in the facts of Lomax v. Peter Dixon & Son [1943] K.B. 671.

[11.245] Interest identifies a payment for the use of money by reference to the period of use of that money. This meaning is reflected in the expression of a rate of interest as a percentage of the amount lent, payable for a specified period of use. It is also reflected in the statement of principle that, in the absence of a contrary provision, “interest accrues from day to day”. “Accrues” in this statement may have a meaning different from its meaning when it is said that a receipt has accrued, or an outgoing has accrued, and is thus derived by or incurred by a taxpayer on an accruals basis of tax accounting in relation to the item.

[11.246] The fact that an item is correctly described as interest, a premium or a discount, will not necessarily provide an answer to the question whether the item has the character of income or the character of deductibility. Where the issue is income character, the question will be whether the item is a gain derived from property. Where the issue is deductibility the question will be whether it is a relevant and working expense of some process of income derivation. If an item is correctly described as a premium, it may yet be income as a gain derived from property of the lender: it is likely to be such if, though payable only on the termination of the lending, its amount will abate by reference to the period of time the loan has been on foot and in such circumstances a claim by the borrower to a deduction of the premium as a payment for the use of property used in a process of income derivation may be open. That a premium or discount may be income of the lender in other circumstances as a gain derived from property will be apparent from the discussion of principle by Lord Greene M.R. in Lomax v. Peter Dixon, considered in [2.285]ff. above.

[11.247] A premium or discount that is not income as a gain derived from property, may yet be income as a profit on the realisation of a revenue asset. The character of the lending as being on revenue account or on capital account is not relevant when the issue is whether the item derived is income as a gain derived from property. Whether the lending is on revenue account or on capital account becomes critical if the question is whether the premium is income as a profit on realisation of an asset. A premium or discount may be a deductible loss by the borrower where the liability arising from his borrowing is on revenue account.

Accounting for interest

[11.248] Generally, interest will be accounted for on a cash basis. In some circumstances, however, interest will be accounted for on an accruals basis—where, for example, it is derived by a bank from loans made in the ordinary course of its business.

[11.249] Accounting for interest on a cash basis will follow principles considered in [11.122]–[11.136] above. There are questions as to the scope of s. 19, and as to the scope of a principle of constructive receipt, for example where interest is “capitalised” or interest presently receivable is assigned to another. These questions, where an interest receipt presently receivable is assigned to another, are discussed below in Chapter 13. The outcome of that discussion is that the effect of the assignment on interest that is presently receivable by a lender is a receipt by the lender if he is on a cash basis in relation to the item, and there is a derivation by him. It will follow that there is no derivation of interest by a lender who has assigned a debt and with it the right to interest, if the interest becomes presently receivable subsequent to the assignment. Nor is there a derivation of interest by a lender if he assigns a right to future interest—the loan being one that gives rise to a right to future interest as distinct from expectancies—if interest becomes presently receivable subsequent to the assignment. The interest will be derived by the assignee. The assignment does not give rise to any constructive receipt by the assignor. In some circumstances interest will have to be accounted for on an accruals basis. The assumption in C.I.R. (N.Z.) v. National Bank of N.Z. Ltd (1977) 77 A.T.C. 6001 at 6034, and in National Commercial Banking Corp. of Aust. Ltd (1983) 83 A.T.C. 4715 is that interest is derived by a taxpayer on an accruals basis in relation to the interest, when it becomes presently receivable by him, and thus on the lapse of each time period for which it is receivable.

[11.250] Accounting on a cash basis for incurring of outgoings for interest raises issues parallel with those raised in regard to derivation. The view has been taken in this Volume that there is a notion of cash accounting applicable to outgoings, and that this notion will be attracted whenever receipts by the taxpayer in the same process of income derivation would be accounted for on a cash basis. It is true that accounting for outgoings has been considered in the authorities, more especially in James Flood Pty Ltd (1953) 88 C.L.R. 492 and Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 as if no distinction between a cash basis and an accruals basis is to be drawn. But the authorities all involve circumstances where accounting for related receipts would be on an accruals basis. In [11.174]–[11.180] above, principles of cash accounting in relation to the incurring of outgoings are discussed, and the possibility of a principle of constructive payment explored. These principles will be applicable to accounting for interest outgoings.

[11.251] Where a taxpayer is on an accruals basis in regard to outgoings of interest, the principles in James Flood and Nilsen govern. But their application gives rise to special problems. The notion of an accrual that will be an outgoing incurred is not always the converse of an accrual that will be derivation of an item. The possibility is raised by the statements of principle in James Flood that an item may be deductible notwithstanding that it will not become presently payable until some later time and that it involves a defeasible liability. Interest income, it is assumed, will not be derived by a lender on an accruals basis until the time has run in respect of which interest is payable and the interest is presently receivable. Interest, it seems, can be prima facie an outgoing incurred even though the time in respect of which the interest is payable has not yet run and the liability to pay is defeasible. The matter is discussed in [11.119] above. A principle that an outgoing is incurred only as the benefit arising from it is consumed, will, however, defer deductibility of the interest outgoing so that it is deductible only as the period of the loan to which it relates elapses. The authorities are Alliance Holdings Ltd (1981) 81 A.T.C. 4637 and Australian Guarantee Corp. Ltd (1984) 84 A.T.C. 4642.

Accounting for premiums and discounts

​In relation to the lender

[11.252] The meaning of the words “premium” and “discount” are explained in [11.244] above. The present concern is with the possible application of receipts and outgoings tax accounting, where the item is a premium or discount. The possible treatment of a premium or discount as income in the form of a profit on the realisation of an asset is considered in [12.183]-[12.184] below.

[11.253] In some circumstances it is possible to regard a premium received or a discount allowed in relation to a loan, as income derived from property. The matter was discussed in connection with Lomax v. Peter Dixon & Son [1943] K.B. 671 in [2.285]ff. above. Where the loan does not provide for interest or provides for interest at less than the prevailing commercial rate, the conclusion may be drawn that a premium receivable on repayment of the loan, or the difference between the amount of the loan and the amount in fact paid to the borrower when the loan moneys were paid to him, is a gain to the lender derived from property and income on this basis. The conclusion will not be drawn in relation to an amount that can be said to be “for the capital risk” the lender experienced in making the loan. “Capital risk” includes the possibility of a fall in the purchasing power of the currency in which the loan was made. So far as the premium or discount does recoup a fall that has in fact occurred, it is in substance a return of the money lent and not a gain derived from the money lent. This recognition of a consequence of inflation is some concession by income tax law to a reality which has otherwise been steadfastly excluded from consideration in the judicial development of the law.

[11.254] The treatment of a premium as income derived from property will be more likely if its amount is related by the loan agreement to the period the loan has been on foot. If a rebate of the premium is available to the borrower on early repayment of the loan, a conclusion that the premium is a payment to him for the use of the money lent is more easily drawn.

[11.255] Lomax v. Peter Dixon is not concerned with the time of derivation of a premium or discount held to be income as a gain derived from property. If the taxpayer is on a cash basis in relation to the item, the time of derivation must be the time of repayment of the loan. Where he is on accruals, the time of derivation is presumably when the loan becomes repayable. Willingale v. International Commercial Bank Ltd [1978] A.C. 834 may be authority, though the approach in that case appears to have been in terms of a profit realised that was income.

​In relation to an assignee from the lender

[11.256] Characterisation of a premium or an amount of original issue discount as income derived from property becomes near impossible where there has been an assignment of the debt owed by the borrower. And the tax accounting problems are unmanageable.

[11.257] The original lender who has assigned will not receive and will have ceased to be entitled to receive the payment which will include the premium or discount. There may be some basis for treating the premium or discount as derived by him in some part referable to the period he held the debt, and for treating it as income in the form of a gain derived from his holding of the debt for this period. But such an approach would be confronted by the circumstance that the taxpayer may not in fact receive the amounts treated as having been derived by him. The amount he receives on assignment will not necessarily reflect the amount of the premium or discount referable to the period he held the debt. Indeed the prospect that there could be an assignment with these attendant problems may be good reason to put out of consideration generally any idea of treating a premium or discount as being income derived from property.

[11.258] The difficulties of characterisation and of tax accounting are no less when the treatment of the assignee is in question, even if that assignee in fact holds until the loan is repaid. The element of any discount will be reflected not in what the assignee paid for the debt, but what was paid for it on original issue. An assignee will not know what was originally paid for the debt.

​In relation to the borrower

[11.259] The question in relation to the borrower is whether the amount of original issue discount, or premium payable on repayment, may be treated as an outgoing for the use of the money borrowed. There may be reason to treat a premium in this way where the premium abates on early repayment of the borrowing, or where the amount of interest payable is less than a commercial rate. And there may be reason to treat it as a payment for use in other circumstances. There is, however, no principle that the character of the outgoing by the borrower must match a character of income derived from property in the hands of the lender. Deduction by the borrower must in any event depend on the satisfaction of a test of relevance which will look to the use of the money borrowed in a process of income derivation, an aspect of the transaction obviously irrelevant in determining the character of the receipt in the hands of the lender.

[11.260] Section 67 proceeds on a view that some expenses in relation to a borrowing are not outgoings incurred for the use of the money borrowed. A special regime of deductibility is applied to those expenses. The scope of s. 67 and its relationship to s. 51(1) were the subject of some consideration in Ure (1981) 81 A.T.C. 4100 and were discussed in [10.217]ff. above.

[11.261] Whether the outgoing is one that will be paid to the lender, or to a person who has succeeded to the rights of the lender, a characterisation of the outgoing as a payment for the use might be appropriate, even when a characterisation of the receipt by the lender as a receipt for the capital risk in lending is appropriate. But treating a payment to recoup the lender for any loss he may incur as a result of a fall in the value of money lent, as a payment for the use of the money, is at least difficult. The economic significance of a payment to recoup a fall in value is a repayment of the loan. A payment so regarded is not a payment for use.

[11.262] If a discount or premium is seen as a payment for the use of money and a deductible outgoing under s. 51(1), there will be a question of when the outgoing is incurred. If Alliance Holdings Ltd (1981) 81 A.T.C. 4637 and Australian Guarantee Corp. (1984) 84 A.T.C. 4062 are followed, an outgoing for interest, unless the liability is only contingent, will be deductible by an accruals basis taxpayer as the period of the loan in relation to which the interest payable elapses ([11.250]-[11.251] above).

[11.263] If a discount or premium is not seen as a payment for the use of money, it will not be deductible as an outgoing. The borrower will need to establish a loss expense on the discharge of his liability. Deductibility will require a finding that the liability was on revenue account, which is a different notion from liability to repay in a process of income derivation. Deductibility on this basis is considered in [12.185]-[12.186] below.

The Treatment of Discounts on the Negotiation of Bills of Exchange

[11.264] Difficult questions of analysis arise if it is sought to explain a transaction involving a bill of exchange as a lending of money, or as one that gives rise to a relationship of debtor and creditor between parties to the bill. Those questions of analysis cannot be avoided if the issue is whether a party to a bill of exchange has derived “interest”, or has paid “interest”. Such issues are posed in the operation of withholding tax, a subject outside the scope of this Volume. The questions of analysis do not arise where the issue is simply whether the taxpayer has derived income, or has incurred a deductible outgoing.

[11.265] A person who discounts a bill will be entitled on maturity to a payment greater than the amount he paid for the bill. Whether this greater amount is his income as a gain derived from his property—the obligations evidenced by the bill—is a question no different from that which arises when a taxpayer acquires a debt at a discount, a matter considered in [11.252]-[11.258] above. A taxpayer who is the drawer may negotiate a bill at a discount, and come under a liability to pay a greater amount on maturity as a party liable on the bill than the amount he received on negotiation. Whether he incurs a deductible outgoing depends on the possible characterisation of the discount as an expense for the use of money which he has outlaid in a process of derivation of income. It is no different from the question already considered in regard to a person who receives an amount as a loan in exchange for an obligation to repay a greater amount ([11.259]-[11.263] above).

[11.266] A transaction involving a bill of exchange may, of course, involve relationships which do not correspond with relationships involved in the lending and borrowing of money, and the assignment of a debt for money lent. Where those relationships are involved the issue of derivation of income and the incurring of a deductible outgoing need to be resolved on other principles. Thus a bank which receives a fee for providing a service in accepting a bill of exchange as an accommodation party, derives the fee as income but not in the character of a gain derived from property. If on payment of the bill on maturity it does not receive equivalent funds from the party accommodated, it suffers a loss that is deductible. It is a loss in relation to the discharge of an obligation that is a liability on revenue account. Clearly it does not incur an outgoing that is an expense for the use of money.

[11.267] The possibilities of a party to a bill of exchange deriving income in the nature of a profit on the realisation of an asset, incurring a deduction in the nature of a loss on such realisation, or deriving income or incurring a loss on the discharge of a liability are further considered in [12.217]-[12.219] below.

Accounting for Royalties and Income Derived from Property

[11.268] Attention was given in [2.309]ff. and [4.114]ff. above to items that are income either as royalties within the meaning of the word in s. 26(f) unaided by the definition in s. 6, and items that might be called royalties but are income only as items that are within the ordinary usage meaning of income as gains derived from property. Generally all these items are income in their gross amount, not as specific profits when the income element would be a part only of the gross amount. Where the item is income in its gross amount there will, at least in some circumstances, be an apparent offence to the principle that income involves a gain. In what follows, an attempt is made to identify the occasions when there is risk that accounting for income derived from property will result in the taxing of items that are not wholly gains. The possibility of applying specific profit accounting in such circumstances is raised, and the corrections that result from the operation of depreciation and amortisation provisions are noted.

[11.269] It is necessary, more particularly to enable a consideration of the role of the depreciation and amortisation provisions, to distinguish circumstances in which some proprietary rights remain with the taxpayer and circumstances in which all proprietary rights have been transferred. And it is necessary to draw a number of other distinctions.

Where general property rights remain with the taxpayer

[11.270] A distinction may be drawn between circumstances where property is physically depleted by use, and circumstances in which it is not.

​Property physically depleted by use

[11.271] Excluding for a moment the fact that timber is a renewing resource, McCauley (1944) 69 C.L.R. 235 is an affront to a principle that income is a gain. The taxpayer was simply unfortunate in the means he adopted by which to realise his property in timber standing on his land. There was no gain in the realisation of the timber unless the receipt by the taxpayer exceeded, in regard to any taking, the market value of the timber before that taking, or, perhaps, the market value at the time the taxpayer entered into the arrangement under which the timber was taken.

[11.272] Certainly where the physical property taken in a McCauley royalty situation is not a renewing resource—it is blue metal, gravel or sand—there is an affront to the principle. Where the physical property is timber, it is arguable that timber as it grows is already a gain derived from property that will be realised on disposition of the timber, whatever the form the disposition takes—though the point was not taken in Stanton (1955) 92 C.L.R. 630. This argument would justify the result in McCauley, save so far as the timber taken had grown before the taxpayer acquired the land. And it affords a justification for the express provision in s. 124J by which, in McCauley circumstances, a deduction may be allowed for an appropriate part of the cost of the timber at the time the land with growing timber was acquired. Section 124J is considered in [6.184], [6.198-9], [7.19], [7.28], [7.54], [11.271] above and [12.82] below.

​Property not physically depleted by use

[11.273] Where the property is not physically depleted by use, and its value does not decline by use or by effluxion of time, a receipt that is a gain derived from the property may be seen as pure gain. An illustration would be a receipt in respect of non-exclusive licence to use a trade mark.

[11.274] There is, however, at least a theoretical difficulty in treating the receipt as a pure gain when exclusive rights to use are given. It could be said that there has been a partial realisation of property: there is no gain derived from the property. The distinction between a receipt that is a premium on the grant of exclusive rights to use and a receipt that is a payment for use is perhaps beyond drawing except in the terms of form factors: periodicity and a provision for abatement if the period of the exclusive licence does not run its course have been relied on.

[11.275] If the law were to allow a deduction against receipts in respect of property not physically depleted by use whose value does not decline as a result of use or by effluxion of time, so as to relieve from tax that element of the receipts that is not a gain, the fixing of the amount of the deduction could not avoid being arbitrary.

[11.276] Where the property is not depleted by use but its value declines as a result of use, the depreciation provisions of the Assessment Act seek to keep faith with the principle that income is a gain. Those provisions are considered in [10.130]ff. above. The amount of the deduction is fixed by the provisions and is to a degree arbitrary. Where the property is not depleted by use, but its value declines by effluxion of time, the amortisation provisions of Div. 10B of Pt III seek to keep faith with the principle that income is a gain. Division 10B is considered in [10.239]ff. above. The amount of the deduction is fixed by those provisions. The deduction is related to the life of the asset and the effluxion of time. In [10.241] and [10.261] above, attention is drawn to an argument that Div. 10B has no application where a licence is given in exchange for receipts that are income as royalties or gains derived from property. If the Division does not extend to such a situation, it fails to a degree to keep faith with the principle that income is a gain.

Where general property rights are disposed of

[11.277] It would seem that there may be income derived from property where the form of receipts for the use of property is satisfied, notwithstanding that there has been an outright disposition of the property. The matter is considered in [2.332]ff. above. In this instance there are no statutory provisions that would keep faith with the principle that income is a gain. Both the depreciation provisions and the amortisation provisions are available only where the taxpayer is a continuing “owner”. The suggestion is made by Barwick C.J. in Cliffs International Inc. (1979) 142 C.L.R. 140 at 150-151 that the receipts by Howmet Corp. and Mt Enid Ltd were income of those companies, presumably as royalties or income derived from property. The protection of the principle that income is a gain would require a deduction of so much of the value of the shares held by those companies in the company that owned the mining rights as had not been recouped by the lump sum receipt. The deduction would be spread over the period of possible receipts arising from the exercise by Cliffs International of the mining rights, or perhaps spread by reference to a measure of the exercise by Cliffs International of those mining rights.

Accounting for royalties and income derived from property on an accruals basis

[11.278] Attention has been directed in [11.250] above to the possibility that for some taxpayers interest may have to be accounted for on an accruals basis. The New Zealand decision in C.I.R. (N.Z.) v. National Bank of N.Z. (1977) 77 A.T.C. 6001, 6034 would appear to have been accepted in Australia (National Commercial Banking Corp. of Aust. Ltd (1983) 83 A.T.C. 4715). It was assumed in Aktiebolaget Volvo (1978) 78 A.T.C. 4316 that the receipts in respect of the keep-out covenant entered into by Volvo Sweden, if they were income, would be accounted for on an accruals basis.

[11.279] The assumption in Volvo led, in the view of Jenkinson J., to some strange consequences flowing from the drafting of the definition of royalty in s. 6, and the provisions of s. 6C which at the time gave an Australian source to royalties (as defined), when they were paid by a resident to a non-resident. If Jenkinson J. had concluded that the receipts by Volvo Sweden from Volvo Australia were royalties and were of an income nature, he would none the less have held that they were not assessable income of Volvo Sweden—a non-resident—because at the time of their derivation by Volvo Sweden they did not as yet have an Australian source. The receipts were derived when they became payable by Volvo Australia to Volvo Sweden: they were to be accounted for on an accruals basis. But they did not acquire an Australian source until the following year, when they were actually paid to Volvo Sweden.

[11.280] The view expressed by Jenkinson J. involves an extension of the principle that the income character of an item must be judged at the time of derivation. As extended, the principle also requires that the source of an item must be judged at the time of its derivation, which in the Volvo circumstances was the time when the amounts became receivable by Volvo Sweden. The effect of s. 6C was to give an Australian source only to an amount paid. Payment did not occur until the next following year of income. The amounts derived by Volvo Sweden could not therefore have an Australian source at the time of derivation. The analysis requires a conclusion that there could not have been a derivation of assessable income by Volvo Sweden, even though the payment had been made immediately after the amount became payable. At the instant of derivation, an Australian source would still be lacking.

[11.281] The implications of the view taken by Jenkinson J. might have been avoided by interpreting s. 6C so that it gave an Australian source retrospectively. In fact s. 6C, and the definition of royalty in s. 6, were amended shortly after the Volvo decision so as to add the words “or credited” after the word “paid”. It may be that the amendment shows an intention that would preclude a retrospective operation, and to confirm the analysis of Jenkinson J. In which event, the adequacy of the amendment becomes critical. It will appear from the discussion in [11.46] above that an amount may be derived by an accruals basis taxpayer without any “crediting” by the person from whom an amount is receivable. Crediting—presumably an entry in the books of the person from whom the amount is receivable—may be a step in a constructive receipt by a cash basis taxpayer. But it is irrelevant to a receipt by a taxpayer on an accruals basis in relation to the item. The possibility therefore remains that an item may escape inclusion in assessable income because it is derived before it acquires an Australian source.

Accounting for annuities and periodical receipts

[11.282] It would be assumed that receipts that are income as annuity receipts or under the periodical receipts principle will be accounted for on a cash basis. The receipts do not admit of characterisation as business receipts.

[11.283] Attention has been drawn in [2.209] and [2.215]ff. above to the prospect that annuity receipts and other periodical receipts may be income in their gross amounts even when they have been purchased, and the resulting defeat of the principle that income is a gain. There are provisions in s. 27H (formerly s. 26AA) in regard to annuity receipts—which may be a more limited category of receipts than those that are the subject of the ordinary usage periodical receipts principle—which preserve the principle that income is a gain by excluding from income a part of each receipt as reflecting the purchase price. Those provisions may not be effective in all circumstances. The discussion in [2.220]–[2.221] above of Just (1949) 8 A.T.D. 419 and Egerton-Warburton (1934) 51 C.L.R. 568 is relevant. And they will not apply where the relevant receipts are not annuity receipts or a superannuation pension, though they are within the ordinary usage periodical receipts principle. There is room for a judicial development of the law that will apply profit accounting to annuity and periodical receipts by excluding from income so much of each receipt as may be seen as proceeds of an outlay to acquire the right to that receipt. The identification of the outlay, and its valuation, will no doubt present problems. But the problems ought not to be any less soluble than the problems of determining cost which the High Court assumed in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 required solution. There is a line of argument that would say that the express provisions in s. 27H excluding amounts reflecting the purchase price, have covered the field and leave no room for judicially established principles. However appropriate the expressio unius rule of interpretation may be in the interpretation of other statutes, it has limited appropriateness in a taxing statute, and none where it will exclude a principle that is vital to the integrity of the tax.

Correlation of Accounting for Receipt and Accounting for a Deduction by the Payer

[11.284] Attention has been directed in a number of places in this Volume to the absence of any general principle which might have asserted that a payment received acquires income character from the deductibility of the payment by the payer, and that a payment made acquires a character of deductibility from the income character of the receipt of the payment in the hands of the payee. Thus there is no principle which would assert a necessary correlation between the character of a receipt by the taxpayer in a situation as in Dickenson (1958) 98 C.L.R. 460 and deductibility by the oil company making the payment.

[11.285] Equally there is no principle that would assert a necessary correlation between the method of accounting for a receipt that is income, and the method of accounting for the payment of it where the payment is deductible. Thus a taxpayer may be on cash in regard to the amount of a receipt of income and the person who pays that amount may be on accruals in regard to deductibility. The common situation will be a taxpayer receiving interest accounted for on a cash basis, and a taxpayer paying interest accounted for on an accruals basis. It will follow that the moment of accounting for the income receipt will differ from the moment of accounting for the deduction, and both may not occur in the same year of income. A taxpayer may derive an amount of income accounted for on an accruals basis, and another may be entitled to an allowable deduction accounted for on an accruals basis in relation to the payment of that amount. In that situation there may be a radical want of correlation arising from the decision in Australian Guarantee Corp. Ltd (1984) 84 A.T.C. 4642. The payee of interest will account, even though he is on an accruals basis, no sooner than the time when interest becomes presently receivable by him. The payer will be entitled to deduct when he comes under a liability to pay interest, though payment is, by the loan agreement, deferred till the time of repayment of the loan. The want of correlation is mitigated only by the fact that deductibility is spread over the period of the loan.

[11.286] Even though, in a particular case, the moment of derivation of an amount by a taxpayer accounting on an accruals basis, and the moment of incurring of the related outgoing by another taxpayer accounting on an accruals basis are the same in all other respects, there will remain the prospect of a want of correlation arising from the application of the principle in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 in regard to derivation, and the possible absence of any corresponding principle in regard to outgoings. Australian Guarantee Corp. Ltd suggests a principle that would be the converse of Arthur Murray applied to outgoings, though the Federal Court may not have intended to assert a general principle. There is nothing in the judgment to indicate that the court was aware of the significance of their decision for general principles of tax accounting. An item otherwise derived will be brought to account over the period during which it is earned in accordance with the principle in Arthur Murray, but the related outgoings otherwise incurred may be deductible immediately, notwithstanding that the benefit arising from that outgoing will be consumed over a period. The common illustration is a company that is now entitled to receive an amount in respect of management services that it promises to perform in the future. It will account for this amount over the period during which it will provide the services. The company that is liable to pay now for the services it will receive is, it seems, entitled to deduct the amount of the payment now. The matter is discussed in [11.116]–[11.121] above.

[11.287] The Commissioner may feel that it is in all circumstances unfair that no income is derived by the taxpayer receiving when another taxpayer who is liable to pay or does pay is entitled to a deduction. But there is certainly no principle or specific provision that would support the Commissioner’s point of view.

[11.288] The Commissioner may be content to assert a more limited point of view that would claim unfairness where the derivation and incurring involve a transaction between associated taxpayers. Two kinds of situation may be distinguished:

• (i) One taxpayer incurs an outgoing that is deductible, but the related receipt will not at any time be income of the associated taxpayer who receives. In language adopted above in the context of assignment of income situations, there may be said to be an income swallow. The taxpayer incurring the outgoing insulates from tax an equivalent amount of its income. There is no income of the like amount derived by the associated taxpayer. An illustration is a payment for a tie made by an oil company to a subsidiary company. The company that pays claims the application of B.P. Australia Ltd (1965) 112 C.L.R. 386. The company receiving claims the application of Dickenson (1958) 98 C.L.R. 460. The Commissioner may find support for his view that this outcome is unfair in the general anti-avoidance provisions of the Assessment Act contained in Pt IVA. The view of this Volume is that he does not need the support of Pt IVA. It is already available in the terms of s. 51(1): where the parties are associated, an objective inference that the outgoing was not incurred for the purpose of deriving income is open.
• (ii) One taxpayer incurs an outgoing that is presently deductible but the related receipt by the associated taxpayer will not, wholly or in some part, be income derived until a later year of income. If one considers together the interests of the associated taxpayers, there is in effect a deferral of tax on income that for the time being is insulated from tax by the incurring of the outgoing. In this situation the Commissioner is given support by the specific provisions of s. 82KK.

[11.289] Section 82KK deals specially with interest that may be deductible by one taxpayer, who is on an accruals basis, when liability to pay arises, and subject to withholding tax in the hands of a taxpayer who is an associate, only when paid to him. “Associate” is defined in a comprehensive manner in s. 82KH(1). The effect of s. 82KK is to defer the deduction until interest is actually paid so that deduction and derivation of income occur in the same year.

[11.290] For the rest, s. 82KK draws a distinction between situations involving the supply of goods or services and other situations. The supply of goods or services is assumed to be the only kind of situation to which the principle in Arthur Murray will apply. The effect of s. 82KK(3) is to defer the deduction of outgoings to an associate for goods or services to the years in which the goods or services to which the outgoings relate are supplied or provided. The manner of the deferral is more specifically provided for in s. 82KK(4).

[11.291] In other situations, s. 82KK(2) deems an outgoing to an associate to have been incurred in the year of income or in a subsequent year of income only to the extent to which it represents an amount actually paid in that year of income. The assumption is that the amount will be income of the associate receiving payment in the year of income in which it is paid to him. That assumption will be correct only if receipts for goods or services are the only situations in which the Arthur Murray principle is applicable. In [11.111]–[11.112] above it was suggested that the principle, or a wider principle, is applicable to passive income, for example rent or interest received in advance. If it is applicable, s. 82KK is deficient. An actual payment of interest between associated persons will, it seems, be deductible when it is paid, notwithstanding that the interest received will be income derived over the period of lending to which the interest received relates.

[11.292] In all its applications s. 82KK is confined by s. 82KK(2)(b) to circumstances where the outgoing was incurred “by reason of, as a result of, as part of or in connection with an agreement, course of conduct or course of business that was entered into or carried out for the purpose, or for purposes that included the purpose, of securing that … [the receipt by the associated person] would not be included in [his] income … until a subsequent year of income” It may be doubted whether s. 82KK should thus be confined in its application. It is argued in [16.41]–[16.42] below that provisions of the Assessment Act which depend for an application on a finding of what is referred to as a tax avoidance purpose, are undesirable and unnecessary. Provisions which are directed to denying a tax advantage only when it may be inferred that a party to a transaction entered the transaction wanting the tax advantage that it gave, reflect a most curious approach: a taxpayer may have a tax advantage, provided it cannot be inferred from his actions that he wanted the advantage. If it is thought unacceptable that tax advantages may attend transactions between associated taxpayers, it is appropriate to deny them in all such transactions. At the same time there is good reason to question the principles from which the tax advantages arise. There is a tax advantage to be gained from any transaction, whether or not entered into with an associated person, that will allow a current deduction of an outgoing that is otherwise incurred in advance of the provision of goods or services, or the use of property of another, that is obtained by the outgoing. That advantage will be denied if a principle is adopted that will treat such an advance payment as deductible only as it is consumed in the sense explained in [11.116]–[11.119] above. There is a tax advantage that is to be gained by any taxpayer who is on a cash basis in relation to an item if actual receipt by him is delayed. There is reason to adopt accruals as the basis in relation to items of interest, rent and royalties, whenever they are derived in relation to business operations, which would include the lending of money to an associated company. The assumption of Jenkinson J. in Aktiebolaget Volvo (1978) 78 A.T.C. 4316 that Volvo Sweden was on an accruals basis in relation to the royalty receipts may point the way.