The Assessment Act in its provisions covered in this Volume is the Act as at 1 January 1985. The case law considered embraces reported decisions up to 1 January 1985.

Since 1 January the Act has been amended in some relevant respects by the Taxation Laws Amendment Act 1985. The amendments are few and not fundamental, but attention should be drawn to them. More significant are amendments foreshadowed by Government announcements, the one in late 1984 and the other in early 1985, which have not yet been expressed in a Bill. As foreshadowed these amendments will deal with deferred interest securities, securities issued at a discount and indexed capital securities, both in respect of the income character of any gain derived and the deductibility of any loss or outgoing incurred. They will also deal with what might be called business fringe benefits. Some attention should be drawn to the possible implications of such amendments if they come to be made.

More significant again are amendments foreshadowed in the Government’s preferred option in its White Paper of 4 June 1985, which include the taxing of capital gains and a new approach to the taxing of fringe benefits. An account of these proposals is not attempted in this addendum.

The 1985 judicial decisions involve some new applications of existing principles, though in some respects the formulation and application of principles might be questioned. Attention should be drawn to them.

The Taxation Laws Amendment ACT 1985

The Taxation Laws Amendment Act 1985 makes a number of amendments to the provisions of the Assessment Act concerned with the taxation of life assurance companies and superannuation funds. The amendments are all directed to the repeal of what might be called the 30/20 requirement which, if not observed, involved unfavourable tax consequences for life assurance companies and some superannuation funds.

The 30/20 requirement imposed an obligation to hold 30 per cent of assets in public securities, including 20 per cent in Commonwealth securities. The repeal of the requirement involves the repeal of s. 121C, a section referred to in [1.16], and consequential amendments to s. 26AF, referred to in [4.164] and [11.158, 159], to s. 121CA referred to in [1.3, 17] and [4.174] and to s. 82AAS referred to in [4.143, 157] and [10.113-116]; the repeal of s. 121D referred to in [1.3, 23] and [4.93, 174], and consequential amendments to s. 121B referred to in [1.16, 23] and [4.93, 172, 174], to s. 121DA referred to in [1.3, 20] and [4.157, 174, 178] and to s. 121DAB referred to in [1.3, 19, 20, 21] and [4.93, 174]; and the repeal of s. 121DE.

Section 26AFA has been amended to remove the reference in s. 26AFA(1) to s. 26(d). That reference is the subject of comment in [4.164].

Amendments have been made to s. 82KH to extend the operation of s. 82KL by extensions to the definitions of “relevant expenditure” and “eligible relevant expenditure”. The extensions are concerned with deductions under certain expenditure recoupment schemes incurred after 24 September 1978, but will not apply to deductions under schemes entered into after 27 May 1981. From that date the schemes are left to the possible operation of Pt IVA. The extensions to the operation of s. 82KL relate to schemes to exploit deductibility under Div. 10B of Pt III, or the general provisions of s. 51(1). Sections 82KH and 82KL are considered in a number of places in the text, more especially in [10.330-343] and [16.11, 13]. Section 80(5) has been amended so as to deny loss carry forward in respect of losses that arise from deductions under schemes of the kind to which the new provisions of s. 82KH refer, that were entered into on or before 24 September 1978. Section 80(5) is considered in [10.374].

The Taxation Laws Amendment Act 1985 includes provisions amending Div. 1A of Pt III to remove Christmas Island from the scope of that Division. Subject to some transitional provisions, Christmas Island has become part of mainland Australia for all purposes of the income tax law. The new provisions are in s. 24BA. Division 1A is considered in [1.24, 25].

Amendments Foreshadowed in Government Statements

Deferred interest securities, securities issued at a discount and indexed capital securities

Amendments foreshadowed by the Government statement in late 1984 relate to deferred interest securities, securities issued at a discount (including so-called DINGO bonds) and indexed capital securities issued after 17 December 1984. The statement (CCH Australian Federal Tax Reporter, para. 98-840) makes the assumption that “under existing income tax law the gain to an investor from holding [such] securities (i.e. the difference between purchase price and the amount received at sale or maturity) is income, akin to interest”, and observes that “[the gain] is taxed at redemption/maturity of the instrument”. This assumption underlies the provisions of s. 23J and is discussed, in connection with that section, in [2.295, 296] and [12.214], and, more generally, in [6.313] and [11.252-258]. The foreshadowed changes in the law are thus explained in the statement:

The statement also includes the observations that “under the present law the investor is not taxed on the deferred interest until he receives it at maturity, but there has been a Federal Court decision (F.C. of T. v. Australian Guarantee Corporation Ltd) that the issuer may be allowed a deduction of the interest as it accrues throughout the life of the security, even though the interest is not payable until maturity”, and that “The same position could follow with discounted securities”. Implicit in these observations is some questioning of the Federal Court decision. In fact, the Commissioner sought and obtained special leave to appeal to the High Court in that case, but the leave was subsequently rescinded, possibly because of the foreshadowing of amendments to the Act in the statement. Australian Guarantee (1984) 84 A.T.C. 4642 is discussed in [11.116-121] and in other contexts, where it is regarded as reflecting an important development in general principles of tax accounting.

The foreshadowed amendments will abandon, where they apply, the principle of tax accounting that a gain to be income must be realised—a principle considered in [12.59-72]. They will treat a gain as income as it “accrues”, in a sense of that word that is otherwise irrelevant in tax accounting. They will treat as income an unrealised increase in the value of an asset.

The foreshadowed amendments will, it seems, apply only where a bond has been issued at a discount. Where a bond that carries a low rate of interest compared with current commercial rates is purchased at a discount, any income derivation by the holder will be deferred until the time of redemption or his sale of the bond. Whether there is income at that time will depend on the correctness of the assumption that the excess of the amount realised over cost,where the bond is not a revenue asset and s. 25A is not applicable, is “in the nature of interest”.

Business fringe benefits

The foreshadowed amendments to overcome the decision in Cooke and Sherden (1980) 80 A.T.C. 4140 are the subject of a statement of 4 February 1985 (C.C.H. Federal Tax Reporter, New Developments, para. 98-858). The amendments will include in the income of the purchaser who receives an otherwise tax free benefit from a supplier, the amount that the benefit would have cost the purchaser in an arm’s length transaction. The amendments will apply to benefits given or granted after 4 February 1985. Where a benefit granted to the purchaser is made available to an ordinary employee of the business “the taxation treatment in the hands of the employee will continue to be determined under the existing income tax law”, presumably s. 26(e).

The Judicial Decisions

Two new Federal Court decisions are Lau (1984) 84 A.T.C. 4929 and Merv Brown Pty Ltd (1985) 85 A.T.C. 4080. Lau is disappointing in the failure of the Federal Court to consider the relationship between its decision in the case and its decision in Australian Guarantee. The latter decision is explained in the text of this volume as establishing a principle that an outlay which is the cost of an advantage that will be consumed over a period of years in a process of income derivation—in Australian Guarantee the advantage of the use of the borrowed money—will be deductible only as the advantage is consumed. It would follow from that principle that an outlay on management services to be performed by another over a period of years—21 years in Lau—is deductible, if deductible at all, over the period of years in which services will be performed. Alternatively the outlay may be seen as the cost of an advantage that is a structural asset and not deductible. The cost of the advantage of the long-term tie to which the garage proprietor was made subject in Strick v. Regent Oil Co. Ltd [1966] A.C. 295 was held in that case to be a capital outlay.

Though the Federal Court in Lau did not consider the principle in Australian Guarantee, it did consider the possibility that the outlay was a capital outlay. Beaumont J. concluded that the outlay was a revenue outgoing because it was a payment for a regular return in services. The payment in Strick v. Regent Oil, unless a form approach centring on the payment as a payment of a premium is taken, was a payment for a regular return in the selling by the garage proprietor of the taxpayer’s oil products.

The decision of the majority of the Federal Court in Merv Brown is disappointing. It gives no attention to the agency cases. The failure of the Supreme Court to give attention to the agency cases is noted in the text of the Volume at [2.486]. With respect, the question in Merv Brown was not whether the sale of the import entitlement was a normal incident of trading activities or a purpose for which the taxpayer carried on business. The question was simply whether the import entitlement was a revenue asset, and that was to be answered in terms of the significance of the import entitlement to the taxpayer’s business operations. In none of the agency cases was the question posed by the Federal Court given any attention. Indeed it could not be said of any of the cases in which the agency was held to be a revenue asset that sale was ever contemplated. In all cases the realisation of the agency was by way of a surrender of the rights given by the agency for a sum of money. The decision of the Federal Court involves the consequence that the cost incurred by a taxpayer in the circumstances of Merv Brown in the purchase of an import licence is not at any time deductible by him, notwithstanding that the cost is incurred in carrying on his business. It must be seen as the cost of a structural asset, and no amortisation provisions are available.

The decision of Lusher J. in Creer (1985) 85 A.T.C. 4104, like the decision of the Federal Court in Lau, fails to consider the principle in Australian Guarantee which would have directed that the payments of rent in advance should be spread over the periods of the leases. And the decision allows an immediate deduction of the rent paid in advance without any consideration being given to the relevance of the outgoing to the derivation of income. That relevance, it is submitted, depended on the prospect that the property leased to the taxpayer would continue to be used by him in a process of income derivation, presumably by sub-letting. The onus of showing relevance rested on the taxpayer. The discussion of Ilbery (1981) 81 A.T.C. 4661 in the text of the Volume at [6.117-136] and [11.117-120] is in point.

The decision of David Hunt J. in Gwynvill Properties Pty Ltd (1985) 85 A.T.C. 4046 distinguished Ilbery on the ground, amongst others, that the taxpayer in that case did not carry on a business. David Hunt J. held that the taxpayer in Gwynvill was entitled to a deduction for interest paid in advance, and the interest was deductible on payment. The assumption that the second limb of s. 51(1) allows deductions on a more generous basis than the first limb is not supported by authority. Gwynvill, like Creer, fails to consider the principle in Australian Guarantee. Relevance to the derivation of income was assumed rather than expressly found. The payment was an amount of interest for a period of five years. A demonstration of relevance where a payment of interest is made in advance may be easier where the taxpayer conducts a business and the amount borrowed has become part of the funds available for use in the conduct of the business.

The judgment of David Hunt J. includes an affirmation (at 4056) that “… contrary to the Ramsay principle applicable in England, it remains necessary to consider and respect the legal form of the transaction in question … it is not legitimate to disregard … the nature of the contracts made; and there is no room in this connection for taxation by end result or economic equivalence …”. This affirmation, made in relation to deductibility under s. 51(1), is an expression of the extended form and blinkers approach considered in the text of the Volume, more especially at [6.83-84, 108–111] and [9.17-26]. There is no reference in the judgment in Gwynvill to the rejection of the extended form and blinkers approach by Dixon J. in Hallstroms Pty Ltd, referred to in the text of the Volume at [9.18], or to the support given Dixon J. by Gibbs J. in South Australian Battery Makers referred to at [9.19] in the text of the Volume.

Mutual Acceptance Limited (1984) 84 A.T.C. 4831 is an application of the principle that a gain arising on the discharge of a liability on revenue account is income. At the request of the lender a finance company repaid a borrowing by the payment of a lesser amount than the amount it had borrowed. The principle has been established in cases relating to exchange gains considered in the text of the Volume in [6.327-329] and [12.192-211]. Enderby J. undertook a lengthy review of the exchange gains cases in deciding that the borrowing by the finance company involved a liability on revenue account. His conclusion that “the gain had the character of income which could be expected to arise from time to time from the difference between the price of [the taxpayer’s] borrowed money and the price of the money it loaned out” involves an assumption that the revenue character of the liabilities arising from the borrowings of a finance company is to be explained in the manner referred to in the text of the Volume at [12.210].

Kratzmann’s Hardware Pty Ltd (1985) 85 A.T.C. 4138 is an application of the High Court’s decision in Murphy’s case (1961) 106 C.L.R. 146, considered in the text of the Volume at [12.102-106]. The principle is sometimes expressed as “once trading stock, always trading stock”. The decision also raises a question of the correlation between continuing business principles and the operation of s. 25A(1). One would have thought that a transaction of acquisition which was a transaction of a continuing business could not be seen as the first step of a s. 25A(1) transaction in the event that the business was discontinued. This would be at odds with the views on the correlation between continuing business principles and s. 25A(1) expressed in Investment and Merchant Finance (1971) 125 C.L.R. 249 and Whitfords Beach (1982) 150 C.L.R. 355. The matter of correlation is considered in the text of the Volume in [2.431-436] and [3.4-11].

In Milton Corporation Ltd (1985) 85 A.T.C. 4243 the Commissioner sought an extension of the so-called banking and life assurance cases to the circumstances of a company whose business was, in the view of the court, the borrowing and lending of money. Those cases are considered in the text of the Volume at [2.455-477]. The extension sought would parallel the extension of the life assurance cases to the circumstances of a taxpayer carrying on a general insurance business in Chamber of Manufacturers Insurance Ltd (1984) 84 A.T.C. 4315 discussed in [2.476-477]. The decision of Lusher J. in Milton Corporation might be said to accept that the extension sought by the Commissioner is appropriate. His conclusion was, however, that the principle of the banking cases did not require on the facts of the case before him that profits on the sale of the investments should be treated as income. In reaching this conclusion he recognised and adopted, in relation to a business of borrowing and lending money, the formulation of principle in the Federal Court in Chamber of Manufacturers that gains on the sale of investments that are part of a “reserve fund” are income. His notion of a “reserve fund” is “standby funds to meet … a run” (at 4249), which is a more limited notion than that of a fund “to meet claims and expenses in all reasonably foreseeable contingencies” adopted by the Federal Court in Chamber of Manufacturers (at 4318-9) and considered in the text of the Volume at [2.475-477]. The investments in Milton Corporation were not held as part of the standby funds.

The manner of making and realising investments in Milton Corporation did not admit of any characterisation of the investment activity as a business of switching—the explanation of the judgment of Gibbs J. in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106 given in the text of the Volume at [2.465-466].

Kelly (1985) 85 A.T.C. 4283 is an application of a principle considered in the Volume in [2.162]. A prize may be income as a reward for services where it is connected with the rendering of services to a degree which will make it a product of those services. The connection that will make it a product does not require that the giving of the prize was, in the intention of the donor of the prize, to reward the taxpayer for services rendered by the taxpayer to his employer or to the donor. It is enough that competing for the prize is incidental to the taxpayer’s employment. In Kelly the prize was for the “best and fairest” footballer, and the donor was a television station. The general principle stated in the Volume in Proposition 13 [2.367-428] that a gain that is a reward for services is income might be better expressed as “a gain which is a product of services is income”. The word “reward”, unless understood in a broad sense, may be too limiting. The word “product” will embrace a receipt which is incidental to the employment.

The decision of Murphy J. in the Victorian Supreme Court in Myer Emporium Pty Ltd (1985) 85 A.T.C. 4111 raises questions of some significance. The conclusion of Murphy J. was that the sale by Myer of the rights to future interest, separated from the right to repayment of the loan, was a sale of a structural asset, and that the proceeds were not in any part income. He rejected an argument that the proceeds were income as compensation receipts. The question whether the proceeds of realisation of a structural asset may be income as compensation for income flows that might have been derived from the asset is considered in the text of the Volume in [2.510-517]. The view that the rights to interest receipts constituted an asset independent of the debt for the money lent and could be disposed of by assignment, supports the view taken in [13.32-34] of the text of the Volume. That view is that an assignment of rights to future receipts is an assignment, in the metaphor adopted by Kitto J. in Shepherd (1965) 113 C.L.R. 385, of a tree from which the future receipts may be derived by the assignee as income receipts. The period for which the taxpayer thought it necessary to make the loan in Myer in order that the assignment might escape the operation of Div. 6A of Pt III, assumes a view of the operation of Div. 6A which is not accepted in the text of the Volume. The matter is considered at [13.85-90]. Had the loan been regarded as a revenue asset there would have been awkward questions in determining the profit that was income on the sale of the rights to future interest. Murphy J. was conscious of the problem. The provisions of legislation foreshadowed in the Government’s statement of 17 December 1984 in regard to deferred interest securities and securities issued at a discount will include a provision whereby an issuer who buys bonds and makes separate sales of the right to the principal sum and of the rights to the receipts of interest, will have a cost of the rights determined by an apportionment of what it has paid for the bonds. Those provisions will not it seems apply to the sale of the rights by a taxpayer in the situation of Myer who was not a purchaser of the loan and its attendant rights but the original lender. As a matter of general principle it might be doubted, in any event, that any outlay in acquiring or making a loan can be seen as a cost of future interest. It will follow that the seller of the rights, if they are seen as part of a revenue asset, will generate income in the amount of the gross proceeds. At the same time the sale of the loan separated from the rights will have a cost of the whole amount outlaid. The selling of the loan and the retention of the rights to interest raises the possibility of generating a deductible loss. There may be thought to be a need of a provision such as in s. 6BA to achieve generally what is proposed in a limited context in the foreshadowed provisions in relation to the issue of securities at a discount. Those foreshadowed provisions will presumably apply to the finance company buyer in a Myer situation so that it will not be entitled to an immediate deduction of the cost of acquiring the rights to future interest receipts. As a matter of general principle the submission would be made that the cost is the cost of a wasting revenue asset that is not immediately deductible but deductible only as the asset is consumed in the process of deriving the interest receipts.

1 July 1985