[7.1] In Chapter 5, above, attention was given to the framework of s. 51 (1). The view there taken ([5.7]–[5.13] above) is that the exceptions in the concluding part of s. 51 (1) are not true exceptions, but are simply statements of what must be distinguished from items which qualify for deduction under the earlier part of the subsection. Among these exceptions are “losses or outgoings … of a capital … nature”. A capital loss or outgoing is simply an expense which, though relevant to the derivation of income, fails to achieve deductibility because it is not a working expense.

[7.2] It follows that characterisation of a relevant expense as a working expense is a denial that it is a capital expense, and a characterisation of an expense as a capital expense is a denial that it is a working expense. Because of the contradistinction drawn in the excepting of capital expenses, a good deal of decision making on the deductibility of expenses has focused on the question whether the expense is a capital expense, and it is helpful to review the characterisation in these terms of a number of classes of expense.

[7.3] In some instances, the focus on the question whether there is a capital expense has tended to cause an oversight of another question which ought to have been given attention—whether there is an expense at all. The view taken in this Volume is that, save where the Assessment Act expressly so provides, the cost of a non-wasting asset is not a deductible expense. It may be a cost which will enter the calculation of a loss which is deductible on the realisation of the asset. It will be such if the asset is a revenue asset. But the incurring of the cost is neither an outgoing nor presently a loss. The cost is best described as an outlay. In these circumstances a characterisation of the cost as capital is an anticipation of a characterisation that will need to be made on the realisation of the asset, when the issue will not be whether there is a deductible outgoing but whether there is a deductible loss. The characterisation of the outlay as capital is a conclusion that the asset acquired is part of the structure of the process by which income is derived, and that a loss on the realisation of that asset will be non-working, and may be described as a capital loss.

[7.4] The losses and outgoings considered in Chapter 6 above under the title “Relevant expenses that are working” have for the most part raised issues of relevance rather than issues of working character. Generally, working character has been evident. On occasions, however, the prospect that a loss or outgoing that is relevant might be denied working character because it is capital was raised. Thus it was noted that a loss arising from the deprivation of an asset may be capital where the asset is a part of the structure of the process by which income is derived. And an outgoing by payment of interest in advance may be capital, if it is seen as the cost of a lasting advantage.

[7.5] The losses and outgoings considered in the present chapter are evidently relevant, and the question is whether they have a working character, or, put negatively, whether they should be denied a working character because they are capital. The meaning of capital, so far expressed in the words “related to the structure of the process of income derivation”, has been the subject of a wealth of judicial pronouncements. Classical among these are pronouncements by Dixon J. in Sun Newspapers Ltd (1938) 61 C.L.R. 337 in Australia, and by Viscount Cave L.C. in British Insulated & Helsby Cables Ltd [1926] A.C. 205 in the United Kingdom.

[7.6] Dixon J. in Sun Newspapers Ltd said:

[7.7] No pronouncement will, however, be definitive. The judgment of Dixon J. is referred to in all the judgments in the High Court in Cliffs International Inc. (1979) 142 C.L.R. 140. Yet the conclusion that there were deductible outgoings was reached only by a majority. The first of the matters which Dixon J. thought should be considered will no doubt be determinative if there is a single outlay that is fairly to be regarded as a cost of the advantage, and the advantage is part of the structure of the process of income derivation. But Cliffs International indicates that the characterisation of an outlay as a cost of an advantage may take the enquiry beyond the terms of any contract which concerns that advantage. The second matter—the manner in which the advantage is to be used, relied on or enjoyed—must bear on the question of the character of the advantage. The second matter is thus no more than an indication of what may determine the character of the advantage referred to in the first matter. The third matter focuses on the identification of the advantage. The advantage may be the right to present and future use and enjoyment of property or it may be only the current enjoyment of property. An illustration may be found in the distinction between a lease giving rights to present and future enjoyment, secured by the payment of a premium, and the current enjoyment secured by the payment of rent under the lease. And the matters to which Dixon J. drew attention are only some of the matters that are relevant to a conclusion that an expense is a capital expense. It will be seen that an expense may be denied deduction on the ground that it is a capital expense though no asset or advantage is secured by the expense.

[7.8] The pronouncement taken from the judgment of Viscount Cave L.C. in British Insulated & Helsby Cables that has become classical is:

The pronouncement by Viscount Cave L.C. puts emphasis on the “bringing into existence of an asset or advantage for the enduring benefit of the trade”, and there is a like emphasis on this factor in the pronouncements of Dixon J. It will appear from the examination of the judgments in the High Court decision in John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 later in this chapter, and more especially the judgment of Dixon C.J. in that case, that, at least in Australian authority, bringing into existence an enduring advantage is not a necessary condition of the characterisation of an outgoing as capital. The problems of characterisation of losses and outgoings as working or as capital are considered under headings which distinguish situations where an asset is acquired, from situations where no asset is acquired.

Characterisation of the Costs of Acquiring Assets

Structural assets and revenue assets; non-wasting assets and wasting assets

[7.9] The distinction between working expenses and capital expenses justifies the assertion of a general principle that the cost of acquiring a capital, or perhaps the better term, a structural asset—an asset that is part of the structure of the process of income derivation—is not deductible, nor is a loss on the realisation of such an asset deductible. It does not of course follow that the cost of acquiring a revenue asset—an asset that is not part of the structure of the process of income derivation—is deductible. An explanation has already been offered ([5.24] above) of s. 51 (2) that it specifically displaces a principle that the cost of a non-wasting revenue asset is not deductible, and allows a deduction as part of the special regime, in ss 28ff., applied by the Assessment Act to trading stock. In other circumstances the cost of a non-wasting revenue asset is not deductible, though that cost may enter the calculation of a loss that is deductible on the realisation of the asset. The cost is not an outgoing: it is no more than an outlay. The concept of a non-wasting revenue asset covers assets in which a business deals, or which is otherwise turned over in the carrying on of the business such as the investments of a life insurance company or banking company or the investments of the taxpayer in London Australia Investment Co. Ltd (1997) 138 C.L.R. 106. And it covers a receivable which is a revenue asset and which may give rise to a loss or gain on realisation—an exchange loss or gain, for example, or a loss arising because the receivable becomes a bad debt and is realised for less than its cost. The asset may waste, in some sense of the word, but the wasting is not the consumption of the cost of the asset in the process of income derivation. A motor vehicle is a non-wasting revenue asset of a business that deals in cars. A motor vehicle is a wasting, though very likely a capital, asset of a business that uses motor vehicles in the transporting of its products. The conclusion in both Nchanga Consolidated Copper Mines Ltd [1964] A.C. 948 and B.P. Australia Ltd (1965) 112 C.L.R. 386 may be explained as a conclusion that the asset acquired—a relatively short term restriction on another’s activity which would have involved competition with the taxpayer—was a wasting revenue asset. Export entitlements acquired by an exporter and import licences acquired by an importer are very likely wasting revenue assets.

[7.10] Where a wasting asset is a structural asset, the cost of it will not be deductible and a loss on realisation of the asset will not be deductible under s. 51 (1). The cost may, however, be deductible under express provisions allowing deductions for depreciation or amortisation of the costs of wasting capital assets, for example those relating to depreciation of plant or articles used in a process of income derivation (ss 54ff.), amortisation of items of commercial or industrial property used in a process of income derivation (Div. 10B of Pt III), and provisions which have a like operation specifically in relation to the mineral and timber industries (Divs 10, 10AA and 10A of Pt III). Where no express provisions allow deductions, the cost of a wasting structural asset, for example the asset acquired by the taxpayer in Strick v. Regent Oil Ltd [1966] A.C. 295 or by the taxpayer in Ballarat & Western Victoria T.V. Ltd (1978) 78 A.T.C. 4630, will not be deductible at any time. A payment of interest in advance, such that a lasting advantage in the use of money thereafter at no or low interest is achieved, may be seen as the cost of a wasting capital asset so that the payment in advance will not be deductible at any time. The matter is considered in [6.86]–[6.141] above. The costs of acquiring know-how that is a structural asset will not be deductible at any time, though those costs are consumed in the taxpayer’s manufacturing operations. The costs of acquiring a restrictive covenant given by an employee are not deductible, though the advantage of immunity from competition is a business advantage that wastes over the period of the covenant. The costs of acquiring goodwill are not deductible at any time. In this last instance there may however be an argument that the goodwill does not waste in the carrying on of a business.

[7.11] Where the wasting asset is a revenue asset the cost of it, it is generally assumed, is deductible at the time the cost is outlaid. The cost is treated as an immediate outgoing. In dealing with the deductibility of interest paid in advance in [6.86]ff. above, it was suggested that where the asset acquired—the use of money at no or low interest in the future—is a revenue asset, the interest outgoing is incurred not at the time of payment but over the period of the borrowing as the interest cost is consumed. Such an approach was taken in Arthur Murray (1965) 114 C.L.R. 314 in regard to the derivation of income. It was also suggested that if the interest cost is not treated as incurred in this way, it should not qualify as a relevant expense. A claim for the deduction of interest on money borrowed may well depend on a showing by the taxpayer that the money borrowed is outlaid and will continue to be outlaid during the period to which the interest relates in a process of income derivation. A taxpayer cannot satisfy this onus in relation to interest paid in respect of the future use of money and the interest so paid will not be deductible.

[7.12] Where the advantage gained in acquiring a wasting revenue asset appears to have no function save in a process of income derivation—the advantage in B.P. Australia or in Nchanga—the taxpayer claiming an immediate deduction can satisfy the onus of showing that his cost is relevant. And if he realises the asset there is the prospect that he will derive income in the form of a profit. In theory that profit is the amount by which the proceeds of realisation exceed the cost of the asset, but s. 82 will preclude the subtraction of the cost already allowed as a deduction. The Commissioner is, however, at risk that the asset may be realised in circumstances which do not involve any receipt by the taxpayer of the value of the asset. He may dispose of the asset to an associate for less than its value, or make a gift of the asset to another, as the taxpayer did in Mason v. Hammond Innes [1967] 2 W.L.R. 479, or the cost may be consumed in circumstances which show no continuing relevance to a process of income derivation. Unless some general principle of the kind adopted in the United Kingdom in Sharkey v. Wernher [1956] A.C. 58, which imports a deemed realisation at market value, is held applicable, the whole of a cost will have been allowed, notwithstanding that, in the events which have occurred, that cost has not in the whole of its amount been incurred in a process of income derivation.

[7.13] Insisting that the cost of a wasting revenue asset is incurred only as the cost is consumed will mitigate this unfairness to the Commissioner. There will however be problems in determining what costs are ordinary deductible outgoings and deductible immediately, and what costs are to be regarded as costs of revenue assets and deducted only as they are consumed. The problems have some kinship with those which arise under the trading stock provisions in drawing a distinction between “overheads” or “on-costs”, which must be so treated and, in effect, deferred by the operation of the trading stock provisions until the items are realised, and other overheads which will formally and in effect be deductible immediately.

[7.14] The problem of distinguishing ordinary outgoings in carrying on a business from the costs of non-wasting revenue assets which the business produces and which are turned over in carrying on the business, is highlighted in the United Kingdom decision in Mackenzie v. Arnold (1952) 33 T.C. 363. An author may make a number of outlays, for example for travel in researching material for a novel. There will be problems going to contemporaneity if it is not yet evident that he has entered on a business of authorship. However, even if it is accepted that a business has commenced there are problems of distinguishing costs which are ordinary outgoings in carrying on the business, and deductible if they are relevant, and costs which are not deductible but may enter the determination of a loss or a profit on the realisation of the copyright in the novel that is written following the research. Other problems are posed if the author is a non-resident at the time he engages on research. The research expenses, if the author should submit a return and claim deduction for them, will presumably be denied deduction as not relevant to the derivation of assessable income. Even if the costs are seen as present outgoings, the author will none the less be unable to establish the relevance of those outgoings to the derivation of assessable income. If he remains a non-resident the sale of the copyright can generate assessable income only if the gain on realisation has an Australian source.

[7.15] If the costs are treated as costs of acquiring the copyright in the novel that he writes, they will enter the calculation of a loss or profit on realisation, which will be deductible or be assessable income if the author is at the time of realisation an Australian resident. The loss will be deductible and the profit assessable income, unless the income that would have resulted or does result is exempt under s. 23 (q) as foreign source income subject to tax in the country of source. Treating the costs of research as costs of the copyright may be thought to produce the more logical and the fairer outcome.

[7.16] The assumption in the observations just made is that copyrights are not trading stock of an author. If a copyright is to be treated as trading stock and the research costs are to be treated as costs of the copyright, the operation of the trading stock provisions (ss 28ff.) will be to allow outgoing deductions at the time of incurring those costs. The outgoings will however be deferred until the year in which the copyright is realised. The operation of the trading stock provisions becomes distorted if the taxpayer is not resident at the time of incurring the costs and becomes resident at the time of realisation. There is a prospect of denial of the outgoing deductions for costs of the copyright, notwithstanding that the proceeds of realisation are assessable income. The prospect is a consequence of the departure from basic principle involved in the statutory regime.

Costs of trading stock

[7.17] It follows from the analysis in the immediately preceding paragraphs that costs of trading stock are not outgoings deductible under s. 51 (1), if that subsection is considered without the assistance of s. 51 (2). Trading stock are non-wasting revenue assets and their cost is an outlay, not an outgoing, though the cost will enter the calculation of a loss that is deductible on the realisation of the trading stock. Section 51 (2) has displaced this operation of the Act. The subsection is part of a special regime applicable to trading stock as defined in s. 6. That regime is contained in Subdiv. B of Div. 2 of Pt III. It was the subject of some observations in ([5.24]) and is dealt with in more detail in Chapter 14 below. Where assets are turned over in the carrying on of a business but are not trading stock—the investments of a life insurance company or a banking company, or the investments in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106—the cost of an asset is not deductible though it will enter the calculation of loss or profit on realisation.

[7.18] Difficulties in distinguishing costs which are to be treated as costs of trading stock and costs which are ordinary deductible outgoings may be suggested by the discussion of the difficulties of identifying the costs of a copyright which is produced by the work of an author, in [7.14]–[7.16] above. Other difficulties arise in distinguishing costs which relate to the acquiring of a source of supply of trading stock and costs of acquiring trading stock.

[7.19] Costs which relate to the acquisition of a source of supply of trading stock, for example mining rights, or land with standing timber, will ordinarily be non-wasting and not deductible. Where the taxpayer deals in mining rights, in timber bearing land or in rights to take timber from land, the costs of acquisition will be deductible as costs of rights or land which are themselves trading stock. Where, however, he proposes to use the rights or land as a source of supply of trading stock in the form of minerals or timber, the costs of the rights and land are not deductible. The rights and land are structural assets and the taxpayer must in general rely for any tax relief in respect of the costs of them on provisions of the Assessment Act in Divs 10, 10AAA, 10AA, 10A which relate to the mining and timber industries.

[7.20] What is said of land bearing timber is applicable to land which includes soil, sand or gravel, which the taxpayer acquiring the land proposes to take from the land and sell, or to rights to take soil, sand or gravel which the taxpayer acquiring the rights proposes to exercise in order to acquire the commodity for sale. In these instances, however, there are no provisions of the Act giving any relief in respect of the costs of acquiring the land or rights.

[7.21] In some circumstances it may be held that the taxpayer has not acquired rights or land which will yield trading stock, but has acquired the stock immediately and is therefore entitled to a deduction of his costs of trading stock. The distinction between acquiring “the means of obtaining [the] raw material” of a business and acquiring “[the] raw material itself” (Golden Horse Shoe (New) Ltd v. Thurgood [1934] 1 K.B. 548 at 565) is not definitively drawn in the cases. Golden Horse Shoe involved dumps of gold mine tailings and the purchase of the tailings was held to be the acquisition of trading stock. It may be important that the dumps were not a natural part of the soil. In Kauri Timber Co. Ltd v. C. of T. (N.Z.) [1913] A.C. 771, one of the transactions with which the case was concerned was a purchase of timber standing on land with a right to remove the timber. The Privy Council treated the transaction as the purchase of a source of trading stock. In Stow Bardolph Gravel Co. Ltd v. Poole [1954] 1 W.L.R. 1503 the purchase of deposits of sand and gravel was treated in the same way. The conclusion reached by Buckley J. in Hopwood v. C. N. Spencer Ltd (1964) 42 T.C. 169 is not easily reconciled with Kauri Timbers and Stow Bardolph Gravel. A purchase of land carrying timber entered into by the shareholders of a company was construed as a purchase by the shareholders, for themselves, of the land apart from the timber, and a purchase for the company of the timber on the land. Buckley J. concluded that the company had purchased the timber as trading stock. The matter’ is the subject of further consideration in [14.39]ff. below and in [6.179]ff. above.

[7.22] The denial of a deduction for the cost of the means of obtaining trading stock leaves open the possibility of a deduction of the value of an item at the moment the taxpayer acts to take the item into his business as trading stock. In the situations envisaged in previous paragraphs, that moment is the time immediately before trees are severed, or soil, sand or gravel is quarried from the soil. The deduction is of the value of the item before any value is added by the severance or quarrying. Where the land and its timber, soil, sand or gravel has become committed to a business of exploiting the resource, the more appropriate time at which to value in determining the cost on taking would be the time the commitment was made. At least in the case of timber, which is a renewing resource, it is appropriate to bring in as income any increase in value of the timber between the time of commitment and the time of taking. Allowing as cost the value of the timber at the time of commitment will achieve this.

[7.23] The United Kingdom cases and the Australian decision in White (1968) 120 C.L.R. 191 are not necessarily opposed to allowing a cost in this way at the time of taking. The possibility of allowing such a cost is raised in at least one of the United Kingdom cases. It was not raised in White. The matter is the subject of consideration in [6.195]ff. above.

[7.24] The principle is accepted that a taxpayer who takes an item, which until now he has held privately or as a capital asset, and makes it a revenue asset of his business, is entitled to a deduction if the item forthwith becomes trading stock, or to a subtraction in computing any loss or profit on realisation if it forthwith becomes a revenue asset but not trading stock. The principle was accepted, most recently, in Curran (1974) 131 C.L.R. 409 by Gibbs J., though, with respect, it was in that case misapplied: the principle can have no application to an item which is a receipt in carrying on a business. The bonus shares and the amount applied in paying them up were receipts in carrying on the business of the share trader taxpayer. To allow a deduction of the value of the item, or a subtraction in computing the loss or profit on its realisation, is to confound the income tax in its most basic operations. If the item is properly to be regarded as an item of exempt income, there is room for a principle which will require the protection of the exemption by allowing a cost, so that the item is exempted not only at the time of its derivation but also at the time of its realisation. Some such principle may explain the judgment of Barwick C.J. in Curran, though, with respect, it, too, was misapplied. The High Court had settled in Gibb (1966) 118 C.L.R. 628 that a bonus issue from a capital profit is not exempt income—it is simply not income. And there is need of another principle—that where an item is received and its value is income, a deduction must be allowed of that value as a cost of that item if it is trading stock, or a subtraction of the value must be allowed in computing the loss or profit on its realisation if it is a revenue asset but not trading stock. The deduction or subtraction must be allowed to prevent double tax. Treating the value of the item as income may be regarded as bringing in the proceeds of a notional realisation. The asset must then be deemed to have been re-acquired at a cost equal to the amount of those proceeds. In Curran, on the previous authority of Gibb, the bonus issue was neither an item of exempt income nor of assessable income. An allowance of a deduction or subtraction was inappropriate. It would have been appropriate had the item been a bonus issue from a revenue profit, in which case there would have been an assessable dividend, and to the extent of the amount of the income assessed a deduction should be allowed as the cost of trading stock. A contrary view expressed in the judgment of Stephen J., who dissented in Curran, is, with respect, unacceptable.

[7.25] Where the item has been acquired otherwise than in carrying on the business—where it is held privately or as a structural asset of the business prior to its being taken in as trading stock or other revenue asset—the value of the item is deductible or subtractable so as to ensure that the taxpayer is not taken to derive as income what is, in effect, his investment in the business.

[7.26] The allowance of a deduction or subtraction of the value of the item immediately before it is taken into the business as a revenue asset will pose difficult problems of valuation, but they are problems which the law has to meet in other contexts: like problems must have arisen in computing the profit that was held, in principle, to be an item of income in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355.

[7.27] The allowance of a deduction should extend to situations where the taxpayer does not own the item prior to its being acquired as trading stock: a right to take will need to be valued. There is a precedent for valuing a right that is exercised in acquiring a revenue asset, and allowing that value as a cost in computing the profit from the realisation of the asset, in the decision of Kitto J. in Executor, Trustee & Agency Co. of S.A. Ltd (Bristowe’s case) (1962) 36 A.L.J.R. 271.

[7.28] In some circumstances the allowance of a deduction or substraction of the value of the item may, by inference, be excluded by specific provisions of the Act. Thus, s. 124J allows a deduction of a part of the cost to a taxpayer of acquiring land carrying standing timber, where the timber is felled by the taxpayer and taken into a business as a revenue asset of that business or where the taxpayer derives royalty income as a result of giving rights to another to fell the timber. Where land is acquired carrying standing timber the operation of the section depends on a part of the cost of the land being shown to be “attributable” to that timber. The operation of s. 124J is less than satisfactory where the land has been acquired perhaps many years before the operations from which income is derived are embarked upon. It is arguable none the less that the specific provisions of s. 124J exclude the general principle that would allow deductions or subtractions as the land is taken into the operations from which income is derived.

The identification of “cost”

[7.29] Some indication of the problems in identifying a cost as a cost of a non-wasting revenue asset may emerge from the discussion of the research costs of an author in [7.14]–[7.16] above. Where the asset is trading stock, there are a number of judicial decisions, considered in [14.30]ff. below, principally concerned with the question whether costs which go beyond the more immediate costs are to be regarded as costs of trading stock which will be deferred by the operation of s. 28 if the item is still on hand at year end. The question in the language of accounting is whether deferral is required of “direct” costs only, or must be applied also to “on-costs”, or, again, whether “direct” costing or “absorption” costing is to be applied.

[7.30] The relevant item of expense where the trading stock provisions apply is a deemed outgoing deductible under s. 51 (2), but subject to deferral by the operation of s. 28. Where the item is a non-wasting revenue asset, the relevant item of expense is the loss that may arise on the realisation of the asset. The cost of the asset is not an outgoing. It is an outlay. Whether the item of expense is a deemed outgoing under s. 51 (2), or a loss arising because the proceeds of realisation are less than the outlay in acquiring the asset, the requirements of contemporaneity and relevance applicable to an ordinary outgoing will apply.

The costs of acquiring structural assets

[7.31] The word “asset” is not intended to have a meaning that will import the notions of proprietary rights which belong to the law of property. A more appropriate term—indeed the term used by Dixon J. in the classical formulation of principle in Sun Newspapers Ltd (1938) 61 C.L.R. 337 ([7.6] above)—is “advantage”. The use of the word asset in accepted formulations of principle carries the risk that an argument of the kind made by counsel in Ilbery (1981) 81 A.T.C. 4234; 81 A.T.C. 4661 referred to in [6.118] above may prevail. Counsel argued that the prepayment of interest was not a capital outgoing for it did not involve an acquisition of an asset: “If you make a list of [the taxpayer’s] assets on the day before and after the transaction, there would be no change.” The submission was made in [6.117] above that the advantage of being entitled to retain borrowed money at no interest or at low interest rate obtained by a payment of interest in advance may be a structural asset. The advantage of having a superannuation fund available to its employees which results from a substantial initial contribution establishing the fund, is a structural asset of the company making the payment. This was the conclusion in British Insulated & Helsby Cables Ltd [1926] A.C. 205 from which the classical formulation of principle by Viscount Cave L.C., quoted in [7.8] above is taken.

[7.32] The range of assets that may be structural is not limited by any legal or commercial notions of property. Some indication of what may be included may appear from the discussion of Propositions 14 and 15 in Chapter 2 above. Van den Berghs Ltd v. Clark [1935] A.C. 431 at 442 is authority that a contract which relates to “the whole structure of the [taxpayer’s] profit-making apparatus” is a structural asset. Rights under an insurance contract may be structural. Ransburg Australia Pty Ltd (1980) 80 A.T.C. 4114, discussed in [6.235]–[6.241] affords an illustration. In ECC Quarries Ltd v. Watkis [1975] 3 All E.R. 843 rights inherent in planning permission to extract sand and gravel from land were held to be structural, and the costs of an unsuccessful application for such permission denied deduction as capital.

[7.33] Immunity from competition may be a structural asset. The cost to the company of a restrictive covenant taken from an employee was denied deduction in Associated Portland Cement Manufacturers Ltd v. Kerr [1946] 1 All E.R. 68. The immunity gained by the payment, at least if it is judged by the ambit of the restriction placed on the employee, was substantial. The observations of Lord Greene in the Court of Appeal, however, stress the commercial significance to the taxpayer of the immunity. B.P. Australia Ltd (1965) 112 C.L.R. 386, in concluding that the costs of the agreements between garage proprietors and the taxpayer were not capital outgoings, had regard to the significance of each individual tie in the total operations of the taxpayer.

[7.34] The House of Lords in Strick v. Regent Oil Ltd [1966] A.C. 295, in concluding that the costs of similar tie agreements were capital outgoings, also had regard to the significance of each individual tie. But the conclusion was assisted by the circumstance that the payments were in terms premiums paid by the taxpayer for leases to the taxpayer of the garage premises owned by the garage proprietors. There is an assumption in the judgments of the House of Lords of a rule of extended form which may insist that, save where a taxpayer deals in leases, a lease is always a structural asset and a premium paid for the lease is a capital outgoing. In this aspect the case may express an approach to the determination of what an outgoing is for—what is the purpose or function of the outgoing—in terms of extended form and blinkers. It is an approach that is at odds with the approach taken in Dickenson (1958) 98 C.L.R. 460 in reaching a conclusion as to what a receipt was for. A receipt expressed to be for a restrictive covenant was ultimately judged to have that character, but that judgment is expressed in the commercial language of “giving up a sphere of action”, and it was made only after a close consideration of all the circumstances.

[7.35] It is true that an extended form and blinkers approach was taken by the Privy Council in the New Zealand appeal in Europa Oil (N.Z.) Ltd v. C.I.R. (N.Z.) (No. 2) (1976) 76 A.T.C. 6001, encouraged by the Australian High Court decision in Cecil Bros Pty Ltd (1964) 111 C.L.R. 430, and that extended form and blinkers, though qualified, was adopted by the High Court in South Australian Battery Makers Pty Ltd (1978) 140 C.L.R. 645. Some comment on this development has already been made, and there are further comments later in this chapter. But those cases raised a question of relevance of an outgoing, rather than the issue of working as distinct from capital character of a relevant outgoing. In the latter field the statement of Dixon J. in Hallstroms Pty Ltd (1946) 72 C.L.R. 634 at 648 remains unquestioned: “What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.”

[7.36] A taxpayer may enter on a course of action that involves the obtaining of an immunity from competition that might have come from a number of persons. In B.P. Australia the taxpayer followed the practice of securing ties with garage proprietors to the end that all its outlets would sell the taxpayer’s products exclusively. The judgments in the case consider each tie severally in the context of the taxpayer’s total business operations. An approach that treated all the ties secured by the taxpayer as one advantage to be judged as structural or revenue, may require a conclusion that each tie is structural as part of a total structure. Treating each tie severally is an encouragement to a number of short term and limited area ties, which may indeed be secured by contracts with the same person.

[7.37] In Sun Newspapers Ltd (1938) 61 C.L.R. 337 the payment was for an interest in a newspaper published in competition with the taxpayer’s paper, the taxpayer proposing to shut down the rival paper, and for a covenant by the person from whom the interest was acquired not, for 3 years, to publish another newspaper within 300 miles of Sydney. The payment was denied deduction as a capital outgoing. The payment was seen as achieving an increase in the taxpayer’s goodwill. Sun Newspapers contrasts with the United Kingdom case of Nchanga Consolidated Copper Mines Ltd [1964] A.C. 948 where deduction was allowed of a payment by a taxpayer copper producer, under an agreement by which the producer receiving the payment would shut down its operations for a year. The payment was made in conjunction with payments by other producers. The object of the payments was to achieve a temporary restriction in output in a period of over-supply. The distinction between the cases must rest on the greater significance of the immunity from competition secured in Sun Newspapers compared with that secured in Nchanga.

[7.38] If a payment to secure immunity from competition may be seen as a capital outgoing, a payment to secure entry to a market may be capital. If the company that had received the payment in Sun Newspapers had itself subsequently made a payment to secure a release from its covenant, that payment would presumably have been a capital outgoing.

[7.39] A conclusion that an asset is structural and the cost of it not deductible must always depend on a judgment of the significance of the asset to the process of income derivation. In making that judgment a rule of accounting that would capitalise an expense of an asset, and amortise that expense if the asset is a wasting asset, and the action of the taxpayer in applying that rule in his own accounts, will have a bearing but will not be definitive. The recognition of a bearing appears in the judgments in B.P. Australia Ltd (1965) 112 C.L.R. 386 at 403 and in Strick v. Regent Oil Ltd [1966] A.C. 295 by Lord Morris (at 334) and Lord Reid (at 316). The extent of the bearing of rules of accounting and the fact that they have been applied is a pervasive question: it is not limited to the characterisation of outgoings. It was raised in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 on the question of when an item of income is derived. It is raised on questions of the general basis of tax accounting—cash or accruals—which may apply to a taxpayer. Courts in both Australia and the United Kingdom are agreed that accounting rules and the application of them are significant but not decisive. Odeon Associated Theatres v. Jones [1973] Ch. 288 and Heather v. P.E. Consulting Group Ltd [1973] Ch. 189 suggest they have a greater significance in the United Kingdom than in Australia. Both Arthur Murray and Henderson (1970) 119 C.L.R. 612 in Australia may be thought to minimise their significance.

[7.40] The relevance of accounting rules and their application in relation to the characterisation of an asset as structural or revenue, may be thought to be affected by the differing consequences of the characterisation. An accountant will amortise the cost of a wasting asset over the life of the asset. Amortisation, for tax purposes, of the cost of a wasting capital asset will be allowable only where express terms of the Assessment Act provide for this. Which may suggest that the capitalisation of the cost of an asset should be the less readily accepted for tax accounting than for financial accounting.

[7.41] In commenting on the suggestion of a form and blinkers approach in the judgments of the House of Lords in Strick v. Regent Oil in [7.35] above, reference was made to the judgment of Dixon J. in Hallstroms Pty Ltd (1946) 72 C.L.R. 634 as unquestioned authority rejecting such an approach in Australia when the issue is whether an outgoing is working or capital. There are United Kingdom cases in which the Hallstroms approach in terms of a practical or business point of view is taken. Thus in Royal Insurance Co. v. Watson [1897] A.C. 1, a payment was made by the taxpayer, which had acquired the business of another insurance company, to a former employee of the latter company who had become an employee of the taxpayer. The payment terminated the employee’s services. The payment was not however characterised as a payment to terminate his services, but a payment to acquire the business. The agreement under which the taxpayer acquired the business provided for the making of the payment, and the Lord Chancellor thought it appropriate in characterising the payment to look at “the whole circumstances of the transaction” (at 6).

[7.42] Looking to all the circumstances will not necessarily require a characterisation at odds with the form of the payment. Thus in Australia in Morgan (1961) 106 C.L.R. 517 the fact that a payment expressed to be by way of adjustment of rates was provided for in an agreement by which property was acquired did not dictate a conclusion that the payment was a cost of acquiring the property. Morgan was relied on by Walters J. in Goldsbrough Mort & Co. Ltd (1976) 76 A.T.C. 4343 in reaching a conclusion, in this instance against the taxpayer, that the receipt of a like adjustment was not proceeds of sale of the property but an adjustment of rates, as it was in form. The circumstance that the amount of the receipt would vary depending on the time of settlement reinforced the inference from the form of the agreement. Morgan may be contrasted with Foxwood (Tolga) Pty Ltd (1981) 147 C.L.R. 278 where a payment to the purchaser of a business in respect of long service leave obligations undertaken by the purchaser was treated by the court as an abatement of the purchase price of the business. In this instance the characterisation of the payment rejected its form.

[7.43] The general principle considered in [2.34]ff. above, that the character of an item must be judged in the circumstances of its derivation by the taxpayer, is matched by a principle that the deductibility of a loss or outgoing must be judged in the circumstances of the incurring of the loss or outgoing by the taxpayer who claims the deduction. There is no principle that a receipt which is income in the hands of the receiver is deductible by the payer. None the less it would be a theoretically proper result if a view of the facts taken in characterising a receipt as income or otherwise in the hands of the payee were also to be taken in characterising the payment as deductible or otherwise by the payer.

[7.44] There is, of course, no estoppel that will bind the Commissioner, a board, or a court to take the same view in relation to payee and payer. Where the assessment of the payer is before a court, the court will not know how the payee has been assessed. None the less, it is proper that a receipt seen to be for entering into a restrictive covenant when the question is whether the person receiving derives income, should be seen as a payment for the restrictive covenant when the question is whether the payer is entitled to a deduction. Where the conclusion is that a receipt expressed to be for a restrictive covenant given by an employee is from a practical or business point of view a further receipt of a reward for services, it should retain that complexion when the deductibility of the payment by the employer is in question as it was in Associated Portland Cement Manufacturers Ltd v. Kerr [1946] 1 All E.R. 68.

[7.45] There is no principle that a series of receipts which are income of the receiver are deductible by the payer. But the view of the facts which gives the series of receipts its income quality in the hands of the receiver should, in theory, be adopted when the question is deductibility by the payer. A view of the facts in Cliffs International Inc. (1979) 142 C.L.R. 140 which would make the receipts by Howmet Inc. and Mt Enid Pty Ltd income, as being, in a broad sense, gains from the use of property, should also be taken when the question is the deductibility of the payments. An acceptance of a theory of this kind may explain the observations by Barwick C.J. that the receipts by Howmet and Mt Enid were income. The receipts were not for the right to use, but in respect of the actual use of the mining rights vested in Cliffs by the events which began with the sale by Howmet and Mt Enid of their shares in the company—Basic—which had those mining rights. The payments by Cliffs International were tolls payable on the occasions of use of the mining rights and, as such, were working expenses. They were in effect costs of use. From a practical or business point of view it was really irrelevant to the characterisation where the property in mining rights rested. It will be recalled that the third matter of those considered relevant by Dixon J. in Sun Newspapers Ltd (1938) 61 C.L.R. 337 to the characterisation of an outgoing as revenue or capital was the means adopted to obtain the advantage sought. The third matter might have been expressed in terms that would have asserted that the means of payment bears on the identification of the advantage. The means of payment in Cliffs International indicated that the advantage obtained was the use of the mining rights. A payment for use is not a payment to obtain structure. Cliffs International does not stand for a principle that the manner of payment for a structural asset can convert what would otherwise be capital expenses into working expenses.

[7.46] Cliffs International (1979) 142 C.L.R. 140 should be seen as rejecting an extended form and blinkers approach to the interpretation and application of s. 51, in favour of an approach which looks to the practical or business significance of the expense. It is true that Barwick C.J. sought to reconcile his conclusion with a form and blinkers approach. A judicially adopted rule that would say that a payment for a structural asset is a capital outlay and is not deductible creates a hazard for a taxpayer if a form and blinkers approach is taken to the application of the rule. A taxpayer who enters a transaction which gives rise to legal relations which require a payment by the taxpayer in consideration of the acquisition of an asset, has stumbled into a transaction which will deny him deductions. In the operation of the rule, the form approach identifies consideration for the payment with what the payment is for, and insists that no other aspect of the circumstances is relevant to a conclusion on that issue. Barwick C.J. sought to fit his conclusion that the payments in Cliffs International were not for the shares, despite the description of the payments as “deferred payments” of the “price” of the shares, by an assertion that the words were a wrong description having regard to all the terms of the contract. The description, he said was “quite obviously inapt” (at 148). “The recurrent payments were not made for the shares though it might properly be said that they were payable as a consequence of the purchase of the shares” (at 149). This might be thought to turn the form and blinkers approach in on itself and demonstrate its barrenness in the interpretation and operation of s. 51(1). The issue in Cliffs International was whether the payments were working expenses. A conclusion that they were is sufficiently explained by saying that a payment which is a toll payable for the use of a business asset is a working expense and it is irrelevant where the legal title to the asset may rest. A statement of that kind explaining the conclusion should not, however, be taken to be a rule. The statement is intended to express a practical or business judgment of the circumstances.

[7.47] In Cliffs International the payments were required over the whole life of the mine. A view of the payments as tolls payable for the use, rather than payments for the asset used, is more easily taken in these circumstances than it is when the payments are to extend only for part of the life of the asset, as in Colonial Mutual Life Assurance Society Ltd (1953) 89 C.L.R. 428 which was referred to and distinguished in Cliffs International. In I.R.C. v. Land Securities Investment Trust Ltd [1969] 1 W.L.R. 604 the payments in respect of the acquisition of reversions of property, payments charged on the reversions, were to be made over a period of 10 years. In denying the taxpayer a deduction for purposes of the then United Kingdom excess profits tax, the House of Lords treated the payments as having been made for the reversions. There is an observation by Lord Donovan that “It is true that capital assets may be purchased by income payments; and what the position would be if perpetual rent charges had been the consideration in the present case does not here have to be determined” (at 612). The observation lends support to a view that payments over the whole life of an asset are the more likely to be seen as payments for the use of the asset. In Ballarat & Western Victoria T.V. Ltd (1978) 78 A.T.C. 4630 payments for the use of a T.V. mast were made in the first five years of a period of entitlement to use that was limited only by the life of the mast and which, it was assumed, would extend for many years beyond the five years. The payments were denied deduction.

[7.48] There is another basis of distinguishing Colonial Mutual Life. In that case the building whose use by letting triggered the payments to another, was in part erected on land which was the property of the taxpayer prior to the transaction under which the obligation to make the payments arose and in part on land acquired from the person to whom the payments were made. The taxpayer assumed an obligation in relation to the use of property which he might otherwise have used without payment. A view that the payments were not for the use, but simply payments on use, was for this reason the more likely.

[7.49] A series of payments which would be deductible as tolls for the use of an asset may be commuted to a present payment, which may in its amount reflect the fact that payment is made earlier. However the amount is calculated, it will not follow that the payment should have the same character as the payments in a series would have had. An illustration is the payment of interest in advance. The phrase “interest in advance” tends to obscure the significance of the payment. It is a commutation of future payments, and if it secures a substantial immunity from future payments, it may be denied deduction as a payment to acquire a lasting advantage which is structural. The characterisation of interest in advance was the subject of some comment in [6.117]ff. above.

[7.50] It may be thought that there is some difficulty in reconciling this view of a payment of interest in advance with authorities concerned with the payment of pensions to retired employees. In Hancock v. General Reversionary & Investment Co. [1919] 1 K.B. 25 an already retired employee accepted an insurance policy, on which his employer had paid a lump-sum premium, in satisfaction of his pension rights. The policy provided for the payment of an annuity. The employer was allowed a deduction of the lump-sum premium. The case was described by Rowlatt J. in Morgan Crucible Co. Ltd v. I.R.C. [1932] 2 K.B. 185 at 195 as “very much on the line”. There is in any case an important difference. If the unfunded superannuation scheme had provided for a lump-sum payment to the employee and a lump-sum had been paid, it would, one may assume, have been deductible. A payment to commute an obligation to pay a pension should not be treated differently. But a lump-sum payment to obtain a loan which is interest free or at low interest where the loan is of substantial duration would be denied deduction as capital. A payment to commute an obligation to make a series of payments by way of interest should not be treated differently. J. Gadsden & Co. v. C.I.R. (1964) 14 A.T.D. 18 may appear to conflict with the views just expressed. A payment to commute an obligation to make periodical payments for the use of knowhow was held deductible. The commutation payment should have taken its character from the character a single sum, being the only payment required by the agreement, would have had. It should not take its character from the payments commuted. A payment in commutation of the payments held deductible in Cliffs International should not be held deductible. To allow a deduction of the commutation payment is to encourage the taking of a deduction by employing two steps—an agreement to pay periodical amounts and an immediate commutation—when a deduction would be denied if only one step has been employed. The use which counsel in Ilbery (1981) 81 A.T.C. 4661 sought to make of the decision in Nevill (1937) 56 C.L.R. 290 was not warranted by that decision. The payment in Nevill was not made in commutation of obligations to make future payments of salary, and if it had been, it would have taken its character from the character a single sum, being a payment of salary in advance, would have had. Where a present payment of future salary is made, there are the same prospects that it will be found to be capital as there are where there is a present payment of future interest. The payment secures the advantage of the employee’s services without further payment. If the payment is in respect of a number of years of future service, it may be held to give rise to an enduring advantage.

[7.51] The cost of acquiring an asset which is structural will be denied deduction as an outlay that is not an outgoing, if the asset is not a wasting asset, or it will, in any event, be denied deduction as a capital outgoing. But circumstances may bring about a change in the character of an asset, so that what was structural becomes a revenue asset. In such circumstances an allowance should be made against the proceeds of sale of the revenue asset to reflect the cost of the asset. The allowance should be the value of the asset at the time it became a revenue asset. If no allowance is made, there is an affront to the principle that an item is not income save where, and to the extent that, it involves a gain.

[7.52] A related problem arises where an asset was not acquired as an asset of any business: it was acquired and has been held privately. The asset is now taken into the business as a revenue asset of that business. An illustration may be a car owned and used privately by a second-hand car dealer who now sells the car through his second-hand car sales yard. Another illustration might involve a land developer and dealer who develops and sells in the course of his business land that he has inherited. In these circumstances it is well established that the taxpayer is entitled to treat the value of the property at the time it is committed to his business as a cost of trading stock. In the United Kingdom there is authority in Craddock v. Zevo Finance (1946) 27 T.C. 267. In Australia there is authority in Bernard Elsey Pty Ltd (1969) 121 C.L.R. 119 and in the judgment of Gibbs J. in Curran (1974) 131 C.L.R. 409, though in the former case the issue concerned the operation of the second limb of s. 26(a) (now s. 25A(1)) and in Curran, as it was submitted in [7.24] above, the principle was misapplied. There is authority, too, in Official Receiver in Bankruptcy (Fox’s case) (1956) 96 C.L.R. 370.

[7.53] The problem of an allowance for the cost of a structural asset that becomes a revenue asset has some affinity with another. A taxpayer may come to dispose of an asset which is held as a non-business asset, or as a structural asset of a business, in a transaction which will yield income receipts as periodical receipts, as royalties or as receipts which compensate for income receipts. At a number of points in Chapter 2 above, illustrations were given, and it was asserted that the denial of any allowance for the cost of the asset offends the principle that income involves a gain. The starkest illustration is that afforded by the facts of Egerton-Warburton (1934) 51 C.L.R. 568 ([2.204]ff. above). Another illustration is afforded by McCauley (1944) 69 C.L.R. 235 [2.314] above. In these instances the Assessment Act has provisions— in s. 27H and s. 124J—which seek to preserve the principle that income involves a gain, though the inadequacy of s. 27H was revealed in Egerton-Warburton and the inadequacy of s. 124J in White (1968) 120 C.L.R. 191. The existence of these provisions may inhibit the recognition of a general principle that would allow the subtraction of the value of so much of the non-business asset or structural asset, as is the subject of the transaction which will yield income receipts. In the case of a structural asset, the existence of depreciation and amortisation provisions, which apply to the cost of the asset and provide for balancing charges and allowances, must also inhibit the recognition of a general principle, though those provisions do not assist in the situation of a disposition of the structural asset itself. Depreciation and amortisation provisions are concerned with an allowance for the wasting of structural assets. The allowance is of the cost of the assets as those costs are consumed in a process of income derivation. Such provisions are unhelpful where a structural asset is exchanged for income returns, and, in any event, depreciation and amortisation provisions are less than adequate to cover the occasions where the costs of structural assets are consumed in a process of income derivation. Reference is made in [7.10] above and [7.62] below to a number of occasions where the law is inadequate.

[7.54] The specific provisions should not preclude the development of a general principle. Section 82 will protect the Commissioner against any risk of double allowance. Where an asset that was a structural asset and has become a revenue asset is disposed of, the appropriate allowance is the value of the asset at the time immediately before it became a revenue asset. Thus, timber on timber-bearing land may have been held privately, or as a structural asset of a business, up to the time it became a revenue asset. The value of the timber felled, immediately before the felling, is the appropriate allowance against the proceeds of realisation of the timber. Section 124J is inadequate. Its operation depends on actual costs at whatever time the land and the timber were acquired. There may indeed be no cost where the land and timber have been inherited. Where an asset held as a non-business asset, or as a structural asset of a business, is disposed of in a transaction which will yield income receipts (as periodical receipts, royalties or receipts which compensate for income receipts), the allowance should be the value of the asset at the time immediately before the disposition.

[7.55] It may be said that the effect of the allowance is to exclude from tax a capital gain that may have accrued between acquisition of the asset and its becoming a revenue asset or its disposition, and that the objective should be the more limited one of ensuring that tax should not be levied on a receipt which does not represent any accretion to economic power. Any objective stands to be obstructed in its achievement by the fact that general income tax law has regard only to realised gains. An allowance of value as a cost may preclude the bringing in of a gain which has already accrued but is unrealised. And it will preclude the bringing in of a capital gain which may have been realised, but not taxed, at an earlier time, and is now represented by the asset. An attempt to exclude this accrued gain, or already realised but untaxed gain, from the value that is to be allowed as a cost, will enmesh the law in what may be an unending tracing back of the asset into forms of wealth previously held which may have generated gains which are now reflected in the asset.

[7.56] Where an asset that is not a revenue asset of a business is disposed of for receipts which have an income character, the suggestion is that there should be an allowance of the value of the asset at the time of disposal, to be applied against the proceeds of disposal. It is true that the consequence may be severely to limit the amount that is brought to tax as periodical receipts, royalties or compensation receipts. Indeed, if the value of an asset is simply the present value of the income flows that it will produce, the amount brought to tax will in many cases simply reflect the interest factor, that may arise from any deferment of the receipts beyond the time of realisation.

[7.57] An allowance of the value of the asset disposed of to be set against the proceeds will raise the prospect of a deductible loss arising where the taxpayer has entered on an unfavourable arm’s length transaction, or has dealt with another in a non-arm’s length transaction. Such a loss would be within established principles where the asset has become a revenue asset. The allowance of a loss where a non-business or structural asset is disposed of for proceeds which are income would break new ground.

[7.58] Where the asset has been the subject of depreciation or amortisation deductions under ss 54ff. or Div. 10B of Pt III, there will be need to correlate the operation of the principles now proposed with the balancing allowance or charge provisions. In the case of depreciation the correlation would be straightforward. In the case of amortisation under Div. 10B, it would be the more difficult. It will be seen in [10.235]–[10.269] below that the operation of Div. 10B is not clear where there has been a partial disposition of an item of commercial or industrial property for receipts which are income as periodical receipts, as royalties or as compensation receipts.

[7.59] There will be occasions when the proceeds of realisation of a nonbusiness or structural asset will include both income and non-income elements. A sale of standing timber that is a structural asset may be for a lump sum and for amounts that are royalties. It will be important to confine any allowance to a fraction of cost determined by the ratio which the income element in the proceeds bears to the total proceeds.

[7.60] The discussion so far has glossed over the problems that lie in the notion of proceeds of realisation. It will be evident, in the case of timber, that a McCauley agreement involves a realisation of an asset, though too much regard for rationalisation of the notion of royalties as receipts “for the use” of an asset may obscure this reality. It would be equally true of a McCauley (1944) 69 C.L.R. 235 agreement applied to sand gravel or blue metal presently part of land. The grant of a licence in respect of an item of commercial or industrial property which has a limited life (which would exclude a trade mark) will generally be a disposition of property, though there might be some difficulty in so regarding it where the licence is not exclusive. Clearly there must be problems in fixing the extent of the realisation and any allowance must be related to the extent of the realisation.

The Characterisation of Expenses where no Structural Asset is Acquired

[7.61] In John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 at 36 Dixon C.J. said:

[7.62] Clearly an expense whose object is the enlargement of structure will be capital notwithstanding that it does not in fact result in any increase in structure. The expense may be unsuccessful. There is United Kingdom authority that will support a proposition of that kind: Southwell v. Savill Bros Ltd [1901] 2 K.B. 349; Pyrah v. Annis & Co. Ltd [1957] 1 W.L.R. 190; and more recently ECC Quarries Ltd v. Watkis [1975] 3 All E.R. 843. At the same time, there is a disposition in United Kingdom authorities to commit the “logical fallacy” to which Dixon C.J. refers in the passage quoted and turn the dictum of Viscount Cave round by saying that an expense cannot be attributable to capital unless it is made once and for all, and is made with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. Southern v. Borax Consolidated Ltd [1941] 1 K.B. 111 and Morgan v. Tate & Lyle Ltd [1955] A.C. 21 reflect such a disposition. In John Fairfax & Sons Fullagar J. drew attention to the fact that Southern v. Borax Consolidated Ltd had been rejected by four judges of the High Court in Broken Hill Theatres Pty Ltd (1952) 85 C.L.R. 423, as a decision that “cannot be supported”. Southern v. Borax Consolidated had already been rejected by Dixon J. in Hallstroms Pty Ltd (1946) 72 C.L.R. 634 in a dissenting opinion that was approved by the majority of the High Court in Broken Hill Theatres. There is thus some basis for saying that United Kingdom law on the matter of capital outgoings has come to differ from the Australian law, and United Kingdom authorities may need to be received with caution. The Australian law may none the less be thought the less desirable as a matter of policy. Where an expense gives rise to a structural asset that is a wasting asset, there may be available depreciation or amortisation provisions which will provide for deductions. Where no asset is acquired, or the expense does not relate to a wasting structural asset in a way that attracts the available depreciation or amortisation provisions, the expense, though consumed in a process of income derivation, will at no time be deductible. The expenses in Broken Hill Theatres were at no time deductible. The expenses in Foley Bros Pty Ltd (1965) 13 A.T.D. 474, 562 were at no time deductible, though in that case the unavailability of deductions might be justified on the ground that the expenses related to goodwill which does not waste. The expenses of defending structure considered in [7.66]ff. below may not be seen as expenses related to a structural asset justifying the application of depreciation or amortisation provisions, and any relevant structural assets may not, in any event, attract such provisions.

Expenses of effecting a change in structure

[7.63] A rejection of the logical fallacy that would be involved in turning the dictum of Lord Cave round, is most evident in the Australian authorities in the decision of the High Court in Foley Bros Pty Ltd (1965) 13 A.T.D. 474, 562. The taxpayer had paid an amount to a United Kingdom company to obtain release from an obligation not to scale down—discontinue in part—its Australian operations. Thereafter the company shut down a number of its branches in Australia. The High Court held the money paid to secure the release from the obligation was a capital outgoing. Kitto, Taylor and Menzies JJ., affirming the decision of McTiernan J., said: “It is a fundamental error to treat a freedom to dispense with whole branches of a widespread enterprise as if it were only a freedom to move the goods in a shop from one counter to another. The true contrast is between altering the framework within which income producing activities are for the future to be carried on and taking a step as part of those activities within the framework.”

[7.64] Whether or not the contract, release from which is obtained by a payment, is an aspect of structure, or “framework” in the language of Foley Bros Pty Ltd, must depend on considerations examined in the discussion in Chapter 2 above of Van den Berghs [1935] A.C. 431 ([2.489] above) and the agency cases ([2.485]–[2.486] above). It would, for example, be wrong to draw a conclusion from W. Nevill & Co. Ltd (1937) 56 C.L.R. 290 that a payment to obtain release from a service agreement with a managing director is always to be seen as concerned “with the ever recurring question of personnel”. That phrase is used in Nevill (at 306) by Dixon J. to describe the payment made to the managing director. Where the managing director is employed, as in Bennett (1947) 75 C.L.R. 480, under a contract which gives him wide and exclusive powers over the employer’s business, it is possible to treat the contract as one going to structure, and to deny a deduction of a payment to obtain release from the contract.

[7.65] Anglo-Persian Oil Co. Ltd v. Dale [1932] 1 K.B. 124 is consistent with Australian law only if the agency agreement is seen as one that was less than fundamental. A payment which put an end to an agency agreement through which the taxpayer had carried on its business in the Middle East, was held deductible. All judgments in the Court of Appeal emphasised that there was no enduring benefit resulting from the discontinuance of the agency. There is thus some ground to suggest that the decision was moved by Dixon J.’s “logical fallacy”. There is however an indication of a basis of decision acceptable in Australian law, in the description of the payment in the judgment of Lord Hanworth M.R. as one made to “put an end to an expensive method of carrying on the business”. There is a possible distinction to be drawn between structure within which a business is carried on and a method of carrying on the business.

Expenses of defending as distinct from maintaining structure

[7.66] It is in the area of what may be called defence expenditure that differences between the United Kingdom and the Australian law become most apparent. Expenses of defending one’s business against compulsory acquisition by another might be thought very obviously to go to structure, if the “logical fallacy” arising from British Insulated & Helsby Cables Ltd [1926] A.C. 205 is rejected. Morgan v. Tate & Lyle contrasts with Ward v. C.I.R. (N.Z.) (1968) 15 A.T.D. 196 and, in Australia, with John Fairfax & Sons Pty Ltd business operations. The occasion, moreover, was special. The same observations (1959) 101 C.L.R. 30. In the latter case a view of the facts which would see the expenses as costs of acquiring the shares in the company taken over was not excluded by any member of the court. At the same time it was agreed that the expenses were capital even if seen as expenses of defending title to shares already acquired. It may indicate the fortuitous consequences that follow from the logical fallacy, that its application would have justified the frantic efforts of the taxpayer in the early hours of Monday morning to ensure that acquisition of the shares was complete before any legal proceedings could be taken to challenge the acquisition.

[7.67] The range of expenses that may be called defence, in any proposition that expenses of defence of structure are capital, is however limited. In Hallstroms Pty Ltd (1946) 72 C.L.R. 634 the grant of the extension of a patent would have imposed significant limitation on the taxpayer’s planned might be made in regard to Broken Hill Theatres Pty Ltd (1952) 85 C.L.R. 423. The grant of a licence to a competitor to operate a picture theatre would have significantly threatened the taxpayer’s goodwill, and the occasion of threat was special. In Broken Hill Theatres the legal expenses of opposing the grant were denied deduction. Broken Hill Theatres approved the dissenting judgment of Dixon J. in Hallstroms, where he had taken the view that the expenses of opposing the grant of the extension of the patent were capital.

[7.68] Some expenses will be outside the notion of defence expenditure. They may be called maintenance expenses and may be deductible. In this instance it is the recurrence of the expenses of the class to which the expense belongs which precludes a conclusion that the expense is capital. Recurrence is recognised as a relevant factor in the formulation of matters by Dixon J. in Sun Newspapers Ltd (1938) 61 C.L.R. 337. In Snowden & Willson (1958) 99 C.L.R. 431 the class to which the expense belonged was on-going expenses of obtaining payment from customers. A failure to resist the challenge to the company’s business operations which was involved in the inquiry by the Royal Commission would have led to refusals by customers to pay instalments under contracts they had entered, and to challenge those contracts. The expense is of a class of acts which may be described as acts in carrying on the operations whence income is derived. The fact that in some sense they relate to structure does not displace their character as working expenses. A premium for insurance of factory premises against fire is deductible as a working expense.

[7.69] In the discussion in [6.17]ff. above it was suggested that unusualness which may not deny the character of relevance to an expense may yet deny an expense a working character. Where the question is simply one of relevance, it may be appropriate to treat an event as one of very broad class of events which are “ever-recurring”, as Dixon J. did in W. Nevill & Co. Ltd (1937) 56 C.L.R. 290. Where the question is whether an expense is a working, as distinct from a capital, expense, it may have to be seen as one of a narrower class of events that are not fairly described as “ever-recurring”. Expenses of defence which are structural will relate to a special challenge to the continuance of a business or the holding of property whence income is derived. It may be appropriate to refer to them as expenses of defence in a situation of peril, though the word “peril” may be too limiting. It is enough that a significant element of a taxpayer’s business operations are the subject of some special challenge. Expenses of a builder in resisting an action brought by a customer will generally be working expenses. But expenses of appearance in proceedings brought by a licensing authority to deregister the builder may well be non-working. In Snowden & Willson the High Court expressly negatived a view of the facts that would have seen the appearance before the Royal Commission as a matter of defence in a situation of peril.

[7.70] In a Snowden & Willson situation a distinction between revenue and capital outgoings in terms of acquisition of structure, change in structure or defence of structure becomes unhelpful. An actual increase in goodwill or an increase in capacity to engage in operations from which income may be derived, which may result from a payment, will not deprive it of a revenue character if the payment is made in meeting circumstances which are an on-going experience of the business. Expenses of advertising, though directed to increasing goodwill as well as maintaining it, are a response to the on-going need to hold and if possible increase the goodwill of a business.

[7.71] Expenses which are incurred in the on-going effort of a business to break through the commercial and legal limitations to which it is subject may be working expenses, even though success may bring an increase in structure, and even though they may be seen as directed to that increase in structure. An illustration of a commercial limitation is the present range of goodwill of a business. An illustration of a legal limitation may be hours of trading to which a business is subject (Cooper v. Rhymney Breweries Ltd [1965] 1 W.L.R. 1378), or quota restrictions on import, or export, or on manufacture, to which a business is subject.

[7.72] The significance of “recurrence” in the more restricted meaning the word carries where the question is whether an expense is a working expense supports the view taken in this Volume that the exception of losses or outgoings of a capital nature in s. 51(1), like the other exceptions in the subsection, is not a true exception. Deductibility depends on an expense being relevant to to the derivation of assessable income and on its being a working expense. In whatever way losses or outgoings of a capital nature are identified in other respects, only one basis of identification is significant: a capital expense is a non-working expense.

Expenses that are Irrelevant: Losses or Outgoings of Capital

[7.73] It will be noted that s. 51(1) makes a distinction between “losses or outgoings of capital” and “losses or outgoings of a capital … nature”. So far in this chapter references to capital losses and outgoings are references to those that may be covered by the latter form of words. “Losses or outgoings of capital” may have a distinct meaning. That meaning cannot depend on the source of money that has been used in the making of the outgoing. A doctor who sells a car used in his practice and uses the proceeds of sale in the making of payments that would otherwise be deductible should not be denied deduction of those payments. The meaning could identify distributions made by a business to its proprietors. Other illustrations would be a payment by way of a return of capital made by a company to its shareholders. In this illustration company law language would accord with the tax language. Another illustration might be a dividend paid by a company, in which case company law language and tax language would diverge. Yet another illustration might be the appropriation of assets of a business by one of its proprietors, as in Ash (1938) 61 C.L.R. 263 or in Curtis v. Oldfield (1925) 9 T.C. 319 at least in the explanation of those cases given in [6.71]–[6.73] above. In none of these illustrations would the exception of losses or outgoings of capital operate as a true exception. In all the illustrations the outgoing would fail to qualify as a relevant expense: the outgoing is not incurred in gaining income, it is an application of income derived.