Chapter 10
[10.1] The Assessment Act contains a great number of specific provisions which may be seen as confirming, extending or qualifying deductibility under the general provisions of s. 51(1). Some of these provisions, for example ss 28, 36 and 51(3), directly concern matters of tax accounting which are considered in Part III, and are excluded from present consideration. Some provisions which do not have any current operation, or depend for their operation on legal relations having been entered into in the past, for example Div. 4 of Pt III relating to leases, are also excluded from present consideration. Provisions which relate only to the affairs of particular industries, for example those contained in Div. 10 (General Mining), are listed but are not discussed. Discussion is for the most part confined to provisions which raise some question of correlation with s. 51(1), or some matter of comparison or contrast with the operation of s. 51(1).
[10.2] A specific provision in providing for a deduction may confirm in some respect the operation of s. 51(1), or confirm and extend its operation, or it may provide for a deduction also provided for under another specific provision. Where it does, an item of expense is deductible under more than one provision, and there is need of a provision that will determine which is to be applied, or indeed, that both are to be applied. Such provisions are found in s. 82, and in s. 82AM in relation to the investment allowance. They are surveyed at the outset of discussions that follow: [10.4]ff. below.
[10.3] The classification of specific provisions adopted is:
Within each classification, sections are dealt with in the order in which they appear in the Act. The choice of sections to be included in each classification is tentative. The inclusion of a section assumes, in some instances, answers to questions in regard to the correlation of a section with s. 51(1) which call for discussion. Thus s. 53 is classified as a section confirming a part of the operation of s. 51(1). In fact it may be a specific provision displacing the operation of s. 51(1). In which event, it would be necessary to specify the area over which s. 53 may be regarded as a code. To the extent that s. 53 displaces the operation of s. 51(1), it should be included in the classification adopted for such provisions.
[10.4] An expense may be deductible under s. 51(1) and under some specific provision, or it may be deductible under two specific provisions. Section 51(1) and s. 53 relating to repairs (on the assumption that it is not a code), or s. 51(1) and s. 72, relating to rates and taxes, afford illustrations of the former. Sections 54ff. relating to depreciation and s. 82AB giving an investment allowance, is an illustration of the latter.
[10.5] Sometimes the Act allows the taxpayer to deduct the same expense twice. Section 82AM, relating to the investment allowance, is an illustration. The general provision is, however, expressed in s. 82: “where in respect of any amount, a deduction would but for [s. 82] be allowable under more than one provision of [the] Act, and whether it would be so allowable from the assessable income of the same or different years, the deduction shall be allowable only under that provision which in the opinion of the Commissioner is most appropriate.” The general provision in s. 82, by which a discretion is given to the Commissioner, contrasts with a number of provisions in relation to particular industries, by which an option is given to the taxpayer to take a deduction for depreciation under s. 54ff. or to take a deduction under the particular industry provision—ss 122N(2), 123E(2) and 124JC(2).
[10.6] The Commissioner’s discretion is important when a deduction is allowable under s. 51(1) and under one of the sections referred to in s. 79C, which imposes a limitation on the deductibility of expenses deductible under those sections. The reference to a deduction “in respect of the amount” allowable under more than one provision in the Act raises a question whether two deductions are in respect of the same amount. Two deductions may be in respect of the same amount, though they have been incurred in different years. A taxpayer may not have claimed a deduction under s. 63 for a write-off of a bad debt in an earlier year, and now claims a deduction for a loss in respect of the debt under s. 51(1). It may be asked whether the latter deduction is in respect of the same amount as the deduction for a write-off. If it is, the Commissioner may have a discretion to refuse to allow the s. 51(1) deduction, asserting that the s. 63 deduction is the more appropriate, and the taxpayer may in the result be denied any deduction because amendment of the assessment of the earlier year is not, in the circumstances, within the power of the Commissioner under s. 170(4). “Allowable” presumably means allowable on the facts as they are: if the taxpayer has not written off the specific debt in the earlier year, there may be no room for the Commissioner’s discretion under s. 82.
[10.7] An expense may, prima facie, be subtractable, in computing the amount of a profit that is income, or the amount of a loss that is deductible, under s. 51(1) or s. 52. Such an expense may also be an outgoing deductible under some specific provision, for example s. 75A relating to land used in carrying on a business of primary production. Section 82(2) expressly denies the subtraction of the outlay in computing the profit or loss, if the outlay was an outgoing deductible under a specific provision. Section 82(2) would in its terms extend to deny the subtraction of an outlay that was deductible under s. 51(1). It will appear from the analysis in [5.15], [5.36] and [7.11] above that an outlay on a wasting revenue asset may be deductible under s. 51(1), for example an outlay on the oil company tie in B.P. Australia Ltd (1965) 112 C.L.R. 386. The outlay will not be subtractable in computing the profit that is income on the realisation of the wasting revenue asset or the loss that is then deductible. The prospect of a loss will be confined to a case where the cost of the revenue asset was properly deductible over a period of years, and the amount of the proceeds on realisation of the asset is less than the amount of the cost that has not, at the time of realisation, been allowed as a s. 51(1) deduction. Whether s. 51(1) requires the cost of a wasting revenue asset to be spread forward over the years of consumption of that cost in the use of the asset, is a matter explored in [7.11]–[7.16] above.
[10.8] The deductibility under s. 51(1) of expenses for repairs to property used for the purpose of producing assessable income was considered in [6.149] and [6.159] above. The view there taken is that expenses for repairs may be relevant if the property is used by the taxpayer for the purpose of producing assessable income, and they will be working expenses if they are maintenance expenses. The notion of use for the purpose of producing assessable income in such a statement of principle is the subject of comment in [6.114]–[6.116] above. Where property is let to another at less than a commercial rent, the purpose of the letting being in part to confer a gratuitous benefit on the tenant, there are mixed purposes in the use and an apportionment is required. Whether repair expenses are working expenses will depend on the application of principles considered in [7.1]ff. above. Issues of working character will arise in relation to expenses that “improve” or “reconstruct an entirety”, in the language of decisions on s. 53.
[10.9] In fact there is no judicial decision on the operation of s. 51(1) in relation to repairs. All decisions are concerned exclusively with the operation of s. 53. It might be inferred from this that s. 53 is assumed to be a code displacing the operation of s. 51(1). Some inference of an intention that s. 53 is a code might be drawn from the express denial by s. 53(2) of deduction of expenditure incurred upon repairs to any premises or part of premises not held, occupied or used for the purpose of producing assessable income. If s. 53 is held to be a code, there will be a need to define the area covered by the code, from which s. 51(1) is excluded. So long as the issues raised by s. 53 are those that would be raised in any event by s. 51(1) the extent of displacing of s. 51(1) is of no practical significance. To the extent that s. 51(1) has some wider operation than s. 53, the extent of displacing becomes critical. In [6.157] above there is some discussion of a wider operation for s. 51(1) than the operation of s. 53 where repairs are effected by a tenant who does not have tenant rights. Section 53 may in some respects have the wider operation. To this extent the question whether it is a code is not important. The section may not require contemporaneity of the incurring of an expense and the holding occupation or use for the purpose of producing income, as s. 51(1) requires. And the connection between the expense and the holding for the purpose of producing income that will make the expense relevant may be less than what may be required by s. 51(1).
[10.10] Some comparison of the scope of s. 53 in regard to repairs and of s. 54ff. in regard to depreciation is instructive. A deduction may be available for repairs to a building (“premises”) under s. 53, while depreciation is available only in respect of “plant or articles”, words that, in the absence of express extension, do not cover buildings (“structural improvements”) that are not “plant”. A taxpayer may be entitled to a deduction for repairs to property he uses to produce assessable income, even though he does not own that property. Depreciation is available only to the owner of property.
[10.11] An expense for repairs may be deductible under s. 53, and be a cost of a unit of property that is depreciable under s. 54ff. The deduction for repairs is allowable, but the amount of that deduction is excluded by s. 57(3) from the costs for purposes of depreciation: there is thus no room for the operation of s. 82.
[10.12] An expense for repairs that is not deductible under s. 53 because it is an improvement or the reconstruction of an entirety, is not necessarily a cost of a unit of property depreciable under s. 54ff. The unit of property may not be plant or articles—it may be a structural improvement that is neither plant nor deemed to be such by the definition of plant in s. 54(2). The taxpayer may not be the owner of the property. In this instance the taxpayer is not entitled to a deduction for repairs or for depreciation. There is thus a possible penalty in the denial of any deduction, save under Div. 10C or Div. 10D of Pt III, if repairs to a structure are an improvement or a reconstruction of an entirety, or in the denial of any deduction, if repairs to any property are an improvement or a reconstruction of an entirety and the taxpayer is not the owner of the property. Divisions 10C and 10D are dealt with in [10.212]ff. below.
[10.13] A number of principles that emerge from the interpretation of s. 53 call for some comment. Two of them have already been referred to: the “reconstruction of an entirety” as distinct from the restoration of a part is not a deductible repair, and an “improvement is not a repair”. A third principle asserts that an “initial repair” is not deductible: an expense that is to be seen as a cost of the acquisition of the property repaired is not deductible. A fourth principle asserts that there is no deduction for a “notional” repair: there is no deduction under s. 53 for an expense that the taxpayer might have incurred but did not incur.
[10.14] The first three principles raise a question as to the structure of s. 53, akin to a question discussed at length in [5.8]–[5.12] above about the structure of s. 51(1). The first and third principles tend to assume that an item may be a repair but is excluded from deduction by the exclusion of expenditure of a capital nature. The second, in its formulation, assumes an analysis of the structure of s. 53 of the kind adopted in this Volume in relation to s. 51: an item is not a repair unless it is a working—in this instance a maintenance— expense. The exclusion of expenditure of a capital nature merely emphasises that a non-working expense is not a repair expense. Important consequences turn on what may be the correct analysis of the structure of s. 51(1), more especially when the significance of the exceptions of private or domestic outgoings is the issue raised. It may indicate that there are no consequences which depend on the correct analysis of the structure of s. 53 that differing analyses are reflected in the principles as they are asserted. The word repair is used in this Volume in a way that will include an item that can be denied deduction because it is not working. The correctness of the analysis that the language assumes remains unresolved.
[10.15] The concept of an “entirety” which is central to this principle is indeterminate. The phrases that are used in the cases to identify an entirety— “separately identifiable as a principal piece of capital equipment” and “a physical thing which satisfies a particular notion”—are circular. The phrase used in the statutory provisions governing depreciation (s. 56) and the investment allowance (s. 82AB) is “unit of property”, and discussions on the meaning of that phrase may have some bearing. Ready Mixed Concrete (Victoria) Pty Ltd (1969) 118 C.L.R. 177 adopts a notion of “functionally complete” as the meaning of “unit”. But the conclusion in Lindsay (1961) 106 C.L.R. 377 that the slipway was an entirety could not be explained on the ground that it was functionally complete. Western Suburbs Cinemas Ltd (1952) 86 C.L.R. 102 may support a conclusion that a ceiling in a theatre is an entirety, but again it is not easily regarded as an item that is functionally complete. The question whether or not a water tank in a building is an entirety, so that its replacement is not a repair, remains a matter of debate between taxpayer and the Commissioner. If the item is an entirety it may yet be difficult to regard it as a unit of property, so that the cost may be deductible if the item is plant. And it may not be plant. The notion of plant is examined in [10.142]ff. below in connection with ss 54ff. The debate between taxpayer and Commissioner proceeds in the rhetoric of indeterminates.
[10..16] An expense which has as its purpose the reconstruction of an entirety may not be dissected or apportioned so as to allow a deduction of parts of the expense attributable to work which does not amount to reconstruction of an entirety. There is no express provision for dissection or apportionment in s. 53 that is applicable in these circumstances. To dissect or apportion and allow a deduction of any part of the expense would simply destroy the principle that the reconstruction of an entirety is not a deductible repair. The expense in a Lindsay situation does not become deductible by apportioning it into parts referable to different sections of the slipway. There is of course a difference between the facts in Lindsay and facts which would involve the expense of the progressive restoration of part of the slipway over a period of time. Progressive restoration may involve a number of repair expenses, each deductible. The line between an expense or a number of expenses which have a single function of reconstruction of an entirety, and an expense or a number of expenses, which have several functions, each no more than restoration of a part, will not always be easily drawn. In Rhodesia Railways Ltd v. C. of T. (Southern Rhodesia) [1925] 1 S.Af. T.C. 133, the restoration of sections of a railway track was held not to be the reconstruction of an entirety. But restoration, whether or not the subject of distinct expenses, carried out over a short period of years and not in pursuance of an on-going programme of restoration may well be held to involve the reconstruction of an entirety.
[10.17] Lindsay (1961) 106 C.L.R. 377 is authority that a repair expense does not improve merely because the material used is more expensive than the original material, or because some addition or alteration to the thing repaired is involved. In Lindsay it was held that a concrete slipway replacing a wooden slipway did not involve an improvement, and this notwithstanding that the new concrete slipway was longer than the original.
[10.18] To be an improvement the repair must involve a significantly greater efficiency in function—an acoustic ceiling replacing an ordinary ceiling—or a significant reduction in the incidence of future repairs—copper guttering replacing steel guttering, or a concrete floor replacing a wooden floor subject to rotting because of dampness. This concept of improvement was the subject of comment by Danckwerts J. in Thomas Wilson (Keighley) Ltd v. Emmerson (1960) 39 T.C. 360. He saw it as discouraging the proper use of resources. The effect is to give a tax subsidy to what was the less efficient use of resources. Sometimes a lesser subsidy—it will be deferred—will be given through depreciation. Where the property repaired is a building that is neither plant nor deemed to be plant there will be no subsidy through depreciation though there may be a lesser subsidy under Divs 10C and 10D of Pt III.
[10.19] Greater efficiency in some existing function will make a repair an improvement. There is a question suggested by the judgment of Windeyer J. in W. Thomas & Co. (1965) 115 C.L.R. 58 whether a repair that adapts property to a new function is an improvement. A building in need of painting, and presently painted in a dark colour appropriate to its use as a store, may be re-painted in a light colour appropriate to the intended use of the building as a factory. A store may be cleaned so as to adapt it to its intended use as a factory.
[10.20] A repair may involve greater efficiency in function or greater durability as to some part only of the work done in the repair. There is a question whether the expense may be dissected or apportioned so as to allow a deduction of so much of the expense as does not relate to work that improves. The question was raised in [9.14] above where the view is expressed that an apportionment is not appropriate. In the words of Kitto J. in Western Suburbs Cinemas Ltd (1952) 86 C.L.R. 102 at 109 “if a total expenditure is of a capital nature, so is every part of it”. The identification of the “total expenditure”, as those words are used in Western Suburbs, poses problems. If it be assumed that a ceiling in a theatre is not an entirety, the denial of a deduction for repairs by replacing the ceiling must depend on the replacement being an improvement. The replacement may involve new joists and battens which are of the same material as the old, and a new surface which is different from the old and is more durable. A conclusion that there are in effect two repairs, and that the expenses referable to the joists and battens should be apportioned, may be open.
[10.21] The scope of the principle that an initial repair expense is not deductible depends on the meaning that may be given to the work “initial”. A repair is not an initial repair simply because it is the first repair to the property since the acquisition of the property. Nor is it an initial repair simply because it restores property that has suffered some deterioration as a result of use prior to its acquisition by the taxpayer, even though that deterioration is the major part of the deterioration made good by the repair. W. Thomas & Co. (1965) 115 C.L.R. 58 may stand for a principle that a repair after acquisition is an initial repair, if repair was “due” at the time of acquisition of the property, in the sense that there was a need for repair judged by standards of good husbandry of property. Whether W. Thomas & Co. in this respect correctly reflects the decision of the House of Lords in the Law Shipping Co. Ltd v. I.R.C. (1923) 12 T.C. 621 may be the subject of some debate. In that case the vessel could not be used on any new voyage after its acquisition, until it had been surveyed and repairs directed by the survey had been carried out. This may suggest a meaning of “initial” which would confine non-deductible repairs to those that are necessary to make possible the continued functioning of the property repaired. Such a meaning of “initial” may appear to have been adopted by the English Court of Appeal in Odeon Associated Theatres [1973] Ch. 288, though there is considerable emphasis in the case on whether an accounting convention would require that the expense be “capitalised”, that is, treated as a cost of acquisition and not as a revenue expense.
[10.22] An “initial” repair expense is a non-working expense. It is an additional cost of acquiring a structural asset. And it is irrelevant that the taxpayer was unaware of the need for repair at the time of acquisition of the asset. If the expense is an initial repair expense it may not be dissected or apportioned so as to allow a deduction of some part of the expense that may be said to make good deterioration arising from the use of the asset after acquisition. The arguments against dissection or apportionment made in relation to the entirety and improvement principles are again applicable. Section 53(3), considered further in [10.31] below has no application. The Commissioner has a power to apportion only where the whole amount could be deductible under s. 53(1).
[10.23] A repair undertaken before it is due, in the sense adopted in [10.21], will not for this reason be denied deduction. There is a principle, expressed by Windeyer J. in W. Thomas & Co. (1965) 115 C.L.R. 58 in the metaphor of “a stitch in time”, which would allow a deduction if it was reasonable to undertake the repair. Repainting is perhaps the most obvious illustration of a repair that may be undertaken “early” without an effect on deductibility. In W. Thomas & Co., Windeyer J. held that a taxpayer who repaints shortly after acquiring property does not make full and true disclosure simply by disclosing the times of acquisition and repainting. The Commissioner is entitled to know that the repainting was not an early repair. The repainting will not however be deductible unless it is undertaken to restore deterioration. Repainting to change the colour of a building found unattractive will not be a repair.
[10.24] In some circumstances a repair undertaken in some connection with the disposition of the item repaired will not be deductible: it will be treated as a cost of disposition of the item and denied deduction, just as a repair which was a cost of acquiring the item may have been denied deduction. There is a question of the kind of connection with the disposition that will make the repair what may be called a “final” repair. The fact that the person who acquires property “due” for repair will not be entitled to a deduction when he carries out what are “initial” repairs, may suggest that a taxpayer who proposes to dispose of property due for repairs should effect repairs before he disposes of it. If he acts to repair before he has entered into any agreement to dispose of the property, though contemplating the disposition, he will presumably be entitled to a deduction. If, however, he enters into a contract under which he agrees to carry out repairs before completion, the costs of those repairs may well be denied deduction. Foxwood (Tolga) Pty Ltd (1981) 147 C.L.R. 278 has a bearing. A payment to the buyer of a business, by way of an adjustment to the purchase price, to provide the money from which the buyer might make payments for long service leave to employees who had accrued that leave at the time the business was acquired, was treated as a cost of disposing of the business. In Peyton (1963) 109 C.L.R. 315 a deduction was denied of an amount paid by a lessee to a lessor in lieu of effecting repairs the lessee was obliged by the lease to carry out. The payment was treated as a cost of assigning the lease. A deduction is now available in circumstances of Peyton following the enactment of s. 53AA, discussed in [10.125][10.127] below. But the cases recognise a principle that an expense may be denied deduction, whatever treatment it might otherwise be given, if it is a cost of disposing of property that is not a revenue asset.
[10.25] There is a reference in the judgment of Windeyer J. in W. Thomas & Co. to a repair as a restoration of deterioration due to “wear and tear”. Which may suggest that a repair to restore damage caused by some extraordinary event—a fire or malicious damage by another—is not deductible. At least in the malicious damage situation, it may be thought that the expense does not have a working character. The discussion of W. Nevill & Co. Ltd (1937) 56 C.L.R. 290 in [6.17]–[6.21] above is relevant. Deductibility may be supported on the ground that the event is of a class which is a recognised incident of the holding of property.
[10.26] There is some room for an argument that a repair is “abnormal” and not deductible—in effect that it should be treated as a cost of acquiring the item repaired—if the need for repair is the result of some inherent defect in the item at the time of acquisition. A building that was erected on inadequate foundations may be in frequent need of repairs caused by movement of the structure. There is some room for an argument that a repair made necessary by an inherent defect in the item is a cost of the item and not deductible. Any such principle would pose a question of the meaning to be given to the notion of inherent defect, and this in itself may make the principle unattractive. A building may be erected with wooden floors too close to the ground, and thus subject to rotting. It may be asked if this is an inherent defect so that the cost of replacing the flooring is not a deductible repair. A repair directed to removal of the defect, for example by the replacement of the wooden floors with concrete floors, will not doubt be denied deduction as an improvement. But a simple replacement of the wooden floors, albeit done the more frequently because of the defect in the building, should not be denied deduction.
[10.27] A principle of contemporaneity as an aspect of the interpretation of s. 51(1) was explained in [5.37]–[5.48] above and as an explanation of the decision in Ilbery 81 A.T.C. 4234; 81 A.T.C. 4661 in [6.120] above. The principle, is, it seems, distinct from the requirement of relevance, though A.G.C. (Advances) Ltd (1975) 132 C.L.R. 175 may indicate that the High Court is ready to restate the principle in a way that will reduce its significance, so that contemporaneity becomes no more than an indication of relevance.
[10.28] Whether a principle of contemporaneity has any place in the operation of s. 53 must be answered from the terms of s. 53(1) and s. 53(2). Section 53(3), which gives the Commissioner a power to apportion in some circumstances, applies only to expenditure otherwise deductible under s. 53(1). Section 53(1) is equivocal. On one interpretation it expresses a principle of contemporaneity that is the same as that applicable under s. 51(1): an expense which is otherwise for repairs is deductible if it is contemporaneous with the holding, occupation or use of property for the purpose of producing assessable income, or with the holding, occupation or use of property in carrying on a business for the purpose of producing assessable income. Contemporaneity would be judged by reference to the time the expenditure was “incurred”, which would leave some room for planning by a taxpayer, and would be a hazard for the unwary. If the taxpayer accounts for the expenditure on a cash basis a deduction may be available for expenditure for repairs, effected before the property is let but paid for after the commencement of letting, and a deduction may be denied for expenditure for repairs effected while property is let but paid for after the letting has ceased. Planning so as to make payment after the letting had commenced might be defeated by a principle suggested by the “initial” repairs principle—an expense for repairs prior to the commencement of the letting is an expense to prepare the property for income derivation. Indeed if there is no such principle, the “initial” repairs principle appears not as fundamental doctrine but as a rogue intruder into this part of the law. And the Commissioner may have power, under s. 53(3), to defeat the planning. He may have power to apportion the expenditure and deny a deduction of such part of it as relates to the use of the property prior to the commencement of the letting.
[10.29] None the less the occasions of the hazard will be many. The taxpayer who effects repairs between tenancies will be denied deduction, unless he ensures that the expenses are incurred after the new tenancy commences. It is true that the contemporaneity principle may produce similar hazards in the operation of s. 51(1). Which may indicate that, as a distinct principle, it should be abandoned. There will then be no need to resort to a notion of business “suspension”, as distinct from cessation, as was done in A.G.C. (Advances), to save the deductibility of an expense. In the case of s. 53, there is no obvious presence of a principle of relevance waiting to judge the significance of a want of contemporaneity. And the “initial” repairs doctrine may be thought to preclude a principle of relevance: it is not significant that the need for repair is due in part to earlier holding, occupation or use of property other than for the purpose of producing assessable income, or unless that holding, occupation or use had brought about a situation in which repairs were “due”.
[10.30] While there is no obvious presence of a principle of relevance, a view of s. 53 that it does no more than confirm s. 51(1)—that it is, in a phrase used by Sir Owen Dixon, “epexegetical” (Parke Davis & Co. (1959) 101 C.L.R. 521 at 527)—would justify drawing a principle of relevance from s. 51(1). It is then possible to give s. 53 an operation that is parallel with the operation of s. 51(1) in regard to payments of interest on money invested in assets, or payments of insurance, rates and taxes on property. The operation of s. 51(1) in regard to these expenses is to allow a deduction to the extent to which the function of the expense is to maintain property in its use for the purpose of income derivation. A parallel operation of s. 53(1) would be to allow deduction of expenses for repairs to the extent to which their function is to maintain property in its use for the purpose of income derivation. There will be problems, however, in making an apportionment where the need for repairs has arisen out of use of the property in a prior year of income. The operation of the principle of apportionment so far as s. 51(1) is concerned is, it seems, to apportion by reference to the amount of time during the year of income when the property was used in a process of income derivation, which will be generally, though not always, appropriate. In any case, s. 53(1) does not include the words “to the extent to which” that appear in s. 51(1). The consequence may be that s. 53(1) does not admit of an apportionment—an amount is wholly relevant or not relevant at all. There will remain, however, a question whether an expense can be relevant even though there is no holding, occupation or use of the property during the year of income for the purpose of producing assessable income. The property may have been held, occupied or used for that purpose during a previous year of income. Again s. 53(1) is equivocal. The words “in the year of income” control “incurred”. They may not control “held, occupied or used”.
[10.31] Section 53(3) gives the Commissioner an express power of apportionment so as to deny the deduction of some part of expenditure that would be an allowable deduction under s. 53(1). The power given is to allow a deduction of only so much of the deduction otherwise allowable “as, in the opinion of the Commissioner, is reasonable in the circumstances”. It might be argued that the express provision precludes any apportionment in the operation of s. 53(1): it could not have been intended to add a power to apportion where there could already have been an apportionment in the operation of s. 53(1). The argument has force although, it should be noted, s. 53(3) is an addition to the Assessment Act in 1984 and ought not to control the meaning of words in the section as orginally enacted.
[10.32] If one assumes that subs. (3) is the only provision under which there can be an apportionment, there will remain questions as to the scope of its operation. The section gives the Commissioner the power to apportion where the property was “held, occupied or used by the taxpayer only partly for the purpose of producing assessable income, or only partly in carrying on a business for that purpose”. Those words admit of one or more of the following meanings:
The first meaning would bring s. 53(3) into operation where, for example, the roof is repaired of a building that includes a shop and a residence. The second would bring s. 53(3) into operation where a house has been let for only part of any period prior to the repair. The third meaning would bring s. 53(3) into operation where, for example, a house has been the subject of a charity letting, involving purposes to derive income and to be charitable. Circumstances may be within two or more of these meanings. Thus a house may be let in a charity letting for only part of any period prior to the repair. Which may explain why s. 53(3) does not dictate any formula by which the apportionment is to be made.
[10.33] In all instances the above formulations of meaning refer to use in any period prior to the repair. Which is to assume an interpretation of s. 53(1) that does not apply the words “in the year of income” to the holding, occupation or use of the relevant property. If those words are to be applied to the holding, occupation or use, the circumstances in which the Commissioner has power will be narrower, but there will remain a question of whether he can, in the proper exercise of his power, take into consideration the fact that the property was not held, occupied or used for the purpose of producing income in some period prior to the year of income, and the need for repairs has arisen to a degree out of the holding, occupation or use during that period. And there will be a question whether he can take into consideration any holding, occupation or use subsequent to the time of the repair.
[10.34] Attention was directed in [6.156] above to a possible interpretation of the word “use” in s. 53, such that a taxpayer who lets property at a non-commercial rental to a relative or other recipient of his charity, must none the less be regarded as using the property exclusively in the derivation of income. Such an interpretation of the word “use” in s. 67 was adopted by the Federal Court in Ure (1981) 81 A.T.C. 4100. The interpretation was the subject of comment in [6.115]–[6.116] above and again in [6.152] above. The view expressed in those paragraphs would reject this interpretation of the word. Expenses of repairs to property which is the subject of a charity letting have only in part a function to maintain property in its use for the purpose of income derivation. The consequences for the operation of s. 53 raise issues already explored.
[10.35] Section 64 provides that expenditure incurred by the taxpayer by way of commission for collecting his assessable income is an allowable deduction. The section simply confirms the operation of s. 51(1). It is the subject of some comment in [6.284] above.
[10.36] Some legal expenses that are not working expenses are expressly made deductible by ss 67, 67A, 68 and 68A. They are considered in [10.217]–[10.232] below. Section 64A is intended to allow deduction of other legal expenses that are not deductible under s. 51(1). The structure of the provision is curious. It confirms the operation of s. 51(1) in regard to the legal expenses (defined in s. 64A(1)) of a business, and seeks to extend the operation of s. 51(1), subject to a money limit of $50, by adopting a form of words which omits the references to “outgoings of capital or of a capital private or domestic nature” that appear in s. 51(1). The operative provision is s. 64A(2).
[10.37] On the view taken in this Volume of the structure of s. 51(1), s. 64A can have no operation beyond the partial confirmation of s. 51(1). The omission of the so-called exception of capital outgoings has no effect in increasing the range of deductibility, if an expense that is a capital outgoing can never be embraced by the words “incurred in the carrying on of a business for the purpose of gaining or producing assessable income”.
[10.38] Some of the history of s. 72 and problems of the interpretation were considered in [6.149]–[6.155] above. The provision in s. 72(2) in regard to the assessability of refunds was considered in [2.549] and [4.223]–[4.226] above.
[10.39] The correlation between the operation of s. 51(1) and the operation of s. 72 raises questions which are parallel with questions already raised in [10.8]–[10.9] and [10.27]–[10.33] above in regard to repairs. Those questions concern the possibility that s. 72 is a code, the need for contemporaneity, the formulation of any principle of relevance, the need for apportionment and the operation of the express power to apportion given by s. 72(1c). There is however one important difference: subss (1) and (1B) of s. 72 require, for deductibility, both that the amount should be paid in the year of income and that the relevant property should be used during the year of income for the purpose of gaining or producing income. In the result, the question raised in relation to s. 53 whether a deduction may be allowed where the property was held, occupied or used for the purposes of producing assessable income in a period prior to the year of income, but not in the year of income, has no parallel in relation to s. 72. But there will be parallel questions as to the operation of the power to apportion given to the Commissioner by s. 72(1C).
[10.40] There is a curious aspect of s. 72 which may be noted. It would appear that it has a potential application to allow a deduction notwithstanding that the income from the use of the relevant property is exempt income. Subsections (1), (1B) and (1C) of s. 72 omit the word “assessable” before the word “income”.
[10.41] The deduction for which s. 51A provides is intended to be additional to and distinct from any deduction that may be available to the taxpayer under s. 51(1).
[10.42] The amount of the deduction is limited in various ways by subs. (2) of the section. All the limits are related to the amount of a “living-away-from-home” allowance which is included in the assessable income of a taxpayer who is an employee. Where the allowance is granted under the terms of any law or of any award order or determination of an industrial tribunal, or of an industrial agreement, the deduction is a sum calculated as provided in the subsection. In other circumstances the deduction is limited by a discretion given to the Commissioner to determine how much of the allowance is reasonable: the deduction is limited to the amount of the allowance that the Commissioner considers reasonable (less $2 per week).
[10.43] If the allowance is not assessable income of the employee, no deduction is available under s. 51A. The definition of “living away from home allowance” in s. 51A(3) is so much of an allowance “as the Commissioner is satisfied is in the nature of compensation to the employee for the additional expenses (not being expenses which are allowable as a deduction under s. 51) incurred by him or which would be incurred by him if the allowance or benefit were not received, through having to live away from his usual place of abode in order to perform his duties as an employee”.
[10.44] The inter-relation of s. 51A and general principles of income and deductibility is not easily discerned. It is arguable that an allowance in the nature of compensation for the expenses specified in the definition is not income. Proposition 7 discussed in [2.113]ff. above is relevant. There is authority in Hochstrasser v. Mayes [1960] A.C. 376 that an allowance to meet expenses incurred by an employee in serving the interests of his employer, is not income. The expenses in these circumstances are not deductible by the employee. If expenses are deductible by the employee, an allowance in the nature of compensation for them is not a “living away from home allowance”, and s. 51A can have no operation.
[10.45] The reply to the argument in terms of Hochstrasser v. Mayes would refer to Lunney (1958) 100 C.L.R. 478 and assert that the expenses of living away from home are not expenses that are incurred in the interests of the employer: they are incurred as a consequence of the employee’s decision to maintain his usual abode in a place remote from his place of work. The allowance is akin to an allowance received by an employee to meet his expenses of travel between home and his place of work. The allowance is income and the expenses are not deductible. In truth, his expenses of living away from his usual place of abode in order to perform his duties as an employee are, in function, somewhere between the expenses of living at home, an allowance for which is not within the contribution to capital principle, and the expenses of moving one’s home so as to be near to a new place where the employee is now required to work, an allowance for which is within the contribution to capital principle.
[10.46] The expenses are the more likely to attract the contribution to capital principle if the employee is required to work away from his usual place of abode only for a limited period. In such circumstances it is more easily asserted that the expenses are a consequence of the location of his place of work, rather than a consequence of the location of his place of abode.
[10.47] If he has been required to move permanently to a new place of work, the allowance is less likely to attract the contribution to capital principle, and s. 51A will have room to operate. There is then the prospect that the Commissioner will at some stage conclude that the allowance is not a living away from home allowance, because it is not compensation to the employee for additional expenses incurred by him through having to live away from his usual place of abode in order to perform his duties. The Commissioner may say that after a lapse of time within which the taxpayer might have shifted his usual place of abode the expenses are not the result of having to live away from his usual place of abode in order to perform his duties. They are the result of his decision not to move his usual place of abode. At least it may be open to the Commissioner to take such a view where it would be reasonable to expect the taxpayer to move his usual place of abode. The fact that the new place of work is in some remote area will be relevant.
[10.48] The discussion so far has been concerned with a taxpayer who is required by his employer to change his place of work. Section 51A may operate in circumstances where the taxpayer enters on an employment for a new employer at a place of work remote from his usual place of abode. It will be relevant to a conclusion by the Commissioner that the allowance is a living away from home allowance that the new employment is for a limited period or that the place of work is in some remote area.
[10.49] The section can only operate if the taxpayer has a usual place of abode and lives away from it in order to perform his duties as an employee. If he in fact moves his usual place of abode to the location of his new place of work, there is no room for the operation of the section.
[10.50] Some reference was made in [6.310]–[6.321] above to the operation of s. 63, and some comparisons were drawn with the operation of s. 51(1) in relation to losses arising in regard to receivables.
[10.51] The specific deduction for the “write-off” of a bad debt under s. 63 differs from the deduction that may be available in regard to a receivable under s. 51(1) in a number of respects. The most significant difference is that s. 63 may allow a deduction though no expense has yet been incurred under s. 51(1). It is enough to warrant a deduction under s. 63 that a “bad debt” has been “written off as such”. A deduction under s. 51(1) for a loss in regard to a receivable must await the realisation of the receivable. Realisation, it was asserted in [6.318]–[6.319] above, occurs when a receivable is disposed of, when something is taken in satisfaction of the receivable, when the receivable is released or when the receivable becomes irrecoverable because the debtor is bankrupt and without assets, or becomes irrecoverable in a commercial sense because the debtor cannot be found or is without assets.
[10.52] The event that gives rise to deduction under s. 63 is a “write-off”, an accounting entry directed not to the taxpayer’s receivables in general—a provision for bad debts is not a write-off—but to a specific receivable considered to be bad.
[10.53] A “write-off”, as those words have been interpreted in their use in s. 63, more especially in Point (1970) 119 C.L.R. 453, would not be a realisation of a receivable so as to give rise to a loss deduction under s. 51(1). The use of the words “write-off” in s. 63A to identify the event which gives rise to deductibility under s. 63 and s. 51(1) was the subject of some comment in [6.318] above. The use of a single phrase may have its origin in what may appear to be the assumption in a recommendation of the Ligertwood Committee (Report of the Commonwealth Committee of Taxation, June 1961) that the words “and no other bad debts” which appeared in s. 63 prior to 1963 should be deleted (Report, para. 146). The recommendation follows an observation by the Committee that:
“145. We consider that any loss, except one of a capital, private or domestic nature, which results from business operations should be allowable in accordance with the tests contained in s. 51. We take the view that a loss in respect of an advance made in the course of carrying on a business should fall for consideration as an allowable deduction under s. 51 of the Act, but that course is at present not available because of the words ‘and no other bad debts’ contained in s. 63.”
The assumption in that observation is that “written-off as such” is the moment of incurring a loss in respect of a receivable under s. 51(1), and that s. 63 by the words “and no other bad debts” had limited the operation of s. 51(1). The assumption receives no support in judicial decision, and it would be at odds with the fundamental principle that the Assessment Act, save where specific provision is made, is concerned with realised losses and gains.
[10.54] The deletion of the words “and no other bad debts” from s. 63 did not, in fact, have any effect on the operation of s. 63 or s. 51(1). Section 63, then as now, extended the operation of s. 51(1) by allowing a taxpayer to anticipate the loss deduction under s. 51(1) by the earlier write off of a debt. At no stage did it limit the operation of s. 51(1). It would be an odd construction of the section that it should be held to be a code in regard to the deduction of losses in respect of receivables. There has been no hint in the authorities in regard to exchange losses that the only available deduction in regard to an exchange loss in respect of a receivable is for a write-off reflecting the anticipated loss the taxpayer is likely to suffer, if a movement in the exchange rate that has occurred is sustained until there is a receipt of the receivable. It is no doubt arguable that any s. 63 code relates only to “bad debts”, and that a receivable that has fallen in value because of a variation in exchange rates is not in this respect a “bad debt”. But the search for the scope of a s. 63 code was always unnecessary. The reference to “no other bad debts” was intended to emphasise that s. 63, in its operation to allow the advancement of deductibility of an expense, was confined to the kinds of receivables specifically mentioned. It remains so confined after the deletion of the words.
[10.55] The assumption in the Ligertwood Committee recommendation may reflect another assumption about s. 51(1)—that the section is an aspect of receipts and outgoing accounting and that it does not provide for the deduction of a “loss” that is a balance of cost and proceeds. Such an assumption has now been rejected in International Nickel Aust. Ltd (1977) 137 C.L.R. 347, and more directly in relation to bad debt losses, in A.G.C. (Advances) Ltd (1975) 132 C.L.R. 175.
[10.56] The effect on general principles of the references to writing-off in s. 63A must await judicial decision. It would be strange indeed if it were taken to enact the misapprehension on which the recommendation of the Ligertwood Committee proceeded.
[10.57] Section 63 is applicable only to the kinds of debts that are listed in the section: (a) “[debts which] … have been brought to account by the taxpayer as assessable income of any year”, and (b) “[debts which]…are in respect of money lent in the ordinary course of the business of the lending of money by a taxpayer who carries on that business.” The latter will include a debt for interest on money lent in the ordinary course of such a business: National Commercial Banking Corp. of Australia (1983) 83 A.T.C. 4715. The receivables to which s. 51(1) has potential application are in some respects wider: a comparison in this respect is made in [6.315]–[6.316] above. Section 63 will extend to a receivable in respect of the supply of trading stock because the method of the Act in s. 28 and s. 51(2) is to make the proceeds of supply of trading stock assessable income. Section 63 will not apply to a receivable in respect of the supply of property which is a revenue asset but is not trading stock. Section 51(1) may apply to such a receivable. Section 63 will extend only to some receivables arising from lending. Section 51(1) will apply to any lending on revenue account, which may include a loan to an employee of the taxpayer, or a loan to the taxpayer’s supplier or to an outlet for the taxpayer’s production. In some respects the receivables to which s. 63 has an application are wider than those that may be the subject of a loss deduction under s. 51(1). A debt which has been brought to account as assessable income is not necessarily a revenue asset in respect of which there may be a loss deduction. It was explained in [6.310] above that accommodation granted by a seller or supplier of services in allowing the buyer a long term in which to pay may be an accommodation granted on capital account. The receivable will not be a revenue asset. The instance was given of a parent company that provides finance for its subsidiary in this manner. The parent has invested in the subsidiary. Paragraph (b) of s. 63, as interpreted in National Commercial Banking Corp. of Australia, will include a debt for interest receivable on money lent in the ordinary course of business, even though that interest is to be accounted for on a cash basis. In this instance s. 63 may be thought to have a rogue operation. Section 51(1) would not allow a loss deduction in these circumstances.
[10.58] Section 63 will probably extend to allow the deduction of a bad debt write-off even though the writing off is done after the business activity in which the receivable arose has ceased. It is perhaps arguable that the write-off referred to in s. 63 must be an entry in the books of a business that is presently carried on, but such a construction is unlikely. Section 51(1) is limited in its operation by the principle requiring that the incurring of a loss must be contemporaneous with the process of deriving income.
[10.59] Section 63, it is assumed, contemplates a partial write-off of a debt. It may be written off to the extent that, in the bona fide judgment of the taxpayer, it will not realise the amount at which it was brought to account: G. E. Crane Sales Pty Ltd (1971) 126 C.L.R. 177 at 192, 196-7, per Walsh and Gibbs JJ. There may thus be several “write-offs” in respect of the same debt, each write-off involving a revised estimate of the extent to which the debt is bad. A loss deduction under s. 51(1) in respect of a receivable arises finally on one event. The amount of the loss is a matter of fact, not primarily one of estimate, thought a value may need to be given to what is received by the taxpayer on the realisation in determining the amount of the loss.
[10.60] A s. 63 deduction is available only in respect of a “bad debt”. The suggestion is made in [6.317] above that the phrase “bad debt” may limit the operation of the section to circumstances where the debtor is unable to pay the full amount of the debt. It follows that a debt in a foreign currency is not a bad debt simply because a change in the exchange rate has brought about the consequence that payment in full of the debt will, in Australian currency, yield an amount less than the amount of Australian currency at which the debt was brought to account. Section 51(1) is available whatever the reason the receivable fails to realise its cost.
[10.61] Point (1970) 119 C.L.R. 453 is authority that a debt which ceases to exist as a debt owed to the taxpayer cannot thereafter be the subject of a write-off for which s. 63 may allow a deduction. If debts are assigned by a taxpayer company to a receiver and manager who is not simply an agent to collect the debts, s. 63 is no longer available to the taxpayer: G. E. Crane Sales Pty Ltd, Betro Harrison Constructions Pty Ltd (1978) 78 A.T.C. 4431. The assignment, again on the authority of Point, is not itself a “write-off”. It follows that if the taxpayer has ceased at the time of the assignment to carry on the business whence the receivable arose, s. 51(1) and s. 63 deductions are both precluded. Point, it is true, concerned a release under a scheme of arrangement, but what is true of a release should equally be true of an assignment.
[10.62] Where s. 63 applies, the amount of the deduction is the amount written-off. Where a deduction is claimed under s. 51(1), the deduction is the amount of the loss and, in calculating that amount, it is necessary to bring the account any proceeds of realisation. The difficulties that may arise in determining the amount of the loss where realisation involves a release under a scheme of arrangement, as in Point, or where the realisation is an assignment to a receiver and manager, as in A.G.C. (Advances) Ltd (1975) 132 C.L.R. 175 are the subject of some comment in [6.321] above. Section 63 is not immune from those difficulties. Subsection (3) provides that where a taxpayer “receives an amount in respect of a debt for which a deduction has been allowed to him under this or the previous Act, his assessable income shall include that amount.” Where a debt that has been the subject of a write-off is subsequently released under a scheme of arrangement or is assigned to another, the proceeds of the release or assignment must then be brought to account. The language of s. 63(3), it might be noted, seems adapted only to a situation where the “write-off” was of the whole amount of the debt, which may suggest that a partial write-off is not contemplated by the section, despite the judicial assumption that it is.
[10.3] The operation of the contemporaneity principle in determining deductibility under s. 51, and the fact that the principle does not operate in relation to s. 63, suggest that book debts for goods or services supplied should not be assigned to the buyer of a business. The seller should retain them. If he retains the debts the seller will be entitled to write-off debts that become bad. The buyer who has taken an assignment will not be able to write-off the debts that become bad, because they will not have been brought to account as assessable income of the buyer. In G. E. Crane Sales Pty Ltd (1971) 126 C.L.R. 177, s. 63 was held not to be available to the buyer of book debts because the write-offs occurred after further assignment to a receiver and manager, so that they were no longer debts owed to the buyer. The court reserved its opinion on the question whether the debts could be said to have been brought to account as assessable income of the buyer.
[10.64] If the buyer of a business does acquire the book debts he may be entitled to deductions for any losses on the realisation of the debts, provided he continues to carry on the business. This is to assume that the book debts so acquired are revenue assets of the business carried on by the buyer, an assumption that may not be sound. The seller of a business who disposes of the book debts may be entitled to deductions for losses realised on the disposition. This is however to assume that the realisation of revenue assets in the act of disposing of a business may generate deductible losses under s. 51(1), another assumption that may not be sound. It will be apparent that the retention of book debts, by the seller of a business, is the more appropriate action.
[10.65] In A.G.C. (Advances) Ltd (1975) 132 C.L.R. 175 the debts owing to the taxpayer were owed in respect of the principal sums under hire purchase transactions. They had not been brought to account as assessable income, and s. 63 had no application. The High Court allowed deductions under s. 51(1), for what were described by counsel as “write-offs”. The outcome is more than a little confusing. There was no argument on the question of when the losses occurred. All members of the High Court made observations which at least leave room for the point of view taken in [10.58] above that writing off is not the event which gives rise to a loss deduction under s. 51(1). Barwick C.J. (at 185) referred to the “writing off of the debts, which for this purpose seems to have been regarded by counsel as the time at which the loss was incurred”. Gibbs J. said: “it may be assumed that the losses were incurred when the amounts were written off…” (at 192). Mason J. said: “That the relevant amounts were losses incurred at the time when they were written off is not in question…” (at 195). It is a demonstration of the inadequacies of analysis and doctrine that the assumption of s. 63A is found in the agreement between counsel in A.G.C. (Advances), and that the taxpayer had to be saved from being defeated by the contemporaneity principle by a conclusion that the business had not ceased, but was suspended.
[10.66] It may assist an understanding of the interplay of s. 51(1) and s. 63 to consider the effect of those sections at different stages of a series of events that involve a taxpayer on an accruals basis of tax accounting, who, being entitled to $100,000 for services supplied to a company in the carrying on of his business, accepts a debenture for $100,000 issued by the company, and subsequently sells that debenture for $50,000.
[10.67] If it be assumed that no action was taken by the taxpayer at any time explicitly to write-off any part of the original debt or the debenture debt, his right to any deduction must rest on the operation of s. 51(1). Neither the acceptance of the debenture nor the sale of the debenture is a write-off that could attract s. 63.
[10.68] The acceptance of the debenture could be a realisation of the original debt—a revenue asset—and give rise to a loss deduction. The amount of the loss would be the difference between the amount of the original debt and the value of the debenture, a value that will reflect the rate of interest, the term of the debt and the financial responsibility of the debtor. Whether or not the acceptance of the debenture is a realisation of the original debt may turn on whether the debenture was taken by way of security for the original debt or in satisfaction of the original debt. If it was taken by way of security there would as yet have been no realisation of the original debt, though there would be a realisation if the taxpayer sells the debenture in the exercise of his power of sale. If the proceeds are less than the original debt, and the balance is commercially irrecoverable, there will be a deductible loss to the extent of the balance.
[10.69] The acceptance of the debenture in satisfaction of the original debt is not necessarily a realisation of the debt. A number of authorities, some concerned with the question whether a cash basis taxpayer has received a payment of interest on a debt when he takes a new promise by the debtor to pay, may suggest that a taxpayer who has no choice between receiving payment in cash—there being no offer of cash—and taking the debenture, has not realised the original debt: Parker v. Chapman (1928) 13 T.C. 677; C. of T. (Q.) v. Union Trustee Co. [1931] A.C. 256; Cross v. London & Provincial Trust Ltd [1938] 1 K.B. 792; Griffin Shave & Co. Pty Ltd v. C. of T. (N.S.W.) (1933) 2 A.T.D. 305; Calders Ltd v. I.R.C. (1944) 26 T.C. 213. Realisation of the original debt is, presumably, to be treated as delayed until the debenture debt is realised. At the time there will be a loss deduction of the difference between the original debt and the proceeds of realisation of the debenture debt. A disposition to treat a new debt taken in satisfaction of an original debt as not being a receipt of the original debt may be appropriate when the issue is whether the taxpayer has a receipt that will be income derived by him. A different view might be thought appropriate when the issue is whether the taxpayer has a s. 51(1) loss deduction. However, though involving a loss on discharge of a liability, Caltex Ltd (1960) 106 C.L.R. 205 may indicate that there is no realisation of a loss. The case involved the acknowledgement of a new debt to a new party. But it was not held to be a discharge of the original liability so as to generate an exchange loss deduction under s. 51(1).
[10.70] Caltex Ltd left open a question whether the new debt acknowledged involved a liability on revenue account, so that a discharge of the new debt might generate an exchange loss deduction. Coherent principle would demand that the new debt be so regarded. And if a taxpayer has taken a new debt in satisfaction of an original debt owed to him, and the taking of the new debt does not involve a realisation of the old, the new debt should be treated as standing in the shoes of the old so that a loss deduction in respect of the old may arise when the new debt is realised.
[10.71] Where a taxpayer takes not a new debt but some other kind of property in satisfaction of an original debt, there would appear to be no room for a view that the taking of the property is not a realisation of the original debt. The fact that a cash payment is not offered to him will be relevant to the question of the character in his hands of the property taken, but it does not prevent a conclusion that there has been a realisation of the original debt.
[10.72] It is possible to conclude that the new item of property, though taken in a realisation of the original debt has, none the less, the revenue character of the original debt, so that a loss on the realisation of the new item will be deductible under s. 51(1). The new item of property may have the character of a revenue asset because it was acquired in the process of obtaining satisfaction of the original debt. Mr O’Neill in a Board case ((1970) 70 A.T.C. 273 at 277) said of a loss on the realisation of the new item of property: “The loss that was in fact sustained was incurred [by the taxpayer] in an operation of business concerned with the regular inflow of revenue—the collection or conversion to cash of debts owed to it for goods supplied in the ordinary course of its business…” The cost of the new item of property will be the amount brought into the calculation of any gain or loss on the realisation of the original debt. The reference to gain is intended to emphasise that the realisation of the original debt, being by hypothesis a revenue asset, may generate a gain if the new item of property taken in satisfaction is of greater value than the amount of the original debt. So too, if the new item of property is held to be a revenue asset, the taxpayer will be at risk that the realisation of that item will produce a gain that is income.
[10.73] The new item of property will have a revenue character if it has been acquired in the process of obtaining satisfaction of the original debt. It will have been so acquired if the taxpayer was not offered a choice between payment in full in cash and the new item of property. If he has been offered cash, but responded to an invitation to invest the money in some item of property—it might be shares in the debtor company—the shares do not attract the character of the original debt. They are not acquired in the process of obtaining satisfaction of the original debt. They are an investment of the proceeds of the original debt. If the shares are revenue assets in the hands of the taxpayer, it will be because they are assets of a business of dealing in shares, or they are held as assets of a business of investing of the kind in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106 or in the banking and life insurance cases.
[10.74] The discussion so far has been limited to the effect of s. 51(1) at different stages of the series of events. The taxpayer might have written off the original debt in whole or in part and become entitled to a deduction under s. 63 before he accepted the debenture. If the taking of the debenture is a realisation of the original debt, there will be an operation of s. 63(3) on the taking of the debenture. If the value of the debenture exceeds the written down amount of the original debt, there is “an amount received in respect of the debt” which is assessable income of the taxpayer. Section 63(3), it was noted above, is not easily applied in a partial write-off situation, but if it is held that s. 63(1) does apply to a partial write-off, the amount of income under s. 63(3) must be confined to the excess of the value of the debenture over the written down amount of the original debt. The value of the debenture is an amount received in respect of the debt because of the operation of s. 21, which deems the money value of the debenture to have been received.
[10.75] The taking of the debenture in realisation of the original debt will be an occasion of a s. 51(1) loss deduction. In computing that loss, s. 82(2) will deny a subtraction of the deduction allowed under s. 63, save so far as that deduction has been reversed by the operation of s. 63(3). If it has been reversed, a sensible operation for s. 82 requires that it should not be treated in the operation of s. 82(2) as a deduction allowed. If the debenture has a value greater than the original debt, there is a prospect that both s. 63(3) and the general principle applicable to the realisation of a revenue asset will bring in a profit. The profit will not be twice included in income: an item that is income under two provisions of the Act is income once only.
[10.76] If the debenture is taken in satisfaction of the original debt but this is not held to be a realisation, there will be an operation of s. 63(3) on the receipt of the debenture, but no operation of s. 51(1). There will be an operation of s. 63(3), because a debenture received in satisfaction of the original debt is, by force of s. 21, deemed to be an amount received in payment of the original debt. When the debenture is realised, there will be a need to correlate the operation of s. 51(1) with the earlier operation of s. 63. If s. 63(3) has had the effect of bringing in as income a profit on the receipt of the debenture, it will be necessary to ensure that any profit on the realisation of the debenture—prima facie the surplus of the amount received on realisation of the debenture over the amount of the original debt—that has already been treated as income under s. 63(3), is not again treated as income. This objective will be achieved by allowing the profit treated as income under s. 63(3) as a cost in computing any profit that is income on the realisation of the debenture. The amount of the debt written off under s. 63 will not be subtractable in calculating the profit on realisation of the debenture. This follows from s. 82.
[10.77] Any write-off of the original debt subsequent to the receipt of the debenture in satisfaction of the original debt will not have any tax consequences. It comes too late—Point (1970) 119 C.L.R. 453—and no problems of correlation with s. 51(1) can arise.
[10.78] The Assessment Act was amended in 1973 to introduce provisions qualifying deductibility of losses under s. 63 and s. 51(1) by a company, where there is a break in continuity of ownership of the company between the time of the debt arising and the time when the debt is written off, or the time when a loss in relation to the debt is realised. The effect is to limit the deductibility which would otherwise arise under s. 63. The effect is also to limit the availability of a deduction that would otherwise be allowable under s. 51(1).
[10.79] The pattern of the provisions in ss 63A, 63B and 63C follows the pattern of provisions in ss 80A, 80B, 80DA and 80E which deny loss carry forward by a company where there has been a break in continuity of ownership of the company. The latter provisions are considered in [10.375]–[10.420] below.
[10.80] Sections 63A, 63B and 63C were introduced in order to defeat a practice designed to circumvent the operations of predecessors of the company loss carry forward provisions. Shares in a company with potential bad debts losses not yet the subject of write-off and not yet realised, would be sold. The bad debt losses would then be incurred. If these losses created a loss to be carried forward, ss 80Aff. could not defeat the carry forward of the loss because the break in continuity of ownership would have occurred before the loss was incurred.
[10.81] The effect of s. 63A and s. 63B is that a bad debt loss incurred under s. 63 or s. 51(1) is not deductible unless there is a continuity of ownership of the company subsisting at all times in the year in which the debt arose and in the year in which the loss was incurred. There is a qualification in s. 63C, whereby a continuity of carrying on the same business subsisting at the time immediately before the change in ownership and in the year in which the bad debt loss is incurred will exclude the operation of s. 63A and s. 63B.
[10.82] Section 80F supplements the provisions of s. 80Aff. If the deductibility of a bad debt loss is otherwise preserved by the operation of s. 63C, and a loss to be carried forward results from the deduction of that loss, the carry forward of the loss may yet be denied. It will be denied if the Commissioner is satisfied that the company carried on business in the year of incurring of the bad debt loss for the purpose of satisfying and securing the protection of s. 63C, unless the company has continued to carry on the same business in the year in which the loss carried forward is sought to be deducted.
[10.83] Section 69(1) provides for the deduction of expenditure incurred by the taxpayer in the year of income for the preparation by a registered tax agent of a return required by or under the Assessment Act to be presented to the Commissioner in respect of the income of the taxpayer. Expenditure incurred by the personal representative of a deceased taxpayer in presenting the return of the income of the deceased is deemed to be expenditure incurred by the deceased (subs. (2)). Some comment was made on s. 69 in [6.292] above. The view was there taken that the expenses of preparing a return of income as distinct from the expenses of recording income are not deductible under s. 51(1).
[10.84] Some attention was given to the provisions of s. 71 in [6.67]–[6.77] above. In one respect it allows a deduction beyond the operation of s. 51(1). The loss is an allowable deduction in the year in which it is ascertained, which may be a later year of income than that in which the loss was incurred for purposes of s. 51(1). In other respects the section may be narrower or wider in its operation than is s. 51(1). The section in its present form is the result of amendments made in 1963 following the decision of Kitto J. in Levy (1960) 106 C.L.R. 448 that losses which result from the action of a person who is not an employee are not deductible under s. 51(1). The decision is the subject of some comment in [6.68] above, where it is said that the decision in Levy is simply at odds with the Full High Court decision in Charles Moore & Co. (W.A.) Pty Ltd (1956) 95 C.L.R. 344. Section 71 is narrower in its operation than s. 51(1), in that it will not allow a deduction where the loss results from the action of a person employed solely for private or domestic purposes. In Charles Moore it was held that loss by the action of an armed robber was a relevant expense. It should follow that loss that results from action by a person employed solely for private or domestic purposes may be a relevant expense. A deduction under s. 51(1) could not be denied if an armed robbery in the circumstances of Charles Moore was carried out by a person employed by the taxpayer for domestic purposes.
[10.85] Section 71 is also narrower in its operation in confining deductibility to a loss “of, or in respect of, money that is or has been included in the assessable income of the taxpayer”. Where a loss arises from some act of deprivation of property which is a capital asset, s. 51(1) will not allow a deduction: the expense is not a working expense. But whether money is a capital asset or a revenue asset, it is submitted in [6.70] above, is a matter of the way in which it is held, not a matter of its origin. A characterisation of an asset in terms of its origin is simply unacceptable: it leads to fortuitous consequences. Thus the misappropriation by the wages clerk of the proceeds of a cheque drawn to pay the wages of employees will not give rise to a deduction under s. 71 if the cheque is drawn on an overdrawn bank account, an overdraft having been arranged.
[10.86] The language of s. 71 which confines the operation of the section to a loss in respect of money “that is or has been included in the assessable income of the taxpayer”, may result in a wider operation for the section than the operation of s. 51(1). Money that has its origin in a transaction whereby its receipt is a derivation of assessable income—which is presumably the money identified by the words of s. 71—may in the manner in which it is held be a capital asset of the taxpayer’s business, or, indeed, have ceased to be an asset of the business, the taxpayer having effected a drawing by taking cash or cheque for his private purposes, or by paying it to the credit of his private bank account. The deprivation of that money will give rise to a loss deduction under s. 71, when it would not give rise to a loss deduction under s. 51(1).
[10.87] And the allowing of a deduction in respect of deprivation by a person employed—which imposes a test of relevance which picks on only one element in the circumstances—may involve a wider operation for s. 71 than the operation of s. 51(1). Charles Moore sets a very embracing test of relevance for purposes of s. 51(1). But at least in theory deprivation by a person employed may not always be a relevant deprivation.
[10.88] Section 73 was the subject of some examination in [6.252]–[6.266] above. A deduction under s. 73 in respect of a subscription to an association may be available:
[10.89] Subscriptions of these kinds are likely to be relevant expenses for purposes of s. 51(1), but they may not be. And a deduction under s. 73 will not be denied where deduction would be denied under s. 51(1) because the subscription is a non-working expense.
[10.90] The deductions allowable under s. 73 are thus in some respects wider than those that might be allowable under s. 51(1), though they are in some other respects narrower—there is a money limit of $42 in regard to each subscription in the cases of subss (2) and (3). Where the deductions allowable under s. 73 are narrower, the question is raised whether s. 73 excludes deductibility under s. 51(1). An argument might be made that s. 73 is a code. The view is taken, however, in [6.255] above that it should not be so regarded.
[10.91] Deductibility of subscriptions to associations, whether under s. 73 or s. 51(1), is affected by s. 51AB. The section overrides s. 73 and s. 51(1) in denying a deduction of an outgoing to secure enjoyment of certain facilities. Section 51AB is the subject of some examination in [6.261] above.
[10.92] Section 74(1) allows a deduction of expenditure in being elected as a member, or in contesting an election for membership of certain legislative bodies, including the federal parliament. Section 74(2) requires that any amount received by way of reimbursement should be treated as assessable income.
[10.93] Expenses of this kind would be denied deduction under s. 51(1), either because they are not contemporaneous with the derivation of income as a member, or because they are not working—they relate to the acquisition of the office, and the office is, presumably, a structural asset. Maddalena (1971) 45 A.L.J.R. 426 is relevant.
[10.94] Section 51(1) is confined in its terms to the allowance of deductions incurred in deriving assessable income. Section 77 allows the deduction of a loss incurred by a taxpayer in carrying on an “exempt business” in Australia. “Exempt business” is defined in subs. (1) of s. 77 as a business the income, if any, from which would be exempt income. An illustration would be a business of working a mining property for the purpose of obtaining gold: s. 23(o).
[10.95] The calculation of the amount of the loss is controlled by s. 77(2), so that no subtraction may be made which would not have been an allowable deduction if the income (if any) had been assessable income.
[10.96] Where a deduction has in fact been allowed and a profit is derived from the exempt business in any of the following three years of income, the profit will be assessable income to the extent of the amount of the loss that has been deducted.
[10.97] Section 78(1)(a) allows deductions of gifts, other than testamentary gifts made to certain funds authorities and institutions. In most circumstances such gifts would not be deductible under s. 51(1). Section 78(1)(a) thus involves a significant extension of deductibility beyond what is allowable under s. 51(1).
[10.98] Deductibility under s. 78(1)(a) is qualified in a number of ways The gift must be of money, or of property purchased by the taxpayer within 12 months immediately preceding the making of the gift. The latter qualification is modified in relation to gifts of works of art by s. 78(1)(aa) and (ab) which make distinct provisions for the allowance of deductions in respect of these items. The amount of the gift where property is transferred is determined by s. 78(2).
[10.99] Section 78A contains provisions denying deductibility of gifts made in circumstances where, among others, the amount or value of the benefit derived by the fund, authority or institution as a consequence of the gift may reasonably be expected to be less than the amount or value of the gift at the time it was made, or where the donor or an associate of the donor may reasonably be expected to obtain a benefit.
[10.100] Section 78A is directed against the use of s. 78(1)(a) to obtain a tax advantage. The interpretation of the word “gift” in s. 78(1)(a) in McPhail (1968) 117 C.L.R. 111, Cyprus Mines Corp. (1978) 78 A.T.C. 4468 and Leary (1980) 80 A.T.C. 4438 has significantly reduced the need for s. 78A. In McPhail, Owen J. put an interpretation on the word that precludes a conclusion that a transfer of property is a gift where an “advantage of a material character [is] received by the transferor by way of return” (at 116). Cyprus Mines Corp. and Leary confirm this interpretation. In Leary Deane J. accepted that a “usual attribute” of a gift is that to be a gift the donor must act from a “detached and disinterested generosity”. If such an attribute is required s. 78A will be unnecessary where an associate of the would-be donor receives a benefit. But s. 78A will have an operation in circumstances suggested by Coppleson (1981) 81 A.T.C. 4019 where the property transferred will fall substantially in value if action is not taken by the transferee.
[10.101] The operation of s. 78(1)(a) in allowing deductions of gifts is clearly wider than the operation of s. 51(1). Section 78(1)(a) has no test of relevance, nor any equivalent test, such as there is in s. 73. Gifts made to funds authorities or institutions by a self-employed taxpayer, or by a company or trust conducting a business, will generally be denied deduction under s. 51(1). In some circumstances, however, a gift will be deductible because its purpose is to secure opportunities to do business, or to attract goodwill. A gift may persuade the donee institution that it should purchase its requirements of goods or services from the taxpayer: the gift has the same function as a discount allowed. A gift, if it is publicly acknowledged, may induce those who come to know of the gift to purchase goods or services from the taxpayer.
[10.102] The deductibility under s. 51(1) of a gift to an institution that carries out activities which will further the interests of the taxpayer making the gift, will depend on considerations explored in [6.257–6.259] above in regard to subscriptions to an association.
[10.103] A gift to an institution by an employee will rarely be deductible under s. 51(1). The outgoing must be relevant to the derivation of the income of the employee, not the income of his employer. Reference was made in [6.266] above to the interpretation that has been given to the judgment of Menzies J. in Hatchett (1971) 125 C.L.R. 494. If that interpretation is correct, and the judgment of Menzies J. is taken to establish the law, a deduction for a gift by an employee will be deductible only where he is required to make the gift by the terms of his employment.
[10.104] Deductibility under s. 78(1)(a) is subject to s. 79C. The effect of s. 79C is, in general, to preclude a deduction under s. 78(1)(a) to the extent that it would create or increase a loss available for carry forward under s. 80. Section 80 is considered in [10.367]ff. below.
[10.105] Section 78(1)(c) provides for the allowance of a deduction where a taxpayer pays a pension, gratuity or retiring allowance to a person who is or has been his employee, or a dependant of his employee. The deduction is limited to the amount which in the opinion of the Commissioner was paid in good faith in consideration of the past services of the employee in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income.
[10.106] Such a payment would not always be deductible under s. 51(1). A payment may be deductible under s. 51(1) only where it is a further reward for services that the employer is bound to pay, where it may be said to be made to resolve an “ever-recurring question of personnel” as in W. Nevill & Co. (1937) 56 C.L.R. 290 ([6.17] above), or where it will, by its example, foster the goodwill of existing and future employees.
[10.107] Section 78(1)(c) does not displace the operation of s. 51(1). The opening words of the paragraph in the reference to “sums which are not otherwise allowable deductions” preserve the operation of s. 51(1).
[10.108] A director of a company is not necessarily an employee. An employee must hold his position under a contract of employment. A director may, however, be both a director and an employee: he may have a service agreement with his company.
[10.109] Section 78(1)(c) is concerned, in its terms, with “sums paid”. There is a question whether the transfer of property other than money involves the payment of a sum. Whim Creek Consolidated N.L. (1977) 77 A.T.C. 4503, concerned with the meaning of the words “money paid on shares”, may suggest that it does. In any event, s. 21 may have the effect of deeming a sum to have been paid.
[10.110] The Commissioner may under s. 78(1)(c) deny a deduction to the extent that, in his opinion, the amount was not paid in good faith in consideration of the past services of the employee. The fact that the payment is unreasonably high will have a bearing on the formation of his opinion. Where deduction is claimed under s. 51(1), the fact that the payment is unreasonably high may require a conclusion that the purpose of the payment was not such as to attract deductibility or that there was another purpose of the payment beyond a purpose that would attract deductibility. Where the inference is that there were two purposes in the payment, the one a purpose that would attract deductibility and the other a purpose that would make the payment irrelevant, an apportionment may be proper.
[10.111] Deductibility under s. 78(1)(c) is subject to s. 79C. The effect of s. 79C is, in general, to preclude a deduction under s. 78(1)(c) to the extent that it would create or increase a loss available for carry forward under s. 80. Section 80 is considered in [10.367] below.
[10.112] A pension, gratuity or retiring allowance may be an allowance, gratuity or compensation paid “in consequence of the retirement” of a person from an “office or employement” held by him in a private company (as defined in s. 6). In this event the circumstance that the amount of the payment is unreasonably high may attract the operation of s. 109, and this whether the payment is otherwise deductible under s. 51(1) or s. 78(1)(c). Section 109 is concerned with a sum paid or credited by a private company to a person who is or has been a shareholder or director of the company or a relative of a shareholder or director. To the extent that the sum exceeds an amount that, in the opinion of the Commissioner, is reasonable, it is not an allowable deduction and is, for most purposes, to be treated as a dividend paid by the company. Section 109 is the subject of further comment in [10.348]–[10.358] below. The correlation between s. 109 and Subdiv. AA of Div. 2 of Pt III is considered in [4.159] above.
[10.113] Contributions made by a taxpayer to a superannuation fund to provide superannuation benefits for himself would not be deductible under s. 51(1). The fact that he is required by a contract of employment to make the contributions, would not make them deductible. The requirement might give the contributions a quality of relevance but they would not be outgoings: the contributions are made by way of investment. Contributions not required by the terms of a contract of employment could not be seen as relevant to any process of income derivation. They are not in any event outgoings.
[10.114] Sections 82AAS and 82AAT, in allowing deductions of contributions made by an “eligible person” to a “qualifying superannuation fund” to obtain superannuation benefits for that person or his dependants, extend deductibility beyond s. 51(1). A “qualifying superannuation fund” is one the income of which is exempt from tax by virtue of para. 23(ja), or is a fund to which s. 23FB applies in relation to the year of income ([4.174] above). Deductibility under s. 82AAT is subject to s. 79C.
[10.115] The deduction under ss 82AAS and 82AAT is intended to give to the self-employed, and to the employee who is not a member of an employer-supported fund, some equivalent of the tax advantage the employed person may have in that the latter is not treated as deriving income when his employer makes a contribution to a superannuation fund of which the employee is a member. “Eligible person” is defined so as to exclude a person of whom it is reasonable to expect that retirement benefits will be provided upon his retirement, or for his dependants in the event of his death, and those benefits will be attributable to contributions to a fund made by a person other than the relevant person, or will be paid out of moneys that will not represent the relevant person’s contributions to a fund. The latter aspect of the exclusion is intended to cover the circumstance that a retirement benefit may be paid by an employer directly, instead of his providing a benefit by contributions to a fund.
[10.116] The assumption that an employee does not derive income when his employer makes a contribution to a superannuation fund is the subject of some observations in [2.22] and [4.167] above.
[10.117] Sections 82KM-82KS allow a deduction of certain costs of thermal insulation of a dwelling owned and used by a taxpayer as his sole or principal residence. The provisions reflect a policy of encouraging energy conservation. Such thermal insulation costs would not be deductible under s. 51(1): they are not relevant to the derivation of income.
[10.118] In [2.67]–[2.94] there is some discussion of the operation of the provision of Div. 9 of Pt III relating to co-operative companies, as defined in s. 117, and referred to in this Volume as Assessment Act co-operatives. Some of the receipts of an Assessment Act co-operative that would otherwise not be income because of the operation of the principle of mutuality are made income by s. 119. Not all such receipts are made income: interest receipts of an Assessment Act co-operative that would not be income because of the mutuality principle are not made income.
[10.119] Where s. 119 does not extend to a receipt by an Assessment Act co-operative, and that receipt attracts the mutuality principle, a rebate or bonus—the words are taken from s. 120—paid to the member from whom the receipt comes, will not be deductible. While the rebate or bonus may be seen as a discount allowed on the charge made for the goods or services to which the receipt relates, it is not an expense incurred in deriving income.
[10.120] Where s. 119 does extend to a receipt by an Assessment Act co-operative, the rebate or bonus would ordinarily be deductible by the co-operative under s. 51(1) as an expense in the nature of a discount, incurred in deriving assessable income. The operation of s. 51(1) in this context is confirmed by s. 120(1)(a), which allows a deduction of “so much of the assessable income of [an Assessment Act] co-operative as…is distributed among its shareholders as rebates or bonuses based on business done by shareholders” with the co-operative. The drafting of s. 120(1) is curious in its reference to the distribution of “assessable income”. Similar language in s. 71 used in relation to losses suffered by a taxpayer through embezzlement, is the subject of comment in [10.85] above. Deductibility under s. 51(1) does not depend on the actual outgoing being traceable to a receipt which involved the derivation of assessable income. In requiring a tracing, s. 120(1) has a narrower operation than s. 51(1). Presumably the tracing called for is a tracing through accounting entries, and not the equity tracing which s. 71 must contemplate.
[10.121] Section 120(1)(b) allows a deduction of “so much of the assessable income of [an Assessment Act] co-operative company as…is distributed among its shareholders as interest or dividends on shares”. In this respect s. 120(1)(b) extends deductibility beyond what would be allowed by s. 51(1). In [6.301]–[6.307] above a distinction was drawn between an expense in deriving income and a distribution of income derived. A payment to a shareholder, from whatever fund it is made, whose function is to make a distribution of profits to a shareholder is not deductible under s. 51(1): it is not an expense in deriving income. A conclusion that the function of the payment is to make a distribution of profits is clearly appropriate where payment is made in the manner of a dividend. It may not be so easily drawn where the payment is made as interest on capital subscribed by a shareholder—the other situation dealt with in s. 120(1)(b). Such payment as interest is in a marginal area, in this respect like interest paid on convertible debentures where deductibility has been made to depend on the specific provisions of ss 82Lff. considered in [10.344]–[10.347] below.
[10.122] There is another respect in which s. 120(1)(b) confers a privileged treatment on an Assessment Act co-operative. A distribution among the shareholders of a mutual association that is not an Assessment Act co-operative, will not in any circumstances be deductible by the association. To the extent that the association’s receipts are not income because they are subject to the mutuality principle, non-deductibility of the distribution does not involve a disadvantage when compared with the treatment of distributions by an Assessment Act co-operative. But a mutual association may have income from non-mutual dealings—returns, for example, from the investment of its funds with non-members. To the extent that it has such income, the denial of a deduction of a distribution is a disadvantage when compared with the treatment of an Assessment Act co-operative. The deduction allowed by s. 120 (1)(b) extends to distributions made from any receipts of an Assessment Act co-operative, whether they are receipts made income under s. 119 or are receipts that would be income in any event.
[10.123] The deduction allowed by s. 120(1)(c) applicable to an Assessment Act co-operative that has as its primary object the acquisition of commodities or animals from its shareholders for disposal or distribution (s. 117(1)(b)), involves privileged treatment for such a co-operative. Section 51(1) would not allow the deduction of an amount paid in repayment of a loan in the circumstances described in s. 120(1)(c).
[10.124] A number of specific provisions of the Act allow deductions in respect of outgoings that are relevant to the derivation of assessable income but are not working, or are not contemporaneous. The deductions in all instances relate to outgoings. Where they involve the acquisition of assets, the assets are wasting assets—their cost is consumed in the derivation of income.
[10.125] In [10.24] above reference was made to the decisions in Peyton (1963) 109 C.L.R. 315 and in Foxwood (Tolga) Pty Ltd (1981) 147 C.L.R. 278 that a payment made on the disposition of property used to produce income or on the disposition of a business, may be a non-working expense, as an expense of disposing of the property.
[10.126] In Peyton the payment was made by a lessee to the lessor as an amount in respect of repairs, in order to secure the lessor’s consent to an assignment of the lease. Section 53AA is presumably intended to allow a deduction by specific provision for the expense which in Peyton was not deductible under s. 51(1).
[10.127] Section 53AA requires that the lessee should have become liable to pay money because of his breach of a covenant in the lease that he will repair. A payment in discharge of such a liability is deductible by the lessee if the property is held or was held by the lessee for the purpose of producing assessable income. In allowing a deduction for a payment that is not contemporaneous with the holding of the property to produce income, s. 53AA may be seen as going beyond the operation of s. 51(1). So far as s. 53AA relates to a contemporaneous payment, it will allow a deduction beyond what would be allowable under s. 51(1), only so far as s. 53AA applies in a Peyton situation. A contemporaneous payment in discharge of a liability to pay which has arisen by reason of the non-performance of an obligation to repair would ordinarily be a relevant and working expense. It is a payment of an ever-recurring kind, akin to rent, and an expense of maintaining the leasehold interest. There are difficulties about the application of s. 53AA to a Peyton situation. The lessee in a Peyton situation may not as yet be in breach of an obligation to repair, so that no obligation to make a payment to the lessor by reason of non-performance has arisen. The lessee may make the payment for repairs that are due in order to secure the lessor’s consent to assignment.
[10.128] There is a specific provision in s. 26(1) that “any amount referred to in s. 53AA” received by a lessor is income of the lessor. The receipt by the lessor would be income in any event as a gain derived from property, or as compensation for an outgoing on revenue account that he may incur in effecting the repairs himself. The authority for the operation of the compensation receipts principle would be Carapark Holdings Ltd (1967) 115 C.L.R. 653, discussed in [2.536]–[2.539] above.
[10.129] Costs of converting plant for use in connection with decimal currency or the metric system of measurement are deductible exclusively under ss 53F and 53G. Such expenses would ordinarily not be deductible under s. 51(1), though they might have been deductible under the depreciation provisions considered in [10.130]ff. below. They would be deductible under s. 51(1) only where the item of plant is of such limited durability or significance that an expense to acquire it would be a working expense. Sections 53F and 53G are, by s. 53F(3) and 53G(3), made an exclusive code. There is no room for the operation of s. 51(1) or the depreciation provisions.
[10.130] A group of sections of the Act concerned with the deduction of depreciation have a much wider application in regard to the deductibility of non-working expenses than those so far considered. Sections 54–62 provide for the deduction of depreciation during the year of income of any property, being plant or articles, owned by the taxpayer and used by him during that year for the purpose of producing assessable income, and of any property being plant or articles owned by the taxpayer which has been installed ready for use for that purpose and is during that year held in reserve by him. The word “depreciation” is not defined but the reference intended by the word is to the “wastage”, the fall in value of an asset over the relevant period.
[10.131] Section 55(1) provides for some correlation between the amount of deduction for depreciation and the actual decline in value of the item of property in the year of income. The Commissioner is required to make an estimate of the effective life of the property, and to fix the annual depreciation per centum accordingly. But the amount of depreciation allowed in a year of income as a deduction may be different from the actual decline in value for several reasons. The calculation of the amount of depreciation is made by reference to the historical cost of the property, and not its value at the commencement of the year of income. A deduction for depreciation thus becomes a deduction of the historical cost spread over the life of the asset. And the amount of depreciation may be different from the actual decline in value, because the annual depreciation per centum fixed under s. 55(1) has been increased by some more specific provisions which provide for what might be called accelerated depreciation. One such provision is s. 57AG, which imposes a loading on normal depreciation rates applicable to certain units of property acquired under contracts entered into after 19 August 1980. Another such provision is s. 57AL which provides an optional accelerated rate of depreciation in certain situations. Moreover a number of provisions exclude the operation of s. 55(1). The Commissioner’s estimate of the effective life of the property is irrelevant when the rate of depreciation per centum in respect of an item of property is fixed by the statute. This is done by s. 55(2), which fixes the annual depreciation per centum of property listed in the subsection—property used by the taxpayer principally for the purpose of providing clothing cupboards, first aid, rest room or recreational facilities, meals or facilities for meals for persons employed by the taxpayer in his business or for the care of children of those persons. The rate fixed is 33 1/3 per cent. And the Commissioner’s assessment of the effective life of property is irrelevant where the depreciation allowable is fixed directly by the Act in ss 57AE, 57AH, 57AJ, 57AK and 58 in respect of specified items of property—property used for the purpose of storage of grain, hay or fodder (s. 57AE), property used for the purpose of storage of petroleum fuel (s. 57AJ), property used in connection with basic iron or steel production (s. 57AK) and property used for the purpose of transporting petroleum (s. 58).
[10.132] The depreciation provisions could have an operation in relation to a non-contemporaneous expense and in this respect are wider in their operation than s. 51(1). The cost of an item of property acquired for use in a process of income derivation might have been incurred before the commencement of the process. Where the asset is acquired for use in a business the incurring of the cost would generally be seen as the commencement of the business, if the business has not otherwise commenced, so that there is no want of contemporaneity. But an asset may be acquired in order to be leased to another in a process of deriving income from property. In such circumstances the principle that requires contemporaneity may deny any deduction if s. 51(1) were otherwise the applicable provision. Deductions are however allowable under the depreciation provisions. An inference that they are allowable is to be drawn from subss (1A), (1B) and (1C) of s. 56. These subsections provide for deductions for depreciation where property is used only for some part of a year of income for the purpose of producing assessable income, or is installed ready for use for some part only of a year of income. The deduction for depreciation is limited to a proportion of what would be allowable if the property had been used at all times during the year for the purpose of producing assessable income, or had been installed ready for use at all times in the year of income. The assumption is that a cost incurred before use, or before installation for use, may attract depreciation deductions.
[10.133] There will be circumstances where the asset is acquired for private purposes, and thereafter comes to be used in a process of income derivation. For example, a motor car, acquired and used for private purposes, might come to be used for professional purposes. In such circumstances, depreciation would first be allowed in the year in which the asset comes to be used in the process of income derivation, and it would be appropriate to regard the cost of the asset as the value at the time it first comes to be so used. A like approach is accepted in regard to the cost of items acquired for private purposes which are taken into the trading stock of a business. There is no clear support in the statutory provisions for determining cost in this way. Curran (1974) 131 C.L.R. 409 may be thought to offer judicial support in the case of the items that come to be trading stock, though the point is made in [7.24] above that the case is unacceptable in treating the shares as having been acquired, and then taken into trading stock.
[10.134] The view in the last paragraph rejects a submission that the reference to “cost” in s. 56(1)(b) and in s. 62(1) will extend to the cost of a unit of property that at the time the cost was incurred was not intended to be used in a process of income derivation. An inference might be drawn from s. 61 to support such a submission. The Commissioner has a discretion under s. 61 to allow such deduction “as in his opinion is proper” where a unit of property acquired for private purposes comes to be used in a process of income derivation. And it would be said, on the authority of Anderson (1956) 11 A.T.D. 115, that a valid exercise of that discretion would determine the amount of the deduction on the assumption that the unit of property had been wholly used in a process of income derivation since its acquisition: s. 61 is not in its terms limited to circumstances where property, in the year of income in which depreciation is claimed, was used partly for private purposes and partly in a process of income derivation.
[10.135] Anderson was concerned with a unit of property which was acquired for use partly in a process of income derivation, and is not directly relevant in the circumstances now considered. And the application of an Anderson approach in the circumstances now considered would require that assumptions should be made about the exercise of elections as to the method of depreciation or specific provisions determining rates of depreciation, which were not in fact open to the taxpayer.
[10.136] If the submission is a correct interpretation of the Act, a taxpayer who acquired an item of property some years ago for private purposes, and now proposes to use it in a process of income derivation, would be advised to sell the item of property and acquire another; at least he would be so advised whenever the value of the unit is greater than a notional depreciated value that might be asserted on some assumptions about how the depreciation provisions would have operated had the unit been originally acquired and used in a process of income derivation.
[10.137] There is another basic question about the meaning of “cost” for purposes of the operation of s. 56. A taxpayer may acquire property from another by way of gift, or he may acquire it in a transaction not at arm’s length from a person who sells the item to the taxpayer at a price less than its market value. It is arguable that the meaning of “cost” will include the element of gift in the transaction by which the unit of property is acquired. An argument is made in [14.57]ff. below that the cost of an item of stock for purposes of the trading stock provisions may include the value of an element of gift. And a like argument is made in [12.78]ff. below that the value of an element of gift is a part of the cost of property acquired in a transaction in which a profit on realisation is income or a loss is deductible.
[10.138] To be deductible under s. 51(1) an expense must be relevant to some process of income derivation. The parallel test of deductibility for depreciation requires use during the year of income for the purpose of producing assessable income, or installation during the year of income ready for use for that purpose. The parallel test may be less demanding than the test of relevance. An employee who uses his own property—a motor vehicle or some electronic equipment—in connection with his duties as an employee, may have difficulty in establishing the relevance of associated expenses. Those difficulties are considered in [8.38]–[8.90] above in relation to travelling, self-education and entertainment expenses. Where the employee claims depreciation on the item of property, it is presumably enough that he has in fact used the item in doing the work for which he is paid.
[10.139] A deduction may be available under s. 51(1) for an expense which prima facie would attract depreciation deductions. Section 56(3), noted above in regard to repairs, will in these circumstances preclude any deduction for depreciation. The cost of acquiring a wasting revenue asset is deductible under s. 51(1) though, it has been submitted, the deduction should be spread over the life of the asset ([6.129] above). Whether deductible immediately or spread over the life of the asset, the cost will not enter the cost that may be the subject of depreciation deductions.
[10.140] An item of property that is properly to be regarded as a wasting revenue asset will have a limited effective life. If its effective life is substantial—it||involves an enduring benefit—it will be a structural asset, and no deduction will be available under s. 51(1). The cost of the item is not a working expense. B.P. Australia Ltd (1965) 112 C.L.R. 386 and Strick v. Regent Oil Ltd [1966] A.C. 295 are relevant. Where a deduction is denied under s. 51(1) because the item of property involves an enduring benefit, there is the prospect of depreciation deductions in respect of the item. The depreciation provisions are not in their terms confined to costs that are non-working expenses, though this will generally be the area of their operation. In theory, there may be an expense denied deduction under s. 51(1), because of want of relevance, that would, if relevant, be regarded as a working expense. An employee’s expense in providing himself with a small calculator which he uses in his employment may be an illustration. Such an expense would attract deductions for depreciation: the calculator would be an article used by him for the purpose of producing assessable income.
[10.141] Some matters of principle raised by the detail of the depreciation provisions call for examination. These relate to the definition of property to which the provisions apply and to the method of allowance of deductions for depreciation, more especially the determination of “cost” and the consequences of disposal of an item of property.
[10.142] The words of s. 54 confine the operation of the depreciation provisions to “plant or articles” that are “owned” by a taxpayer and are “used by him” during the years of income for which depreciation is claimed “for the purpose of producing assessable income” or are “installed ready for use for that purpose” and held in reserve by the taxpayer during that year of income.
[10.143] The meaning of the word “article” is the subject of an observation by Taylor J. in Quarries Ltd (1961) 106 C.L.R. 310 at 316: “I see no reason for denying the word ‘article’ the comprehensive meaning which it normally bears or for thinking that it was not used in the section by way of extension.” He considered that the word would not ordinarily comprehend a structure erected or built in situ but, in the case before him, he held that it did comprehend portable huts. If a wide meaning is given to the word “article”, the meaning of the word “plant” in its application to property which is not a fixture will not be significant.
[10.144] The word “plant” has its ordinary meaning, extended in some respects and perhaps controlled by the definition in s. 54(2). The meaning may be controlled by the reference to “machinery, implements, utensils and rolling stock”. Only one of these words, “machinery”, would embrace a fixture, and some argument might be made that a fixture should not be regarded as plant unless it has some kinship with machinery. That kinship could be that the item of property has a dynamic function. In fact, it will be seen, the word plant has been held to extend to a fixture that is static, if it plays a part in an industrial or commercial process. But there is room for insisting on a dynamic quality in characterising an item of property as plant where there is no industrial or commercial process, or where there is, but the item of property does not play a part in that process: the item may be a lift to convey passengers, an electricity generator that provides lighting only, or a hot water heater as an amenity.
[10.145] In what follows, the discussion is confined to the meaning of plant where the item of property is a fixture. The whole of a building may be plant: a brick kiln or a cooling tower are the most obvious illustrations. A part of a building may play a part in an industrial process and thus be plant. A chimney whose function is to create a draught necessary for an industrial process has been held to be plant for purposes of United Kingdom legislation, and the decision would be followed in Australia (Re Nutley & Finn [1894] W.N. 64. Cf. Margrett v. Lowestoft Water & Gas Co. (1935) 19 T.C. 481). A distinction has been drawn in the Australian authorities between a building which plays a part in an industrial process and is, therefore, plant, and a building which merely houses plant, or provides a setting in which an industrial process is carried, and is therefore not plant: Broken Hill Pty Co. Ltd (1969) 120 C.L.R. 240 at 247, 263. In Wangaratta Woollen Mills Ltd (1969) 119 C.L.R. 1 McTiernan J. held that, save for the outer cladding, the walls and ceiling and floor of a building which constituted a dye-works were plant. The ceiling and walls were designed to prevent condensation and to carry away vapours, and the floor was designed to provide drainage to carry away excess dye. The exclusion of the outer cladding is not consistent with the view suggested by some words in the judgment of Kitto J. in Broken Hill Pty Co. Ltd (1969) 120 C.L.R. 240 at 263:
“I regard as plant the buildings which are more than convenient housing for working equipment and (considered as a whole, i.e. without treating as separate subjects for consideration the iron roofing and cladding of buildings where the main structural members are specially adapted to the needs of the processes to be carried on inside) play a part themselves in the manufacturing process, e.g. the holding bay for the basic oxygen steel-making installation as well as the very specialised building which because of its in-built equipment forms part of that installation, and also the casting pit (but not the slag pit).”
[10.146] The notion of “plays a part” includes elements of the specific and the necessary. The pit for servicing a locomotive, held not to be plant (as the word is used in s. 62AA) in Moreton Central Sugar Mill Co. Ltd (1967) 116 C.L.R. 151, was specific to the industrial process carried on by the taxpayer but it was not necessary. It was, at most, convenient. Kitto J. said (at 157):
“All I need to say is that the word has never, I think, been held, and should not now be held, to include a structure built into the ground so as to form a static and permanent feature of the place in which a business may be carried on and having no other function than to provide a convenient stand for the performing of work in the business.”
The pit in Morton Central may be distinguished from the dry dock held to be plant for purposes of the United Kingdom legislation in I.R.C. v. Barclay, Curle & Co. Ltd [1969] 1 W.L.R. 675. The dry dock was both specific and necessary. The false acoustic ceiling constructed in Macquarie Worsteds Pty Ltd (1974) 74 A.T.C. 4121 so as to lessen the volume of air in a building that had to be processed by air conditioning, may be seen as neither specific nor necessary. Mahoney J. held the ceiling was not plant, though air conditioning was necessary to maintain the quality and temperature of air required for the taxpayer’s industrial process: the taxpayer operated a spinning mill.
[10.147] In terms of the distinction between playing a part and providing a setting, the ceiling in Macquarie Worsteds was indistinguishable from the ceilings in Imperial Chemical Industries of Australia & N.Z. Ltd (1970) 120 C.L.R. 396. In the latter case, Kitto J. (at 397) expressed the following view (which was confirmed by the Full High Court in ICI Australia Ltd (1971) 127 C.L.R. 529):
“This appeal which comes from a Board of Review under s. 196 of the Income Tax Assessment Act 1936–1969 (Cth), concerns (a) acoustic metal pan fittings and their supporting framework, forming ceilings in two office buildings owned and used by the appellant during the year of income ended 30 September 1961, and (b) such part of the electrical installations in one of those buildings as consisted of wiring and conduits therefor and trunking. The question in regard to each is whether it was ‘property, being plant, or articles owned by a taxpayer and used by him during (the year of income) for the purpose of producing assessable income’ within the meaning of s. 54 of the Act as it stood in relation to that year. If it was, depreciation is allowable in the assessment of the appellant’s tax. The Commissioner has disallowed a claim for the depreciation and the board has upheld the assessment.…The truth is that the ceilings with which we are concerned do nothing for the appellant’s business that they would not do for the business of any other occupier. They are in like case with the walls, floors, windows and doors, not to mention the roof: that is to say they are useful for anyone who wants to work in the building, and more useful than less well thought out units of the same kind would be, but still only part of a general setting for work, not part of the apparatus of any income producing process. In my opinion they are not ‘plant’.”
[10.148] A test in terms of what is “necessary” may be inferred from the judgment of McTiernan J. in Wangaratta Woollen Mills: an item of property is necessary to an industrial process if the process could not be carried on without it, or if the product would be unsatisfactory without it.
[10.149] The distinction between playing a part and providing a setting must leave a substantial marginal area. It may be asked what view should be taken of the steel framework and cladding of a building that supports a gantry crane.
[10.150] A building will be plant if it plays a part in a commercial process, as distinct from merely providing shelter for that process. It may not be easy to identify a building which plays a part in a commercial process. The fixtures —electric conduit and wiring and acoustic ceilings—of an office building in Imperial Chemical Industries, were held not to play a part. They were “parts of the general equipment of the building…and having no relevance to the activities of the appellant beyond the relevance they would have to any occupier’s activities” ((1970) 120 C.L.R. 396 at 398-9). Insulation of a building against sound and vibration may possibly be held to play a part in the use of a computer, though there is room for a submission that the insulation is not specific to the process. No doubt the computer itself plays a part and will be plant, notwithstanding that it is a fixture. The computer will in any case qualify as plant for a reason considered in [10.152] below.
[10.151] In all the cases so far considered, the building was owned by the taxpayer who conducted the industrial or commercial process, and some of the language used in the judgments may suggest that, in order to be plant, an item of property must play a part in an industrial or commercial process carried on by the taxpayer who claims depreciation deductions in respect of it. This, it is submitted, is to confuse two distinct issues—whether the item of property is plant and whether it is used by the taxpayer to produce assessable income. An item of property may be plant though it is not presently used by any person to produce income. Indeed, s. 54 contemplates such a situation, by allowing depreciation in respect of an item of plant which is installed ready for use for the purpose of producing assessable income and during the year of income is held in reserve. The test of character as plant that it plays a part in an industrial or commercial process, should be reframed so that it refers to an item of property being adapted to playing a part in an industrial or commercial process. It follows that a building may be plant, and depreciation deductions in respect of it may be available to a person who has leased the building to another who conducts the industrial or commercial process in which the building plays a part. The act of leasing the building to another is, it seems, a use of the item of property to produce income, income in the form of the rent reserved in the lease.
[10.152] If leasing property to another is a use of property by the lessor to produce income, an issue will arise as to whether or not an item can be plant when the function of the item is to produce a private service and not to play a part in an industrial or commercial process. A test which would lead to a conclusion that such an item is plant may also justify a conclusion, in some circumstances, that an item which does not play a part in, but merely provides a setting for an industrial or commercial process, is plant. Stoves, hot water heaters and lifts that are fixtures in domestic dwellings let to others, are it is submitted, plant and depreciable under s. 51. Yet there is no industrial or commercial process in which they might play a part. They are plant because they have a dynamic function, as distinct from the static function performed by the elements of the buildings that simply provide shelter. The same items in an industrial or commercial building will attract depreciation deductions for the owner, whether he lets the building to another or himself uses the building in carrying on some industrial or commercial activity for the purpose of providing income. None of the items would be described as “machinery” so as to be within the definition of plant in s. 54(2)(a), but, it has already been submitted ([10.144] above), that word suggests a notion of plant that finds the quality of plant in dynamic function.
[10.153] There is a reference in Imperial Chemical Industries to an electric generator in the basement of the building, installed ready for use in an emergency to provide power when the public supply failed ((1970) 120 C.L.R. 396 at 399). The case does not decide that depreciation was not available to the taxpayer in respect of that item of property. The question was simply not raised. The item is as much setting for the commercial activity as were the electric wires that might have carried the power generated by the generator. But the generator has an active function. The function of the wires is passive.
[10.154] The limitation of depreciation deductions to items of property that are plant or articles involves the exclusion of buildings and fixtures that do not qualify as plant. Some extension of the notion of plant in relation to buildings and fixtures is achieved by s. 54(2)(b) applicable to certain fences, dams and other structural improvements on land which is used for the purposes of agricultural or pastoral pursuits, for the purposes of forest operations or for the purposes of pearling operations. And there is a further extension by s. 54(2)(c), applicable to certain plumbing fixtures and fittings installed in premises by a person carrying on a business of producing assessable income, where those fixtures and fittings are provided principally for the use, for personal purposes, of persons employed by him in that business or for the care of children of those persons.
[10.155] Provisions having the same effect as the depreciation provisions allow deductions in respect of the cost of hotel and apartment buildings used for traveller accommodation (Div. 10C of Pt III) and in respect of certain income producing buildings (Div. 10D of Pt III) ([10.212]ff. below). These and other provisions beyond s. 54(2) applicable to buildings and fixtures used in particular industries, in partcular the mining industry, may be thought to achieve substantial coverage in allowing deductions in respect of the costs of wasting structural assets that are tangible.
[10.156] Division 10B of Pt III, considered below in [10.239]–[10.269] makes provision for the allowing of deductions in respect of the cost of wasting structural assets that are items of commercial or industrial property. But there remain intangible wasting structural assets in respect of which no deductions are allowable. The cost of the ties—paid by way of premiums on leases— in Strick v. Regent Oil Ltd [1966] A.C. 295 would not attract deductions in Australia. No deductions are available in respect of the cost of goodwill that is a structural asset, though in this instance it may be said that the asset is not wasting.
[10.157] A number of sections of the Act limit the operation of the depreciation provisions by providing expressly for deductions in respect of expenses that would otherwise attract their operation. Section 75B applies to certain capital expenditure incurred by a taxpayer who carries on a business of primary production, where the expenditure is incurred on the construction acquisition or installation of plant or a structural improvement for the purpose of conserving or conveying water. The whole of the expenditure is deductible in the year in which it is incurred. Section 75C makes similar provision in regard to certain expenditure on fencing incurred by a taxpayer carrying on a business of primary production. Where these provisions apply, depreciation under s. 54 is not available to the taxpayer who incurred the expenditure, or to another person. Thus, depreciation is not available to a person in respect of his cost of acquiring the plant or structural improvement from the person who incurred the expenditure (s. 54(5) and s. 54(7)).
[10.158] Deductions may be available under other special industry provisions in respect of expenditure that would otherwise attract the operation of the depreciation provisions. These special industry provisions, for example Div. 10 of Pt III in relation to general mining (s. 122H), allow the taxpayer an election to take deductions under the special industry provisions or the depreciation provisions.
[10.159] Deduction under the depreciation provisions is available in respect of property “used by [the taxpayer] during [the] year of income for the purpose of producing assessable income” and in respect of property “which has been installed ready for use for that purpose and is during [the] year held in reserve”. Some comment on the meaning of use for the purpose of producing assessable income was made in [10.151]–[10.152] above. The words extend to the leasing of property to another. A consequence is that the owner who leases may have deductions for depreciation earlier than the lessee would have had if he had acquired the plant or article as owner. Deductions are available to a lessor from the time he leases the plant or article to another. Deductions are available to an owner who does not lease only from the time he uses the property directly in a process of income derivation, or installs it ready for such use. The outcome is that entitlement to depreciation may be accelerated if plant or an article is leased by one taxpayer to another.
[10.160] The effect of s. 56 is that depreciation is allowable only in respect of the cost of a “unit of property”. The notion of “unit of property” has been the subject of examination in a number of judicial decisions concerned with the same words used in provisions providing for investment allowances, earlier under ss 62AAff. and more recently under ss 82AAff. In Ready Mixed Concrete (Vic.) Pty Ltd (1969) 118 C.L.R. 177 Kitto J. held that a concrete mixer powered by its own motor mounted on the back of a truck was a unit of property to which the earlier investment allowance prima facie applied, and that it was not excluded by s. 62AA(3)(b) as being itself a “road vehicle …ordinarily used…for…the delivery of goods”. In reaching the latter conclusion Kitto J. said (at 184):
“In my opinion, therefore, the transit mixers are property to which the section applies, unless they are excluded from that category by subs. (3). That subsection describes a number of classes of plant or articles, to none of which it is suggested that the mixers can be held to belong unless it be those described in paras (b) and (f). Paragraph (b) refers to ‘road vehicles … of the kinds ordinarily used for … the delivery of goods (including the delivery of goods of a particular kind)’. Even assuming that a component part of a road vehicle may be excluded from the section by this paragraph, it is clear, I think, that a transit mixer is not within the description. It is not really a component of a total vehicle comprising itself and the truck, being a vehicle ordinarily used for the delivery of ready mixed concrete. Notwithstanding the mode and degree of annexation, the truck and the mixer are functionally separate and independent units of property.”
The concluding words of the quotation do not suggest that an item of property will not be a unit of property unless it is functionally separate and independent of other items of property. “Functionally separate and independent” are a description of the transit mixer, which had already been found to be a unit of property. The description was intended to explain why the mixer should not be characterised as a road vehicle.
[10.161] A view that an item of property cannot be a “unit of property” unless it is functionally separate and independent of other items of property is rejected by McTiernan J. in Wangaratta Woollen Mills Ltd (1969) 119 C.L.R. 1, in holding that a piston and spring were a unit of property, even though they could not be used without a can into which they fitted. McTiernan J. said (at 13–14):
“Sliver cans are used in the spinning factory for other purposes besides use with spring and piston to hold a sliver. For example they are commonly used to hold fibre bobbins on removal from the machine. I therefore regard the can as one unit of property, and the spring and piston as another, as an additional attachment to enable the can to be used for a more specialised purpose. It is true that the spring and piston cannot be used without the can, but the same could be said of any attachment for a tractor such as a mower or post-hole digger operated from a power take off.”
The judgments of Kitto J. and McTiernan J. are referred to in Tully Co-operative Sugar Milling Association Ltd (1982) 82 A.T.C. 4454 where Thomas J., in holding that a pumping station was a unit of property, observed that pumps, which with starter motors and other items made up the pumping station, were also units of property. Thomas J. said (at 4459):
“In my opinion a component may be a unit of property for the purposes of s. 82AB in the context of a manufacturing system, if it can be shown to perform a discrete function, or if it can be shown to vary the performance of that system. Furthermore, where there is expenditure upon a complex group of items (as in the present case) I do not think that there is necessarily a single and absolute answer as to what the units are. To my mind the appellant is correct when it says that the mixed juice pumping station was a unit. The Commissioner may also be corect when he submits that the Kelly and Lewis pumps are units in respect of which claims could be made. If they are both units, or capable of being treated as units, the taxpayer may indicate the unit of property which he says he has acquired or constructed after 1st January 1976, and if it is in truth a unit of property he is entitled to the benefit of the section. It does not matter that he could also have nominated a smaller unit, or a number of smaller units of property.”
An item may presumably have a “discrete” function without having a function separate and independent of other items of property. A pump will not function without a motor to drive it. But there remains a question of the degree of separateness required by the word “discrete”. Thomas J. at one stage rejects the idea that a bolt or a nut has a discrete function, and at another is prepared to contemplate that it might have a discrete function (at 4458). One may need to go to the even more particular to find an item that has a function that is not discrete. It may be asked whether a taxpayer acquires a distinct unit of property if he galvanises steel components of a factory already acquired and used, in order to increase their durability.
[10.162] The reference in the passage quoted from the judgment of Thomas J. to varying the performance of the system, as a test of an item being a unit of property, may have been intended to accommodate the judgment of McTiernan J. in Wangaratta. In which event it could be inferred that he did intend the notion of “discrete” to require both separateness and independence. But it seems hardly appropriate to describe a pump as varying the operation of a motor.
[10.163] The view expressed by Thomas J. that the taxpayer may indicate what is the unit of property where there is a larger item that is a unit of property and parts of that item which are also units, is not without its difficulties. If the taxpayer may indicate, the Commissioner may wish to indicate differently. Granted that the taxpayer’s indication prevails in the circumstances of Tully Co-operative, it may be asked whether it will prevail where the taxpayer seeks to deny the operation of some provision of the Act. The taxpayer may have disposed of some part of a “system” which may be regarded as a unit of property. He may seek to avoid a balancing charge under s. 59 ([10.188]–[10.207] below) by indicating that he regards the system as the unit and not any part of it.
[10.164] Where a taxpayer effects some change to existing plant or articles the question will arise whether the change brings into existence a unit of property in respect of which depreciation may be allowed. It may be possible to regard the costs of change as costs of the existing unit of property, though costs in an operation distinct from acquisition would not easily be so regarded. In some circumstances the costs will be costs of repairs deductible under s. 53, and any question of operation of the depreciation provisions is excluded (s. 56(3)). But the costs may not be deductible as costs of repairs. The actions of the taxpayer may amount to effecting initial repairs. They may be the reconstruction of an entirety. They may effect an improvement. They may adapt the existing plant or article to a new function. Where repairs are initial repairs, the principle by which deduction is denied asserts that the costs are to be treated as costs of acquisition of the item of property repaired. In this situation the case for treating the costs as costs of the item originally acquired, and allowing depreciation on this basis, must be strong, though the structure of the depreciation provisions is not readily adapted to allowing depreciation of costs incurred in an operation distinct from the original acquisition.
[10.165] Where the actions of the taxpayer involve the reconstruction of an entirety, there is the prospect that there will have been a fresh acquisition of a unit of property and thus depreciation deductions will be available. But the coincidence of “entirety”—the judicial concept developed in interpreting s. 53—and “unit of property”—the statutory concept embodied in the depreciation provisions—should not be assumed. It will appear from the discussion in [10.15]–[10.16] above that the judicial concept has not been expressed in the language of separate function. To the extent that a unit of property is a larger unit than an entirety there is the possibility that deduction will be denied under s. 53 and under the depreciation provisions.
[10.166] Where the actions of the taxpayer involve an improvement or the adapting of property to a new function, there is again the possibility that deduction will be denied under s. 53 and under the depreciation provisions. If a taxpayer for the first time galvanises the steel components of existing plant or articles to prevent corrosion, he may be taken to have improved, and not be entitled to a deduction for repairs. It was suggested in [10.160] above that the galvanising is not a unit of property. If the taxpayer effects changes by cleaning and repainting of the kind undertaken in W. Thomas & Co. Pty Ltd (1965) 115 C.L.R. 58, in order to adapt a building to a new use, he may be denied a deduction for repairs. Again it is not easy to identify a new unit of property which would justify the application of the depreciation provisions.
[10.167] The property must be owned by the taxpayer if depreciation is to be an allowable deduction under s. 54. Where the building in which plant is installed is leased to the taxpayer, the law of fixtures must presumably be applied in determining whether depreciation of the plant is an allowable deduction to the taxpayer or to the lessor. Thus the law of fixtures will be relevant on the question whether plumbing fixtures and fittings, which are “plant” by express provision in s. 54(2)(c), are depreciable property. In this instance, if the fixtures and fittings are owned by the lessor, depreciation will not be allowable either to the taxpayer or to the lessor. While generally the use of property for the purpose of producing assessable income which is involved in leasing that property to another is sufficient to entitle the lessor to depreciation, this is not so where the property is plant only by virtue of s. 54(2)(c). The fixtures and fittings must be provided principally for the use, for personal purposes, of persons employed by the taxpayer who claims depreciation, or for the use of children of those persons.
[10.168] The classical form of hire purchase agreement delays the passing of property in goods under hire purchase until the exercise of the option to buy by the payment of the last instalment. Where plant or articles used for the purpose of producing assessable income are being acquired under a hire purchase transaction they are not owned by the taxpayer who is acquiring them, and strictly, s. 54 has no application. It is understood, however, that it is the practice of the Commissioner to allow the taxpayer either to deduct depreciation on the cash price as the cost of the plant or article and also to deduct the interest element in the instalments paid in the year of income, or, alternatively, to deduct depreciation on the total amount payable as the cost of the plant or articles, no further deduction being then allowed for interest.
[10.169] If the Commissioner refuses to make these concessions it does not follow that the taxpayer acquiring goods on hire purchase will be entitled only to deduct the interest element in the instalments he pays. It is arguable that some further part of the instalments are deductible under s. 51 as payments for the use of the plant or article. In a simple leasing situation, the lessee is entitled to deduct under s. 51 periodical payments by way of rental of property used to produce assessable income. The Commissioner may however rely on the judgment of Walsh J. in Poole and Dight (1970) 122 C.L.R. 427 to support an argument that, apart from the interest element, the instalments are not deductible because they are for the acquisition of an asset, no basis of apportionment having been established. Payments expressed to be made for the acquisition of property are not to be regarded as payments for the use of that property simply because they are made during a period in which the taxpayer enjoys the use of that property, but prior to acquisition. At the same time payments expressed to be made for the acquisition of property will not necessarily be denied deduction, even when they are made after the acquisition of the property. Payments which are spread over the whole life of the property that has been acquired, may yet be regarded as payments for the use of that property. Cliffs International Inc. (1979) 142 C.L.R. 140, considered in [7.45] above, is relevant. Payments which are thus deductible over the life of the property cannot enter the cost of the property for purposes of depreciation deductions (s. 56(3)).
[10.170] A transaction may be entered into which involves a lease which provides for payments described as rent, the amount of the payment being greater than the value of the current use of the property leased. The lessee may be given an interest in the property by a provision which, in one form, requires that the property, or some property in the same condition as the property leased, will be sold to the lessee at the conclusion of the lease for a sum determined in accordance with the agreement. In another form of transaction the interest may be given to an associate of the lessee. In South Australian Battery Makers Pty Ltd (1978) 140 C.L.R. 645 the Commissioner unsuccessfully sought to deny a part of the payment by way of rent in the latter form of transaction. The case is discussed in [9.17]–[9.32] above. Specific anti-avoidance provisions have now been included in ss 82KH, 82KL and 82KJ, and Pt IVA may have some operation. The view is taken in [9.19] above that the High Court might be expected to overrule South Australian Battery Makers, so that the Commissioner might thereafter deny some part of the deduction for rent relying only on the words of s. 51(1). The denial of a deduction of some of the rent in the first form of transaction referred to is consistent with South Australian Battery Makers. A taxpayer who is the owner of property may be entitled to depreciation deductions where he leases that property to another. The leasing by the owner is a use of the property by him to produce income. The observation was made in [10.159] above, that this use commences with the lease. In the result an owner lessor may be entitled to depreciation deductions sooner than an owner who uses property directly in a process of income derivation. The latter will be entitled to deductions, at the earliest, when the property is installed by him ready for use.
[10.171] The allowance of deductions for depreciation requires the fixing of what is referred to in s. 55(1) as “annual depreciation per centum” of a unit of property. As explained in [10.131] above, this fixing may require the action of the Commissioner under s. 55(1), or it may be done by the Assessment Act itself in provisions such as ss 55(2), 57AE, 57AH, 57AJ, 57AK and 58. In one instance—s. 57AG—both the action of the Commissioner and a fixing by the Act based on the Commissioner’s determination are called for.
[10.172] The Commissioner is required by s. 55(1) to make an estimate of the effective life of the unit and from this to fix the annual depreciation per centum. Strict compliance with s. 55(1) in regard to the fixing of the percentage depreciation by the Commissioner would appear to require a decision in respect of each unit of property. However, considerations of administrative convenience have dictated the fixing of percentage rates of depreciation in respect of a wide range of items of property by Income Tax Order 1217. Unless the Commissioner in a particular case is expressly asked, or himself decides, to make an estimate of effective life and thus determine rates of depreciation appropriate to particular items of plant, the percentage rates specified in I.T.O. 1217 will apply.
[10.173] Section 56 provides for two methods of calculation of “depreciation allowable”—the diminishing balance method and the straight line (or prime cost) method. Unless the taxpayer exercises the option given him by s. 56(1) (b) (which must be exercised in accordance with s. 56A), depreciation will be calculated in accordance with the diminishing balance method under s. 56(1)(a). The depreciation allowable under this method is one and a half times the annual depreciation per centum fixed under s. 55 (which includes a fixing by s. 55(2) or by the combination of s. 55 and s. 57AG) of the depreciated value of the unit of property at the beginning of the year of income. The meaning of “depreciated value” of a unit of property is dealt with in s. 62(1). It means the cost of the unit of property to the person who owns or owned the property at the time when depreciated value falls to be determined less the total amount of depreciation (if any) allowed or allowable in respect of that unit in the assessments of the income of that person for any period prior to that time. Thus if the unit of property cost the taxpayer $1,000 and the annual depreciation per centum is 10 per cent, the taxpayer under the diminishing balance method will be entitled to a deduction of 15 per cent of $1,000 in the first year, that is, $150, and in the second year a deduction of 15 per cent of $850 and so on. Where the taxpayer has exercised his option and the straight line method of depreciation applies, s. 56(1)(b) provides that the depreciation allowable shall be the percentage per annum fixed under s. 55 of the cost of the unit. Thus in the illustration just taken, if the taxpayer has elected the straight line method of depreciation, he will be entitled to a deduction of $100 in each of the ten years of effective life of the unit of property.
[10.174] Save in the exercise of the option given by s. 56, or in certain special situations with which subss (2) and (3) of s. 56A are concerned, a change in the method of calculating depreciation to be allowed to a taxpayer may only be made with the leave of the Commissioner (s. 57).
[10.175] Where the depreciation allowance is fixed directly by the Assessment Act in provisions such as ss 57AE, 57AH, 57AJ, 57AK and 58, the deduction for depreciation is determined by the section itself, and not by the provisions of ss 55 and 56. Thus s. 57AE(2) (a)(i) provides that “notwithstanding anything contained in ss 55, 56, 56A and 57 … the depreciation allowable to a taxpayer … in relation to a year of income in respect of a unit of property to which [section 57AE applies] … is 20% of the cost of the unit”. The method of depreciation in this instance is thus straight line. And the deduction for depreciation under those provisions is not affected by those subsections of s. 56, considered in [10.178] below, which are concerned with the reduction of the depreciation allowable where the taxpayer has used the property to produce income for only part of the year of income.
[10.176] Mention has been made of s. 57AG which imposes a loading on normal depreciation rates applicable to certain units of property. Where the property was acquired by the taxpayer under a contract entered into on or before 30 April 1981, the loading is 20 per cent of the percentage actually fixed. Where the property was acquired by the taxpayer under a contract entered into after 30 April 1981 the loading is 18 per cent. Thus, if a unit of property is now acquired, and it is depreciable on a prime cost basis at 10 per cent per annum, this will be increased to 11.8 per cent by s. 57AG. Alternatively, if the diminishing balance method of depreciation is used, the normal rate of one and a half times the prime cost rate—in the example 15 per cent—is increased by 18 per cent of that amount to 17.7 per cent.
[10.177] Section 57AL, introduced in 1983, provides for accelerated depreciation of plant ordered after 19 July 1982. The accelerated rates apply only if the prime cost method of depreciation is used: s. 57AL(4). The taxpayer may elect that the section will not apply: s. 57AL(7). If the section does apply, the accelerated rate varies according to what the prime cost rate of depreciation would have been, but for s. 57AL (after loading pursuant to s. 57AG). If the prime cost rate of depreciation is 20 per cent or less, the accelerated rate is 20 per cent. If the prime cost rate of depreciation is above 20 per cent but below 33 1/3 per cent (after loading pursuant to s. 57AG) the accelerated rate is 33 1/3 per cent. There is no acceleration where the prime cost rate exceeds 33 1/3 per cent. Nor does s. 57AL apply to certain vehicles, works of art, structural improvements, and units of property dealt with by s. 57AH or s. 57AJ.
[10.178] Subsections (1A), (1B) and (1C) of s. 56 were inserted in the section in 1979 to deal with the question of the amount of depreciation allowable for a year of income when a unit of property is first used to produce income, or is first installed ready for use, during a year of income. A unit of property might be acquired and used on the last day of the year of income, and a full deduction for depreciation calculated in accordance with s. 56(1)(b) claimed in respect of that year of income. The subsections adopt a mechanical method of determining the amount of depreciation allowable in such circumstances, a method which simply reflects the number of days during the year of income during which the unit of property was not used to produce income, or was not installed ready for use in this way.
[10.179] Presumably, the subsections apply whether or not the first use for the purpose of producing income, or the first installation for the purposes of such use, occurred during the year of income. This is the inference from the opening words of subs. (1B). There is then the greater problem of correlating the operation of the subsections with s. 61, which is concerned with circumstances where the use of property has been “only partly for the purpose of producing assessable income”. The matter is further considered in [10.208]–[10.211] below. The problems of correlation will arise in some situations where the depreciation allowable is determined directly by the Assessment Act in provisions such as ss 57AE, 57AH, 57AK and 58. Subsections (1A) and (1B) of s. 56 have no application unless adopted. They are adopted by s. 57AG(3) and s. 57AK(b). But s. 61 will apply. All the sections referred to provide for the allowance of depreciation under s. 54—at least that is the inference from their drafting. The Commissioner’s discretion under s. 61 is attracted where a deduction would “otherwise [be] allowable under s. 54”.
[10.180] The amount of depreciation allowable by the operation of s. 56 depends ultimately or immediately on the “cost” of the unit of property. Where diminishing balance is applicable the relevant percentage is applied to the “depreciated value”, which in turn is defined in s. 62 as the “cost” of the unit of property less the total amount of depreciation allowed or allowable in respect of the unit in assessments of the owner. Where straight line applies, the relevant percentage is applied to the cost of the unit. Where the amount of the depreciation allowance is determined directly by the Assessment Act under ss 57AE, 57AH, 57AJ, 57AK and 58, the relevant percentage is applied to the “cost” of the unit (ss 57AE(2), 57AH(3), 57AJ(4), 57AK(5) and 58(4)). There are questions as to the meaning of “cost”.
[10.181] Where the circumstances do not attract the operation of the provisions of ss 56(4), 62(2) or 62(3), “cost” is a matter of actual cost, the word having its ordinary meaning, and the question becomes one of the appropriateness of regarding as costs only direct costs. A like question, it will be seen ([14.30]ff. below), arises in determining the cost of stock for purposes of the trading stock provisions of the Act. In that context the question is expressed in terms of the appropriateness of direct costs as against “on-costs”. If the expenses are treated as costs of stock, deductibility is deferred by the operation of s. 28 until the stock is realised. The taxpayer, in regard to the cost of trading stock, will wish to take a direct cost approach so that other expenses may enjoy deductibility under s. 51(1) without any deferral by s. 28. And he will not wish to treat as costs for purposes of s. 28, expenses not deductible under s. 51(1). If such expenses are treated as costs, there will be a fortuitous item of assessable income, as a result of the operation of s. 28, that will be corrected only when the stock is disposed of. In regard to the cost of property subject to depreciation, the taxpayer will wish to take an approach that will treat as costs any expenses that are not deductible under s. 51(1). Kitto J. in Broken Hill Pty Co. Ltd (1968) 120 C.L.R. 240 adopted a view of cost for purposes of the operation of Div. 10 (General Mining) of Pt III, which would confine the expenses which are costs to those that are directly related to the acquisition of the unit of property. He held (at 265) that the costs of demolition of an old building were not costs of a new building that replaced the old:
“… the demolition expenditure of structure A is, in my opinion, an expenditure which the original erection of that structure makes it necessary for the landowner to meet some day; and whether it is best treated for accountancy purposes as a cost to be dealt with in the same way as the cost of structure A, or as if it were part of the cost of structure B, or as a charge in a capital account relating to the land, it is in point of fact, considered as a cost, a cost of obtaining a site suitable for the new structure, and not a cost of the new structure itself. It stands in clear contrast with expenditure on excavations for the foundations of a new structure. No doubt that expenditure is part of the cost of the new structure, but the reason is that the excavations do not bring about any general advantage for the land: on the contrary, the only purpose they serve is peculiar to the new structure. Even in the common case where a site on which plant is to be erected has first to be cleared of trees, I should think that the correct view would be that the clearing is an improvement to the land rather than part of the installation of the plant, for its effect is upon the general usefulness of the land and accordingly its cost is part of the cost of the improved land and not part of the cost of the plant. A fortiori where the site has to be cleared of a structure which has been artificially placed in a position where it is an obstacle to the installation of the plant but would equally be an obstacle to other uses for the site, it seems to me that the cost of removing the obstacle is an expense which the taxpayer who installs the plant has taken upon himself by putting the obstacle there in the first place or by acquiring the land with the obstacle upon it. It is part of the cost of getting the land he needs for the plant, and not part of the cost of the plant.”
The treatment of the costs of demolition might have been different if the taxpayer had contracted with another to have the old buildings demolished and the new buildings erected. An expense may be a direct cost to the taxpayer though it reflects an on-cost incurred by the person who has supplied an item of property to the taxpayer. The earlier decision of Kitto J. in B.P. Refinery (Kwinana) Ltd (1960) 12 A.T.D. 204 may illustrate. The on-costs of the contractor who built a refinery for the taxpayer included temporary accommodation for workmen that was in due course demolished by the contractor. The taxpayer’s costs of the items of plant included in the refinery were held to extend to a share of the costs of the contractor in respect of the temporary accommodation. The contract provided for payment of a fixed amount for the construction of the refinery, plus an amount equal to the contractor’s expenses.
[10.182] The view expressed by Kitto J. in Broken Hill Pty Ltd that expenses of excavations for foundations are costs of the new building, would support a submission that the cost of plant for depreciation purposes would include not only the purchase price but also any customs duty and expenses of obtaining delivery. The expenses are specific to the item of property.
[10.183] Expenses of installation, where the functioning of the item requires that it be a fixture, may qualify as costs: it would be said that the item is not yet plant until it is installed. Installation expenses of other items could be regarded as expenses that come too late, and are not costs of the item. The argument for treating installation expenses as costs would assert that any expenses that are incurred prior to the moment when the item is first used or installed ready for use do not come too late. In Lister Blackstone Pty Ltd (1976) 134 C.L.R. 457 the High Court allowed a deduction under s. 51(1) of the expenses of moving trading stock to new premises. The question whether the expenses were part of the cost of the trading stock and thus subject to the operation of s. 28 was not raised. There is room for an argument that the expense of moving an item that has already been acquired as trading stock is not a cost of trading stock, and for a parallel argument in regard to depreciable property. The expenses of moving plant to a new location could be the subject of depreciation deductions only as costs of the plant. The expenses are not costs of an additional unit of property. The expenses might possibly be deductible as working expenses under s. 51(1). Against this possibility is the concession by the taxpayer in Lister Blackstone Pty Ltd that “the cost of preparing the new premises and of moving plant and equipment thereto was … an item of expenditure on capital account” (at 462, per Jacobs J.). The decision of Kitto J. in Broken Hill Pty Co. Ltd (at 260–261) that the demolition expenses were not working expenses is also against the possibility.
[10.184] There are a number of provisions directed against tax planning that would seek to give a high cost to a unit of property in a purchase from another in a transaction not at arm’s length. Section 60(1) expresses a general principle that where a person has acquired any property in respect of which depreciation has been allowed or is allowable he shall not be entitled to any greater deduction for depreciation than that which would have been allowed to the person from whom the property was acquired if that person had retained it. There is a proviso which would increase the amount of depreciation that may be deducted by the buyer by the amount of any balancing charge under s. 59 included in the assessable income of the seller as a result of the transaction. The operation of s. 59 is explained in [10.188]–[10.207] below. Moreover, s. 60(2) gives the Commissioner a discretion to allow depreciation calculated by reference to the buyer’s actual cost, where the Commissioner is of opinion that the circumstances are such that depreciation should be so calculated.
[10.185] Section 60 will be effective to defeat planning to give an artificially high cost to a unit of property for purposes of depreciation where depreciation in respect of the property has been allowed to the person from whom the taxpayer acquired the property. But it is ineffective where the property was not depreciable in the hands of that person. An artificially high cost may of course generate income for the seller. But the seller may be a non-resident supplier who is not subject to Australian tax. Provisions against planning to give a high cost were added to the Assessment Act in 1979. Where the taxpayer’s allowable deductions are calculated under s. 56(1)(b) (straight line) the control is in s. 56(4). Where his allowable deductions are calculated under s. 56(1)(a) (diminishing balance) the control is in s. 56(3). The cost of the unit of property is deemed to be the amount that would have been the cost of the unit if the parties to the transaction had dealt with each other at arm’s length in relation to the transaction.
[10.186] Sections 56(4) and 62(3) have no application when depreciation allowable is not calculated under s. 56. Section 56AE (s. 57AE(3)), s. 57AH (s. 57AH(6)), s. 57AJ (s. 57AJ(4)) and s. 57AK (s. 57AK(6)) either contain their own provisions directed against planning to give a high cost, or expressly adopt s. 56(4).
[10.187] Section 57AF imposes a limit on the cost by reference to which depreciation may be calculated where the unit of property, subject to some exclusions, is a motor vehicle that is a motor car or station wagon. The limit is indexed under the provisions of the section.
[10.188] Where any property of a taxpayer in respect of which depreciation has been allowed or is allowable is disposed of, lost or destroyed at any time in the year of income, s. 59 makes the depreciated value of the property at that time, less the amount of any consideration receivable in respect of the disposal, loss or destruction, an allowable deduction. However, if the consideration receivable exceeds the depreciated value, the excess, to the extent of the sum of the amounts allowed and allowable in assessments for income tax in respect of depreciation, must be included in the taxpayer’s assessable income of that year. An amount thus made assessable income is referred to in subs. (2A) of the section as a “balancing charge”. The operation of s. 59 to the extent that it would bring an amount in as assessable income in the year in which a unit of property is disposed of, lost or destroyed, is qualified by subss (2A), (2B), (2C), (2D) and (2E) of s. 59. On the request in writing of the taxpayer, made when lodging his return of income or within such further time as the Commissioner allows, the balancing charge, instead of being brought in as assessable income, may be applied successively to reduce: (i) the cost for the purposes of calculating depreciation of any unit of property acquired by the taxpayer during the year of income as a replacement; (ii) the cost for the purposes of calculating depreciation of any other unit of property acquired by the taxpayer during the year of income; and (iii) the depreciated value at the beginning of the year of income of other units of property. By s. 59(2D) the taxpayer, if he has not already made a request in the year of disposal, loss or destruction, may make a request not later than the second year of income after the year of disposal, loss or destruction, that the balancing charge be applied to lower the cost of a unit of property acquired in the year of request to replace the unit disposed of, lost or destroyed. Section 59(1) does not in its terms refer to a “unit” of property. But other subsections do, and the reference to “depreciated value” imports the concept of a unit. If the disposal is of part of a unit, there is no room for the operation of s. 59. The scope of the concept of unit, considered in [10.160]–[10.166] above, becomes critical.
[10.189] “Consideration receivable” is expressly defined in subs. (3) of s. 59 as follows:
[10.190] Paragraph (c) suggests the importance in a conveyancing transaction involving the disposal by sale of units of property in respect of which depreciation has been allowed or is allowable, that the sale transaction should allocate values to such units of property. The seller, by an allocation is in a position to determine how s. 59 will operate in his case. If no allocation is made the consideration receivable will be the amount determined by the Commissioner, and the amount so determined may result in s. 59 operating in a way which the seller would not have chosen. The buyer of property will of course also have an interest in the setting of the “consideration receivable” for purposes of s. 59, if he intends to use the property in a process of income derivation. Where the consideration receivable has been set so as to give an allowable deduction to the seller, the effect will be to limit the amount of depreciation which may be claimed by the buyer. Presumably, it is not open to the buyer to say that his costs exceeded the value allocated to the property.
[10.191] The significance of an allocation relevant to para. (c), or the setting of a sale price relevant to para. (a) has been very much diminished by the addition to s. 59, in 1979, of subss (4) and (5). Where there is a disposition of property by a taxpayer by sale and
the consideration receivable by the taxpayer in respect of the disposal is deemed to be that market value or that depreciated value, whichever is the less: s. 59(4). “Consideration receivable” for this purpose is determined by s. 59(5). In its application to a sale of property with other assets, s. 59(5) would make the consideration receivable the amount allocated to the property in the agreement. The circumstances are, it seems, within s. 59(5) (a)(i). The application of s. 59(5) to any circumstances requires that the Commissioner be satisfied that the taxpayer and the other party were not dealing with one another at arm’s length. It may be asked whether the Commissioner may validly be satisfied where the transaction was in all respects an ordinary commercial dealing between two unassociated parties who agreed on an allocation of value to the unit of property.
[10.192] Section 59(4) will apply to a sale of property in respect of which depreciation has been allowed or is allowable where that sale does not include other assets, and it will apply to a sale of property with other assets where no value has been allocated to the property sold and a determination has been made by the Commissioner as contemplated by s. 59(3)(c). In the latter situation the Commissioner’s power to determine the consideration receivable provided for in s. 59(3)(c) is not thought to be enough to protect the Commissioner. The sale of the property in respect of which depreciation has been allowed or is allowable with other assets, may have been for a total price that is less than the market value of that property. The Commissioner’s power to determine the consideration receivable for purposes of s. 59(3) is, presumably, limited so that the consideration receivable may not exceed the total price, and it may also be limited so that the Commissioner’s determination must reasonably distribute the total price among the assets sold. Where the amount determined by the Commissioner under s. 59(3)(c) is less than the market value and less than the depreciated value, and the taxpayer and the other party to the transaction were not at arm’s length, the consideration receivable is deemed to be the lesser of the market value and the depreciated value.
[10.193] The question is raised in [10.191] above whether parties may validly be regarded as not acting at arm’s length, so that s. 59(4) is attracted, simply because they have made an allocation of value to a unit of property in a transaction involving the sale of depreciable property with other assets. If they cannot be validly so regarded, the Commissioner will be denied the operation of s. 59(4). In which event the correctness of a view that emerges from some of the judgments in Ferling (1966) 115 C.L.R. 603 will be important. This view is that an amount specified in the agreement by which property is sold with other assets will not be the “separate value allocated to the property” for purposes of s. 59, unless it is a real value and not simply a value adopted for the purposes of bringing about tax consequences.
[10.194] Whatever be the effect of the amount set by the agreement in regard to what is assessable income of the seller or an allowable deduction to the seller, it may well be that it is irrelevant in setting the cost to the buyer, save to the extent that it has resulted in a balancing charge to the seller which will affect the ceiling imposed by ss 60(1) and 62(2) on the depreciation which may be allowed to the buyer. The buyer’s cost is not necessarily determined by the definition of consideration receivable in s. 59(3). Where property is sold with other assets, it is arguable that an amount allocated is a cost only if it can be shown that there was a divisible contract in relation to the property. The allocation of a value to property in a contract does not necessarily make the contract divisible in relation to that property (Comptroller of Stamps v. Martin [1967] V.R. 369).
[10.195] The meaning of “property sold with other assets” was the principal issue raised by Ferling. The case might be thought to have decided that where the property in question is a fixture—for example, a building which is made depreciable by s. 54(2)(b)—a sale of the fixture as part of the land is not a sale of the fixture “with other assets”, with the result that such a sale does not produce a “consideration receivable” and s. 59 can have no application. What is sold is the land of which the fixture forms a part.
[10.196] Such an interpretation of s. 59(3)(c) has been questioned in the Federal Court in Mullins (1981) 81 A.T.C. 4643. The interpretation may have had the virtue that it denied success to tax planning which sought to exploit s. 59 by a sale of land with a depreciable fixture, at a very low value allocated to the fixture. But success is now in any event denied by s. 59(4) and (5).
[10.197] The judgments in Henty House Pty Ltd (1953) 88 C.L.R. 141 amount to a decision that a resumption of property involves a disposition by sale. In applying s. 59(3)(c) the Commissioner adopted the values assigned to units of property by the Department of the Interior in calculating the amount of compensation payable on the resumption. The values were adopted not as values allocated to the units of property, but as the bases on which the Commissioner exercised his power to determine the amounts of consideration. Henty House, in holding that the resumption involved a sale of the fixtures that were part of the property resumed, is inconsistent with Ferling so far as the latter decides that units of property that are fixtures are not sold with other assets when the property of which the fixtures are part is sold.
[10.198] Section 59(3) requires that a distinction be drawn between a loss or destruction of property and a disposal. Where property is lost or destroyed, the consideration by reference to which the balancing charge or allowable deduction is calculated is limited to “the amount or value received or receivable under a policy of insurance or otherwise in respect of the loss or destruction” (s. 59(3)(b)). Where, however, property is “disposed of otherwise than by sale”, the consideration receivable is the value of the property at the date of disposal.
[10.199] Machinery that has become defective may he replaced, and the original machinery treated as scrap. If these circumstances are treated as a destruction any allowable deduction will be calculated on the basis that there is a nil consideration receivable. There may subsequently be a disposal on the sale of the scrap, but this will, presumably, not be a relevant event under the depreciation provisions, though the proceeds might be held to be income as proceeds of sale of a revenue asset that has a nil cost, s. 82 being applicable. If treating the unit of property as scrap is held to be a disposal, there will be consideration receivable of the value of the property at the time it is so treated. Holding that there is a disposal will require a very wide meaning for the words “disposed of”, perhaps wider than the wide meaning considered appropriate by the High Court in Henty House. Williams, Webb, Kitto and Taylor JJ. considered that the words “should be understood as meaning no less than ‘becomes alienated from the taxpayer”‘ ((1953) 88 C.L.R. 141 at 152). If treating the unit of property as scrap is held to be a disposal at its value at that time, on the subsequent sale of the scrap there will, presumably, be income or loss depending on the amount of the proceeds, a cost being allowable of the value at the time of disposal. The argument would be that the scrap is a revenue asset.
[10.200] Henty House contemplates a wide meaning for the word “loss” in s. 59. It is enough that the item “ceases to be physically accessible” to the taxpayer ((1953) 88 C.L.R. 141 at 152 per Williams, Webb, Kitto and Taylor JJ.).
[10.201] The calculation of a balancing charge or an allowable deduction under s. 59 is based on the “consideration receivable”. It would appear that consideration is receivable in respect of a disposal loss or destruction though the amount has not yet been ascertained. In this respect there may be a difference between accounting for depreciation, and accounting generally by an accruals basis taxpayer where the issue is whether a receivable has been derived. Williams, Webb, Kitto and Taylor JJ. said in Henty House (1953) 88 C.L.R. 141 at 155–6:
“Uncertainty may be due, in the case of an ordinary sale of depreciated property, to the fact that the price has still to be fixed by arbitration or otherwise by reason of the terms of the sale contract; or it may be due, in the case of loss or destruction, to the fact that an assessment has to be made under a policy of insurance; or it may be due, in the case of a sale of depreciated property together with other property, to the fact that the Commissioner has not yet determined an amount under subs. (3)(c); or it may be due, in the case of a disposal otherwise than by sale, to the fact that the value of the property is undetermined. But the existence of the uncertainty, for whatever cause … afford[s] no ground for denying to s. 59 the construction which its precise terms require.”
[10.202] Section 59AA was inserted in 1952 to overcome the decision in Rose (1951) 84 C.L.R. 118 that the words “disposed of” in s. 59 did not include a change in the interests of persons in property, arising, for example, from the formation or dissolution of a partnership or a variation in the constitution of a partnership. By s. 59AA, where such a change in interest occurs, the provisions of the Act relating to depreciation now apply as if the person or persons who owned the property before the change had, on the day on which the change occurred, disposed of the whole of the property to the person, or all the persons by whom the property is owned after the change for a consideration equal to the amount specified in the agreement in consequence of which the change occurred as the value of the property for purposes of that agreement, or, if there is no such agreement or no amount is so specified, an amount determined by the Commissioner. It will be noted that the effect of s. 59AA is to preserve to the parties a measure of control, by specifying a value of the property in the agreement, of the kind available by virtue of s. 59(3) in regard to other dispositions of property in respect of which depreciation has been allowed or is allowable. The measure of control is significantly limited by s. 59AA(2), added in 1979. Where the amount specified in the agreement is less than the amount that was the market value of the property immediately before the time when the change occurred, and is also less than the depreciated value immediately before that time, the depreciation provisions will operate as if there had been, at the time when the change occurred, a disposal of the property for a consideration equal to the market value of the property immediately before the change, or the depreciated value immediately before the change, whichever is the less.
[10.203] Section 59AA(2) also provides that the depreciation provisions apply in the circumstances as if “the person or persons who owned the property after the change had, at the time when the change occurred, acquired the property at a cost equal to the amount specified in the agreement”. The effect is to impose a penalty of lost depreciation deductions—a fall out—if a low value has been specified in the agreement. Section 59AA(2) joins s. 62(2) in expressly determining the cost for purposes of depreciation deductions for the person acquiring, where property has been acquired from another person to whom depreciation had been allowed or is allowable. There is a limit to the buyer’s cost imposed by s. 60(1). Where the limit operates, the person acquiring the unit of property is deemed to have acquired it at a cost equal to the depreciated value of the unit immediately prior to the time of acquisition, plus the amount of any balancing charge included in the assessable income of the seller. Section 62(2) has no application where the buyer has acquired at a price less than the depreciated value in the hands of the seller. There will be no operation of s. 60(1), and thus no operation of s. 62(2). Section 59AA(2) does have an operation in these circumstances.
[10.204] There is no parallel operation for s. 59 where s. 59AA has not been engaged. The point has already been made that the cost to the buyer is not necessarily the amount of the consideration receivable by the seller, whether the amount provided for in the agreement by which the property is disposed of or the amount deemed to be the consideration receivable by the operation of s. 59(4) and (5). Where there is a sale of the property subject to depreciation without any other assets, it may be argued that the buyer’s cost includes the gift extended by the seller in the low amount of the sale price. Where the sale is made with other assets, the value allocated to the property subject to depreciation may not in any event be properly regarded as the price under the contract, save where the contract is divisible.
[10.205] There is a question whether gift is a disposal for purposes of s. 59. It will be recalled that Williams, Webb, Kitto and Taylor JJ. in Henty House Ltd (1953) 88 C.L.R. 141 considered that the words “disposed of” should be understood as meaning no less than “becomes alienated from the taxpayer”. If death is a disposal, the consideration receivable will be the value of the property at the date of death (s. 59(3)(d)).
[10.206] Where the property in question was an asset of a partnership, and s. 59AA operates on death of a partner, there will be a question whether any amount specified in the partnership agreement or some other agreement between the partners can be said to be an “amount specified in the agreement in consequence of which the change occurred as the value of the property for purposes of that agreement”. If it cannot, or no amount has been specified, the death will be a deemed disposal, in accordance with s. 59AA, for a consideration of an amount determined by the Commissioner, which may be the market value of the property. Where the death of a partner brings about a dissolution of a partnership or a dissolution and an automatic vesting in the other partners of the interest of the deceased, the words of s. 59AA(1) would appear to be applicable. Where the partnership business is, under the partnership agreement, carried on by the surviving partners for themselves and the estate of the deceased there may not be a dissolution (Peterson (1960) 8 A.I.T.R. 119) though it is arguable that there has been a variation in the constitution of the partnership so as to engage the operation of s. 59AA.
[10.207] Where the assets of a business are disposed of, lost or destroyed and in consequence the business ceases to be carried on, the effect of s. 59 may be to include in the assessable income of the person who carries on the business a substantial amount by way of balancing charges. There will thus be a bunching of income which the individual taxpayer, because of the progressive rate structure, may regard as a hardship. Section 59AB gives the individual taxpayer some relief against such bunching, provided he has not already become entitled to relief by way of the averaging provisions (Div. 16 of Pt III), and provided he has not requested under subss (2A) or (2D) of s. 59 that the balancing charge be applied in reduction of the costs or depreciated values of other properties instead of being included in his assessable income. The relief given by s. 59AB follows the same pattern as Div. 16A of Pt III, which relates to the income of an author or inventor. There is a calculation of a notional income by subtracting from taxable income a part of the abnormal income which arises from the balancing charges and a rate of tax is determined by reference to that notional income; such rate of tax is then applied to the whole taxable income.
[10.208] Some reference has already been made to the problems of correlating the operation of subss (1A), (1B) and (1C) of s. 56 with the operation of s. 61. Subsections (1A) and (1C) of s. 56 provide for a mechanical method of determining the depreciation allowable where a unit of property is used to produce income, or is installed ready for use, “for part only of a year of income”. Section 61 applies where “the use of any property by the taxpayer has been only partly for the purpose of producing assessable income”. In this case only “such part of the deduction otherwise allowable under s. 54 or s. 59 in respect of that property as in the opinion of the Commissioner is proper” is an allowable deduction. Subsections (1A), (1B) and (1C) of s. 56 apply to the determination of the amount of deductions for depreciation allowable under s. 56, s. 57AG or 57AK. In no circumstances have they any application to the determination of the amount of an allowable deduction under s. 59. Section 61 applies to the determination of the amount of an allowable deduction where a deduction is allowable under s. 54 or s. 59. Presumably a deduction allowable under the specific provisions of ss 57AE, 57AG, 57AH, 57AJ and 57AK is allowable under s. 54 so that s. 61 is attracted. And a deduction under s. 59 is allowable where depreciation is allowable under one of the specific provisions so that in these circumstances s. 61 is also attracted.
[10.209] Where subsections (1A), (1B) and (1C) of s. 56 and s. 61 are both applicable, there is, prima facie, an irreconcilable conflict in their operations. The conflict will be avoided only if use for the purpose of producing income “for part only of a year of income” is treated as exclusive of use “only partly for the purpose of producing income”. It may be possible to distinguish (i) a situation where for part of a year property is not used, and for another part is used, to produce income, from (ii) a situation where for the whole of the year property is used only partly for the purpose of producing income. But drawing the distinction will be a demanding exercise. Anderson (1956) 11 A.T.D. 115 was decided at a time when the subsections had not been added to s. 56. The facts are stated in the case to have involved use of a motor car partly for the purpose of producing assessable income. Presumably the car was at all times during the year held both for private purposes and income derivation purposes in the intention of the taxpayer. It may be possible to assert that the subsections of s. 56 are only applicable when for some part of a year the property was not, in the intention of the taxpayer, held for any purpose of producing assessable income. The resulting distinction between the areas of operation of the subsections of s. 56 and s. 61 may be a useful reconciliation, but it is hardly justified by the language of the sections.
[10.210] Some aspects of the operation of s. 61 are considered in Anderson in relation to s. 59. A valid formation of an opinion by the Commissioner requires him to determine a notional depreciated value on the assumption that depreciation in the years before disposal had been allowed on the basis of use wholly for the purpose of producing assessable income. The Commissioner may then allow a deduction of some part of the deduction that would have been allowable on disposal, had the notional depreciated value been the actual depreciated value. The deduction that would have been allowable may have been limited by the operation of s. 59(4). In this event the deduction allowed by the Commissioner under s. 61 will be some part of the deduction so limited. It will be noted that s. 61 has no relevance to the determination of the amount of a balancing charge under s. 59. For this purpose s. 59 is alone applicable, and the depreciated value is the actual depreciated value.
[10.211] It may be inferred from Anderson that where diminishing balance applies in relation to property partly used for the purpose of producing assessable income, a valid opinion formed by the Commissioner will involve the allowance of a part of the deduction that would have been allowable under ss 54 and 56, had the amount of that deduction been calculated by reference to a notional depreciated value, reflecting deductions in earlier years that would have been allowable had the property been wholly used for the purpose of producing assessable income.
[10.212] Mention has already been made ([10.155] above) of Divs 10C and 10D, which, with the depreciation provisions, achieve substantial coverage in allowing deductions in respect of the costs of wasting structural assets that are tangible. To satisfy Div. 10C there must have been “qualifying expenditure” in respect of the construction of a building or of an extension, alteration or improvement to a building in Australia; such construction must have commenced after 21 August 1979; and such a building must have been for use wholly or principally for the purpose of operating a hotel: s. 124ZB. Division 10D applies to a construction that commenced after 19 July 1982. The criteria in Div. 10D are similar to the criteria in Div. 10C, but Div. 10D extends the scope of deductibility to capital expenditure relating to the construction of all income-producing buildings, except for residential buildings and certain exhibition buildings: s. 124ZG.
[10.213] Neither Div. 10C nor 10D refers to depreciation per se, but the method of deduction provided for in both cases amounts to a fixed 2½ per cent prime cost method of depreciation over 40 years: ss 124ZC, 124ZH. The rate is 4 per cent for buildings whose construction commenced after 21 August 1984. There is no provision for loading or acceleration, unlike the regime provided for by ss 54–62. And no deductions are allowed in respect of any property in respect of which depreciation is available under s. 54: ss 124ZB(3), 124ZG(3).
[10.214] It has been noted in [10.188]ff. above that s. 59 provides an adjustment by way of balancing charge or allowable deduction where an item of property, to which s. 54 applies, has been disposed of or destroyed. There is no similar provision for adjustments in Div. 10C or Div. 10D. The price that the new owner pays for the building is irrelevant in determining the depreciation available to him: there is a 40 year depreciation which will not be affected by a change in ownership, provided that new owners use the property for the requisite purposes outlined in Divs 10C and 10D. Similarly, the price the vendor receives will not affect the vendor’s tax liability. The policy behind this reluctance to allow balancing adjustments was expressed by the Asprey Committee: “… the difficulty of ensuring a fair and realistic segregation, within the proceeds from the sale of a property, of that part of those proceeds applicable to a building dictates that there be neither a balancing charge nor a balancing allowance” (Taxation Review Committee, Full Report (A.G.P.S., 1975), p. 96).
[10.215] Sections 124ZE and 124ZK go some way towards providing for the type of adjustments found in s. 59: they provide for a deduction of the “residual capital expenditure”—in effect the notional depreciated value—less the proceeds of insurance or compensation where the building has been destroyed. The effect of ss 124ZE and 124ZK is consistent, to some degree, with the policy recommendations of the Asprey Committee which argued:
“There would need to be exceptions, in the case of demolition or damage to a depreciated building, to the general rule that balancing adjustments are not made. Problems of segregating amounts received between land and buildings would not arise here … In the case of demolition or destruction, the difference between the written down value of the building and the salvage or insurance proceeds would be allowed as a deduction in the year of demolition. If the proceeds exceeded the written-down value, the excess, up to the sum of the depreciation deductions previously allowed to the taxpayer, would be a balancing charge … Where there is only partial damage, any insurance recoveries would be offset against the cost of any restoration not deductible as a repair. Any amount not so absorbed would be treated as a balancing charge to the extent of depreciation previously allowed to the taxpayer … Insurance recoveries in respect of restoration amounting to repair are income under existing law and the repair cost deductible. Balancing deductions would not be allowed, since depreciation will continue to be available on the original schedule” (Asprey Report, pp 96–97).
Curiously, Div. 10C and Div. 10D make no provision for a balancing charge in the case of destruction of a building (or part of a building), even though balancing deductions are provided for. Thus, the only balancing adjustment provided for by Div. 10C and Div. 10D is a balancing deduction where the amount received pursuant to the destruction of a building (or part of building)— under a policy of insurance or otherwise—is less than the residual capital expenditure (or the amount of it attributable to the destroyed part).
[10.216] The relationship between ss 124ZE and 124ZK on the one hand and s. 53 on the other hand is not entirely clear. It is presumed that damage subject to repairs contemplated by s. 53 is different from destruction of part of a building contemplated by ss 124ZE and 124ZK. This assumption is consistent with the view of the Asprey Committee in the latter part of the extract above.
[10.217] Section 67(1) provides for deductions, spread over the period of the borrowing, in respect of expenditure incurred by the taxpayer in borrowing money used by him for the purpose of producing assessable income. The period of the borrowing for this purpose is in some circumstances a deemed period specified in s. 67(2). Where the total expenditure incurred by a taxpayer in a year of income is less than $100, spreading the expenditure over the period of the borrowing is not required: the whole of the expenditure is an allowable deduction in the year of income.
[10.218] Section 67(1) is not in its terms limited to expenditure that is not working. Expenditure incurred by a taxpayer in borrowing money could be seen as working expenditure deductible under s. 51(1), at least when the liability to repay is a liability on revenue account. All judges in the Federal Court in Ure (1981) 81 A.T.C. 4100 assumed that the costs of obtaining a loan are not working. There may be room for a rethinking of that assumption in view of the decision in AVCO Financial Services Ltd (1982) 150 C.L.R. 510 and in particular the abandonment in that case by Gibbs C.J. of a view that a borrowing always gives rise to a liability on capital account. There is at least an awkwardness in saying that a payment to obtain a borrowing to be used in a process of income derivation is not a working expense because it is an expense to obtain an enduring advantage in the form of the accommodation received, and at the same time treating the borrowing as a liability on revenue account so as to allow a deduction of a loss in discharging the liability. A more helpful analysis would say that where money is borrowed on revenue account the costs of obtaining the borrowing are deductible as working expenses. Alternatively, they are outlays in assuming a liability on revenue account and will enter the determination of profit that is income or a loss that is deductible on the discharge of the liability.
[10.219] If costs of obtaining a borrowing are deductible in any circumstances under s. 51(1), there will be problems of correlating the operation of s. 51(1) and the operation of s. 67. All judges in the Federal Court in Ure (1981) 81 A.T.C. 4100 were able to avoid any such problems. Deane and Sheppard JJ. held that none of the costs—valuation fees, legal costs and guarantee fees— that fell to be considered in relation to s. 67 were working expenses, and all were in fact deductible in the manner allowed by s. 67. Brennan J. held that the guarantee fees, which were payable over the period of the loan, were working expenses—expenses of maintaining or servicing the borrowing—and were deductible under s.51(1). He held that they were not deductible under s. 67, because they were not expenditure incurred in borrowing money.
[10.220] Where s. 51(1) and s. 67 are both prima facie applicable, s. 67 will, presumably, prevail as the more specific provision. If the costs are seen as outlays in obtaining the accommodation comparable with costs of revenue assets and not deductible under s. 51(1), they will be deductible under s. 67 and, in the operation of s. 82(2), will not be subtractable in determining any profit or loss that is income or deductible on the discharge of the liability.
[10.221] If the interpretation of the word “used” in s. 67 adopted by the Federal Court in Ure (1981) 81 A.T.C. 4100 is accepted, it will follow that no apportionment is possible under s. 67 so as to deny part of the cost of the borrowing in circumstances like those in Ure, notwithstanding the addition in 1984 of subs. (4) of s. 67. And if s. 67 is a code there will be no possibility of an apportionment under s. 51(1). Section 67(4) will not make an apportionment possible because it operates only where the taxpayer had borrowed money “used by” him only partly for the purpose of producing assessable income. The interpretation given to “used” in Ure requires a conclusion that, in the circumstances of that case, the money has been wholly used for the purpose of producing assessable income. Subsection (4) will be confined to an operation in circumstances where some part of the money borrowed has not been on-lent, or is not in the year of income on-lent, at interest.
[10.222] Section 67 raises questions of a requirement of contemporaneity and a requirement of relevance like those raised in relation to s. 53 in [10.27]–[10.30] above, and in relation to s. 72 in [10.38]–[10.39] above. If there is a contemporaneity requirement, the taxpayer may be denied deduction if he has paid the costs of borrowing before the money borrowed comes to be used for the purpose of producing assessable income. The importing of such a requirement is unlikely. Any requirement of relevance might on the face of the section be satisfied if the money borrowed has at any time been used for the purpose of producing assessable income. It may not matter that in the year of income in which an amount becomes otherwise deductible, the money borrowed is no longer used for the purpose of producing assessable income. The view was taken in [6.86]ff. above that s. 51(1) will allow a deduction of an interest cost only if the amount borrowed continues in the year of income to be outlaid for the purpose of deriving assessable income.
[10.223] Under s. 67A a taxpayer who incurs expenditure (not including payments of principal or interest) in connection with the discharge of a mortgage given by him as security for the repayment of money borrowed by him, or the payment by him of the whole or a part of the purchase price of property purchased by him, may be entitled to deduct that expenditure. The whole of the expenditure is deductible if the money or property was used by him “wholly for the purpose of producing assessable income”. Such part of the expenditure as the Commissioner determines is deductible if the money or property was used by him “partly for that purpose”.
[10.224] Section 67A is not in its terms confined to allowing deduction of expenses that would not be deductible under s. 51(1). It may have been assumed, in line with the assumption made in Ure (1981) 81 A.T.C. 4100 in relation to the expenses of borrowing money, that expenses of repaying a borrowing can never be deductible under s. 51(1). The assumption in Ure is questioned in [10.218] above. In the present context it would be said that where the liability to repay the money borrowed, or to discharge the debt owed for the purchase price of the property purchased, is a liability on revenue account, the expenses of discharging the liability are working expenses. AVCO Financial Services Ltd (1982) 150 C.L.R. 510 is authority that a loss on the discharge of a liability on revenue account is deductible, and it should follow that other expenses incurred in discharging the liability are deductible. Alternatively these other expenses are of costs of the accommodation received, like the amount paid in repayment of the borrowing, and may go to increase the loss on the discharge of the liability.
[10.225] An overlap in the operations of s. 51(1) and s. 67A will not be important unless there is some difference in the deduction allowed. There is at least one difference evident where the money or property was used only partly for the purpose of producing assessable income. Under s. 67A a deduction is allowable of such part of the expenditure as the Commissioner determines. Under s. 51(1) the allowability of a deduction depends on the operation of the words “to the extent to which”, and no discretion is conferred on the Commissioner. There may be another difference. If the interpretation of “used” adopted in Ure is accepted, a borrowing in the circumstances of that case will be a borrowing that is wholly used for the purpose of producing assessable income, so that the whole of the expenditure will be deductible. If the deduction is under s. 51(1) only a portion of the expenditure will be deductible: it will be deductible in accordance with the principle applied in Ure to the deductibility of the interest.
[10.226] Section 68 allows the deduction of expenditure incurred by a taxpayer for the preparation, registration and stamping of a lease, or of an assignment or surrender of a lease, of property that is to be, or has been, held by him for the purpose of producing assessable income. The words of the section must have a wide operation, and will for the most part cover situations where s. 51(1) would not allow a deduction. A lease of property will most often be a structural asset of the lessee, though the possibility that a lease is in some circumstances a wasting revenue asset should not be excluded. If s. 68 and s. 51(1) do overlap, problems of correlation will not arise since each section will have the same operation. At least this is so if s. 51(1) gives an immediate deduction, as clearly s. 68 does, of costs of a wasting revenue asset. This view has been expressed above that the expense under s. 51(1) should be spread over the life of the wasting revenue asset. If there is overlap and a problem of correlation arises, s. 68 will, presumably, prevail as the more specific provision.
[10.227] There will be a number of situations within s. 68 where a deduction would not be allowable under s. 51(1) because the expense is not a working expense or is not contemporaneous. Expenses that may be seen as expenses of taking, assigning or surrendering a lease that is not a revenue asset are not working expenses. Expenses of taking a lease, or of the assignment or surrender of a lease, may be deductible under s. 68, if the property is to be used by the lessee, or has been used by the lessee, to produce assessable income. In these situations the contemporaneity principle may exclude deductibility under s. 51(1), even though the lease is a revenue asset of a business carried on by the lessee.
[10.228] The circumstances so far considered are all concerned with the deduction of expenses incurred by the lessee. Section 68 in its terms, seems applicable to expenses incurred by the lessor. An expense of the lessor in giving a lease of property that had been used by him to produce assessable income would not be deductible under s. 51(1) because of that use. The expenses of a lessor in relation to the surrender of a lease of property that the lessor proposes thereafter to use to produce assessable income would be denied deduction under s. 51(1), on the ground that it is not contemporaneous with that use, and on the ground that it is not a working expense of that use.
[10.229] Section 68 will allow an apportionment of expenditure where the property is to be, or has been, held by the taxpayer only partly for the purpose of producing assessable income. So much only of the expenditure, as, in the opinion of the Commissioner, is reasonable, is an allowable deduction. The meaning of “held partly for the purpose” is discussed in relation to s. 53(3) in [10.27] ff. above.
[10.230] Section 68A allows the deduction of expenditure “in obtaining or seeking to obtain, for the purpose of producing assessable income,
[10.231] The section will allow an immediate deduction of expenses that might otherwise have been deductible only under the provisions of Div. 10B of Pt III considered in [10.235]–[10.269] below. If deductible under s. 68A, they are, presumably, excluded from deductibility under Div. 10B as expenses that are not “of a capital nature”, though this is to give those words a meaning they do not have in other contexts.
[10.232] In the application of the section to expenses of “seeking to obtain”, where the seeking is unsuccessful, there could be no overlap with Div. 10B. But in this aspect, and more widely, s. 68A may overlap with s. 51(1). If the item of property would be a revenue asset of the taxpayer’s business, expenses of seeking to obtain it would be deductible under s. 51(1). And the expenses of obtaining the item of property would be deductible if the asset would be trading stock of the business. Problems of correlation between s. 68A and s. 51(1) will not arise since both provisions have the same operation. In any case, circumstances in which the item of property may be at once a revenue asset and an asset to be obtained for the purpose of producing assessable income, are not easily imagined, more especially if the item of property is a revenue asset as trading stock.
[10.233] Section 68A will allow an apportionment of expenditure when it was incurred in obtaining, or seeking to obtain, the grant, extension or registration only partly for the purpose of producing assessable income. So much only of the expenditure as, in the opinion of the Commissioner, is reasonable, is an allowable deduction. As in relation to s. 68, the interpretation of the word “used” by the Federal Court in Ure (1981) 81 A.T.C. 4100 is, presumably, inapplicable.
[10.234] Section 70A contains detailed provisions in relation to the deductibility of “expenditure of a capital nature” on the connection of mains electricity facilities to land. The reference to expenditure of a capital nature ensures that there are no problems of correlation with s. 51(1). There could however be problems of correlation with other specific provisions of the Act were it not for subs. (9), which makes s. 70A prevail, displacing the operation of other specific provisions. The deduction under s. 70A is of the whole of the expenditure, though the facilities are only partly for use in carrying on a business for the purpose of producing assessable income.
[10.235] Reference has already been made to the fact that, generally, the Assessment Act does not allow deductions in respect of the cost of wasting structural assets that are intangibles ([7.10] above). Deductions are however allowable under Div. 10B of Pt III in respect of the costs of items of commercial or industrial property—patents, copyrights and registered designs. Where the costs relate to a “qualifying Australian film”, as defined in s. 124ZAA, the special incentive provisions of Div. 10BA of Pt III apply. These allow an accelerated deduction equivalent to 150 per cent of the expenditure of a capital nature in producing, or by way of contribution to the cost of producing, such a film. Division 10BA and some provisions of Div. 10B modify the operation of Div. 10B in relation to costs of an Australian film. Division 10BA and the modifying provisions of Div. 10B are not considered in what follows, the attention being directed to the provisions of Div. 10B as they operate in relation to items of commercial or industrial property other than eligible Australian films.
[10.236] The provisions of Div. 10B broadly parallel the depreciation provisions of the Act considered in [10.130] ff. above, but there are important differences. Allowable deductions under Div. 10B are available in respect of the residual value of the unit of property, residual value involving the subtraction from the cost of the unit of deductions allowed or allowable under the Division. The deductions in this respect parallel the diminishing balance deductions for depreciation, but they are in effect equivalent to the straight line deductions for depreciation, because the fraction of the residual value that is deductible in any year increases as the remaining “effective life” of the property decreases. The “effective life” of the unit of property is a notion corresponding with annual depreciation per centum under the depreciation provisions. But the Commissioner has no function to perform in determining the effective life of a unit. It is fixed by the terms of s. 124U.
[10.237] “Cost” is defined in s. 124R in a way that may preclude any possibility that the taxpayer might, save where some specific provision allows, claim that the value of the unit of property is its cost, where he has not incurred an equivalent expense in the purchase of the item of property.
[10.238] Amortisation deductions under Div. 10B are available in respect of property used by the taxpayer in the year of income, or in a previous year of income, for the purpose of producing assessable income, and in this respect they accord with depreciation deductions. But deductions under Div. 10B are available in respect of property if it has in an earlier year been used to produce assessable income, even though there is no use to produce income in the year of income in which the deduction is claimed. And Div. 10B will be attracted if there is or has been use which is only in part for the purpose of producing assessable income. There are no provisions in Div. 10B corresponding with subss (1A), (1B) and (1C) of s. 56, and s. 61.
[10.239] The amortisation provisions are available to a person who possesses rights (“the owner”) as the “grantee or proprietor of a patent … granted in Australia”, as the owner of a copyright subsisting in Australia, as the owner of a design registered in Australia or as a licensee under such a patent copyrights or design (s. 124K(1)). They are not available to a person who possesses rights as the owner of or a licensee under, a trade mark. A trade mark is not a wasting asset.
[10.240] They are available to the person who possesses the rights if he has used the rights for the purpose of producing assessable income in the year of income, or in a previous year of income (s. 124L(1)). Once the rights have been used to produce income, amortisation deductions continue to be available as long as the taxpayer possesses the rights, whether or not he continues to use the rights to produce income.
[10.241] Amortisation deductions are available to a person who possesses relevant rights as a licensee. The giving of a licence by the owner of a patent, copyright or design is a disposal of rights (s. 124V(1)) and, presumably, is not a use of those rights. It would follow that a taxpayer who has not otherwise used the rights to produce income, will not be entitled to amortisation deductions if he gives a license to another in return for royalties or other receipts that are income. If he has already made some undoubted use to produce income, the prospect of a denial of amortisation deductions will not arise.
[10.242] Deductions are available to the person who possesses the rights if he acquired them: (1) by being the inventor, the first owner of the copyright or the author of the design; (2) by purchase; (3) by virtue of a disposal otherwise than for valuable consideration by a person who possessed the rights, who was himself entitled to deductions or would have been so entitled had he used the rights for the purpose of producing income; or (4) by virtue of a transmission by operation of law from a person who possessed the rights and was himself entitled to deductions or would have been entitled had he used the rights for the purpose of producing income.
[10.243] The amount of an amortisation deduction in a year of income is a fraction of the residual value of the property constituted by the rights possessed. The residual value must be divided by “a number equal to the number of whole years in the effective life” of the property as at the commencement of the year of income (s. 124M(1)). No deduction is allowable in a year of income in which the owner (the person who possesses the rights) ceases to be the owner (s. 124M(3)), save where he ceases to be the owner because of the transmission of the property by operation of law (s. 124M(5) (a)) or where the property was purchased or otherwise acquired by the owner for a specified period, and he ceases to be the owner by reason that the specified period terminates (s. 124M(5) (b)).
[10.244] “Effective life” is determined by s. 124U. The period is deemed to commence in relation to the owner of a property at the commencement of the year of income during which the owner first used the property for the purpose of producing income, and ends at the end of a year of income. The length of the period will be determined by the time of ending, which, generally, is the time when the property will terminate. In the case of property acquired for a specified period (a licence for a period) the period will end with the termination of that period, if this is earlier than the time of termination of the patent copyright or design to which the property relates. In the case of a copyright the time of ending is 25 years after the commencement of the period, if this time of ending is earlier than the termination of the copyright.
[10.245] “Residual value” at any time is determined by subtracting from the cost of the unit of property to the owner the sum of:
It will be seen that the proceeds of a disposal in part (a licence given to another) are “consideration receivable”, save to the extent that the proceeds have “been included” or are “to be included” in the assessable income of the owner under any provision of the Assessment Act other than the Division (s. 124T(3)). It follows that royalties that are assessable income received under the grant of a license which is a disposal in part, will not go to diminish the residual value.
[10.246] “Cost” is determined by s. 124R. If the owner became the owner by reason of being the inventor of the invention that is the subject of the patent, by reason of being the first owner of the copyright or the author of the design, his cost is, generally, the expenditure of a capital nature incurred by him before the unit of property came into existence, where that expenditure was incurred in relation to devising the invention, producing the work in which the copyright subsists or producing the design (s. 124L(1)(a) and s. 124R (1)(a)). If an author incurs expenses in research for a book, his expenses may be expenses of a revenue nature if he has already commenced a business of authorship. Such expenses are clearly not “expenditure of a capital nature”, if they are incurred in acquiring a copyright that will be sold in the course of the business of authorship. They will be deductible under s. 51(1) as costs of trading stock if the trading stock provisions apply, or they will be costs of revenue assets that will enter the determination of any profit that is income or loss that is deductible. His expenses may however fail to qualify as revenue expenses, because they are incurred before the commencement of a business of authorship. It may be asked whether such expenses are “expenditure of a capital nature”.
[10.247] If the taxpayer at all times intended to licence another to publish the work or to publish the work himself, the expenses are, presumably, expenses of a capital nature. There is another possibility. The taxpayer may have incurred the expenses intending to sell the copyright in the business of authorship. Subsequently he decides to license another to publish, or decides to publish himself. There is no room for s. 36. It is not in its terms applicable even if the item of property. is trading stock. The principle in Sharkey v. Wernher [1956] A.C. 58 may operate and it may give the taxpayer a deemed cost of the value of the item of property. But that deemed cost is not made a cost for purposes of Div. 10B by any of the provisions of s. 124R. None of the paragraphs of s. 124R(1) is applicable. The taxpayer will need to argue that “cost” for purposes of s. 124s, which fixes the residual value, will include a deemed cost where an item ceases to be a revenue asset and becomes a structural asset.
[10.248] There is a question of the limiting effect of the phrase “directly in relation to” in s. 124R(1) (a). Problems akin to those explored in relation to “cost” for depreciation purposes are posed. The word “directly” may be held to confine the scope of the “expenditure of a capital nature”, so that the words embrace only “direct” costs as distinct from “on-costs”.
[10.249] There is a qualification in subss (2) and (3) of s. 124R, which may result in the cost being less than the expenditure incurred in relation to deriving or producing the invention, copyright work or design. If the Commissioner is satisfied that the owner was not dealing at arm’s length when he incurred expenditure in relation to the supply to him of goods or services, the cost will be the amount of the expenditure of a capital nature that, in the opinion of the Commissioner, would have been incurred by the owner if he had dealt at arm’s length with the supplier. In this and in a number of other provisions noted below, Div. 10B deals with planning to give an inflated cost to an item of property. It was seen ([10.184]–[10.186] above) that the depreciation sections did not include fully effective provisions against such planning until 1979.
[10.250] If the owner became the owner by purchase of the unit of property, his cost is, generally, “the expenditure of a capital nature on the purchase of the unit of property” (s. 124R(1) (b) and s. 124L(1) (b)). These words may embrace expenses incurred before the commencement of any process of income derivation. And they will embrace expenses incurred at a time when the taxpayer has formed the intention of licensing another to use the property acquired or the intention directly to exploit the property himself. Where the Commissioner is satisfied that the owner and the person from whom he purchased the property were not dealing with one another at arm’s length, the expenditure of a capital nature incurred by the owner on the purchase is deemed to be the value of the unit of property at the time of purchase or the cost of the unit to the person from whom he acquired it, whichever is the less (s. 124R(3)). If the purchase was a purchase of a part of a unit of property, for example a purchase of a license to use the unit of property, and the purchase is not an arm’s length purchase, references in subs. (3) of s. 124R to the cost to the previous owner and to value are to be construed as references to such part of that cost or of that value as the Commissioner determines (s. 124R(4)).
[10.251] Where the unit of property was purchased by the owner with other property and no separate value has been allocated to the unit, the expenditure of the owner on the purchase of the unit for purposes of Div. 10B will be so much of the purchase price of the unit and the other property as the Commissioner determines (s. 124R(5)).
[10.252] If the owner became the owner by virtue of the disposal (otherwise than by way of transmission by operation of law) in whole and otherwise than for valuable consideration, the cost of the owner so acquiring will generally be the residual value of the unit in relation to the last preceding owner of the unit immediately before the time of the disposal of the unit (s. 124R(1) (c) (i) and s. 124L(1) (c)). Where the acquisition arises from a part disposal the cost is such part of the residual value in relation to the last preceding owner as the Commissioner determines (s. 124R(1) (c) (ii) and s. 124L(1) (c)). A similar provision operates where the disposal is by way of transmission by operation of law. In this instance however the reference is to residual value less any deductions allowed or allowable in respect of the unit of property in an assessment in respect of income of the last preceding owner of the year of income in which the transmission took place (s. 124R(1)(d) and s. 124L (1)(d)). It will be recalled ([10.243] above) that s. 124M(5) will allow a deduction to the owner in the year in which the transmission takes place, where he ceases to be the owner by virtue of the transmission of the unit by operation of law.
[10.253] The cost to the new owner following a disposal otherwise than for valuable consideration or by transmission, will be the residual value in the hands of the previous owner, notwithstanding that the previous owner did not at any stage use the property for the purpose of producing assessable income. The previous owner will have a residual value under s. 124S notwithstanding that he was not at any time “the owner of a unit of industrial property to whom [the] Division applies”, and thus entitled to amortisation deductions under s. 124M. He cannot be an owner to whom the Division applies unless he has used the unit of property for the purpose of producing assessable income (s. 124L(1)). The residual value of the previous owner may have been acquired by him initially as a person who took in a disposal otherwise than for valuable consideration or on a transmission to him. And the residual value of the person from whom he took may have been acquired in the same way. Ultimately, however, residual value must, it seems, be traced to a cost which reflects expenses incurred by a person who devised the invention or produced the copyright or design, or expenses incurred in the purchase of the unit of property. The question whether there may be a cost in circumstances not covered by any of the paragraphs of s. 124R, which would reflect value at the time property becomes a structural asset in a process of income derivation, was the subject of some observations in [10.247] above.
[10.254] Sections 124N and 124P deal with the consequences of disposal of a unit of property, or cessation of a unit. They are broadly parallel with the provisions of s. 59 relating to disposal of property subject to depreciation, considered in [10.188]ff. above. They apply only when the owner of the unit of property is a person to whom the Division applies, that is to say he must have used the property for the purpose of producing assessable income.
[10.255] There may be an item of income, corresponding with what is referred to in s. 59 as a “balancing charge”, where a unit of property is disposed of and the amount of the consideration receivable in respect of the disposal exceeds the residual value of the unit of property in relation to the taxpayer at the time of disposal. Where there is no residual value, the item of income will be the consideration receivable (s. 124P(1)). However, there is a limitation, in s. 124P(3), applicable in both situations, so that the amount of income may not exceed the sum of the deductions which have been allowed or are allowable in respect of the unit under the Division in assessments of income of the taxpayer less the sum of the amounts if any which have under the section been included in the assessable income of the taxpayer of a previous year of income in respect of the unit. There may have been inclusions in assessable income because of part disposals as explained in [10.258] below.
[10.256] “Consideration receivable” is defined in s. 124T. Where the property is disposed of by sale the consideration receivable is, generally, the sale price less the expenses of the sale (s. 124T(1) (a)). Where the property is sold with other assets and a specified price is not allocated to the property, the consideration receivable is such part of the sale price as the Commissioner determines less such part of the expenses of sale as the Commissioner determines (s. 124T (1) (b)). Where there is a disposal by operation of law the consideration receivable is an amount equal to the residual value of the unit in relation to the owner immediately before the time of transmission (s. 124T (1) (c)). In this last instance, the arising of an item of income is precluded by the equality of residual value and consideration receivable. The assumption in s. 124T(1) (c) that a transmission by operation of law is a disposal, has a bearing on the question, raised in dealing with the depreciation provisions, whether death is a disposal for purposes of those provisions. Transmission by operation of law for purposes of Div. 10B is defined in s. 124K so that it includes transmission on death. Section 124K (3) may however be pointed to as the explanation of the assumption in s. 124T(1)(c). On one view of that subsection it deems a transmission by operation of law to be a disposal. On another view, however, the subsection is simply concerned with identifying the time at which disposal takes place under a transmission.
[10.257] It has already been noted ([10.245] above) that the consideration receivable does not include an amount receivable in respect of the disposal that has been included or is to be included in the assessable income of the owner under provisions of the Act other than Div. 10B.
[10.258] These provisions by which an amount may be included in assessable income are applicable to a part disposal. There is a part disposal where a licence is given in respect of a unit of property (s. 124V). Where there is a part disposal and the consideration receivable is less than the residual value of the property, the consideration receivable will go to reduce the residual value of the unit of property (s. 124S(1)). Where the consideration receivable exceeds the residual value, there will be assessable income within the limits set by s. 124P(3). The unit of property which the taxpayer retains after the disposal in part, is deemed to be the same unit of property as the unit of property disposed of in part.
[10.259] Section 124N provides for an allowable deduction on disposal in whole of a unit of property or on its ceasing to exist. Where the consideration receivable is less than the residual value there is an allowable deduction of the difference between the consideration receivable and the residual value: s. 124N. Where there is a disposal in part an allowable deduction cannot arise. The consideration receivable is simply set against the residual value (s. 124S (1)).
[10.260] Where a unit of property ceases to exist by reason of the patent or copyright, or the registration of the design, ceasing to be in force, the amount of any residual value of the unit of property is an allowable deduction.
[10.261] The grant of a licence is a part disposal by the owner of the patent, copyright or design, and the grant could not produce an allowable deduction for the owner. But the licensee is the owner of a unit of property. If he surrenders his licence and there is no consideration receivable in respect of the surrender, the amount of the residual value will be an allowable deduction. If he surrenders “in consideration of the payment to him of an amount”,it seems that he will be taken to have disposed of a unit of property and ss 124P and 124N will apply. This would appear to be the effect of s. 124V (2) (a) in providing that the surrender is not a disposal of the unit “unless the surrender was made in consideration of the payment to him of an amount”. The owner of a unit of property who receives the surrender of the licence is entitled, generally, to an increase in the cost of the unit by an amount equal to the expenditure he incurred in obtaining the surrender (s. 124S(2) (a)). There is however a control on planning to inflate the cost of a unit of property, of the kind already noted in subss (2) and (3) of s. 124R. By s. 124S(2), if the Commissioner is satisfied that the owner and the person surrendering were not dealing with one another at arm’s length, and the consideration given for the surrender is greater than the value of the licence or, if not, it is none the less greater than the expenditure incurred by the person who surrendered the licence, in obtaining the grant of the licence, the cost of the unit of property is increased only by an amount equal to the value of the licence or that expenditure, whichever is the less.
[10.262] Section 124T(1), in defining consideration receivable, deals only with disposals by sale and transmission. It does not deal with a disposal for no consideration. Section 124T(2), however, assumes that a disposal without consideration is a disposal to which ss 124N and 124P are applicable. It provides that the consideration receivable is to be taken to be the amount that was the value of the unit of property or part of the unit at the time of the disposal, “if the Commissioner is satisfied, having regard to any connection between the owner and [the other party to the disposal], or any other relevant circumstances, that the owner and that other person were not dealing with each other at arm’s length in relation to the disposal”. Presumably, the mere circumstance that there is no consideration for a disposal will not be sufficient to enable the Commissioner to reach a valid satisfaction that the parties were not dealing with one another at arm’s length.
[10.263] Section 124T(2) is directed more generally against planning to obtain an allowable deduction on disposal. The planning would seek to deflate the amount receivable. Section 124T(2) extends not only to the circumstances considered in the last paragraph but also to a non arm’s length transaction in which the amount receivable by the owner in respect of the disposal is less than the value of the unit or part of the unit at the time of disposal. The effect of s. 124T(2) is that the consideration receivable may be taken to be the amount that was the value of the unit or part of the unit at the time of disposal. Section 124T(2) has a similar operation to the provisions of s. 59(4) added to the depreciation provisions in 1979.
[10.264] The reconstructed amount of consideration receivable under s. 124T (2) does not necessarily settle the cost of a unit of property for purposes of determining amortisation deductions available to the person to whom the property was sold. Most likely the buyer’s cost will be the price under the contract of sale. Where this has been set at an amount less than the value and the Commissioner has acted under s. 124T(2), there is the prospect of what might be thought to be a fall-out. A deduction is denied to the seller and to the buyer of an amount that would have been deductible by the buyer had the unit of property been sold to him for its value. Where there is a sale for the value of the item the buyer will be entitled to deductions reflecting that value as his cost, and the sum of the deductions to seller and buyer may exceed the deductions that would have been allowable to the seller had he retained the unit of property for its effective life. There is no provision of the kind included in ss 60(1) and 62(2) in relation to depreciation, whereby the deductions available to a buyer may not exceed the deductions that would have been available to the seller had he retained the property.
[10.265] The contrast has already been drawn between Div. 10B, which allows an amortisation deduction in respect of a unit of property owned by the taxpayer that has been used by him for the purpose of producing assessable income, whether in the year of income in which a deduction is claimed or in an earlier year, and the depreciation provisions which allow a deduction only in respect of property used in the year of income in which the deduction is claimed, or in respect of property installed ready for use in that year. The approach of Div. 10B avoids any concern with apportionment when property is in the year of income used only partly to produce income. The apportionment aspects of the depreciation provisions are not without their difficulties. In any case, the idea of an item of property subject to Div. 10B being used partly to produce assessable income may be thought difficult to imagine: it will be said that it is used to produce income or not used at all.
[10.266] Section 124w makes provision for a deemed disposal on a change in the ownership of, or in the interest of persons in, a unit of property, where the person or one or more of the persons who owned the unit before the change has or have an interest in the unit after the change. The corresponding provision in relation to depreciation is s. 59AA.
[10.267] Section 124W makes detailed provision as to the consideration receivable by the persons who owned the unit of property before the change, and as to the cost of the unit of property for purposes of amortisation deductions by the persons who own the unit of property after the change. The section distinguishes three situations. The first situation contemplates that the agreement in consequence of which the change occurred specifies an amount as the value of the unit of property which is in fact the value of the unit. Presumably, the market value is meant. The old owners are deemed to have disposed of the unit of property at this value. The new owners are deemed to have incurred expenditure on the purchase of the unit of property equal to the value of the property, or the cost of the unit to the old owners, whichever is the less (s. 124W(3)). In this context, in contrast with actual disposal situations, a principle is asserted that the new owners may not have deductions that would not have been available to the old owners had there not been a deemed disposal.
[10.268] The second situation contemplates that the agreement in consequence of which the change occurred has specified an amount as the value of the unit of property which is greater than its value in fact. The old owners are deemed to have disposed of the unit of property for the amount specified, and there may be an item of assessable income derived by them when that amount exceeds the residual value in their hands. The new owners are deemed to have incurred expenditure of the amount of the value in fact or the cost of the unit to the old owners, whichever is the less (s. 124W(4)). Again a principle is asserted that the new owners may not have deductions that would not have been available to the old owners had there not been a deemed disposal.
[10.269] The third situation contemplates that the agreement in consequence of which the change occurred has specified an amount as the value of the unit which is less than the value in fact of the unit. The old owners are deemed to have disposed of the unit of property at its value in fact. The new owners are deemed to have incurred expenditure of the amount of that value or the cost of the unit to the old owners, whichever is the less (s. 124W(5)). Again a principle is asserted that the new owners may not have deductions that would not have been available to the old owners had there not been a deemed disposal. At the same time, in contrast with the probable operation of the corresponding provision (s. 124T(2)) applicable to an actual disposal, ([10.264] above), there is no fall-out. The new owners do not have to take the amount specified in the agreement as their cost. In this respect, s. 124W differs in its operation from the corresponding provision, s. 59AA, in regard to depreciation. Where the amount specified in the agreement is less than “market value” (the phrase used in s. 59AA), and less than the depreciated value, s. 59AA(2) substitutes the market value or the depreciated value, whichever is less, as the consideration receivable by the old owners, and the new owners are deemed to have acquired the property at a cost equal to the amount specified in the agreement.
[10.270] The question has been raised in earlier paragraphs, in regard to a number of specific provisions, whether those provisions may be said to cover a field, and within that field to displace the operation of s. 51(1). The question was raised, for example, in regard to s. 53 relating to repairs ([10.9] above). A specific provision may allow deduction in a way different from the operation of s. 51(1). It may allow deductions of an expense spread over a number of years, for example s. 67 discussed in [10.217]–[10.222] above, while s. 51(1), it is assumed, allows a deduction of the expense in one year of income. It may make deductibility depend on a discretion given to the Commissioner, for example s. 67A discussed in [10.223]–[10.225] above: no such discretion is given to the Commissioner by s. 51(1). In such circumstances an argument that the specific provisions are a code is stronger. Where the specific provisions do not operate as a code and there is no provision allowing deduction under both s. 51(1) and the specific provisions, s. 82 considered in [10.4]–[10.7] above will apply, and a deduction will be allowed under the provision which in the opinion of the Commissioner is most appropriate.
[10.271] Where specific provisions do operate as a code, s. 51(1) is displaced, and the specific provisions belong under the present heading. Attention is now confined to two illustrations of specific provisions displacing s. 51(1), the first illustration, s. 52, depending on an inference that the specific provision is a code and the second, Subdiv. AA of Div. 3 of Pt III, depending on an express provision to that effect. In the first illustration, a determination of the field covered by the code raises issues of considerable importance.
[10.272] Section 52(1) provides that any loss incurred by the taxpayer in the year of income upon the sale of any property or from the carrying on or carrying out of any undertaking or scheme, the profit (if any) from which sale, undertaking or scheme would have been included in his assessable income, shall be an allowable deduction. There is a proviso of some importance in determining the field to which the operative provision applies. The proviso denies a deduction, unless the Commissioner otherwise directs, if the taxpayer has failed to notify the Commissioner by the date on which he lodges his first return “after having acquired the property”, that the property has been acquired by him for the purpose of profit-making by sale or for the carrying on or carrying out of a profit-making undertaking or scheme. The Commissioner’s power to direct otherwise is subject to a condition that the Commissioner must be satisfied that the property was acquired by the taxpayer for the purpose of profit-making by sale or for the carrying on or carrying out of any profit-making undertaking or scheme. A number of other subsections, added to s. 52 in 1984, provide for the allowance of a deduction for a loss in particular circumstances that are described by reference to subsections of s. 25A. Section 25A(1), it will be recalled, takes the place in the Assessment Act that formerly belonged to s. 26(a), now repealed. The other subsections of s. 25A extend and refine the operation of s. 25A(1) in ways that are explained in Chapter 3 above. The operation of the subsections of s. 52 added in 1984 have been considered in Chapter 3 above. The present concern is with the operation of s. 52(1), the subsection that prior to 1984 constituted the whole of s. 52, and the extent to which it may constitute a code.
[10.273] In a number of places in this Volume an analysis has been adopted which would treat the reference to “loss” in s. 51(1) as intended to embrace a failure of an asset to realise its cost, in circumstances where a surplus on realisation—a profit— would be assessable income. The analysis would also treat the reference to loss as intended to embrace an exchange loss in circumstances where an exchange gain would be assessable income. The allowing of the deduction of losses of the latter kind is now established by a number of decisions of the High Court, most recently AVCO Financial Services Ltd (1982) 150 C.L.R. 510, though little attention is given to an explanation of deductibility by reference to the words of s. 51(1). The deductibility under s. 51(1) of a loss where there is a failure of an asset to realise its cost in circumstances otherwise the same as those in the banking and insurance company cases, or in London Australia Investment Co. Ltd (1977) 138 C.L.R. 106, would not be doubted. In all these illustrations if a profit had resulted, the profit would have been income by ordinary usage and it would have been a recurrent experience of a business. The loss is, at least potentially, also a recurrent experience of the business. It is relevant and, provided it concerns a revenue asset or liability, a working expense. An acceptable rule may thus assert that where there is a continuing business a loss is deductible in circumstances where a profit would have been assessable income.
[10.274] The word “loss” in s. 51(1) will cover other circumstances of a negative balance of proceeds over costs. Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 has confirmed that a profit from an isolated transaction of land development may be income by ordinary usage. No comment is addressed in the case to the deductibilitly of a loss arising from such a transaction. A rule that a loss is deductible in circumstances where a profit would have been assessable income may, in this instance, be too wide. Granted that the relevance of an expense is not to be determined by a blast-from-the-whistle approach [5.34], there may yet, in some possible events, be difficulty in saying of a loss in a Whitfords Beach situation that it was incurred in gaining or producing the assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing such income. The notion of carrying on a business ought not to be limited to carrying on a continuing business. But whichever limb of s. 51(1) is relied on, the loss, to be relevant, must be an experience in a process from which income might have been derived. The “abortion” of an isolated venture from which a profit that is income may have been derived, will preclude the derivation of income and, equally, preclude the incurring of a deductible loss. None the less, if the carrying out of the plan of development in Whitfords Beach had resulted in a loss, the loss would, it is submitted, have been deductible under s. 51(1). At least it would have been deductible if s. 52(1) does not exclude the operation of s. 51(1) in the facts of Whitfords Beach.
[10.275] Section 52(1) aside, the word “loss” in s. 51(1) will extend to a negative balance of proceeds over costs in a transaction that might have generated a profit that is income by force of s. 43—sales in Australia of goods manufactured out of Australia or imported into Australia. A profit in the circumstances covered by s. 43 would be income by ordinary usage. The effect of s. 43 is simply to preclude the operation of the trading stock provisions, and to refine the meaning of cost for purposes of the ordinary usage notion. Section 51(1) will operate to allow a loss in the same way as it operates to allow a loss in a London Australia Investment situation.
[10.276] Section 52(1) aside, the word “loss” in s. 51(1) will extend to a negative balance of proceeds over costs in a transaction that might have generated a profit that is income by force of s. 25A(1) (formerly s. 26(a)). The word income in s. 51(1) is not limited to items that are within the ordinary usage notion of income. In [1.30]ff. above there is a rejection of a view that the word “income” in s. 25 is limited to items that are income by ordinary usage, and the view is taken that the reference is to any item that is income by force of the Assessment Act. In [1.43] above there is a rejection of a view that might be thought to have been taken in Harrowell (1967) 116 C.L.R. 607, that the word “income” in s. 47 refers to income by ordinary usage. In each of these instances, there is a view to be rejected. It has never however been suggested that the word income in s. 51(1) is limited to items that are within the ordinary usage meaning of income. In the thoroughly confused logic that bedevils analysis of these issues, it would be said that the phrase “assessable income” used in s. 51(1) precludes any limitation of the meaning of the word income.
[10.277] There is none the less a question as to when a loss may be said to be relevant to the derivation of an item that is income under s. 25A(1). Just as in the isolated business venture ordinary usage income situation considered in the last paragraph, the words “in gaining or producing … the assessable income” must be construed in a way that will allow deduction not-withstanding that there is no income from the activity to which the claimed deduction relates, either in the year of income or in any other year. In [5.30] above there is a reference to indications in judicial statement that the definite article in the first limb of s. 51(1) does not give the first limb a more limited operation than the second limb.
[10.278] It would be agreed that a loss is not relevant to the derivation of an item that is income under the second limb of s. 25A(1)—profit-making undertaking or scheme—if property is realised in the aborting of the scheme. What is true in regard to a loss in an isolated business venture that might give rise to a profit that is income by ordinary usage—the Whitfords Beach situation —must also be true in the lesser isolated venture that might give rise to a profit that is income within the extension of the notion of income that results from s. 25A(1). The question now is whether there is any comparable notion of aborting a first limb transaction—property sold that was acquired for profit-making by sale—so that a loss on sale will not be deductible under s. 51(1). The forsaking of a purpose to resell at a profit will not preclude the derivation of a profit that is income if a profit results from the later sale of property acquired for such a purpose. It may follow that a loss that is relevant and thus deductible is incurred on sale despite the forsaking of the purpose.
[10.279] There is a question as to when a loss may be said to be relevant to the derivation of an item that is income under s. 26AAA—property purchased and sold within 12 months—so that, s. 52(1) aside, it will be deductible under s. 51(1). It may, in this situation, be even more difficult to identify a notion of aborting the transaction, than it is in the case of s. 25A(1) first limb.
[10.280] In fact there has been no discussion in any authority of the possible operation of s. 51(1) in allowing a loss in any of ordinary usage isolated venture income, s. 25A(1) or s. 26AAA situations. In the case of an isolated business venture ordinary usage income situation, the absence of discussion may not be surprising: it was not till the decision in Whitfords Beach Pty Ltd (1982) 150 C.L.R. 355 that there was a clear recognition of an ordinary usage isolated business venture income principle. But the issue cannot be avoided.
[10.281] It is perhaps not surprising that there has been no discussion in the authorities of the possible deductibility of a loss under s. 51(1) in a s. 25A(1) situation. With some justification, s. 52(1) has been assumed to be a code. It is however surprising that there has been no discussion of the possibility of deductibility of a loss under s. 51(1) in a s. 26AAA situation. The discussion has centred on the availability of a loss deduction under s. 52. The conclusion reached by the Federal Court in Werchon (1982) 82 A.T.C. 4332 that s. 52(1) has no application to a s. 26AAA situation, must direct attention to s. 51(1).
[10.282] Werchon is authority that s. 52(1) has application only to situations where a profit would be income by force of s. 25A(1). The conclusion in Werchon is based on the history of s. 25A(1) and s. 52(1). Section 52(1) in an earlier form, was added to the Assessment Act in 1930 at the same time as an earlier form of s. 25A(1) was added. The conclusion is supported by the language of the proviso added by amendment to s. 52(1) in 1941. The proviso may also suggest that s. 52(1) is a code in relation to the deductibility of a loss in such situations. The scope of s. 25A(1) was examined by the High Court in Whitfords Beach. The judgments in that case are not definitive, but they may stand for a conclusion that s. 25A(1) has no operation save to extend the notion of income for purposes of the Act beyond what is income by ordinary usage. It would follow that s. 25A(1) has no operation in the circumstances of the banking and life insurance cases, in the circumstances of London Australia Investment Ltd (1977) 138 C.L.R. 106 or in the circumstances of Whitfords Beach, and that s. 52(1) has no application in those circumstances. Deductibility of losses is left to the operation of s. 51(1).
[10.283] The Federal Court in Werchon (1982) 82 A.T.C. 4332 did not address itself to the question whether s. 52(1) is a code covering the field of its operation so that s. 51(1) is displaced. The observation of members of the court as to the operation of the proviso may suggest that it is a code. The proviso would be deprived of any function if the taxpayer could call on s. 51(1), unless s. 52 has in some respect a wider operation within the field than s. 51(1) may have. It was suggested above that s. 51(1) may have a test of relevance that does not go as far as s. 52(1), in the latter’s application to a situation that would have been within the first limb had a profit resulted. The test under s. 52(1) is simply that the loss was incurred “upon the sale of any property, … the profit (if any) from which sale would have been included” in the taxpayer’s assessable income.
[10.284] There is a difficulty in the way of holding that s. 52(1) is a code. It would be accepted, though there are some observations by Barwick C.J. to the contrary, that the second limb of s. 25A(1) can operate in relation to property that was not acquired for the purpose of carrying out of a profit-making undertaking or scheme. Yet the proviso to s. 52(1) would deny a deduction for a loss in that situation. There would not have been any notice given by the taxpayer, and no valid notice could, presumably, have been given: Werchon may support a view that a notice contrary to the facts is a nullity. The Commissioner’s power to allow a deduction for the loss in the absence of notice will not arise. In the circumstances, he could not be satisfied that the property was acquired by the taxpayer for the purpose of carrying on or carrying out a profit-making undertaking or scheme.
[10.285] It may be appropriate to treat s. 52(1) as a code covering a field limited to circumstances where property was acquired with a purpose of the kind described in the proviso, leaving the taxpayer to rely on s. 51(1) in other circumstances.
[10.286] Section 82AAC allows as deductions amounts set apart or paid in the year of income by a taxpayer as or to a fund or funds, from which the benefits are to be provided, for the purpose of making provision for superannuation benefits for, or for dependants of, an employee. The employee must be an “eligible employee” as defined in s. 82AAA. The right of the employee or dependant to receive the benefits must be fully secured, and other conditions, including limitations on the amount deductible, provided for in Subdiv. AA must be met. “Superannuation benefits” is defined in s. 6 to mean “individual personal benefits, pensions or retiring allowances”.
[10.287] Section 82AAR expressly makes Subdiv. AA a code governing deductibility of employer contributions to superannuation funds which fall within the field specified in that section. The section provides that “a deduction is not allowable under any provision of this Act other than [Subdiv. AA] in respect of an amount set apart or paid by a taxpayer as or to a fund for the purpose of making provision for superannuation benefits for, or for dependants of, an employee or employees”. The consequence is that, within the specified field, a taxpayer is denied deductibility under s. 51(1). Were it not for s. 82AAR, recurrent payments would, generally, be deductible under s. 51(1). They are relevant as payments directed to securing the goodwill and loyalty of employees. If the payments are required by contracts of service, they may have the same quality of relevance as wages and salaries paid. Any difficulty in establishing deductibility under s. 51(1) is likely to be a difficulty of showing that a payment is a working expense. It will be apparent from British Insulated & Helsby Cables Ltd v. Atherton [1926] A.C. 205 that a substantial initial contribution by an employer to a fund may not qualify as a working expense. It may be seen as securing an enduring benefit. It does not maintain a capacity to provide superannuation benefits to employees, it establishes that capacity. British Insulated & Helsby Cables lends support to a conclusion that an expense is not a working expense when it is a payment of interest in advance for a significant period, a conclusion considered in [6.117]–[6.118] above.
[10.288] When Subdiv. AA applies, the question of degree that arises in separating a deductible payment from a non-deductible payment in the application of the principle in British Insulated & Helsby Cables, is answered in s. 82AAE by imposing money limits on deductible payments, related to the number of employees and the amount of their remuneration, and the giving of a discretion to the Commissioner to allow deductions beyond those limits.
[10.289] Provisions, referred to under the last heading, which establish codes which displace the operation of s. 51(1) are in effect provisions denying deductibility under s. 51(1). The intention under the present heading is to deal with provisions which simply deny deductions which would otherwise be allowable under s. 51(1), without setting up any distinct regime under which the deductions may be allowable.
[10.290] Section 31C was inserted in the Act at the time of the introduction of provisions directed to allowing a deduction of a percentage of the cost of trading stock on hand at the commencement of a year of income. The deduction, referred to in the heading of Subdiv. BA of Div. 2 of Pt III which provided for the deduction, as “trading stock valuation adjustments”, was intended to achieve some correction of the distortion of profits from the sale of trading stock which may result in inflationary conditions, if the deduction for the cost of stock is limited to the amount of the historical cost. Subdivision BA allowed a further deduction, reflecting, to a degree, the rate of inflation over the relevant year of income. The further deduction was, generally, a percentage of the cost, and the advantage of a high cost in limiting the amount of taxable income from the sale of trading stock was thus increased. Section 31C was intended to defeat planning to give a high cost, thus denying an increased tax advantage that would result from the trading stock valuation adjustment. Trading stock valuation adjustment was withdrawn with effect from 1 July 1979, but s. 31C has been retained as a continuing control on planning to inflate the cost of trading stock. A higher cost will shift taxable income from the purchaser. It may increase the income of the vendor, but there may none the less be an advantage arising from the fact that the shift of income is to a vendor who is not subject to Australian tax, being a non-resident who does not derive income from an Australian source. New provisions in Div. 13 of Pt III, added in 1981, have made s. 31C unnecessary as the means of denying the latter advantage: s. 31C is now displaced by s. 136AB(2). But s. 31C as a means of denying the advantage of income shifting between Australian residents remains effective.
[10.291] Section 31C gives the Commissioner power to reconstruct the price at which trading stock is acquired. The reconstruction will increase the taxable income of the purchaser and decrease the taxable income of the vendor, thus producing the distribution of income between them that would have occurred had no attempt been made to inflate the price. The Commissioner’s power arises if he is satisfied that vendor and purchaser were not dealing with each other at arm’s length, and is also satisfied that the purchase price is greater than what would have been the purchase price if the parties had been dealing with one another at arm’s length, or, alternatively, that the purchaser could have purchased an identical article from another at a price less than the purchase price. The Commissioner’s power in effect allows him to substitute for the purchase price either the arm’s length price or the price of an identical article, whichever is less.
[10.292] Section 31C enables the Commissioner to deny some part of a deduction that Cecil Bros Pty Ltd (1964) 111 C.L.R. 430 appears to hold must be allowed in full. Cecil and subsequent developments from that decision are discussed in [6.6] and [9.17]ff. above. Section 31C will be of less significance if the demise of the form and blinkers approach to the operation of s. 51(1), a demise heralded in the Federal Court decision in Ure (1981) 81 A.T.C. 4100, comes to be confirmed by the High Court. A payment that is, commercially, an over-payment for goods or services, made to an associated person, justifies an objective inference of two purposes in the payment only one of which relates to the derivation of income. To the extent that an inference of a purpose to shift income can be drawn, an apportionment so as to deny the deduction of some part of the payment will be appropriate.
[10.293] Section 31C will continue to have some significance: it provides, in its reference to the cost of purchase of an identical article, a more precise test of what is the amount deductible than s. 51(1) may provide. Where the Commissioner acts under s. 31C the taxpayer’s action is the more restricted, because he must challenge the exercise of a discretion.
[10.294] Subdivision B of Div. 2A of Pt III was added to the Assessment Act in 1978. Its principal function parallels the function of SS 80A-80F considered in [10.367]–[10.420] below, which are intended to deny the carry forward by a company of a loss, in the sense of an excess of allowable deductions over assessable income, incurred in one year of income so that the loss is applied against assessable income in determining the taxable income of a subsequent year of income, where there has been a substantial change in beneficial interests in shares in the company. Sections 80A-80F have no application where (i) a company in the early part of a year of income incurs deductible expenses which exceed its assessable income derived in that part of the year, and then (ii) suffers a substantial change in beneficial interests in its shares, and thereafter during the remainder of the year of income (iii) derives assessable income that exceeds allowable deductions. Subdivision B, in provisions which have come to be referred to as “current year loss provisions”, has an operation in such a situation which will in effect deny deduction of otherwise deductible expenses, so far as they exceed assessable income of the early part of the year, in computing the taxable income of the year of income.
[10.295] Subdivision B is a further expression of the policy against the sale of shares in companies that have suffered losses, losses in the sense of an excess of allowable deductions over assessable income, a policy that was and remains expressed in SS 80A-80F. An individual engaged directly in a process of income derivation who has suffered losses cannot sell the losses to another and thus realise the value of the tax relief that the application of those losses may bring. A shareholder engaged through a company in which he holds shares in a process of income derivation ought not to be able to realise the value of losses experienced by the company by selling his shares in the company.
[10.296] The current year loss provisions extend not only to the indirect realisation of losses by the sale of shares in a company that has already experienced losses in the early part of a year of income, but also to an indirect realisation of the potential for the application of losses that may be incurred in the latter part of a year of income where the company has made profits in the early part of the year. Selling shares in a company which has an excess of assessable income over allowable deductions in the early part of the year of income is a realisation of that potential. The provisions of SS 80A-80F do not need to deal with the latter situation since, it will be seen, the Australian law does not allow the carry-back of a loss incurred in a later year to a year in which there was a surplus of assessable income over allowable deductions. The idea that there may be value in the shares of a company because the profits so far earned in a year of income may be absorbed by the losses that may arise under new owners of the shares, may be thought remote. The value is likely to depend on the ease with which the new shareholders can bring about a loss experience by the company in the latter part of the year of income, by creating deductions which do not in fact reflect expenses which diminish the resources of the company. Tax planning in the second half of the 1970s was characterised by “expenditure recoupment” schemes which were directed to establishing such deductions. Such schemes are now the subject of specific anti-avoidance provisions of the kind noted above in connection with s. 78(1)(a), and noted further in dealing with SS 82KH, 82KL and 82KJ.
[10.297] Central to the operation of Subdiv. B is the occurrence during a year of income of a “disqualifying event”. A disqualifying event is:
The occurrence of such an event will require that a year of income be treated as divided into “relevant periods” (s. 50B), whose limits are set by the beginning of the year of income, the disqualifying event and the end of the year of income. There will be more than two periods if there is more than one disqualifying event during the year of income. A calculation is made of assessable income and allowable deductions of each period. If the assessable income exceeds allowable deductions, the company in that period (an “income period”) has a notional taxable income. If allowable deductions exceed the assessable income of the period (a “loss period”), the company has a notional loss. There is provision for spreading some items of income and deduction over the year of income so that they will fall to some degree in each period. Some other items do not enter the calculation of notional taxable income of a period, or notional loss of a period. These “full year amounts” enter the final calculation of taxable income of the year of income (s. 50C). In that final calculation a notional loss will not be subtractable unless it has been taken into account in ascertaining the “eligible notional loss” (s. 50D). It will be an eligible notional loss to the extent of the amount of the notional taxable income of an income period if there is a continuity of beneficial ownership at all times in the loss period and at all times in the income period, within the tests in s. 50D(2), but a notional loss will not enter eligible notional loss if the loss period commenced with a disqualifying event or the income period commenced with a disqualifying event of the kinds set out in events (ii), (iii), (iv) and (v) above (s. 50D(3)).
[10.298] Though the drafting is involved, the effect would appear to be that a notional loss may enter “eligible notional loss” because of a continuity of ownership where there have been two disqualifying events involving discontinuities, if there is a continuity between the first period and the last period.
[10.299] A discontinuity of beneficial ownership of shares or a change in control will not preclude a notional loss entering eligible notional loss, in the manner specified in subss (4) and (6) of s. 50D, if there has been a continuity of business of the kind specified in those subsections. But continuity of business will not enable a notional loss to enter eligible notional loss if the loss period commenced or the income period commenced with a disqualifying event within events (iii), (iv) and (v) in [10.297] above (s. 50D(9)).
[10.300] The tests of continuity of beneficial ownership in s. 50D(2) and of a change in beneficial ownership in paras (a), (b) and (c) of s. 50H are adapted from the provisions of s. 80A. Section 50K adopts the provisions of s. 80B, including s. 80B(5), for the purposes of the operation of s. 50D(2) and s. 50H. Sections 80A and 80B(5) are the subject of some comment in [10.375]ff. below. The concept of continuity of business follows the same concept in s. 80E. Section 80E is the subject of some comment in [10.399]ff. below. The significance of continuity of business is less under the current year loss provisions than under the loss carry forward provisions in that it cannot overcome disqualifying events at the commencement of the loss period or the income period. Though the drafting of SS 80E and 80DA is not entirely clear on the matter, it seems that a continuity of business will prevent the defeat of loss carry forward that would otherwise result from s. 80DA, a section which has functions similar to the disqualifying events listed in events (iii), (iv) and (v) in [10.297] above (s. 50H(1) (e), (f), (g) and (h)).
[10.301] The operation of s. 51AB in denying deductions in respect of expenses of securing or maintaining membership of, or rights to enjoy facilities provided by a “club”, as defined in s. 51AB(1), was the subject of some comment in [6.261] above.
[10.302] The same section denies deductions of expenses incurred for or in connection with (i) the acquisition of ownership of, or rights to use, a “leisure facility”, (ii) the retention of ownership of, or of rights to use, a “leisure facility”, (iii) any obligation associated with ownership of, or rights to use, a “leisure facility”, or (iv) the use, operation, maintenance or repair of a “leisure facility”. “Leisure facility” is defined in s. 51AB(1) so that it means, save where the item is an “excepted facility”, a boat, land used or held for use for or in connection with holidays or sport, recreation or similar leisure-time pursuits, or a building or other structure used or held for use in that way. “Excepted facility” is defined in s. 51AB(1). The effect of the latter definition is to prevent the denial of a deduction where the item is held for sale or is used or held for use in specified ways. In the case of a boat, the uses that are specified are (i) letting on hire in the ordinary course of a business of such letting, (ii) transporting for reward members of the public, goods or substances in the ordinary course of business; and (iii) use that the Commissioner is satisfied is essential to the efficient conduct of the taxpayer’s business. In the case of land, buildings and structures, the uses that are specified are (i) the derivation of income in the nature of rents, lease premiums, licence fees or similar charges; (ii) the provision for reward of facilities for holidays, or for sport, recreation or similar leisure-time pursuits in the ordinary course of a business of providing such facilities; and (iii) the provision, for use principally by employees of the taxpayer or for the care of children of those employees or, where the taxpayer is a company, for use principally by employees of the company who are not members or directors of the company or for the care of children of those employees, of facilities for holidays or for sport, recreation or similar leisure-time pursuits.
[10.303] Where the expense is incurred by a taxpayer in connection with a leisure facility for his own use, deductibility under s. 51(1) would raise issues of relevance and working character of the expense that the taxpayer might find difficulty in having resolved in his favour, the more so where the taxpayer is an employee. Where he invites others—clients, customers or shareholders— to use the facility, there would be some prospect of relevance as expenses in furthering the goodwill of the business. The policy in denying deduction is to establish a firm rule against the taxpayer that will prevent the taxpayer enjoying a tax subsidy for what is in truth expenditure on his own recreation, and may discourage him from providing recreation for customers clients and shareholders that will be tax free to them. Where the expenses are incurred by an employer in providing leisure facilities for employees or, in the case of a company, for its directors, relevance and working character under s. 51(1) would most likely be resolved in favour of the taxpayer: the expenses may be seen as expenses of providing conditions of service for employees or directors or rewarding them for their services. The denial of deductions by s. 51AB is in this area the more significant. The policy in denying the deduction is apparently to achieve some control over the provision of what may be in fact tax-free fringe benefits enjoyed by employees and directors. There would be difficulty in taxing the employee or director under s. 26(e) on the value to him of the facility: there is a prospect that the facility would be characterised as a condition of service and not a reward for services. However, in denying deductions to the employer, s. 51AB leaves the prospect that the employee or director may be taxed on the value of the facility, while the employer is denied a deduction of its cost.
[10.304] The policy of controlling tax-free fringe benefits becomes attenuated by that element in the definition of “excepted facility” (para. (e)(iii)) which refers to “the provision, for use principally by employees of the taxpayer or for the care of children of those employees or, where the taxpayer is a company, for use principally by employees of the company who are not members or directors of the company or for the care of children of those employees, of facilities for holidays or for sport, recreation or similar leisure time pursuits”.
[10.305] Where s. 51AB operates, a deduction is denied under s. 51(1). There is an associated provision in s. 54(3) which denies a deduction for depreciation on property that is a leisure facility as defined in s. 51AB.
[10.306] Section 52A may empower the Commissioner to deny a deduction, to the extent that he considers that the amount is unreasonable, where it relates to expenditure incurred by a taxpayer in the purchase or acquisition of choses in action purchased or acquired as trading stock, or in the carrying out of any profit-making undertaking or scheme (s. 52A(1) (2)). The section may also empower the Commissioner to deny a deduction or the subtraction of a cost, that is claimed in respect of the value of a chose in action that has been acquired by a taxpayer and thereafter is treated by the taxpayer as an asset of a business carried on by the taxpayer, or is used by the taxpayer in the carrying on or carrying out of a profit-making undertaking or scheme (s. 52A(2A (2B)).
[10.307] In the latter aspect s. 52A gives statutory recognition to a principle that the value of an asset may be the cost of the asset for purposes of the trading stock provisions, or in determining the profit that is income on the realisation of an asset. Some reference has already been made to this principle, and it is the subject of further observations in Part III of this Volume.
[10.308] The effect of s. 52A is that the Commissioner may deny a deduction or the subtraction of a cost, even though the expenditure or the cost reflects the value of the chose in action at the time it is acquired as trading stock or becomes trading stock, or at the time it is acquired in the carrying on or carrying out of a profit-making undertaking or scheme, or comes to be used in carrying on or carrying out such a scheme. The section was added to the Act in 1978 and its operation extended in 1979 to enable the defeat of tax planning that involved the creation of losses in transactions by which choses in action—principally shares—were acquired and thereafter made to suffer a substantial reduction in value. In the case of shares, the reduction in value might be achieved by a payment of dividends on other shares, or the making of a bonus issue confined to other shares. The shares reduced in value would be sold at a loss. In exercising his power to allow only a deduction or a cost of an amount that he considers reasonable, the Commissioner is directed by subs. (3) to have regard to a number of matters. The matters identify aspects of the tax planning at whose defeat the section is directed.
[10.309] There is no provision of s. 52A that requires the Commissioner to treat the amount of the cost allowed as a deduction, or taken into account in computing a profit, as the amount of the proceeds of the sale by the person from whom the taxpayer acquired the chose in action. Section 31C, considered in [10.290]ff. above, makes the amount ascertained under the section the purchase price “for all purposes of [the] Act in relation to the purchaser and the vendor” (s. 31C(1)).
[10.310] Section 65 empowers the Commissioner to deny a deduction that would otherwise be allowable, where there is a payment made or a liability incurred by a taxpayer to an “associated person”. The power given by subs. (1) is to deny the deduction to the extent to which the payment or liability, in the opinion of the Commissioner, is not reasonable. “Associated person” is defined in s. 65(1D). In all aspects of the definition a notion of “relative”, defined in s. 6, has a role.
[10.311] In one respect s. 65 differs from s. 52A just considered, and from a number of other provisions yet to be considered, in particular ss 82KJ and 82KL, which provide for the disallowance of a deduction but leave the transaction intact so far as the tax consequences for the person receiving the payment are concerned. Section 65(1A) provides that, subject to s. 65(1B), where, by virtue of subs. (1) any amount is not an allowable deduction “that amount shall, for the purposes of the Act, be deemed not to be income of the associated person”. The effect of subs. (1B) is to qualify the operation of s. 65(1A): where the deduction denied is a deduction otherwise allowable in computing the net income of a partnership in which a private company is a partner, the company partner is deemed to have paid a dividend of an amount ascertained in accordance with subs. (1C), and subs. (1A) is excluded. The deeming is, it seems, for the purposes of determining the consequences of the payment for the company partner, for example in relation to undistributed profits tax, and for the purpose of determining the consequences for the person receiving the payment. He is deemed to have derived as a dividend the amount ascertained in accordance with subs. (1C).
[10.312] There are no guidelines set out in the section governing formation of an opinion by the Commissioner. In this respect the section differs from s. 52A. Presumably, an amount is unreasonable if it is greater than the amount one would have expected to be paid, had the parties to the payment not been associated. It would follow that, having regard to the findings of fact by the trial judge in Phillips (1977) 77 A.T.C. 4169; (1978) 78 A.T.C. 4361, the Commissioner could not have denied deductions in the circumstances of that case, if the section had been available to him. The payments were, in the conclusion of the judge, such as might have been made in arm’s length transactions. Section 65 is not attracted when a person who must put a profit into the hands of another, chooses to put it into the hands of an associated person.
[10.313] Section 65, it has been explained, is one of a number of provisions by which a deduction may be denied. The relationships between these provisions are not always apparent, though any priority of application that must be accorded to one of them over another may have significant tax implications. Thus the denial of a deduction under s. 65 will be of a lesser amount than the denial of a deduction under s. 82KJ, which must deny the deduction of the whole of an outgoing. And the denial of a deduction under s. 65 will, generally, diminish the amount that is income of the taxpayer receiving the payment. The denial of a deduction under s. 82KJ has no effect on the income of the taxpayer receiving the payment.
[10.314] Section 51AB, considered in [10.301]–[10.305] above, clearly has an application that can leave no room for the application of any other provision. By s. 51AB(4) the denial of a deduction is “notwithstanding anything in any other provision of [the Act]”. Section 51 (1) itself in applying an apportionment may be said to deny a deduction. Other provisions, as far as they operate at all, will operate on what is otherwise deductible under s. 51 (1).
[10.315] Sections 82KL and 82KJ have no priority over ss 52A, 65, 108 and 109. As between themselves, s. 82KJ has priority over s. 82KL. Sections 52A, 65, 108 and 109 have priority over s. 82KJ because s. 82KJ may deny a deduction only of a “loss or outgoing in respect of which a deduction would, but for this subdivision [Subdivision D being ss 82KH-82KL] be allowable” (s. 82KJ(a)). Section 82KJ has priority over s. 82KL because s. 82KL is concerned only with “relevant expenditure”, as defined in s. 82KH, which is in all instances expenditure which would be allowable apart from s. 82KL. If the High Court is persuaded to overrule Cecil Bros Pty Ltd (1964) 111 C.L.R. 430—Phillips (1978) 78 A.T.C. 4361 and Ure (1981) 81 A.T.C. 4100 may be heralds of such an event—a taxpayer may be glad that his deduction is partially denied under s. 51, for he is not then at risk to a disallowance of the whole outgoing under ss 82KJ or 82KL.
[10.316] The intention of s. 177B (3) and of s. 177B (4), when read with the definition of “tax benefit” in s. 177C, is that other provisions of the Act which may deny a deduction will operate in priority to Pt IVA, But Pt IVA, unlike ss 82KJ and 82KL, may, in theory, operate to deny a deduction of that part of an outgoing which has survived the operation of other provisions. Section 177C (1) is concerned with a situation in which a deduction (not an outgoing) is allowable, which would not have been allowable if the tax avoidance scheme had not been entered into or carried out. Pt IVA has an operation similar to s. 65 in providing, in s. 177F (3), for a compensating adjustment to the income of a taxpayer where a deduction has been denied to another taxpayer under s. 177F (1). There is however this difference that the operation of s. 177F (3) depends on the exercise of a discretion by the Commissioner. The operation of s. 65 (1A) in providing for a compensating adjustment is automatic on the operation of s. 65 (1).
[10.317] There is a question whether the taxpayer can require the Commissioner to exercise a discretion given to him by a provision that has priority, for example s. 65, where the exercise of the discretion so as to deny the deduction of part of an amount will exclude the operation of another provision, for example s. 82KJ, that would deny the deduction of the whole of an amount. A payment to which s. 82KL would otherwise apply because of a recoupment arrangement, may have been made to a relative. The taxpayer may prefer the partial denial of a deduction under s. 65 to the total denial under s. 82KJ.
[10.318] Section 65 (1) applies to a “payment made or liability incurred” in the year of income to an associated person that would, but for the subsection be an allowable deduction. Its operation is to allow a deduction only to the extent to which, in the opinion of the Commissioner, the payment made or liability incurred is reasonable. Inferentially the operation is to deny a deduction to the extent to which in the opinion of the Commissioner the payment made or liability incurred is not reasonable. “Associated person” is defined in s. 65 (1D) in terms that distinguish the application of the section “to a taxpayer” (s. 65 (1D) (a)), and the application of the section “to a partnership for the purpose of calculating in accordance with section 90 the net income of the partnership or a partnership loss”.
[10.319] It may help to further an understanding of the scope of the operation of s. 65 (1) to ask a number of questions. In what circumstances, if any, will s. 65 (1) apply to a payment or a liability incurred:
[10.320] A payment by an individual taxpayer who is not a trustee to a person who is his relative, as defined in s. 6, is within the operation of s. 65 (1). The relative is an associated person (s. 65 (1D) (a) (i)). And a payment by such an individual taxpayer to a partnership, a partner in which is his relative, is within the operation of s. 65 (1). The partnership is an associated person (s. 65 (1D) (a) (ii)). “Partnership” has the meaning given to it by the definition in s. 6, which is wider than its ordinary meaning in extending to persons in receipt of income jointly.
[10.321] The propositions in the last paragraph may require qualification where the person to whom payment is made, though he is a relative of the individual taxpayer, receives the payment as trustee, or where the relative who is a partner in the partnership receiving payment is a trustee. It is arguable that the policy of s. 65 (1) is not attracted in these circumstances. Save where the trustee has a beneficial interest in the trust, or where another relative has a beneficial interest, the operation of s. 65 (1) would be fortuitous.
[10.322] A payment by an individual taxpayer who is not a trustee to a company in which a relative of the taxpayer is interested is not within the operation of s. 65 (1). The company is not an associated person. It could not be argued that a payment to a company is a payment to a person interested in the company.
[10.323] A payment by an individual taxpayer who is not a trustee to a trustee of a trust in which a relative of the taxpayer is a beneficiary is not within the operation of s. 65. It is assumed that the trustee is not a relative. It could not be argued that a payment to a trustee is a payment to a beneficiary, more especially when the trust is a discretionary trust.
[10.324] A payment made directly by a company that is not a trustee cannot attract the operation of s. 65 (1). The company may be a taxpayer but the payment is not made to an associated person. A company cannot have a relative. In these circumstances, there may be an operation of s. 108 or s. 109, considered in [10.348]–[10.358] below. A payment made by a partnership in which a company is a partner will be within the operation of s. 65, if the person (not being a partner in the partnership) to whom payment is made is or has been, or is a relative of a person who is or has been, a shareholder in, or a director of a company being a private company, in relation to the year of income, that is a partner in the partnership. The person to whom payment is made is an associated person (s. 65 (1D) (b) (iii)). In these circumstances there will, presumably, be no operation of ss 108 or 109. Crowe (1958) 100 C.L.R. 532 may be authority that a payment by a partnership is not a payment by a person that is a member of that partnership, though the case can be explained on the basis that the words of s. 82H with which it was concerned—“amounts paid by the taxpayer as premiums or sums for insurance on the life of the taxpayer—are more specific than the words of s. 108 or s. 109. Where s. 65 (1) does apply to a payment made by a partnership in which a company is a partner, the consequences are a denial of a deduction to the extent that the payment is not reasonable, and the further consequences specifically determined by s. 65(1B). The company is deemed to have paid, on the last day of the year of income, a dividend of an amount ascertained in accordance with s. 65(1C), and subs. (1A), which in other circumstances takes the amount denied deduction out of the income of the person receiving payment, has no application. The effect of s. 65(1B) is, it seems, to require that the amount denied deduction should be treated as a dividend paid by the company, with the consequences that it may satisfy an obligation to distribute so as to prevent a liability to undistributed profits tax, and should be treated as a dividend received by the shareholder or relative. The latter effect may appear to follow from s. 65(1B)(b), though it is not dictated by that provision. Though the amount denied deduction is deemed to be a dividend received by the shareholder or relative, it does not necessarily follow that it is his income. Rutherford (1976) A.T.C. 4304, a decision on s. 108, is authority that deeming a receipt to be a dividend does not make the receipt income. It will be income, by force of s. 44(1), only if it was in fact paid “out of profits” of the company.
[10.325] It is arguable that a payment made directly by a trustee acting as trustee cannot be within the operation of s. 65(1). Section 65(1D)(a), which alone is relevant in that subsection, contemplates a payment by a “taxpayer”. It is true that the calculation of net income of a trust estate required by s. 95 is made “as if the trustee were a taxpayer”. Yet the fact that the person to whom payment is made is a relative of a trustee who is an individual should not, as a matter of policy, attract the operation of s. 65(1). Policy might require the operation of s. 65(1) where the person to whom payment is made is beneficially interested in the trust, but this is not enough to raise an associated person relationship within s. 65.
[10.326] Similar observations might be made where the payment is made to a partnership, a partner in which is a relative of a trustee who is an individual.
[10.327] Reference was made in [10.324] above to the decision of Kitto J. in Crowe (1958) 100 C.L.R. 532. Section 65(1D)(b) is intended to overcome in specific situations the effect of a conclusion from that decision that a payment by a partnership is not a payment by a member of the partnership. In overcoming the effect of such a conclusion in specific situations, s. 65(1D)(b) may be thought to have confirmed that conclusion in its application to other situations. It will be seen that this could be of some importance in regard to the operation of ss 108, and 109. In dealing with specific situations, subparas (i) and (ii) of s. 65(1D)(b) establish an associated person relationship where a payment is made by a partnership to a relative of a partner in the partnership, or to another partnership a partner in which is a relative of a partner in the partnership making the payment. The relationship is established for the purpose of calculating, in accordance with s. 90, the net income of the partnership or a partnership loss. The assumed need for the express provision in s. 65(1D) (b) (ii) to deal with a payment to another partnership, a partner in which is a relative of a partner in the partnership making the payment, may be thought to confirm an inference from the decision in Crowe that a payment to a partnership is not a payment to a person who is a member of that partnership. There are again implications for the operation of ss 108 and 109, and in this instance for the operation of s. 65 itself. Section 65(1D)(b) (iii) establishes an associated person relationship where a payment is made by a partnership to a person who is or has been, or is a relative of a person who is or has been, a shareholder in, or a director of, a company, being a private company in relation to the year of income, that is a partner in the partnership. There is no express provision of the kind that appears in s. 65(1D)(b) (ii), which would make a payment to a partnership in which a person of the kind described in s. 65(1D) (b) (iii) is a member, a payment to that person. Section 65(1D)(b) (iv) establishes an associated person relationship where a payment is made by a partnership to a person who is, or is a relative of, a beneficiary in a trust estate the trustee of which is, in his capacity as trustee of the trust estate, a partner in the partnership. It is curious that there is no provision in s. 65(1D) establishing an associated person relationship where a payment is made by a trustee of a trust estate to a person who is, or is a relative of, a beneficiary in the trust estate.
[10.328] Section 65(2) denies a deduction of expenditure incurred and payments becoming due, by the taxpayer in the year of income in or for the maintenance of his wife or any member of his family under the age of 16 years. Deduction is denied even though the expenditure and payments becoming due were incurred in the production of assessable income. The denial of a deduction in circumstances where the expenditure or payments were not incurred in the production of assessable income seems unnecessary, having regard to the terms of s. 51(1). Where the expenditure or payments were so incurred—most likely they will be rewards for services rendered by the wife or child to the taxpayer in relation to the carrying on by him of a business—it is not obvious why deduction should be denied. If the amounts are not reasonable, s. 65(1) will to this extent operate to deny deduction. If the amounts are reasonable and are income of the wife or child, there seems to be no reason to deny deduction because amounts have been applied by the wife or child in maintaining himself, or have been applied by the taxpayer in maintaining the wife or child. There may be reason to deny a deduction if the provision of maintenance by the husband is not to be regarded as a benefit within s. 26(e) received by the wife or child, so that there is a prospect of a deduction being available to the husband and no income derived by the wife or child. It is perhaps arguable that the receipt by the wife or child of what the taxpayer would be required to provide in any case because of his duty to support, is not a benefit. Such a view of s. 65(2) would confine the operation of the subsection to circumstances where the application is made by the taxpayer. There is reason in the words of the subsection—“expenditure incurred by the taxpayer in or for the maintenance”—for such a view. It would be appropriate for the subsection to include an express provision of the kind that appears in s. 65(1A) in relation to the operation of s. 65(1), so that there will not be income derived by wife or child where a deduction is denied to the husband taxpayer.
[10.329] Section 159U provides for inclusion of “expenses of self-education”, as defined in that section, in concessional rebate expenditure that may attract a rebate of tax under s. 159N. The amount that may be treated as a rebatable amount is limited by s. 159U(3) to $250. By s. 82A, expenses that are within the definition of expenses of self-education are, to the extent of the first $250, denied deduction under s. 51(1) and must be dealt with as rebatable amounts. Whether they will, as rebatable amounts, generate any actual rebate of tax depends on there being a total of rebatable amounts in the year of income exceeding $2,000 (s. 159N). The deductibility under s. 51(1) of expenses that may be expenses of self-education is dealt with in [8.38]–[8.56] above, where further reference is made to s. 82A.
[10.330] The present concern is with ss 82KJ and 82KL. Section 82KK does not operate to deny a deduction outright. It affects only the timing of a deduction and is considered in [11.284]ff. below.
[10.331] Sections 82KJ and 82KL, if they operate at all, deny a deduction of the whole amount of an item of expenditure. They differ in this respect from s. 65 which provides for a partial disallowance.
[10.332] The relationship between ss 82KJ and 82KL and other specific provisions denying deductions was the subject of some observations in [10.313]–[10.318] above. Thus, s. 65 will be applicable in advance of ss 82KH and 82KL, and if it is applied, the applications of s. 82KH and s. 82KL will, in effect, be precluded. The part of an expense that is deductible after the operation of s. 65, the Commissioner having formed the opinion that it is to this extent reasonable, will be relevant expenditure for purposes of s. 82KL. But there could not be said to be an additional benefit obtained “in relation to that relevant expenditure”. The additional benefit will have been obtained in relation to the part of the expense that has been denied deduction under s. 65. For similar reasons, where s. 65 operates the operation of s. 82KJ will be precluded.
[10,333] Sections 82KJ and 82KL were added to the Assessment Act to deal with tax planning through so-called “expenditure recoupment” schemes, which relied on Cecil Bros Pty Ltd (1964) 111 C.L.R. 430, and South Australian Battery Makers Pty Ltd (1978) 140 C.L.R. 645 and the form and blinkers approach to the operation of s. 51, and to the operation of other sections allowing deductions. That approach is discussed in [9.17]–[9.26] above. That the approach is destructive of the integrity of the income tax is reflected in the involved and complex provisions that have been adopted to overcome it. These provisions will become unnecessary if the approach comes to be rejected. Indeed they will have no room to operate. The operation of s. 65 already precludes the operation of ss 82KJ and 82KL. The denial of part of an outgoing under s. 51(1) because it was to this extent not incurred in gaining assessable income will have the same consequence.
[10.334] Since the enactment of ss 82KJ and 82KL, the form and blinkers approach has become not an advantage but a hazard for the tax planner. Full deductibility under s. 51 may let in ss 82KJ and 82KL, which will deny any deduction. If form and blinkers are rejected in circumstances such as in South Australian Battery Makers, and an outgoing held deductible only in part under s. 51(1), the taxpayer will be entitled to some deduction. If ss 82KL and 82KJ are let in because the whole outgoing is deductible under s. 51(1), the taxpayer may be denied any deduction. Sections 82KJ and 82KL have in effect an operation by way of penalty.
[10.335] Section 82KJ was enacted before s. 82KL, though in the same year. Section 82KJ is an apparent legislative response to the actual decision in South Australian Battery Makers. In fact the section may not operate in the particular circumstances of that case. Gibbs A.C.J. noted in his judgment that the amount of the payment was reasonable as a payment for the use of the premises. One of the conditions of the operation of s. 82KJ is that the outgoing “was greater than the amount … that might reasonably be expected to have been incurred, at the time when the loss or outgoing was incurred, in respect of that benefit if the loss or outgoing had not been incurred by reason of, as a result of or as part of a tax avoidance agreement”. The benefit in the South Australian Battery Makers circumstances would be the use of the premises. In any event, the circumstances of that case may not involve a “tax avoidance agreement”, and an outgoing to attract the operation of s. 82KJ must have been incurred by reason of, as a result of or as part of a “tax avoidance agreement”. “Tax avoidance agreement” is defined in s. 82KH.
[10.336] Where a payment is made in the circumstances of South Australian Battery Makers, but with the difference that the payment is greater than the amount that might reasonably be expected to have been incurred, s. 82KJ will operate to deny any deduction for the payment if it was incurred as a result of or as part of a tax avoidance agreement. It will be recalled ([9.19]–[9.20] above) that in South Australian Battery Makers Gibbs A.C.J. took the view that, despite Europa Oil (N.Z.) Ltd v. C.I.R. (N.Z.) (No. 2) (1976) 76 A.T.C. 6001, a denial of a deduction of part of the payment for rent would have been appropriate if the resulting benefit of a lowering of the price payable under an option to acquire the premises had accrued to the taxpayer by way of increase in the value of an interest in the associated company that held the option. In fact there was no accrual of benefit in this way, because the taxpayer did not hold shares directly or through another company in the company holding the option. The companies might be described as sister companies. Section 82KJ will be attracted where an associate “has acquired, will acquire or may reasonably be expected to acquire property by reason of, or as part of the tax avoidance agreement”. A company will be an associate, as that word is defined in s. 82KH(1) (b), in the circumstances of South Australian Battery Makers.
[10.337] The wide definition of “associate” avoids some of the limitations, considered in [10.310]–[10.327] above, on the operation of s. 65(1). Thus a trustee of a trust estate or a company may be an associate of an individual taxpayer (s. 82KH(1) (a) (iv) and (v)). A trustee of a trust estate or a company may be an associate of a company taxpayer. A company may be an associate of a trustee of a trust estate.
[10.338] It seems, however, that a trustee of a trust estate cannot be an associate of the trustee of another trust estate, nor can a partnership be an associate of a taxpayer.
[10.339] The interpretation of the words “property has been, will be, or may reasonably be expected to be, acquired by the taxpayer, or by an associate of the taxpayer” in s. 82KJ (c), raises important issues as to the operation of the section and its relationship to s. 65. A payment may be made to an associate which is not reasonable, having regard to all benefits in respect of which the payment was incurred. The payment may have been made in a simple plan of income shifting. It would not appear appropriate to describe the amount of the payment beyond a reasonable payment as property acquired by the associated person. The language of para. (b) and para. (d) contemplates that there is some property acquired by an associated person which is distinct from the receipt of the payment whose deductibility is in question. One would have expected any change in the law in regard to simple over-payments in income shifting to have been done through s. 65(1). If s. 82KJ has no application, the deficiencies in the definition of “associated person” for purposes of s. 65 become important.
[10.340] The interpretation of s. 82KJ (c) raises other issues. The person to whom payment is made by a taxpayer may not be an “associate” so that the issue discussed in the preceding paragraph cannot arise. The payment may be made to a trust or to a partnership. The question that may then arise for decision is whether the entitlement of a beneficiary or a partner to a distribution, or an actual distribution to a beneficiary or a partner, who is an associate of the taxpayer, can be described as property that will be or has been acquired by the associate. In this connection the interpretation of para. (c) will be affected by the provisions of para. (d). An acquisition of property will not engage the operation of s. 82KJ unless the consideration (if any) that was payable or might reasonably be expected to be payable in respect of the acquisition of that property was less than the consideration that might reasonably be expected to have been payable, or to be payable, if the outgoing had not been incurred. Paragraph (d) would appear to contemplate an acquisition that might have been the subject of some “consideration payable”. It would be straining the words of the paragraph to say that consideration was paid by the beneficiary or partner in the form of the rights to distribution that were satisfied by the distribution. In any event that consideration is not easily described as a consideration that is less than the consideration that might reasonably be expected to have been payable if the outgoing had not been incurred. If paragraph (c) does not apply to a distribution to a beneficiary or to a partner, s. 82KJ will not be applicable to the circumstances of an overpayment to a trust or partnership in the course of income-shifting. It will not apply to an overpayment in circumstances otherwise within Phillips (1978) 78 A.T.C. 4361.
[10.341] Section 82KL was enacted shortly after s. 82KJ. It is limited in its operation to “eligible relevant expenditure” as defined in s. 82KH. The scope of “relevant expenditure”, also defined in s. 82KH, has been expanded on several occasions since the enactment of the section, so that the section now applies to a wide range of payments. Relevant expenditure is eligible relevant expenditure if the expenditure was incurred by reason of, as a result of or as part of a tax avoidance agreement, and the taxpayer or an associate has obtained a benefit or benefits in addition to the benefit in respect of which the relevant expenditure was incurred. The benefit in respect of which the relevant expenditure was incurred is specified for the items of relevant expenditure to which s. 82KL applies by definition in s. 82KH(1G). Any other benefit is an additional benefit. The definition refers only to the obtaining of an additional benefit by the taxpayer, but s. 82KH(1P) deems a benefit obtained by an “associate”, as defined in s. 82KH, to be a benefit obtained by the taxpayer. The notion of obtaining an additional benefit is intended to be broader than the notion of acquiring property in s. 82KJ, but s. 82KL may, none the less, not be wide enough to cover the overpayment situations considered in [10.339]–[10.340] above in relation to s. 82KJ. It is arguable that the additional benefit must be of a kind that could have been “obtained” by the taxpayer.
[10.342] Section 82KL provides that where the sum of the amount or value of the additional benefit and the “expected tax saving” is equal to or greater than the amount of the eligible relevant expenditure, no deduction is allowable in respect of any part of the eligible relevant expenditure. “Expected tax saving” has a meaning given by a definition in s. 82KH(1), which is itself the subject of a definition in s. 82KH(1B). Normally, it is the amount by which the tax payable by the taxpayer would be less if a deduction were allowable in respect of the eligible relevant expenditure. The arithmetic of s. 82KL will limit the operation of the section to circumstances where the planning for a tax advantage has been immodest. In this respect it is narrower in its operation than s. 82KJ. If a company subject to tax on its taxable income at 46 per cent, or its associate, obtains an additional benefit that has a value that is less than 54 per cent of the amount of the relevant expenditure, s. 82KL will not operate. In other respects, s. 82KL has a wider operation. It does not require that the payment should be unreasonable in amount having regard to the benefit in respect of which the relevant expenditure was incurred. And it will operate if an additional benefit is obtained even though there could not be said to be an acquisition of property as s. 82KJ requires. It will operate, for example, where a consequence of the incurring of the relevant expenditure is the so-called collapse of a loan made to the taxpayer or an associate. It may have been agreed between the person receiving the payment and an associate of the taxpayer who has borrowed from that person, that the loan should, on the making of the payment, become repayable at a date so delayed that the loan becomes virtually valueless. In circumstances of this kind s. 82KL is given an extended operation by s. 82KH(1J).
[10.343] Section 82KH(1H) adapts s. 82KL so that it will apply in some circumstances involving the payment of interest in advance, like those in Ilbery (1981) 81 A.T.C. 4661 considered in [6.117]ff. above. The decision in Ilbery was that the interest paid in advance was not deductible under s. 51(1), so that, if the events were to occur now, there would be no room for the operation of s. 82KL. But s. 82KL may indicate the difficulty of dealing with tax planning that relies on an anticipated judicial decision that an outgoing is deductible under s. 51(1). The operation of s. 82KL in the circumstances of Ilbery is extended by s. 82KH(1H). The family trust that acquired the debt is deemed to have obtained a benefit being the difference between what was paid for it and the amount of the debt, not, it should be noted, the value of the debt. In fact the debt had no greater value at the time it was acquired than the amount paid for it. The need to deem facts which are a drastic contradiction of the truth in order to bring about a denial of the deduction of the interest paid, underlines that any judicial decision upholding the deduction of the interest paid in Ilbery would have confounded basic principle. The integrity of the income tax once destroyed by a wrong decision on basic principle, cannot be fully restored by any legislation.
[10.344] In [6.301]–[6.307] above, there is a discussion of the distinction between an expense of deriving income and an application of income derived. In [6.304] above there is a reference to the significance of that distinction in relation to a payment of interest on debentures as distinct from a payment of a dividend on shares. Interest on debentures is, generally, deductible; dividends are not.
[10.345] There will be circumstances, however, where interest on debentures becomes indistinguishable in its function from a distribution of profits as dividends. Thus, the debentures may be convertible into shares. There may be good reason for allowing the deduction of a distribution of profits by a company in the form of dividends, as a method of ensuring that profits moving through a company intermediary to a shareholder are not taxed at both the company and the shareholder levels. But while the separate taxation of profits derived by a company and dividends received by a shareholder is maintained, some restraint must be imposed on the deductibility of interest paid to holders of convertible debentures.
[10.346] It might have been possible to deny deduction of interest on convertible debentures on the ground that such interest is not incurred in the process of income derivation. Since 1960, however, express provision has been made in what is now Div. 3A of Pt III denying deduction of interest on convertible debentures in specified circumstances. The 1960 provisions denied deduction on a broad front. In 1970 deductibility of interest on some convertible debentures was restored, and in 1976 further relaxation of the denial of deductibility was made. The restoration of deductibility is intended to provide scope for the use of convertible debenture as a means of raising capital. Deduction is allowed only if the convertible debentures meet strictly defined tests. Thus the option to convert must rest with the debenture holder so that, pending conversion, he has the income yield and security of investment that the loan provides.
[10.347] If deduction were allowed of interest paid on all convertible debentures, the operation of the present separate system of taxing company profits would be undermined. That system, where no undistributed profits tax applies, depends for its operation on pressure by those who have an interest in accumulated profits for some measure of current distribution. In the case of a high-income shareholder, the under-taxation of undistributed profits is compensated for by the over-taxation, at company and shareholder levels, of distributed profits. In the case of a holder of convertible debentures, whose debentures give him a potential claim on a portion of undistributed profits, the pressure for current distribution is satisfied by the interest he receives.
[10.348] Sections 108 and 109 provide for the denial of deduction by a private company (as defined in s. 103A) of certain payments made to shareholders and directors, and to relatives of shareholders and directors. These provisions have a purpose similar to the purpose of the provisions just considered denying deductibility of interest on convertible debentures. Payments that are in substance distributions of profits should be treated in that way.
[10.349] In the case of payments covered by s. 108, deduction under s. 51(1) would in most instances have been denied in any case. The section is intended, however, to have the further function of ensuring that the receipt of the payment by the shareholder is income. In this respect the section may be ineffective. Where the section operates, the amount paid or asset distributed is deemed to be a dividend paid by the company. Rutherford (1976) 76 A.T.C. 4304 is authority that this is not enough to engage the operation of s. 44(1) and make the receipt by the shareholder income. Section 44(1) makes a dividend out of profits income, and a deemed dividend under s. 108 will not be income if in fact it was not paid out of profits. The Commissioner’s opinion that the payment represents a distribution of income, necessary if the payment is to be deemed a dividend, will not supply the element of fact that it is paid out of profits. And the deeming that the payment is a dividend does not in itself make it income. Gibb (1966) 118 C.L.R. 628 considered in [2.244] above, in overruling Fuller (1959) 101 C.L.R. 403, and adopting the dissenting judgment of Dixon C.J. in Fuller, is authority that the payment is only given the character of a payment within the definition of dividend in s. 6. And such a payment does not necessarily have an income character.
[10.350] The scope of s. 108 is narrow in a number of respects. It is arguable that the section has no application to a payment made to a shareholder that is not made by way of advance or loan. The payment, if it is not made by way of advance or loan, must be one made “on behalf of, or for the individual benefit of” a shareholder. The section may not therefore apply to an over-payment made to a shareholder for goods or services provided by the shareholder.
[10. 351] The payment must have been made to, on behalf of, or for the individual benefit of a shareholder. “Shareholder” refers to a person registered as such, or having a right to be registered (Patcorp Investments Ltd (1977) 140 C.L.R. 247). The section has no application to a payment to a relative or other associate of a shareholder.
[10.352] Crowe (1958) 100 C.L.R. 532 considered in [10.324] above may require a conclusion that a payment by a partnership is not a payment by a company that is a member of the partnership. Section 65(1) may fill this gap in the operation of s. 108—“associated person”, it will be recalled, is given an extended meaning by s. 65(1D) (b)—though the question for the Commissioner under s. 65(1) is whether in his opinion the payment is reasonable, while under s. 108 the question is, whether in the Commissioner’s opinion the payment represents a distribution of income.
[10.353] Like s. 65(1), s. 108 may not apply to a payment to a partnership, a partner in which is a shareholder in the company making the payment.
[10.354] Section 109 shares some of the narrowness of s. 108, where, for example, a payment is made by a partnership or is made to a partnership. The deeming that the amount is a dividend will not be sufficient to make it income: it must have been in fact paid out of profits. And s. 109 has its own limitations. Thus it applies only to a “sum paid or credited”. This may not include the transfer of property other than money. Section 108 does extend in terms to “assets distributed”, though curiously only when this is done “by way of advances or loans”, and in other circumstances, the application of the section is confined to “payments”.
[10.355] Under s. 109 the Commissioner may deem a payment to a person who is not in fact a shareholder to be a dividend. The payment may have been made to a director or to a relative of a shareholder or director. It may be deemed to be a dividend if it is a payment that is or purports to be remuneration for services rendered by the person to whom the payment is made, or is an allowance gratuity or compensation in consequence of the retirement of that person from an office or employment held by him in the company, or upon the termination of any such office or employment. The deeming will arise if the Commissioner forms the opinion that the payment exceeds an amount that is reasonable. It will arise in relation to the excess.
[10.356] Section 109 expressly provides that the excess is not an allowable deduction. There are dicta in W. J. & F. Barnes Pty Ltd (1957) 96 C.L.R. 294 that s. 109 can apply only when the payment would otherwise have been an allowable deduction, whether under s. 51 or possibly s. 78(1) (c) considered in [10.105]–[10.112] above. The interpretation of the section in this respect will be important where a retiring allowance of an unreasonable amount has been paid. The amount by which the payment exceeds a reasonable amount could be denied deduction under s. 51 as a payment made for a purpose that will not make it relevant to the gaining of assessable income. Issues already considered as to the effect of Cecil Bros Pty Ltd (1964) 111 C.L.R. 430 and Europa Oil (N.Z.) Ltd v. C.I.R. (N.Z.) (No. 2) (1976) 76 A.T.C. 6001 are raised. The excess is unlikely to be deductible under s. 78(1)(c). The Commissioner could not be expected to form the opinion that the excess was “paid in good faith in consideration of the past services” of the employee.
[10.357] If s. 109 does not operate, because the payment would not otherwise be an allowable deduction, the payment may have the character of an eligible termination payment in the hands of the person receiving it so that it is subject to the operation of Subdiv. AA of Div. 2 of Pt III: para. (a)(v) of the definition of eligible termination payment in s. 27A(1) will not operate to take the amount out of the definition.
[10.358] Where s. 109 operates, it will deem the excess to be a dividend paid by the company. If Rutherford (1976) 76 A.T.C. 4304 is followed, it will not necessarily be income of the person receiving the payment. It must in fact have been paid out of profits. And there is another-problem. The person receiving what is deemed to be a dividend may not be a shareholder in the company, and unless he is deemed to be a shareholder there could be no derivation of income by him under s. 44(1). The question is whether a deeming of a payment to be a dividend is a deeming that the person receiving the amount is a shareholder. The definition of “dividend” in s. 6 refers in all its aspects to payments to shareholders.
[10.359] Section 31C, considered in [10.290]–[10.293] above, was inserted in the Act following the decision in Isherwood & Dreyfus Pty Ltd (1979) 79 A.T.C. 4031. Though not confined in its operation to income shifting in international transactions, s. 31C empowers the Commissioner to deny a deduction of some part of the amount paid for trading stock in the circumstances of Isherwood & Dreyfus, which involved an international transaction.
[10.360] A new Div. 13 was inserted in the Act in 1982, applicable where there is an international agreement as defined in s. 136AC. In the application of Div. 13, the operation of s. 31C must be disregarded (s. 136AB(2)). The effect is presumably, that the Commissioner may act under s. 31C, if he has not determined that s. 136AD(3) should apply. The definition of “international agreement” in s. 136AC is intended to identify situations where the parties to a transaction may have fixed the price of property or services so as to shift income from a person who would have been subject to Australian tax on that income, to another person not subject to Australian tax, or to another person who will be subject to Australian tax at a lesser rate, for example tax by withholding at 10 per cent on interest received by him. The shifting of income might take the form of charging a lower price for property or services supplied to a person who will not be subject to Australian tax on the profit he may make in supplying those goods or services to another. Or it might take the form of charging a higher price for property or services supplied to a person who will be subject to Australian tax on the profit he makes, a profit that will be the less because of the higher price he has paid. The present concern is with the operation of Div. 13 where the form of income shifting is the charging of a higher price. The general effect of Div. 13 in these circumstances is to limit the deduction that is allowable, or the cost that will determine the amount of a profit that is income, to the amount that would have been paid for the property or services had the parties been dealing at arm’s length with each other.
[10.361] Section 136AD(3) applies only when “property” has been acquired under an “international agreement”. The latter term is defined in s. 136AC. “Property” is defined in s. 136AA(1), so that it includes “services” and services is defined so that it includes rights provided under an agreement for or in relation to the lending of money. Where the Commissioner is satisfied that the parties to the agreement, or any two or more of those parties, were not dealing at arm’s length with each other in relation to the acquisition of property, and the amount of the consideration in respect of the acquisition exceeded the arm’s length consideration in respect of that acquisition, the Commissioner may determine that s. 136AD(3) should apply. In which event, consideration equal to the arm’s length consideration will be deemed to be the consideration given by the taxpayer. “Arm’s length consideration” is defined in s. 136AA(3) (d). It is the consideration that might reasonably be expected to have been given, or agreed to be given, if the property had been acquired under an agreement between independent parties dealing at arm’s length with each other in relation to the acquisition. The arm’s length consideration is a matter of fact. There is however a function given to the Commissioner by s. 136AD(4), if for any reason it is not possible or not practicable to ascertain the arm’s length consideration, to determine an amount which is then deemed to be the arm’s length consideration. It will have been noted that under s. 31C the “arm’s length price” is a matter in all circumstances of the Commissioner’s opinion.
[10.362] Like s. 31C, Div. 13 provides for carrying the arm’s length price determined in relation to one party, into the tax affairs of another party to the international agreement. However, Div. 13 differs from s. 31C in that consequential adjustments to the assessable income of the other party depend on the exercise of a distinct discretion given to the Commissioner by s. 136AF. Under s. 31C the consequential adjustment is automatic: the price determined in accordance with the section is deemed to be the amount paid “for all purposes of the application of the Act in relation to the purchaser and the vendor” (s. 31C(1)).
[10.363] Part IVA is the subject of further consideration in Chapter 16 of this Volume. The present purpose is to note the possible operation of Pt IVA so as to deny deduction of an outgoing otherwise allowable. Part IVA applies to any scheme where a taxpayer has obtained a tax benefit in connection with the scheme and, having regard to a number of specified circumstances, it would be concluded that the persons or one of the persons who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the taxpayer, or that taxpayer and another or other taxpayers, to obtain a tax benefit in connection with the scheme. “Scheme” is defined in s. 177A(1), so that it is a very wide concept. Tax benefit is defined in s. 177C so that it includes a deduction being allowable to a taxpayer where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, if the scheme had not been entered into. The word “scheme” might be thought to carry some suggestion of an evil mind, but any such suggestion is removed by the definition of the word. Part IVA thus may operate to deny a deduction simply because a taxpayer acted for the purpose of obtaining the tax deduction. At least where it is evident that the policy of the Act is to allow a deduction as a means of attracting the taxpayer into a course of action that is thought to be desirable—the investment allowance may be an illustration—a provision that a taxpayer may not have a deduction because he acted to obtain it becomes bizarre in its inappropriateness. Section 177C(2)(b) goes some way to mitigating this quality of the bizarre, by making exceptions to the operation of Pt IVA where “the allowance of the deduction to the taxpayer is attributable to the making of a declaration, election or selection, the giving of a notice or the exercise of an option by any person, being a declaration, election, selection notice or option expressly provided for by [the] Act”. But a measure of the bizarre remains. The “choice” principle in relation to s. 260, the predecessor of Pt IVA, sought to remove the suggestion of the bizarre, in the operation of that section, but the development of the “choice” principle in Mullens (1976) 135 C.L.R. 290 and Cridland (1977) 140 C.L.R. 330 left s. 260 virtually without any operation, save where the words of the Act have failed to express what is otherwise an evident policy opposed to the tax benefit.
[10.364] A number of other questions as to the operation of Pt IVA are considered in Chapter 16 below. One of them is provoked by the discussion of the operations of s. 65 and ss 82KJ and 82KL in [10.310]ff. and [10.330]ff. above. It may be asked whether there can be a tax benefit, as defined in s. 177C, where a payment is made by a trust estate or by a partnership. Section 177C (1)(b) refers to a “deduction being allowable to the taxpayer”. It is true that a calculation of “net income” of a trust estate required by s. 95(1) involves bringing in what would be assessable income if the trustee were a taxpayer, and subtracting what would be allowable deductions if the trustee were a taxpayer. But this does not make an expense incurred by the trustee a deduction allowable to a taxpayer. A like observation might be made in regard to the calculation required by s. 90(1) of the net income in the case of a partnership. In the case of a trust estate, the definition of “taxpayer” in s. 177A(1) may overcome the difficulty—“taxpayer includes a taxpayer in the capacity of a trustee”. But there is no equivalent provision when the question is raised in regard to a partnership.
[10.365] Part IVA, like s. 31C, s. 65 and Div. 13 of Pt III, includes a provision, in s. 177F(3), whereby the Commissioner’s denial of a deduction may lead to a reduction of the amount that is assessable income of another taxpayer. The making of the reduction by the Commissioner is a matter in his discretion, conditional upon the earlier exercise of his discretion to deny the deduction, but otherwise independent of the discretion to deny the deduction. In this respect Pt IVA is from the same mould as Div. 13 of Pt III, and differs from s. 31C and s. 65.
[10.366] In a number of provisions the Act allows deduction of what might be called notional expenses. The deduction, in a number of instances, is intended to overcome the distortions that may arise from the system of annual accounting applicable in determining the amount on which tax is levied. The deduction for losses carried forward from earlier years is the principal illustration. In other provisions a deduction may be allowed that is calculated by reference to an expense that is already deductible, though possibly over the life of some asset. The deduction is in addition to the deduction of the actual expense. The principal illustration is the investment allowance. A deduction may be allowed of a deemed expense where a transfer of income is for tax purposes to be treated as if the transfer had not been made. There is a deemed payment by the transferor to the transferee of the amount of income transferred, the deemed payment being for the purpose for which the income was transferred.
[10.367] “Loss” as used in the provisions now to be considered has a meaning distinct from two other meanings already noted. The word as used in s. 51(1) refers to the failure of an asset to realise its cost. Section 59, in stating the events which may give rise to an item of assessable income or allowable deduction where property subject to depreciation ceases to be available to a taxpayer, uses the word loss in the sense of permanent deprivation of an asset. Loss in the present context refers to what might be called negative income of a year of income. It is defined in s. 80(1) as the excess, in any year of income, of allowable deductions over assessable income and net exempt income of that year. The meaning has its affinity with the meaning of the word in s. 51(1). The purpose of the provisions of ss 80ff., in allowing the deduction of the excess against income derived in later years, is to mitigate the distortion in the amount of income subject to tax that would arise if each year of income were treated as quite distinct from each other year. The mitigation is however limited. The carry-forward of a loss to later years is limited to seven years, save where the loss is a loss incurred in engaging in primary production as defined in s. 80AA(2), in which event carry forward is unlimited in time. However no carry back of a loss is allowed to any taxpayer: a loss in one year cannot be applied against income derived in an earlier year. There are restrictions on the carry forward of a loss where the taxpayer becomes bankrupt. There are restrictions on the carry forward of losses applicable to all losses incurred by companies. A company will be denied the application of a loss carried forward if there has been a substantial change in the beneficial ownership of shares in the company or in certain other circumstances, unless the company carries on the same business. The policy of the restrictions on the carry forward of losses by companies is also reflected in the provisions of Subdiv. B of Div. 2A of Pt III considered in [10.294]-[10.300] above, the “current year loss provisions”. Those provisions were included under a heading concerned with the denial of deductions otherwise allowable. That is their effect. The provisions now considered allow a deduction for what is not in any sense an expense of the year of income, and may be seen as a notional expense. They then restrict the deduction of that expense where the taxpayer is a company.
[10.368] Section 80(1) provides that a loss shall be deemed to be incurred in any year when the allowable deductions (other than the concessional deductions and the deductions allowable under s. 80 or s. 80AAA or s. 80AA) from the assessable income of that year exceed the sum of that income and the net exempt income of that year, and the amount of the loss shall be deemed to be the amount of such excess. The reference to s. 80AA is to a provision governing the carry forward of a loss incurred by a taxpayer engaged in primary production. “Net exempt income” is defined in s. 80(3). The most significant item of exempt income is likely to be income that is exempt under s. 23(q)—foreign source income of a resident that is taxed in the country of source. “Concessional deductions” is defined in s. 6 to mean deductions allowable under Subdiv. C (interest in respect of housing loans) or E (expenditure in respect of home insulation) of Div. 3 of Pt III.
[10.369] One aspect of the definition of a loss available for carry forward is that a loss when carried forward cannot create or increase a loss available for a new carry forward: If it could, the limitation on the period of carry forward would be nullified. Section 80(2) provides for the application of a loss carried forward. It is first applied against net exempt income of a year of income and then against assessable income. Where there is more than one loss available for application, the losses are taken into account in the order in which they were incurred.
[10.370] There are problems of correlating the provisions as to the determination of a loss available for carry forward and as to the application of such a loss. The most effective correlation will be achieved if it is accepted that there is assessable income and net exempt income in a year of income to receive the application of a loss to the extent that the operation of s. 80(1) fails to give rise to a loss available for carry forward in the year of income. Where the allowable deductions that are subtractable under s. 80(1) are less than assessable income, there will be assessable income to receive the application of a loss carried forward. Where those allowable deductions exceed the assessable income and there is net exempt income, there will be net exempt income to receive the application of the loss carried forward to the extent that the allowable deductions are less than the assessable income and the net exempt income.
[10.371] Specific provisions relating to particular industries are not examined in any detail in this Volume. Sections 80AA and 80AAA provide for the determination of the amount of a “loss incurred in engaging in primary production” and the amount of a “film loss”, and for the application of these losses. In the case of a film loss, there are restrictions on the application of the loss that do not have any parallel in the primary production loss provisions. And unlimited carry forward is available only in respect of a loss incurred in primary production.
[10.372] A loss cannot be carried forward through the bankruptcy of the taxpayer. Section 80(4) denies the deduction of a loss carried forward if a taxpayer has become a bankrupt, or has been released from any debts by the operation of an Act relating to bankruptcy. The denial is to a degree qualified by subss (4A) and (4B) of s. 80, so that a deduction is allowable of an amount paid in respect of a debt that the Commissioner is satisfied was taken into account in ascertaining the amount of the loss. The policy of the qualification is not apparent. An appropriate qualification might have allowed the loss carry forward to the extent that it arose from debts contracted and paid, whether paid before or after bankruptcy and whether paid by the trustee or by the bankrupt.
[10.373] There are provisions in s. 80AA (subss (6), (7) and (8)) relating to primary production losses, and in s. 80AAA (subss (9), (10) and (11)) in regard to film losses, which parallel the provisions of s. 80 as to the effect of bankruptcy.
[10.374] A number of provisions of the Assessment Act have been enacted in more recent years directed against what have come to be referred to as schemes of tax avoidance. Among these are s. 52A (considered in [10.306]-[10.309] above), ss 82KH-82KL (considered in [10.328]ff. above) and Pt IVA (considered in [10.363]ff. above). All of these anti-avoidance provisions commenced their operations from specified dates. However a number of provisions of s. 80 (subss (5), (6) and (7)) and of s. 80AA (subs. (12)), give these anti-avoidance provisions, so far as they could be applicable, a limited earlier operation. In effect the anti-avoidance provisions are deemed to be in operation at an earlier date for the purpose of determining whether there are losses available for carry forward.
[10.375] Provisions for loss carry forward may be seen as some expression of a policy that Government should contribute towards a loss suffered by a taxpayer who in other years contributes part of his profit to Government in the form of tax paid. In the case of an individual, the policy allows a Government contribution only to the extent of what would otherwise be the taxpayer’s liability to contribute in other years, and then only when the liability to contribute arises in years subsequent to the year of loss. There is no question of contribution by Government by way of negative tax in the year of loss, and there is no carry back of losses. The Government contribution by relief from tax in the year of carry forward is available only to the taxpayer who suffered the loss. He cannot dispose of the inchoate right to a contribution by Government, nor will it be available to his estate or to his heir if he dies.
[10.376] At first sight these principles are maintained where the taxpayer is a company. Save where s. 80G operates so as to allow the transfer of a loss within a group of companies, the company cannot dispose of its inchoate right, and loss carry forward ceases to be available if the company is liquidated. There will however, in the absence of special provisions applying to companies, be an opportunity for the shareholders in a company to realise the inchoate right to a Government contribution by selling their shares. And the inchoate right will not be affected by the death of a shareholder. The value of shares attributable to the inchoate right will survive the death of the shareholder.
[10.377] In fact, special restrictions have been applied to the carry forward of losses by companies, intended to overcome the advantage over operating as an individual that would otherwise be attracted to operating through corporate form. The restrictions are a compromise that allows for some preservation of the inchoate right despite a disposition of shares by a shareholder or a change in ownership resulting from the death of a shareholder. Loss carry forward by the company can be retained if there is a continuity of beneficial ownership of shares covering more than 50 per cent of the shares, and continuity of ownership is not affected by the death of a shareholder so long as the shares are held by the trustee of the shareholder’s estate in his capacity as trustee, or are beneficially owned by a person who received the shares as beneficiary in that estate.
[10.378] The provisions deeming a continuity of beneficial shareholding in the event of a death of a shareholder are in s. 80B(3). There is a question of the meaning of the words which refer to a person “who received the shares as a beneficiary in [the] estate”. It is arguable that a beneficiary who takes shares in specie in satisfaction of his interest in an estate, when the shares would otherwise have to be sold and the proceeds distributed, does not receive the shares as a beneficiary.
[10.379] The provisions denying loss carry forward where there is an insufficient continuity of beneficial ownership are contained in ss 80A-80E. The significance of the related provision in s. 80F has already been explained in [10.78]-[10.82] above.
[10.380] Section 80A(1) denies the deduction of a loss by a company unless there is a continuity of beneficial ownership of shares exceeding one half, at all times in the year in which the loss was incurred and in the year in which it is sought to apply the loss. Section 80A (1) is subject to ss 80B, 80DA and 80E. The operation of s. 80B may deem shares not to be beneficially owned in some circumstances. And s. 80DA may, in the circumstances provided in the section, deny the carry forward notwithstanding that a continuity of beneficial ownership exceeding one half can be established. Section 80E however works a qualification on ss 80A (1) and 80B, and, it seems, on s. 80DA, so that loss carry forward will be available despite those provisions if the same business is carried on by the taxpayer in the year of loss and in the year of claimed application of the loss.
[10.381] Section 80A (1) defines the continuity of beneficial ownership that is prima facie necessary if loss carry forward is to be allowed. There must be continuity of beneficial ownership of shares carrying between them more than one half the voting power, the right to receive more than one half of any dividends that may be paid by the company and the right to receive more than one half of any distribution of capital of the company. The beneficial ownership must subsist at all times in the year of loss and in the year of claimed application of the loss, subject, however, to a discretion given to the Commissioner by s. 80A (5), where a change occurs in beneficial ownership during a year of loss, to allow the application of such part of the loss as he considers to be the amount of the loss that was incurred after the change in beneficial ownership.
[10.382] The continuity of beneficial ownership required by s. 80A (1) must be established to the satisfaction of the Commissioner, where the company is a private company as defined in s. 103A. Where it is not, loss carry forward will be denied unless “the Commissioner considers that it is reasonable to assume” that the tests of continuity of beneficial ownership in s. 80A (1) are met. The tests all refer to a “right” to exercise power, or to receive dividends and distributions of capital. The tests are cumulative. It may be asked whether the Commissioner could ever be satisfied, or consider it reasonable to assume, that the tests are met, where the articles of the company include a differential dividend clause which gives the board a discretion to pay a dividend on some shares to the exclusion of other shares, or include a clause allowing differential distribution of capital. In these circumstances no share would appear to give a “right” to a dividend that “may be paid”, or the right to receive a distribution of capital.
[10.383] Where shares in the company are held by a trust, it is the “beneficial” ownership of the shares that is relevant. Where shares in the company are beneficially owned by another company, or another company has an interest in its shares, the operation of s. 80A (1) may be displaced by subss (2) and (3). It will be displaced if the company requests the Commissioner that subs. (3) should apply, or the Commissioner considers it reasonable that subs. (3) should apply. Where subs. (3) applies, loss carry forward will be denied unless the Commissioner is satisfied or considers that it is reasonable to assume that, through interposed companies trusts or partnerships, persons not being companies had continuing beneficial interests in the nature of control of voting power, rights to receive dividends and rights to receive distributions of capital, parallel with the rights that must be carried by shares under s. 80A (1) if continuity of beneficial ownership is to be established under that subsection. The manner in which interests in dividends and distributions of capital are to be established is the subject of subs. (4). As in the case of s. 80A (1), there is a problem as to the operation of subss (3) and (4) where the board of a company is given a discretion as to the payment of dividends or distribution of capital.
[10.384] The applicability of subss (3) and (4) on request by the company, will be important to the company where there has been a change in the share-holding in the company that would require that the loss carry forward should be denied under s. 80A (1), but the change in ultimate interests of persons who are not companies is not enough to defeat loss carry forward under s. 80A (3). Shares in a company that has suffered losses may have been disposed of by its holding company to a sister company. The company disposing and the company acquiring may be wholly owned subsidiaries of another holding company.
[10.385] The applicability of subss (3) and (4) where the Commissioner considers it reasonable that subs. (3) should apply, will be important to the Commissioner where there has been no change in shareholding in the company that has suffered losses, but there has been a change in the interests of persons in a company that holds shares in the company that has suffered losses.
[10.386] Section 80B (5) empowers the Commissioner in some circumstances to treat shares as not being beneficially owned in the year of income of claimed application of a loss. The circumstances set out in the subsection in para. (b), contemplate an agreement entered into before or during the year of income, or the giving of a right, power or option which “in any way directly or indirectly, related to, affected, or depended for its operation on” any one of four specified matters. These matters concern:
By para. (c) of the subsection, the Commissioner’s power to treat the shares as not being beneficially owned is also dependent on the agreement having been entered into, or the right, power or option having been given or acquired, for the purpose, or for purposes that included the purpose, of enabling the company to take the loss into account. By subss (10) and (11) “agreement” is given a broad meaning, and any of the words “agreement, right, power or option” may be satisfied though there is no right of enforcement by legal proceedings, and none was intended.
[10.387] Two decisions of the High Court on the interpretation of s. 80B (5), and observations made in those cases, justify a number of conclusions as to the effect of the subsection. Those cases are K. Porter & Co. Ltd (1977) 52 A.L.J.R. 41, and Students World (Australia) Pty Ltd (1978) 138 C.L.R. 251. An agreement by the continuing shareholders that they will not sell their shares may attract the operation of s. 80B (5). Clearly, subpara. (b) (ii) is satisfied, and the purpose of the agreement may be to enable the company to take the loss into account, so that para. (c) would be satisfied: the purpose was to ensure that something does not happen—the sale of their shares by the continuing shareholders—that would preclude the required continuity of beneficial ownership. There is no decision on the matter of whose purpose it is that matters, and whether the purpose that is relevant is an objective or subjective purpose.
[10.388] An option given by the continuing shareholders to a person who has acquired shares, the option enabling him to acquire the shares of the continuing shareholders after the loss has been applied by the company, may satisfy subpara. (b) (i) or (ii). In this instance the purpose of enabling the application of the loss may be found in the reassurance given to the person who has taken the option that he can shift income to the company without thereby conferring a continuing benefit on the continuing shareholders. Any increase in the value of their shares enures through the option to the ultimate benefit of the person who has taken the option.
[10.389] An agreement that the continuing shareholders will exercise their powers so as to make the persons who have acquired shares directors of the company may satisfy subpara. (b) (i) and subpara. (b) (iii). In this instance the purpose of enabling the application of the loss may be found in the purpose to give the control of the management of the company to the persons who have acquired shares, so that profits might be made against which the loss will be applied. On the basis of a similar analysis, the giving of proxies by the continuing shareholders may satisfy subparas (b) (i) and (b) (iii), and para. (c).
[10.390] An agreement by which shareholders undertake to sell less than half of their shares to a buyer may attract the operation of s. 80B (5), if the agreement is left unexecuted. Until the agreement is executed it affects all their shares. When the agreement is executed, it does not affect the shares that remain in the hands of the continuing shareholders in a way that will attract the operation of s. 80B (5).
[10.391] Subsection (6) of s. 80B is directed against provisions in a company’s memorandum or articles, or in an agreement, by which shares which have been retained by continuing shareholders will or may cease to have rights at any time after the end of the year of claimed application of a loss. The shares are deemed not to have had those rights during the year of claimed application of the loss. Subsection (7) makes similar provision in regard to provisions by which shares in the company will or may commence at any time after the end of the year of claimed application of the loss to carry rights that they did not carry at any time during that year. Such shares would enable those who have acquired shares in a company that has suffered losses to come to have control of the company after the losses have been applied.
[10.392] Section 80DA was added to the Assessment Act in 1973 at a time when the provisions of ss 80A and 80B were amended in ways that made the limitations on carry forward more stringent. Thus the continuity of interest required was increased from 40 per cent to more than 50 per cent. Section 80DA was intended to increase the limitations. The section has an operation distinct from the operation of ss 80, 80AA and 80AAA: it commences “Notwithstanding section 80, 80AAA and 80AA …”.
[10.393] Section 80DA (1) specifies in a number of paragraphs circumstances which will prevent the carry forward of a loss by a company. Each is specified in broad terms, though some qualifications may result from the interpretations of s. 80DA (1) that are contained in the remaining subsections of s. 80DA. Paragraph (a) of subs. (1) is directed to the shifting of income to a loss company in the year of loss—“during the year of income the company derived income that the company would not have derived if the loss, or part of the loss, had not been available to be taken into account”. Paragraph (a) of subs. (1), standing alone, would deny loss carry forward to a company that is one of a number of wholly owned subsidiaries, where income has been shifted, by transfer pricing, from another subsidiary. This is to assume that a company derives income that it would not have derived if the loss had not been available, if it sells goods that it would not otherwise have acquired, or would otherwise have acquired at a higher cost. However s. 80DA (2) qualifies the operation of para. (a) so that the paragraph is inapplicable “where the continuing shareholders will benefit from the derivation of the income to an extent that the Commissioner considers to be fair and reasonable having regard to their rights and interests in the company”. “Continuing shareholders” is defined in s. 80DA (6) so that the phrase refers to persons on whose holdings or interests the company might rely for purposes of showing the continuity of ownership or interests that will satisfy s. 80A (1) or s. 80A (3). In the situation of a transfer of profits between sister subsidiaries para. (a) of subs. (1) should not therefore preclude loss carry forward.
[10.394] But para. (b) of subs. (1) raises a prospect of such a denial. Even when read with subss (4) and (5), para. (b) leaves the prospect that the advantage a subsidiary derives in not having to pay tax on income shifted to its sister subsidiary—a company that has suffered losses—will preclude the carry forward of losses by the sister subsidiary. Subsection (4) prevents the operation of para. (b) of subs. (1) only where an advantage has been obtained by a person who had a shareholding interest in the company that claims the application of a loss. It is not clear why the operation of para. (b) should be precluded only in these circumstances. Indeed the purpose of para. (b) is less than clear.
[10.395] Paragraph (c) of s. 80DA (1) will deny loss carry forward where there has been some action in the conduct of the business affairs of the company claiming the application of a loss, which discriminates against the continuing shareholders—persons on whose continuing shareholdings or continuing interests the company might rely as satisfying the tests imposed by subss (1) or (3) of s. 80A (s. 80DA (6)). The making of loans only to new shareholders may be an illustration. Paragraph (c) will also deny loss carry forward where there has been conduct of the “affairs” of the company “without proper regard to the rights, powers or interests of continuing shareholders in the company”. Conduct of affairs which fails to recognise the “rights [or] powers” of the continuing shareholders may not be difficult to identify. The failure to pay a preferential dividend to which the continuing shareholders are entitled may be an illustration. Another illustration may be the failure to give notices of meetings to continuing shareholders. Conduct of affairs which does not have proper regard for the interests of continuing shareholders may be more difficult to identify. Action which discriminates against continuing shareholders, for example in the making of a new share issue, would no doubt be within para. (c), though such action may in any event bring s. 80A (1) into operation so as to deny loss carry forward. Where action does not discriminate—it may be a failure to pay any dividend—the operation of para. (c) is not clear. It is perhaps arguable that proper regard is not given to the “interests” of continuing shareholders if moneys that would otherwise be available to pay a dividend are used to repay debts owed to the new shareholders. The debts may have been acquired by the new shareholders as part of the arrangement under which they acquired their shares.
[10.396] Paragraph (d) would appear to make an assumption about the operation of s. 80A (1). The acquisition by a person of voting control of a company might be thought to involve necessarily a change in beneficial ownership that would involve a denial of loss carry forward under s. 80A (1). If, however, emphasis is placed on the words of s. 80A (1) that refer to “persons who … beneficially owned shares … carrying between them” the rights specified, the acquisition of voting control by one person as a result of movements in shareholdings among persons all of whom were and remain shareholders, would not involve a denial of loss carry forward under s. 80A (1). Paragraph (d) would appear to assume that this is so, and it provides for the denial of loss carry forward if the acquisition of control in this way was undertaken in order that loss carry forward would continue to be available. But the operation of the paragraph is less than clear.
[10.397] The denials of loss carry forward by ss 80A and 80DA are subject to the saving provisions of s. 80E. A continuity of business may preclude a denial of loss carry forward by the operation of s. 80A, or s. 80DA, at least where that section would operate in addition to s. 80A. There may be some question whether s. 80E will act to save the application of a loss carried forward where there is the necessary continuity of ownership for purposes of s. 80A, and s. 80DA would operate alone to deny carry forward.
[10.398] Section 80E was added to the Assessment Act in 1964 at a time when ss 80A and 80B were enacted. Important changes were made to s. 80A and s. 80B in 1973, but any changes to s. 80E at that time were matters of drafting only. It was said at the time of enactment that s. 80E would be a saving provision of a kind that appeared in United States and United Kingdom law. The policy of the section is none the less a matter of speculation. It may be asked why a market in the shares of companies that have suffered losses should be encouraged where the buyers are prepared to maintain the businesses of the companies. The answer may be that a company’s business, albeit an unsuccessful business, is a commercial entity whose preservation is important. The buyer may be able to revive and foster this entity, though it will be seen that the tests of continuity of business in s. 80E, that must be satisfied if loss carry forward is to be allowed, may hamper his actions directed to those ends.
[10.399] Any analysis of the framework of s. 80E and the interpretation of its provisions pose difficult questions. Even more difficult is a threshold question as to the correlation of s. 80E and s. 80DA. Section 80DA was added to the Act in 1973 but no attempt has been made in any detail to adapt the language of s. 80E so that the section may clearly operate as a saving provision that will preclude the denial of loss carry forward by s. 80DA. Section 80E simply states that where its provisions are complied with “sections 80A and 80DA do not prevent the whole of the loss being … taken into account”. And s. 80DA(1) itself, in its opening words, provides for the denial of the application of a loss “subject to s. 80E”.
[10.400] The operation of s. 80E(1) is however by its terms predicated on there otherwise being a denial of the application of a loss “by reason of a change that has taken place in the beneficial ownership of shares in the company or in any other company” (s. 80E(1) (a)). Section 80DA does not deny the application of a loss by reason of such a change, though some change of that kind is likely to have been associated with the circumstances which give rise to a denial under s. 80DA. Section 80DA will no doubt have a saving operation where there will otherwise be both a denial under s. 80A by reason of a change, and a denial under s. 80DA by reason of circumstances specified in that section. It would be strange then that there should be no saving operation where only s. 80DA operates to deny. Yet it will demand a very free interpretation of s. 80E to give effect to the undoubted intention that continuity of business should prevent the denial of the application of a loss where only s. 80DA would operate to deny.
[10.401] An analysis of the framework of s. 80E raises a question of the significance of the word “the” in the phrase “the same business” in para. (b) of s. 80E(1). On one analysis it is necessary to find one business covering all the business activities of the company immediately before the change, and to find that same business carried on in the year of application of the loss. There may be difficulty in finding, and, indeed, in describing, this one business where the company is a conglomerate engaged in a number of diverse activities in separate divisions, each one of which would ordinarily be regarded as a separate business. On another analysis, s. 80E(1) (b) would be read as if it had provided “carried on … [a] business the same … as it carried on immediately before the change”. This analysis is clearly the more convenient, and it will be seen, makes it easier to fix the operation of para. (c) of s. 80E(1). It is the analysis asserted by the taxpayer in Boyded (Holdings) Pty Ltd (1982) 82 A.T.C. 4236. A car selling activity in the outer suburbs, it was submitted, was a business distinct from another business constituted by wholesale car parts activity in inner suburbs. The fact that the car selling business had been sold before the year of claimed application of the loss did not prevent there being a continuing business of wholesale spare parts selling that was the same as a business carried on before the change in beneficial ownership of shares in the company. If the analysis that requires all business activity before a change to be regarded as one business is correct, the taxpayer in Boyded (Holdings) is faced with the task of establishing that the sale of the car selling division of one business did not prevent that business remaining the same business. In that task he may be defeated by the persuasive authority of the judgment of Walton J. in Rolls-Royce Motors Ltd v. Bamford (1976) 51 T.C. 319.
[10.402] An analysis of the kind asserted in Boyded (Holdings) makes it easier to explain the operation of para. (c) of s. 80E(1). It will be noted that, in its reference to business, para. (c) contemplates that the taxpayer may have a business in the year of application of the loss distinct from a business that it carried on “before”—presumably at any time before—“the change took place”. The saving effect of s. 80E is not destroyed by para. (c) if a business carried on after the change is a business “of a kind” that the company carried on before the change. So understood, para. (c) is inconsistent with the one business analysis of para. (b), and points to an analysis of that paragraph of the kind asserted in Boyded (Holdings).
[10.403] There is thus the possibility that a new business may be commenced after the change which will not destroy the saving effect, provided it is a business of a kind that was carried on at some time before the change. Presumably if a business has ceased, a business of the same kind commenced thereafter cannot be the “same business” for purposes of para. (b), but it may be a business of the same “kind” for purposes of para. (c). There is also the possibility that if a new business commenced after the change is not of the same kind as a business carried on before the change so that the saving effect of s. 80E is precluded, the saving effect in a subsequent year of income may be restored by a cessation of that new business before that subsequent year of income.
[10.404] The second limb of para. (c) will preclude the saving operation of s. 80E if at any time during the year of claimed application of the loss the company derived income from a transaction that it had not entered into in the course of its business operations before the change in beneficial shareholding. On the face of it this limb of para. (c) will preclude the operation of s. 80E even though the new transaction does not prevent a business after the change being the same business for purposes of para. (b), and does not prevent a business after the change being a business of a kind carried on before the change for purposes of the first limb of para. (c). A company may not previously have entered into credit arrangements in making sales. Granting of credit to customers in the year of claimed application of a loss may not have the consequence that a business has ceased to be the same business or ceased to be a business of a kind not carried on before the change. But if a credit transaction is a different kind of transaction from the cash transactions previously entered into, the second limb of para. (c) would appear to exclude the saving effect of s. 80E.
[10.405] However, Sheppard J. in J. Hammond Investments Pty Ltd (1977) 77 A.T.C. 4311 has endeavoured to limit the operation of the second limb of para. (c) in excluding the saving effect. He said (at 4318):
“I have reached the conclusion that the second limb of the paragraph is not intended to refer to the daily transaction involved in carrying on a business but to transactions of an isolated and independent kind, which transactions have nevertheless arisen in the course of the taxpayer’s business operations.”
On this interpretation, regular credit transactions, though they are of a kind not previously entered into, will not preclude the saving effect of s. 80E. But an isolated lease transaction, producing rent, which occurs in the course of property dealing—property having been acquired that is tenanted—will preclude the saving effect, if no lease transaction has been entered into prior to the change. Regular transactions, though of a different kind will go only to the question whether there is a business that is the same as a business carried on before the change, or whether there is a business after the change of a new kind. Only an isolated transaction can involve the risk of precluding the saving effect of s. 80E by attracting the operation of the second limb of para. (c). The interpretation proposed by Sheppard J. will favour the company whose experience before the change has included the greatest diversity of income producing transactions. And it has the consequence that, though the saving effect of s. 80E may be precluded by a transaction in the year of income, the saving effect may be restored in a later year of income by ensuring that no isolated transaction is entered into. The interpretation of Sheppard J., it should be noted, is not endorsed by the judgment of Campbell J. in Fielder Downs (W.A.) Pty Ltd (1979) 79 A.T.C. 4019. The interpretation gives the second limb an operation that might be considered fortuitous.
[10.406] Subsection (2) of s. 80E is directed against action that would involve commencement of a business, or entering into a transaction, before a change in beneficial shareholding occurs, for the purpose of ensuring that carrying on of that business after the change or deriving income from a transaction of that kind after the change, will not preclude the saving operation of s. 80E. The terms of s. 80E(2) assume the analysis of s. 80E(1) (b) asserted in Boyded (Holdings) Pty Ltd and thus lend support to the analysis. It is assumed that the carrying on, after the change, of a business that was commenced before the change will satisfy the test in para. (b) of s. 80E(1), even though the company had another business at the time of the change which may have ceased to be carried on.
[10.407] Where the commencement of a business before the change or the entering into a transaction before the change was done for the purpose of attracting the saving operation of s. 80E, that saving operation is denied by s. 80E(2). The commencement of a business will result in the denial of the saving operation of s. 80E(2) only when it is a business that the company “had not previously carried on”. Presumably, in this context, the words “of a kind” must be read in. A business now commenced could not be the same business as one previously carried on. It follows that the commencement of a business prior to the change, even though for the purpose of attracting the saving operation of s. 80E, will not cause the loss of that saving operation if it is a business of a kind that the company had carried on at some time previously.
[10.408] Judicial interpretation of s. 80E has been concentrated on para. (b), the question being whether business operations in the year of claimed application of a loss are such that there is not the same business as that carried on immediately before the change. The assumption in the cases, save in Boyded (Holdings) Pty Ltd (1982) 82 A.T.C. 4236, has been that the company has not at any time carried on more than one business, and the possibility of differing analyses of para. (b) canvassed in paras [10.401]–[10.403] above has not been relevant. The question whether business operations in the year of claimed application of the loss involve the same business as a business carried on immediately before the change—the question posed by para. (b) of s. 80E(1)—is different from the question whether the business operations in the year of claimed application of the loss involve a business that is different in kind from a business carried on at any time before the change—the question posed by the first limb of para. (c) of s. 80E(1). The latter question is reserved for later comment.
[10.409] The judgment of Gibbs J. in Avondale Motors (Parts) Pty Ltd (1971) 124 C.L.R. 97 offers “identical” as the meaning of “same” in s. 80E(1) (b), which excludes a meaning that would say that it is enough that the business in the year of claimed application of the loss is of the same kind as a business before the change. But “identical” is a word that itself calls for interpretation. The judgment of Gibbs J. in Avondale Motors justifies an inference that once a business ceases, a newly commenced business cannot be the same business as the business that ceased. The notion of cessation is indeterminate to a degree. A.G.C. (Advances) Ltd (1975) 132 C.L.R. 175 would draw a distinction between cessation and suspension, and suggests that business operations resumed after suspension may be the same business as the business that was suspended.
[10.410] The Full High Court in A.G.C. (Advances) may have weakened the standing of Avondale Motors. A.G.C. (Advances) raised a question of contemporaneity and its significance in relation to deductibility under s. 51(1). The case was considered in [10.27]ff. above. The relevance of the case to the interpretation of s. 80E is remote.
[10.411] A change in the shareholding of a company will not affect the identity of the company’s business. This is an assumption in the very terms of s. 80E. And, one would think, a change in management or in staff engaged in carrying on business operations should not affect identity. It is true that such changes were mentioned by Gibbs J. in Avondale Motors but the reason for any significance given to them is not explained.
[10.412] A change in the name of the company may affect the identity of its business. Avondale Motors and Fielder Downs (1979) 79 A.T.C. 4019 suggest a principle which would assert that an event which brings about an immediate change in the goodwill within which the business operations of a company are conducted, will affect the identity of its business. It would be said that a change in name, at least when it is a radical change, involves the abandonment of personal goodwill associated with the former name.
[10.413] A change in place of operations may affect identity. It may have the effect of abandoning local goodwill. If the change in place of operations is accompanied by a change in name, as was the case in Avondale Motors, it will be very difficult thereafter to claim identity. In Avondale Motors there was an added factor: the company ceased to operate under a franchise given by one motor vehicle manufacturer and began to operate under another. This factor, added to the factors of change of name and locality of operations, made the change in the goodwill within which the company’s operations were conducted a complete change. The change of franchise in Avondale Motors has its parallels in other changes which will involve the loss of one group of customers and the acquiring of another. A taxpayer who has exclusively offered agistment for cattle on his land, and now turns to raising his own cattle on his land, has moved from one group of customers to another. A change in operations that involves a movement from one group of customers to another group may in some sense be a natural progression—a company engaged in the production of clover seed on its land may switch to the raising of cattle on that land. Fielder Downs is authority that identity of business is none the less affected.
[10.414] The shedding, by discontinuance or sale, of some division of the company’s operations may affect identity. The decision of Walton J. in Rolls-Royce Motors Ltd v. Bamford (1976) 51 T.C. 319 is persuasive authority. In this context the correct analysis of para. (b) of s. 80E(1) becomes critical. If the division that is shed from the company’s operations can, for purposes of para. (b), be seen as a business separate from another business constituted by the activities that continue, the shedding will not affect the identity of the business that continues.
[10.415] The adding of new operations may affect identity. Again the question of the correct analysis of para. (b) is raised. If the new operations are seen as a separate business, they will not affect identity. There may of course be a failure to meet the tests of para. (c), unless the business constituted by the new operations is of a kind that was carried on before the change. If the new operations are no more than the adding of new products to those already sold, or produced and sold, identity ought not to be affected, at least where the products are of a kind that existing customers would expect the company to sell in carrying on its business. A company publishing law textbooks that embarks on publication of school textbooks may cause its business to change its identity.
[10.416] If a company changes the method of its operations, identity ought not to be affected. A business which sells for cash does not change its identity if it commences to sell on credit terms. It will continue to operate within its existing goodwill. A change in method may however raise a question of the operation of the second limb of para. (c). The company may not have sold on credit terms at any time before the change in beneficial ownership of its shares, and it will be said that sale on credit terms is a new kind of transaction. There may be some help for the company in the view taken by Sheppard J. in J. Hammond Investments Pty Ltd (1977) 77 A.T.C. 4311 in the passage quoted in [10.405] above. He would limit the second limb of para. (c) to transactions of an isolated kind that are not “daily transactions” in carrying on a business.
[10.417] The company may engage in business operations, in the year of claimed application of the loss, which involve shifting of income into the company from an associate. The company will buy from the associate at a substantial discount, and sell in its normal outlets. Such a change in method of operations still leaves the company operating within its existing goodwill, and identity of business is presumably not affected. And the observations of Sheppard J. in J. Hammond Investments may afford a reply to an argument that purchasing from the associate involves a new kind of transaction such that there is a failure to meet the test in the second limb of para. (c). Alternatively, it would be said that the identity of the person who is the other party to a transaction does not go to the question whether the transaction is of a different kind.
[10.418] Income shifting operations, it was seen in [10.393]–[10.394] above, may attract the operation of s. 80DA so that loss carried forward is prima facie denied, even though subss (1) and (3) of s. 80A do not apply to bring about a prima facie denial. In which event the question in the last paragraph as to the operation of s. 80E is raised, and the broader question as to the correlation of s. 80DA and s. 80E discussed in [10.399]–[10.400] above.
[10.419] The effect on identity of business of the acquisition of goods in the course of income shifting is an aspect of a wider question of the effect of a change in the source of supply of goods. Gordon & Blair Ltd v. I.R.C. (1962) 40 T.C. 358 is persuasive authority that a company which ceases to manufacture goods, though it continues to market goods of the same kind, now obtained from another, does not carry on the same business. The supplier may be an associated company that has acquired the manufacturing operation. The correct analysis of para. (b) is again raised. If the analysis in Boyded (Holdings) is adopted, it may be possible to say that manufacturing was a distinct business and the cessation of manufacturing does not affect the identity of the business of distributing. Whether or not manufacturing was a distinct business will need to be answered by reference to the existence of a distinct management and staff structure, and distinct accounting.
[10.420] Clearly the question whether a business after the change is the same as a business before the change, a question raised by para. (b), is distinct from the question raised by the first limb of para. (c), whether a business after the change is of the same kind as a business before the change. A business may be of the same kind as a business carried on before the change even though it operates within a different goodwill. The scope, though probably not the size, of operations will, however, be relevant. A business after the change that lacks a division that was part of a business before the change may be of a different kind. And the same may be said where a business after the change has a division that was not part of a business before the change.
[10.421] Subdivision B of Div. 3 of Pt III provides for a deduction of a fraction of capital expenditure on a new unit of eligible property (s. 82AB). “Eligible property” is defined in s. 82AQ to mean “plant or articles within the meaning of s. 54”. There are, however, a number of exclusions. Thus structural improvements, subject to some exceptions, are excluded (s. 82AE). The availability of the deductions is subject to a number of conditions, and there is a time limit on availability prescribed by s. 82AB.
[10.422] The deduction is allowable, in respect of expenditure on a unit of property, notwithstanding that a deduction is allowable in respect of that unit of property under another provision of the Act, save where it is allowable under ss 70A, 75C, 75D, 122J, 123B or 124AH (s. 82AM). For this reason it is appropriate to treat the deduction as allowable in respect of notional expenditure. Its effect is to give tax relief as an incentive to encourage investment expenditure.
[10.423] The availability of the investment allowance reflects a current Government policy. It is not part of the basic structure of the income tax, and the detail of the allowance is not further pursued in this Volume.
[10.424] Division 6A of Pt III requires that, in some circumstances where there has been a transfer of a right to receive income from property, the income is to be treated for tax purposes as if the transfer had not been made (s. 102B). The circumstances involve a transfer of the right to receive income for a period that will terminate before the seventh anniversary of the date on which income from property is first paid to, or applied or accumulated for the benefit of, the transferee.
[10.425] Treating the income as if the transfer had not been made is intended to produce the consequence that the income is income of the transferor. Section 102C is intended to produce the further consequence that the transferor is entitled to a notional expense, reflecting a payment that he might have made to the transferee had he not transferred the right to receive the income. An amount equal to an amount of income in fact paid to the transferee, or applied or accumulated for his benefit, under a transfer that s. 102B requires should be treated as not having been made, is deemed to have been paid by the transferor to the transferee for the purpose for which the right was transferred. The deductibility of the notional expense will depend on the operation of other provisions of the Act, including s. 51(1), on a payment made for that purpose. Where the transfer was made for the purpose of rewarding a person for services rendered, there may be a deduction of the notional expense under s. 51(1), if a payment for that purpose would in the circumstances be relevant and working.
[10.426] Division 6A of Pt III is further considered in Chapter 13 of this Volume.
[10.427] The Assessment Act contains a great number of provisions applicable only to particular industries, and many of these provisions create allowable deductions. Sometimes the particular industry provisions extend the operation of general provisions. Thus the definition of plant for purposes of the operation of the provisions allowing deductions for depreciation is extended by s. 54(2) to include certain structural improvements on land which is used for the purposes of agricultural or pastoral pursuits, certain structural improvements on land that is used for the purpose of forest operations, and certain structural improvements which are used for the purposes of pearling operations and are situated at or in the vicinity of a port or harbour from which those operations are conducted.
[10.428] Other particular industry provisions do not extend the operation of the general provisions, but provide specially for deductions. Thus special provision is made in Div. 10C of Pt III so as to allow what is in effect depreciation of buildings used in the travel industry. Special provision is made in Subdiv. B of Div. 10A of Pt III so as to allow what is in effect depreciation of buildings used in carrying on a business of milling timber.
[10.429] Some of the particular industry provisions allow deductions which are different in kind from any deductions allowable under general provisions. A taxpayer engaged in a business of primary production is entitled to deductions of a wide range of expenses that would not be deductible under s. 51(1). Some of these expenses are deductible over a period of years, for example those dealt with in s. 75A. Others are deductible in the year in which they are incurred, for example those dealt with in ss 75B and 75D. Special deductions are available to taxpayers engaged in some aspect of the timber industry, for example under s. 124F or s. 124J. A special deduction which includes an element of notional expense of the kind allowable under the investment allowance provisions referred to in [10.421] and [10.423] above is available in respect of an investment in Australian films (Div. 10BA of Pt III). A life insurance company is allowed a special deduction in respect of the actuarial value of its liabilities (ss 114 and 115).
[10.430] Some industries are subject to provisions which seek to provide a special regime for some aspects of the industry’s operations, to a degree displacing the general provisions. Thus special regimes apply to the deduction of expenses of general mining, the transport of minerals and petroleum mining (Divs 10, 10AAA and 10AA of Pt III). The expenses would in most instances not be deductible under the general provisions. The exclusiveness of each special regime is in any case established by a section denying deductions under other provisions where deductions are allowable under the relevant Division (s. 122N, in relation to general mining, s. 123E in relation to transport of minerals, and s. 124AN in relation to petroleum mining). In relation to general mining and petroleum mining the exclusiveness of the special regime is qualified by provisions which give the taxpayer an election to have the general depreciation provisions applied to expenditure on plant (s. 122H in relation to general mining, and s. 124AG in relation to petroleum mining).
[10.431] The provisions allowing deduction of expenses of particular industries are not further considered in this Volume.