Chapter 5
[5.1] In [1.1]-[1.9] above the general framework of the Assessment Act by which taxable income is determined and tax is levied on taxable income was explained. “Taxable income”, as defined in s. 6, is “the amount remaining after deducting from assessable income all allowable deductions”. Allowable deductions reduce the amount of assessable income on which tax is levied, and thus reduce the amount of tax. The amount of tax will depend on the applicable rates of tax, as explained in [1.1] above. It will also depend on the credits against tax that may be available to a taxpayer, for example under Div. 18 (credit in respect of tax paid in Papua New Guinea), under s. 45 (relating to tax paid in a foreign source on dividends), or under the Income Tax (International Agreements) Act (relating to tax paid in a number of countries with which Australia has double tax agreements). The amount of tax will depend on deductions from tax, for example the deduction provided for in s. 100 where tax is levied on the assessable income of a beneficiary in a trust after an assessment has been made on the trustee, as representing the beneficiary, under s. 98. And it will depend on rebates of tax which may be available to the taxpayer, for example the rebate on dividends received by a shareholder that is a company under s. 46, and the concessional rebates under Div. 17 of Pt III, which relate the amount of tax to the personal circumstances of the taxpayer.
[5.2] In general these allowable deductions, credits against tax, deductions from tax and rebates of tax are available only where the circumstances involve the derivation of income. But there are important exceptions. The most important are the concessional rebates. And there are some allowable deductions, for example the deduction for gifts made to certain charities (s. 78), the deduction in respect of home insulation expenditure (Subdiv. E of Div. 3 of Pt III) and the deductions for contributions to superannuation schemes by self-employed persons and certain employed persons (Subdiv. AB of Div. 3 of Pt III) which do not relate to the derivation of income.
[5.3] Part II of this Volume is primarily concerned with allowable deductions that relate to the derivation of income, more especially with the allowable deductions which depend on the general provisions of s. 51. The method of Part II is to deal at length with s. 51, explaining its framework and operation and drawing out the fundamental distinction between expenses which are deductible under the section as working expenses and those which are not deductible because they are of a capital nature. The specific provisions of the Assessment Act which allow deductions are then considered. Some of these provisions, for example s. 53 relating to repairs, may confirm, extend, limit or modify the principles contained in s. 51. Other specific provisions provide for the deduction of expenses which would not be deductible under s. 51, because they are of a capital nature. A number of them are of general application, for example ss 54–62 which relate to deductions for depreciation, and allow deductions of the cost of a wasting capital asset as that cost is consumed in the process of deriving income. One set of provisions of general application, Subdiv. B of Div. 3 of Pt III (investment allowance) allows a deduction of part of the cost of a wasting capital asset when that cost is incurred. It allows the deduction in addition to any deductions by way of depreciation. In this instance the function of the deduction is not to allow a cost of deriving income, but to give an incentive, by way of tax relief, to encourage certain investment action by the taxpayer.
[5.4] Some specific provisions relate to particular industries: mining (Div. 10 of Pt III), transport of certain minerals (Div. 10AAA of Pt III), prospecting and mining for petroleum (Div. 10AA of Pt III), timber operations (Div. 10A of Pt III) and Australian films (Div. 10BA of Pt III). They may allow immediate deduction of expenses that would probably not be allowable under s. 51 because they are of a capital nature (for example minerals prospecting expenditure), or allow deduction of the cost of wasting capital assets on a more generous basis than that allowed by the general depreciation provisions. These provisions may be seen as giving favoured treatment to the industries concerned. The favoured treatment amounts to subsidies to those industries. There is a body of opinion, which would question the general appropriateness of providing subsidies indirectly through tax relief. The matter is considered in the Asprey Report (Taxation Review Committee, Full Report, A.G.P.S., Canberra, 1975, Ch. 3, paras 23–26).
[5.5] The fact that the provisions of the Act applicable to a particular industry appear more generous when compared with those generally available does not always require a conclusion that the provisions are subsidy or “tax incentive” provisions. There are industries where the general provisions may not operate fairly to give deductions of the cost of wasting capital assets, and special provisions may be necessary. This was the view of the Asprey Committee in making recommendations for changes in the provisions relating to the mining industry. There can be no question, however, that the Australian films provisions in Div. 10BA of Pt III are subsidy provisions.
[5.6] The investment allowance provisions referred to in [4.3] above and in [10.421]–[10.423] below, in allowing a deduction additional to depreciation, give a deduction for a notional expense. There are other illustrations of deductions for notional expenses. The provisions of ss 80ff. allowing the deduction of a loss carried forward from an earlier year of income, may be seen in this way. The deduction is of the amount of the negative income of an earlier year—the excess of expenses of that year over the income of that year. The deduction serves to correct the unfairness that would otherwise arise under a tax system which determines the income subject to tax by reference to a period of one year—the year of income. The deduction for an income equalisation deposit provided for in Div. 16C of Pt III had a similar function.
[5.7] The provisions of s. 51(1) call for the close examination that follows, extending over this chapter and Chapters 6, 7, 8 and 9 below. The subsection provides for the deduction of “losses and outgoings”, words which may have distinct meanings, “to the extent to which they are incurred”. Apportionment is contemplated and there is a notion of incurring which is parallel with the notion of derivation in relation to income. Losses and outgoings are deductible where they are “incurred in gaining or producing assessable income”, or where they are “incurred … in carrying on a business for the purpose of gaining or producing such income”—the alternatives are referred to as the two “limbs” of s. 51(1). The subsection then proceeds to except losses or outgoings “to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income”.
[5.8] There is one aspect of this framework that requires examination at the outset: are the exceptions in the concluding part of s. 51(1) true exceptions, or are they simply statements of what must be distinguished from items which qualify for deduction under the earlier part of the subsection? The issue is between true exception and contradistinction. The issue has been the subject of some judicial debate, more especially in the High Court in John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 and in Forsyth (1981) 148 C.L.R. 203 and Handley (1981) 148 C.L.R. 182. There is no judicial decision, however, in which it has been held that an item was prima facie deductible under one or other of the limbs of s. 51(1), yet was excluded from deduction by one of the exceptions. Clearly one of the exceptions is by way of contradistinction only—the exception of losses and outgoings incurred in relation to the gaining or production of exempt income. In Fairfax Dixon C.J. drew attention to the fact that an item within this exception could not be within one or other of the limbs, since each is concerned with losses and outgoings incurred in relation to the gaining or producing of assessable income.
[5.9] What is clear in the case of the exempt income exception may not be thought so clear in the cases of the capital and private or domestic exceptions. But the fact that the exempt income exception is by way of contradistinction at least suggests that the other exceptions have the same function. And there are reasons in logic and good sense why the other exceptions should be regarded as stated only by way of contradistinction. It will be noted that the exceptions repeat the words “to the extent to which” that appear in the earlier part of the subsection. If the exceptions are true exceptions it is necessary to contemplate that there may be a loss or outgoing which is in part within one of the limbs and that some part of that part may be denied deduction by the operation of one of the exceptions. Such a framework, while logically conceivable, becomes conceptually so complex as to be unmanageable. It is no less logical to read the second use of the phrase “to the extent to which” with the first use of that phrase, so that the intention is merely to emphasise that to the extent that an outgoing is not within one of the limbs, it will be denied deduction because it is capital, private or domestic. The observation by Aickin J. in Handley (1981) 148 C.L.R. 182 at 200 that s. 51(1) “does not require a two-stage apportionment” is a denial that the capital and private or domestic exceptions are true exceptions.
[5.10] The good sense in reading the exceptions as intended only to distinguish will appear from the examination of the interpretation and application of the earlier part of the subsection which makes up much of this and following chapters. It will be seen that the pervasive idea that will explain why a loss or outgoing is within one of the limbs is that it is a “working”, “constant demand”, “operating” or “maintenance” loss or outgoing. Such losses or outgoings are contrasted in the judicial decisions with “capital” or “structural” losses or outgoings. The adoption of a view that a capital loss or outgoing may be a special kind of an expense (the word is used hereafter to cover both losses and outgoings) within one of the limbs, would require a rewriting of much of the volumes of decisions on the interpretation and application of s. 51(1).
[5.11] It is true that the judicial decisions are not locked in to language which would exclude the possibility that an expense is at once a working expense and a private or domestic expense. There are, indeed, judicial observations in Forsyth and Handley, and in other cases, that some expenses are “essentially private”. What is intended by such observations is not always clear. One possibility is that it is intended to assert that expenses which relate to such matters as the provision of food, shelter, or medical treatment for oneself, or the expense of travel between a work place and one’s home, are necessarily private and are to be denied deduction, however much they are relevant to the derivation of income. If this is the intention, the commercial traveller will be put at a severe disadvantage. It would be a disadvantage that is quite without any sense. This is not to say that expenses that relate to the provision of food, shelter and medical treatment for oneself should be readily found to be working expenses. If they are readily found to be working expenses, the application of the Assessment Act will have moved significantly towards becoming a tax only on income saved. The same observations might be made in relation to expenses of travel between a work place and one’s home.
[5.12] The view adopted in this Volume is that the exceptions in s. 51(1) operate only by way of contradistinction. Accepting this analysis, the effect of s. 51(1) is to allow the deduction of expenses relevant to the derivation of assessable income, to the extent that they are working expenses, and are contemporaneous with activity whence income is derived, or with the holding of property for the derivation of income. Such a statement of the effect of s. 51(1) may obscure some of the problems of interpretation, but it is helpful in asserting the irrelevance of the meanings of “capital” and “private or domestic”, save so far as they may identify the reason that an expense is not a working expense. Where an expense is relevant to the derivation of income, to say that it is capital is to say that it is not working because it relates not to the process by which income is derived but to the structure of the activity that produces income, or to the property itself whence income is derived. Where an expense is not relevant to the derivation of income, to say that it is capital gives no more reason why it is not a working expense than may be given by saying that it is a private expense. It may be an accepted use of words to describe the expenses of extending the house in which one lives as capital, and not so to describe the expenses of maintaining the house. Such a use of the word is not significant for the operation of an income tax, however significant it may be for the operation of a capital gains tax. What is significant for income tax purposes is that the expense is not relevant to the derivation of income. The want of relevance is sufficiently stated by saying that the expense is “private or domestic”.
[5.13] In summary, on the analysis adopted:
[5.14] The words used in s. 51 to identify the items with which the section is concerned are “losses and outgoings”. There has been very little discussion in the cases of what may have been intended by the use of these words. At times the words are quoted as if they were interchangeable. Whatever its overlap in other respects with “outgoings”, “loss” must have a distinct meaning in order that s. 51 might provide for the deduction of a specific loss where a specific profit would be income by ordinary usage.
[5.15] The view that the Assessment Act is concerned only with “receipts” and “outgoings” save where specific provisions, such as s. 25A and s. 52, provide otherwise, was examined in Chapter 1. A contrary view was taken: a gain that is income by ordinary usage may be a specific profit—the balance of proceeds over cost. Where this is so, there must be provision for the allowance of a specific loss, if loss and not profit is the outcome. The situations where specific profit is the item of income may be summarily stated thus:
[5.16] The view that the word “loss” in s. 51(1) is intended to provide for the deduction of a specific loss, where a specific profit would be income, is in some conflict with a number of observations made by Gibbs J. in Nilsen Development Laboratories Pty Ltd (1981) 144 C.L.R. 616 at 629. Gibbs J. sought to limit the significance of an observation he had made in International Nickel Australia Ltd (1977) 137 C.L.R. 347 at 352 that “where the income of the taxpayer is derived from trade there is not really a difference between the concept of income and that of profit”. He insisted that the observation was to be confined to the determination of income, and that, once income has been ascertained, the view of Dixon C.J. in Caltex Ltd (1960) 106 C.L.R. 205 at 218 must prevail: “[whether a deduction is allowable] is not a matter depending upon proper commercial principles or accountancy practice but on the legal criterion set by s. 51(1).” If commercial or accounting practice as to the determination of a profit are relevant to the conclusion that an item of profit is income, as Gibbs J. thought they were in International Nickel, it is hard to see why they should cease to be relevant if the item of deduction is a loss. There must be a deduction for a loss if circumstances otherwise the same as in International Nickel give rise to a loss rather than a profit. And if the loss is deductible, it must be so under s. 51(1), for no other provision would make it deductible.
[5.17] The case on deductibility in relation to events which involve a taxpayer being deprived of an asset reflect a less than adequate analysis of the significance of the use of the word “loss” in s. 51(1). The cases are considered in [6.52]–[6.77] below. A taxpayer may be deprived of an asset because it has been taken from him by another (an employee or a third party) or by its destruction. Whatever the cause of deprivation, the item of deduction, if any is allowable, is the loss suffered in the sense of the failure of the asset to realise its cost. Where a revenue asset, such as a spare part held for use in making repairs to assets of a business, is destroyed and there is no residual value in the scrap, there will be a deduction of a loss in the amount of the cost of the spare part. The item of deduction is not the value of the item, and any suggestion that it is involves a confusion between the word loss in its usage in s. 51(1) and its usage in a phrase such as “the taxpayer suffered the loss of a quantity of spare parts by their destruction in enemy action”. The judgments in Guinea Airways Ltd (1950) 83 C.L.R. 584 do not clearly differentiate these distinct usages, though the usage in the sense of the correlative of specific profit is implicit in the assumption that the appropriate deduction was the cost of the spare parts, not their value at the time the taxpayer was deprived of them by destruction.
[5.18] Where the property of which the taxpayer is deprived is cash, the appropriate item of deduction will be the amount of the cost of the cash. Save where the cash is in foreign currency, the cost may be taken to be the amount of the cash, and there will be no difference in the amount of the deduction whether the item of deduction is seen as a loss by failure of the asset to realise its cost or as an outgoing of the amount of the cash. But the characterisation of the item as a loss by failure of the asset to realise its cost focuses the question on the nature of the holding of the cash—whether it is held on revenue account, on capital account or on private account.
[5.19] The view that the word “loss” in s. 51(1) refers to the failure of an asset to realise its cost does not exclude the possibility that the word may be used in the sense of outgoing by deprivation in other sections of the Act. Section 59, for example, in the reference to property in respect of which depreciation has been allowed being “disposed of, lost or destroyed”, uses the word “lost” to refer to a deprivation, presumably a deprivation by being unable to find the property. Yet the deduction allowed, it should be noted, is akin to the deduction of a loss under s. 51(1). It is a deduction of the depreciated value of the property, generally the cost of the property moderated by any consideration receivable in respect of the loss by deprivation.
[5.20] These uses of the word “loss”—to refer to the failure of an asset to realise its cost and to refer to the deprivation of an asset—must be distinguished from another use of the word. In ss 80ff. provision is made for the deduction, against assessable income of later years, of a “loss” being the amount of the excess of allowable deductions over assessable income in an earlier year. The word loss in this context has its parallel in the negative balance of a profit and loss account in financial accounting. The reference is not to a specific loss in relation to some asset, but to a failure during a year of income to generate assessable income at least equal to the expenses of that year, expenses which may include specific losses.
[5.21] It is apparent from the cases on exchange losses that the word “loss” in s. 51(1) covers both the failure of an asset to realise its cost, which has so far been assumed to be the meaning of the word in the subsection, and the discharge of a liability by paying an amount greater than the amount at which that liability has been brought to account as a deduction by an accruals basis taxpayer, or the amount acknowledged to be payable in respect of a borrowing on revenue account. The deduction for a loss in these circumstances, is the correlative of the inclusion in income of a specific profit on the discharge of a liability on revenue account.
[5.22] The reference in s. 51(1) to a “loss” incurred is a reference to a realised loss. No deduction is allowable under s. 51(1) comparable with the deduction for an unrealised loss by way of depreciation in s. 54ff.
[5.23] References under the last heading to the distinction, within expenses deductible under s. 51(1), between outgoing and loss raise a question of the reason for the non-deductibility as an outgoing of a cost that will enter the determination of a specific profit which is income, or a specific loss which is deductible.
[5.24] Section 51(2) provides that the “expenditure incurred or deemed to have been incurred in the purchase of stock used by the taxpayer as trading stock shall be deemed not to be an outgoing of capital or of a capital nature”. It is assumed that the effect is to ensure the immediate deductibility of the cost on the purchase of trading stock. Such a deduction is necessary if the trading stock provisions in ss 28ff. are to operate fairly. An increase in the value of trading stock on hand at the end of a year of income over trading stock on hand at the beginning of a year of income must be included as assessable income. The value of trading stock acquired during a year which are still on hand at the end of the year will therefore increase the assessable income. The intention is that the cost of acquiring such stock will be deferred, by this increase in assessable income, to the next year of income or a later year when the stock is sold. The mechanism of s. 28 requires that there be a deduction on which the deferral can operate. Section 51(2) seeks to ensure that there is such a deduction, by removing what was thought to be the reason for denying such a deduction. The subsection is not happily expressed. It led to some speculation by Dixon C.J. in John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 at 35 who inclined to the view that the cost of trading stock would not in any case be regarded as being of a capital nature. It is clearly not of a capital nature in the sense explained later in this and following chapters. It does not relate to the structure of the business, unless stock has been acquired beyond any holding for sales in the ordinary course of business: at some point the acquisition of stock could relate to structure for the same reason that the acquisition of an abnormal quantity of spare parts was held to relate to structure in some of the judgments in Guinea Airways Ltd (1950) 83 C.L.R. 584. The acquisition of trading stock to be sold in the ordinary course of business is a capital outgoing only in the sense that the cost should be “capitalised”, the word being thus used in an accounting sense to refer to costs which should not have any present effect on the profits of a business. Section 51(2) would have avoided using the word capital in a sense different from its use in s. 51(1), had it simply provided that expenditure on trading stock shall be deemed to be an outgoing for purposes of s. 51(1). Without some such provision, the cost of trading stock, like the cost of other revenue assets which are non-wasting, would not be deductible under s. 51(1). The word outgoing, it is submitted, connotes an outlay which is consumed or will be consumed in the process of derivation of income. The cost of a non-wasting revenue asset involves an outlay, if that word is used simply to denote the payment of money or the transfer of other property, but not an outgoing. The cost of the non-wasting asset may be equated with the outlay of a $10 note in exchange for 10 $1 notes. The outlay will not be consumed in the process of derivation of income.
[5.25] The need to accept the proposition that the cost of a non-wasting asset is not an outgoing and is not deductible under s. 51(1), may be demonstrated by considering the consequences of a contrary proposition if shares and land had not been held to be items which fell within the definition of trading stock in s. 6 of the Assessment Act. A trader in shares or land would need only to consider his likely taxable income at a time near the end of the year of income, and make purchases of shares or land whose cost would equal his anticipated taxable income. He would in the result have no taxable income, and by repeating the same operation each year could accumulate wealth but never have any taxable income. An awareness of this consequence may have disposed the High Court in Investment & Merchant Finance Co. Ltd (1971) 125 C.L.R. 249 to hold that shares could be trading stock, so that the mechanism of s. 28 would operate to require that a deduction of the cost of the shares would, in effect, be deferred to the year of income in which they were sold. But this way out is not available where an item cannot be brought within the mechanism of s. 28. It will not be possible in the circumstances of London Australia Investment Co. Ltd (1977) 138 C.L.R. 106 and in the other circumstances listed in [5.15] above. In those circumstances the assertion that specific profit is the item of income carries the consequence that the cost of the item is not deductible as an outgoing.
[5.26] It must be conceded that the identification of a cost which is an outlay but not an outgoing, may pose difficulties of the kind that have to be met in the operation of the trading stock provisions in deciding whether costs of trading stock which are not direct are to be treated as costs that must be deferred by the mechanism in s. 28. The difficulties are a consequence of an insistence by the Commissioner on what is referred to as “absorption” costing: Philip Morris Ltd (1979) 79 A.T.C. 4352.
[5.27] The two limbs of s. 51(1) are:
[5.28] The words “to the extent to which” and the second limb were added to the general deduction section in 1936. The significance of the words “to the extent to which” is the subject of some comment later in this chapter. The intention in the adding of the second limb, according to an observation in Ronpibon Tin N.L. (1949) 78 C.L.R. 47 at 55 was to overcome a view that an outgoing whose purpose is to reduce future expenses—by achieving economies and greater efficiency—is not deductible under the first limb. However, W. Nevill & Co. Ltd (1937) 56 C.L.R. 290 is authority that this view was always mistaken.
[5.29] The second limb is confined in its operation to expenses incurred in carrying on a business. “Business” is defined in s. 6 so that it will include activity which would amount to a business for purposes of the ordinary usage principle expressed in Chapter 2 as Proposition 14 ([2.429]ff. above), so far as that principle relates to what is there identified as a continuing business. It will not however include the simple holding of property whence income is derived. And s. 6 expressly excludes “occupation as an employee”.
[5.30] The second limb of s. 51(1) would however appear to overcome the difficulties which attend the use of the word “the” before “assessable income” in the first limb of s. 51. Though endeavours have been made in the cases—in Ronpibon (1949) 78 C.L.R. 47 at 56, in the judgment of Dixon C.J., in Finn (1961) 106 C.L.R. 60 and in other judgments referred to by Lockhart J. in Total Holdings (Aust.) Pty Ltd (1979) 79 A.T.C. 4279 at 4282—to read the word “the” so far as possible out of the first limb of s. 51, there may yet be room for a submission that the first limb does not justify a deduction where the income-earning activity, or the holding of property to which the outgoing relates, has not produced any assessable income in the year of income in which the deduction of the outgoing is claimed. It is arguable that interest is not deductible where it is interest paid on a loan of money which has been invested in shares, if no dividend has yet been received or no dividend has been received in the year of income. If the second limb is attracted, the limitation suggested on the operation of the first limb will be escaped. At least this will be so if the word “such” before “income” in the second limb is taken to refer to assessable income in general, as is suggested in Ronpibon (1949) 78 C.L.R. 47 at 56 and in Snowden & Willson Pty Ltd (1958) 99 C.L.R. 431 at 436, per Dixon C.J.
[5.31] Where the income-earning activity to which the deduction relates has generated assessable income in the year of income in which the deduction is claimed, it would not appear that the second limb carries the range of deductible outgoings beyond the first limb. There is, it is true, some suggestion in the judgment of Fullagar J. in Snowden & Willson at 443 that the second limb does extend the range of deductible outgoings in one respect: it may cover business expenditure “arising out of exigencies created by unusual or difficult circumstances” which, the suggestion is, would not be covered by the first limb. The suggestion is also made by Fullagar J. in his judgment in John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 at 40.
[5.32] The word “necessarily” in the second limb might have been construed so as to limit the operation of the limb in a way not applicable to the first limb. It has, however, been construed as requiring no more than that the expense should be “clearly appropriate” or “adapted” for the carrying on of the business (Ronpibon (1949) 78 C.L.R. 47 at 56; Snowden & Willson Pty Ltd (1958) 99 C.L.R. 431 at 436-7 and 444). In Snowden & Willson Dixon C.J. at 437 interpreted the word “necessarily” as meaning “dictated by the business ends to which [the expenditure] is directed, those ends forming part of or being truly incidental to the business”. The connection with the derivation of income required by the second limb, would not appear to be any closer in this regard than that required by the first limb.
[5.33] Whether the applicability of the first limb or the second limb is in question, the inquiry must be concerned with the connection between the expense and the particular process of derivation of income. It is for this reason, and not because he does not have available to him the words in the second limb, that an employee may appear to be less favourably treated than the self-employed person. The different treatment of the employee compared with the self-employed person, for example, in relation to self-education expenses, is considered in [8.38]ff. below.
[5.34] Whichever limb the taxpayer relies upon, it is not necessary for him to show that in the year of income there was assessable income, or that there was an expectation of assessable income, with which the outgoing can be matched. In the language of Ferguson J. in Toohey’s Ltd v. C. of T. (N.S.W.) (1922) 22 S.R. (N.S.W.) 432 at 440, it is not necessary to “track each item of expense … and allocate it to some definite item of income”, as if to determine that a “lump of coal put into a steamer’s furnace was responsible for a particular blast from the whistle”. The tracing of self-education expenses into increased salary proposed by Menzies J. in Hatchett (1971) 125 C.L.R. 494 as a test of deductibility may be seen as simply one test of relevance and thus reconcilable with Toohey. On other occasions, however, a “blast from the whistle” approach does appear to have influenced judicial decision. In Chapkhana (1977) 77 A.T.C. 4412 Wickham J. supported his conclusion that premiums on a personal disability policy taken out by an employee were not deductible by saying: “there is no sufficient reason for concluding that the occasion of the outgoing constituted by the premiums is such as would be expected to produce income” (at 4414). His reason adopts some of the language of Ronpibon (1949) 78 C.L.R. 47 at 57 where the High Court said: “the occasion of the loss or outgoing should be found in whatever is language. Tracing has, more recently, been expressly rejected by the Federal Court in Total Holdings (Aust.) Pty Ltd (1979) 79 A.T.C. 4279 at 4283, per Lockhart J.
[5.35] It might, however, have been thought that s. 51 requires that an outgoing, to be deductible, must be matched with the income of the year of income, in the sense that it is an outgoing which accounting principles would regard as a proper charge against the income of that year of income in computing the profit of that year. But the courts have not held that, to be deductible, an outgoing need be so matched: Ronpibon (1949) 78 C.L.R. 47; Herald & Weekly Times Ltd (1932) 48 C.L.R. 113; W. Nevill & Co. Ltd (1937) 56 C.L.R. 290; Texas Co. (Australasia) Ltd (1940) 63 C.L.R. 382; and John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30 especially per Menzies J. at 45–46.
[5.36] Some matching does result, it will be seen in Part III, from the principle of tax accounting established in Arthur Murray (N.S.W.) Pty Ltd (1965) 114 C.L.R. 314 that a receipt is not income derived until it has been earned. The effect of this principle may be to delay the derivation of income until the year of income in which matching outgoings are incurred. But it seems that there is no principle of tax accounting which will require the deferring of an outgoing to the year of income in which matching income is derived. The Privy Council in B.P. Australia Ltd (1965) 112 C.L.R. 386 and the House of Lords in Strick v. Regent Oil [1966] A.C. 295 did not consider it appropriate to defer the costs of wasting revenue assets—contracts under which garage proprietors agreed to sell only the taxpayer’s products—over the life of those assets. There is no principle of tax accounting which would allow the carrying back of a receipt or an outgoing to the year in which matching deductible outgoings or income receipts were incurred or derived. Such carrying back would in many cases be precluded in any event by the limitations on the Commissioner’s powers to amend assessments under s. 170.
[5.37] Ronpibon and Amalgamated Zinc (De Bavay’s) Ltd (1935) 54 C.L.R. 295 have drawn from the use of the words “in gaining” in the first limb and “in carrying on” in the second limb, a requirement that an expense to be deductible must be contemporaneous with the process by which income is derived. These cases emphasise that the outgoing must have been incurred “in the course of” the income-producing activity or the holding of the income-producing property to which the income relates. If the outgoing is incurred before that activity commences (Maddalena (1971) 45 A.L.J.R. 426) or before the property is acquired, or if it is incurred after the activity ceases (De Bavay’s; Ronpibon; Pennant Hills Restaurants Pty Ltd v. Barrell Insurance Pty Ltd (1981) 145 C.L.R. 625, per Gibbs J. at 642) or the property is disposed of, it is not an allowable deduction. In the latter aspect the law as to deduction differs from the law as to when a receipt is income. A receipt which is a product of an income-producing activity or which is derived from property will be income notwithstanding that it is derived after the activity has ceased or the property has been disposed of. This is the assumption in Hayes (1956) 96 C.L.R. 47 and Squatting Investment Co. Ltd (1954) 88 C.L.R. 413.
[5.38] In De Bavay’s and Ronpibon the expenses were not deductible because the business had ceased. In De Bavay’s the expenses—contributions to a fund to compensate employees who had incurred a disease associated with mining—were incurred at a time when the company had given up all thought of mining. And in Ronpibon, where the expenses included the payment of allowances to dependants of employees who were now interned by the enemy, the resumption of mining was impossible because the mines had been overrun by the enemy. In other circumstances, there may be some question as to whether the business has ceased. In A.G.C. (Advances) Pty Ltd (1975) 132 C.L.R. 175 it was held that the business had not ceased. It had merely been suspended. The expenses—losses in respect of bad debts—were incurred after the business had resumed, and the case does not decide how expenses during the period of suspension should be regarded. Queensland Meat Export Co. Ltd (1939) 81 St. R. Qd. 240 may indicate that expenses are deductible if the business is merely suspended. The distinction between cessation and suspension thus becomes important. It may be asked whether a business is merely suspended if it has ceased to be profitable to carry on business, as in the facts of Heavy Minerals Pty Ltd (1966) 115 C.L.R. 512 or if raw material supplies have become inadequate, as in Queensland Meat Export Co. Ltd, and plant is put on a care and maintenance basis. It is arguable that there is a mere suspension if the taxpayer has the intention to resume operations when it is thought commercially appropriate to do so, though Inglis (1977) 77 A.T.C. 4305 may reject such an argument. There is a question of how Ronpibon is to be distinguished—in that case the resumption of operations, at least in the same country as that in which the former operations had been carried on, was physically impossible. Ronpibon involves a notion of business which is specific to particular assets: presumably the same view would have been taken in the case, in regard to the deduction claimed for the dependants’ allowances, even though the company continued to operate a mine in Australia.
[5.39] Where there is a decision by the taxpayer permanently to cease operations, cessation does not necessarily occur on the taking of that decision: it is still possible that expenses of administration and maintenance are deductible pending realisation of the business assets: I.R.C. v. South Behar Railway Co. Ltd [1925] A.C. 476.
[5.40] In A.G.C. (Advances) the majority opinions (Barwick C.J. and Mason J.), while accepting the contemporaneity requirement, albeit with some reluctance, suggest that there may be a distinction to be drawn between an outgoing incurred after cessation, and a loss which though incurred after cessation, is in respect of an asset acquired before cessation. The deductions claimed in A.G.C. (Advances) were in respect of receivables that had arisen in the course of the business activity but had failed to realise their cost, as the Commissioner submitted, after the cessation of the business. It is arguable that a loss in these circumstances is more closely connected with the business activity than the payments to the fund in De Bavay’s, or the payments of the allowances in Ronpibon.
[5.41] Problems as to the moment of commencement of a business are no less than the problems as to the moment of cessation. A feasibility study, in the sense of a study to determine whether a decision to commence business would be sound commercially, comes too soon. At least this is so if one identifies “the business” for purposes of the contemporaneity principle as specific to a particular undertaking as in Ronpibon. Cf. Broken Hill Pty Co. Ltd (1969) 120 C.L.R. 240 at 258-60.
[5.42] An aspiring author who incurs expenses in collecting material for a book may be held to have incurred expenses which come too soon. The questions whether a business of authorship has yet commenced, and, if it has, when it commenced, will involve issues considered in [2.439]–[2.443] above. Ferguson (1979) 79 A.T.C. 4261 will have some bearing.
[5.43] The contemporaneity requirement, where the item is a pre-commencement expense, may be reinforced by the requirement that to be deductible an expense must be a working expense. A feasibility study may be thought to relate to the structure of the business to be established rather than to the process of business operations, and for this reason not to be a working expense. A postcessation expense may be less likely to fail to qualify as a working expense, but Foxwood (Tolga) Pty Ltd (1981) 147 C.L.R. 278 may suggest the possible characterisation of an expense as not working because it relates to the closing down of the business.
[5.44] The requirement of contemporaneity may defeat the allowance of a deduction where the expense relates to income derived from property. Interest payments on money borrowed to finance the erection of an office building for letting, and incurred before any part of the building is let, may be denied deduction as expenses incurred before the process of deriving income commences. The question raised is whether the process of deriving income commences at the time of a decision to build or only when at least part of the building is let. The answer may depend on whether the letting is an aspect of a business activity, and on the time when that business commences. There will be a question whether “business”, as the word is used in s. 51(1), has the meaning it has in ordinary usage principles (Proposition 14 in Chapter 2). The definition of the word in s. 6 may suggest that it does, and that is the view taken in this Volume. The judgment of Jones J. in Somers Bay Investment (1980) 80 A.T.C. 4411 may indicate that it has a wider meaning.
[5.45] Payment of rates, repairs and interest expenses after the cessation of the letting of property may be denied deduction under s. 51(1) by the contemporaneity requirement. Again it will be relevant that the letting may be seen as part of a business of letting and that the business has not ceased. The contemporaneity requirement will of course only apply if the deduction is claimed under s. 51(1). Expenses of rates and repairs may be deductible under the specific provisions of ss 72 and 53. A deduction for rates is not allowable under s. 72 unless the amount “is paid in respect of land that is, or premises that are, used by the taxpayer during the year of income for the purpose of gaining or producing income or carrying on a business for the purpose of gaining or producing income”. The deduction for repairs under s. 53 is subject to a similar provision, though words requiring that the property be used “during the year of income” do not appear. In effect ss 72 and 53 have their own contemporaneity requirements, and may give rise to problems of interpretation. It may be asked whether a relevant use of land by the taxpayer at any time during the year of income is sufficient to satisfy the contemporaneity requirement, if the payment is made at a time when the land is not used in a relevant way. And it may be asked whether use by the taxpayer at any time will justify a deduction for repairs effected during a year of income. Subsection (3) of s. 53, added in 1984, may suggest that it will.
[5.46] The requirement of contemporaneity may defeat the allowance of a deduction where the expense relates to employment income. The leading case is Maddalena (1971) 45 A.L.J.R. 426, where travel expenses were incurred in seeking a contract of employment to play football for a club, and legal expenses were incurred in relation to the making of that contract. The High Court contrasted the taxpayer’s position with that of a self-employed plumber, who may incur expenses of obtaining contracts in quoting for work to be done. The self-employed person has already entered on an income earning activity. The person seeking employment has not. At least this is so, in the view of the court, if the employment will involve a contract of service, as distinct from a contract for services.
[5.47] The technicalities of that distinction might have been thought remote in resolving the broad issue of principle posed by s. 51(1). Maddalena could have been decided on the basis that the expenses were not working expenses. They were capital as expenses relating to the structure of the income-earning activity—the contract of employment. The contract was a structural asset, as distinct from a revenue asset. A contract of service will normally be a structural asset, though C. of T. (Vic.) v. Phillips (1936) 55 C.L.R. 144, in the judgment of Starke J., suggests the possibility that a contract which is one of a number of contracts of service entered into by the same person may be a revenue asset of a business of providing services under contracts of service. At the same time, a contract for services may be a capital asset of a business of providing services. The discussion in [2.384]–[2.385] above is relevant. The result in Maddalena would, presumably, have been the same had it been approached not in terms of contemporaneity but in terms of the distinction between structural and working expenses. The approach in fact taken leaves a suggestion of a disadvantage imposed by s. 51(1) on a person who derives income under a contract of service. There is a reinforcement of the suggestion of discrimination already present in the words of the subsection, which confine the second limb to “business” situations, and in the definition of “business” in s. 6 so as to exclude “occupation as an employee”—the latter words, it would be assumed, refer to activity under a contract of service.
[5.48] A consequence of Maddalena is that the payment of a periodical subscription in respect of the taxpayer’s membership of a trade or professional association, made in anticipation of entering a sole contract of service, is not deductible under s. 51(1). It may be deductible under the specific provision in s. 73(3), which does not impose any test of contemporaneity, though it is narrower in other respects than s. 51(1). Another consequence of Maddalena is that the payment of a periodical subscription at a time when the taxpayer is not employed under a contract of service—is “unemployed”—is not deductible under s. 51(1). The case, indeed, leaves one to doubt the wisdom of a contemporaneity rule. It may yet be possible for a court to hold that the absence of contemporaneity is no more than an indication that an expense is not relevant. Which will leave room for a conclusion that other factors may give relevance to a non-contemporaneous expense.
[5.49] The view of the framework of s. 51(1) explained in [5.7]–[5.13] above, has the consequence that, to be deductible, an expense must be relevant to the derivation of assessable income, and must be a working expense. These two elements tend to be run together in much of the judicial elaboration of the operation of s. 51(1). It is summed up in the phrase “incidental and relevant”. The phrase is unhelpful, to the extent that it places the two elements out of their logical order. The first issue must always be whether the expense is relevant. If it is not, it is not deductible. It may be described in this event as “private or domestic”, though the appropriateness of such a description is not an issue of itself going to deductibility. If the expense is relevant, it will be deductible if it is a “working expense”—a phrase which is more expressive of the criterion than “incidental”. Other expressions of the criterion are “constant demand”, “operating” or “maintenance”. If a relevant expense is not a working expense, it may be described as “capital”.
[5.50] To be deductible under s. 51(1) an expense must be relevant to the derivation of assessable income. The requirement of relevance to assessable income is emphasised by the contradistinguishing exception of expenses relevant to the derivation of exempt income. The requirement of relevance to assessable income imports all the principles explored in Part I. Thus working expenses which relate to property will be deductible if the property is held for the derivation of income in the carrying on of a business, or is held for the derivation of income from property. A conclusion that gains are not income because there is no business from which the gains arise (Proposition 14 in Chapter 2) will carry the consequence that expenses which relate to those gains are not deductible. The hobby farmer is not entitled to deductions under s. 51(1), because gains from his activity are not income. A conclusion that the letting of property to another at a modest rental, moved by a charitable motive or family generosity, is not a letting which can give rise to a gain derived from property, will carry the consequence that expenses which relate to the property let are not deductible. The matter is more fully considered in [6.161]–[6.167] below. It is enough to note at this point that the question whether any rent arising from the letting is income, or would be income if derived, is primary. The answer may be that it is not, if the purpose of the letting was not to obtain a commercial return, just as gains from an activity which could amount to a business will not be income if the purpose of the activity is not to derive an overall profit from that activity. In the same way, a conclusion that the lending of money to another at no interest or at a modest rate of interest, moved by a charitable motive or family generosity, is not a lending which can give rise to a gain derived from property, will carry the consequence that an interest expense which relates to the money lent is not deductible.
[5.51] While logically distinct, the issues of relevance and working character tend to be run together in a decision on the deductibility of an expense. Where however the focus of the discussion is on the private or domestic contradistinction, the issue is likely to be simply one of relevance. The expenses of travel to and from a place of work could hardly be seen as other than working. The issue, as in the cases of the expenses of food and clothing, is whether the expenses are sufficiently related to the process of income derivation. The resolution of that issue cannot always depend on precedent and logic. At the margin of any legal principle a policy judgment must be made, though most often that policy judgment will be obscured by judicial observations on the “difficulties” experienced in coming to a decision. A conclusion that an expense is private or domestic may be dictated by the need to preserve the base of the income tax against a submission which can be made in regard to almost any expense imaginable, that it has some relevance to the derivation of income. The minority judgments in Forsyth (1981) 148 C.L.R. 203 and Handley (1981) 148 C.L.R. 182 are impeccable in their logic. There is no question that home-study expenses have some relevance to income derivation. The logic of the majority judgment is not impeccable. The notion of “essential character” of expense does not clarify. It serves only to obscure the policy decision that to allow deductions of all home-study expenses would be to set the point where expenses are sufficiently connected to be relevant so far from the process of derivation of income, that the base of the income tax is in danger of becoming limited to income saved. These matters are considered further in [8.10]–[8.37] below.
[5.52] Where questions of relevance and working character are run together, it is generally because there can be no question of relevance, and the issue is simply whether the expense is a working as distinct from a capital expense. John Fairfax & Sons Pty Ltd (1959) 101 C.L.R. 30, considered in [7.61]–[7.62] and [7.70] below affords an illustration.
[5.53] Sometimes, however, relevance and working character are virtually indistinguishable. Some of the cases involving events by which a taxpayer is deprived of his assets, considered in [6.52]–[6.77] below, might equally be explained on the score of relevance as on the score of working character.