Commissioner of Taxation v Faywin Investments Pty Ltd

Re: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
And: FAYWIN INVESTMENTS PTY LIMITED
Nos. G684-685 of 1989
FED No. 185
Income Tax
90 ATC 4361
22 FCR 461

COURT

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Bowen C.J.(1), French(1) and Hill(2) JJ.

CATCHWORDS

Income Tax - allowable deduction - Australian Film - investment - after production almost completed - reimbursement of capital contributed by Film Corporation - payment made through production account - whether "expended . . . in producing a film" - policy of Division 10BA.

Words and Phrases - "expended directly in producing a film" - "directly"

Income Tax Assessment Act 1936 Division 10BA

Copyright Act 1968 ss. 86 and 90

HEARING

SYDNEY

#DATE 10:5:1990

Counsel and Solicitors : Mr T.M. Jucovic QC and
for appellant Mr S.J. McMillan instructed by

Australian Government Solicitor
Counsel and Solicitors : Mr A.H. Slater instructed by

for Respondent Messrs Freehill Hollingdale and Page

ORDER

The appeals are dismissed.

The appellant pay the respondent's costs of the appeals.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

JUDGE1

In January 1981 Faywin Investments Pty Limited contributed $600,000 to the cost of producing an Australian Film "Hoodwink". Although payment was made to a production account in the name of the producer the money, along with funds contributed by another investor, was immediately applied to reimburse the New South Wales Film Corporation to the extent of $700,000 for funds already contributed by it, the bulk of which had been expended in connection with the production of the film which was then almost completed. Faywin filed its return for the years ended 30 June 1981 and 30 June 1982 on the basis that it was entitled to a 150% deduction on the $600,000 it had expended pursuant to the provisions of Division 10BA of the Income Tax Assessment Act 1936 relating to investment in Australian films and applying s.23H in those two years in relation to half of its unrecouped capital expenditure. The Commission has however assessed Faywin on the basis that its expenditure, being applied to reimburse the Corporation, was not money expended in producing a film in the sense that it would give rise to the benefits conferred by Division 10BA. Faywin objected to the assessments issued on that basis for 1981 and 1982 but its objections were disallowed. An appeal was then instituted which ultimately came on before Lockhart J. and was successful. The Commissioner now appeals against that decision to the Full Court.

Factual Background

On 1 October 1980 the Prime Minister in an election policy speech announced proposals to provide substantial new income tax benefits for investors in the production of Australian films. The announcement was followed by a detailed press release by the Minister for Home Affairs on 18 December 1980. Central to the proposal was a 150% tax deduction on the amount of capital expended by investors on or as a contribution towards production costs of Australian films. The relevant legislation embodied in a new division 10BA of the Income Tax Assessment Act was introduced into the House of Representatives in May 1981 and took effect from 26 June 1981. It was initially expressed to provide deductions in respect of capital expenditure under contracts entered into after 28 May 1981 and, subject to the Commissioner being satisfied that expenditure under contracts entered into after 1 October 1980 would satisfy the same criteria, that expenditure would attract the same tax concessions.
The present case concerns a film called 'Hoodwink'. The facts were not in dispute. Development of a script for the film based upon an existing manuscript by Karl Synnerdahl was undertaken in early 1978 and 1979 by CB Films Pty. Ltd. with financial support to the extent of $16,600 from the New South Wales Film Corporation. In return for that support the Corporation acquired 70% of the film rights including the right to adapt the manuscript and to use any adaptation for making a film. A further advance of $10,500 was made by the Corporation in May 1980 to enable CB Films to pay for copyright in existing draft scripts and to commission and acquire two further scripts. In consideration of that advance the Corporation was to take a 70% interest in the project, described in the agreement then made between the parties as "the total undertaking of producing and marketing the film and script and any rights whatsoever in connection therewith or arising in the course of the development thereof". $80,000 was advanced under a deed dated 27 June 1980 and expressed to supersede all prior agreements. The Corporation under that deed acquired 90% of the beneficial interest in "the project" as previously defined.
The project progressed and on 3 October 1980, two days after the Prime Minister's announcement, the Corporation wrote to CB Films confirming that it would invest $750,000 in the film "on and subject to" certain terms and conditions which were set out. These included:-

"1. Production budget: $1,000,000.00 (AUS);

2. Commencement of Principal Photography: on or about 10 November 1980;

3. Private Sector Investment: $250,000.00 - to be underwritten by the Corporation;

4. The Corporation may elect to lay off part of its $750,000.00 (AUS) investment to third parties.

.

.

.

6. That the Corporation recoups its investments pari passu and pro rata with the private investments and be entitled to the portion of 100% of net profits of the film represented by: Producers 30% Investors including Corporation 70%.

7. The Corporation will provide up to $150,000.00

(AUS) to meet any overages on the production budget on condition that any sums so provided bear interest thereon at the rate of 12% per annum recoverable immediately before the investments. The production budget shall be increased to incorporate any fee charged by the Corporation."

Filming commenced in November 1980 and was completed by 30 April 1981. The Corporation paid CB Films a total of $915,000 up to 31 December 1980. This included the script development payments made in January 1979 and subsequently. Of this sum $835,642 had been spent in connection with the production by 4 January 1981. A further $200,000 was paid in March 1981.
As foreshadowed by its letter of 3 October 1980 the Corporation moved in January 1981 to "lay off" part of its investment with third parties. On 19 January 1981 it entered into a deed with three investors, Faywin Investments Prop.Ltd, Dominguez and Barry and one Peter Hains.
The terms of the deed represent a rather awkward adaptation of a form of agreement contemplating investment in advance of production rather than, as was the case here, after the bulk of production costs had been incurred. The parties were the Corporation (designated NFC in the agreement), CB Films, the Investors set out in the first schedule and two directors of CB Films, Olive and Sullivan, designated as guarantors.
The deed recited CB Films' desire to produce the film 'Hoodwink' (recital A), the delivery of a script to the Corporation (recital B), the fact that filming commenced on 10 November 1980 (recital C), that Mr Claude Watham had agreed to direct the film (recital D) and that the budgeted cost of the film totalled $1,115,000 (recital E). Cash investments were to be made by the Corporation to the extent of $515,000 and by the investors to a total of $600,000. The Investors could be added to from time to time with comcomitant reductions in the Corporation's contribution (recital F). The film was to be distributed by Hoyts Theatres Ltd (recital G) and the guarantors had agreed with CB Films to act as co-producers of the film and to guarantee to the Corporation and the other Investors the due performance by CB Films of its duties and obligations under the deed (recital H). The opening of an account styled "Hoodwink No. 1 account" and another styled "CB Films Pty Limited, Hoodwink Imprest account" also designated as the No. 2 account were set out in recital I. Recital J recorded that the Corporation had undertaken to supervise the production and distribution of the film "in the manner hereinafter mentioned".
Clause 1 of the substantive provisions of the deed contained various definitions including that of the term "Investors" as follows:-

""Investors" includes each and all persons who prior to completion of the film agree with the Production Company with the prior written consent of the NFC to pay or provide money or services to the Production Company to acquire the Copyright or part thereof and includes the NFC and the Other Investors but does not include any person who only provides services (without the written consent as aforesaid) or lends or gives money for the production. Any one of the Investors is referred to as "an Investor". "Investment" means the respective amounts actually paid or provided to the Production Company by the Investors pursuant to this Deed in the acquisition of the Copyright or an undivided part thereof and does not include moneys lent or given by the Investors and in relation to each Investment "Investment" has a corresponding meaning."

CB Films covenanted, by clause 2, to commission the composition of a musical soundtrack for the film and to become full copyright owner in relation to the film script, music and the manuscript. By clause 2.4(a) it assigned absolutely to the Investors the whole of the copyright mentioned earlier in clause 2. It covenanted also to secure the services of the cast and crew set out in the fifth schedule (clause 3). Clause 3A referred to the stated intention of the Commonwealth Government to introduce legislation enabling the 150% deduction for investment in the production of Australian films and the requirement, as a pre-condition of that deduction, that a certificate be issued in relation to each such film. It provided for the investors to have the option, if the legislation did not proceed, or a certificate were not granted, to require from the corporation the return of their full cash outlay.
Clause 4 established a No. 1 account and provided for its operation upon "the joint signatures of a nominee of the NFC and or a nominee of the Production Company (sic)". All moneys in the No. 1 account and the No. 2 account were to be held on trust and applied only in accordance with the budget and the provisions of the deed (Clause 4.1(h)). Clause 4.2 provided:

"4.2 Each Investor shall pay into the No. 1 Account moneys in the amounts and at the times prescribed in the cash flow chart comprising part of the Second Schedule hereto."

Reflecting the maladaption of the deed to the actual circumstances of the case clause 4.3 provided for the payment of $15,000 from the No. 1 to the No. 2 account 14 days before commencement of principal photography.

Clause 4.A provided that all funds at any time standing to the credit of the No. 1 account would be the property of each investor in the proportion that his investment bore to the whole of the money paid into the account should not be dealt with except in the manner prescribed. 4.A.1(b) permitted investment of surplus funds in the No. 1 account by CB Films as trustee for the investors subject to the direction of the Corporation and in clause 4.A.2 it was provided:-

"4.A.2 On payment from the No.1 Account or from the No. 2 Account of moneys necessary to comply with the requirements of clause 5 or the requirements of the Budget so much of the moneys so paid as are owned by Investor (excepting any moneys paid pursuant to clause 8.4 hereof or otherwise borrowed to satisfy over budget expenses) shall by that payment be converted into an investment."

Any surplus after completion of production was to be applied to the marketing of the film. Again, inappropriately to the circumstances of the investment, clause 5A provided for pre-production clearance of Trade Union membership of personnel employed in the film, observance of award requirements and the obtaining of all relevant authorisations, agreements, licences or clearances required by law to employ any of the cast or crew.

Clause 5 provided for production to proceed as soon as practicable "following the execution hereof" and contained covenants as to the competence of CB Films, production standards, completion within the production schedule, access to sets by Investor representatives, retention of the title "Hoodwink" credits, previews, production reports and budget over-runs. It also provided for recovery by the investors of their moneys if any one of various default events were to occur. Other covenants relating to indemnity agreements, infringements of copyright, other actionable wrongs on the part of CB Films (clause 6) Insurance (clause 7) and budget variations (clause 8) were also set up. Clauses 9 and 10 related to ownership of the copyright in the film. Each investor's share of the copyright was to be in the proportion that its investment bore to the budgeted cost set out in the Schedule. To the extent that the Corporation had an interest in the future copyright in the film that interest was assigned in part by operation of these provisions. It was not disputed before his Honour that by reason of the payment made by Faywin under the deed it later became one of the first owners of the copyright in the film. Marketing and distribution of proceeds were covered in clauses 11 and 12 and other forms of exploitation of the copyright in clause 13. Information relating to the accounts, the Guarantors' guarantee and indemnity and disclaimer of a partnership relationship were dealt with in clauses 14, 15 and 16. Among the other ancillary provisions (clauses 17 to 21), clause 18 provided that the deed would "supercede all former agreements between all or any of the parties hereto in respect of the financing of distribution of the film."
In the First Schedule the Investors were set out together with the amounts of their respective investments, their percentage recoupment entitlement on capital and the profit percentage. The amount to be invested by Faywin was $600,000, for Dominguez and Barry $100,000 and for Peter Hains $115,000. The Corporation was shown as investing $300,000.
The implementation of the investment transaction did not reflect that contemplated by the agreement. On 19 January Mr Montague William Smith, then Managing Director of Faywin, instructed his secretary to draw a cheque for $600,000 for him to take "to the signing ceremony", as he called the execution of the agreement. He placed the cheque in his pocket without looking at it closely and later in the office of the Corporation took it from his pocket and placed it on the table. He then observed that it was made out in favour of the Corporation. By agreement with the General Manager of the Corporation the cheque was altered so that the words "Hoodwink No. 1 account" were added to the payee section and the instruction "please pay into the account of CB Films Pty Ltd - Hoodwink Account" was endorsed on the back. The cheque was handed over and the deed executed by the parties. As appears from CB Films' record of receipts and payments on the No. 1 account, $700,000 was paid in by Faywin and Dominguez and Barry on 19 January and the same amount paid out to the Corporation on the same day. The money paid in by Faywin was in effect used to reimburse the Corporation for money it had contributed and which had already been applied to the cost of producing the film.
The critical question before his Honour was whether the sum of $600,000 paid to the producer by Faywin on 19 January 1981 constituted capital moneys expended "in producing or by way of contribution to the cost of producing a film" for the purposes of s.124ZAF.
Statutory Framework
Division 10BA of the Income Tax Assessment Act 1936 (disregarding amendments made since 1981) commences with s.124ZAA which sets out definitions of various terms in the division including the following which are found in sub-section (1):-

"Australian Film" means a film that -

(a) has been made wholly or substantially in Australia or in an external Territory and has a significant Australian content; or

(b) has been made in pursuance of an agreement or arrangement entered into between the Government of Australia or an authority of the Government of Australia and the Government of Australia and the Government of another country or an authority of the Government of another country; "copyright", in relation to a film, means copyright subsisting in the film by virtue of Part IV of the Copyright Act 1968 and includes copyright subsisting in, or in relation to, the film or in any work comprised in the film, under the law of a country other than Australia; "future copyright" means copyright to come into existence at a future time or upon the happening of a future event.

"qualifying Australian film" means a film that is -

(a) an eligible film; and

(b) an Australian film;

The nature of the expenditure contemplated by the division is elaborated in sub-sections (3) and (6):-

"124ZAA(3) In this Division, a reference to the expenditure of capital moneys is a reference to the expenditure of moneys that is expenditure of a capital nature.

124ZAA(6) A reference in this Division to moneys expended in producing a film is a reference to moneys expended to the extent to which those moneys are expended directly in producing a film."

A system for the grant of provisional and final ministerial certificates that a film is, or will be when completed, a qualifying Australian film is established in sections 124ZAB, 124ZAC and 124ZAD. Section 124ZAE (replaced in 1983) provided for a taxpayer to elect that Division 10BA would not apply in relation to a film.

Section 124ZAF establishes the deduction entitlement and provides in the relevant parts:-

"124ZAF(1) Subject to this Subdivision, where - "(a) A taxpayer has, under a contract entered into on or after 28 May 1981 expended capital moneys in producing, or by way of contribution to the cost of producing a film;

(b) At the time when the moneys were expended -

(i) the taxpayer was a resident; and

(ii) a provisional certificate or a final certificate was in force in relation to the film;

(c) the Commissioner is satisfied that, at the time when the moneys were expended -

(i) the taxpayer expected to become the first owner, or one of the first owners, of the copyright in the film when that copyright came into existence; and

(ii) the taxpayer intended to use that copyright, or the taxpayers interest in that copyright, as the case may be, for the purpose of producing assessable income from the exhibition of the film to the public in cinemas or by way of television broadcasting or from granting rights to exhibit the film to the public in cinemas or by way of television broadcasting;

(d) by reason of the moneys being expended, the taxpayer became the first owner, or one of the first owners, of the copyright in the film; and

(e) either of the following conditions is applicable:

(i) the taxpayer has used the copyright or the taxpayer's interest in the copyright, as the case may be, for the purpose of producing assessable income from the exhibition of the film to the public in cinemas or by way of television broadcasting or from granting rights to exhibit the film to the public in cinemas or by way of television broadcasting;

(ii) the taxpayer derived assessable income under an agreement entered into before the copyright came into existence under which the taxpayer agreed upon the copyright coming into existence, to grant rights to another person to exhibit the film to the public in cinemas or by way of television broadcasting, an amount equal to 150% of the amount of the moneys expended shall be allowed as a deduction in the assessment of the taxpayer in respect of income of -

(f) where, in the year of income in which the condition specified in paragraph (e) was first satisfied in relation to the taxpayer in relation to the copyright, the taxpayer became the first owner, or one of the first owners, of the copyright - that year of income; and

(g) in any other case -

(i) the year of income in which the condition specified in paragraph (e) was first satisfied in relation to the taxpayer in relation to the copyright, or

(ii) the year of income in which the taxpayer became the first owner or one of the first owners of the copyright, whichever is the later year of income.

(2) covers the case where the taxpayer has died before completion of the film

(3) where the Commissioner is satisfied that, if sub-sections (1) and (2) applied in relation to the expenditure of capital moneys under contract entered into on or after 1 October 1980, an amount would be, or would become, allowable as a deduction to a taxpayer in a year of income under sub-section (1) or

(2) in respect of capital moneys expended by the taxpayer under a contract entered into on or after 1 October 1980 and on or before 27 May 1981, that amount shall be allowed as a deduction in the assessment of the taxpayer in respect of income of the year of income in which the moneys were expended.

(4) In determining for the purposes of sub-section

(3) whether an amount would be, or would become, allowable as a deduction to a taxpayer in a year of income under sub-section (1) or

(2) if those sub-sections applied in relation to the expenditure of capital moneys under contracts entered into on or after 1 October 1980, section 124ZAG shall be read as if references in that section to the relevant amount referred to in that section being expended in producing a film were references to the relevant amount being expended in producing the film before the expiration of the period of 12 months after the end of the year of income in which the relevant amount was expended by the taxpayer.

(5) For the purposes of the application of section 124ZAG in accordance with sub-section (4), where -

(a) moneys are expended in producing a film; and

(b) having regard to the benefit in respect of which those moneys are expended, those moneys, or a part of those moneys, could reasonably be expected to have been expended at a later time, those moneys, or that part of those moneys, as the case may be, shall be taken to have been expended at that later time.

(6) (this provides for subsequent disallowance of deductions initially allowed in relation to contracts entered into on or after 1 October 1980)

(7) in this section a reference to assessable income includes a reference to amounts that but for s.23H would be assessable income.

s. 124ZAG addresses the situation in which a taxpayer makes a contribution to the cost of producing a film but not all of the sum so contributed is expended in producing the film:-

"124ZAG

Where -

(a) but for this section and sections 124ZAL and 124ZAM an amount (in this sub-section referred to as the "relevant amount") would be taken for the purposes of this Division to have been expended by a taxpayer by way of contribution to the cost of producing a film; and

(b) the whole of the relevant amount is not expended in producing the film, the following provisions have effect:

(c) where no part of the relevant amount was expended in producing the film - no part of the relevant amount shall be taken for the purposes of this division to have been expended by the taxpayer;

(d) where part only of the relevant amount was not expended in producing the film - the relevant amount shall be reduced by that part of the relevant amount that was not expended in producing the film."

This section applies where payments properly characterised as contributions to the cost of producing a film because they are made for that purpose are not wholly expended in producing a film. It may be, for example, that some of the money contributed is expended to meet costs other than those associated with production or for some other purpose. In effect the section collapses the wide class of payments "expended by way of contribution to the cost of producing a film" into the narrower class of amounts "expended in producing a film". It operates as a qualification on the range of payments deductible under s. 124ZAF(1). It has also to be read in the light of s.124ZAH which addresses the case in which funds contributed by the taxpayer form part of a common pool out of which moneys have been expended in producing the film. In such a case the characterisation of all or part of the moneys contributed as money expended is facilitated by the section which provides:-

"124ZAH(1) Where -

(a) a taxpayer has expended capital moneys by way of contribution to the cost of producing a film; and

(b) an amount of moneys has been expended in producing the film out of moneys that include the moneys expended by the taxpayer, then, for the purposes of this Division, so much of the moneys expended by the taxpayer as the Commissioner determines shall be taken to be included in the amount referred to in paragraph (b) that has been expended in producing the film."

The section is a deeming provision and read with s.124ZAG has the result that the taxpayer's contribution to production costs is taken to be reduced, for the purposes of s.124ZAF, to the amount treated by the Commissioner as expended in production of the film. It enables characterisation of an appropriate proportion of the taxpayer's contribution as moneys expended on production even though it may have been mixed with other funds contributed and even though only part of the pool so created has been expended on production. It provides in effect, a facility for apportioning among investors contributing to a production account the benefit of production expenses and the corresponding burden of non-production expenses according to their respective contributions, albeit the Commissioner is not in terms bound to apportion on that basis.

Sections 124ZAJ and 124ZAK respectively relate to non-arms length transactions and expenditure on assets not used or later disposed of. They are not directly relevant for present purposes. Section 124ZAL provides for reduction of the amount taken to have been expended by the taxpayer where, at or before the time it was expended, the taxpayer partially assigned his future copyright in the film. And under s.124ZAM only such of the moneys expended as are "at risk" are to be taken as expended for the purposes of the Division. It was common ground, as appears from the Statement of Facts and Issues agreed between the parties, that the expenditure incurred by the producer was incurred under contracts made at arms length and that Faywin was "at risk" in respect of its $600,000. The remaining provisions, s.124ZAN relating to variation of contracts entered into before 1 October 1980, s.124ZAO limiting the deductibility of revenue expenses and s.124ZAP relating to expenditure by partnerships are also not directly relevant for present purposes.
The Trial Judge's Findings
In his judgment the learned trial Judge undertook some discussion of the first limb of s.124ZAF dealing with the category of capital moneys expended in producing a film. Ultimately however, his Honour based his decision upon his construction of the second limb relating to capital moneys expended by way of contribution to the cost of producing a film. He observed that modern methods of financing films would include arrangements under which the producer might raise finance to cover certain parts of the production expenses and look to investors to reimburse him for the expenses thus incurred. In his Honour's opinion payments made by investors in these circumstances could fall into the second category under s.124ZAF(1)(a) as contributions to the cost of producing a film. He would not construe division 10BA as placing upon contributors some form of obligation to police, by a tracing process, the actual expenditure of contributions by the producer into the precise components involved in production expenses. In his Honour's opinion the test is that there must be, in a practical and commercial sense, a link between the contributions of investors and expenditure of film production expenses, a link which is not determined by applying technical rules of tracing developed by the courts for different purposes.
His Honour set out various factors which he regarded as relevant to the application of the test, they being:-

". the temporal proximity of the contributions of investors to the incurring of the production expenses;

. the temporal proximity of the contributions to the performance of production work; . whether the contributions, though not necessarily traceable to, may be identified or equated in a practical sense with, the monies expended in production work; . whether the contributors obtained or expected to obtain the first copyright in the film."

The question whether the test was satisfied would depend upon the facts of each case. He accepted that once the process of production was complete and what remained was essentially the marketing of the film, it became more difficult to characterise contributions by investors as moneys expended by way of contributions to the cost of producing the film. In the present case however he concluded that the film corporation could not qualify for any deduction once the other contributors were substituted to the extent of the farmed out liability. The investors, who then stood in the shoes of the Corporation, had, in a real sense, financed the production of the film and "expended capital moneys . . . by way of contribution to the cost of producing" the film within the meaning of s.124ZAF(1)(a). His Honour referred to the intention of the legislation which was to promote the production of Australian films and did not call for any narrow interpretation. On the other hand he said:

"the deduction will not be available under the second limb to contributors if on the facts of the particular case they cannot point in a practical and commercial sense to their contributions as having been used to defray costs in the production of the film."

His Honour also referred to provisions in Division 10BA protective of that objective. In this connection he discussed the "at risk" provisions of s.124ZAM and s.124ZAJ relating to non-arms length transactions, s.124ZAL reducing the level of allowable deduction where future copyright is assigned and s.124ZAN enabling the Commissioner to refuse a deduction where contracts have been re-arranged or re-constructed for the purpose of changing the date on which they were entered into so as to bring in the provisions of the Divisision.
Contentions on Appeal
The appellant submitted that payments out of the account of the respondent's contribution had to be shown to be an expenditure of capital moneys by way of contribution to the cost of producing a film. The moneys must be expended directly in producing a film, in the sense of there being a direct connection between the payment and the processes of production. His Honour's description of the production of a film as encompassing all the steps in the process or processes of production of a film as a result of which the film is created was accepted. Whilst moneys paid to CB Films by the Corporation were contributions to the cost of production in the relevant sense the $600,000 paid by Faywin was not so expended. It was applied simply to reimburse the Corporation. To characterise the reimbursement other than as a loan or repayment of capital was to permit two deductions for the one expense. His Honour had erred, it was said, in holding that the Corporation (assuming it to be a taxable person) could not qualify for any deduction once the other contributors were substituted to the extent of the farmed out liability.
The second contention that, contrary to the concession made at first instance, Faywin was not a first owner of copyright in the film, was based upon a proposition that "copyright exists in the film as soon as it comes into existence from time to time during the course of production". This submission which became fainter as it was expounded depended upon a concept of copyright in the film as somehow composed of successive copyrights that arise in the partly completed work or parts thereof. This contention is clearly wrong. The copyright in a "cinematograph film" is a right which arises in the completed work by virtue of s.s. 86 and 90 of the Copyright Act 1968. The relevant copyright will not arise until the production process is complete including necessary editing. And although in the present case it is apparent that the bulk of the production work had been done when Faywin made its investment it is also clear that the film had not been completed and that copyright in the film had not come into existence. Once it can be said that the film has been completed and that copyright has arisen it will not be possible for any new investor to fulfil the qualifying condition in s.124ZAF(1)(c)(i) "expected to become the first owner or one of the first owners of the copyright in the film when that copyright came into existence".
In support of his Honour's decision counsel for Faywin submitted, as his Honour had found, that Division 10BA was intended to provide an incentive to investment in film production and should not be construed narrowly. Its benefits should not be confined to the production company or the provider of seed money, nor should they be denied to those who are induced to contribute money to bring to fruition a partly germinated project. His Honour's test which looked for the existence of a practical and commercial relationship between outlay and production was adopted. Correspondingly broad interpretations of "in producing" as used in s.124ZAF and "directly" as used in s.124ZAA(6) were advanced. The latter term it was said did no more than exclude indirectly expenses which were a sine qua non rather than causative of production. The concept of "contribution to the . . . cost of producing the film" embodied in the second limb was directed to timing and method of expenditure. To come within this limb the taxpayer's outlay need not be made before the film was commenced. The film might be underwritten by others. The taxpayer's expenditure alone or with others must bear the burden of the production costs so that the film is made and obligations to creditors, lenders and underwriters are discharged.
On its proper construction it was said Division 10BA imposes three cardinal requirements upon the investor:

1. he must contribute funds which together with those contributed by other investors are sufficient to cover the production costs of an Australian film and thereby become an initial copyright owner

2. he must use the film to produce assessable income

3. he must be at risk, that is, there must be no collateral arrangement which guarantees recoupment of his outlay.

Faywin was said to meet those requirements on either limb of paragraph (a) of s.124ZAF(1).
Characterisation of the Faywin Payment
Though it be a contribution to the cost of producing a film a taxpayer's investment is not deductible except to the extent that it is "expended in producing the film" within the meaning of sub-section 124ZAG(1). And by virtue of sub-section 124ZAA(6) that means "expended directly in producing (the) film." The word "directly" qualifies the range of expenditure incurred "in producing a film" that is deductible. A narrow construction of that word is possible which limits the relevant class of "direct" expenditure to payments made for goods or services used in or comprising elements of the production process. But such a construction would unduly limit the range of legitimate commercial arrangements that may be entered into in connection with the financing of film production. Consistently with the purpose of the Division which is to promote the production of Australian films, and recognising the commercial environment in which it must be applied, the requirement that moneys expended be expended 'directly' in production is no more than a requirement that there be a sufficiently close connection between the outlay and the production process. The assistance to be derived from the Explanatory Memorandum accompanying the Income Tax Assessment Bill 1981, which introduced the new Division 10BA is limited but the approach there described is consistent with this construction. The memorandum said of sub-section 124ZAA(6):-

"The relevant moneys are to be those that are expended directly producing a film, as distinct from moneys such as brokerage fees for arranging that a group of people join together to produce a film."

So construed the word will not necessarily exclude a payment made to some intermediary or agent who pays it to a producer who in turn applies it to acquire goods or services which are used in or comprise elements of the process of production. Nor would the term "directly" exclude the payment of moneys to a producer for the purpose of repayment of bridging finance borrowed and expended on such goods and services. The connection between outlay and production is still sufficiently close to fall within the concept of a direct expenditure. And, depending on the circumstances of the case, a payment made to be applied and which is applied by way of reimbursement of funds contributed by the Corporation, is similarly capable of constituting a direct expenditure in the sense proposed.

Section 124ZAH brings within the class of moneys expended in producing the film "moneys . . . expended in producing the film out of moneys that include moneys expended by the taxpayer". This provision was explained in the Second Reading Speech as follows:-

"Only expenditure outlaid directly in the production of a film will qualify, but the legislation is framed so that, again taking into account practices in the film industry, individuals or partners whose expenditure is in the form of a contribution to a production account will enjoy the deduction to the extent that the moneys contributed are so outlaid."

The section is an aid to the characterisation of an appropriate proportion of a taxpayer's contribution to a production account as money expended in producing a film. It avoids the need to engage in a tracing exercise. But there is a limiting class of case where the connection between the taxpayers' outlay and the production of the film is so close, even though the outlay is paid into a production account, that it can be said directly and without the aid of section 124ZAH to constitute capital moneys expended in producing the film. It is not appropriate to define the boundaries of that class. Whether a contribution to an account is so closely connected with production expenditure as to be capable of that characterisation is a matter of fact. Some difficulty may arise where a payment into a production account is characterised, in the limiting class, as money expended in producing the film. Other payments into the same account may not be able to be so characterised. In that case they may be subject to the apportionment authorised by s.124ZAH between contributors of production and non-production expenditure paid out of the account. The burden of that apportionment would rest inequitably on those other investors. The anomaly that arises in such a case resembles that which would occur when one investor contributes money which does not go through the production account and is expended directly in producing the film under the first limb of s.124ZAG(1). It is, in a sense, an accident of timing in such a case that the burden of apportionment of non-deductible expenditure is not spread proportionately across all investors. That is a feature and perhaps a defect of the legislative scheme. But to treat as falling outside the scheme entirely, a reimbursement of production expenses which passes transiently through a production account is to defeat its evident beneficial policy.

It is apparent from the facts as found by his Honour and which were not in dispute that the moneys paid by Faywin and Dominguez and Barry on 19 January 1981 were immediately applied to reimburse the Corporation some $700,000 of the $915,000 it had at that time contributed to the production. To 4 January $835,642 had been incurred in connection with the production of the film. And although his Honour referred to some questionable heads of expenditure in the budget set out in the Second Schedule to the deed no-point appears to have been taken that these or the budgeted costs totalling $1,042,340 were not costs of production of the film in the relevant sense. On this issue his Honour said at page 20 of the judgment:-

"I should say that my analysis of the expenses included in the Second Schedule to the deed of 19 January 1981 is intended to be of a broad kind because the particular items were not subjected to any detailed analysis in the course of argument. The parties were content to approach the matter on a general basis to support the conclusion, in which counsel for both parties agreed, that most of the relevant expenses relating to the process of production of the film "Hoodwink" had been incurred before 19 January 1981."

His Honour characterised Faywin's payment as a contribution to the costs of producing the film and eligible for deduction under the second limb of s.124ZAF(1)(a). As appears from the proceeding analysis that characterisation is not sufficient to so qualify an outlay as deductible. The money must either directly or by virtue of s.124ZAF and 124ZAH, read together, fall within the class of moneys expended in producing the film. On the facts of this case the money contributed by Faywin, although paid into the production account, was intended to be applied and was applied by the producer to immediately reimburse the Corporation in part for its investment. It is true that the Corporation's contribution as at the date of the deed was some $915,000 of which $835,532 had been expended upon production. But, maladapted as it was to its factual matrix, the terms of clause 3.A of the deed relating to the pending enactment of Division 10BA and the circumstances of the payment make it reasonably clear that the money paid to the Corporation was intended to reimburse deductible expenses, the Corporation not being taxable in any event.
In the circumstances the relevant connection between Faywin's outlay and the cost of production is sufficiently close to answer the description of a direct expenditure within the first limb of s.124ZAF(1)(a). It follows, although for reasons different from those advanced by his Honour, that the appeal should be dismissed.

JUDGE2

The appellant, the Commissioner of Taxation appeals against the decision of a judge of this Court (Lockhart J) allowing the appeals of the respondent taxpayer, Faywin Investments Pty Limited against the assessments of its income tax in respect of the years income ended 30 June 1981 and 30 June 1982 respectively.

The substantial matter in dispute in the appeal and before his Honour was the availability to the respondent of a deduction pursuant to s.124ZAF of the Income Tax Assessment Act 1936 (Cth) ("the Act") in respect of an amount of $600,000 paid by it to C B Films Pty Limited ("the Producer") on 19 January 1981 in respect of an Australian film "Hoodwink". If that deduction be unavailable, a subsidiary question arises as to whether the taxpayer was entitled pursuant to s.124M(1) of the Act to a deduction of $300,000 in each of the years of income.
The facts were not in dispute and may be shortly stated.
The New South Wales Film Corporation ("the Corporation") a statutory body constituted by the New South Wales Film Corporation Act 1977 (NSW) and deemed by that Act to represent the Crown, was established inter alia "to encourage and assist in, whether by the provision of financial assistance or by other means, the making, promotion, distribution and exhibition of films" (s.11(1)(b) of the New South Wales Film Corporation Act). The Corporation became interested in the possibility of making the film ultimately to become "Hoodwink" in December 1978 and prior to 27 June 1980 had invested $37,100 in the project. On 27 June 1980 the Corporation entered into a deed with the Producer agreeing to invest a further sum of $80,000 towards the film. On 3 October 1980 the Corporation indicated by letter to the producer that it would, subject to certain conditions, invest $750,000 in the proposed film; it being a term that the Corporation might:

"elect to lay off part of its $750,000 (Aus) Investment to third parties"

The letter indicated that a "comprehensive document" would be thereafter prepared for execution. It is unclear whether the $750,000 included the $37,100 earlier invested but nothing turns upon that.
Shooting of the film commenced in early November 1980 and principal photography was completed by 22 December 1980. By 31 December 1980 the total amount paid by the Corporation to the producer in respect of the film was $915,000 and by 4 January 1981 the outgoings incurred by the producer in connection with the production of the film amounted to $835,642.
Some time prior to 19 January 1981 the Corporation had decided to "lay off" part of its investment. To this end the taxpayer and a group of other investors, Messrs Dominguez and Barry and Peter Hains were interested in investing in the film to the extent of $600,000, $100,000 and $115,000 respectively and a deed was entered into on 19 January 1981 between the Corporation, the three new investors, the Producer and two guarantors.
The form of the Deed was, perhaps unfortunate, in that it involved the adaptation of a precedent contract for the production of a film, where production had not commenced, to the situation where a large part of the production work had in fact been completed. It referred to a budget of $1,115,000 to produce the film, this amount to be satisfied from the investment by the three new investors of $600,000 (sic) plus a maximum investment of $515,000 to be contributed by the Corporation. The first schedule however, made it clear that the three new investors were to invest a total of $815,000 and that the Corporation's investment was to be $300,000.
Under this Deed each investor undertook to pay into an account styled by the Deed "the No. 1 Account", the amount of his investment in accordance with a cash flow chart said to be part of a schedule. There was no such chart and the intention of the parties, determined by what they did, indicates that the taxpayer was to provide its investment immediately.
Clause 4.A.1 (which was significant to the respondent's submissions) provided:

"4.A.1 Until all moneys are paid out of the No. 1 Account in accordance with this Deed:

(a) all funds at any time standing to the credit of the No. 1 Account in the proportion that the whole of the moneys paid by any investor into the No. 1 Account (whether in the capacity of Investor or not) from time to time subject to sub-clause (b) and (c) hereof) bears to the whole of the moneys paid into the No. 1 Account shall remain the property of that Investor but shall not be dealt with except in the manner prescribed in this Deed;

(b) if there are funds in the No. 1 Account not required from time to time to comply with the Budget then those funds shall be invested by the Production Company as trustee for the Investors but only if and as directed by the NFC;

(c) no investment pursuant to (b) hereof will be directed by the NFC unless:

(i) the investment is an investment authorised by the N.S.W. Trustee Act, 1925 or otherwise from time to time authorised by the Investors; and

(ii) the Investors whose funds are to be invested (being those Investors sharing ownership of funds in the No. 1 Account in accordance with sub-clause (a) hereof) consent to investment of their respective proportion of the funds available for investment to be invested;

(d) The Production Company acknowledges and undertakes that in making any investment pursuant to this clause it will act only as trustee for the Investors and that the beneficial ownership of all of the capital invested and of all income derived therefrom is and shall remain at all times the property of the Investors in the proportions referred to in sub-clause (a) hereof."

The Deed contemplated that payments from the No 1 Account would be used to meet, progressively, the requirements of the budget. In fact that was not what happened and the actual course of events was not at all that contemplated by the Deed.
Under the Deed the Production Company undertook to produce the film in accordance with the budget. There were provisions in the agreement concerned with budget overruns. Clause 9.1 provided:

"Upon completion of the film subject to any prior interest subsisting by way of mortgage or charge created with the prior written consent of each investor the Copyright shall be held and owned by the investors absolutely. Each investor's share of the Copyright shall be in the proportion that its investment bears to the budgeted cost (set out in the Sixth Schedule hereto)."

The Deed also contained provisions as to the share of ownership in the copyright once each investor had recouped his investment.

The budget scheduled to the agreement was made up as at 12 November 1980. It was divided into two parts: "Above the Line Costs" i.e. story and script and development, producer's fees, directors and cast (principals) totalling $273,700) and "Below the Line Costs" of $726,140 comprising largely production unit salaries, sets and properties and miscellaneous expenditure. To those two categories are added finance and legal charges and overheads of $42,500 to bring the total to $1,042,340 to which was to be added a 10 per cent contingency amount.
What actually happened was that on the date of the Deed the taxpayer paid $600,000 to the Producer. Similarly Messrs. Dominguez and Barry paid $100,000 on that day. No investment appears to have been made on that day by Mr Peter Hains. The producer thereupon drew a cheque for $700,000 in favour of the Corporation. The result in law was that the taxpayer became entitled to an interest in the copyright of the film when completed and the moneys it contributed went to reimburse the Corporation for some of the funds it had by then outlaid and as consideration for a reduction in the Corporation's interest in the ultimate copyright in the film.
In March 1981 the Corporation paid a further $200,000 to the Producer, production of the film having continued after 19 January 1981. The answer print of the film was given on 30 April 1981 and the release print shortly after on 7 May 1981.
It was agreed by the parties that the Corporation had, prior to 31 December 1980 invested a total of $915,000 by payment to the producer and that prior to 4 January 1981 the Producer had incurred outgoings "in connexion with the production of the film" as follows:

Script, Producers and

Directors Fees $176,348 Amounts payable to principals of caste (sic) $45,000 Production unit fees and salaries $161,235 Other "below the line" costs $424,632 Indirect costs $28,427 -------- $835,642

It may, presumably, therefore be inferred either that some part of the contribution of the Corporation had not been expended by the Producer as at 19 January 1981 or that the Producer had expended more than $835,642 but that some part of the expenditure was not "in connexion with the production of the film". Possibly the words "in connexion with the production of the film" as used in the agreed statement of facts and issues brought into existence by the parties were intended to refer to that expenditure which, within the meaning of s.124ZAA(6) of the Act, was "expended directly in producing" the film.

The Statutory Background

Money outlaid in the production of a film to be exploited by exhibition of that film will ordinarily be an outgoing on capital account and thus precluded from deductibility under the general deduction provisions of s.51(1) of the Act. I say ordinarily, because there may be cases where the business of the taxpayer is such that such expenditure is an ordinary working expense (cf. in the case of petroleum exploration expenditure the decision of the Full Court of this Court in Federal Commissioner of Taxation v. Ampol Exploration Ltd (1986) 2 ATC 4859).

To alleviate the hardship which the non-deductibility of such capital expenditure may cause (a film being a wasting asset) the legislature enacted Division 10B of the Act (inserted by Act No 101 of 1956, s.20) which broadly deals with certain kinds of industrial property rights. It provides that expenditure of a capital nature on the production or acquisition of an industrial property right of the kind referred to in the Division is to be amortised over the life of that right. In 1977, as an incentive to the production of Australian films, Division 10B was amended. Thereafter in the case of an industrial property right which consists of the copyright of an Australian film, as defined in s.124K(1) of the Act, a taxpayer could elect to treat the effective life of the copyright as being the period commencing in the year of income in which the film was first used to produce assessable income and ending at the end of the next year of income. In other words, the capital cost of the film was permitted to be amortised effectively over two income tax years.
As part of a policy obviously designed to encourage the development of an Australian film industry, a more favourable treatment of investment in Australian films was provided by Act No 111 of 1981 by the insertion into the Act of Division 10BA of Part III, ss.124ZAA-124ZAP effective as from 24 June 1981. The 1981 amending legislation was preceded by a statement made by the then Minister for Home Affairs and Environment on 18 December 1980 and applied to expenditure incurred under a contract entered into on or after 1 October 1980. The legislation to give effect to the matters appearing in the statement was not, however, enacted until June 1981 (Act No 111 of 1981, s.13, became effective on 24 June 1981) and when enacted contained, as is inevitable in such cases, more detail than was contained in the Ministerial Statement. The taxpayer's investment, accordingly was made at a time when the legislation had not yet been introduced into parliament.
The scheme of the 1981 concessions was simple. Subject to the conditions laid down in Division 10BA, a deduction of 150 per cent of the capital expenditure incurred in producing a film, where that expenditure resulted in the acquisition of the actual copyright in the film, was to be allowed in the year in which the copyright in the film was first used to produce assessable income. In addition, an exemption from income tax of an amount of the net earnings of the investor in the film up to 50 per cent of the investment was granted by s.23H of the Act enacted at the same time.
The deduction under Division 10BA is conferred by s.124ZAF which provided at the relevant time as follows:

"124ZAF(1) Subject to this Subdivision, where -

(a) a taxpayer has, under a contract entered into on or after 28 May 1981, expended capital moneys in producing, or by way of contribution to the cost of producing, a film;

(b) at the time when the moneys were expended -

(i) the taxpayer was a resident; and

(ii) a provisional certificate or a final certificate was in force in relation to the film;

(c) the Commissioner is satisfied that, at the time when the moneys were expended -

(i) the taxpayer expected to become the first owner, or one of the first owners, of the copyright in the film when that copyright came into existence; and

(ii) the taxpayer intended to use that copyright, or the taxpayer's interest in that copyright, as the case may be, for the purpose of producing assessable income from the exhibition of the film to the public in cinemas or by way of television broadcasting or from granting rights to exhibit the film to the public in cinemas or by way of television broadcasting;

(d) by reason of the moneys being expended, the taxpayer became the first owner, or one of the first owners, of the copyright in the film; and

(e) either of the following conditions is applicable:

(i) the taxpayer has used the copyright or the taxpayer's interest in the copyright, as the case may be, for the purpose of producing assessable income from the exhibition of the film to the public in cinemas or by way of television broadcasting or from granting rights to exhibit the film to the public in cinemas or by way of television broadcasting;

(ii) the taxpayer derived assessable income under an agreement entered into before the copyright came into existence under which the taxpayer agreed, upon the copyright coming into existence, to grant rights to another person to exhibit the film to the public in cinemas or by way of television broadcasting,

an amount equal to 150% of the amount of the moneys expended shall be allowed as a deduction in the assessment of the taxpayer in respect of income of -

(f) where, in the year of income in which the condition specified in paragraph (e) was first satisfied in relation to the taxpayer in relation to the copyright, the taxpayer became the first owner, or one of the first owners, of the copyright - that year of income; and

(g) in any other case -

(i) the year of income in which the condition specified in paragraph (e) was first satisfied in relation to the taxpayer in relation to the copyright; or

(ii) the year of income in which the taxpayer became the first owner, or one of the first owners, of the copyright,

whichever is the later year of income." It is conceded by the Commissioner that the provisions of paragraphs (b) to (e) were all satisfied in the present case. The issue between the parties was whether, having regard to the later provisions of s.124ZAG and s.124ZAH, it was correct on the facts of the present case to say that the taxpayer either expended moneys in producing, or by way of contribution to the cost of producing, the film, so as thereby to be entitled to a deduction of 150 per cent of that expenditure.
Some other provisions should now be mentioned. Section 124ZAA(1) contains definitional provisions of which the following may be noted:

"'copyright', in relation to a film, means copyright subsisting in the film by virtue of Part IV of the Copyright Act 1968 and includes copyright subsisting in, or in relation to, the film or in any work comprised in the film, under the law of a country other than Australia; 'future copyright' means copyright to come into existence at a future time or upon the happening of a future event;"

Further s.124ZAA(6) provides: "A reference in this Division to moneys expended in producing a film is a reference to moneys expended to the extent to which those moneys are expended directly in producing a film."

Sections 124ZAG and s.124ZAH provide as follows:

"124ZAG Where -

(a) but for this section and sections 124ZAL and 124ZAM, an amount (in this sub-section referred to as the 'relevant amount') would be taken for the purposes of this Division to have been expended by a taxpayer by way of contribution to the cost of producing a film; and

(b) the whole of the relevant amount is not expended in producing the film, the following provisions have effect:

(c) where no part of the relevant amount was expended in producing the film - no part of the relevant amount shall be taken for the purposes of this Division to have been expended by the taxpayer;

(d) where part only of the relevant amount was not expended in producing the film - the relevant amount shall be reduced by that part of the relevant amount that was not expended in producing the film.

124ZAH(1) Where -

(a) a taxpayer has expended capital moneys by way of contribution to the cost of producing a film; and

(b) an amount of moneys has been expended in producing the film out of moneys that include the moneys expended by the taxpayer, then, for the purposes of this Division, so much of the moneys expended by the taxpayer as the Commissioner determines shall be taken to be included in the amount referred to in paragraph (b) that has been expended in producing the film. 124ZAH(2) Sections 124ZAJ and 124ZAK apply, for the purposes of sub-section (1), in determining whether, and the extent to which, moneys have been expended in producing a film."

Finally, s.124ZAL provides:

"124ZAL(1) Where -

(a) but for this section and section 124ZAM, an amount would be taken for the purposes of this Division to have been expended by a taxpayer in producing, or by way of contribution to the cost of producing, a film; and

(b) at the time when that amount was expended, or before or after that time, the taxpayer partially assigned his future copyright in the film,

the amount referred to in paragraph (a) shall be reduced by such amount as the Commissioner considers reasonable.

124ZAL(2) A reference in sub-section (1) to an assignment by a taxpayer of future copyright in a film includes a reference to the taxpayer entering into an agreement to transfer copyright in the film to another person upon the copyright coming into existence or at any time after the coming into existence of the copyright."

The Judgment Appealed Against

His Honour held that s.124ZAA(6) applied only to the first limb of s.124ZAF(1)(a) (moneys expended in producing the film) and not to the second limb (moneys contributed to the cost of producing the film). In his Honour's view there was no requirement to trace contributions to production by an investor into the precise components involved in production expenses. It was sufficient if there was "in a practical and commercial sense a link between the contributions of investors and the expenditure of film production expenses. . .". His Honour suggested as a guide a number of matters that could be relevant, viz.

". the temporal proximity of the contributions of investors to the incurring of the production expenses;

. the temporal proximity of the contributions to the performance of production work; . whether the contributions, though not necessarily traceable to, may be identified or equated in a practical sense with, the monies expended in production work; . whether the contributors obtained or expected to obtain the first copyright in the film."

In his Honour's view on the facts of the present case "the investors had. . . in a real sense financed the production of the film; or to use the words of para.124ZAF(1)(a) 'expended capital moneys. . . by way of contribution to the cost of producing', the film". In the result, the taxpayer was held to be entitled to a deduction of 150 per cent of the whole of the amount of $600,000 paid by it to the producer. No question therefore arose as to the deduction by way of amortisation under Division 10B of the Act.

The Submissions

For the Commissioner it was submitted that attention was required to be directed, not at the payment by the taxpayer into the No 1 Account, but at the payment out of that account. It was submitted that where the funds paid out went merely to reimburse the Corporation for expenditure which the Corporation had outlaid, such expenditure could neither be characterised as expenditure in producing the film, nor as expenditure by way of contribution to the cost of producing the film. It was further submitted that this result was made manifest by the provisions of ss.124ZAG and 124ZAH which imported into the Division in respect of expenditure which was by way of contribution to the cost of producing a film, the requirement in s.124ZAA(6) that the expenditure out of the contribution account be directly on production.
Next it was suggested that any alternative interpretation could lead to a double deduction which could not have been the intention of the legislature. Finally, support for the submissions was sought to be found in an analysis of the provisions of the Copyright Act as applied to film production. It was submitted that copyright existed in the film as it was shot so that the expenditure would not lead to a first copyright in the film in the hands of an investor unless that investor had made his investment prior to the production of the film. This submission was made notwithstanding a concession made prior to the hearing below that the taxpayer was one of the first owners of the copyright in the film for the purposes of the Act.
For the taxpayer, reliance was placed on the policy of the legislation to provide a deduction of 150 per cent to an investor who invests moneys in a film which moneys are at risk and who, as a result, becomes the first owner of the copyright in the film. It was submitted the Division should not be narrowly construed so as to impede this policy having regard to the practicalities of the film industry. On the facts of the present case it was submitted that the taxpayer had both expended moneys in producing the film and had expended the moneys by way of contribution to the cost of producing the film.
For the taxpayer it was denied that the possibility of a double deduction arose. Further, no question of tracing of funds, it was said, arose. It was sufficient that a taxpayer had invested in a film, had become the first owner of the copyright and that funds in the amount of his investment had been outlaid in the production of the film. The provisions of ss.124ZAG and 124ZAH did not, it was submitted, require a different view to be taken.
Discussion
The general policy of the legislation cannot be in doubt. The provisions of Division 10BA represent the granting of a very significant income tax concession in respect of investment in Australian films. The legislative purpose was to produce an incentive for persons to invest in such films (and thereby become the first owner or one of the first owners of the copyright in them) in order to assist the Australian film industry.
The revenue was to be safeguarded in two important ways. First, s.124ZAJ of the Act ensured that film production costs were not inflated in non arm's length transactions with a consequent inflation of the deduction. Second, the provisions of s.124ZAM create an "at risk rule" limiting the expenditure qualifying as a deduction under the Division to amounts in respect of which the investor is at risk of loss should the film venture fail. In the present case it could not be suggested that the taxpayer's investment in the film was any less at risk in the relevant sense than would have been the case had the taxpayer's contribution been directly used to pay production costs rather than in reimbursing the Corporation in respect of amounts which the Corporation had initially outlaid.
There is clearly nothing in the general policy of the legislation which supports the Commissioner's submissions. To the contrary, it may be asked why the legislature should, provided two deductions for the same expenditure were not available, grant a deduction only when amounts were contributed by investors in advance of expenditure on production being made and not where the investor contributes an amount after some of the expenditure on production has been incurred so as to reimburse that expenditure. If the Commissioner's submissions are to be accepted it will be because the language of the Division compels that result. The logic of the submission as a matter of policy is not apparent.
Reference was made by counsel for the respondent to what was said by Bowen CJ and Ellicott J in Federal Commissioner of Taxation v. Top of the Cross Pty Ltd (1981) 81 ATC 4563, 4571 as subsequently applied by Hunt J in Penrith Rugby League Club Ltd v. Commissioner of Land Tax (1983) 2 NSWLR 616, 622 and by Sheppard J in Plessey Australia Pty Ltd v. Federal Commissioner of Taxation (1989) 89 ATC 5163, 5168. The decision in the latter was unanimously affirmed on appeal.
In Top of the Cross Pty Ltd their Honours took account of the purpose of the legislation there under consideration(s.62A of the Act), remarking that it was "not to raise revenue but rather to encourage taxpayers to enter into franchising agreements" (4571). Their Honours referred to the provisions of s.15AA of the Acts Interpretation Act 1901, which directs the adoption of a construction which advances the legislative purpose. While there is no doubt that the words of their Honours are equally applicable to the present case, it is necessary to have regard to the language of Division 10BA itself to determine the matter in controversy between the parties.
Section 124ZAF(1)(a) is directed at two classes of case. The first is where the expenditure of a taxpayer is expenditure which may properly be characterised as expenditure of capital moneys in producing the film. The word "in" followed by a participle, may lend itself to either a broad or more restrictive interpretation, depending upon the context in which it is employed. Thet broader interpretation construes the word "in" as meaning "in the course of" or "in connection with". See Pioneer Concrete (NSW) Pty Ltd v. Federal Commissioner of Taxation (1986) 86 ATC 4435 at 4441; Amalgamated Zinc (De Bavay's) Ltd v. Federal Commissioner of Taxation (1935) 54 CLR 295 at 309. The narrower interpretation construes the word "in" as meaning "directly in".
The present context includes the definitional provisions of s.124ZAA(6) which make it clear that it is only moneys expended directly on production that qualify for consideration. The first limb of s.124ZAF(1)(a) therefore looks at the expenditure of a taxpayer where that expenditure is incurred directly in producing the film. To the extent that the expenditure of a taxpayer relates, for example, to matters of financing, attracting investors or arranging for distribution arrangements, that expenditure will fall outside s.124ZAF(1)(a).
It is not necessary for the purposes of the present case to define with precision what is involved in the concept of "production". Lockhart J in the judgment appealed against in a passage which counsel for both parties accepted, said:

"In Division 10BA, in particular para 124ZAF(1)(a), when talking of the cost of producing a film, the relevant elements of production of the film are all the steps in the process or processes of production of the film as a result of which the film is created. To produce the film is to bring it into existence from its constituent elements and as a result of the various processes whereby it is put together. It is the action or process of producing the film and all the ingredients involved in that. The expenses deductible under Division 10BA include expenses related to the production processes themselves and plainly involve, for example, most of the expenses of the kind described in the Second Schedule to the deed of 19 January 1981 as 'below the line' costs, including the salaries of production staff, costumes, sets and properties and living and travel expenses during production. They also include the 'above the line' costs set out in the Second Schedule, namely, expenses on story and script rights and fees paid to producers, directors and cast."

I too am content to adopt his Honour's analysis of the concept of production expenses, noting, as his Honour did, that whether expenditure was indeed directly on production would require consideration of the particular expenditure in the context of the facts of a particular case. No such analysis was attempted in the present case.
An alternative reading of s.124ZAA(6) and the one which commended itself to his Honour, was that the force of the word "directly" was that the expenditure had to be incurred without the intervention of an intermediary or agent. That is a possible interpretation and one which, as his Honour held, ultimately may make no difference to the resolution of the present case. However, as the Explanatory Memorandum circulated by the then Treasurer, the Hon Mr John Howard for the Income Tax Assessment Amendment Bill 1981 points out at p 32 of the Memorandum, the purpose of subs.(6) is to:

"assist in identifying which of the moneys expended in relation to the production of a film are to be the subject of the 150% deduction."

The memorandum illustrates the operation of the subsection by distinguishing those moneys expended directly in producing a film from those (such as brokerage fees) used for arranging that a group of people join together to produce a film. This reinforces the construction which I prefer.

When regard is had however to the existence of the two limbs in s.124ZAF(1)(a), then notwithstanding the provisions of s.124ZAA(6) to which I have referred, it is clear that two situations are envisaged by the legislation. Under the first, the taxpayer's expenditure is expenditure directly made in the course of production of a film by the taxpayer. That is to say the taxpayer himself was the producer of the film. This would not mean that the taxpayer to qualify must necessarily hold the camera or pay the wages of the artist and film crew involved in production. A taxpayer who employs a production house to make a film necessarily incurs the amount payable to the production house as part of the cost of producing the film. The emphasis in s.124ZAF on production costs alone being eligible for the ultimate deduction would in such a case give rise to a question of fact as to whether the whole of the contract price was directly outlaid on production of the film.
The second limb of s.124ZAF(1)(a) is concerned not with expenditure directly on the process of production but expenditure which is by way of contribution to the cost of producing the film. The second limb envisages that more than one party will have expended funds and that in respect of a particular taxpayer his expenditure will be "by way of contribution". The word "contribution" derives from the Latin "contribuere" meaning to "bring together". In its present context the word looks to moneys expended in common with others toward the goal of producing the film. Thus the contribution is money paid by a taxpayer jointly with others, generally at least, into a production account which is used to pay production outgoings.
It is explained in the Explanatory Memorandum at p 37 that the second limb ensures:

". . . that deductions are available in respect of capital contributions to a production account to be used for the purpose of producing a qualifying film."

In my opinion the second limb looks to the destination of the moneys outlaid by a taxpayer (in the present case the $600,000 paid by the taxpayer to the producer) rather than to the destination of the funds thereafter. The expenditure will obtain its character as a contribution to the cost of producing a film from the purpose of the taxpayer rather than from the manner in which the funds are expended.
Because the second limb looks at the character of the taxpayer's expenditure having regard to the purpose with which it is made, a taxpayer who contributed to a production account moneys intended to be devoted to production, might, in the absence of other provisions gain a deduction albeit that the moneys were not in fact expended for that purpose. Lockhart J held, in my opinion correctly, that s.124ZAA(6) had no application to the second limb of s.124ZAF(1)(a). Hence, without more, expenditure outlaid by way of a contribution to a production account would be deductible notwithstanding that such expenditure was in fact used to defray broking fees payable to procure investors to invest in the film, at least if the investment was not earmarked for that purpose.
Specific provisions to avoid this result are to be found in ss.124ZAG and 124ZAH, the latter operating as an interpretational provision for the former. This view of the purpose of ss.124ZAG and 124ZAH is supported by the explanatory memorandum which in the notes immediately prior to the explanation of s.124ZAG says at p 38:

"The remaining provisions of Subdivision (B) (i.e. ss.124ZAG to 124ZAN) are designed, broadly, to ensure that the amount of any expenditure in or by way of contribution to the production of a film that is to qualify for deduction under s.124ZAF is to be restricted to amounts that are genuinely expended directly in the production of the film."

Before dealing with ss.124ZAG and 124ZAH it may be observed that there is nothing in the notion of "contribution" which would require that the expenditure to which the second limb relates be confined to expenditure by way of contribution prior to the commencement of production on a film. The words of s.124ZAF(1)(a) are sufficiently general to encompass moneys paid either before or after production provided that the essential character of that expenditure as being a contribution to the cost of producing the film is satisfied.
Section 124ZAG, considered alone, is also not destructive of the taxpayer's case. At the most, standing alone it is ambiguous. Where the second limb of s.124ZAF(1)(a) is satisfied, s.124ZAG focuses attention on the question whether the whole of the relevant amount is, as a matter of fact, not expended in producing the film. In applying s.124ZAG, s.124ZAA(6) ensures that attention be restricted to expenditure directly on production to the exclusion of what might shortly be described as non production expenditure.
The word "amount" in s.124ZAG if that section were to stand alone, is capable of two meanings. It may refer to the specific moneys contributed by the investor or it may refer to the dollar amount of his contribution. Having regard to s.124ZAH, however, I would conclude that the determination of whether "an amount" is expended in producing a film has, in a case involving the contribution into a common fund, to be determined in accordance with s.124ZAH.
Section 124ZAH is an allocation section. It is concerned with the problems arising from the fact that usually a production account will be a common fund to which more than one person will contribute. From that common account moneys may be expended some, but not all of which, may satisfy the requirement of s.124ZAA(6), namely that the funds are expended directly on production. As the explanatory memorandum points out in discussing the section at p 38:

"Proposed subsection 124ZAH(1) applies for the purposes of s.124ZAG to authorise the Commissioner of Taxation, in circumstances where taxpayers contributed towards the production of the film, to attribute actual expenditure on the production of that film out of the relevant production account to the contributions of a particular taxpayer."

The normal function of s.124ZAH is easily understood. Let it be assumed that three investors contribute a total of $1,000,000 to a production account in the shares $250,000, $400,000 and $350,000 and that the total of funds expended from that account directly on production amount to $500,000 disbursed over a period of months. Without s.124ZAH(1), if s.124ZAG required tracing of actual amounts to determine whether those amounts were expended directly on production as required by s.124ZAA(6) the result would arise that a particular taxpayer who had contributed to the production account might wholly lose the deduction because it could be shown that the particular moneys he had contributed were totally expended in a non production expense (e.g. broking, distribution, etc.). What s.124ZAH(1) does is to make tracing unnecessary and inappropriate by allowing the Commissioner to allocate among the participants in the common fund the total expended directly on production. Thus if s.124ZAH is applied to the example given above, the Commissioner would allocate to the first investor one quarter of the $500,000 expended on production; to the second investor two fifths of $500,000; and to the third 35 per cent of $500,000. It is hard to see how a method of apportionment that was not pro rata could be a proper exercise of the discretion, at least in the usual case.

It seems to me necessarily to follow that where moneys are contributed into a common fund, and the present is such a case, and the moneys so contributed are expended by way of contribution to the cost of producing a film, s.124ZAH must be an exclusive code for determining as between the contributors how much each of them will be taken to have expended for the purposes of s.124ZAG. It cannot be the case that an exercise of tracing can be undertaken under s.124ZAG on its own because by so doing one investor in the common fund may be taken to have expended the whole of his investment while another investor may be taken to have expended none at all. The clear legislative purpose is that investors to a common fund share the deduction available to them under s.124ZAF in accordance with an allocation to be made by the Commissioner under s.124ZAH.
That being the case it is necessary to consider whether s.124ZAH permits, on the facts of the present case, an allocation at all. If it does not, then it seems to me to follow that no deduction at all is available to the taxpayer in the present case. If it does, and since no determination has been made by the Commissioner under s.124ZAH, it must necessarily follow that the matter should be remitted to the Commissioner to make an allocation in accordance with the section.
The application of s.124ZAH(1), depends, in the facts of the present case, upon whether it can be said that an amount of moneys has been expended in producing the film out of moneys that include the taxpayer's contribution. The resolution of that question involves a determination of an issue of fact. That issue of fact is whether any amount of money has been expended in producing the film (in the sense in which those words are used in s.124ZAA(6)) out of moneys that include the moneys contributed by the taxpayer.
In a case where a taxpayer's contributions to the common fund precede the actual process of production there will ordinarily be no difficulty. Section 124ZAH(1)(b) will require an investigation of the disposition of the production account to determine whether and to what extent those moneys have been used directly in producing the film. In a case where a producer has borrowed funds in the course of his production activity which funds have been expended directly on production in the sense used in s.124ZAA(6) and moneys in the production account are used to repay the borrowings, it is, in a commercial sense, correct to say that the production account was expended by the producer directly in producing the film notwithstanding that the funds are paid directly to a finance company, for in such a case the payment to the finance company will take the same character as the character of the expenditure financed. This being the case, should any different result follow if the moneys in the production account are paid not to a financier in repayment of moneys borrowed to pay direct production costs but to another investor such as the Corporation?
The fact, in the present case, that the funds were paid first to the Producer and then by the Producer to the Corporation can hardly make a difference. It was always the intention that the funds in the production account would go to the Corporation notwithstanding the somewhat different provisions of the contractual arrangements between the parties. If one sought to apply s.124ZAH directly to a case where moneys had been paid by an investor not into the production account but directly to the film Corporation it would, in my opinion, be difficult to say that the investor was entitled to a deduction. It would be difficult to characterise the payment as a first limb case, that is to say as one where the taxpayer had expended moneys directly in producing the film. Rather the payment would be seen as the purchase price for the future copyright interest which the investor is to have. The payment might be characterised as a contribution to the cost of producing a film in which case it would be necessary to endeavour to apply s.124ZAG to a class of case which did not involve a common fund allocation as required to be made under s.124ZAH. The issue would then be whether it could be said that the whole of the amount of the taxpayer's contribution was expended directly in producing the film. In my opinion such a factual conclusion could not be drawn where the amount paid is but the purchase price for the interest in the film acquired by the taxpayer.
It would be strange indeed if a different result would on the facts of the present case follow merely because the funds have been paid into a production account. No part of the moneys contributed by the taxpayer to the production account ever went on direct production costs for those costs had already been incurred. The funds were merely used as a payment to the Corporation of consideration for the assignment by the Corporation of part of its interest in the ultimate film, and in a practical sense to reimburse the Corporation of some part of its expenditure. I find the language of s.124ZAH(1)(b) intractable on the facts of the present case.
If one applies the construction which I have given to the facts of the present case the following conclusions emerge:

1. There is no doubt the taxpayer contributed $600,000 to a common fund by way of a contribution to the cost of producing the film.

2. Because a common fund was involved the provisions of ss.124ZAG and 124ZAH apply.

3. Section 124ZAH can have no operation because the production expenditure was not defrayed out of the moneys actually expended by the taxpayer. Those moneys merely went as consideration to the Corporation for the assignment of an interest in the future copyright.

It follows in my view that no part of the taxpayer's contribution was deductible under s.124ZAF of the Act.
Even if I were wrong in concluding that no part of the moneys in the common fund were expended in producing the film, it would not follow that the taxpayer should succeed on the present appeal. It would be necessary to refer the matter back to the Commissioner of Taxation who would need to allocate the $700,000 contributed to the common fund among the contributors to that fund to determine how much the taxpayer would be taken to have expended by way of contribution for the purposes of s.124ZAG.
I should say that if, contrary to my view, the taxpayer were entitled to a deduction, the submission of the Commissioner that the result would be that two deductions were available, the one to the taxpayer and the other to the Corporation, is not tenable. The Corporation, assuming it were not exempt from taxation, would not be entitled to a deduction because its deduction would be reduced by s.124ZAL. That section provides as follows:

"Where -

(a) but for this section and s.124ZAM, an amount would be taken for the purposes of this Division to have been expended by a taxpayer in producing, or by way of contribution to the cost of producing, a film; and

(b) at the time when that amount was expended, or before or after that time, the taxpayer partially assigned his future copyright in the film,

the amount referred to in paragraph (a) shall be reduced by such amount as the Commissioner considers reasonable."

It would clearly be unreasonable to permit a taxpayer, who had been effectively reimbursed on an assignment of part of the future copyright to retain the full deduction. It would be a proper exercise of discretion under s.124ZAL to reduce any deduction available to a person in the position of the Corporation who has been recouped the amount of his expenditure.
Finally I should say that I found no assistance at all from the Commissioner's submissions derived from the Copyright Act. It is clear from Division 10BA that what is there referred to as the "copyright in the film" is the copyright which comes into existence when the film, as finally exploited for the purposes of gaining or producing assessable income comes into existence. The fact that there may be in existence other rights in the nature of copyright in exposed film which ultimately may form part of the completed film and in part or all of the soundtrack before the film is ultimately completed is irrelevant to the operation of Division 10BA.
It therefore becomes necessary to consider the respondent's case under Division 10B of the Act to a deduction of $600,000 amortised over the two income tax years 1981 and 1982 respectively.
The deduction granted under Division 10B is conferred by s.124M of the Act which provides:

"124M(1) Where, at any time during the year of income, a taxpayer is the owner of a unit of industrial property to whom this Division applies, an amount equal to the residual value of the unit in relation to the taxpayer as at the end of the year of income divided by a number equal to the number of whole years in the effective life of the unit in relation to the taxpayer as at the commencement of the year of income shall, subject to this Act, be an allowable deduction in respect of the unit."

By virtue of s.124UA(1), the effective life of the relevant unit of industrial property being a right in the Australian film is effectively two income tax years. To be entitled to the deduction the respondent must be the owner of a unit of industrial property to which Division 10B applies, a matter to be determined by reference to s.124L of the Act. To so qualify the respondent must have become the owner of the relevant unit of industrial property either by virtue of being the first owner of the relevant copyright right: s.124L(1)(a)(ii) or by virtue of having incurred expenditure of a capital nature on the purchase of the relevant unit of industrial property: s.124L(1)(b).
The expression "unit of industrial property" is defined in s.124K(1) relevantly as meaning:

"rights possessed by a person as - . . .

(b) the owner of a copyright subsisting in Australia . . .

and includes equitable rights in respect of such a . . . copyright . . ."

Prima facie the respondent qualifies. The parties were agreed that the respondent became one of the first owners of the copyright in the film and its agreement with the Corporation clearly created in it equitable rights in that copyright so as to satisfy the definition of "unit of industrial property".
The Commissioner, however, submitted that Division 10B did not confer upon the respondent any deduction. It was said, first, that s.124L(1)(a) had no application because it was a prerequisite to that subsection applying that before the relevant unit of industrial property came into existence the taxpayer had incurred expenditure directly in relation to producing the copyright and that on the facts of the present case that prerequisite was not satisfied.
Second, it was said that s.124L(1)(b) had no operation because it required that, at the time of "purchase" of the relevant unit of industrial property, that unit of property be in existence. Thus it was said, there could never be a case of a person who would qualify as an owner by virtue of an agreement to purchase a future copyright in a film (or for that matter a future right to the patent in an invention) because the language of s.124L, when read in conjunction with s.124K(1) required the unit of industrial property "purchased" to be in existence.
In my view there is no substance in the submission. It is clear that the Division requires that by the time the first annual deduction is to be available there be a subsisting copyright in the film. However, a person who, for valuable consideration agrees to purchase an interest in a copyright as and when granted, can properly in my view be said to have "purchased" the interest in the copyright which springs up as and when the film is created.
It follows in my view that I would allow the appeal, and in place of the orders made below I would order that the assessments be remitted to the Commissioner to be amended to give effect to the allowance in the two years of income involved of the deduction under s.124M(1) and the reasons for judgment herein. As both sides have been partially successful in the appeal I would order that the respondent pay the Commissioner's costs of the proceedings below but that there be no order as to the costs of the appeal.

[1990] FCA 185

10 MAY 1990