Commissioner of Taxation v Sharpcan Pty Ltd
[2018] FCAFC 163
•27 September 2018
FEDERAL COURT OF AUSTRALIA
Commissioner of Taxation v Sharpcan Pty Ltd [2018] FCAFC 163
Appeal from: Sharpcan Pty Ltd and Commissioner of Taxation (Taxation) [2017] AATA 2948 File number: VID 22 of 2018 Judges: GREENWOOD ACJ, MCKERRACHER AND THAWLEY JJ Date of judgment: 27 September 2018 Catchwords: TAXATION – appeal from a decision of the Administrative Appeals Tribunal – were taxpayer incurred expenditure to acquire gaming machine entitlements under Gambling Regulation Act 2003 (Vic) – whether Tribunal erred in finding that expenditure was on revenue account and deductible under s 8-1 of the Income Tax Assessment Act 1997 (Cth) – whether expenditure was “outgoing of capital, or of a capital nature” – whether expenditure was incurred to provide a necessary component of the profit-making structure of the taxpayer’s business
TAXATION – whether expenditure on gaming machine entitlements was “capital expenditure” deductible over 5 years in accordance with s 40-880(2) of the Income Tax Assessment Act 1997 (Cth) – whether expenditure was “incurred to preserve (but not enhance) the value of goodwill” within the meaning of s 40-880(6)
Legislation: Gambling Regulation Act 2003 (Vic) Ch 3, Divs 5, 8, 9, 10; ss 3.4.1(1)(ab), 3.4.2(d), 3.4A.1(1)(a), 3.4A.2(1), 3.4A.7(1), 3.4A.8(2), 3.4A.16(1), 3.4A.27, 3.6.6, 3.6.6(2)(b), 3.6.6A, 3.6.6A(7)
Gambling Regulation Amendment (Licensing) Act 2009 (Vic)
Income Tax Assessment Act 1997 (Cth) ss 8-1, 40-880, 40-880(2), 40-880(5), 40-880(5)(f), 40-880(6); Part 3-1, ss 100-25, 108-5, 108-5(2)(b), 100-25, 110-25(5), 110-25(5A)
Tax Laws Amendment (2006 Measures No 1) Act 2006 (Cth)
Explanatory Memorandum, Tax Laws Amendment (2006 Measures No 1) Bill 2006 (Cth)
Cases cited: Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (2009) 239 CLR 27
Ausnet Transmission Group Pty Ltd v Commissioner of Taxation (2015) 255 CLR 439
BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386
Certain Lloyd’s Underwriters v Cross (2012) 248 CLR 378
Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 140
Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428
Commissioner for Railways (NSW) v Agalianos (1955) 92 CLR 390
Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1
Commissioner of Taxation v Montgomery (1999) 198 CLR 639
Commissioner of Taxation v Roberts & Smith (1992) 37 FCR 246
Federal Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503
Federal Commissioner of Taxation v Cooper (1991) 29 FCR 177
Federal Commissioner of Taxation v Murry (1998) 193 CLR 605
Federal Commissioner of Taxation v Pine Creek Goldfields (1999) 91 FCR 263
Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645
Federal Commissioner of Taxation v Unit Trend Services Pty Ltd (2013) 250 CLR 523
GP International Pipecoaters Pty Ltd v Commissioner of Taxation (1990) 170 CLR 124
Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634
Henriksen v Grafton Hotel Ltd [1942] 2 K.B. 184
Herring v Federal Commissioner of Taxation (1946) 72 CLR 543
ICM Agriculture Pty Ltd v Commonwealth (2009) 240 CLR 140
Jeffrey v Rolls-Royce (1962) 40 TC 443
Lacey v Attorney-General (Qld) (2011) 242 CLR 573
Life Insurance Co of Australia Ltd v Phillips (1925) 36 CLR 60
Minister for Immigration and Border Protection v SZVFW (2018) 92 ALJR 713
Momcilovic v The Queen (2011) 245 CLR 1
Ounsworth v Vickers Ltd (1915) 3 K.B.
Pascoe v Federal Commissioner of Taxation (1956) 30 ALJR 402
Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355
Sun Newspapers v Federal Commissioner of Taxation (1938) 61 CLR 337
SZTAL v Minister for Immigration and Border Protection (2017) 91 ALJR 936
The Commissioner of Taxes (South Australia) v Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108
Thiess v Collector of Customs (2014) 250 CLR 664
Tyco Australia Pty Ltd v Federal Commissioner of Taxation (2007) 67 ATR 63
Visy Packaging Holdings Pty Ltd v Federal Commissioner of Taxation (2012) 91 ATR 810
Western Gold Mines NL v Commissioner of Taxation (W.A.) (1938) 59 CLR 729
Date of hearing: 11 May 2018 Registry: Victoria Division: General Division National Practice Area: Taxation Category: Catchwords Number of paragraphs: 344 Counsel for the Applicant: Mr G J Davies QC and Ms J E Jaques Solicitor for the Applicant: ATO Review and Dispute Resolution Counsel for the Respondent: Mr T P Murphy QC and Mr D J McInerney Solicitor for the Respondent: Rigby Cooke Lawyers ORDERS
VID 22 of 2018 BETWEEN: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Applicant
AND: SHARPCAN PTY LTD
Respondent
JUDGES:
GREENWOOD ACJ, MCKERRACHER AND THAWLEY JJ
DATE OF ORDER:
27 SEPTEMBER 2018
THE COURT ORDERS THAT:
1.The appeal is dismissed.
2.The appellant pay the costs of the respondent of and incidental to the appeal.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
REASONS FOR JUDGMENT
GREENWOOD ACJ:
Background
In the immediately relevant financial years ending 30 June 2010 and 30 June 2012, Spazor Pty Ltd (“Spazor”) was the Trustee for the Daylesford Royal Hotel Trust (“the Trust”). Spazor, as Trustee for the Trust, acquired the business undertaking of the Royal Hotel located in the main street of Daylesford in the Hepburn Shire of Victoria, on 8 August 2005 for $1,025,000.00. The Trustee conducted that business until it sold the business on 9 November 2015. The activities undertaken by Spazor relevant to the appeal and described in these reasons were undertaken at all times on behalf of the Trust.
The respondent, Sharpcan Pty Ltd (“Sharpcan”) is the beneficiary of the Trust. Sharpcan was, in the financial year ending 30 June 2012, presently entitled to 100% of the income of the trust estate.
At the date of acquisition by the Trustee, the business undertaking of the Royal Hotel involved deriving revenue from a number of integrated activities including: providing accommodation in its 11 guest rooms; sales of food and drink at its restaurant, café and public bar; gaming on 18 electronic gaming machines onsite; and wagering (on racing and keno).
As to the gaming activities, it will be necessary to explain the legislative and structural arrangements under which those activities were undertaken onsite as those matters bear on the questions in issue in the appeal. However, for present purposes, it is sufficient to note that from 2005 until 15 August 2012, the Trustee engaged in gaming activities onsite, consistent with the Gaming Regulation Act 2003 (Vic) (the “Act”), on the footing that Spazor had been granted a “venue operator’s licence” (s 3.4.8; s 3.4.12(1) of the Act) as the operator of the venue on which gaming occurred on 18 machines, and Tattersalls Gaming Pty Ltd (“Tattersalls”) had been granted a “gaming operator’s licence” (s 3.4.29; s 3.4.31; s 3.4.32 of the Act) enabling it to conduct gaming at the Royal Hotel by and through those 18 machines at the venue, taken together with a venue operator’s agreement made between Tattersalls and the Trustee for that purpose which commenced on 8 August 2005 for a period of six years. That agreement was extended on 15 April 2009 to 15 August 2012.
Section 3.4.1 of the Act conferred authority on Spazor, relevantly, to “possess [approved] gaming equipment” (s 3.4.1(b)) and to “manage and operate an approved venue” (s 3.4.1(c)). Section 3.4.2 of the Act conferred authority on Tattersalls to “obtain … approved gaming machines”; to “supply approved gaming machines”; and to “conduct gaming at an approved venue”, among other things: s 3.4.2(a), (c) and (d).
Under these arrangements, Tattersalls was the gaming operator from 8 August 2005 until the expiration of its gaming operator’s licence on 15 August 2012, of 18 gaming machines which it owned and operated at the Royal Hotel as an approved venue. The venue was operated by the Trustee as an approved venue operator, under the Act. Revenue derived from conducting gaming was derived by Tattersalls as the gaming operator. The Trustee, however, derived income in respect of gaming conducted on the site of the Royal Hotel (by Tattersalls) in the form of a percentage of the net revenue from gaming, that is, the gross receipts less returns (payouts) to those persons playing the 18 machines. This was, in effect, the method of quantifying the fee payable by Tattersalls to the Trustee.
Mr David Canny, a director of Spazor and Sharpcan and an experienced hotel operator responsible for the operation of the Royal Hotel, gave uncontested evidence that the machines were designed to return 90% of the “amounts played”, to players. The machines, by the 2010 financial year, turned over $44,000.00 per day, that is, patrons/customers attracted to the Royal Hotel by one or more or all of its activities described at [3] of these reasons, paid into the 18 gaming machines $44,000.00 each and every day.
Mr Canny gave evidence that daily gaming revenue after payouts to players, was $4,400.00 (10%) each and every day, on average. The evidence is that, of that sum, Tattersalls paid the Trustee 24.7% or $1,086.80. This is the quantification of the amount the Tribunal described as “commissions” paid by Tattersalls to the Trustee: Tribunal Decision (“TD”), para 6. On these figures, the State of Victoria in the form of the Victorian Commission for Gambling Regulation (the “VCGR”) received (in effect, as a tax on gambling) 33.3% or $1,465.20 of that sum. Tattersalls also received 33.3%, and 8.3% or $365.20 was paid to a fund called the “Community Support Fund” (the “Fund”): Canny Witness Statement, 28 April 2017, paras 34 and 66; Canny Witness Statement, 13 September 2017, paras 1 and 2.
As to the pre‑16 August 2012 statutory arrangements, s 3.6.6 of the Act addresses the topic of “Taxation”.
Section 3.6.6(1) provides that a gaming operator (Tattersalls) must ensure that amounts are paid in accordance with subsection (2), in respect of the periods determined by the Commission. Section 3.6.6(2)(b)(ii) provides for payment of 25% of the “total daily net cash balances of gaming machines of the gaming operator” at the Royal Hotel, during the relevant period, to the Trustee as venue operator (in the event that GST not be payable on a relevant supply, or 27.5% if GST is payable on the relevant supply). Section 3.6.6(2)(c) provides for payment of 8.33% of those daily net cash balances to the VCGR (and thus to the Fund) and s 3.6.6(2)(d) provides for payment to the VCGR of 24.24% of those total daily net cash balances to the VCGR. However, during the relevant period, the percentage to be paid to the VCGR was, it seems, 33.33%. Mr Paul Foley is a consulting accountant who was responsible for supervising the input of data into the accounting system used by the Trustee (in the operation of the Royal Hotel business). He says in his Witness Statement that for the financial years 2006 to 2012 net gaming revenue was distributed as follows: 33% to Tattersalls; 33% to the VCGR; 8.33% to the Fund; and the balance (which on these figures is 25.67%) to the Trustee. No doubt, these figures are rounded up.
These daily amounts as described in [8] of these reasons, projected over 365 days of the 2010 financial year (assuming trading every day of the year), suggests that gaming revenue or so‑called “commissions” paid to the Trustee as its gross income from gaming activities conducted on the site of the hotel amounted to $396,682.00.
However, the Commissioner took the Full Court to a document described as “Key Financial Statistic Summary” for the Royal Hotel being Attachment “PF1‑1” to the Witness Statement of Mr Foley. That document shows a range of statistics. The annual total of the net daily balances available for distribution for the years 2006 to 2012 were as follows:
2006
2007
2008
2009
2010
2011
2012
Annual total of the net daily balances available for distribution
$1,261,031
$1,490,772
$1,612,331
$1,513,211
$1,527,781
$1,451,431
$1,273,854
The following statistics drawn from the Key Financial Statistic Summary show the gross income in each financial year for each segment of the hotel business (which, in the case of gaming, is the Trustee’s percentage of net daily balances received as commissions).
Business Segment
2006
2007
2008
2009
2010
2011
2012
Accommodation
$118,885
$134,034
$113,935
$110,472
$143,386
$181,643
$188,565
Bar
$420,555
$616,039
$624,340
$618,720
$657,207
$644,821
$650,942
Food
$598,537
$693,386
$683,511
$670,033
$725,428
$706,581
$770,608
Gaming “commissions” paid to the Trustee @ 25.01% of net daily balances
$315,384
$372,842
$403,244
$378,454
$381,973
$363,003
$318,591
Wagering
$48,582
$59,478
$60,900
$65,620
$67,550
$67,047
$67,606
Total
$1,501,943
$1,875,321
$1,885,930
$1,843,299
$1,975,544
$1,963,095
$1,996,312
The following table sets out the total gross revenue from the hotel undertaking from all sources, the gaming revenue derived by the Trustee and the percentage that gaming revenue represents as a proportion of total gross revenue:
Year
Gross Revenue
Gaming Revenue
%
2006
$1,501,943
$315,384
20.9984%
2007
$1,875,321
$372,842
19.8815%
2008
$1,885,930
$403,244
21.3817%
2009
$1,843,299
$378,454
20.5313%
2010
$1,975,544
$381,973
19.3351%
2011
$1,963,095
$363,003
18.4914%
2012
$1,996,312
$318,591
15.9589%
Since the total annual net daily distributable balances were those set out in the schedule at [12] (which represent 10% of the money paid into the 18 machines), the total annual money paid into the 18 gaming machines in each year and the daily total payments into those machines was as follows:
Amounts
2006
2007
2008
2009
2010
2011
2012
Total amounts paid into the 18 gaming machines each year
$12,610,310
$14,907,720
$16,123,310
$15,132,110
$15,272,810
$14,514,310
$12,738,540
Daily payments assuming 365 days of trading
$34,548.79
$40,843.06
$44,173.45
$41,457.83
$41,843.31
$39,765.23
$34,900.10
The total amounts paid into the 18 gaming machines each year for the financial years ending 2013, 2014 and 2015 were, $10,537,610, $9,974,880 and $11,423,190 resulting in daily payments into those 18 machines (assuming a 365 day year) of $28,870.16, $27,328.43 and $31,296.41, respectively. The statistics at [12] and [15] of these reasons give an indication of the extent of the financial outcomes derived from the custom of patrons of the Royal Hotel in each segment of the business and overall for the financial years 2006 to 2012, being the financial years before the new regime commenced on 16 August 2012.
Although it will be necessary to turn to the evidence in some detail, it is sufficient to note for present purposes that Mr Canny gave evidence, which is not challenged, that the income derived by the Trustee from gaming in the form of payments made to it by Tattersalls was an essential component of the income of the business of the Royal Hotel.
All of these pre‑16 August 2012 structural arrangements changed, however, by reason of amendments made to the Act in 2009 by the Gambling Regulation Amendment (Licensing) Act 2009 (Vic) (the “2009 Amending Act”), the relevant provisions of which commenced on 16 August 2012 upon the expiration of the Tattersalls licence.
The “main purpose” of the 2009 Amending Act is recited in s 1 of that Act as including amendments to “substantially restructure the gaming industry” by providing for the creation and allocation of “gaming machine entitlements under which gaming by means of gaming machines will be authorised” and by “providing for a new licence for the monitoring of the conduct of gaming” and by “imposing certain ownership and related person restrictions in relation to licensees and persons registered on the relevant Roll”. As a result of these amendments, gaming on the 18 machines onsite became gaming conducted by the Trustee rather than Tattersalls. In order to conduct gaming in respect of those 18 machines on the site of the Royal Hotel, the Trustee had to acquire a gaming machine entitlement (a “GME”) in respect of each machine. In the absence of such an entitlement, the Trustee could not conduct gaming and, as a result, could not generate income from gaming as part of the business of the Royal Hotel. In the period after 16 August 2012, the obligations of the Trustee, put simply, were these.
First, the Trustee had to ensure that the 18 machines on the premises were “approved machines” (an approval for the existing 18 machines). As to that, the Trustee entered into an agreement with PVS Australia Pty Ltd (“PVS”) which held a licence to provide approved machines and granted the necessary approval for those existing 18 gaming machines.
Second, the Trustee had to ensure that gaming operations on the site of the Royal Hotel were “monitored” and it engaged a company holding a monitoring licence under the Act (as amended) to provide those services for which it paid a fee.
Third, it became liable to the State of Victoria for ongoing taxes from income it generated from conducting gaming and the new provision addressing that obligation became s 3.6.6A of the Act, as amended.
It will be necessary to briefly examine the new statutory structure later in these reasons.
The auction process
The mechanism by which the State of Victoria proposed to allocate GMEs to hotels and clubs was by means of an auction process. The process was as follows.
The Minister, under the provisions of the Act, as amended, established a maximum of 27,500 GMEs available for allocation in the auction process. There were to be a maximum of 13,750 hotel GMEs State‑wide and a maximum of 13,750 club GMEs State‑wide. Bidders would compete with each other to receive an allocation of entitlements on the basis of the price they offered for those entitlements by placing orders (unconditional offers) in the auction system. Bidders would compete not only for entitlements in their own geographic area (for example, the Hepburn area) but with other bidders throughout the State. Being the only bidder in a geographic area would not mean that that bidder would be allocated any of the available GMEs in that area. For the purpose of the auction there would be 176 geographic markets made up of 88 hotel markets and 88 club markets. One of those geographic regions was the Hepburn Shire with an allocation of GMEs capped at 112 (although allocations never reached the level of the cap). The auction would be conducted over two rounds. In round one, orders would be submitted through a secure internet site over a period of 10 business days in April/May 2010. In round two, orders would be submitted using State supplied computers at a nominated venue on a single day in May 2010 to complete the auction process, which turned out to be 10 May 2010. A bidder that failed to submit an order in a particular market in round one would not be able to participate in the round two auction. Round one would provide qualified bidder representatives with an opportunity to place and revise their initial orders over a 10 day period. Prior to the start of round two, bidders would be provided with the market prices and details of their own “provisional” winning allocations from round one.
All of these matters are contained in a document called “Gaming Auction document 2”. The document was available to all potential bidders in the auction. The document tells potential bidders that the sole criteria for determining successful orders in the auction is the price offered “relative to competition, within the constraints of the caps and limits, across the State”. The auction system would not take into account “any other factors”.
The price in each market might differ due to variations in the demand for GMEs across the State and the value placed on GMEs by bidders in each market. The auction system would calculate which orders were successful and the price in each market. Every bidder which had placed an order above or equal to the calculated market price at the end of the auction (round two) would be “eligible” to receive an allocation of entitlements (subject to the completion of the relevant agreements). All bidders in the same market would pay the same price (the market price) for their entitlements. The price offered for GMEs would not necessarily be the price to be paid for those entitlements. However, a bidder would never pay more than their maximum order price.
In presenting initial orders, bidders were required to offer a price per GME which was greater than or equal to the “opening bid price”. The auction system would not allow an order to be submitted where the price offered was below the opening bid price. An opening bid price had been set for club entitlements and hotel entitlements. For hotel entitlements, the opening bid price was $11,000.00.
Although it will be necessary to explain the factors that informed the thinking of Mr Canny (as the guiding mind of the Trustee) and Mrs Canny (as the nominated bidder), as they entered into the auction process and particularly the formulation of the maximum price they could afford to bid in such an auction for each GME having regard to the profitability of the business of the Royal Hotel, it is sufficient for present purposes to note that Mrs Canny, on behalf of the Trustee, participated in the auction to try and secure 18 GMEs, that is, one GME for each of the 18 machines that had been historically located on the site of the Royal Hotel and had, historically, been productive of the gaming income derived by the Trustee in the form of commissions paid by Tattersalls in connection with gaming onsite, as part of the hotel business. Mr Canny was unable to act as the bidder for the Royal Hotel on the day as he was a participant in a bid process for another hotel in which he had an interest, the Red Lion, at Ballarat. Mr Canny says that he knew that the “value [of the Royal Hotel] would fall if it did not have gaming machines – not just through the loss of gaming revenues but also due to a flow on throughout the business”: Witness Statement of Mr Canny, 28 April 2017, para 82.
In the final round auction conducted on 10 May 2010, the Trustee was successful in its bid for 18 GMEs. The total cost of the 18 GMEs was $600,300.00 including a $10,000.00 non‑refundable bond, or $33,350.00 per GME. Mr Canny, for the Trustee, took up the option of paying the acquisition price by quarterly payments under a deferred payment arrangement over six years commencing in May 2010. In May 2010, the Trustee paid an amount of $60,030.00. From 16 August 2012, to 31 August 2016, further amounts of $30,015.00 were paid quarterly in discharge of the total debt of $600,300.00 for the 18 GMEs.
The pending imperative
The Trustee found itself in a position where, on 9 May 2010, the day before the auction, it was (and would be until 15 August 2012), conducting the business of a hotel deriving “commissions” income from gaming activities onsite and deriving income from all of the other activities conducted at the hotel, made in part at least, more robust by reason of the presence of gaming machines onsite. As the evidence shows, patrons or customers of the Royal Hotel were contributing gross gaming revenue of a very significant amount each and every day at the hotel and thus significant daily net cash distributable balances arose. The daily net cash distributable balances were 10% of the amounts set out in Item 2 in the table at [15] of these reasons for each year having regard to the evidence of Mr Foley to which the Full Court was taken: 90% of those balances were returned to patrons. As a result of the auction on 10 May 2010, the Trustee now found itself in a position where it was required to pay $600,300.00 for the 18 new “GMEs” which would enable it to “operate”, now as the gaming operator, from 16 August 2012, the same 18 machines on the same site albeit for a 10 year period commencing on 16 August 2012 under the new regime. I will return to the specific statutory features of the new regime later in these reasons.
Importantly, Mr Canny (and no doubt with Mrs Canny) for the Trustee was confronting, immediately before the auction, a present factual position and a counterfactual possibility. The immediate factual position was that the Trustee was conducting the business of the Royal Hotel which secured to it income from gaming activities (through commissions paid by Tattersalls). The forward‑looking counterfactual possibility was one where the Trustee, should it not be successful in winning the auction process with its bids, would have to confront conducting the business of the Royal Hotel without any GMEs and thus without any right to conduct gaming through the 18 gaming machines onsite and thus without any gaming revenue at all. This, no doubt, as the Commissioner accepts (see [233] to [236] of these reasons) represented a major threat to the revenues and profitability of the hotel and to the value of the goodwill based on the attractive force of gaming for the hotel’s custom. That custom would be significantly less in the counterfactual scenario without gaming onsite.
Although the evidence does not go this far, it seems to me fair and reasonable to assume as a matter of rationality and practicality in the real world of commercial daily life in Victoria that every club and hotel throughout Victoria which had, prior to 10 May 2010, enjoyed revenue from gaming activities onsite (whatever the legal structure may have been which enabled that activity to occur according to law), and which was unable to obtain GMEs in the auction process on 10 May 2010, would each have been in a position where their custom would have fallen, their revenues and profitability would have fallen, the attractive force for custom would have been less and the value of the goodwill of the enterprise in question would also have fallen.
The evidence demonstrates, as described later in these reasons, that the possibility of a failure to secure 18 GMEs for the Royal Hotel’s business undertaking was thought to be, by Mr Canny, a strategic threat to the custom and profitability of that undertaking.
The claimed deductions
Sharpcan says that the Trustee of the Trust was entitled to a deduction for the amounts paid in acquiring the GMEs in calculating the net income of the Trust estate for the year ending 30 June 2010. It says that on 10 May 2010, the Trustee incurred a liability to make payments totalling $600,300.00 over a six year period from 1 May 2010.
For the purposes of s 8‑1 of the Income Tax Assessment Act 1997 (Cth) (the “1997 Act”), there is and has been no dispute between the parties that the outgoing was incurred in gaining or producing assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. The Commissioner says, however, that the outgoing was of a capital nature and thus its deductibility is precluded by s 8‑1(2)(a) of the 1997 Act. The respondent says that the outgoing was a liability properly characterised as a liability on revenue account and therefore deductible.
The first question therefore is whether the liability was of a capital nature or on revenue account having regard to all of the relevant considerations in relation to the outgoing.
The second question is whether the outgoing of $600,300.00, if it be a capital item, is deductible over five years commencing in the 2010 income year under s 40‑880 of the 1997 Act.
The Commissioner, before the Tribunal, accepted that if the gaming machine expenditure was deductible either in full under s 8‑1 when incurred or deductible over five years under s 40‑880, the net income of the Trust for the 2012 income year would be nil and thus the assessable income for the 2012 income year would be reduced by the whole of the amount of $139,901.00 assessed to Sharpcan by the Commissioner in that income year.
Section 40‑880(1) provides that the object of the section is to make certain business capital expenditure deductible over five years if the expenditure is not otherwise taken into account and a deduction is not denied by some other provision of the tax law and the relevant “business” is carried on for a taxable purpose. Section 40‑880(2)(a) provides for the deduction, relevantly, in these terms: “You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur in relation to your *business”. However, s 40‑880(5) provides, among other things, that a person cannot deduct anything under the section for an amount of expenditure incurred to the extent that “it could, apart from [s 40‑880], be taken into account in working out the amount of a *capital gain or a *capital loss from a *CGT event”: s 40‑880(5)(f).
Section 40‑880(6), however, limits the application of the exception contained in s 40‑880(5)(f) by providing that the exception does not:
… apply to expenditure you incur to preserve (but not enhance) the value of goodwill if the expenditure you incur is in relation to a legal or equitable right and the value to you of the right is solely attributable to the effect that the right has on goodwill.
So, the second question is whether the prohibition contained in s 40‑880(5)(f) upon the availability of the deduction, otherwise available under s 40‑880(2) over the period of the relevant five income years, is rendered inapplicable to the capital expenditure (if it be in the nature of capital) incurred by the Trustee in acquiring the 18 GMEs for $600,300.00. That turns on whether the expenditure is incurred by the Trustee “to preserve (but not enhance) the value of goodwill” (as those words might be construed) and whether the expenditure is in relation to a legal or equitable right, and the value to the Trustee of the right is solely attributable to the effect that the right has on goodwill.
The parties agreed before the Tribunal and agreed before the Full Court that, subject to the operation of s 40‑880(6) in the context of the “facts overall” (T, p 7, lns 36‑40), s 40‑880(5)(f) applies to deny the availability of a deduction under s 40‑880(2)(a). In other words, the parties accept that each GME is a CGT asset (s 995‑1; s 108‑5 of the 1997 Act) and not an exempt asset.
The relevant facts
It is now necessary to consider aspects of the findings of the Tribunal and other aspects of the documents and other evidence before the Tribunal to which the Full Court was taken by each of the parties. As to the evidence to which we were taken, it should be noted that there was no challenge by the Commissioner to the evidence of Mr Canny: T, p 7, lns 36‑40; T, p 9, lns 31‑32; T, p 12, lns 37‑43; T, p 15, lns 31‑33. The Commissioner relies upon the facts set out in paras 2, 6, 7, 8 and most of paras 9 and 10 of the Tribunal’s Decision. I will identify those matters in the course of setting out some aspects of the “facts overall”, having regard to the observations at [89] to [93] of these reasons.
As already mentioned, Mr Canny is the sole shareholder and director of Sharpcan. He is the sole shareholder and director of Spazor. He has worked in the hotel industry since the 1980s and is an experienced hotel venue operator. In 2004, Mr Canny, together with Mr Wayne Sharp, began investigating the possibility of purchasing the business undertaking of the Royal Hotel. Having regard to his experience in the hotel industry, Mr Canny took the view that the appropriate price to pay to acquire the business of the Royal Hotel was a multiple of four times its net profits adjusted for particular items such as drawings by directors. Mr Canny considered that a multiple of four times net profit was appropriate given that the Royal Hotel had gaming machines, even though those machines did not produce the majority of the Hotel’s revenue. The presence of gaming machines at the venue justified a higher multiple than a non‑gaming hotel as it meant that the Royal would, in the view of Mr Canny, “generate a steady cash flow and a stable profit margin that could be used to improve other areas of the Royal’s operations, such as its food and beverage and accommodation services”. Mr Canny understood, from his experience in the hotel industry, that hotels without gaming revenue tended to be sold for around three times their net profit whereas hotels that were “more heavily reliant on gaming machines were commonly sold for six or seven times net profit”.
Ultimately, Mr Canny agreed with the vendor a sale price of $1,025,000.00 which was approximately four times the net profits of the hotel from all its activities.
A goodwill component of the purchase price was calculated by deducting from the total purchase price the value of the chattels transferred including the “liquor licence”.
The purchase did not involve a purchase of the freehold to the property. The purchase was subject to the mortgagee consenting to the landlord granting Spazor, as and from the settlement date, a lease over the premises. Spazor’s assumption of the lease was important. It had 27 years of its term left to run including extensions. Mr Canny says he would not have acquired a business with a lease for less than 25 years because it would not have provided a sufficient term to recoup investment in the business. Ideally, he says, the term needed to be 25 to 30 years.
As part of the purchase, Spazor had to secure a wide‑range of approvals relating to the accommodation, the sale of food, the sale of liquor and compliance with other health regulations. It is not necessary to detail all those matters here. Spazor also had to obtain a venue operator’s licence from the VCGR, a venue operator’s agreement with Tattersalls and premises approval from the VCGR as already mentioned. These were obtained. With effect from 8 August 2008, the Trustee entered into the venue operator’s agreement with Tattersalls under which the Trustee was required to conduct gambling activities in accordance with the Act and the conditions of the agreement with Tattersalls. Tattersalls was required to install and maintain the 18 gaming machines onsite and maintain a master computer terminal for processing returns. The Tattersalls gaming machines were already located onsite along with the master computer terminal and monitoring equipment. All gaming revenue, net of payouts to players, was paid into a special purpose bank account with payments made from that bank account in accordance with the distributions described at [8] of these reasons.
Mr Canny says that when the Trustee acquired the Royal Hotel, Mr Canny was “acutely aware” that the hotel was located in a small town heavily reliant on tourism, weekend and holiday trade. Mr Canny’s intention was to achieve revenue growth by developing the business of the Royal Hotel in a way that attracted more tourists and maximised the amount tourists would spend at the venue during peak tourism times. He says that the peak periods and holidays were the times when the Royal Hotel achieved a significant amount of its trade. He says that this helped to subsidize its ability to provide a local facility to residents of Daylesford and surrounds all year offering reasonable prices. He says that a “key component” of the Royal Hotel’s offering to tourists and, more generally, visitors to the Daylesford area, included gaming machines which provided an entertainment option to supplement the other activities on offer at the hotel. He says that, in his view, for the Royal Hotel to be sustainable it needed to maximise its trade during peak tourist periods and, for this reason, the Trustee invested extensively in improving its accommodation offering, general fit‑out of the hotel and the fit‑out of the kitchens. Mr Canny agreed with the landlord that the Trustee would make extensive improvements to the premises and the lease would be extended for a further term of eight years. The first major renovation consisted of moving the public and gaming areas to maximise the use of those areas. The Trustee obtained approval from the VCGR to relocate aspects of the equipment used in relation to gaming. The improvements enhanced use of the public bar by patrons of the gaming area. As part of the renovation, the Trustee relocated the “Pub Tab” facility into the old gaming room so as to maximise the social aspect of wagering and also improve bar sales.
New kitchen facilities were installed in 2007 by the Trustee enabling the hotel to serve 1,000 meals per week especially during peak tourist periods and weekends.
Various promotional activities took place to attract guests to the Royal Hotel including mail‑outs and notices about live entertainment and information directed to those who were specifically interested in receiving information about gaming.
Other renovations took place to enhance the attractive force of the Royal Hotel in all of its various services. It is not necessary to describe those events aimed at enhancing the integrated services of the Royal Hotel to its patrons, customers and generally within the catchment of the Daylesford area.
As to the gaming activities, gaming machines allow patrons to deposit notes or coins into the machine in order to play. The machines are designed to return to patrons a minimum of 90% of the amounts played. The margin retained (10%) is generally described as the “total gaming revenue”. Each gaming machine was connected to a telephone line to Tattersalls which monitored each gaming machine and enabled communication to the gaming terminal located at the cashier. Generally, gaming machine payouts of $100.00 or more would not be paid in cash from the machine but would be paid by a staff member at the cashier on production of a ticket produced by the machine. Each day the Royal Hotel was required to reconcile the gaming room cash float, tickets, each gaming machine “hopper” and each gaming machine “drop box”, with the Tattersalls reports. On a regular basis, employees of the Royal Hotel would collect the money inserted into each gaming machine and deposit that money in a special purpose bank account. The “Gaming Trust Account” was the account from which Tattersalls each week took its “sweep” so as to obtain its share of the gaming revenue. Tattersalls calculated its share of the gaming revenue by reference to amounts which were recorded as having passed through the gaming machines as transmitted to Tattersalls through the terminal. Both Tattersalls and the VCGR arranged regular visits to the Royal Hotel to monitor compliance with the gaming regulations.
In terms of the physical practices after the commencement of the new regime on 16 August 2012, Mr Canny says that the Royal Hotel continued the same practice of banking the receipts from each gaming machine into the account. The gaming revenues from each gaming machine continued to be monitored across telephone lines as before except that the monitoring service was undertaken by Intralot Gaming Services Pty Ltd (“IGS”) rather than Tattersalls.
Mr Canny says that on 10 April 2008, the Premier of Victoria, Mr Brumby, announced the commencement from 16 August 2012 of a new regulatory and licensing regime under which there would be a transition from Tattersalls as the gaming operator to a “venue operator system”. Mr Canny understood that the venue operator would now be directly responsible for the conduct of gaming operations in its venue. That responsibility included acquiring and operating gaming machines and paying a monitoring service fee; the payment of a supervision charge; and the payment of gaming taxes. Mr Canny understood that IGS had been appointed as the monitoring licensee for a 15 year term and monitoring services fees would be paid directly to it. In September 2009, Mr Canny received an information pack from the Victorian government explaining aspects of the new regime.
The factors informing Mr Canny’s approach to the auction process
Mr Canny understood that a key feature of the new venue operator system, would be the requirement to bid for and hold a GME for each gaming machine in order to continue “gaming activities” albeit within a different legal structure. Mr Canny says that he understood that each GME would have a 10 year term from 16 August 2012 to 15 August 2022. He understood that it would also be necessary for the ongoing operations of the business of the Royal Hotel to continue the existing approvals in terms of a premises approval from the VCGR, a venue operator’s licence and the existing food and health approvals.
In April 2010, Mr Canny received a further information pack from the Victorian government entitled “Gaming Auction Event Booklet” which described the proposed auction process. In the lead‑up to the auction, Mr Canny engaged Mr Richard Whitehouse, an analyst (PVS), to provide advice about the bidding strategy which might be adopted in the auction and the price that the Trustee should pay on behalf of the Trust for the acquisition of the 18 GMEs at the Royal and the price that ought to be paid for GMEs at the Red Lion in Ballarat by the hotel operator in that case, Bacceney Pty Ltd. Mr Canny had an interest in that company and the operation of the Red Lion.
Mr Whitehouse provided a report to Mr Canny for the Red Lion which contained advice about the maximum price that a rational person would bid to acquire GMEs at the Red Lion. The advice set out the assumptions determining the price a rational person would pay. The rational price was understood by Mr Canny to be the maximum price that could be paid in order to acquire the GMEs and yet “broadly maintain” a reasonable rate of return on the assets deployed in the business of the Red Lion. Mr Canny says that based on the report for the Red Lion, he prepared a one page document as a “bidding guide” for the acquisition of the GMEs at the Royal Hotel. He provided the bidding guide to Mrs Canny as she was going to undertake the auction process for the Royal Hotel. Mr Canny would attend the bidding process for the Red Lion. Mr Canny says that there were “sufficient similarities” between the Red Lion and the Royal Hotel to make the Red Lion report a “reasonable basis for determining the most [that the Trustee] should pay for GMEs at the Royal”. The degree of similarity is better explained by Mr Canny in his second affidavit. He says that he adapted Mr Whitehouse’s report based on his own knowledge of the gaming machine returns achieved at each venue. He says that he calculated that the gaming machines at the Royal Hotel returned approximately 80% of the returns gaming machines achieved at the Red Lion. He says that Mr Whitehouse had calculated a rational bid price for the Red Lion of $81,515.00 per GME. He says that he applied the 80% figure to that amount in order to determine a rational bid price for the Royal Hotel and thus the rational maximum bid price for each GME by the Trustee would be $65,212.00. The total cost to the Trustee for 18 GMEs to enable the Trustee to operate the existing 18 gaming machines onsite would be $1,170,000.00.
The one page “bidding guide” prepared by Mr Canny for his wife projected the possibility that the Trustee might bid up to the full amount of $81,515.00 (rather than the 80% discounted amount) for each GME, for 18 GMEs at a total cost, on that basis, of $1,467,270.00. The bidding guide commences with an opening price of $11,100.00. Mr Canny understood that the minimum opening bid price for the auction would be $11,000.00. In the bidding guide, Mr Canny also records a price per GME of $85,000.00 to $100,000.00. However, in respect of these bids, the number of GMEs sought declines from 17 to 15. Mr Canny says that his assessment was that if the price of each GME exceeded $85,000.00, he (speaking for the Trustee) would be unable to finance the acquisition of all 18 GMEs. Mr Canny says that he set an amount of $1.5 million as the maximum amount the Trustee could spend on GMEs. To fall within that cap, the number of GMEs would need to fall to 15 at $100,000.00 per GME. Mr Canny also formed the view that if the price exceeded $100,000.00 for each GME, the burden of the fixed costs of having the machines on the premises (such as the dedicated space, the monitoring obligation and other infrastructure and related costs) meant that it would not be “worthwhile having less than 15 machines” and thus the Trustee should not continue bidding any further in the auction. Mr Canny’s assessment was that increases in the price per GME beyond $100,000.00 would result in fewer GMEs being acquired which would fall below the critical mass of 15 GMEs, and thus less than 15 gaming machines onsite generating gaming revenue.
The evidence of Mr Canny, as the guiding mind of the Trustee, is that acting on professional advice from PVS, he calculated the maximum price the Trustee could afford to pay to acquire 18 GMEs and, if necessary, the maximum price to be paid for 15 GMEs (at a higher price per GME than that thought possible or desirable for each GME if 18 GMEs were to be acquired in the auction), while at the same time trying, from a trading perspective, to “broadly maintain” a reasonable rate of return on the assets deployed in the business of the Royal Hotel. The calculation of these maximum prices in this way by Mr Canny set out in the bidding document for the auction, makes plain the significance of the income from gaming to the total revenue of the business of the Royal Hotel and the imperative, leading into the auction process, to preserve gaming revenue for the business as a going concern. The bidding schedule, as delivered by Mr Canny to Mrs Canny for the auction, is set out below:
SPAZOR
Hotel – Hepburn
No.
Price
Total Cost
Deposit
Opening Bid
18
$11,100
$199,800
$19,980
18
$12,000
$216,000
$21,600
18
$15,000
$270,000
$27,000
18
$20,000
$360,000
$36,000
18
$25,000
$450,000
$45,000
18
$30,000
$540,000
$54,000
18
$35,000
$630,000
$63,000
18
$40,000
$720,000
$72,000
18
$45,000
$810,000
$81,000
18
$50,000
$900,000
$90,000
18
$55,000
$990,000
$99,000
18
$60,000
$1,080,000
$108,000
18
$65,000
$1,170,000
$117,000
18
$70,000
$1,260,000
$126,000
18
$75,000
$1,350,000
$135,000
18
$80,000
$1,440,000
$144,000
18
$81,515
$1,467,270
$146,727
17
$85,000
$1,445,000
$144,500
16
$90,000
$1,440,000
$144,000
15
$95,000
$1,425,000
$142,500
15
$100,000
$1,500,000
$150,000
As events transpired in the course of the auction it proved not to be necessary to bid to the limit of the maximum postulated bids. The Trustee acquired the 18 GMEs at a price of $33,350.00 per GME or $600,300.00 in all.
Financial statistics in the period of the new regime according to Mr Foley’s attachment
The Key Financial Statistic Summary attached to Mr Foley’s Witness Statement also sets out financial information for the trading activity of the Royal Hotel for the financial years ending 2013, 2014 and 2015 in the new regime. The following schedule sets out the gross income received in those financial years in respect of each business segment for the hotel. In the case of gaming income, the following schedule shows the gross income received by the Trustee from gaming after payments made to the VCGR, PVS, IGS and payments in respect of the acquisition of the GMEs.
Business Segment
2013
2014
2015
Accommodation
$176,946
$196,425
$261,946
Bar
$638,167
$685,351
$793,765
Food
$730,555
$816,538
$876,182
Gaming: total annual net daily balances for distribution
$1,053,761
$997,448
$1,142,319
Gaming income derived by the Trustee
$423,504
$365,278
$395,346
Wagering
$70,840
$68,166
$67,971
Total gross income from all segments for each of these years was as follows: 2013 - $2,040,012; 2014 - $2,131,758; and 2015 - $2,395,210. Income from gaming represented the following percentages of total income: 2013 – 20.75%; 2014 – 17.13%; 2015 – 16.5%.
These statistics, like the statistics at [13] of these reasons represent gross income figures and do not take account of the profitability of each segment of the business. Mr Canny says that each segment of the business was enhanced by the presence of gaming machines and in the period of the new regime, enhanced by the presence of GMEs and thus of gaming machines. In that sense, the business undertaking of the Royal Hotel was an integrated interdependent business operation.
The net profit contribution of each segment of the hotel business, and particularly the net profit contribution of the gaming part of the business undertaking for the financial years ending 2006 to 2012 are set out in the schedule below.
Net Profit Contribution by Business Segment
2006
2007
2008
2009
2010
2011
2012
Accommodation
$88,239
$94,330
$80,098
$75,032
$107,893
$140,527
$139,126
Bar
$194,795
$335,750
$340,265
$325,835
$333,486
$236,139
$240,931
Food
$42,954
$64,446
$38,787
$1,553
$12,059
$79,070
$126,573
Gaming
$258,106
$310,235
$342,933
$311,830
$288,226
$277,048
$231,809
Wagering
$3,941
$1,280
$10,931
$2,127
$48,284
$3,552
$5,280
The net contribution to net profit from gaming can be seen in the schedule for each financial year. The total net profit for each financial year after the distribution of all overhead expenses not directly referable to each business segment resulted in the following total net profit for each financial year.
2006
2007
2008
2009
2010
2011
2012
Total Net Profit
$65,444
$175,164
$124,153
$73,217
$68,989
$154,949
$146,587
The consequence for total net profit of the business undertaking overall arising out of a loss of the net profit contribution from gaming, can readily be seen apart from any question of the extent to which the presence of gaming activities onsite enhanced the revenue and net profitability of the other segments of the business of the Royal Hotel.
The net profit contribution from gaming after taking into account payments directly related to the new regime in the years 2013, 2014 and 2015 was, $308,806, $250,431 and $274,315 respectively. The net profit overall from all activities in those three financial years after the distribution of overheads not directly referable to each segment of the business, was $11,479, $15,252 and $237,257 respectively. Again, the consequence for total net profit of the business undertaking overall arising out of a loss of the net profit contribution from gaming, can readily be seen apart from any question of the extent to which the presence of gaming activities onsite enhanced the revenue and net profitability of other segments of the business of the Royal Hotel.
The factual matters addressed by the Tribunal at paras 2, 6, 7, 8, 9 and 10 upon which the Commissioner relies have already been identified in these reasons. It is now necessary to identify the legal features of the new regime.
The new regime
The 2009 Amending Act brought about a “substantial restructure of the gaming industry”. Section 3.4A.5 of the Act, as amended, conferred power on the Minister to “create gaming machine entitlements” and “allocate” them to “venue operators”. Section 3.4A.5(4), subject to particular matters, requires the Minister to impose conditions on GMEs as to the type of venue in which gaming may be conducted and the geographic regions within which gaming may be conducted. Section 3.4A.1 provides that on and after the relevant day, the conduct of gaming in an approved venue is lawful only if the venue operator “holds a [GME] that authorises the conduct of gaming” and the relevant s 3.4A.5(4) conditions are satisfied.
By s 3.4A.2(1), a GME “authorises” the venue operator holding the GME, subject to the Act, related agreements required by the Act, and relevant conditions “to acquire approved gaming machines” and “to conduct gaming on one approved gaming machine in an approved venue operated by the venue operator”. A venue operator’s licence authorises the licensee to “acquire and transfer” GMEs in accordance with the new Part 4A (s 3.4.1(1)(aa), and s 3.4.1(1)(ab)), authorises the licensee, while holding GMEs, to conduct gaming on approved gaming machines in an approved venue operated by the licensee.
The Commissioner says that a GME created under the Act conferring the rights or authorities described in the Act renders a GME an intangible asset of the holder. Section 3.4A.6 provides that despite s 3.4A.5, the Minister may refuse to allocate a GME to a venue operator unless the operator enters into relevant agreements addressing “matters related to the [GME]”. A GME remains in force for 10 years (s 3.4A.7) although it may be transferred earlier under the Act (s 3.4A.7(2)) or extended by the Minister (s 3.4A.7(2)) for not more than two years beyond its expiry date otherwise. The details of a venue operator holding a GME (among other information) is to be noted on a Register maintained by the VCGR.
A GME is capable of being transferred by a venue operator subject to the specified payment arrangements and “the [GME] transfer allocation and transfer rules” (the “Rules”): s 3.4A.17. However, a venue operator “must not transfer a [GME] to a person who is not a venue operator”. An agreement, arrangement or deed that purports to effect a transfer of a GME to someone who is not a venue operator is either “void” or of “no effect”: s 3.4A.16(1)‑(3). Thus, there is no general secondary market for GMEs. A GME only has use or value in the hands of a venue operator and cannot be held by someone who is not a venue operator, with all of the regulatory controls applicable to venue and venue operators.
The Commissioner contends that because a GME is able to be transferred under the Act and Rules, a GME has “extrinsic value” and is portable from one venue operator to another subject to the Act and Rules.
Under Part 4A, Div 6 of the Act, the venue operator (Trustee) must commence the conduct of gaming by means of an approved gaming machine under a GME within the statutory period: s 3.4A.23. If the venue operator does not do so, the GMEs held by the venue operator are forfeited to the State: s 3.4A.24. If a venue operator engages in conduct giving rise to forfeiture (on a relevant date) under the conditions of a “related agreement” for the purposes of s 3.4A.6, the GMEs will be forfeited to the State on that date: s 3.4A.27. On and after the day of forfeiture of the GMEs under any of Div 6, Div 7 or Div 8, any amount owed to the State for the allocation of GMEs becomes immediately due and payable: s 3.4A.32.
The Commissioner places emphasis upon these provisions about the capacity to transfer GMEs to another venue operator (the “extrinsic value” point) and the “exposure to forfeiture” provisions under Divs 6, 7 and 8, as demonstrating, it is said, aspects of the very different “nature” of the intangible asset in the form of a GME (and the rights attached to it) acquired by the Trustee, as compared with the legal source of the earnings derived and rights exercised, by the Trustee under the earlier pre‑16 August 2012 “Tattersalls” regime. These considerations are said to be factors indicating that the obligations cast by the Act on the venue operator under the new regime in relation to GMEs are not simply related to deriving a revenue stream from gaming activities and thus the outgoing incurred on 10 May 2010 in acquiring the GMEs is said to be in the nature of capital and not on revenue account.
This distinction is said to be made more plain by those new provisions of the Act (s 3.6.6A) which provide for the payment of tax on the amount of “average revenue per GME” derived from gaming (on a machine corresponding to each GME) by a venue operator which conducts gaming in an approved venue for which there is a “Pub Licence” in place, that is, a hotel. The calculation of the tax is directly related to the revenue stream derived from the trading activity of gaming according to the integers of the formula. That section (s 3.6.6A) was not in the Act in the pre‑2012 regime. It was not necessary because, in the pre‑2012 period, a venue operator could not “conduct” gaming. That conduct and the payment obligation for tax fell to Tattersalls as the entity conducting gaming.
In seeking to properly characterise the nature of the outgoing incurred on 10 May 2010, the Commissioner says that the fundament of the error by the Tribunal is that it conflated the structural statutory and legal arrangements that subsisted in the pre‑2012 period concerning the role of the Trustee as a venue operator and Tattersalls as the owner of the machines (and the entity “conducting” gaming), with the very different role of a venue operator itself conducting gaming (by acquiring and deploying the new GMEs, as a new statutory creature), to derive income. Because the outgoing of 10 May 2010 secured the acquisition of the GMEs, as a new statutory entitlement, which enabled gaming to be conducted so as to derive income, the outgoing is said to bear the character of capital. Without the GMEs, no business of gaming could be conducted on and from 16 August 2012. The Commissioner says that the outgoing is in the nature of capital because the GMEs exhibit the following characteristics said to be emblematic of capital.
First, the GMEs are intangible assets created pursuant to statute.
Second, they can be bought and sold.
Third, they confer a statutory authority necessary to lawfully conduct gaming on gaming machines.
Fourth, they last for 10 years.
Fifth, the outgoing was a sum set at auction and it was a lump sum even though an agreement was reached that it be paid by instalments.
Sixth, the amount was payable irrespective of the fortunes of the business.
Seventh, although it is true that gaming continued to be conducted at the premises occupied by the Trustee, the fundamental change in the arrangements involved the Trustee conducting gaming and becoming entitled to the whole of the income generated from the gaming activities and the entitlement would subsist for the entire period of 10 years.
Eighth, the Trustee became responsible for outgoings in relation to the conduct of gaming such as making payments to PVS for the supply and maintenance of the existing machines; paying a fee for ongoing monitoring of the gaming machines; and becoming responsible for paying the taxes imposed by the Act in respect of the conduct of gaming.
The Commissioner says that all of these things are features of the new regime which need to be taken into account in determining the true character of the outgoing of the acquisition cost of the GMEs on 10 May 2010 of $600,300.00.
Consideration of the issues
In these reasons, I have attempted to set out the particular facts and circumstances of the Trustee’s activities in order to assess the proper context within which the question of whether the outgoing is in the nature of capital or on revenue account arises. In 1938, Dixon and Evatt JJ observed, in determining whether an item was a matter of capital or income, in Western Gold Mines NL v Commissioner of Taxation (W.A.) (1938) 59 CLR 729 at 740, that “it is necessary to make both a wide survey and an exact scrutiny of the taxpayer’s activities” [emphasis added]. Their Honours also observed that they had become “only too familiar with the standard or criterion which the law provides for distinguishing between the two” and “it is a most unsatisfactory criterion, and a decision must often be made by reference to matters of degree and by reason of the weight given to particular circumstances affecting the activities of the taxpayer …”. The question in issue in that case, put simply, was not the character of an outgoing but rather the character of a receipt in the form of an unrealised “excess” and whether it gave rise to a profit or was capital in nature. Nevertheless, the observations remain relevant in determining the character of an outgoing.
In 1965, Lord Pearce, delivering judgment for the Privy Council in BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386 at 399 (“BP Australia v FCT”), in determining whether expenditure was recurrent, said this:
Their Lordships agree with Owen J. in thinking that if regard was had to “the whole picture” the expenditure was recurrent. To find whether expenditure is of a recurrent nature one must take a broad view of the general operation under which the expenditure was incurred. Here it was made to meet a continuous demand in the trade. …
[emphasis added]
In 1979, Barwick CJ in Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 140 at 148 (“Cliffs International”) said, in relation to the question of whether the payments made in that case were capital payments, “[t]he proper conclusion in each case in this particular area of the law is peculiarly dependent upon the particular facts and circumstances of [the] case” [emphasis added].
Moreover, I am not assisted by observations that the outgoing in question in this case is either like or unlike payments made in an entirely different case. In this area of the law, there is little to be gained by defaulting to analogical references or analogical reasoning (Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1 at 43 [151], Crennan J; see also Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at 661 [64], Gaudron, Gummow, Kirby and Hayne JJ), or the outcome of finely balanced evaluative judgments entirely dependent upon the calculus of factors determining that balance in other cases and other circumstances. The outgoing, in this case, either is in the nature of capital having regard to the calculus of factors relating to the taxpayer’s activities, “exactly scrutinised”, or it is not. That is not to say that the decision as to characterisation is either black or white; or binary/on or off. In some cases, it may be clear (there are “obvious cases” that “lie far from the boundary”: BP Australia v FCT at 397) but such cases are unlikely to (or at least ought not to) find their way into the appellate structure of judicial decision‑making.
Generally, an evaluative judgment must be made in the context of all of the circumstances of the taxpayer’s activities taking account of the “whole picture” with an eye to understanding precisely what the outgoing is “calculated to effect from a practical and business point of view” (Dixon J, Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 at 648 (Hallstroms”) yet taking account of the legal nature of the obligation in question giving rise to the outgoing and the liability discharged by making the payment: Ausnet Transmission Group Pty Ltd v Commissioner of Taxation (2015) 255 CLR 439 at 474 [74] (“Ausnet”), Gageler J citing GP International Pipecoaters Pty Ltd v Commissioner of Taxation (1990) 170 CLR 124 at 137 (“GP International”). The inquiry includes “most importantly the commercial purpose of the taxpayer in having become subjected to any liability that is discharged by the making of [the] expenditure”: Ausnet, Gageler J at [74]. In determining the questions in issue in this appeal, it is important to keep in mind all of these considerations at [89] to [93] of these reasons, especially the need for “exact scrutiny” of the Trustee’s activities with a view to understanding the “whole picture” within which the expenditure was incurred.
That is not to say, plainly enough, that matters of general principle cannot be distilled from the authorities. Nor is it to suggest that reference to the facts of a particular case are of no value in illustrating a proper understanding of the principle. However, there is no utility in attempting to find in the facts of one case, an analogical answer to the question in issue on the actual facts of the particular case as to the contested character of an outgoing.
One important statement of principle is to be found in GP International at 137 (by the Court; Brennan, Dawson, Toohey, Gaudron and McHugh JJ), in these terms:
The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by making the expenditure, for the character of the advantage sought by making the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation; Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation; Cooper v Federal Commissioner of Taxation.
[citations omitted; emphasis added]
That proposition was affirmed in Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1 Crennan J at 43 [148], Gleeson CJ, Gummow J, Callinan J and Heydon J each separately agreeing, and also by the plurality in Ausnet in the discussion at [15] to [22].
The reference by the Court in GP International at 137 to Sun Newspapers is a reference to the well‑known discussion by Sir Owen Dixon of the considerations which help to identify (and remain a “valuable guide” in identifying; BP Australia v FCT at 386) the distinction between expenditure on revenue account and on capital account: Sun Newspapers v Federal Commissioner of Taxation (1938) 61 CLR 337 at, particularly, 359 to 363. The distinction is often not always easy to draw. At the threshold, the distinction might well correspond with the distinction between the business entity, structure or organisation “set up” for earning profits, on the one hand, and the “process” by which an organisation so set up, “operates” or goes about deriving “regular returns” by means of “regular outlays”, on the other hand: Dixon J at 359.
Sometimes, the business structure may be represented by no more than “intangible elements … constituting goodwill, that is, widespread general reputation, habitual patronage by clients or customers and an organised method of serving their needs” [emphasis added]: Dixon J at 360. The plurality in Ausnet at [21] found that “implicit” in this observation is the “uncontroversial proposition” that an intangible asset might, according to its nature and function in the conduct of the business, be properly characterised “as forming part of the structure of the business” and thus “the cost of its acquisition” is a capital cost.
Sometimes, there may be a great aggregation of assets deployed in the production of goods or services: Dixon J at 360.
But whatever the form, the source of the earnings is the “profit‑yielding subject”: Dixon J at 360.
Orthodoxy suggests that outgoings upon “establishing” or “enlarging” or indeed “replacing” the profit‑yielding subject matter are “entirely different” in nature from the “continual flow” of working expenses supplied “out of the flow of revenue”: Dixon J at 360. But, the “practical application” of such orthodoxy is difficult and the “basal difficulty” lies in the fact that the “extent, condition and efficiency” of the profit‑yielding subject is “often” as much the product of the “course of operations” as it is of a “clear and definable outlay by way of establishment, replacement or enlargement” of the profit‑yielding subject itself: Dixon J at 360. The distinction is “even harder to maintain” in relation to the “intangible elements” forming an important part of many profit‑yielding subjects: Dixon J at 360. One illustration of that difficulty may be that in some cases goodwill may have been gradually established by continual advertising over a number of years growing the goodwill of the undertaking as the business proves to be successful. In such a case, the expenditure on advertising might be regarded as an ordinary business outgoing on account of revenue: Dixon J at 361.
One standard by which outgoings may be characterised as attributable to capital account or revenue account is whether the outlay is, on the one hand, “recurrent, repeated or continual” or whether it is “final” or made “once and for all”.
Even greater emphasis has been given to the distinction which might be found in the “nature of the asset or advantage obtained by the outlay”: Dixon J at 361. This distinction involves examining the “result or purpose” of the expenditure to determine whether it brings into existence or procures an asset or advantage of a “lasting character” which will “endure for the benefit of the organisation or system or profit‑earning subject”: Dixon J at 361. If so, the outlay will be distinguished from expenditure to be recouped by “circulating capital or working capital”: Dixon J at 361.
However, the conception of “an asset or advantage for the enduring benefit of a trade” is one which should receive “elastic application”: Dixon J at 361.
Moreover, the “idea of recurrence” and the “idea of endurance or continuance over a duration of time” both depend on “degree and comparison”: Dixon J at 362.
As to recurrence, the “real test” is between expenditure made to meet a “continuous demand” as compared with expenditure which is made “once for all”: Dixon J at 362, adopting the observations of Rowlatt J in Ounsworth v Vickers Ltd (1915) 3 K.B. at 273, explained his understanding of that notion in this way at 362:
By this I understand that the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely. … Recurrence is not a test, it is no more than a consideration the weight of which depends upon the nature of the expenditure.
[emphasis added]
The lasting character of the advantage gained by the outlay is not necessarily a determining factor in the characterisation of the outgoing: Dixon J at 362. Rights and advantages of particular duration and nature may be the subject of recurrent payments which are referrable to capital expenditure or income expenditure “according to the true character of the consideration given”, that is, whether on the one hand it is a capitalized sum payable by deferred instalments or, on the other hand, expenditure in the nature of higher payments or rental payments accruing at particular intervals, for the use of the thing: Dixon J at 363.
Ultimately, Dixon J synthesised these points of distinction in this way at 363:
There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.
The High Court delivered judgment in Sun Newspapers on 23 December 1938. On the same day, the Court also delivered judgment in The Commissioner of Taxes (South Australia) v Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108. In that decision, Dixon J had some further things to say about the difficulty of determining whether a particular expenditure or outgoing falls to capital account or revenue account and the relationship such a distinction bears to commercial practice and principles of accountancy. At 152 to 154, Dixon J made these observations:
Income, profits and gains are conceptions of the world of affairs and particularly of business. They are conceptions which cover an almost infinite variety of activities. It may be said that every recurrent accrual of advantages capable of expression in terms of money is susceptible of inclusions under these conceptions.
… But in nearly every department of enterprise and employment the course of affairs and the practice of business have developed methods of estimating or computing in terms of money the result over an interval of time produced by the operations of business, by the work of individuals, or by the use of capital.
Familiar but striking examples of this necessary reliance upon commercial principles and general business understanding may be found in the case law dealing with expenditure laid out for the purpose of trade, with outgoings on account of capital, with capital profits, and with the question whether items should be taken into consideration for any given accounting period rather than for that which follows or perhaps for that which preceded. …
The tendency of judicial decision has been to place increasing reliance upon the conceptions of business and the principles and practices of commercial accountancy. …
But the process by which the principles and practices evolved in business or general affairs are drawn upon for the solution of questions presented to courts of law almost inevitably leads to a development in the law itself. For, under our system of precedent, a decision adopting or resorting to any given accounting principle or application of principle is almost bound to settle for the future the rule to be observed and the rule thus comes to look very like a proposition of law.
But in some matters, particularly in the attribution of expenditure between capital and income, the courts have found it impossible to formulate a principle as an induction from commercial practice and have left the matter almost as much as ever in the realm of fact or discretionary judgment. …
In Lothian Chemical Co Ltd v Rogers, Lord Clyde says this:
It is according to the legitimate principles of commercial practice to draw distinctions, and sharp distinctions, between capital and revenue expenditure, and it is no use criticising these, as it is easy to do, upon the ground that if you apply logic to them they become more or less indefensible. They are matters of practical convenience, but practical convenience which is undoubtedly embodied in the generally understood principles of commercial accounting.
I have examined many of the Accounting Standards adopted and published by the Accounting Standards Body to determine whether those standards deal with factors informing, from a professional standards point of view, approaches to the determination of whether an item of expenditure is in the nature of capital or on revenue account. The Standards do not address that matter directly. This probably reflects a view within the Standards Body that the question is best left to be determined according to the facts of the particular transactions giving rise to the expenditure and the view courts might take about that expenditure as an exercise of judicial power in the context of adversarial proceedings where all aspects of the relevant evidence is properly evaluated.
Many of the propositions described at [97] to [108] of these reasons based on the observations of Dixon J in Sun Newspapers were expressly affirmed in Ausnet by the plurality, French CJ, Kiefel and Bell JJ at [14] to [29].
The plurality emphasised at [14] and [15], the “evaluative judgment” required to be made in determining the character of the outgoing by weighing up: the form of the expenditure, its purpose and its effect; the benefit derived by the taxpayer from the expenditure; and the relationship the expenditure bears to the structure of the business as distinct from the conduct of the business. Not surprisingly, some of these factors might point in one direction while others point in a different direction: Ausnet at [15]; BP Australia v FCT, Lord Pearce, 112 CLR 386 at 397.
Although a “once and for all” payment might be a criterion, in a rough way, of whether the expenditure is on capital or revenue account, such a rough criterion cannot, obviously enough, be decisive in every case. An outgoing made with a view to (that is the purpose of) bringing into existence an asset or an advantage for the enduring benefit of a trade, is likely to be an outgoing on capital account but even then there might be special circumstances which suggest an “opposite conclusion”: Ausnet at [15].
The circumstance that the outgoing is recurrent is not determinative of its character: Ausnet at [16].
In Henriksen v Grafton Hotel Ltd [1942] 2 K.B. 184 at 195 (“Henriksen”), Du Parcq LJ, in the Court of Appeal, found that recurrent payments of a charge, imposed as a condition upon the grant of a liquor licence, were in each case, when paid, part of a total amount paid “to acquire the right to trade for a period of years” and at the date when the period began, holding the right was “essential before trading could be begun”. Thus, each payment when made was considered to be “part of a capital outlay”. The plurality in Ausnet at [16] note that Lord Pearce in BP Australia v FCT (writing for the Privy Council) observed at 112 CLR 386 at 405 that Henriksen (which Lord Pearce described as “a special case”) was concerned with a business which could not be carried on without a licence and thus, there was “an element of monopoly” involved which informed the decision that the outgoing in question was on capital account. The plurality at [16] affirmed the relevance of that consideration in a contemporary setting but characterise it as one which might be understood, in Australia, as a matter of “enhanced market power” where the requirement for a licence in order to carry on a trade or business for a period of years, not freely given to “all comers”, constitutes “a barrier to entry for potential competitors into the relevant market”: Ausnet at [16].
Thus, it seems, that if the circumstances of the payment engage the acquisition of something which would operate as a barrier to entry for potential competitors into the relevant market in which the taxpayer engages (thus enhancing the market power of the taxpayer), that circumstance weighs in the balance in determining whether the outgoing bears the character of a capital outgoing, consistent with the principle in Henriksen.
In Sun Newspapers, the contested payments also engaged “an element of monopoly” as, for Rich J, the purpose of the outgoing was to “buy out opposition and secure so far as possible a monopoly” (61 CLR 337 at 347) and for Latham CJ, the payments “did obtain a very real benefit or advantage for the companies, namely, the exclusion of what might have been serious competition” (61 CLR 337 at 355). The question of whether the payments engaged an element of monopoly did not loom large in the reasoning of Dixon J although that consideration falls more fundamentally within the first of Dixon J’s three points of distinction set out at [108] of these reasons: that is, “the character of the advantage sought and in this its lasting qualities may play a part”.
The Commissioner says that the considerations at [114] to [116] apply precisely to this case. The Commissioner says that the Trustee made an expenditure in an auction process to acquire GMEs conferring the right to carry on a gaming business which it could not carry on without having acquired the GMEs and which conferred upon it an element of monopoly in the sense described at [114] and [115] of these reasons.
Where the contested payment is made as part of the consideration for the acquisition of a business, that circumstance will normally be a “key factor” in the assessment of characterisation. The fact that a payment can be viewed as “part of the consideration for the acquisition of a business or capital asset weighs heavily in favour of its character as a capital outlay” [emphasis added]: Ausnet at [18].
Although, as a matter of principle, such a factor weighs heavily in the balance in deciding whether the outgoing is on capital account, the question to be asked in seeking to resolve the “basal difficulty” identified by Dixon J ([101] of these reasons), in the context of the applied facts giving rise to the outgoing is, was the payment made “for” the acquisition?: Ausnet at [18]. But even then there is difficulty.
Section 40-880 was inserted by Act No 76 of 2001 and was applicable on or after 1 July 2001. The provision was amended in 2006, with effect from 1 July 2005, by the Tax Laws Amendment (2006 Measures No 1) Act 2006 (Cth) (2006 Amendment Act). Prior to the 2006 Amendment Act, s 40-880 contemplated a deduction over five years for specific items of expenditure (commonly referred to as “black hole” expenditure because of the likelihood the expenditure would not otherwise have been deductible), which did not include expenditure in relation to goodwill.
As originally enacted, s 40-880(1) provided:
You can deduct amounts for capital expenditure you incur that is one of these:
(a) expenditure to establish a business;
(b)expenditure to convert your business structure to a different business structure;
(c) expenditure to raise equity for your business;
(d) expenditure to defend your business against a takeover;
(e) costs to your business of unsuccessfully attempting a takeover;
(f)costs of liquidating a company that carried on a business and of which you are a shareholder;
(g) costs to stop carrying on a business;
to the extent that the business is or was carried on for a taxable purpose.
Prior to the 2006 Amending Act, taxpayers could take into account expenditure in relation to goodwill in the fourth element of cost base under s 110-25(5). That section provided:
The fourth element is capital expenditure you incurred to increase the asset’s value. However, the expenditure must be reflected in the state or nature of the asset at the time of the CGT event.
In other words, before 1 July 2005, provided the expenditure in relation to goodwill fell within s 110-25, capital expenditure in relation to goodwill could be taken into account when a relevant CGT event occurred, such as when the asset was sold. There was no deduction for expenditure in relation to goodwill over five years under s 40‑880. Obviously, the fourth element of cost base cannot apply to expenditure being an acquisition of goodwill, because goodwill is itself a CGT asset. Expenditure to acquire goodwill falls in the first element of cost base.
Section 40-880 from 1 July 2005
Section 40-880, which in this form was introduced with effect from 1 July 2005, and which is applicable in the present case, provides:
(2)You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur:
(a) in relation to your business; or
(b) in relation to a business that used to be carried on; or
(c) in relation to a business proposed to be carried on; or
(d) to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.
…
(5)You cannot deduct anything under this section for an amount of expenditure you incur to the extent that:
(a) it forms part of the cost of a depreciating asset that you hold, used to hold or will hold; or
(b) you can deduct an amount for it under a provision of this Act other than this section; or
(c) it forms part of the cost of land; or
(d) it is in relation to a lease or other legal or equitable right; or
(e) it would, apart from this section, be taken into account in working out:
(i) a profit that is included in your assessable income (for example, under section 6‑5 or 15‑15); or
(ii) a loss that you can deduct (for example, under section 8‑1 or 25‑40); or
(f) it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event; or
(g) a provision of this Act other than this section would expressly make the expenditure non‑deductible if it were not of a capital nature; or
(h) a provision of this Act other than this section expressly prevents the expenditure being taken into account as described in paragraphs (a) to (f) for a reason other than the expenditure being of a capital nature; or
(i) it is expenditure of a private or domestic nature; or
(j) it is incurred in relation to gaining or producing exempt income or non‑assessable non‑exempt income.
(6)The exceptions in paragraphs (5)(d) and (f) do not apply to expenditure you incur to preserve (but not enhance) the value of goodwill if the expenditure you incur is in relation to a legal or equitable right and the value to you of the right is solely attributable to the effect that the right has on goodwill.
The 2006 Amendment Act which introduced this more general business “black hole” deduction by amending s 40-880 also replaced s 110-25(5) (as set out above) with new ss 110-25(5) and 110-25(5A). The new provisions were:
(5) The fourth element is capital expenditure you incurred:
(a)the purpose or the expected effect of which is to increase or preserve the asset’s value; or
(b) that relates to installing or moving the asset.
The expenditure can include giving property: see section 103‑5.
Note:There are 3 situations involving leases in which this element is modified: see section 112‑80.
(5A)Subsection (5) does not apply to capital expenditure incurred in relation to goodwill.
The effect of those changes was to remove capital expenditure in relation to goodwill from the fourth element of cost base but to allow it to be claimed in the circumstances envisaged by the new s 40-880.
A consequence of the removal of expenditure in relation to goodwill from the fourth element of cost base was that, if the new s 40-880(2) applied to the expenditure such that it was deducible over five years, the expenditure would not receive less generous treatment than it would have under the previous regime (as part of the fourth element of cost base). This was explained in the following way at [2.144] of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No 1) Bill 2006 (Cth):
The fourth change is that the element does not apply to capital expenditure incurred in relation to goodwill. A consequence of this exclusion is that expenditure in relation to goodwill already attracting deductibility over five years does not receive less generous CGT treatment by reason of the enlargement of the fourth element.
Application of s 40-880(6)
The parties agreed that s 40-880(5)(f) applied unless s 40-880(6) prevented it applying. This is because there is no question that the GMEs were a “CGT asset” within the meaning of Part 3-1 of the ITAA 1997: ss 100-25, 108-5.
The construction of s 40-880(6) must begin and end with a consideration of the statutory text. The statutory text must be considered in its context, which includes legislative history and extrinsic materials: Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue (2009) 239 CLR 27 at [47]; Federal Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503 at [39]; Federal Commissioner of Taxation v Unit Trend Services Pty Ltd (2013) 250 CLR 523 at [47].
In Certain Lloyd’sUnderwriters Subscribing to Contract No IH00AAQS v Cross (2012) 248 CLR 378, at [24], French CJ and Hayne J said (emphasis of French CJ and Hayne J, emphasis in original):
The context and purpose of a provision are important to its proper construction because, as the plurality said in Project Blue Sky Inc v Australian Broadcasting Authority, ‘[t]he primary object of statutory construction is to construe the relevant provision so that it is consistent with the language and purpose of all the provisions of the statute’ ... That is, statutory construction requires deciding what is the legal meaning of the relevant provision ‘by reference to the language of the instrument viewed as a whole’, and ‘the context, the general purpose and policy of a provision and its consistency and fairness are surer guides to its meaning than the logic with which it is constructed’.
The purpose of a statute resides in its text and structure, not outside of the statute. The Court is to give the words of the statute the meaning the legislature is taken to have intended them to mean. The task of construction will properly involve the identification of a statutory purpose, which may appear from an express statement in the relevant statute, by inference from its terms and by appropriate reference to extrinsic materials: Lacey v Attorney-General (Qld) (2011) 242 CLR 573 at [43]-[44]; Lloyd’s Underwriters at [25].
The text of the relevant subsections of s 40-880 is set out above. The deduction provided by s 40-880(2) is one of last resort in the sense that, subject to specific exceptions, it operates only in circumstances where other provisions of “this Act” (defined in s 995-1(1)) do not operate to provide for the relevant expenditure to be taken into account: s 40-880(5). The expenditure in relation to the GMEs is taken into account under the capital gains tax regime as the first element of cost base in the acquisition of a CGT asset and is, accordingly but subject to s 40-880(6), caught by s 40-880(5)(f).
Section 40-880(6) operates to allow a deduction in respect of capital expenditure incurred “to preserve (but not enhance) the value of goodwill if the expenditure you incur is in relation to a legal or equitable right and the value to you of the right is solely attributable to the effect that the right has on goodwill”.
Subsection 40-880(6) must be read as a whole and in the context of the whole statutory regime. Whilst recognising that the components of s 40-880(6) must be read together, it is useful to note that the subsection directs attention to three principal matters:
(1)the expenditure was incurred “to preserve (but not enhance) the value of goodwill”; and
(2)the expenditure was incurred “in relation to a legal or equitable right”; and
(3)“the value to you of the [legal or equitable] right is solely attributable to the effect that the right has on goodwill”.
The inquiry in (1) above is into whether the expenditure was incurred to “preserve (but not enhance) the value of goodwill”, as opposed to goodwill. The inquiry in (3) is directed to the value to you of the right and whether it is solely attributable to the effect the right has on goodwill.
Whether expenditure incurred to “preserve (but not enhance) the value of goodwill”
As the Commissioner submitted to the Tribunal, an example of expenditure which would clearly meet the description of expenditure “incurred to preserve (but not enhance) the value of goodwill”, is expenditure to secure a restrictive covenant, such as a payment to a departing business partner in return for an agreement not to operate a similar business in competition – see Tribunal reasons at [22]. The evident purpose of such expenditure is to protect the existing goodwill from damage, that is, to preserve the value of the existing goodwill. That purpose is evident from the effect of the expenditure: preventing competition from a new source (the exiting business partner). The value of such expenditure lies in the effect the existence of the asset has on the value of existing goodwill. The value does not lie in the asset acquired in the sense that, for example, the restrictive covenant does not ordinarily have any value to a third party purchaser of the covenant. The real purpose behind the expenditure was to ensure that the goodwill was preserved, not to own a restrictive covenant.
Purpose of expenditure and effect of expenditure
The inquiry into whether the expenditure was “incurred to preserve (but not enhance) the value of goodwill” is an inquiry into the purpose of the expenditure, not the effect of it. For example, if there was expenditure incurred for the purpose of preserving the value of goodwill but, in the events which ultimately transpired, the value of goodwill was not preserved, the provision would still respond notwithstanding that the expenditure, in the events which in fact transpired, had no effect on the value of goodwill.
However, the effect of the expenditure may, and generally will, be at least probative and often determinative of the purpose of the expenditure because the effect of expenditure is an objectively ascertainable fact which is likely to illuminate the purpose of the expenditure. The inquiry is into the actual purpose of the entity incurring the expenditure. That purpose is to be assessed having regard to the objective circumstances and to the person’s evidence of purpose. A person’s evidence of purpose may need to be closely scrutinised, but the weight to be attributed to such evidence depends on the particular case, including the cogency of the evidence when assessed against the objective circumstances and the fact of, or consequences of, cross-examination – see: Pascoe v Federal Commissioner of Taxation (1956) 30 ALJR 402 at 403, per Fullagar J; Visy Packaging Holdings Pty Ltd v Federal Commissioner of Taxation (2012) 91 ATR 810 at [191], per Middleton J. One of the objective circumstances from which a conclusion as to the purpose of incurring the expenditure can be drawn is the effect the expenditure in fact had, or the likely effect the expenditure might be considered to have, viewed as at the time the expenditure was incurred.
The respondent submitted that the purpose of the expenditure was to preserve (but not enhance) the value of goodwill as, it submitted, the Tribunal had found. The Tribunal stated, at [26]:
… The expenditure on the gaming machine entitlements was to enable the trustee to derive directly the income from gaming activities which the trustee had previously derived indirectly as commissions by the gaming activities carried on by Tattersalls. That purpose of the expenditure (on the assumption that it was of capital) was, from a practical and business point of view, to preserve the value of goodwill and was also reflected in the trustee’s goodwill.
The Tribunal, at [27], went on to conclude that the expenditure enhanced goodwill, because the expenditure “increased the trustee’s rights by 10 years longer than it had previously”.
The respondent submitted that the finding at [26] of a purpose of preserving goodwill was a finding as to purpose, but the finding at [27] of enhancement was one as to the effect of the expenditure. That may be accepted. However, as noted above, the effect expenditure has is relevant to the objective ascertainment of the purpose of expenditure. Reading the Tribunal’s reasons as a whole, it is tolerably clear that it considered, having regard to the objective effect of the expenditure, that the purpose of the expenditure was not “to preserve (but not enhance) the value of goodwill”, but something more than that. That finding was open on the material before the Tribunal.
Subjective purpose
The respondent stated that the evidence of subjective purpose was to be found in (and only in) the following evidence of the directing mind of the Trustee, Mr Canny (at [80] of the affidavit of David John Canny affirmed on 28 April 2017):
My wife and I agreed that she would bid up to the same limit as the maximum price indicated in the Red Lion report. I was not able to actually bid for GMEs for the Royal at the auction of the GMEs as I was bidding for GMEs for the Red Lion and not permitted to move between bidding booths during the auction. As a result, I agreed with my wife and an administrative manager, Kimberley Roberts, to bid for exactly 18 GMEs to continue to enable DRHT [the Trustee] to operate its existing business as it had under the then existing regime.
This evidence demonstrates that the decision was to purchase the GMEs for the lowest possible price so that the Trustee could continue to provide access to gaming services as it had in the past; but that decision necessarily involved acquiring GMEs which would enable the Trustee to conduct the gaming activities and to do so until 2022. If it had not acquired them, the customers would only have had access to gaming until 2012. The profitability of the Trustee taking over the conduct of the gaming activity would depend in part on the amount it paid for the GMEs. This evidence does not demonstrate that the purpose of the expenditure was “to preserve (but not enhance) the value of goodwill”. It demonstrates that the purpose of the expenditure was to acquire GMEs at the lowest possible price.
Effect of expenditure
There was no evidence adduced which quantified the effect on the value of goodwill of the acquisition of the GMEs. It would have been necessary, at a minimum, to identify and value the assets of the business and the likely income stream from the various operations with and without the GMEs and then to determine the value of goodwill in each scenario in order to reach a conclusion as to the actual effect of the expenditure on the value of goodwill. That is not to say that, in an appropriate case, a conclusion might be drawn about the effect of expenditure on the value of goodwill in the absence of quantification or expert evidence on the issue more generally.
In the present case, however, there was no evidence directed specifically to the effect of the expenditure to acquire the GMEs on the value of goodwill of the Trustee’s business. No doubt that was a forensic decision, perhaps informed by the respondent’s view that the effect of the expenditure was not relevant to an analysis of the purpose of the expenditure.
On appeal, the only evidence relied upon by the respondent in respect of the value of goodwill was the following evidence of an accountant, Mr Paul Foley, who had provided accounting and general business advisory services to a number of hotels and hospitality businesses, including the Trustee. In his affidavit affirmed on 28 April 2017, Mr Foley stated:
10.In my experience the change to the new regime from the old regime has not affected the value of hotel businesses when taking into account the cashflow impact of the payment for the gaming entitlements together with the limited tenure for the gaming entitlements expiring in 2022 and as, in substance, the new regime simply substituted the charges previously earned by Tatts with a combination of fees from other third party service providers such as PVS Australia Pty Ltd, Itralot Gaming Pty Ltd and the State government’s gaming tax.
11.However, since the introduction of the new regime there has been greater uncertainty about the potential revenues from gaming machines into the future. This has affected the values of hotels because purchasers cannot be assured of revenues from gaming after 2022 and banks have, as a consequence, been reluctant to lend without that certainty of revenues. The downward pressure on value caused by the 10 year term of the gaming machine entitlements is consistent with the effect a shorter term lease on the price of a hotel, where anything less than 20 years is considered to be too short a term to be considered worthwhile purchasing.
Three observations can be made of this evidence. First, this evidence was general in nature and not directed to the business conducted by the Trustee. Secondly, the general evidence in paragraph [10] does not address the specific evidence as to the expected profitability in the Trustee conducting gaming activities. A cash flow analysis comparing the profit from receiving commissions from Tattersalls (up until August 2012) with the profit from the Trustee conducting gaming activities (from August 2012) was in evidence. Whilst this showed that the profit from gaming was broadly similar for the years 2012 to 2015 to what it had been when the gaming was conducted by Tattersalls, that result was only achieved because of the instalments of purchase price paid by the Trustee to acquire the GMEs. After 2016, when the instalments were no longer payable, the profit was likely to be substantially higher. Thirdly, the general evidence in paragraph [11] is not only not directed to the Trustee’s particular business, but is not directed to the value of goodwill as opposed to the values of hotels.
This evidence did not provide a sound basis for inferring, in respect of the Trustee’s expenditure, that the expenditure had the effect of preserving, but not enhancing, the value of goodwill.
Conclusion on purpose of expenditure
The expenditure here was incurred to acquire the GMEs. The GMEs were purchased so that the Trustee could commence lawfully conducting gaming activities at the Royal Hotel in August 2012 and to continue to do so for a period of 10 years, deriving roughly equivalent profit to that which it had derived from Tattersalls’ gaming activities until 2016 after which (absent a sale of the business) it would derive substantially more profit.
The Trustee considered the purchase of the GMEs desirable (and commercially necessary) so that customers of the Royal Hotel would still be able to access gaming activities at the venue once Tattersalls was no longer able lawfully to conduct such activities. The value of the Royal Hotel business might be anticipated to be adversely affected if the Trustee did not acquire GMEs with the necessary consequence that no gaming activities could have been carried on once the new regime commenced in 2012.
It may be accepted that a motivation for acquiring the GMEs was the positive effect that was perceived as likely to have on the value of the Trustee’s business as a whole. It may also be accepted that the Trustee’s business as a whole included goodwill as an asset. It may be accepted that the Trustee, if it had not acquired the GMEs, would have ceased to obtain revenue from any gaming operations being conducted at its venue. Given the complementary nature of the activities, an absence of gaming activities being able to be conducted on the premises from August 2012 would likely also have adversely affected the non-gambling revenue centres of the business, namely accommodation, food and alcohol.
In these circumstances, it is appropriate to conclude that a motivation of the Trustee in acquiring the GMEs was its perceived effect on the value of the business as a whole and probably on goodwill. The perceived effect was one of increasing the value of the business as a whole and probably goodwill. If the GMEs had not been acquired, the value of the hotels and the goodwill would have reflected the fact that no gaming activities could lawfully be undertaken on the premises from August 2012. The acquisition of the GMEs meant that gaming activities would be able to be conducted, with a substantially higher profit to the Trustee from those activities after the last instalment for the acquisition was paid in 2016.
Section 40-880(6) contemplates a conclusion that the expenditure was incurred “to” preserve (but not enhance) the value of goodwill. It does not expressly state whether that purpose must be a sole purpose or a dominant purpose or one of which no more can be said than that it was one of the purposes behind the expenditure. The use of the word “to”, when read with the second and third matters to which s 40-880(6) directs attention (dealt with below), and with the history of the provision (outlined above), suggests that the subsection does not cover a situation where all that can be said is that the purposes for which a CGT asset was acquired included a purpose of preserving (but not enhancing) the value of goodwill. Here, the real purpose of the expenditure was “to” acquire the GMEs as part of the profit making structure of the business, not “to” preserve (but not enhance) the value of goodwill.
If it is sufficient to engage the operation of s 40-880(6) that a purpose or motivation of incurring the relevant expenditure (acquiring the relevant asset) is one of preserving but not enhancing the value of goodwill, then no such purpose existed because the purpose was not “to preserve (but not enhance) the value of goodwill”.
In the present case, the rights (the GMEs) were acquired to enable the Trustee lawfully to commence conducting gaming activities and derive income (greater over the full term than had previously been derived) through the exercise of the rights and to be able to do so for 10 years absent a sale of the rights to an incoming purchaser; the rights were not acquired “to preserve (but not enhance) the value of goodwill”.
Whether expenditure incurred “in relation to a legal or equitable right”
There was no dispute that the expenditure was incurred in relation to a legal or equitable right.
Whether the value to you of the right is solely attributable to the effect that the right has on goodwill
The value to the Trustee of the GMEs was not solely attributable to the effect that the right had on goodwill. The GMEs provided an entitlement for the Trustee lawfully to conduct gaming at its venue and to generate substantial income from those activities. The GMEs had a value distinct from any effect the GMEs had on goodwill. The GMEs resulted in a taxable income stream. This income stream was different to that which had previously been earned and it was likely to be significantly more profitable after the last instalment was paid in 2016. Further, the GMEs were a valuable asset capable of transfer.
CONCLUSION
The appeal should be allowed and the decision of the Tribunal should be set aside.
I certify that the preceding eighty-eight (88) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Thawley. Associate:
Dated: 27 September 2018
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