Federal Commissioner of Taxation v Brand
[1995] FCA 758
•20 Sep 1995
CATCHWORDS
INCOME TAX - deductions - outgoings allowable to extent to which incurred in gaining or producing assessable income - disproportion between outgoings and income - character of outgoings - voluntary prepayment of seven years licence fees for prawn farming project - deferment of commencement of income earning activity - whether sufficient contemporaneity - Income Tax Assessment Act 1936, s 51(1).
Income Tax Assessment Act 1936 (Cth) sub-s 51(1)
Professor R W Parsons, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (Law Book Co, 1985); "Income Taxation: an Institution in Decay" (1991) 13 Syd L Rev 435
Amalgamated Zinc (De Bavay's) Ltd v FCT (1935) 54 CLR 295
Brand v FCT 95 ATC 4262
Coles Myer Finance Ltd v FCT (1993) 176 CLR 640
FCT v Cooper (1991) 29 FCR 177
FCT v Emmakell Pty Ltd (1990) 22 FCR 157
FCT v Ilbery (1981) 58 FLR 191
FCT v Lau (1984) 6 FCR 202
FCT v Maddalena (1971) 45 ALJR 426
FCT v Osborne (1990) 26 FCR 63
FCT v Riverside Road Lodge Pty Ltd (in liq) (1989) 23 FCR 305
FCT v Smith (1981) 147 CLR 578
Fletcher v FCT (1991) 173 CLR 1
Goodman Fielder Wattie Ltd v FCT (1991) 29 FCR 376
The Griffin Coal Mining Co Ltd v FCT 89 ATC 4745; 90 ATC 4870
Inglis v FCT (1979) 28 ALR 425
Magna Alloys & Research Pty Ltd v FCT (1980) 49 FLR 183
Placer Pacific Management Pty Ltd v FCT 95 ATC 4459
Ronpibon Tin NL v FCT (1949) 78 CLR 47
Ure v FCT (1980) 50 FLR 219
Case 42/95 95 ATC 367
THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA V. RONALD GRANT BRAND
WAG49 OF 1995
LEE, LINDGREN, TAMBERLIN JJ
Perth
20 September 1995
IN THE FEDERAL COURT OF AUSTRALIA )
WESTERN AUSTRALIA DISTRICT REGISTRY ) No WAG 49 of 1995
GENERAL DIVISION )
On appeal from a Judge of the Federal Court of Australia
BETWEEN:
THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Appellant
AND:
RONALD GRANT BRAND
Respondent
MINUTE OF ORDER
THE COURT : LEE, LINDGREN, TAMBERLIN JJ
PLACE : Perth
DATE : 20 September 1995
THE COURT ORDERS THAT:
The appeal be dismissed with costs.
NOTE: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA )
WESTERN AUSTRALIA DISTRICT REGISTRY ) No WAG 49 of 1995
GENERAL DIVISION )
On appeal from a Judge of the Federal Court of Australia
BETWEEN:
THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Appellant
AND:
RONALD GRANT BRAND
Respondent
CORAM:LEE, LINDGREN, TAMBERLIN JJ
PLACE:Perth
DATE:20 September 1995
REASONS FOR JUDGMENT
LEE AND LINDGREN JJ:
NATURE OF PROCEEDINGS
The appellant ("the Commissioner") appeals from an order made by a judge of the Court, R D Nicholson J on 5 May 1995 allowing an appeal by the present respondent ("the Taxpayer") against the Commissioner's disallowance of the Taxpayer's objection to the Commissioner's amended assessment of income tax on income derived by the Taxpayer in the year ended 30 June 1987. His Honour's reasons are now reported as Brand v FCT 95 ATC 4262.
The Commissioner issued a notice of assessment on 23 November 1987 in which the Taxpayer's taxable income was stated as $32,657. However, the Commissioner issued a notice of amended assessment on 18 April 1989 stating the Taxpayer's amended taxable income as $48,657. The additional $16,000 represented an amount which the Taxpayer had claimed as a deduction in his return and which the Commissioner had allowed in the original assessment but disallowed in the amended assessment.
On 22 May 1989, the Taxpayer gave notice of his objection against the amended assessment. On 13 August 1991 the Commissioner gave notice of his disallowance of that objection. On 4 September 1991, the Taxpayer requested the Commissioner, pursuant to the then s 187 (b) of the Income Tax Assessment Act 1936 (Cth) ("the Act"), to refer his decision on the objection to the Court. The Commissioner did so on 18 March 1992. By the time the matter came on for hearing before his Honour on 14-17 February 1995, the Taxpayer's deemed "appeal" (see the then sub-s 189 (3) of the Act) was as to $15,000 only of the claimed but disallowed deduction of $16,000. In circumstances explained later, the issue to which the case has given rise is whether the sum of $15,000 is a deductible loss or outgoing under the first limb of sub-s 51 (1) of the Act.
BACKGROUND FACTS
In August 1986 the Taxpayer's employment with Robe River Iron Associates Ltd was terminated, in consequence of which he received "termination money" of $18,132. He paid this money into a bank account where it remained until he used it to make the two payments totalling $16,000 on 4 June 1987 referred to below.
For many years the Taxpayer had known an investment adviser named Kim Royce who also acted as his accountant and financial adviser. Through Mr Royce, early in 1987 the Taxpayer became aware of a proposed prawn farming project in Northern Queensland. Ultimately, the Taxpayer was to invest in this project in the manner described below pursuant to two written contracts dated 4 June 1987: a Licence Agreement with North Queensland Industries (Townsville) Pty Ltd ("NQIT"), and an Agreement to Farm Prawns with General Rural Services (Prawn Farms) Pty Ltd ("GRS(PF)").
The issues debated before his Honour called for an examination of the events leading to the making of the two agreements. The issues argued on the appeal were more confined than those argued before his Honour. This makes it possible for us to proceed immediately to give an account of the two written agreements and the making of the payments pursuant to them.
By the critical date, 4 June 1987, NQIT was registered at the Queensland Land Titles Office as proprietor of some 694 acres of land at Sleeper Log Creek approximately 34 kilometres north west of Townsville in an area known as Blue Pines Estate. The prawn farming project involved the zoning of this land to "Special Facilities (Aquacultural Activities)" and a "group title subdivision" of it into 189 "Special Facilities (Aquacultural Activities) lots" as shown on a plan identified by the number "M 3533-R". Physically, these 189 lots were to be "aquaculture ponds". The ponds were to be constructed in four "stages" or "sectors" the respective areas of which were numbered 1 to 4. Generally, and relevantly, each pond was to be a square 100m x 100m (10,000 square metres). The proposal was that each pond would be divided into 20 strips with dimensions of 5m x 100m, and that NQIT would grant to investors licences to use one or more of the strips for the purpose of prawn farming by them. The strips were referred to as "lots". The amount of licence fees payable varied according to number of lots the subject of the particular licence agreement.
It may be thought that the use of the word "lots" to refer both to the lots in the plan of subdivision (equivalent to "ponds") and to the "strips within ponds" was bound to give rise to confusion. In the event, the word's chief role in the proceedings, and its only role in the two agreements, was to refer to the strips, and, as the subdivision was never registered, we will also use the word "lots" to refer to the strips. We will refer to the 189 pond-lots as "pond-lots" or simply as "ponds".
An investor might undertake the actual farming operation using such labour as he might choose to engage. He might engage for that purpose GRS(PF), a company associated with NQIT, to manage the lot or lots the subject of his licence. The Taxpayer engaged GRS(PF) for that purpose by the Agreement to Farm Prawns.
Over the period from October 1986 to 4 June 1987 NQIT had been in communication with numerous departments and authorities of the Queensland Government with a view to obtaining the necessary licences, permits and approvals for the project to be undertaken. These included, with respect to water and drainage, the Queensland Water Resources Commission, the Queensland Land Administration Commission, the Beach Protection Authority of Queensland, the Queensland Main Roads Department, the Queensland Department of Marine and Harbours, and the Water Quality Council of Queensland; with respect to various permits, the Fisheries Management Branch, the Queensland Department of Primary Industries, and the Queensland Fish Management Authority; with respect to access, the Queensland Department of Main Roads, the Queensland Land Administration Commission and the Queensland Railways; and with respect to zoning and subdivision, the Council of the City of Thuringowa.
By June 1987 several permits and approvals had been obtained and some development of the site had occurred. Ultimately, however, the only ponds which were ever farmed were four ponds within stage 2, and these were filled and farmed between October 1987 and July 1988 as trial ponds only. Construction of the ponds in stage 1, in which the pond containing the lots the subject of the Licence Agreement were located, was never completed.
This is not to say that as at 4 June 1987 substantial site development work had not been done or substantial moneys had not been expended on the project. A valuation report of Hart Conroy dated 25 July 1987 based on a site inspection on 23 July 1987 attributed an amount of $4,227,100 to the improvements which had been effected down to that time, including $1,934,200 to "pond construction".
On 24 February 1988 the first mortgagee of the land appointed receivers and managers of the land. On 4 March 1988 a provisional liquidator of NQIT was appointed. On 6 April 1988 NQIT was ordered to be wound up. On 23 December 1988 the land and its improvements, such as they were by that time, were sold. The Taxpayer received no return on his investment and does not expect to recover any part of the amount invested.
THE TWO AGREEMENTS AND THE TWO PAYMENTS
Licence Agreement
The Licence Agreement dated 4 June 1987 was made between NQIT as "the Licenser" and the Taxpayer as "the Farmer". It was in respect of lots 3 and 4, pond number 89, sector 1 (later there was a re-numbering, as a result of which pond 89 became pond 28 in the plan of the proposed subdivision but this is presently immaterial). The two lots were said to comprise 1,000 square metres. The description was related to a plan attached to the Licence Agreement. The plan showed pond 89 divided into 20 narrow rectangular strips akin to "lanes" in a swimming pool, but did not indicate which of the 20 were to be lots 3 and 4.
The plan bore date 2 June 1987 and was numbered M 3533-R. It was agreed before his Honour that on 27 May 1987, Michel & Partners (Surveys) Pty Ltd, on behalf of NQIT, made formal application to Thuringowa City Council for its approval of a group title subdivision and that on 17 June 1987 the Council granted approval for such a subdivision into the 189 Special Facilities (Aquacultural Activities) pond-lots shown on plan number M 3533-R.
The Licence Agreement recited that the Taxpayer wished to farm prawns on lots 3 and 4 and (by recital C) that NQIT had constructed, agreed to construct, or made arrangements to have constructed, suitable prawn pond facilities on the land. It recited that NQIT had agreed to provide, by pump, pipelines or channels or a combination of them, a suitable supply of salt and fresh water as required by the Taxpayer from time to time, but not exceeding, in effect, 5,500,000 litres per annum for the lots 3 and 4. Finally, it recited that NQIT had agreed to provide to the Taxpayer an exclusive licence for the use of lots 3 and 4 in pond 89.
The operative provisions of the Licence Agreement are as follows:
"OBLIGATIONS OF THE LICENSER
Licenser licenses the Farmer to exclusive use of [lots 3 and 4] and will provide free and unrestricted access at all times to the said lots.
The Licenser will provide water in accordance with Recital C herein.
The Licenser will pay all rates, taxes and charges to the Local Government Authority together with all licence fees or charges by Water Quality Control or the Fisheries Division of the Department of Primary Industry in the State of Queensland relating to farm licence fees for farming prawns. The Licenser shall apportion mathematically based on total area such charges to each pond and each Farmer shall pay his proportionate share of such charges.
The Licenser shall construct or have constructed or make available ponds to the Farmer in readiness for prawn farming within twelve months of the date hereof [by 4 June 1988].
In the event the licensed area being less than the total pond area the Licenser shall identify the license area by placing of survey pegs on the area concerned and by joining the survey pegs by a line buoyed up by 250mm buoys between the pegs floating in the water of the pond and an identity sign stating the name of the owner and his area.
If the Farmer shall require a barrier between his license area and other areas in the pond, the cost of erecting such barrier shall be at the expense of the Farmer. The Farmer may dispense with this requirement if he joins with other Licensees in partnership to farm his area in a total pond situation.
The Licenser has prepared a plan of subdivision under the Building Units and Group Titles Act and will lodge the plan for sealing with the City of Thuringowa upon completion of construction. The Licenser reserves the right to amend the plan and the description of the land as may be required by the Licensed Surveyors, City of Thuringowa, or Registrar of Titles. The area of land concerned in this Licence Agreement shall not be varied.
POND LICENCE FEE
Upon notice being given by the Farmer to the Licenser that he has appointed/employed/engaged the services of a person or persons for the purpose of conducting the operation of growing, harvesting and marketing prawns in the licensed area, the subject of this Licence Agreement, on his behalf then the Licenser shall permit such person/s to enter into and upon the subject area and if such person were the Farmer, to carry out the activities necessary to grow/harvest/market the prawns provided however that in no way whatsoever shall the obligations /liabilities of the Farmer to the Licenser be in any way varied/affected as a result thereof.
The Licence Fee to be paid by the Farmer as set out in Schedule 2 hereto [see below] if paid annually, notwithstanding the provisions of Clause 4 hereof, shall be paid on the signing of this Licence Agreement.
The Farmer may hereby elect to pay the Licence Fee for seven years occupation of the pond (which fee shall be determined in accordance with Schedule 2 hereto [see below]) and shall pay such Licence Fee upon the signing hereof which payment shall not be subject, as is the Licence Fee in Clause 8 hereof, to the cost of living increases in accordance with the provisions of Clause 12 herein.
10.Notwithstanding the payment in advance in Clauses 8 and 9 hereof the Farmer's right to occupy shall commence on the date that the pond/s is/are ready for the growing and harvesting of prawns which such date shall be advised by the Licenser to the Farmer in writing, and Licence fees shall commence to apply from such date.
WATER CHARGES
11.[The Farmer undertook to pay the Licenser an annual fee of $25 per 1,000,000 litres of water usage.]
ANNUAL REVIEW OF POND LICENCE AND WATER CHARGE FEES
12.[This clause provided for review on 4 January in each year during the 99 year term of the licence, of the Annual Licence Fee and Water Charges in accordance with a formula based on the Consumer Price Index (All Groups) for Brisbane published from time to time by the Commonwealth Bureau of Census and Statistics. It will be recalled, however, that cl 9 provided that if the Farmer elected to pay the licence fee for the first seven years' occupation upon the signing of the Licence Agreement, the Annual Licence Fee would be not reviewable for the first seven years.]
OBLIGATIONS OF THE FARMER
13.The Farmer is aware that other individuals, corporations, trusts and otherwise may from time to time be engaged in growing, harvesting and marketing of prawns in other parts of the pond the subject of this Licence Agreement and the Farmer hereby covenants and agrees that he shall at all times consult either himself, or through consultants employed/engaged by him with such other person and/or through consultants growing, harvesting or marketing prawns from and in the pond to ensure that at all times good husbandry, suitable processes, effective use of chemicals, aeration, stocking and environment in and with respect to the growing, harvesting and marketing of prawns from and in the pond/s is employed.
14.[This clause required the Licenser to take out certain insurances and provided for it to apportion to the Farmer a share of the premium on the basis provided for in cl 3.]
15.The Farmer agrees that the licensed area shall only be used for the growing, harvesting and marketing of prawns and that he shall take care of such area and shall repair in a proper way any damages to the licensed area and/or such other area of the pond of which the licensed areads [sic] forms part resulting from neglect or a deliberate or careless act or a breach of any conditions of this Licence Agreement by the Farmer or any person on, near or in the licensed area with his consent.
........ ........ ........ ........ ........ ........ ....
REBUTTAL OF AGENCY OR PARTNERSHIP ETC.
24.Nothing in this Licence Agreement shall constitute a partnership between the parties nor constitute one the agent of the other.
........ ........ ........ ........ ........ ........ ....
TERMINATION BY THE FARMER
27.The Farmer may cancel this Licence Agreement at any time from the commencement of the Licence period without penalty or fee but no refund is due for any period applicable to the Licence Fee paid in advance.
ADVANCE PAYMENTS
28.The Farmer should he elect to pay the first seven years Licence Fee in advance (as provided in Schedule 2 [see below]) shall not be liable for further cost of Licence Fees that would arise under the Licence in accordance with the Clause 12 hereof until the expiry of seven years from the date hereof.
However nothing in this Licence should be construed as requiring such payment to be in advance and if such payment is made it is completely at the discretion of the Farmer.
29.The said Clause 12 shall be applicable to all water charges from the date of this Licence."
Schedule 2, in standard printed form, stated the amount of the licence fees for each of the first seven years for every 4,000 square metres and for every 500 square metres. The amount increased year by year. For 1,000 square metres the fees over the seven years totalled $16,602, but if payment was made in full in advance, this was reduced to $15,000.
The Taxpayer signed the Agreement. It was signed for and on behalf of NQIT "by its agent" General Rural Services Pty Ltd ("GRS") which executed it under the latter's common seal.
Agreement to Farm Prawns
The Agreement to Farm Prawns dated 4 June 1987 was entered into between the Taxpayer as "the Owner" and GRS(PF) as "the Manager". Recital A was to the effect that the Owner was the beneficial owner or licensee of lots 3 and 4 in pond 89 sector 1 comprising 1,000 square metres (referred to in the Agreement to Farm Prawns as "the Pond") and that all rents, fees and dues had been paid for seven years on the Pond. Recitals B to J were as follows:
"B.The Owner wishes to farm prawns in the Pond and to conduct a business of prawn farming.
C.The Manager acknowledges that the Owner may carry out any or all of the stages or Prawn farming by himself or by other persons or a combination of himself and other persons.
D.The Manager further acknowledges that the Owner shall have the right at all times to harvest and market the prawns of the said Pond by himself or by other contractors.
E.The Manager has represented to the Owner that it is experienced in Prawn Farming.
[sic-letter "F" missing]
The Owner has agreed to provide the Manager with 10,000 post larvae prawns for each Five Hundred Square Metre Area (500 sq. metres) of Pond, the value of which is agreed at Three Cents (3c) each. At the Owner's request the Manager has agreed to manage the Pond and to provide its services as a manager to the Owner, and the Owner has agreed to engage the Manager for the provision of the whole or such part of the services upon the conditions hereinafter set forth.
G.The Manager and the Owner have agreed that the produce of the pond farmed in terms of this Agreement is the property of the Owner and all prawns produced are the property of the Owner subject to the terms of this Agreement.
H.The Manager at the request of the Owner shall sell the prawns produced by the Owner but in the event that the selling price authorised by the Owner is greater than the market price obtainable by the Manager and the Owner is unwilling to accept the market price obtainable by the Manager then the Manager will deliver the prawns to the nearest wholesale market or processor and both parties agree to the market price thereby obtained.
I.In pursuance of the Agreement the Manager has undertaken work to prepare the land for the establishment of a Prawn Farm.
J.The Owner and the Manager now desire that the terms of such Agreement be reduced to writing."
Clause 1 provided for the Manager's obligations. Clauses 1.1-1.10 were as follows:
"1.1To service the pond on the basis of 24 hours per day 7 days per week by computer or personal management.
1.2To feed prawn stock at least three times per day and at least once per night.
1.3To monitor water quality to ensure that pond conditions are suitable for growth of prawn stock.
1.4To ensure sufficient equipment is installed in pond to aerate pond sufficiently for the appropriate requirement of the prawn stock.
1.5To harvest and market the prawns in accordance with this Agreement.
1.6To record all costs of power, feed, water and labour as applicable to the area of the pond.
1.7To prepare a Profit and Loss Statement after each crop.
1.8To distribute the nett profit of the pond in the proportion of 70% to the Owner and 30% to the Manager.
1.9At the expiry of each six (6) months from the date of commencing farming and at least twice in each year for the balance of the period of this Agreement to harvest the prawns produced in the pond.
1.10To advise the Owner of the selling price of green prawns and to comply with the Owner's instructions as to price and disposal of the said prawns, subject to the recital herein."
Clause 1.11 provided that subject to certain conditions, if the Manager handled the total marketing of the produce, the Manager should also be entitled to a selling commission of 15% calculated on the gross selling price less certain specified deductions.
Clause 2 provided that nothing in the Agreement to Farm Prawns was to prevent the Owner from entering upon the land for the purpose of supervising, inspecting and directing the Manager, provided that the Owner should not be entitled to require the Manager to undertake work which would not ordinarily be considered to form part of the best practices of the prawn farming industry or which was not provided for by the terms of the Agreement to Farm Prawns itself. By cl 2.3 the Taxpayer acknowledged that the services set out in the Agreement to Farm Prawns were consistent with "universally recognised good prawn management", agreed that he would not provide less services than those, and that if he should request that GRS(PF) provide more, he and GRS(PF) would agree as to the cost of the additional services to be borne by the Taxpayer prior to commencement of the additional work. As well, the Agreement to Farm Prawns provided that the Owner undertook that if he decided to perform any of the services he would use techniques constituting good prawn management and ensure that no damage was done to adjoining lots.
Clause 2.5 was as follows:
"2.5The Owner shall have the right at all times to harvest and market the prawns of the said pond itself or by other contractors and in such event the fee referred in item 8 [Item 8 stated that the price of contract services payable to GRS(PF) was 30% of the net profit of the crop] shall be 15% of the gross market price as agreed between the Owner and the Manager of the prawns produced from the said area of pond plus Manager's costs to date as applicable to that crop but in the event that the Owner and the Manager do not agree as to the gross market value of the produce then the gross market price shall be the equivalent price obtainable at the nearest wholesale market."
Certain additional provisions were as follows:
"5.0Apportionment Farming
The Owner agrees that if the area of pond referred to in this Agreement is less than a full pond and where the Manager is also the Manager of the other areas of the pond the Owner agrees that the Manager may farm the pond as a whole and implement the accounting of the expenses and crop produced by this Agreement by an apportionment of such expenses and crop proceeds on a basis proportionate to the area of land owned by the Owner as to the total area of the pond.
6.0Fencing
In the event of the Owner owning less than a full pond and the Manager not managing the total area of pond the Manager shall have the right to fence by concrete block wall the Owner's area at the expense of the Owner in accordance with the Prawn Licence Agreement.
8.0Owner's Obligations
The Owner agrees with the Manager that the Owner shall engage the service of the Manager for the price and upon the terms of payment thereof more specifically specified in Clauses 1.8 and 2.5 of this Agreement and as referred to in Item 8 of the said Schedule. [As noted earlier, Item 8 stated that the price of the contract services payable to GRS(PF) for its services was 30% of the net profit of the crop]
16.0Rebuttal of Agency Partnership etc.
Nothing in this Agreement shall constitute a partnership between the parties nor constitute one the agent of the other save the Manager shall be the agent of the Owner for the purpose of incurring any outlays and expenses provided in Clause 2.3 hereof or in marketing the produce of the Owner as provided for in Clause 1.10.
18.0Terms
Subject to the provisions hereinafter contained this Agreement shall commence as at the date hereof and shall continue in accordance with the terms and conditions herein provided until the date specified in Item 6 of the said Schedule." [Item 6 made the expiration date the date seven years from the commencement of farming]
The Agreement to Farm Prawns was executed by the Taxpayer and by GRS(PF) under its common seal.
The two payments:
Fred Newton of NQIT wrote to the Taxpayer enclosing the two Agreements for signature, saying:
"As discussed on the telephone please make your cheques payable to GENERAL RURAL SERVICES P/L Prawn Farm Trust A/C. Also please send (2) two cheques. 1, to the amount of $15,000 and (1) one for $1,000.
Please return all documents complete to PO Box 241 NERANG 4211 QUEENSLAND. On receipt of them I will send you a receipt."
Apparently the Taxpayer complied with this request. There was in evidence before the trial judge a copy of his cheque dated 8 June 1987 in favour of "General Rural Services Pty Ltd - Prawn Farm trust Account" for $15,000. As well, there was in evidence before the trial judge an "interim receipt" number 1939 dated 16 June 1987 issued by "General Rural Services Pty Ltd" to the Taxpayer for $16,000 reading "for licence fees . section one . paid in full". The receipt was endorsed by hand, "UNITS 3-4 POND 89". At the foot of the receipt the following appeared:
"ON A/C NORTH QUEENSLAND INDUSTRIES (TOWNSVILLE) PTY LTD LICENCE TRUST A/C"
The receipt was signed by Mr Newton. We infer that, as requested by Mr Newton, the Taxpayer had drawn a second cheque for $1,000 in a form similar to that of his cheque for $15,000.
The trial judge said that this sum of $1,000 was paid to NQIT to purchase post-larvae prawns for use in the pond. No doubt this was based on the unchallenged affidavit and oral evidence of the Taxpayer that he paid $1,000 "to stock the pond". The effect of the relevant recital in the Agreement to Farm Prawns was that the Taxpayer had agreed to provide to GRS(PF) 20,000 post-larvae prawns at an agreed value of $600 (3 cents each). It was not suggested that we should proceed otherwise than on the basis stated by the trial judge.
The references to a "trust" in Mr Newton's letter, on the Taxpayer's cheque for $15,000 and on the receipt for $16,000 raise a question whether the proceeds of the cheques were indeed held upon a trust and, if so, what the terms of that trust were. The possibility suggests itself, for example, that the proceeds were not to be used for any purpose until NQIT advised the Taxpayer, pursuant to cl 10 of the Licence Agreement, that pond 89 was ready for the growing and harvesting of prawns (it will be recalled that cl 10 provided that the licence fees were to "commence to apply from such date").
This matter was not raised before the trial judge. We were informed on the hearing of the appeal that the Commissioner did not wish to submit that the proceeds of the cheques had been held upon trust. Accordingly, we proceed on the basis that the sum of $15,000 is to be treated as having been paid to NQIT with liberty for it to apply that amount to its own general purposes as it might wish. It seems that in fact the amount was not "set aside" and was in fact applied as NQIT wished.
REASONING OF THE TRIAL JUDGE
The issue debated before his Honour was whether the payment of $15,000 was properly to be characterised as a loss or outgoing "incurred in gaining or producing ... assessable income" for the purposes of sub-s 51 (1) of the Act. Before his Honour, the Commissioner submitted that the Taxpayer's dominant purpose in making the payment was to have the benefit of an allowable deduction for income tax purposes for the year ended 30 June 1987. Much of the evidence and submissions and much of his Honour's judgment dealt with this issue, and with such considerations said to be related to it as that the Taxpayer had elected against paying the licence fees for the first seven years by annual payments totalling $16,602 in favour of making a once-for-all up-front payment of $15,000, and that the Taxpayer had made this election close to the end of a financial year. His Honour rejected the submission, finding that the Taxpayer's objective was to invest all or nearly all of the funds which he had available in what he regarded as a good commercial investment, and that the tax deductibility of the payment was "a consequence, not an objective" of the investment.
It was a different submission, also rejected by his Honour, that the Commissioner pressed on the appeal. This was that in order to be properly characterised as "incurred in gaining or producing ... assessable income" for the purposes of sub-s 51 (1), a loss or outgoing must be made contemporaneously with activity of the Taxpayer which is directed to gaining or producing assessable income. The submission was that the relevant activity to be considered in the present case was prawn farming by the Taxpayer, and it was put that not only did this activity never begin, but, according to the evidence including the terms of the two contracts, the intention always was that it would commence a substantial time after the making of the payment.
His Honour held, however, that unlike the claimed expenditures in FCT v Maddalena (1971) 45 ALJR 426 ("Maddalena") and FCT v Riverside Road Lodge Pty Ltd (in liq) (1989) 23 FCR 305 ("Riverside Road"), the payment was not one for something other than the doing of the work of the project, and in particular, that it was not a payment to enable the project to be researched or investigated. He held that:
"While the payment necessarily preceded the earning of assessable income, the payment was the means of effecting the investment which was expected to produce assessable income" (at 4271-4272 citing Fletcher v FCT (1991) 173 CLR 1 ("Fletcher") at 17)
In relation to the specific provision in the Licence Agreement that the licence fee was to "commence to apply" from the date advised by NQIT to the Taxpayer of the commencement of the right to occupy lots 3 and 4, his Honour held that this did not mean that "the nature and character of the prepayment" was "deferred", and accordingly, that it could not be said that the prepayment lacked contemporaneity with the activity directed to the gaining and production of assessable income.
PARTIES' SUBMISSIONS ON THE APPEAL
Outline of Commissioner's Submissions
On the appeal the Commissioner submitted that the Taxpayer proposed to commence, but never actually commenced, carrying on business as a prawn farmer. Although the licence fee of $15,000 was paid upon the signing of the Licence Agreement, the Taxpayer's right to occupy lots 3 and 4 was to commence only on the date when pond 89 was ready for the growing and harvesting of prawns, and the licence fee was expressed to "commence to apply" only from that date. Clause 4 of the Licence Agreement contemplated that the pond might not be constructed or made available until up to 12 months after the date of the Licence Agreement, that is, until up to 4 June 1988, nearly 11 months after the end of the financial year in which the payment was made. Although the Agreement to Farm Prawns purported to commence as from its date, 4 June 1987, at that time none of the Manager's obligations were capable of performance and pond 89 was not capable of being farmed and was not even in existence.
The Commissioner emphasised that it did not qualify a payment as deductible that without the making of it a taxpayer would not be able to engage in income-producing activity.
As before the trial judge, the Commissioner submitted that the words "in gaining or producing" in the first limb of sub-s 51 (1), like the words "in carrying on" in the second limb, require that an expense be contemporaneous with the process by which income is derived or is to be derived. He submitted that "the occasion of the expense must be found in the activities directed towards the gaining or producing of assessable income" and referred, in support, to Amalgamated Zinc (De Bavay's) Ltd v FC of T (1935) 54 CLR 295 ("Amalgamated Zinc") at 303; Ronpibon Tin NL v FC of T (1949) 78 CLR 47 ("Ronpibon") at 56-57; and Placer Pacific Management Pty Ltd v FC of T 95 ATC 4459 at 4464. The Commissioner submitted that if an expense is incurred before the relevant income-producing activity or business commences, it is not deductible, and referred to Riverside Road, at 313; FC of T v Cooper (1991) 29 FCR 177 ("Cooper") at 198; Goodman Fielder Wattie Ltd v FC of T (1991) 29 FCR 376 ("Goodman Fielder Wattie") at 385-387, and Maddalena, at 427. Accepting that a loss or outgoing may be incurred in gaining or producing assessable income although no income is gained or produced during the year in which it is incurred, the Commissioner submitted that nonetheless as at that time a relevant income-producing activity or business must have been under way, citing Inglis v FC of T (1979) 28 ALR 425 at 427-428. Here, the only relevant activity, prawn farming, had not, and (because of the non-construction of the ponds) could not have, commenced as at 4 June 1987.
The Commissioner referred to the well established distinction between preparing to carry on an income-producing activity or business and actually carrying it on, citing Goodman Fielder Wattie at 385-387; Commissioner of Taxation v Osborne (1990) 26 FCR 63 at 67-68 per Pincus J with whom Spender and French JJ agreed; The Griffin Coal Mining Co Ltd v FC of T 89 ATC 4745 at 4761; 90 ATC 4870 ("Griffin") at 4888.
Outline of Taxpayer's submissions
The Taxpayer submitted that the question for determination under the first limb of sub-s 51 (1) is whether the outgoing bore to the gaining of assessable income such a relation as was necessary to give it the character of an outgoing "incurred in" the gaining of such income, and that this is a question of fact and degree. He submitted that as a matter of fact and degree, the outgoing of $15,000 was incurred in gaining or producing his assessable income. In particular, he submitted that "on a common sense and practical weighing of all the factors", the outgoing was "incidental and relevant" to the production of his assessable income (referring to Fletcher at 17,18). He pointed to the trial judge's findings in his favour as to the dominant reason and purpose for which the payment was made and to his Honour's finding that if the prawn farm had been established it would probably have operated profitably.
The Taxpayer submitted that the prepayment of the licence fees did not signify that the payment was made for any purpose other than the gaining or producing of assessable income, and referred to C of T v Lau (1984) 6 FCR 202 ("Lau") and C of T v Emmakell Pty Ltd (1990) 22 FCR 157 ("Emmakell"). In particular, he pointed to the trial judge's finding that his objective (unlike that of the taxpayer in C of T v Ilbery (1981) 58 FLR 191) had not been to obtain a tax advantage, and that (unlike the taxpayer in Ure v C of T (1980) 50 FLR 219 ("Ure")) he had not moulded or been in a position to mould the transaction so as to maximise its tax advantages for himself.
According to the Taxpayer's submission, the prepayment of licence fees, like the payments in Lau and Emmakell, had a commercial objective and were part of a real business transaction underpinned by genuine commercial considerations. Again, according to his submission, as in Lau and Emmakell, the making of the payment in advance was explicable by reference to financial advantages to the taxpayer (in his case, the reduction in the total amount of licence fee payable under cl 9 of the Licence Agreement and the avoidance of "CPI increases" for the first seven years under cl 28 of the Licence Agreement). He submitted that any desire of his also to obtain a tax advantage was irrelevant because, unlike the position in Ure, there was no significant disparity between the outgoing and the income which it was expected would be earned.
The Taxpayer submitted that the outgoing was "sufficiently proximate" to the expected generation of income, emphasising that it is not necessary that relevant income be produced in the year in which the outgoing is incurred (referring to FC of T v Smith (1981) 147 CLR 578 at 586); that his right to occupy was, after all, contractually bound to commence within 12 months of the incurring of the outgoing (referring to Emmakell at 163); that contemporaneously with the incurring of the outgoing of $15,000 he purchased prawn larvae for use in the licensed area; that as his Honour found he was told by the promoters of the scheme at a meeting which he attended before investing that NQIT was using its best endeavours to see that a first crop of test prawns was harvested before Christmas 1987 and that a commercial crop was expected in mid 1988; that the outgoing had immediate effect and was not refundable; and that the payment was made for the right to occupy and farm rather than for a right to earn assessable income, to satisfy a prerequisite essential to the earning of income, or to protect a source of income, with the result, so the submission went, that decisions such as Maddalena, Riverside Road and Griffin were not relevant.
REASONING ON THE APPEAL
Much of the judicial comment on the first limb of sub-s 51 (1) of the Act was reviewed in the joint judgment of all seven members of the High Court in Fletcher. Although it would be wrong to treat the words of that judgment as if they were the words of a statute, we find it sufficient in this case to refer to several passages without referring to the earlier authorities the effect of which their Honours were stating and which were cited in footnotes. The joint judgment contains the following passage:
"The question whether an outgoing was, for the purposes of s 51 (1), wholly or partly 'incurred in gaining or producing the assessable income' is a question of characterisation. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind. It has been pointed out on many occasions in the cases that an outgoing will not properly be characterised as having been incurred in gaining or producing assessable income unless it was 'incidental and relevant to that end' [citing Ronpibon Tin at 56, Riverside Road at 311-312 and other authorities]. It has also been said that the test of deductibility under the first limb of s 51 (1) is that 'it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income' [citing, inter alia, Ronpibon Tin at 57]." (at 17)
The expression "the assessable income" in sub-s 51 (1) in relation to the year in which an outgoing is incurred "is to be construed as an abstract phrase which refers not only to assessable income derived in that or in some other tax year but also to assessable income which the relevant outgoing would be expected to produce" (Fletcher at 16).
The present case is one in which no relevant assessable income can be identified as income in the course of the gaining of which the licence fee of $15,000 was paid. Accordingly, the case is not one in which,
" ... the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterise the whole outgoing as one which was incurred in gaining or producing assessable income". (Fletcher, at 18)
In a case like the present one, that is to say, a case where no relevant assessable income can be identified, or indeed in a case where relevant assessable income can be identified but is less than the amount of the outgoing, the "motive" and
" ... the end which the taxpayer subjectively had in view in incurring [the outgoing] may, depending on the circumstances of the particular case, constitute an element, and possibly the decisive element, in characterisation of either the whole or part of the outgoing for the purposes of the sub-section". (Fletcher at 17)
But,
"... the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterisation of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect
objects and advantages which the taxpayer sought in making the outgoing. Where that is so, it is a 'commonsense' or 'practical' weighing of all the factors which must provide the ultimate answer. If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterised as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s 51 (1) unless it is either somehow excluded by the exception of 'outgoings of capital, or of a capital, private or domestic nature' or 'incurred in relation to the gaining or production of exempt income'". (Fletcher supra at 18-19).
In the light of the foregoing passages, the trial judge's findings of fact in relation to the Taxpayer's "motive" and "the end which the [Taxpayer] subjectively had in view" assume considerable importance. His Honour found that the transaction
" ... was a real business transaction underpinned by general commercial considerations both as to the making of the investment and, ..., the prepayment". (at 4268)
that
"It was the applicant's overriding objective that he wanted to invest in the project because he regarded it as a good commercial investment." (at 4268)
that
" ... it is a case where both the investment and the making of the prepayment had a commercial objective although structured so as to offer tax advantage to participants. It nevertheless was a real business transaction underpinned by genuine commercial considerations ... " (at 4270)
that
" ... the disproportion between the detriment of the outgoing and the benefit of the income is to be explained by the applicant's genuine desire in the peculiar circumstances in which he found himself to make an investment of real commerciality and to place his funds while he had them in that investment. Tax advantage was a consequence, not an objective." (at 4270)
and that
" ... the payment was the means of effecting the investment which was expected to produce assessable income." (at 4271-4272)
His Honour was entitled to make these findings as to "the end which the [Taxpayer] subjectively had in view" in making the payment of $15,000. These findings satisfy, or go a long way towards satisfying, the test of deductibility under the first limb of sub-s 51 (1) of the Act as explained in Fletcher.
But the Commissioner submits that "an outgoing, to be deductible under the first limb, must be incurred at a time which is contemporaneous with the activity by which it is hoped to derive assessable income", although he accepts that this involves "questions of fact and degree" which are a matter for judgment in each case.
This submission poses certain difficulties. It is difficult to see how "contemporaneity" can be a matter of "degree" as distinct from a simple question of fact. It seems to us that the Commissioner's submission involves two submissions in the alternative: that in order to be deductible an outgoing must be contemporaneous with activity directed to the gaining or producing of assessable income in the course of which it is incurred ("the primary submission"); or in the alternative, that although the incurring of the outgoing need not be contemporaneous with such activity, it may (and on the facts of the present case does) occur "too soon" by reference to that activity to satisfy the statute ("the alternative submission").
The judgments of the Full Court of this Court in Lau and Emmakell are against the primary submission (the Commissioner did not submit that they were wrongly decided). In Lau the Taxpayer prepaid $640 for the first year's rent of 10 hectares of a larger area of land to be used by him for pine plantation purposes, and $39,200 ($3,920 per hectare) for 21 years' management fees. The instrument of "lease" was dated 23 April 1981 and purported to grant a lease of the ten hectares commencing on that date. The management agreement was dated 24 June 1981 and was for a term of 21 years commencing on 23 June 1981. The same persons were in control of the lessor company and the management company. The subject land was not identified in a plan annexed to the instrument of lease. The initial term of the "lease" was three years and there were options of renewal for further three year terms up to 21 years. At some uncertain later date the subject area of ten hectares was identified, but it was subsequently held (in Emmakell at 162) that this had not been material to the decision.
For lack of definition of the subject land, at the time of payment the instrument of lease could not take effect as a lease or even as an agreement to lease a particular area of ten hectares. The management agreement accepted that the subject land was not yet defined. The manager undertook, inter alia, to prepare, improve and maintain the subject land to obtain the best possible plantation area for the growing of the pines in question.
Clearly, the activity directly referable to the gaining or producing of assessable income could not commence immediately and the parties to the two agreements knew this.
Emmakell concerned a payment for the clearing and cultivation of one acre parcels of land for the production of tea tree oil. As at 30 June 1983 no substantial progress had been made towards the establishment of any tea tree plantations on the land, but within a few months after that date, the project was under way. The taxpayer paid to the promoter $8,000 on 28 June 1983 and $4,000 on 30 June 1983 and applied for leases. In the following financial year, it paid a further $11,700 and applied for further leases. Purported "leases" were entered into as were management agreements. Each purported lease and management agreement related to a parcel of one acre. The agreements did not identify the respective one acre parcels to which they related.
The judgment dealt with a sample lease of an unidentified one acre. The term provided for was five years and the total rent was $10,000 of which that for the first year was paid in advance. The management agreement was for the same five year term as the lease with which it was associated. By it the manager undertook to establish, operate and manage the plantation, and in particular, as soon as reasonably practicable, to carry out the improvements and work necessary to establish the tea tree plantations; obtain technical assistance to establish an adequate water supply; have the land cleared, cultivated, watered, irrigated and otherwise improved ready for planting; and acquire and plant Melaleuca alternifolia (approximately 14,000 tea trees to the acre).
Again, it is clear that the payments preceded the activity of tea tree oil production.
The Commissioner sought to distinguish Lau and Emmakell on the basis that "at all material times the taxpayers had existing interests in land and there were management agreements capable of immediate performance". We do not agree that this correctly describes the position in those cases. The taxpayers in Lau and Emmakell could not have interests in land before, in the case of Lau there was agreement on the identity of the particular area of ten hectares in question, and in the case of Emmakell there was agreement on the particular one acre parcels in question. In both of those cases as in the present case, there was to be a subdivision of a larger area of which the subject land formed part, and the carrying out of development work before the income generating activity could begin.
In the present context, the only relevant point of distinction between the present case on the one hand and Lau and Emmakell on the other, is that cl 10 of Licence Agreement in the present case provided that the right to occupy was to commence on the date when the pond was ready for the growing and harvesting of prawns, whereas in Lau and Emmakell the instruments of "lease" purported to grant leases commencing immediately. But the factual circumstances which prevailed in those cases, known to the parties, were such that to the taxpayers' knowledge income producing activity could not commence contemporaneously with the purported commencements of the terms of the "leases" or for some time thereafter. We do not think that the mere fixing of a contemporaneous commencing date of a lease or licence which, it is common knowledge, cannot be given effect, makes a difference in attracting the statutory characterisation.
In any event, the Commissioner's primary submission is that it is the "activity" directed to the gaining or producing of assessable income with which the incurring of the outgoing must be contemporaneous. In Lau and Emmakell, the payments were not contemporaneous with "activity" fitting that description.
In rejecting the Commissioner's primary submission, we should note that the statement in Professor R W Parsons' leading work, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting (Law Book Co, 1985, paras 5-37 to 5-48 that "an expense to be deductible must be contemporaneous with the process by which income is derived" (para 5.37) preceded Fletcher and Emmakell (Lau was referred to briefly in an addendum and not in the respect here relevant). The reference to the work and to the requirement of "an element of contemporaneity" in Riverside Road at 313 signified no more, in our view, than that "an outgoing may be precluded from deductibility if it be incurred at a point too soon before the commencement of the business or income producing activity".
This leads naturally to a consideration of the Commissioner's alternative submission. In several cases, it has been said that an outgoing may be incurred "too soon" for it to be characterised as having been incurred "in" gaining or producing assessable income: see, for example, Maddalena at 427; Riverside Road at 313, and Cooper at 198. The circumstances and extent of any lapse of time between the incurring of a loss or outgoing and the commencement of the relevant activity directed to the gaining or producing of assessable income constitute a factor relevant to the question whether the statutory description is met. The cogency of that factor will vary from case to case, and depends on more than a mere measuring of the period. The temporal hiatus may suggest that the outgoing was incurred for some purpose other than the gaining or producing of assessable income. The test of deductibility is to be found in, relevantly, the language of the first limb of sub-s 51 (1). Statements in the cases that a loss or outgoing was incurred "too soon" for it to satisfy the statute are not intended to lay down a further test but to refer to a factor which, in the circumstances of a particular case, has led to a conclusion that the statutory test is not satisfied.
In the present case, the payment of $15,000 was made on 4 June 1987. By cl 4 of the Licence Agreement NQIT undertook to construct and make available ponds to the taxpayer within 12 months of that date in readiness for prawn farming. That obligation was not expressed to be subject to any condition. The identity of which strips were to be lots 3 and 4 had not been agreed to by NQIT and the Taxpayer. However, as noted already, this alone does not signify that the payment of $15,000 cannot satisfy the statute; cf Lau; Emmakell.
What was the payment of $15,000 as between these parties at arm's length made "for" (cf Magna Alloys & Research Pty Ltd v Commissioner of Taxation (1980) 49 FLR 183 at 191 per Brennan J.) This is "an issue of fact, turning upon the objective circumstances which human experience would judge to be relevant to the issue" (Ure at 224 per Brennan J).
The primary source of evidence of what the sum of $15,000 was paid "for" is the Licence Agreement. The amount was paid for at least the bundle of promises, express and implied, by NQIT contained in or arising from the Licence Agreement. Although cl 1 is expressed as a present grant of licence, it is clear from the lack of identification of lots 3 and 4 in the plan attached to the Licence Agreement and from cll 4 and 6, that cl 1 involved implied promises which would lead to a grant. The Taxpayer paid the fee and gave certain promises in exchange for NQIT's promises. NQIT's promises included the promise of a grant of licence and of access (cl 1), the promise to provide water (cl 2), the promise to pay rates, taxes, charges and licence fees (cl 3), the promise to construct, inter alia the subject pond and to make it available for prawn farming within 12 months (cl 4), the promise to identify lots 3 and 4 (cl 5), the promise to lodge the plan of subdivision for sealing (cl 6), and the promise to permit the Taxpayer, upon his giving notice that he had appointed a person to conduct the operation of growing, harvesting and marketing prawns, to enter upon lots 3 and 4 to carry out the necessary activities.
In our opinion, there is no reason to think that the sum of $15,000 was paid for anything other than those promises. The Agreement to Farm Prawns was entered into contemporaneously with the Licence Agreement. His Honour found that the venture would probably have been profitable. There is every reason to think that NQIT and GRS (PF) as well as the Taxpayer believed this. Accordingly, it is reasonable to think that it was in the parties' interests and that it was their intention that the construction of the ponds in readiness for prawn farming, the sealing of the plan of subdivision and prawn farming itself should occur sooner rather than later. His Honour found that contemporaneously with the incurring of the outgoing, the Taxpayer paid for prawn larvae to stock the pond. He also found that he was told at the meeting which he attended in May 1987, and believed, that NQIT was using its best endeavours to see that a first crop of test prawns was harvested before Christmas 1987 and that a commercial crop was expected in mid 1988. The point is that when the Taxpayer paid the sum of $15,000 as consideration for the bundle of promises by NQIT, there was an irrevocable commitment by the Taxpayer and also by NQIT and GRS(PF) to income producing activity (prawn farming) which was bound to commence by 4 June 1988 at the latest and which they all expected would commence much earlier than that date.
In all the circumstances, we do not think that the payment on 4 June 1987 was "too soon" to deny to it the character which the findings of the trial judge would otherwise give to it, of an outgoing incurred in gaining or producing assessable income.
The reduction in the amount of the licence fee for advance payment, needs to be addressed only briefly. Clause 8 required the Taxpayer to pay the first of the annual licence fees upon the signing of the Licence Agreement; cl 9 provided that he might elect, instead, to pay the whole of the licence fee for the first seven years' occupation upon the signing of the Licence Agreement, in which case he would pay $15,000 instead of $16,602 and would avoid liability to pay "cost of living increases" under cl 12. Clause 10 provided that notwithstanding the "payment in advance" referred to in both clauses 8 and 9, the date on which the Taxpayer would become entitled to occupy lots 3 and 4 would be the date when the pond became ready for the growing and harvesting of prawns.
His Honour accepted the Taxpayer's evidence that he prepaid the licence fees to obtain a "discount" on those fees while he had the money on hand to enable him to do so. Whether there was any commercial value in that step was not in issue and his Honour was satisfied that in paying the sum the Taxpayer had in mind a "commercial objective" as distinct from moulding the transaction to maximize the tax advantage obtainable thereunder.
The Commissioner did not submit that the lump sum paid by the Taxpayer for licence fees included a voluntary prepayment by the Taxpayer of fees that were not payable under the Licence Agreement until subsequent years of income and, therefore, that the outgoing the Taxpayer incurred in gaining or producing the assessable income in the year of income ended 30 June 1987 was incurred only to the extent of the first annual licence fee, being the amount of the outgoing that was properly referable to that year of income. Before us, the case was argued on the basis that the whole of the sum of $15,000 either did or did not fall within the first limb of sub-s 51 (1) of the Act. In particular the Commissioner did not submit that the outgoing should be treated as having been incurred only as and when receipts were derived or expected to be derived; cf Coles Myer Finance Ltd v Commissioner of Taxation (1993) 176 CLR 640 at 665-666 per Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ); and see R W Parsons, "Income Taxation: an Institution in Decay" (1991) 13 Syd L Rev 435 at 461.
The Commissioner also abandoned a ground of appeal which relied upon the argument that the outgoing, in whole or part, was of a capital nature (cf Case 42/95 95 ATC 367). Accordingly we have not dealt with these issues.
CONCLUSION ON THE APPEAL
No ground has been established for interfering with the trial judge's decision and, accordingly, the appeal should be dismissed and the appellant should be ordered to pay the respondent's costs of the appeal.
I certify that the preceding 39 pages are a true copy of the Reasons for Judgment of their Honours Justice Lee and Justice Lindgren.
Associate:
Dated:20 September 1995
Heard: 20 July 1995
Place: Perth
Decision: 20 September 1995
Appearances: Mr M Buss QC with Ms L Price of counsel instructed by the Australian Government Solicitor appeared for the appellant.
Mr G Nettle QC with Mr T Murphy of counsel instructed by Messrs Morrison & Sawers, solicitors, appeared for the respondent.
IN THE FEDERAL COURT OF AUSTRALIA )
WESTERN AUSTRALIA )
DISTRICT REGISTRY ) No WAG 49 of 1995
GENERAL DIVISION )
ON APPEAL FROM A JUDGE
OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN: THE COMMISSIONER OF TAXATION OF
THE COMMONWEALTH OF AUSTRALIA
Appellant
AND: RONALD GRANT BRAND
Respondent
CORAM: LEE, LINDGREN, TAMBERLIN JJ
PLACE: PERTH
DATED: 20 SEPTEMBER 1995
REASONS FOR JUDGMENT
TAMBERLIN J:
I have read the reasons for judgment given by Lee and Lindgren JJ and I agree with their conclusion.
In this matter the controlling principles, in my view, are set out in Fletcher v FCT (1991) 173 CLR 1 at 17. The High Court there formulated the approach to the first limb of s 51(1) in two ways. These are:
Whether the outgoing is "incidental and relevant" to the end of gaining or producing assessable income.
Whether the occasion of the loss or outgoing is to be found in what is expected to produce assessable income.
On either formulation it is necessary to predicate that the loss or outgoing is directed to the production of assessable income. As the Court points out at 16, the reference to "the assessable income" in s 51(1) is both to assessable income derived in that tax year or in any tax year in which the outgoing or loss would be expected to produce assessable income. The exercise requires a determination of the end or purposes of the activity in question.
The findings of fact made, by RD Nicholson J at first instance include a finding that the transaction was a real business transaction underpinned by genuine commercial considerations, both in relation to the making of the investment and in relation to the prepaid licence fee. Importantly, his Honour also found that the payment was intended to be the means of effecting the investment which was expected to produce assessable income. See Brand v FCT (1995) 95 ATC 4262.
This latter finding as to the subjective purpose which the taxpayer had in mind at the time of payment is, in the circumstances of this case, an important element in characterising the outgoing for the purposes of the subsection. This finding does not resolve the question because the ultimate characterisation of the outgoing also calls for an examination of the objective circumstances in which the outgoing was incurred and on the result which the outgoing is objectively calculated to achieve.
The circumstances in which the present payment is made, indicate in my view, that the outgoing can objectively be described as incidental or relevant to the end of gaining or producing assessable income or as being an activity which would be expected to produce assessable income, although none in fact was produced.
One method by which to characterise the nature of an outgoing is to examine the consideration in return for which it was incurred. Here, the factual context and the matrix of rights and liabilities pursuant to which the payment was made are to be discerned from the Agreement to Farm Prawns made on of 4 June 1987, and the Licence Agreement of the same date. The two agreements are inter-related and must be read together as part of an overall legally binding arrangement. It is then appropriate to consider the role which the payment plays in that arrangement.
As a direct result of the entry into those agreements by the taxpayer, North Queensland Industries (Townsville) Pty Limited ("NQIT") was bound to construct or have constructed or make available ponds to the taxpayer in readiness for prawn framing by 4 June 1998, and to provide access to all times to the lots by the taxpayer. In return, upon notice given by the taxpayer to NQIT, the latter was bound to permit an appointee of the taxpayer to enter upon the ponds to carry out the activities necessary to grow, harvest and market the prawns. The licence fee giving rise to the right of the taxpayer to access and use the ponds when constructed was required to be paid on the signing of the Licence Agreement although prepayment was optional. The taxpayer was entitled to elect to pay the licence fee for a period of seven years in advance upon the signing of the Licence Agreement. The commercial advantage was that the prepaid licence fee would not be subject to cost of living increases which would otherwise apply.
Under the Agreement to Farm Prawns, the taxpayer agreed to appoint General Rules Services (Prawn Farms) Pty Ltd ("GRS") to farms, harvest and sell prawns for the benefit of the taxpayer. However, the taxpayer had the right at all times to harvest and market the prawns of the pond by himself or by his agents or contractors.
In the present case the extent of the commitment of the taxpayer to the profit making arrangement is significant and substantial. As from 4 June 1987 the taxpayer was contractually committed to the carrying on of the prawn business farm and the incurring of a licence fee as a necessary step towards the expected production of assessable income. The licence fee was in the nature of rent. It was necessary to pay this fee to secure the access necessary for the breeding, harvesting and selling of the prawns. Regular
access to those ponds was a integral part of carrying on the business.
In Goodman Fielder Wattie Ltd v FCT (1991) 29 FCR 376, Hill J had to consider whether payments made by Goodman Fielder to fund research carried on by the Queensland Institute of Technology and expenditure for manufacturing, administration, research and development, came within s 51(1).
At pp 386-387 his Honour considered the characterisation question and after reference to the decision in Softwood he said:
"The last mentioned case was concerned with the familiar problem of expenditure on feasibility studies, although some of the items in question involved expenditure in testing of raw materials. The expenditure was held not to be deductible.
Critical to the decision in that case was a finding that the taxpayer had not yet committed itself to the project nor made a final definitive decision to do so ... Hence the expenditure in question could not be said to be, ... "part of the cost of trading operations."
The element of commitment to the income producing or business activity is emphasised as well in the decision of Davies J with whom St John J agreed in Inglis v Commissioner of Taxation (Cth) (1979) 40 FLR 191 at 201 in the analogous context of determining whether there had been a cessation of business in a period of quietude." (Emphasis added)
His Honour went on to express the view that it was clear, in the case before him, that the applicant was engaging in
activities of a provisional kind only notwithstanding that it was contemplated that, if the research work funded was successful, there would be products to market and that it was hoped that sales could be embarked upon at an early time.
The purpose of research expenditure or payment for a feasibility study is firstly to investigate whether a proposed or possible line of business activity is viable and secondly to decide whether to make a commitment to the activity. The third stage is the entry into such a commitment. It does not follow from a favourable research or feasibility study, for example that any commitment or outgoing will be made with a view to producing assessable income. In that sense such studies may be discrete from the relevant business activity and may be "too soon" before the business activity commences to justify classification as an activity expected to produce assessable income. This stands in marked contrast to the present case.
In FCT v Maddalena (1971) 45 ALJR 426, the High Court disallowed a claim for a deduction by a footballer in respect of expenditure incurred on travel to Sydney in order to negotiate employment with a metropolitan club to which he desired to move from his former club. He also sought to deduct legal expenses in negotiating the contract. In that case the expenditure was incurred in obtaining work, rather than carrying out work and the expenditure was held not to qualify as a working expense. Menzies J at 427 referred to expenditure which might come "too soon" to be properly regarded as incurred in gaining assessable income.
The suggestion that there must be some contemporaneity of expenditure with income is adverted to in FCT v Riverside Road Lodges Pty Ltd (in liq) (1989) 23 FCR 305 at 313-4. In that decision reference is made to the view of Professor R W Parsons expressed in his work Income Taxation in Australia: Principles of Income Deductibility and Tax Accounting (LBC) (1985), pars 5-37 to 5-48. There are also references in the decisions to expenditure being incurred "too soon" to qualify for deductibility under the sub-section. The expression "too soon" is said to support a requirement that there must be a relatively close temporal relation between expenditure and the production of assessable income.
The Commissioner contends in this case that there is not sufficient contemporaneity between the payment and the production of assessable income.
One difficulty which faces such a contention is that strict correspondence in time was not considered a necessary element for deductibility in FCT v Emmakell Pty Ltd (1990) 22 FCR 157 and FCT v Lau (1984) 6 FCR 202. Nor was it found to be a necessary condition by Pincus J in FCT v Osborne (1990) 26 FCR 63. At 68 his Honour, with whom Spender and French JJ agreed, said:
"A person starting a business of raising annual crops may, in general, deduct the cost of the fertiliser he applies, even if no crop is ever harvested. It seems to me that, likewise, the steps taken to fertilise the ground preparatory to putting in the chestnut plants should be regarded as incurred in carrying on a business."
He pointed out that in Osborne's case there was likely to be a gap of about six years after planting before the trees would yield an economic return. Nonetheless the planting costs were held to be deductible.
In the present case the commitment was that the pond must be provided within one year, from the date of the Agreement, and the expectation based on this contractual commitment, was that income would then be generated. This contractual commitment to the project, in my view, provides sufficient connection between the expenditure and the operations, which it was expected would gain or produce the assessable income, to make the payment deductible within s 51(1).
For the above reasons, I consider that the Appeal should be dismissed with costs.
I certify that this and
the preceding seven (7) Associate:
pages are a true copy of the
Reasons for Judgment herein of Date: 20.09.95
his Honour Justice Tamberlin.
Heard : 20 July 1995
Place : Perth
Decision : 20 September 1995
Appearances : Mr M Buss QC with Ms L Price of counsel instructed by the Australian Government Solicitor appeared for the appellant.
Mr G Nettle QC with Mr T Murphy of counsel instructed by Messrs Morrison & Sawers, solicitors, appeared for the respondent.
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