WARNER MUSIC AUSTRALIA PTY LIMITED v FC of T
Judges:Hill J
Court:
Federal Court
Hill J
On 16 May 1994 the respondent, the Commissioner of Taxation, issued to the applicant, Warner Music Australia Pty Limited (``Warner''), a notice of amended assessment. The amendment included in the assessable income of Warner an amount of $3,798,051 in respect of the year ended 30 November 1991, being a substituted accounting period in respect of the year of income ended 30 June 1991.
Warner duly objected against the inclusion of the amount in question in its assessable income. That objection was disallowed and Warner, in consequence, appealed to this Court against the Commissioner's objection decision. At issue in the appeal is the question of the assessability of the amount of $3,798,051 treated as assessable income by the Commissioner.
The primary facts
Warner, previously known as WEA Records Pty Ltd, carries on a prerecorded music distribution business throughout Australia.
On 21 November 1985, two sales tax assessments were served upon it. The first, issued pursuant to s 10(2A) of the Sales Tax Assessment Act (No. 2) 1930 (``the No. 2 Act''), assessed Warner to sales tax for the period 1 January 1982 to 31 May 1985 in the amount of $599,087.72, with additional tax of $299,543.86 imposed pursuant to s 10(2B) of the No. 2 Act and s 45(2) of the No. 2 Act. The second assessment was in respect of the period 1 February 1982 to 31 May 1982 and was in the amount of $564,544.69, with additional tax of $282,272.34 imposed under s 45(2) of the Sales Tax Assessment Act (No. 1) 1930 (``the No. 1 Act''), and an additional $300,312.80 tax imposed pursuant to s 29 of No. 1 Act as applied by s 12 of the No. 2 Act.
It is difficult from the material filed in this Court to form a clear understanding of the factual circumstances which led to the issue of these assessments. In any event, nothing turns upon them. Suffice it to say that Warner objected against each of these assessments. The substantial issue between Warner and the Commissioner was whether the transaction, by virtue of which records and cassettes became the property of WEA Retail Pty Limited (``WEA Retail''), a wholly owned subsidiary of Warner (in circumstances where a duplicator was interposed between Warner and WEA Retail), constituted a sale of goods by Warner to WEA Retail. There appears also to have been an issue as to the correct sale value upon which the sales tax should have been paid.
Warner did not pay the amounts assessed but instead sought an extension of time for payment. That was disallowed and proceedings were commenced in this Court, under the Administrative Decisions (Judicial Review) Act 1974 (``the ADJR Act''), challenging the refusal. The Commissioner for his part commenced proceedings for recovery of the tax and additional tax in the Supreme Court of New South Wales, and to these proceedings Warner filed a defence.
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The proceedings in this Court were resolved by consent orders in 1987 and the substantial dispute between the parties as to the assessments was ultimately settled on 17 September 1991 when the Commissioner agreed to accept payment of $650,000 in full satisfaction of Warner's liability under the two assessments. In so doing the Commissioner waived all rights to recover the amounts initially assessed without admitting the correctness of Warner's arguments or, as the settlement correspondence said, ``the validity of WEA's sales tax procedures''.
Notwithstanding that it had not paid any part of the sales tax, Warner claimed a deduction for the total amounts assessed of $599,087.72 and $564,544.69, ie $1,163,632.41, in its income tax return for the year ended 30 November 1985, and this claim for a deduction was allowed by the Commissioner. No claim was sought to be made for the additional tax by way of penalty. There is no suggestion that Warner was not entitled to the deduction as claimed in the year in which it was claimed. The unpaid liability for sales tax did not appear in Warner's statutory accounts for the year ended 30 November 1985. However, the Directors' Report accompanying those accounts noted that assessments had been issued to the company, that objections had been lodged with the Commissioner and that it was the opinion of the Directors that no amount was payable under the assessments. The accounts of subsequent years, however, while likewise making no reference to unpaid sales tax in the balance sheets, showed, as a note to those accounts under the heading ``Contingent Liabilities'', the fact that the company (and a subsidiary) had been issued with sales tax assessments and that objections had been lodged. The note indicated the quantum of the liability with comparative figures for the preceding year.
On 23 June 1987 a further two sales tax assessments were served upon Warner. The first of these purported to be made under s 25(2) of the No. 1 Act and concerned transactions which had occurred in the period 1 June 1984 to 30 June 1985 and was in the amount of $4,197,209.20, together with additional tax of $3,656,304.25, said to have been imposed pursuant to ss 46 and 45(2) of the No. 1 Act, as then in force. The second assessment was for an amount of $87,210 sales tax purported to be made under s 25(2A) of the No. 1 Act for the same period. That assessment, as well, included an amount of $75,971.24 by way of additional tax said to be imposed pursuant to s 25(2B) and s 45(2) of the No. 1 Act.
Again, the amounts assessed were not paid. Instead an extension of time was sought and refused and proceedings commenced in this Court under the ADJR Act challenging the refusal to extend time. In the meantime Warner objected against each of the assessments. In respect of the larger of the two, Warner appealed to this Court and in respect of the smaller, to the Administrative Appeals Tribunal.
A compromise was reached of the proceedings under the ADJR Act on 6 December 1988. Under that compromise Warner agreed to pay $1,000,000 to the Commissioner who agreed not to commence recovery proceedings in respect of the balance or to require payment of the balance until the proceedings on the merits had been decided.
The proceedings in this Court came before Davies J who upheld Warner's objection to the assessment before the Court. The proceedings are reported as
WEA Records Pty Ltd v FC of T 90 ATC 4779; (1990) 96 ALR 365. As the report of that case indicates, the parties had presented two questions to be decided separately from other questions arising in the proceedings on the basis that the answer to those two questions could determine the outcome. One of those questions concerned whether duplication of cassettes in the circumstances constituted manufacture and on this issue the Commissioner was successful. The remaining question was whether Warner in the circumstances of the case should be deemed to be the manufacturer of those video cassettes, having regard to the definition of ``manufacturer'' in s 3(1) of the No. 1 Act. On this latter issue Warner was successful although, as was pointed out by counsel for the Commissioner in the present case, this success in part may have depended upon the fact that his Honour refused to allow counsel for the Commissioner in the proceedings to amend certain particulars which had been given to the taxpayer so as to raise a new issue.
In the result Warner's objection to the assessment appealed to the Court was allowed. Consequentially, consent orders were made in the Administrative Appeals Tribunal to allow Warner's objection in respect of the matter
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before that Tribunal which apparently depended upon the same issue. In the result the Commissioner refunded to Warner the amount of $1,000,000 which it had paid as a result of the settlement of the ADJR Act proceedings. The amount refunded was returned by Warner as assessable income in the year of income in which it was paid.Warner claimed a deduction in respect of the sales tax assessed by the two 1987 assessments (ie of $4,197,209.20 and $87,210.00, totalling $4,284,419.20) in its income tax return for the period ended 30 November 1987. Again, it is not suggested that it was incorrect that Warner claim the deduction or that the deduction was not allowable. It was in fact allowed by the Commissioner. No deduction was claimed for the additional tax.
The amounts of the 1987 assessments, like the amount of the 1985 assessment, were not expensed in the company's profit and loss account in the year in which the assessments were served, nor were they shown as a liability in the balance sheet as at the end of that year, or for that matter any subsequent accounting period. However, a note to the accounts under the heading ``Contingent Liabilities'' referred to the issue of the assessments and the fact that objections had been lodged against them.
The combined consequence of the settlement of the 1985 assessments and the allowance of the objections in respect of the 1987 assessments was that Warner was relieved of its liability to pay $513,632 in respect of the 1985 assessments and $3,284,419 in respect of the 1987 assessments. It is the total of these amounts which Warner was no longer required to pay, namely $3,798,051, which the Commissioner assessed to tax as assessable income in the 1991 income tax year. Although Warner was likewise relieved of its obligation to pay additional tax by way of penalty, the present dispute does not cover the additional tax.
The accounting evidence
On behalf of the Commissioner, expert accounting evidence was given by Ms Curran, a partner of Coopers & Lybrand, who had been employed for some thirteen years with the Australian Accounting Research Foundation, the technical arm of the Australian Society of Certified Public Accountants and the Institute of Chartered Accountants in Australia, being appointed a Director - Accounting in 1989. In that time she had been directly involved in or responsible for the drafting and development of various exposure drafts and accounting standards. By way of secondment from that employment, she spent time as a Technical Director of the Accounting Standards Review Board and as the Technical Director of the International Accounting Standards Committee in London.
Ms Curran became a partner of Messrs Coopers & Lybrand early in 1993, responsible for the provision of technical advice, in particular the interpretation of accounting standards. She is a regular presenter of technical papers at accounting conferences and the author of a book entitled ``Australian and International Accounting Standards - the differences'' due for publication in this year.
In her uncontradicted evidence, Ms Curran said that once a sales tax assessment issued and became payable, the accounts of the taxpayer should recognise the liability to pay that assessment in the balance sheet, whether or not the assessments were contested. In her view, if the accounts are to give a full and true view they cannot avoid disclosing the liability in the balance sheet merely by a note to the accounts.
Ms Curran next considered the question whether the amount of the assessment should be ``expensed'' in the profit and loss account in order to determine the operating profit or loss for the period, or whether, in the balance sheet, it should be matched by a corresponding asset referred to as a ``receivable'', that asset being the contingent right to have the assessment expunged in the event of a successful objection and appeal. It seems that there was no relevantly binding accounting standard at the relevant time dealing with the matter.
It is, no doubt, obvious that the question whether a receivable should have been recognised in the balance sheet involved a question of judgment, depending upon factors such as the likelihood of success in contesting the assessment. Also relevant, no doubt, would be matters such as materiality and prudence in the preparation of the accounts. If Warner had had a high expectation of success for its objection, in her view this would have justified recognition of a receivable in an amount equal to the liability. In such a case it would, no doubt, be wrong to recognise the liability as an expense in the profit and loss account.
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Ms Curran then considered what the proper accounting treatment should be in the event that the sales tax liability were forgiven or waived. She said that in such a case the initial accounting entry made to record the liability should be reversed and any corresponding asset written back. She concluded that, if a liability and commensurate asset were recognised at the time of assessment and the balances remained in the balance sheet at the time of forgiveness, the liability and asset would be eliminated from the balance sheet with no impact on the profit and loss account. If, on the other hand, the liability had been recognised at the time of assessment, then at the time of forgiveness the liability would be ``derecognised'' and the forgiveness recognised as revenue. Finally, Ms Curran said that if no accounting recognition of the sales tax liability was made in the year the assessment was received, then, to the extent that the assessment remained unpaid at the time of forgiveness, no subsequent accounting entry or recognition would be required in respect of the forgiveness.
On behalf of Warner, evidence was given by Mr Boymal, a partner of Ernst & Young, who is currently the National Vice-President of the Australian Society of Certified Practising Accountants. Mr Boymal, in addition to his extensive audit accounting experience, had been involved in the setting up of Australian Accounting Standards as a member of the Australian Accounting Standards Board since 1983 and is currently the Deputy Chairman of the Australian Standards Accounting Board.
Mr Boymal made the point that at the time the relevant events happened, the Companies Code, as it then was, while requiring liabilities to be addressed in the accounts, did not offer any definition of liability. He referred to a definition of liability from the Australian Dictionary of Accounting Terms, which mirrored that of the United States Accounting Standard ``FAS Statement of Financial Accounting Concepts No. 3'', and said that under such a definition the key issue was whether management believed that payment of the amount of the liability was probable, either at the time of the original assessment or subsequent thereto.
It is clear from his evidence that there could, at least, be occasions, in his view, where there could be an offsetting asset which, if the view was taken that the whole of the assessment was capable of being overturned on appeal, could be equal in amount to the amount of the liability. In this regard he said nothing different from that which Ms Curran had said. However, according to Mr Boymal, in the relevant years it was common accounting practice to treat a liability to one entity and a receivable from the same entity arising from the same transaction or transactions on a net basis. In other words, if a taxpayer owed the Commissioner a sum of money and the taxpayer believed that it would be wholly successful on appeal so that there was a receivable in an amount equal to the amount of the assessment, the two amounts could be netted off. It was only in respect of years ending after 30 June 1988 that an Accounting Standard was promulgated which dealt with the circumstances where a netting off could occur.
In Mr Boymal's view, it would have been correct in these circumstances, in the years at least in which the assessments issued, to net off the assessments and corresponding receivables and merely to make a note in the accounts of a contingent liability. This of course would assume that it was the taxpayer's belief that the whole of the assessment would be overturned on an appeal.
No doubt in support of the so-called netting off approach, evidence was given by Mr Coyle who was a partner in the firm of Ernst & Young which firm acted for Warner in respect of its sales tax affairs. Mr Coyle gave evidence of a number of meetings with the Financial Director of Warner in which Mr Coyle said words to the effect that the assessments were invalid and ultimately he did not think that the company would have to pay any amount of the tax assessed. It seems, however, that when these comments were made they were limited to the 1987 assessments. Mr Coyle was cross- examined about this advice and conceded that he would have discussed the vagaries of litigation in his advice.
No evidence was given by any Director or officer of Warner as to the views they took of the chances of success of the appeals, either in respect of the 1985 or 1987 assessments.
The Commissioner's principal submission
In a written outline, counsel for the Commissioner indicated that it was the Commissioner's principal contention that the Court should recognise a general principle of taxation law that the assessable income of any
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taxpayer should include the gain or benefit derived by that taxpayer by the reduction or extinction of a liability in respect of which a deduction had been allowed under the Income Tax Assessment Act 1936 (Cth) (``the Act'') in a previous year.It is difficult to see, as a matter of principle, why a payment which has the character of capital becomes income in ordinary concepts, just because the payment has its origin in the refund of a previous amount which had attracted a deduction. The symmetry which such a rule suggests ignores the fact that deductions may be available for amounts which have capital character. Not all deductions are on revenue account.
I was referred to the situation in the United States where it was early held that there was a rule to the effect that a taxpayer who had previously claimed a deduction but who recovered an amount related to that deduction in a subsequent income tax year, should report the recovery as gross income in the later year. The history of that rule is dealt with in the judgment of Stevens J, concurring, in
Hillsboro National Bank v Commissioner of Internal Revenue 460 US 370 at 405-412 and see The Tax Benefit Rule, Bittker, B L & Kanner, S B (1978) Vol 26 UCLA Law Review at 265 and Determining an Individual's Federal Income Tax Liability When the Tax Benefit Rule Applies: A Fifty Year Checkup Brings a New Prescription for Calculating Gross, Adjusted Gross, and Taxable Incomes, Barrett, M (1994) Brigham Young University Law Review at 1.
The need for such a rule is said to evolve from the fact that income tax law requires a system of annual accounting, rather than an accounting of the profit or loss on transactions. Thus if a transaction extends beyond the scope of one tax year, taxpayers may be treated differently from taxpayers whose transactions all occur in the one year, unless some account is taken of the taxation consequences in subsequent years where deductible amounts are subsequently refunded.
The articles to which reference has been made recognise the complications which the tax benefit rule carries with it if taken to its logical conclusion.
The tax benefit of a deduction in one year may be greater or less than the tax collected in the later year because of a change in tax rates. Should the tax benefit rule only operate to the extent of the actual benefit which the taxpayer has achieved by virtue of the deduction? Should the rule apply where, instead of a deduction in the earlier year, the taxpayer has applied a credit or a rebate? In principle there is no difference, for the taxpayer has received a tax benefit and it is the receipt of the tax benefit which, if there be a rule at all, has required the capital payment by way of refund to be treated as income. But the symmetry will not be quite so apparent in such a case for the rebate or credit could be restricted to a nominal amount whereas the receipt will be assessed at full income rates. These and other difficulties are mentioned by Barrett (op cit at 3-4).
It may be argued that the complexities necessary to afford complete justice in the application of any tax benefit rule, might be better dealt with in legislation or, alternatively, that only some parts of the tax benefit rule should be taken into Australian tax law. In the United States, legislation has been enacted to deal with the tax benefit rule, see, for example, The Internal Revenue Code 1986; s 111. But whatever the policy of the law should be and whether it should come about by judicial determination or legislation, senior counsel for the Commissioner concedes that, as a single judge, I am bound by the weight of prior authority to find that there is no such rule in Australia.
It may be true, as submitted by counsel for the Commissioner, that the existence of a tax benefit rule was left open by the High Court in
Allsop v FC of T (1965) 14 ATD 62 at 64; (1965) 113 CLR 341 at 350.9 per Barwick CJ and Taylor J, by Gummow J in
TNT Skypak International (Aust) Limited v FC of T 88 ATC 4279 at 4288-4289 and 4290; (1988) 82 ALR 175 at 188 and 190, and by Beaumont J in
FC of T v Rowe 95 ATC 4691 at 4701; (1995) 60 FCR 90 at 111. But I am bound by the decision of the majority of the Full Court of this Court in Rowe's case (Drummond J, with whom Burchett J in separate reasons agreed) to find that an amount will not be required to be included in assessable income merely because it constitutes a refund of (or a gain arising from the release of a liability in respect of) an amount which had been allowed as a deduction against the income of a previous year (see at ATC 4708; FCR 120). The amount in question must be otherwise income in ordinary concepts or within the definition of assessable income.
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I am thus relieved from the necessity to consider the effect, if any, on this rule which cases such as
H.R. Sinclair Pty Ltd v FC of T (1966) 14 ATD 194; (1966) 114 CLR 537, and
Goldsborough Mort & Co. Limited v FC of T 76 ATC 4343 may have. I note only that special leave has been granted by the High Court to appeal Rowe's case and that the argument on appeal has been heard. If there is henceforth to be such a rule in Australia, and the applicability of it to credits, rebates and the like, it will be because the High Court has finally determined that such a rule is to be applied as part of the common law of taxation in this country.
Did Warner derive business income?
The real issue between the parties is whether the release of Warner from its liability to pay sales tax constituted income in ordinary concepts by virtue of that release constituting a gain or profit forming part of its business income. There are two steps in the resolution of this issue. The first involves the question whether the amount released involved a gain to Warner so as to constitute a profit. The second is whether this profit or gain was on revenue account.
It is now too late to argue in the case of a taxpayer carrying on a continuing business and thus required to account on an accruals basis, that income is confined to that which comes in. Gains, at least if they are capable of being converted into money in a practical and commercial sense, may clearly constitute assessable income:
Abbott v Philbin [1961] AC 352;
Heaton v Bell [1970] AC 728;
International Nickel Australia Limited v FC of T 77 ATC 4383; (1976-1977) 137 CLR 347;
FC of T v Unilever Australia Securities Ltd 95 ATC 4117; (1995) 56 FCR 152.
So, it is common ground between the parties, as indeed it must be, that a trader carrying on a continuing business who in the year of income by virtue of an exchange fluctuation is required to pay less for its trading stock, then the amount initially agreed to be paid at the time of purchase makes a gain in the ordinary course of business on revenue account. So, too, a trader who has incurred a royalty in one year of income, which liability remains unpaid and who, as a result of arbitration or litigation in respect of that royalty, has the amount reduced in another year of income, will have made an assessable gain: cf
Commonwealth Aluminium Corporation Limited v FC of T 77 ATC 4151 at 4161; (1977) 32 FLR 210 at 224.
Reference was made in the course of argument to the decision in
British Mexican Petroleum Co Ltd v IRC (1932) 16 TC 570 (HL), in the context of a submission that an abnormal reduction of indebtedness will not ordinarily constitute assessable income.
The British Mexican Petroleum Co Ltd case is not without difficulties, cf per Mason J in International Nickel at ATC 4394-4395; CLR 367-368 where the case was distinguished as involving a ``unusual transaction'' and see, too, per Murphy J at ATC 4393; CLR 371 and more recently the reasons for judgment of Beaumont J in
FC of T v Unilever Australia Securities Limited 95 ATC 4117 at 4132-4133; (1995) 56 FCR 158 at 172-173.
The facts in British Mexican Petroleum were simple. A company had purchased oil for resale. The purchase price was unpaid and the purchaser was in financial difficulties because the oil had been purchased at too high a price. The vendor of the oil, apparently related to the taxpayer, instead of winding up the taxpayer or reconstructing it, simply released the debt. Rowlatt J, at first instance, was unable to understand how forgiveness in a year of a past indebtedness added to the profits of the taxpayer. However, most of the argument at first instance seems to have been concentrated upon the question whether the accounts of the year in which the stock purchases were made could be reopened, a course which his Lordship rejected. On appeal, the Court of Appeal placed emphasis on some facts in the stated case, not referred to by Rowlatt J, requiring the conclusion that the relief granted to the taxpayer was for the purpose of giving the taxpayer ``new capital''. The Court, however, reaffirmed the view that no alteration needed to be made to the accounts of the earlier year.
In the House of Lords most of the attention was given to the argument that the consequence of a release was that the amounts for trading stock should be treated as never having been expended with the result that the earlier account should be reopened. Their Lordships rejected the course of reopening the accounts. Lord Thankerton, with whom Lord Hanworth, Lord MacMillan, Viscount Dunedin and Lord Atkin all agreed, dealt with the contention that the release itself gave rise to taxable income very briefly. His Lordship said (at 592):
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``The Appellant's alternative contention, which was not seriously pressed by the Attorney-General, is equally unsound, in my opinion. I am unable to see how the release from a liability, which liability has been finally dealt with in the preceding account, can form a trading receipt in the account for the year in which it is granted.''
With respect, if the case is to be taken as authority for the proposition that a release of a debt for trading stock is not taxable, the case is clearly inconsistent with the reasoning of the High Court in International Nickel. But it is hard to see on any view how the case could be correctly decided. Even the basis of the Court of Appeal's decision that the release (or payment which brought about the same consequence) was not taxable because it supplied funds for capital, would seem inconsistent with the decision of the High Court in
GP International Pipecoaters Pty Ltd v FC of T 90 ATC 4413; (1990) 170 CLR 124.
In my view, the time has come when British Mexican Petroleum may safely be treated as not representing the law in Australia, at least so far as it suggests that a release of indebtedness is necessarily of a capital nature. This is not to say that every release of indebtedness of a company would escape tax. Cases such as International Nickel and Unilever make this clear. But the question resolves itself into whether the release of indebtedness constitutes a gain on revenue account or on capital account, a question which ultimately does not require a distinction to be drawn between whether the gain arose by virtue of an extinguishment of a liability or by virtue of the receipt of a payment.
It was not suggested by senior counsel for Warner that the circumstances in which a gain arising by release of an indebtedness constituted assessable income were confined to cases involving exchange gains, although the discussion of the issue normally arises in that context. I was referred to cases such as
The Texas Company (Australasia) Limited v FC of T (1940) 5 ATD 298 at 325, 326, 353-354; (1939-1940) 63 CLR 382 at 427, 428, 464-466;
Armco (Australian) Pty Ltd v FC of T (1948) 8 ATD 335 at 345-346; (1947-1948) 76 CLR 584 at 618;
Caltex Limited v FC of T (1960) 12 ATD 170 at 172-173, 176-177; (1959-1960) 106 CLR 205 at 219-220, 226-227; International Nickel at ATC 4386-4388, 4390-4394; CLR 352-355, 360-367; and, the Canadian case
Eli Lilly & Co. (Canada) Limited v MNR (1955) 55 DTC 1, 139. It is unnecessary to discuss the factual background of these cases, all of which concerned foreign currency fluctuations or the comments made in them. Suffice it to say that all of these cases support the proposition that exchange fluctuations giving rise to a diminution in liability involving the purchase of inventory would be assessable income as being gains made by the taxpayer in the ordinary course of business on revenue account.
What is submitted by Warner is that there is a thread running through these cases which confines the proposition that a reduction in the amount of a liability on revenue account incurred by a taxpayer will always be income in ordinary concepts. It is submitted that it is only where there has been an outgoing taken into account in the year in which it is incurred which is then carried forward as a liability into the accounting period when it is discharged that gives rise to income in ordinary concepts. This is said to be apparent from what is said by Dixon J in The Texas Company case at ATD 325-326, 354 and at 355-356; CLR 427-428, 465-466 and at 468; in Armco at ATD 346; CLR 618; in Caltex at ATD 172-173; CLR 218-219; and in International Nickel at ATC 4394; CLR 366-367.
It is of course correct that in each of the cases to which reference has been made there was a liability carried forward into another accounting period, so that the effect of the exchange gain or loss operated to increase or diminish this liability. Indeed, in one sense the proposition would seem self-evident if all that is meant by it is that an indebtedness must exist in the year of income before it can be said that a reduction of that indebtedness constitutes income. If that is the proposition it would seem that the present case falls within it.
However, it is submitted by Warner that the evidence of accountants and businessmen will be relevant because underlying the need to estimate taxable income lies recognised commercial principles: cf
Commissioner of Taxes (SA) v Executor Trustee and Agency Co of South Australia Limited (Carden's case) (1938) 5 ATD 98 at 132-133; (1938) 63 CLR 108 at 155-156 where, as part of a well-known passage, Dixon J said:
``... The result is that a tax upon the profits or income of such a business must be
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understood as a tax upon the profits or income computed according to the system because, according to common understanding and commercial principles, that is the method of determining the profits.''
Thus, emphasis is placed on the accounting treatment adopted by Warner in respect of the sales tax liabilities. It is submitted that, having regard to the view taken, rightly or wrongly by Warner, that it would be successful in overturning the assessments, there was nothing to expense in the profit and loss account for the relevant years and nothing to carry forward as a liability in the subsequent accounting periods. The conclusion arising from a consideration of this accounting treatment is, so it is said, that in the year when Warner was released from its sales tax liability there was no gain left to be recognised because no liability had been carried forward from an earlier accounting period. Once the conclusion is reached that there is no gain, then a fortiori there could be no income in ordinary concepts derived by Warner.
The submission places heavy emphasis upon accounting treatment. It might be said that in recent times courts have been more ready to accept accounting evidence as relevant to income tax than had been formerly the case. Certainly there is a plethora of cases, commencing with
New Zealand Flax Investments Limited v FC of T (1938) 5 ATD 36; (1938) 61 CLR 179, in which accounting evidence has been considered and sometimes accepted as relevant, see, for example,
Arthur Murray (NSW) Pty Ltd v FC of T (1965) 14 ATD 98; (1965) 114 CLR 314;
RACV Insurance Pty Ltd v FC of T 74 ATC 4169;
Commercial Union Assurance Company of Australia Ltd v FC of T 77 ATC 4186;
Australia and New Zealand Banking Group Ltd v FC of T 94 ATC 4026;
FC of T v Australian Guarantee Corp Ltd 84 ATC 4642, among many others. Indeed quite recently, the Privy Council, on appeal from New Zealand, hinted at its preference for a commercial approach to determining whether an amount is ``incurred'' and thus eligible as a business deduction, rather than the jurisprudential approach presently adopted in Australia in the interpretation of s 51(1):
C of IR v Mitsubishi Motors New Zealand Ltd 95 ATC 4711.
As the cases cited indicate, accounting evidence will be received both where the issue is whether a loss or outgoing is income derived or where the issue is whether an amount is incurred in a year of income. However, the accounting evidence, as New Zealand Flax early demonstrated, will not necessarily be determinative.
Of course, accounting evidence could hardly be determinative where accountants themselves permit alternative treatments.
As has already been demonstrated, at least three possible accounting treatments would have been appropriate for Warner to reflect the sales tax assessments received but not paid, at least before the adoption of a mandatory accounting treatment preventing netting off of liabilities against so-called receivables. First, a taxpayer might expense the sales tax liability in the profit and loss account and bring to account the unpaid amount as a debt in its balance sheet, carrying that debt into later accounting years until the debt was released. Secondly, a company might not expense the liability in full or at all, but bring to account as a liability in the balance sheet the amount of the sales tax assessment and show as a receivable (the value of which would depend upon the opinion of the directors) a comparable amount representing the expectation of the company that its appeal against the sales tax assessment would be wholly or partly successful. Finally, a company might, at least where its view was that the outcome of its objection was certain to succeed, ignore altogether the amount by virtue of netting off the liability against the receivable, expensing the amount in its profit and loss account.
It is said for the taxpayer that the last of these courses is that which was taken by Warner, coupled as it was (at least as and from the 1986 year) with a note in the accounts disclosing a contingent liability. There is some difficulty with the evidence to support this proposition in that no director or auditor of Warner was called, nor indeed any person who participated in the preparation of the accounts. The only evidence as to any view taken by Warner as to the chances of success on objection was that to which I have already referred of Mr Coyle, which related only to the 1987 assessments and, in any event, was admittedly but an incomplete version of the advice he gave at that time.
However, I am not prepared to draw an inference that Warner would act contrary to accepted accounting principles in the
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preparation of statutory accounts for which a major accounting firm was responsible. But the fact that various methods of accounting existed and the fact that those methods of accounting depended on subjective assessments of the prospects of success, leads me to view the submission that the outcome of the present case should be determined by the manner of treatment in the accounts with great suspicion.In my view, the outcome of the present case requires no resort to accounting treatment. Sales tax is a self-assessing tax. A person liable to sales tax is required to furnish to the Commissioner monthly returns within 21 days of the close of the month. The tax becomes payable in respect of transactions in that month within 21 days of the close of the month: s 24 of the No. 1 Act. Prior to Act No. 48 of 1986 where an assessment was made, the notice of assessment could specify a date upon which the tax became payable, in which event it became payable on that date (s 25(4) omitted by Act No. 48 of 1986). That change does not affect the present discussion in any significant way.
In some cases, and the present facts presumably illustrate the point, the Commissioner might be dissatisfied with the returns furnished or suspect that further sales tax is payable and, in the result, make an assessment. Prior to 1 July 1986, the assessment was an assessment of sale value together with a calculation of tax. After 1986 the assessment was referred to merely as an assessment. The tax payable was, by force of statute, a debt due to the Commonwealth and payable to the Commissioner; see s 30 of the No. 1 Act and s 9(2) of the No. 2 Act. Specifically, the Commissioner was entitled to sue for unpaid tax, notwithstanding that there existed a dispute with the taxpayer: see s 43(1) of the No. 1 Act. Amendments made in 1986, consequent upon the transfer of jurisdiction from the Taxation Boards of Review to the Administrative Appeals Tribunal, do not relevantly affect the situation.
A taxpayer had a right of objection and appeal initially to a Board of Review and the Supreme Court and subsequently to the Administrative Appeals Tribunal and to this Court. The notice of an assessment has always been given a special status in sales tax legislation. It is conclusive evidence, except on proceedings on a review or on an appeal, that the amount and the particulars of the assessment were correct: see s 67 of the No. 1 Act, and in respect of notices of assessments served after 1 July 1986, s 10 of the Sales Tax Procedure Act 1934. The differences between these sections are not material to the present discussion: cf
Darrell Lee Chocolate Shops Pty Ltd v FC of T 95 ATC 4301 at 4305.
The cumulative effect of these provisions is that service of a notice of assessment of sales tax gives rise to a statutory liability which may be recovered by the Commissioner. It is difficult to see how the expression ``liability'' undefined in the Companies Code could not have encompassed it. That liability operated to reduce the actual assets of Warner from the moment of time that the notice of assessment issued. While there may be difficulty in a lawyer comprehending the concept of a notice of appeal against an income tax assessment as being property (cf the debate in
Cummings v Claremont Petroleum NL (1996) 137 ALR 1) no doubt it is possible to talk, in commercial terms, of a company having an offsetting right through the objection and appeal procedure whereby a company might hope to bring about a situation that the liability to pay sales tax is extinguished. But whether that is correct or not, Warner had a continuing liability to the Commissioner of Taxation until the 1991 income tax year when, as a result of compromise or court decision as the case may be, it was freed from that liability. In a legal sense, at that point of time Warner made a gain. The fact of that gain is not in any way to be diminished by reference to possible accounting treatments. It cannot be the law that the fact that one taxpayer forms a view that its chances of success on an objection are high and another taxpayer forms the view that its chances of success on a sales tax objection are low, that the consequences of being released from a sales tax liability would differ. In my view, it is unarguable that Warner made a gain when the sales tax liabilities to which it remained subject until the 1991 income tax year, were released.
Once it is accepted that there was a gain, then the question is whether that gain should be characterised as income in ordinary concepts in the year in which the gain was made. Again, this is an issue in my view which permits only one conclusion.
It is trite law that a gain made by a taxpayer in the course of carrying on its business, that is to say within the scope of its business activity,
ATC 5056
is income in ordinary concepts:FC of T v The Myer Emporium Ltd 87 ATC 4363 at 4366; (1987) 163 CLR 199 at 209. In seeking to determine whether a gain is one made in the ordinary course of carrying on a business, it will be necessary to examine in detail both the scope and nature of a taxpayer's business; see the analysis of Gibbs J in
London Australia Investment Company Limited v FC of T 77 ATC 4398 at 4403; (1976-1977) 138 CLR 106 at 116, citing
Western Goldmines NL v Commissioner of Taxation (WA) (1937-1938) 4 ATD 453 at 461; (1937-1938) 59 CLR 729 at 740. This involves ``a wide survey and an exact scrutiny of the taxpayer's activities''.
Where the ordinary activities of a taxpayer are, as was at all relevant times the case with Warner, the sale of items in circumstances attracting sales tax, it is clear that the liability to sales tax will be an ordinary incident of that taxpayer's income producing activities. Thus, as and when a liability to sales tax arises, Warner would clearly be entitled to a deduction for the sales tax liability incurred by it. No suggestion was made to the contrary. Having regard to the sales tax scheme, the deduction would be available, notwithstanding that Warner was dissatisfied with an assessment of sales tax and in consequence exercised its rights to object and, on the disallowance of the objection, to appeal in respect of the sales tax assessment.
It is true that it may be said to be unusual for a taxpayer to be relieved of a liability to pay sales tax, either because it is successful on an appeal or because a compromise is reached to this effect. However, it does not follow that any gain the taxpayer makes as a result is an abnormal gain. That is to use the word ``abnormal'' as meaning ``infrequent'', a meaning which it does not bear in the area of discourse with which the present case is concerned. Although unusual, a gain made by a taxpayer by virtue of being relieved from a liability to pay sales tax is, in my view, properly to be regarded as an incident of the taxpayer's business of selling goods. Even if this is not a correct analysis and it is right to describe the gain to Warner as being abnormal, this description does not require the conclusion that Warner should succeed in the present appeal. Whether or not the gain itself was ordinary or abnormal, it was so intimately connected with Warner's business of selling records, cassettes and the like, that it must be treated as being an incident of that business, even if not an ordinary incident of that business. As such it is, to use the words of the Full Court in Myer ``stamped'' with the character of income.
So much must really be conceded by Warner in that it accepted without dispute the inclusion in its assessable income of the monetary refund it gained in 1991, but objected merely to the assessability of the amount of liability for which it was released. But in truth there is no difference. Whether the tax was refunded or merely released, Warner made a gain which was income in ordinary concepts.
I would accordingly dismiss the application with costs.
THE COURT ORDERS THAT:
1. The application be dismissed.
2. The applicant pay the respondent's costs.
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