CASE 21/97

Members:
SA Forgie DP
JD Horrigan
EK Christie

Tribunal:
Administrative Appeals Tribunal

Decision date: 4 April 1997

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SA Forgie (Deputy President)

On 25 August, 1994, the applicant lodged an application for review of a decision by the Commissioner of Taxation (``the Commissioner'') in respect of an objection against an amended assessment issued under the Income Tax Assessment Act 1936 (``the Act'') on 11 June, 1992 for the year of income ended 30 June, 1989 (``the year of income''). A hearing was held and we gave a decision on 18 June, 1996 (Decision No. 11020).

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2. In that decision, we identified two issues for consideration. The first was whether the sum of $154,196, which was part of the total sum paid to the applicant as a result of the dissolution of a partnership, formed part of his assessable income for the year of income pursuant to sub-section 25(1) of the Act. If it did not, the second issue became relevant. That was whether the sum of $154,196 could be regarded as net capital gain accruing to the applicant as a result of the disposal of his interest in the Firm's work in progress or as a result of his deemed disposal of an asset. If it were decided that capital gain did accrue, the question arises whether the Commissioner is precluded from relying upon it or is limited to the sum of $19,520 shown as the capital gain component in his amended assessment dated 11 June, 1992.

3. In our decision of 18 June, 1996, we decided that the sum of $154,196 is not assessable income within the meaning of sub- section 25(1) (paragraph 46). We then decided that the

``... applicant thought that he was selling, and the continuing partners thought that they were purchasing, among other things, the applicant's interest in the work in progress as a matter entirely separate from the goodwill of the Firm. The continuing partners bought, and the applicant sold, an asset. It is, therefore, subject to capital gains tax within the terms of the Act.''

(paragraph 65)

4. On the evidence at that hearing, we were not satisfied that the amended assessment dated 11 June, 1992 was excessive. We also decided that there was no substantive unfairness in allowing the Commissioner to raise the issue of capital gain at the hearing. The applicant, however, faced difficulties in establishing a cost base as Credits and Debits had destroyed the financial records for the year ended 30 June, 1987. We decided that the applicant should be given an opportunity to establish his cost base from records which, possibly, may be in the possession of others.

5. At the resumed hearing, the applicant was represented by Mr Russell Q.C. with Mr Somers of counsel and the Commissioner by Mr Logan of counsel. Further material was admitted in evidence. On behalf of the applicant, that material comprised a report from chartered accountants. On behalf of the Commissioner, it comprised two statements, dated 25 November and 2 December, 1996 from Omega and two statements, dated 11 and 14 November, 1996 by Ms Judy Callan, an Appeals Officer in the Australian Taxation Office. No further oral evidence was given.

THE SUBMISSIONS - whether the tribunal may consider issues other than that of establishing a cost base.

6. Mr Russell's submissions made on behalf of the applicant were extensive. The fundamental proposition behind them was that the resumed hearing should not be confined to a consideration of the cost base of the work in progress but should be extended to a consideration of all aspects of the implications of capital gains tax. Mr Russell based his submission under three main heads.

7. The first was that, since our decision, the Full Court of the Federal Court has handed down its judgements in two cases:
ICI Australia Limited v FC of T 96 ATC 4680 and
FC of T v Murry 96 ATC 4703. The ICI case, Mr Russell said, dealt with the definition of an asset as comprised in the former paragraph 160A(a) of the Act. It was not a case concerned with work in progress but with whether the taxpayer's right to repay the principal sums on debentures at maturity constituted an asset for the purposes of capital gains tax.

8. Murry's case, Mr Russell continued later, was concerned with goodwill. Dr Gerber, of this tribunal, had found that, if a taxi business could not be operated without a licence, it followed that the licence was so intimately connected with the business as to constitute part of the goodwill of the business (Case 59/95,
95 ATC 473). Drummond J, who with Beaumont J formed the majority (Kiefel J dissenting), said that:

``... the only thing that gives a taxicab licence its commercial value is the assurance of sharing in the available custom which it confers on the holder: a cab licence confers no other benefit on the licensee. The value of the licence can therefore, in my view, fairly be regarded as the value of the only goodwill the taxicab business possesses.''

(page 4714)

Using the same analysis, work in progress affords to the holder an expectation that he or she will share in the profits to be earned by the partly completed work and is goodwill.

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9. In view of these cases, both parties should be given an opportunity to present arguments on all aspects of the implications of capital gains tax with regard to work in progress. That opportunity should also be granted, Mr Russell submitted, because, for various reasons, the capital gains tax implications were not fully argued by either the applicant or the Commissioner at the hearing. Any prejudice to the Commissioner in re-opening the issues must be viewed in the context of his delay in raising the issue of capital gains tax until 17 February, 1995. In Mr Russell's submission it must also be seen in the context of the Commissioner's resiling from paragraphs 13 and 14 of his Tax Ruling IT 2551 and his earlier statement at a conference of the National Tax Liaison Group in Canberra on 3 December, 1986. The written submission of Mr Russell and Mr James included the following extract of what the Commissioner was reported to have said at that conference:

``... that CGT would not apply [to WIP] but income tax would be payable by the purchaser upon realisation of the WIP, the parties taking this into account in settling on the price paid for the WIP.''

(1987 Taxation in Australia, page 520)

10. The essence of Mr Logan's submissions on behalf of the Commissioner was that, apart from the cost base of the work in progress, the issues in the case have been determined. From the Commissioner's perspective, submissions concerning the substantive capital gains tax issues in the case were ventilated at the hearing. Should he wish to do so, the applicant has other avenues to raise and argue the issues. Those avenues are provided by section 44 of the Administrative Appeals Tribunal Act 1975 and by section 39B of the Judiciary Act 1901 and the Administrative Decisions (Judicial Review) Act 1977. The Commissioner reserved his position in relation to any matters that might arise should those avenues be followed.

CONSIDERATION - whether the tribunal may consider issues other than that of establishing a cost base.

11. In adjourning further consideration, we did not determine finally the application for review. What we did do, however, was to determine all but one of the issues that we identified as being raised by that application. With respect to those issues, we made findings of fact, considered the law and determined them finally. We have exercised our powers in relation to those issues. Whether we have done so correctly or incorrectly is not something which we can ourselves review. That is the role of the Federal Court.

12. Whether we would have reached the same conclusions had we made our determinations after the Federal Court had handed down its judgements in the ICI and Murry cases is not a matter upon which it is relevant to speculate. Generally speaking and in the absence of any accrued rights, we must determine an application for review according to the law in force at the time we make the determination (
Re Costello and Secretary, Department of Transport (1979) 2 ALD 934). That principle applies equally to the final determination of the application for review as to the final determination of each of the particular issues which must be resolved to determine that application.

SUBMISSIONS - establishing the cost base.

13. Mr Russell submitted that the cost base for the sale of the applicant's share of the work in progress was $127,674. The cost base of the Firm's work in progress as of 30 September, 1988 was either the sum of its incidental costs pursuant to section 160ZH of the Act or the costs directly incurred in the acquisition of the asset. The most appropriate measure of the cost base is by reference to the ratio of outgoings to revenue applicable to the fees generally rendered by the Firm.

14. A typical ratio for the Firm can be ascertained by examining the three year period between 1986 and 1988. The valuation of the goodwill as at 30 September, 1988 prepared by Trial Balance on 19 December, 1989 includes all relevant balance sheets and profit and loss statements of Alpha & Omega and related entities. Schedules A1, A2 and A3 summarise the historical trading statement and profitability of the Firm and its related entities.

15. The report of Kendalls KBM reveals an average ratio of outgoings to earnings over the three year period from 1986 to 1988 of 82.8%. Given that the value of the Firm's work in progress was $616,196 as at 30 September, 1988, this would mean that its cost base was $510,697. The applicant's share of that cost base would be $127,674. As the amount which the applicant received for disposing his share of the Firm's work in progress was $154,196, the capital gain to him was $26,522. Therefore, the

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Commissioner's assessment should be amended by reducing the applicant's taxable income from $154,196 to $26,522.

16. Mr Logan submitted that the cost base is determined by reference to section 160ZH of the Act. No cost coming within the description in paragraph 160ZH [sic] has been proved. All of the work in progress appears to be referable to contracts of retainer to which the Firm was a party and which were entered at a time after the applicant, Omega, Beta and Gamma had formed the partnership of the Firm. The applicant has not proved that he paid or gave anything at all in acquiring an interest in any of the work in progress of that partnership.

17. Mr Logan submitted that the applicant had not proved that he had incurred incidental costs in acquiring his interest in the work in progress. Those incidental costs, referred to in paragraph 160ZH(1)(b) and sub-sections 160ZH(5) and (6) must be shown to be non deductible by their very definition.

18. Mr Logan continued that, in so far as expenditure has been incurred in enhancing the value of work in progress, that expenditure must be of a capital nature to form part of a cost base ( paragraph 160ZH(1)(c) ). No expenditure of such a nature has been proved to have been made.

CONSIDERATION - establishing the cost base.

19. At the relevant time, sub-section 160ZH(1) of the Act provided that

``Subject to the following provisions of this section, for the purposes of this Part, the cost base to a taxpayer of an asset is the sum of:

• (a) the amount of any consideration in respect of the acquisition of the asset;
• (b) the amount of the incidental costs to the taxpayer of the acquisition of the asset;
• (c) the amount of any expenditure of a capital nature incurred by the taxpayer to the extent to which it was incurred for the purpose of enhancing the value of the asset and is reflected in the state or nature of the asset at the time of disposal of the asset;
• (d) the amount of any expenditure of a capital nature incurred by the taxpayer to the extent to which it was incurred in establishing, preserving or defending the taxpayer's title to, or a right over, the asset; and
• (e) the amount of the incidental costs to the taxpayer of the disposal of the asset.''

20.  Sub-section 160ZH(2) is concerned with the determination of an indexed cost base and sub-section 160ZH(3) with the determination of a reduced cost base. Both adopt principles similar to those in sub-section 160ZH(1) in assessing their respective cost bases.

21.  Sub-section 160ZH(4) sets out what is meant by the ``consideration in respect of the acquisition of an asset'' referred to in paragraph 160ZH(4)(a) . It is:

• ``(a) if the taxpayer has paid or is required to pay an amount or amounts of money in respect of the acquisition - that amount or the sum of those amounts;
• (b) if the taxpayer has given or is required to give property other than money in respect of the acquisition - the market value of that property at the time of the acquisition; or
• (c) if the taxpayer has given or is required to give both an amount or amounts of money and property other than money in respect of the acquisition - the sum of that amount or those amounts and the market value of that property at the time of the acquisition.''

22. There is no evidence that the applicant has given any consideration of the type referred to in sub-section 160ZH(4) for the acquisition of the work in progress.

23. The incidental costs incurred in the acquisition of the asset and referred to in paragraph 160ZH(1)(b) are elaborated upon in sub-section 160ZH(5) which, at the relevant time, provided that:

``Subject to subsection (6), a reference in subsection (1), (2) or (3) to the incidental costs to a taxpayer of the acquisition of an asset is a reference to any expenditure incurred by the taxpayer to the extent to which it was incurred in connection with the acquisition, being-

• (a) fees, commission or remuneration for the professional services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser;
• (b) costs of transfer, including stamp duty or other similar duty;
• (c) costs of advertising to find a seller; or

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• (d) costs in relation to the making of any valuation or apportionment under or for the purposes of this Part in respect of the acquisition,

but excluding any expenditure by way of fees, commission or remuneration paid for professional advice concerning the operation of this Act or of any other law relating to taxation.''

24. An important qualification to sub-section 160ZH(5) is found in sub-section 160ZH(6) . That is that

``The incidental costs to a taxpayer of the acquisition of an asset do not include any amount referred to in paragraph (5)(a), (b), (c) or (d) that has been allowed or is allowable as a deduction to the taxpayer in respect of any year of income.''

25. On the evidence that we have, we are not satisfied that the applicant has established any amounts that come within paragraphs 160ZH(a)-(e) . The report of Kendalls KBM sets out a theoretical basis for establishing a cost base. It has done so by assuming that the amount shown in management accounts for work in progress represents the value of time expended on jobs. The value is costed by applying the charge rate of those professional personnel who have worked on the job. The charge rate for each professional personnel is determined by reference to the cost of labour, allocation of overheads and profit.

26. Where a partnership has terminated, the Kendalls KBM report continued, the method of calculating the amount payable to a retiring partner for his or her share of the work in progress is similar. Therefore, the amount paid to a retiring partner represents an element of unrealised profit. To determine the cost of the work in progress, the profit element needs to be eliminated. It then carried out a calculation as set out in paragraph 15 above.

27. The exercise carried out by Kendalls KBM does not differentiate between costs of the sort described in sub-section 160ZH(1) and other costs which might have been incurred in ``acquiring'' the asset. It does not establish the costs which are of the type described in section 160ZH and which were the cost base to the applicant of acquiring the work in progress. In the absence of his being able to do so, we are unable to find that the Commissioner's amended assessment is excessive.

28. For these reasons, we affirm the objection decision made by the respondent on 30 June, 1994.