• The impact of this case on ATO policy is discussed in Decision Impact Statement: Denmark Community Windfarm Ltd v Commissioner of Taxation (WAD 113 of 2016).

DENMARK COMMUNITY WINDFARM LTD v FC of T

Judges:
Gilmour J
Jagot J
Moshinsky J

Court:
Full Federal Court, Western Australia

MEDIA NEUTRAL CITATION: [2018] FCAFC 11

Judgment date: 5 February 2018

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Gilmour, Jagot and Moshinsky JJ

1. The appellant, Denmark Community Windfarm Ltd ( Denmark ), received a grant from the Commonwealth Government to fund 50% of the cost of construction of two wind turbines in Denmark, Western Australia. Denmark claimed depreciation deductions in relation to the assets it constructed with the assistance of the grant. The issue before the primary judge was whether the amounts Denmark received were "assessable recoupments" within the meaning of s 20-20 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act ). The primary judge concluded that the amounts were assessable recoupments within the meaning of that provision. Denmark appeals from the judgment of the primary judge. For the reasons that follow, we consider that the primary judge was correct to hold that the amounts were assessable recoupments. It follows that the appeal is to be dismissed.

Background facts

2. The following statement of the background facts is substantially based on the reasons for judgment of the primary judge:
Denmark Community Windfarm Ltd v Commissioner of Taxation [2017] FCA 478 (the Reasons ). No issue was raised on the appeal concerning his Honour's statement of the facts.

3. The material before the primary judge included an affidavit of Paul Llewellyn, a co-founder and director of Denmark. That affidavit explained (and it appears that his Honour accepted) that the Denmark Community Windfarm project was initiated in 2003 and supplies clean energy to the Denmark Shire's approximately 2,000 residences, with its turbines generating 55% of Denmark's annual domestic electricity demand.

4. By an agreement dated 18 May 2011 (the Agreement ), the Western Australian Coordinator of Energy agreed to provide Denmark with funding (the Grant ) as part of the Commonwealth's Renewable Remote Power Generation Program (the RRPGP ). The RRPGP was a Commonwealth Government initiative, which provided rebates for renewable energy projects in remote areas. The Grant was to meet 50% of the "Eligible Project Costs" (as defined in the Agreement) to be incurred by Denmark in the construction of two wind turbines in Denmark, Western Australia, up to a maximum of $2,487,800. (In other words, the Grant was capped at $2,487,800.) The Grant was payable in instalments on the completion of identified project milestones. Denmark was duly paid the Grant (totalling the maximum possible amount of $2,487,800) in the financial years ended 30 June 2013 and 30 June 2014.

5.

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ATC 20378

The expression "Eligible Project Costs" was defined in the Agreement as follows:

" Eligible Project Costs " are the capital costs of the equipment and services, exclusive of GST, that are essential for implementation of the Project. Eligible Project Costs shall be based on the following as described in clause 4 of the Denmark Community Windfarm Sub-agreement:

• (a) the costs of all equipment and services that are clearly essential for, and apply solely to, the design, construction and commissioning of the wind turbines;
• (b) the costs of upgrading or modifying equipment required to incorporate the wind turbines into the electricity grid or to reasonably maximise their output; and
• (c) the costs of additional services required for network integration, where services need to be extended to incorporate the wind turbines or to reasonably maximise their output.

6. In the years of income ended 30 June 2013 and 30 June 2014, Denmark incurred Eligible Project Costs. These were recorded in Note 6 to its financial statements for the year ended 30 June 2014, under the heading "Property, plant and equipment", and accounted for as follows:

Infrastructure	2014	2013
	$	$
At cost	5,498,467	5,632,979
Capital grant	(2,487,800)	(2,401,168)
Accumulated depreciation	(194,819)	(54,168)
	2,815,848	3,177,643
Movements in carrying amounts:
Balance at beginning of the year	3,177,643	2,024,310
Less capital grant received	(86,631)	(1,798,211)
Additions	9,356	2,925,897
Capitalised borrowing costs	-	81,022
Disposals	(143,869)	(1,207)
Depreciation	(140,651)	(54,168)
Balance at the end of the year	2,815,848	3,177,643

We note that the figure of $2,487,800 in the column for the 2014 year in the above table is the total of the Grant received in both the 2013 and 2014 financial years.

7. In its accounts, Denmark treated the expenditure on Eligible Project Costs as an outgoing on capital account.

8. The turbines constructed with the assistance of the Grant are substantial. (Each blade is about 24 metres long.) The economic working life of a turbine is between 20 and 30 years depending on long-term site conditions. Windfarms are highly capital intensive, requiring a high percentage of capital investment at the outset. While an income stream is expected through a long-term power purchase contract with an electricity retailer, windfarms are technically challenging.

9. Deductions may be claimed for depreciating assets under Div 40 of the 1997 Act. In the case of small business entities, deductions for depreciating assets may be claimed instead under Subdiv 328-D. It is common ground that Denmark was a small business entity within the meaning of s 328-110 and thus was entitled to calculate its deductions under Subdiv 328-D instead of under Div 40. Denmark elected to do so and claimed deductions in respect of the relevant depreciating assets (namely, the wind turbines) on a diminishing value basis. (Subdivision 328-D permits small business entities to claim deductions for depreciating assets deductible under Div 40 on the basis that its assets are pooled and treated as a single asset: see s 328-170.)

10.

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ATC 20379

In July 2012, RSM Bird Cameron ( RSM ), a firm of accountants, on behalf of Denmark, applied to the respondent (the Commissioner ) for a private ruling regarding the tax treatment of the Grant to be received by Denmark.

11. In the private ruling application, RSM posed the question whether the Grant received by Denmark would be assessable income under either s 6-5 or 15-10 of the 1997 Act. A private ruling was subsequently provided by the Australian Taxation Office (the ATO ) on 4 October 2012 (the Private Ruling ). The ATO answered this question in the negative. It is common ground on the appeal that the relevant amounts are not assessable under s 6-5 or 15-10.

12. In the Private Ruling, the Commissioner also ruled that the Grant was an "assessable recoupment" under s 20-20 of the 1997 Act.

13. Denmark lodged its income tax returns for the 2013 and 2014 years of income in accordance with the Private Ruling, by including an amount of $747,045 as an assessable recoupment in its 2013 return and an amount of $1,271,380 as an assessable recoupment in its 2014 return. We were told by counsel for the Commissioner (and there did not appear to be any dispute about this) that these amounts reflected the depreciation deductions claimed by Denmark in each of those years. It is common ground on the appeal that, if the amounts received under the Grant (totalling $2,487,800) are assessable recoupments, then the amounts to be included in Denmark's assessable income pursuant to Div 20 of the 1997 Act are the figures of $747,045 (for the 2013 year) and $1,271,380 (for the 2014 year).

14. On 28 May 2015, Denmark objected to the Commissioner's assessments for the 2013 and 2014 years of income. Specifically, Denmark objected to the inclusion of the amounts of $747,045 (for the 2013 year) and $1,271,380 (for the 2014 year) in its assessable income.

15. Denmark contended that the Grant it had received in those years of income did not constitute an assessable recoupment within the meaning of s 20-20(2) of the 1997 Act because it was not received by way of indemnity. Denmark also argued that the Grant was not an assessable recoupment within the meaning of s 20-20(2) or 20-20(3) of the 1997 Act because those sections require the relevant deduction to have been claimed "for the loss or outgoing", which, it contended, was not the case (the relevant deductions having been claimed for depreciation or decline in value). Denmark further contended that, as a deduction under Subdiv 328-D is not listed in the table set out in s 20-30 of the 1997 Act, the amount of the Grant was not an assessable recoupment for the purposes of s 20-20(3).

16. On 18 January 2016, the Commissioner gave notice of his decision on the objection. Denmark's objection was disallowed in full. The Commissioner determined that the Grant amounts were assessable recoupments under:

• (a) section 20-20(2) of the 1997 Act, as the amounts were received by Denmark by way of indemnity; or
• (b) section 20-20(3) of the 1997 Act, as the amounts were received in respect of a loss or outgoing incurred and the amounts were deductible under Div 40 of the 1997 Act.

17. The proceeding before the primary judge was an 'appeal' by Denmark pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) from the Commissioner's decision on the objection.

The legislative provisions

18. Division 20 of the 1997 Act includes amounts in a taxpayer's assessable income to reverse the effect of certain kinds of deductions. We will refer to the legislation as in force in the 2013 and 2014 years of income, these being the relevant years in issue.

19. Subdivision 20-A relevantly provides as follows:

What is an assessable recoupment ?

20-20 Assessable recoupments

Exclusion

(1) An amount is not an assessable recoupment to the extent that it is ^*ordinary income, or it is ^*statutory income because of a provision outside this Subdivision.

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ATC 20380

Insurance or indemnity

(2) An amount you have received as ^*recoupment of a loss or outgoing is an assessable recoupment if:

• (a) you received the amount by way of insurance or indemnity; and
• (b) you can deduct an amount for the loss or outgoing for the ^*current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act.

Other recoupment

(3) An amount you have received as ^*recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if:

• (a) you can deduct an amount for the loss or outgoing for the ^*current year; or
• (b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year;

  under a provision listed in section 20-30.

20-25 What is recoupment ?

General

(1) Recoupment of a loss or outgoing includes:

• (a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and
• (b) a grant in respect of the loss or outgoing.

Amount paid for you

(2) If some other entity pays an amount for you in respect of a loss or outgoing that you incur, you are taken to receive the amount as recoupment of the loss or outgoing.

…

20-30 Tables of deductions for which recoupments are assessable

(1) This table shows the deductions under the Income Tax Assessment Act 1997 for which recoupments are assessable.

Note: References are to section numbers except where otherwise indicated.

Provisions of the Income Tax Assessment Act 1997
Item	Provision	Description of expense
1.1	8-1 (so far as it allows you to deduct a bad debt, or part of a debt that is bad)	bad debts
1.2	8-1 (so far as it allows you to deduct rates or taxes)	rates or taxes
1.3	25-5	tax-related expenses
1.4	25-35	bad debts
1.5	25-45	embezzlement or larceny by an employee
1.5A	25-47	misappropriation by an employee or agent
1.6	25-60	election expenses, Commonwealth and State elections
1.6A	25-65	election expenses, local governing body
1.7	25-75	rates and land taxes on premises used to produce mutual receipts
1.8	The former 25-80	upgrading assets to meet GST obligations etc.
1.8A	25-95	work in progress amount
1.8B	item 7 of the table in section 30-15	contributions relating to fund-raising events
1.8C	item 8 of the table in section 30-15	contributions relating to fund-raising auctions ATC 20381
1.9	Division 40	capital allowances
1.10	The former Division 42 (as it applied to *software because of the former Subdivision 46-B)	expenditure on software
1.11	The former Subdivision 46-C	expenditure on software
1.12	The former Subdivision 46-D	expenditure on software, pooled
1.13	The former Division 42 (as it applied to *IRUs because of Division 44)	expenditure on IRUs
1.14	The former 330-15	exploration or prospecting expenditure
1.15	The former 330-80	allowable capital expenditure relating to mining or quarrying
1.16	The former 330-350	petroleum resource rent tax
1.17	The former 330-370	transport capital expenditure relating to mining or quarrying
1.18	The former 330-435	rehabilitation expenditure relating to mining or quarrying
1.19	The former 330-485	balancing adjustment deduction for expenditure relating to mining or quarrying
1.19A	Division 355	R&D
1.20	The former Subdivisions 380-A and 380-C	capital expenditure incurred in obtaining a spectrum licence
1.21	The former Subdivision 387-A	landcare operations expenditure
1.22	The former Subdivision 387-B	expenditure on facilities to conserve or convey water
1.23	The former Subdivision 387-D	grapevine establishment expenditure
1.24	The former Subdivision 387-C	horticultural plant establishment expenditure
1.25	The former Subdivision 387-E	mains electricity connection expenditure
1.26	The former Subdivision 400-A	expenditure on environmental impact assessment
1.27	The former Subdivision 400-B	expenditure on environmental protection activities
1.27A	420-15	registered emissions unit
1.28	775-30	forex realisation loss

…

20-40 If the expense is deductible over 2 or more income years

(1) This section includes an amount in your assessable income if:

• (a) you receive in the *current year an *assessable recoupment of a loss or outgoing for which you can deduct amounts over 2 or more income years; or
• (b) you received in an earlier income year an *assessable recoupment of a loss or outgoing of that kind (unless all of the recoupment has already been included in your assessable income for one or more earlier income years by this section or a *previous recoupment law).

(This section applies even if the recoupment was received before the first of those income years.)

Note: Recoupment of a loss or outgoing that is only partially deductible is covered by section 20-50.

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ATC 20382

(2) Work out as follows how much is included in your assessable income for the *current year because of one or more *assessable recoupments of the loss or outgoing.

Note: The method statement ensures that assessable recoupments are included:

• • only so far as they have not already been included for an earlier income year; and
• • only to the extent of your total deductions to date for the loss or outgoing.
  

  Method statement
  Step 1.	Add up all the *assessable recoupments of the loss or outgoing that you have received (in the *current year or earlier). The result is the total assessable recoupment .
  Step 2.	Add up the amounts (if any) included in your assessable income for earlier income years, in respect of the loss or outgoing, by this section or a *previous recoupment law. The result is the recoupment already assessed . (If no amount was included, the recoupment already assessed is nil.)
  Step 3.	Subtract the recoupment already assessed from the total assessable recoupment. The result is the unassessed recoupment .
  Step 4.	Add up each amount that you can deduct for the loss or outgoing for the *current year, or you have deducted or can deduct for the loss or outgoing for an earlier income year. The result is the total deductions for the loss or outgoing .
  	Note:	The total deductions may be reduced if an amount has been included in your assessable income because of a balancing adjustment: see section 20-45.
  Step 5.	Subtract the recoupment already assessed from the total deductions for the loss or outgoing. The result is the outstanding deductions .
  Step 6.	The unassessed recoupment is included in your assessable income, unless it is greater than the outstanding deductions. In that case, the amount of the outstanding deductions is included instead.

Example: At the start of the 2002-03 income year, a company incurs $100,000 to start to hold a depreciating asset. The company uses the prime cost method, and the effective life is 10 years. $10,000 is deductible for the 2002-03 income year and for each of the following 9 income years under section 40-25.

In the 2002-03 income year, the company receives $20,000 as recoupment. How much is assessable for the 2002-03 income year?

Applying the method statement:

After step 1: the total assessable recoupment is $20,000.

After step 2: the recoupment already assessed is nil.

After step 3: the unassessed recoupment is:

total assessable recoupment minus recoupment already assessed,i.e. $20,000 minus 0 = $20,000.

After step 4: the total deductions for the loss or outgoing are $10,000.

After step 5: the outstanding deductions are:

total deductions for the loss or outgoing minus recoupment already assessed, i.e. $10,000 minus 0 = $10,000.

After step 6: the unassessed recoupment (step 3) is greater than outstanding deductions (step 5), so the amount of the outstanding deductions is included in assessable income, i.e. $10,000.

Applying the method statement to the 2003-04 income year: a further $10,000 is included in the company's assessable income.

20. It is to be noted that the table of deductions in s 20-30 of the 1997 Act, set out above, includes Div 40 of the 1997 Act. The objects of Div 40, as set out in s 40-15, are:

• (a) to allow you to deduct the *cost of a *depreciating asset; and
• (b) to spread the deduction over a period that reflects the time for which the asset can be used to obtain benefits; and
• (c) to provide deductions for certain other capital expenditure that is not otherwise deductible.

21.

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ATC 20383

Division 40 includes two alternative bases for calculating the decline in value of a depreciating asset for an income year, namely the diminishing value method (s 40-70) and the prime cost method (s 40-75).

22. Subdivision 328-D of the 1997 Act concerns capital allowances for small business entities. Section 328-175 relevantly provides:

• (1) You can choose to calculate your deductions and some amounts of assessable income under this Subdivision instead of under Division 40 for an income year for all the ^*depreciating assets that you ^*hold if:
  • (a) you are a ^*small business entity for the income year; and
  • (b) you started to use the assets or have them ^*installed ready for use, for a ^*taxable purpose during or before that income year.

  This subsection has effect subject to subsections (2) to (10).

  Note: If you choose to use this Subdivision for an income year, you continue to use this Subdivision for your general small business pool for a later income year even if you are not a small business entity, or do not choose to use this Subdivision, for the later year: see section 328-220.

23. As noted above, it is common ground that Denmark was a small business entity. Denmark elected to calculate its deductions under Subdiv 328-D instead of under Div 40. It claimed deductions in respect of its depreciating assets, being the wind turbines, on a diminishing value basis.

24. When Subdiv 328-D was introduced in the 1997 Act, there was no corresponding amendment made to include it in the table in s 20-30. The explanatory memoranda to the New Business Tax System (Simplified Tax System) Bill 2000 (Cth) make no reference to the potential impact of Subdiv 328-D on s 20-20 or 20-30 despite addressing the interrelationship with numerous other sections of the 1997 Act. The Commissioner submitted before the primary judge that there could be no policy basis for treating an amount as an assessable recoupment in cases where depreciation deductions had been claimed under Div 40, but not treating the amount as an assessable recoupment where depreciation deductions had been claimed under Subdiv 328-D. The Commissioner suggested that it was most likely a drafting oversight that Subdiv 328-D was not included in the table in s 20-30 when the Subdivision was introduced.

The judgment of the primary judge

25. After setting out the background facts and the statutory framework, the primary judge set out Denmark's contentions at [26]-[45] of the Reasons. The primary judge noted at [28] of the Reasons that it was common ground that the Grant, being a portion of the Eligible Project Costs, fell within the meaning of "recoupment" and "reimbursement" in s 20-25(1)(a). Denmark contended that the amounts it received under the Grant were not "assessable recoupments" within s 20-20(2) or 20-20(3). In relation to s 20-20(2), it was contended that the amounts were not received "by way of … indemnity" within the meaning of s 20-20(2)(a). Denmark also contended that it had not deducted, and was not able to deduct, an amount "for the loss or outgoing" under a provision of the 1997 Act (see s 20-20(2)(b)). In relation to s 20-20(3), Denmark contended that it had not deducted, and was not able to deduct, an amount "for the loss or outgoing" under a provision listed in s 20-30.

26. His Honour considered the issues at [46]-[63] of the Reasons, which we set out in full:

• 46 For the Grant to be an assessable recoupment under s 20-20(2) of the 1997 Act, three requirements must be established:
  • (1) Denmark received the Grant as a recoupment of loss or outgoing;
  • (2) Denmark received the Grant by way of insurance or indemnity; and
  • (3) Denmark can deduct an amount for the loss or outgoing for the current year or Denmark has deducted or can deduct an amount for an earlier income year under any provision of the 1997 Act.
• 47 As to those three matters, it is clear, that the first requirement is satisfied, namely, that the Grant has been received as recoupment of an outgoing, even if the payment was treated as being on capital account.

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  ATC 20384

• 48 As to the second requirement, the Grant was not received by way of insurance, but the Commissioner contends it was by way of indemnity. While 'indemnity' is not defined in the 1997 Act, it bears its ordinary meaning and is to be given a wide construction:
  Batchelor [v Federal Commissioner of Taxation (2014) 219 FCR 453] (at [74]) and
  Falk v Federal Commissioner of Taxation (2015) 101 ATR 445 (at [49]) where Kerr P and Frost DP said '[t]he word "indemnity" is not defined in the [1997 Act] and so it must take its ordinary meaning'.
• 49 In my view, an indemnity, as widely understood, may include a sum of money paid to a person in respect of an outgoing incurred by the person. The Grant was made by way of compensation for half of the Eligible Project Costs incurred in the construction of the wind turbines, albeit that those costs were on capital account.
• 50 The Commissioner argues, and I agree, that the ordinary meaning of the word 'indemnity' gleaned from dictionary definition includes 'a sum of money paid to compensate a person for liability, loss or expense incurred by the person' (Butt PJ (ed), Butterworths Concise Australian Legal Dictionary (3rd ed, LexisNexis, 2005) (at 217)) or 'compensation for damage or loss sustained' (Yallop C (ed), Macquarie Dictionary (4th ed, Macquarie, 2005) (at 722)) and Batchelor (at [51]) and 'something paid by way of such compensation' (Yallop C (ed), Macquarie Dictionary (4th ed, Macquarie, 2005) (at 722)).
• 51 To the extent that [
  Federal Commissioner of Taxation v Wade (1951) 84 CLR 105] may provide helpful observations about the nature of an indemnity, it has been displaced in a more specific sense by the Full Court decision in Batchelor, expressly referable to the statutory provisions under consideration.
• 52 Denmark was required to satisfy certain specific requirements before the payments under the Grant would be made. This does not take it outside of the realm of what could be characterised as an indemnity. In this instance, the Grant was payable in various instalments on completion of certain identified milestones. But there is nothing in payment by way of instalments or by milestones which changes the nature of the proper characterisation of the receipt or, more specifically, the underlying reason for the receipt.
• 53 In this instance the Grant was received by Denmark as compensation for an 'expense' incurred by it. As such, it falls within the meaning of the word 'indemnity'.
• 54 The fact that the expense Denmark was being compensated for was on capital account does not prevent the Grant from being characterised as a payment by way of indemnity. Nor does the fact that the Grant was paid to Denmark pursuant to the RRPGP Agreement as opposed to a contract of indemnity.
• 55 While it is clear the Eligible Project Costs constituted expenditure on capital account, and were therefore not deductible under s 8-1(2)(a) of the 1997 Act, it is not the case that such expenditure was not deductible at all. Expenditure on capital assets can be properly claimed as a deduction over time reflecting the decline in value of the assets. This can be done under either Div 40 or under subdiv 328-D in the case of small business entities such as Denmark. The table in s 20-30 of the 1997 Act includes the whole of Div 40, with the relevant expense described as 'Capital allowances'. Section 20-40 and s 20-45 of the 1997 Act confirms this. Section 20-40 provides the method statement for including an amount in assessable income where a taxpayer has received an assessable recoupment of a loss or outgoing for which the taxpayer can deduct amounts over two or more income years. The example included in both s 20-40 and s 20-45 shows a practical example of a taxpayer who has an assessable recoupment and who has claimed corresponding deductions for depreciation. The sections therefore envisage deductions for decline in value. It follows, therefore, that the Grant is an assessable recoupment under s 20-20(2) of the 1997 Act. As to the further alternative argument

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  ATC 20385

  that the assessable recoupment is limited to the amount of the deductible depreciation in the current year (2014), rather than the full amount of the Grant, the position, in my view, is that the amount of the recoupment required to be included in Denmark's assessable income for each of the years ended 30 June 2013 and 30 June 2014 is an amount equal to the deduction claimed by Denmark in that year (namely, $747,045 for the year ended 30 June 2013 and $1,271,380 for the year ended 30 June 2014).
• 56 In my view, the Grant is also an assessable recoupment under s 20-20(3) of the 1997 Act. The requirements for that provision are that:
  • (1) the Grant must have been received by Denmark as a recoupment of a loss or outgoing; and
  • (2) Denmark can deduct an amount for the loss or outgoing for the current year or has deducted or can deduct an amount for it for an earlier income year under a provision listed in s 20-30 of the 1997 Act.
• 57 As noted, the cost of the wind turbines can be deducted by reference to a decline in value under Div 40, which is a provision listed in s 20-30 of the 1997 Act. The necessary connection between the outgoing and the deduction is apparent from the objects clause in Div 40 (s 40-15) which explains that connection in providing for a deduction for the cost of a depreciating asset, spread over a period that reflects the time for which the asset can be used to obtain benefits. The cost of the asset includes costs incurred at the time when the taxpayer began to hold the asset, such as the amount paid for the asset (s 40-180 and s 40-185 of the 1997 Act). Thus, there is a deduction 'for the outgoing'.
• 58 As the outgoing was deductible under Div 40 of the 1997 Act, the second requirement is satisfied. Denmark, as an alternative, argues that the second requirement is not satisfied as it did not in fact deduct an amount under Div 40, but rather, elected to calculate the deduction under subdiv 328-D, being a provision that is not listed in s 20-30 of the 1997 Act. However, the words of s 20-20(3) do not require Denmark to have in fact deducted an amount for the outgoing under Div 40, rather, it requires that Denmark ' can deduct' an amount for the outgoing under Div 40.
• 59 Shortly put, the fact that Denmark claimed deductions under subdiv 328-D using the method of calculation there prescribed when it could have claimed deductions for the same expense under Div 40, will not preclude the assessability of the recoupment. The 1997 Act was amended to include subdiv 328-D after it was amended to include Div 20. Nothing in the relevant explanatory memoranda suggests that the legislature turned its mind to Div 20 and made a deliberate decision to actually exclude subdiv 328-D from its ambit.
• 60 From the purposive perspective, Denmark's arguments would enable it to receive deductions totalling the full amount of the cost of the wind turbines when it did not actually bear the full financial cost of those expenses as they were subsidised by the Grant.
• 61 That said, it is important to recognise that the question is not as simple as suggesting that because a deduction has been claimed there must be corresponding income declared. That is not so, as a general proposition. In
  Federal Commissioner of Taxation v Rowe (1997) 187 CLR 266 (at 277), the High Court, by majority, rejected the existence of any general principle in taxation law bringing to tax an amount received by a taxpayer which compensates the taxpayer for an amount that had expressly been allowed as a deduction. As the Full Court has noted in Batchelor, it may be accepted that a payment which has the practical effect of compensating a taxpayer for an amount previously claimed as a deduction, will not necessarily make the amount assessable as income.

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  ATC 20386

• 62 There must be a connection between the deduction and the outgoing. The outgoing is the asset's cost. The amount that has been deducted is calculated by reference to the decline in value of the asset. In this instance, Denmark has deducted the amounts for the cost of the wind turbines by calculating depreciation on them pursuant to subdiv 328-D of the 1997 Act.
• 63 Denmark seeks to draw a distinction between the difference in the wording of a deduction 'for the outgoing' as distinct from 'in respect of the outgoing'. Clearly, there is a difference. But this, with respect, while creative as an argument, creates an unduly technical and narrow distinction in the present situation. Were Denmark's contention to be correct, there would be no circumstance for the inclusion of Div 40 in the table in s 20-30 of the 1997 Act. It is expressly imported under s 20-30(3). The test, of course, under s 20-30(2) being the capacity for a deduction as distinct from the actual deduction under a specified provision.

27. For these reasons, his Honour concluded that Denmark's appeal should be dismissed. In relation to costs, as the proceeding below had been the subject of test case funding, his Honour ordered that there be no order as to costs.

The appeal

28. Denmark appeals from the whole of the judgment of the primary judge. Denmark's notice of appeal contains the following ground:

The Court erred in law in concluding that:

• 1.1 the amount of $2,487,800 was paid to and received by [Denmark] by way of indemnity within the meaning of s 20-20(2) to compensate it for the outgoing, being either as compensation for loss or damage, or as compensation for liability, loss or expense, when the amount, properly characterised, is a Federal Government subsidy on account of a non-deductible capital expense;
• 1.2 the amount of the outgoing of $2,487,800 outlaid by [Denmark] is an amount [Denmark] had deducted in an earlier year of income or could deduct in an earlier year of income or a subsequent year of income under with [sic] s 20-20(2) or s 20-20(3) ;
• 1.3 the amount of $2,487,800 could properly be characterised as having been paid and received by way of reimbursement of depreciation under Division 40 ; and
• 1.4 a deduction can be claimed for the amount of the outgoing under Division 40 , which does not create a deduction for the amount of the outgoing, but creates an allowance for the decline in value of a capital asset.

29. The issue raised by the notice of appeal may be briefly stated as follows: whether the primary judge erred in concluding that the amounts received by Denmark under the Grant were "assessable recoupments" within the meaning of s 20-20 of the 1997 Act.

Consideration

30. The Commissioner contends that the amounts received by Denmark under the Grant were assessable recoupments under either s 20-20(2) or s 20-20(3) of the 1997 Act. The primary judge accepted this position.

31. Denmark contends that the primary judge erred in so holding, and that the amounts it received under the Grant were not "assessable recoupments" within either s 20-20(2) or s 20-20(3). In particular, Denmark submits as follows:

• (a) In relation to s 20-20(2), Denmark submits that it did not receive the amounts "by way of … indemnity" within the meaning of s 20-20(2)(a). Further, Denmark submits that it did not deduct, and was not able to deduct, an amount "for the loss or outgoing" under a provision of the 1997 Act (see s 20-20(2)(b)). In brief terms, it says that the depreciation deductions it claimed

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  were not for the relevant outgoing (namely, the expenditure it incurred in constructing the wind turbines); rather, they were for the decline in value of the relevant assets.
• (b) In relation to s 20-20(3), Denmark submits that it did not deduct, and was not able to deduct, an amount "for the loss or outgoing" under a provision listed in s 20-30. Denmark essentially repeats the same argument as it puts in relation to the words "for the loss or outgoing" in s 20-20(2)(b).

32. On the hearing of the appeal, counsel for Denmark accepted that, for the purposes of s 20-20(3), it is sufficient (for an amount to constitute an assessable recoupment) that the taxpayer is able to deduct the amount for the loss or outgoing under a provision listed in s 20-30. In other words, the taxpayer need not have actually deducted the amount for the loss or outgoing under a provision listed in s 20-30 for the requirements of s 20-20(3) to be satisfied. It was also accepted by counsel for Denmark that, although Denmark claimed depreciation deductions under Subdiv 328-D, it could have claimed depreciation deductions under Div 40.

33. It will be convenient to address each of s 20-20(2) and s 20-20(3) in turn.

Section 20-20(2)

34. Section 20-20(2) of the 1997 Act provides, in summary, that an amount received by a taxpayer will constitute an "assessable recoupment" (and so be included in the taxpayer's assessable income) if: the amount was received as "recoupment" of a loss or outgoing; the amount was received "by way of insurance or indemnity"; and the taxpayer can deduct, or has deducted, an amount for the loss or outgoing under a provision of the Act.

35. In the present case, there does not appear to be any issue that the amounts Denmark received under the Grant were "recoupments" as defined in s 20-25(1). The word "recoupment" is defined, in relation to a loss or outgoing, as meaning "any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described" and "a grant in respect of the loss or outgoing". The amounts paid to Denmark under the Grant were recoupments or reimbursements of a portion of the outgoings Denmark incurred in the construction of the two wind turbines. The amounts constituted "recoupments" as defined in s 20-25(1).

36. The next element of s 20-20(2) is that the amounts were received "by way of insurance or indemnity". There is no suggestion that the relevant amounts were received by way of insurance. The question, then, is whether they were received by way of indemnity. Section 20-20(2) of the 1997 Act was considered by the Full Court of this Court in
Batchelor v Federal Commissioner of Taxation (2014) 219 FCR 453 ( Batchelor ). In that case, Edmonds and Pagone JJ noted at [9] that ss 20-20 and 20-25 were inserted into the 1997 Act as part of the re-writing and consolidation of the comparable provisions previously found in s 26(j) of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act ). Section 26(j) of the 1936 Act had provided:

The assessable income of a taxpayer shall include:

• …
• (j) any amount received by way of insurance or indemnity for or in respect of any loss:
  • (i) of trading stock which would have been taken into account in computing taxable income; or
  • (ii) of profit or income which would have been assessable income;

    if the loss had not occurred, and any amount so received for or in respect of any loss or outgoing which is an allowable deduction; …

37. As Edmonds and Pagone JJ noted at [10], the authorities on s 26(j) of the 1936 Act expressed the view that the words "by way of insurance or indemnity" were intended by the legislature to apply broadly: see
Federal Commissioner of Taxation v Wade (1951) 84 CLR 105 at 112 per Dixon and Fullagar JJ, at 116 per Kitto J;
Robert v Collier's Bulk Liquid Transport Pty Ltd [1959] VR 280;
Williamson v Commissioner for Railways [1960] SR (NSW) 252. Further, as Edmonds and Pagone JJ discussed at [11], a difference of view concerning s 26(j) emerged in the decisions in
Goldsbrough Mort & Co Ltd v Federal Commissioner of Taxation (1976) 14 SASR 591 and
Commercial Banking Company of Sydney Ltd v Federal Commissioner of Taxation (1983) 70 FLR 433. This concerned whether it was necessary for there to be an antecedent obligation to indemnify. In Batchelor, Edmonds and Pagone JJ expressed the view (at [13]) that, generally speaking, a payment will not be regarded as an indemnity unless the entitlement to its receipt precedes the event in respect of which it is paid (cf Batchelor at [77] per Wigney J). Edmonds and Pagone JJ explained the design and operation of s 20-20 in the following terms at [12]-[13]:

• 12 Neither s 26(j) of the 1936 Act nor s 20-20 of the 1997 Act is designed to bring to tax every payment received by a taxpayer of an amount for which the taxpayer previously obtained a deduction. In
  Federal Commissioner of Taxation v Rowe (1997) 187 CLR 266 (Rowe) the High Court by majority rejected the existence of any general principle in taxation law bringing to tax an amount received by a taxpayer which compensates the taxpayer for an item that had previously been allowed as a deduction. The majority pointed at 277 to the existence of s 26(j) as telling against the existence of a general principle of the kind which had been advanced in Rowe. It should not be thought, however, that s 26(j) is as wide as the principle otherwise rejected in Rowe. It may be accepted, therefore, that a payment which has the practical effect of compensating a taxpayer for an amount previously claimed as a deduction will not necessarily make the amount assessable as income.
• 13 The "recoupment" of a loss or outgoing is one of the conditions for the operation of s 20-20(2). Recoupment is defined broadly (as may be seen by the definition in s 20-25(1)) but, however broad "recoupment" may be, a receipt will only be an "assessable recoupment" if it satisfies the additional conditions in s 20-20(2)(a) and (b). One of those conditions is that the recoupment be capable of bearing the description of being received "by way of insurance or indemnity". An amount will not satisfy that requirement merely by satisfying the definition of recoupment. It may be accepted that the words "by way of insurance or indemnity" are, and are intended to be, wide, but they must be applied as intended. Generally speaking a payment will not be regarded as an indemnity (whether the word is taken alone or in combination in the composite phrase "by way of insurance or indemnity") unless the entitlement to its receipt precedes the event in respect of which it is paid. An ex gratia payment, for example, is not apt to be regarded as indemnification of a loss or outgoing notwithstanding that its receipt may be said, from the point of view of economic equivalence, to compensate the recipient for a loss which had been suffered or an outgoing which had been incurred. Similarly, a refund would not ordinarily be regarded as an indemnification notwithstanding that its receipt may be said to have rendered a taxpayer harmless, from an economic point of view, for an antecedent loss or outgoing.

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38. The issue in Batchelor was whether an amount received by the taxpayer as a partial refund of her contribution to a deposit paid by a partnership of which she was a member was an amount received "by way of … indemnity" within the meaning of s 20-20(2) of the 1997 Act. All members of the Full Court held that the amount could not be so regarded. Edmonds and Pagone JJ said (at [15]): "It was not an amount paid to compensate a loss but received by [the taxpayer] as a return of what she had contributed to the venture." See also [83]-[84], [102] per Wigney J.

39. In the present case, the amounts received by Denmark under the Grant were received pursuant to the Agreement dated 18 May 2011. The Agreement provided that the Grant was to meet 50% of the Eligible Project Costs to be incurred by Denmark in the construction of two wind turbines, up to a maximum of $2,487,800. The Grant was payable in instalments on the completion of identified project milestones. In these circumstances, the amounts received by Denmark fell within the ordinary meaning of the word "indemnity", which includes, as noted by the primary judge at [50], "a sum of money paid to compensate a person for liability, loss or expense incurred by the person". The

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fact that the amounts were a government subsidy or rebate does not affect the position. The amounts nevertheless bear the character of compensation for a liability, loss or expense incurred.

40. In the course of submissions, counsel for Denmark emphasised that the word "indemnity" is to be construed as part of the composite phrase "insurance or indemnity". It may be accepted that the context in which the word "indemnity" is to be construed includes the reference to both "insurance" and "indemnity" in s 20-20(2)(a). However, we do not consider that this relevantly affects the meaning to be given to the word "indemnity". As indicated above, the word "indemnity" is to be given its ordinary meaning and this relevantly includes a sum of money paid to compensate a person for liability, loss or expense incurred by that person.

41. The third element of s 20-20(2) is that the taxpayer can deduct, or has deducted, an amount for the loss or outgoing under a provision of the Act. In relation to this element, Denmark emphasises the words "for the loss or outgoing" and submits that this phrase is narrower than, for example, "in respect of the loss or outgoing". Denmark contrasts the wording of the current provision with the wording of s 26(j) of the 1936 Act, which used the words "for or in respect of". Denmark submits that both s 20-20(2) and s 20-20(3) require that the taxpayer can deduct an amount "for the loss or outgoing" and that the definite article in this phrase relates to the loss or outgoing, not some other amount, such as depreciation under Div 40 or Subdiv 328-D. Denmark submits that the amount that may be an allowable deduction under Div 40 or Subdiv 328-D relates to the decline in value of a depreciating asset held by a taxpayer, and that this is to be distinguished from the outgoing upon which ss 20-20(2) and 20-20(3) are predicated.

42. In our view, Denmark's submissions in relation to this element are to be rejected. We consider that Denmark's submissions place too much weight on the distinction between the word "for" and the phrase "in respect of". In the context of ss 20-20(2) and 20-20(3), we consider the phrase "for the loss or outgoing" to be sufficiently broad to pick up a depreciation deduction under Div 40 or Subdiv 328-D where the relevant outgoing is the cost of the depreciating asset. In such circumstances, the depreciation deduction may properly be regarded as a deduction "for the loss or outgoing". We reach this conclusion for three main reasons.

43. First, the words used ("for the loss or outgoing") are sufficiently broad to support this construction. Depreciation deductions under Div 40 are (as s 40-15 makes clear) deductions for "the cost of a depreciating asset", which are spread over the effective life of the asset. This object is achieved by s 40-25(1) making the "decline in value for an income year" of a depreciating asset deductible in that year. Two methods are provided for calculating the "decline in value" of a depreciating asset: the "diminishing value method" in s 40-70 and s 40-72 and the "prime cost method" in s 40-75. However, both methods commence in the first year with the asset's "cost" (see the definition of "base value" in s 40-70(1) and the inclusion of "[a]sset's cost" in the formula in s 40-75(1)). The "cost" of a depreciating asset is dealt with in Subdiv 40-C and, broadly speaking, involves two elements: the amount the taxpayer is taken to have paid to acquire the asset (s 40-180); and amounts paid after acquisition to bring the asset to its present condition (s 40-190). Thus, where the relevant loss or outgoing for the purposes of s 20-20(2)(b) is the cost of a depreciating asset, a deduction under either Div 40 or Subdiv 328-D may be said to be a deduction of an amount "for" that loss or outgoing. This is because it is a deduction for the cost of the depreciating asset spread over the effective life of the asset. As the primary judge observed at [55], this is confirmed by the example in s 20-40(2), which specifically refers to deductions for depreciating assets in demonstrating the operation of the method statement in s 20-40(2).

44. Secondly, the inclusion of Div 40 in the table in s 20-30 points strongly against Denmark's construction. Section 20-20(3) provides, in summary, that an amount the taxpayer has received as recoupment of a loss or outgoing (except by way of insurance or indemnity) is an "assessable recoupment" if the taxpayer can deduct, or has

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deducted, an amount "for the loss or outgoing" under a provision listed in s 20-30. As noted above, the table in s 20-30 includes Div 40. If Denmark's submissions were correct, there would be no reason for Div 40 to be included in that table. (That is, if, as Denmark submits, depreciation deductions cannot be deductions for a loss or outgoing, there would be no utility in including Div 40 in the table.) As Denmark's submission in relation to the phrase "for the loss or outgoing" is essentially the same in relation to ss 20-20(2) and 20-20(3), this counts against Denmark's submissions in relation to both provisions. It is not to the point that the table in s 20-30 does not include Subdiv 328-D. While this would seem to be anomalous, the important point for present purposes is that, if Denmark's argument were correct, there would be no need to refer to Div 40 in the table in s 20-30.

45. Thirdly, the construction that we favour is consistent with the purpose of the provisions. Subdivision 20-A is designed to include in a taxpayer's assessable income recoupments of losses and outgoings where the taxpayer is able to claim a deduction for the loss or outgoing. It is consistent with this purpose for the provisions to operate where the deduction is for depreciation under Div 40 or Subdiv 328-D.

46. For these reasons, the amounts received under the Grant were assessable recoupments under s 20-20(2) and the primary judge was correct to so hold.

Section 20-20(3)

47. In light of our conclusion in relation to s 20-20(2), it is strictly unnecessary to consider s 20-20(3). Nevertheless, we briefly indicate our views for the sake of completeness.

48. Section 20-20(3) provides, in summary, that an amount received by a taxpayer will constitute an "assessable recoupment" (and so be included in the taxpayer's assessable income) if: first, the amount was received as "recoupment" of a loss or outgoing (except by way of insurance or indemnity); and secondly, the taxpayer can deduct, or has deducted, an amount for the loss or outgoing under a provision listed in s 20-30. In relation to the first element, if (contrary to our reasons above) the amounts received by Denmark under the Grant were not received by way of indemnity, they were nevertheless recoupments of a loss or outgoing for the reasons given in [35] above.

49. In relation to the second element, for the reasons set out at [42]-[45] above, Denmark was able to deduct an amount "for the loss or outgoing" under a provision listed in s 20-30, namely Div 40. As noted above, Denmark accepts that, for the purposes of s 20-20(3), it is sufficient (for an amount to constitute an assessable recoupment) that the taxpayer is able to deduct the amount for the loss or outgoing under a provision listed in s 20-30. Denmark also accepts that, although it claimed deductions under Subdiv 328-D, it was able to claim deductions under Div 40.

50. It follows that, if the amounts received under the Grant are not assessable recoupments under s 20-20(2), they would be assessable recoupments under s 20-20(3).

Conclusion

51. For the reasons set out above, the appeal is to be dismissed. There is no apparent reason why costs should not follow the event. Accordingly, there will also be an order that Denmark pay the Commissioner's costs of the appeal.

THE COURT ORDERS THAT:

1. The appeal be dismissed.

2. The appellant pay the respondent's costs of the appeal, to be taxed if not agreed.