Case N8

Judges:
KP Brady Ch
LC Voumard M
JE Stewart M

Court:
No. 2 Board of Review

Judgment date: 2 March 1981.

K.P. Brady (Chairman); L.C. Voumard and J.E. Stewart (Members)

The facts in this reference are unusual, and therefore it seems appropriate to set them out in some detail. Conveniently, a statement of facts was agreed with the Commissioner by the taxpayer and is detailed hereunder:

``1. My name is... and I live at...

2. From 1954 until 8 January 1975, I was employed by the family company, A.B. Co. Pty. Ltd., which company was a manufacturer of cool drinks.

3. I became manager of A.B. Co. Pty. Ltd. in April 1970.

4. The company was placed in receivership in January 1975.

5. I commenced business on my own account as a manufacturer of cool drinks on 21 January 1975.

6. On 1 August 1975, I commenced to lease certain items of plant and equipment from A.B. Co. Pty. Ltd. (Receiver Appointed) at a monthly rental of $440 payable one month in advance. A copy of the lease agreement is attached to and forms part of this statement.

7. On page 9 of the lease is a schedule of plant, the subject of the lease. Included therein is a Y fork-lift 2500 lb. capacity.

8. Because of the continued poor performance of the Y fork-lift and the likelihood of costly repairs being required to put this unit into a satisfactory working condition, I approached the Receiver of A.B. Co. Pty. Ltd. (Receiver Appointed) seeking a replacement. The outcome of discussions was that the following was agreed:

  • (a) The Y fork-lift was to be used as a trade-in for a new unit.
  • (b) I was to purchase a new fork-lift on behalf of the Receiver and pay from my own funds the balance of purchase price after any allowance for trade-in on the Y fork-lift.
  • (c) The Receiver was to substitute a new fork-lift for the Y fork-lift on the schedule of leased plant, the subject of the lease.
  • (d) The monthly rental of $440 payable under the leasing agreement was to remain unchanged.

9. In accordance with the agreement between myself and the Receiver of A.B. Co. Pty. Ltd. (Receiver Appointed) the Y fork-lift was disposed of in June 1976, and a new fork-lift was purchased.

10. The Z fork-lift which was purchased from C.D. Motors Pty. Ltd. at a cost of $8,521 was paid for in the following manner:

  • (a) In June 1976 I drew a cheque for $4,300 on my No. 2 Account with the E Trading Bank made payable to C.D. Motors Pty. Ltd. to which company I remitted the cheque.
  • (b) Concurrently the Y fork-lift was taken by C.D. Motors Pty. Ltd. as a trade-in at a value of $4,221.

11. Again in accordance with the agreement at para. 8 above, the Receiver substituted the new unit for the old unit on the schedule of leased plant in the lease.

12. The monthly rental payments under the lease remained at $440.

13. The plant the subject of the lease became the property of my wife... in November 1978 when in consequence of an option agreement dated 3 October

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1975 between her and A.B. Co. Pty. Ltd. (Receiver Appointed) she exercised her right to purchase the plant including the Z fork-lift for $439.

14. The Z fork-lift is still being used by me in the business of manufacturing cool drinks.''

2. The lease agreement was dated 3 October 1975, and provided inter alia:

3. The taxpayer produced in evidence a letter from the Receiver under date of 12 July 1976, agreeing to the substitution in the lease agreement of the Y fork-lift by the new Z fork-lift.

4. The taxpayer's tax return for the year of income in question, viz. the year ended 30 June 1976, was originally prepared by the taxpayer's tax agent on the basis that the taxpayer had purchased the old fork-lift from the Receiver and that he also owned the replacement unit. Accordingly, the investment allowance of 40% of the cost price, $8,521, of the new unit, viz. $3,408, was claimed, and the depreciation schedule was prepared to reflect a capital gain of $3,821, being the difference between the trade-in value of the old fork-lift, $4,221, and its cost price of $400. Also claim was made for a proportionate amount of depreciation on the new fork-lift amounting to $320.

5. In making an assessment on the income as thus returned, the Commissioner adjusted the taxable income to include as assessable income the profit of $3,821.

6. Subsequently, the errors as to the accounting for the changeover of fork-lifts were discovered by the taxpayer's firm of accountants (who are also his tax agents) when the taxpayer undertook a substantial re-organisation of his business early in 1977.

7. As a result, an amended return was submitted in which the claims for investment allowance and depreciation on the new fork-lift were eradicated (and some minor adjustments made to the depreciation claim for other assets) and a deduction was claimed under sec. 51(1) for the amount of $4,300, being the amount paid by the taxpayer as the difference between the cost price of the new unit and the trade-in value of the old unit. The Commissioner disallowed the claim on

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the basis that it was expenditure of capital, or of a capital nature. The Commissioner confirmed his action upon objection by the taxpayer, and in the result the taxpayer has referred the matter to this Board.

8. Whilst the fact situation is somewhat unusual, the matter in issue can be condensed to the simple question: what is the nature of the payment of $4,300?

9. The taxpayer conducted his own appearance and presented his case on the following grounds:

10. In answer, the Commissioner's representative contended that the expenditure was an outlay on capital account.

11. It is clear that the taxpayer, whilst making a contribution to the purchase price of the new unit, did not ever own it. As the statement of agreed facts sets out supra, he bought it ``on behalf of the Receiver''. It was in fact A.B. Co. Pty. Ltd. (Receiver Appointed) to whom the property in the goods passed both legally and beneficially following upon the disposal by it of the Y fork-lift as a trade-in, and the concurrent payment by the taxpayer of the amount of $4,300. Before reaching that conclusion, we canvassed whether it could not be said that a resulting trust was implied in favour of the taxpayer, but after studying the evidence further, we are of the view that the fact situation does not support such a presumption.

12. Also the fact that the taxpayer found it necessary to lease the unit, and the option available to his wife to purchase it upon termination of the lease, negate any notion that the taxpayer owned it. In point of fact, some of the provisions of the lease summarised above restrict his rights as user most stringently; for example, the taxpayer cannot remove the unit from his existing premises without the consent in writing of the lessor.

13. Stemming from the fact that the taxpayer did not ever own the goods, he could not lay claim to the investment allowance deduction provided by sec. 82AB(1)(a) nor to depreciation allowances available under sec. 54(1). Entitlement to such deductions reposed in the A.B. Co. Pty. Ltd. (Receiver Appointed). The fact that the taxpayer did not own the replacement fork-lift unit does not of itself preclude the outlay from being of a capital nature. It is well established that one can incur capital expenditure on the asset of another, refer
Boyce v. The Whitwick Colliery Co. Ltd. (1934) 18 T.C. 655, and
Ounsworth v. Vickers Ltd. (1915) 6 T.C. 671. In the former case, Romer L.J. stated at p. 685:

``A taxpayer can make a capital expenditure upon the land of a third party; it is, none the less, a capital expenditure even if it is upon the land of a third party, and not upon his own land.''

The pronouncement is likewise apposite to items of plant.

14. The taxpayer has based his claim for deduction of the payment of $4,300 on the general deductibility provision of sec. 51(1). That subsection, to the extent to which it is relevant to the case now before us, provides as under:

``All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital... nature...''

Accordingly, even if an outgoing satisfies the criteria for deductibility contained in the first and second limbs of sec. 51(1), it may still

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not be allowable if it represents an outgoing of capital or an outgoing of a capital nature. As the Income Tax Assessment Act does not define capital or go into the matter of what constitutes a capital outgoing, it becomes necessary to study judicial pronouncements on the matter and apply them to the situation before us.

15. The most lucid judicial pronouncement on the subject remains still that of Dixon J. (as he then was) in
Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (1938-39) 61 C.L.R. 337. He said at pp. 359 and 360:

``The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested. In a trade or pursuit where little or no plant is required, it may be represented by no more than the intangible elements constituting what is commonly called goodwill, that is, widespread or general reputation, habitual patronage by clients or customers and an organized method of serving their needs. At the other extreme it may consist in a great aggregate of buildings, machinery and plant all assembled and systematized as the material means by which an organized body of men produce and distribute commodities or perform services. But in spite of the entirely different forms, material and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a `profit-yielding subject', the phrase of Lord Blackburn in
United Collieries Ltd. v. I.R. Commrs. (1929) 12 T.C. 1248, at p. 1254. As general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue. The latter can be considered, estimated and determined only in relation to a period or interval of time, the former as at a point of time. For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose.''

Later, at p. 361, he went on to say:

``In the attempt, by no means successful, to find some test or standard by the application of which expenditure or outgoings may be referred to capital account or to revenue account the courts have relied to some extent upon the difference between an outlay which is recurrent, repeated or continual and that which is final or made `once for all', and to a still greater extent upon a distinction to be discovered in the nature of the asset or advantage obtained by the outlay. If what is commonly understood as a fixed capital asset is acquired the question answers itself. But the distinction goes further. The result or purpose of the expenditure may be to bring into existence or procure some asset or advantage of a lasting character which will enure for the benefit of the organization or system or `profit-earning subject'. It will thus be distinguished from the expenditure which should be recouped by circulating capital or by working capital.''

16. In canvassing these distinctions between outlay on revenue account and outlays on capital account, Dixon J. was restating the various tests applied in such earlier cases as
Vallambrosa Rubber Co. Ltd. v. Farmer (1910) 5 T.C. 529, Ounsworth v. Vickers Ltd. (supra) and
British Insulated and Helsby Cables Ltd. v. Atherton (1926) A.C. 205. His own test as quoted above adopted a more conceptual approach than employed previously, being based on the distinction between the profit-yielding subject (capital) and the profit-yielding process (revenue). He thought there were three main matters to be considered in applying his test:

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Although the decision in the Sun Newspapers case is now over 40 years old, the above principles as enunciated by Dixon J. have received acceptance by the High Court ever since.

17. Applying these principles to the instant case, we are in no doubt that the payment of $4,300 made by the taxpayer was of a capital nature. We find that the amount was outlaid by him to obtain the future use of a fixed asset in his business in order to maximise his profits. The outlay was a once and for all payment. The future use covered a period of 3¼ years from 1 August 1975 to 31 October 1978, at which time his wife exercised her option to purchase it. As from that date only the ownership changed, with the unit still being used by the taxpayer in his business.

18. Before coming to the above conclusion, we canvassed the view whether the payment could not be considered to be a payment in the nature of an instalment of rent, and therefore deductible under sec. 51(1). However, the facts belie that conclusion. Essentially the taxpayer paid out a sum of $4,300 so that a new fork-lift costing $8,521 might be exchanged for an old unit having a trade-in value of $4,221, which he could lease for a term of 3¼ years at no greater rental figure than he was paying for the old unit, with at the very least an expectation of further use in the event of his wife exercising her option.

19. In putting his case before us, the taxpayer argued that the effect of his outlay of $4,300 was to reduce his repair and maintenance bill, and therefore it could not be regarded as of a capital nature. However, the Act does not grant deductibility of an outlay because its effect might well be to reduce expenses which are deductible. The matter was succinctly put by Rowlatt J. in
Anglo-Persian Oil Co. Ltd. v. I.R. Commrs. (1932) 16 T.C. 253 at p. 261, where he stated:

``In other words, you cannot charge against profits the cost of labour-saving machinery by showing that it reduces your annual labour bill.''

Similarly, you cannot obtain deduction for an outlay of a capital nature on the argument that it will reduce future outlays on repairs.

20. It was also argued by the taxpayer that his outlay could not have been of a capital nature because, first, no asset was brought into existence, and, secondly, there did not result from such expenditure any benefit for his business. Dealing with the first part of the argument, we take it that he meant that his business's fixed asset position did not increase through his outlay, and this of course is so. But it does not follow that, because acquisition of an asset for him as owner did not stem from his outlay, such outlay must be on revenue account - refer the dicta of Menzies J. at pp. 53, 54 and 55 in
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959-60) 101 C.L.R. 30, also the judgment of Dixon J. in
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634 at p. 650.

21. Similarly the outlay does not take on a revenue nature because the advantage acquired was temporary. In the Sun Newspapers case previously referred to, Dixon J. said at p. 362:

``Again, the lasting character of the advantage is not necessarily a determining factor. In
John Smith & Son v. Moore (1921) 2 A.C. 13 at p. 20, the coal contracts which Lord Haldane and Lord Sumner thought were acquired at the expense of capital had a very short term.''

22. Lastly, we rebut the taxpayer's contention that accounting principles require the payment to be treated as a charge against revenue over the unexpired period of the lease. It is worth first making the observation that the taxpayer's accountants debited the profit and loss account with the full amount of the outlay in the year in which it was incurred in contradistinction to their own line of argument. However, it has long been held that the way in which a taxpayer deals with a debit in his accounts cannot determine its character for the purposes of the Income Tax Assessment Act (refer
Arizona Copper Co. v. Smiles (1891) 3 T.C. 149 at p. 153,
Broken Hill Theatres Pty. Ltd. v. F.C. of T. (1951-52) 85 C.L.R. 423 at p. 435, and John

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Fairfax & Sons Pty. Ltd. v. F.C. of T. (supra) at p. 46), and therefore the taxpayer's contention, being unsupported by the facts of his situation, is not persuasive.

23. Furthermore, in the case of Broken Hill Theatres Pty. Ltd. v. F.C. of T. (supra) at p.435, Dixon C.J., McTiernan, Fullagar and Kitto JJ., in their joint judgment, approved the following statement of the late Dr. J.A. Hannan in his work Principles of Income Taxation, when at p. 333 he examined whether accountancy standards provide an adequate test of the nature of certain payments. The learned author wrote:

``The fact that a particular outgoing could not properly appear in anything but a Profit and Loss Account may help to decide that it should be allowed as a deduction from the incomings of a trade.''

Here, however, the adage lacks persuasive authority because the item should not have appeared in toto in the profit and loss account in any event.

24. For the reasons detailed above, we consider that the taxpayer's outlay was clearly of a capital nature and, accordingly, the decision of the Commissioner to disallow the objection must be upheld and the assessment before us confirmed.

Claim disallowed

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