Case U53

Members:
BJ McMahon SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 2 March 1987.

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B.J. McMahon (Senior Member)

In the year ended 30 June 1982 the applicant claimed deductions of $1,800 and $70 representing amounts paid by way of "service fee" respectively to the Hooker Future Growth Fund No. 4 and the Hooker Property Investment Trust No. 5. The claim was disallowed and this application is brought to review that decision.

The applicant claims to be entitled to the deduction under sec. 51(1) of the Income Tax Assessment Act ("the Act") which is in the following terms:

"51(1) [Deductions for losses and outgoings] 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, private or domestic nature, or are incurred in relation to the gaining or production of exempt income."

The applicant cited no authority for his claim. He relied upon the general principle that the service fee was a relevant and appropriate business expense chargeable to revenue.

Both amounts were included in larger cheques. The former amount formed part of a cheque for $31,800 made payable to Permanent Trustee Nominees (Canberra) Ltd. (the trustees

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of the fund), and forwarded to that company through the applicant's broker. It is assumed that the sum of $1,800 was accounted for by the trustee to the manager of the fund, namely Hooker Property Holdings Pty. Ltd.

The second amount formed part of a cheque for $1,000 which was dealt with in a similar manner. The manager of the second trust was Hooker Property Funds Management Limited.

The amount of the service fee for the No. 4 Fund was 6% of any unit par values between $21,000 and $500,000 invested in the fund. It was payable in addition to the issue price of $1 per unit. The service fee for the No. 5 Trust was 7¢ per dollar and was included in the issue price of $1 per unit. In each case the service fee was to be paid only once during the life of the Trust.

The respondent contended that the payments made for these service fees were outgoings of a capital nature and thus fell within the exception referred to above.

The evidence was left in an unsatisfactory state. The applicant himself did not give evidence, but that omission was rectified by agreement between the parties. It was agreed that the applicant had in fact paid the moneys in the way described by his representative and that although he expected to obtain some income from the No. 4 Fund and a larger amount of income from the No. 5 Trust, his principal purpose in investing was to obtain capital growth. It was also assumed that although the assets of No. 4 Fund were to be mortgaged, the rate of gearing was such that the fund would generate sufficient income to pay day-to-day expenses and to make some distributions of income to unit holders. The assets of No. 5 Trust were not intended to be mortgaged and the rate of return by way of income on that fund was expected to be larger.

The gap in the evidence consisted of a complete lack of detailed explanation of the meaning of the term "service fee". No trust deeds were produced. No officer of either fund was called to give evidence. No indication of how the service fee was treated for taxation or accounting purposes by the manager, trustee or promoter was put before me. In short the applicant did not offer any satisfactory evidence of the nature of the benefit for which he paid money. Under sec. 190(b) of the Act, the applicant carries the burden of proof. In my view, he has not discharged this burden and that could well be the end of this review. However, two documents were tendered in evidence which contain some relevant material and to which I will refer in coming to a decision. The matter fell for determination upon the basis of these two documents.

As to the No. 4 Fund, a document headed "Private Placement - Open to Unit Holders in Hooker Property Trusts" set out some of the features of the offer upon which the applicant relied.

The only paragraph dealing with the service fee was in these words:

"The service fee is payment in advance for services to be rendered throughout the life of the Fund. As such, we have been advised, that the service fee would be tax deductible for most investors (section 51(1) of the Australia Income Tax Act)."

The paragraph in question then went on to quote the rates of service fees expressed as a percentage of the amount invested. There is no reference anywhere in the offer document to the type of services to be rendered, or how or when they were to be rendered, or how or when they were to be rendered or how they differed from any other services to which the applicant might be entitled under the trust deed or the general or statutory law.

The second document, being a prospectus, contained more exact information in relation to the No. 5 Trust. However, its brief reference to a service fee was contained in the following words:

"The managers and trustees receive fees for their services during the life of the Trust. The opening price of the units ($1.00) includes a once only service fee of 7¢. This fee is for the setting up and promotion of the trust and a continuing information service for unit holders throughout the life of the trust."

In so far as a service fee is a reimbursement for the cost of setting up and promotion of the trust, it is clearly a capital item. Once again, however, the document does not state what information service is to be provided for unit holders. So far as the No. 5 Trust is concerned, at any rate the services to be rendered are defined as information services. In the No. 4 Fund they remained undefined. It may be noted in passing that unit holders are entitled to a

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good deal of information under the terms of most trust deeds required to be entered into under the Companies Acts of the various States before interests may be issued to members of the public.

There was no question that the net cost of the units was not deductible. Clearly that would be a capital item. The only question was whether having tacked on an amount loosely described as a service fee the promoters had rendered that additional amount capital or income.

One of the classic characterisations of "upfront" payments as capital is to be found in
British Insulated and Helsby Cables Ltd. v. Atherton (1926) A.C. 205 at p. 213 where Viscount Cave L.C. said:

"But when an expenditure is made not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital."

This statement has been followed in many Australian cases. I will refer to only two of the more helpful passages in subsequent cases which assist in understanding the concept to which his Lordship referred.

In
Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337, Dixon J. said at p. 361:

"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 ensure for the benefit of the organisation or system of `profit earning subject'. It will thus be distinguished from the expenditure which should be recouped by circulating capital or by working capital."

In 1959, Dixon C.J. (by that time Chief Justice) returned to the theme in
John Fairfax & Sons Pty. Ltd. v. F.C. of T. 101 C.L.R. 30 at p. 36:

"It is not in my opinion right to say that because you obtain nothing positive, nothing of an enduring nature, for an expenditure it cannot be an outgoing on account of capital. What Viscount Cave L.C. said in British Insulated and Helbsy Cables Ltd. v. Atherton (1926) A.C. 205 was this, `But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital' (1926) A.C. at pp. 213, 214. That is an affirmative proposition. But it is hardly necessary to say that it is a logical fallacy to turn it round and say that an expenditure cannot be attributable to capital unless it is made once for all and is made with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. Nor did Viscount Cave L.C. mean to say that no expenditure falling outside his proposition could be of a capital nature. No doubt it is not often that an outgoing is voluntarily incurred without anything to show for it. The cynical might say that is a phenomenon so rare that for illustrations of such an outgoing you must look to the cost of litigation. It is, however, a feature that is always likely to occur when the purpose of the expenditure is to limit or buy off opposition or forestall or get rid of some present or threatened disadvantage. Of course, you can have expenditure of that kind which on the soundest principles of accounting is chargeable against revenue. But you might confidently expect to find that much expenditure of the kind was undeniably on capital account."

Both the "once for all nature of the payments and the nature of the asset or

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advantage obtained by the outlay" in this case illustrate characteristics of capital expenditure.

In my opinion the once for all service payment made by the applicant was necessary in order to acquire the capital asset which he sought. It is an integral part of the cost component of each unit. Payment of the service fees is not optional. Units will be issued only if the issue price is accompanied by (or in the case of No. 5 Trust) includes the appropriate amount for the service fee. It is so inextricably bound up with the balance of the cost of the units that it cannot be separated out into another category. It was argued that the value of the unit was not enhanced by payment of the service charge on application. The fact is that there would be no unit issued if it were not paid. If it is the obligation of unit holders to pay that charge once only, then a subsequent owner of the unit would not be liable for it. This must be reflected in the price he would be prepared to pay for a unit already issued, assuming there was a market for such units.

The fact that the service fee in each case is expressed as a percentage of the amount of the investment strengthens this conclusion. In the case of the No. 5 Trust, the service fee consisted of 7¢ in each dollar. However, this may still may be expressed as a percentage of the "true cost", namely 93¢. In that particular case I have calculated it as 7.526%. If the fee was truly for the provision of unspecified services or even for information services, how can the appropriate amount be linked through a fixed percentage to the cost of units for which the unit holder subscribed? The cost of information per unit holder must in logic be a fixed sum. The cost of providing information does not increase with the number of units held. To my mind the percentage concept indicates that if any service was to be rendered, it would not be in the nature of management services (which are provided for elsewhere in the information documents). All expenses upon a day-to-day basis for the running of the properties and of the trusts are a first charge on revenue and are covered by such items as the manager's, trustee's and auditor's fees, and the general postages and stamp duties on cheques which are referred to in the offer document for the No.4 Fund. The service fee must, therefore, be in a different category.

It seems to me that it is expressed as a supplement to the issue price in an endeavour to make that component of the issue price deductible for tax purposes in the hands of subscribers. In my view the endeavour must be unsuccessful. The two components are an indissoluble whole and both fall to capital.

Furthermore, the service fee differs from all other claims on the profitability of the venture, both in its method of financing and in its nature. It cannot be said to be an expense incurred by the applicant in the management of his own portfolio. If any services are to be provided they would be provided by the trust manager, who stands between the investor and the trustee.

I have not dealt with the question whether a once and for all payment to cover services rendered during the eight year anticipated life of the trust would, in any event, be available as a deduction until such time as those services were rendered over the life of the trust. In my view it is not necessary to decide this issue. I take the view that the so-called service fee is no more than a thinly disguised addition to the capital cost and forms part of the capital cost of the acquisition of the assets.

For those reasons the decision under review is affirmed.