SANCTUARY LAKES PTY LTD v FC of T

Tribunal:
Administrative Appeals Tribunal, Melbourne

MEDIA NEUTRAL CITATION: [2012] AATA 404

S A Forgie (Deputy President)

Sanctuary Lakes Pty Ltd (Lakes) has applied for review of two decisions, dated 23 December 2009 and 23 February 2010, made by the Commissioner of Taxation (Commissioner) disallowing in full objections it made to assessments he had made. The first related to his assessment of income tax and the second to his assessment of penalties payable. Both related to the 2003 income year and to claims for deductions made by Lakes arising out of transactions arising from its involvement in the Sanctuary Lakes Development at Point Cook in Victoria. I have decided to affirm the Commissioner's decisions.

THE ISSUES

2. The issue in this case is whether the Commissioner's assessments are excessive. The Commissioner described Lakes' application for review as raising five issues and, if relevant, the issue of penalties and their remission. Lakes' has agreed that the application raises five subject areas but disputes the description given to those areas by the Commissioner. I have reproduced the Commissioner's description but used italics to identify the words that concern Lakes. I have followed them with Lakes' concern in bolded words in brackets:^[1] Applicant’s submissions at [12] The Commissioner’s summary of issues originally identified a further issue relating to whether certain losses were available to transfer to Lakes from Clubs in the 2003 income year). That issue was discontinued prior to hearing: Applicant’s submissions dated 23 November 2011, FN 6. No further reference is made to it in these reasons.

• (1) Is Lakes entitled to claim a deduction in the 2003 income year for a loss of $8,436,342 incurred on the sale of memberships ( too limited ) in the Sanctuary Lakes Golf Club?
• (2) is Lakes entitled to deduct from its assessable income in the 2003 income year all or any of the amount of $1 million deposited into Maddocks Trust Account on 29 January 2003?
• (3) Is Lakes entitled to an income tax deduction in the 2003 income year for the amount of $3,410,252 being the write-off of advances ( incorrect ) made by Lakes to the Sanctuary Lakes Residents Association Limited (SLRA)?
• (4) Is Lakes entitled to a deduction of $4,134,000 in the 2003 income year in respect of its obligations to undertake development works under cl 5.2 of the Loose Ends Agreement^[2] The agreement known as the “Loose Ends Agreement ” is dated 30 June 2003 and follows upon the earlier Development Lease and Supplementary Agreement; see [100]-[105] below. ( too limited )?
• (5) Is Lakes entitled to a deduction of $1,275,800 in the 2003 income year for expenditure in relation to obligations under s 173 of the Planning and Environment Act 1987 (Vic) incurred under cl 5.2 of the Supplementary Agreement ( too limited )?

STRUCTURE OF REASONS

3. A more detailed index appears in Attachment D. For the moment, I note that I have divided these reasons into the main sections shown in the table below. Although divided in that way, they are not intended to be read disjunctively. For example, my consideration of each of the issues in relation to the assessment of income tax is to be read with my understanding of the law as set out in Attachments B and C as well as with the findings of fact in the Factual Background section and the legislation in the Legislative Background.

THE LEGISLATIVE BACKGROUND

Assessable income

4. A taxpayer's "assessable income" includes income according to ordinary concepts. That is called "ordinary income'^[3] Income Tax Assessment Act 1997 (ITAA97), s 6-5(1) and, for an Australian resident, includes ordinary income derived directly or indirectly from all sources, whether inside or outside Australia, during the income year.^[4] ITAA97, s 6-5(2) Assessable income also includes some amounts that are not ordinary income but are included by a particular statutory provision about assessable income. That is statutory income.^[5] ITAA97, ss 6-10(1) and (2) If an amount is neither ordinary income nor statutory income, it is not assessable income.^[6] ITAA97, ss 6-15(1) and (2) Ordinary income or statutory income exempted from income tax under the Income Tax Assessment Act 1997 (ITAA97) or another Commonwealth law is exempt income.^[7] ITAA97, s 6-20(1) If ITAA97 excludes, either expressly or by implication, ordinary income from being assessable income, it is also exempt income.^[8] ITAA97, s 6-20(2)

General deductions

5. Each claim is made under the general deduction provisions of s 8-1 of the ITAA97 which provides:

• "(1) You can deduct from your assessable income any loss or outgoing to the extent that:
  • (a) it is incurred in gaining or producing your assessable income; or
  • (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.
• (2) However, you cannot deduct a loss or outgoing under this section to the extent that:
  • (a) it is a loss or outgoing of capital, or of a capital nature; or
  • (b) it is a loss or outgoing of a private or domestic nature; or
  • (c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or
  • (d) a provision of this Act prevents you from deducting it.
• (3) A loss or outgoing that you can deduct under this section is called a general deduction ."

6. As Ms Schilling submitted, s 8-1 is recognised as having two limbs: a positive and a negative limb. The positive limb, which actually comprises two subsidiary limbs, sets out the circumstances in which a deduction is allowable. The negative limb sets out the circumstances in which it is not.

7. Both of the subsidiary positive limbs require a connection to be made between two things. The first requires a connection between the loss or outgoing's being incurred and the taxpayer's "gaining or producing assessable income". The second requires a connection to be made between a loss or outgoing and its being "necessarily incurred in carrying on a business…" which has a particular purpose. It must be a "business for the purpose of gaining or producing…[the taxpayer's] assessable income". The word "business" is defined so that it "… includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee."^[9] ITAA97, s 995-1(1)

A qualification: trading stock

8. Section 70-25 of ITAA 97 qualifies the exception in s 8-1(2)(a) by providing that:

"An outgoing you incur in connection with acquiring an item of *trading stock is not an outgoing of capital or of a capital nature."

As the note to the section states, this means that s 8-1(2)(a) does not prevent an outgoing incurred in acquiring trading stock from being deducted as a general deduction under s 8-1(1).

A. Income year in which outgoing for acquisition of trading stock deducted

9. Section 70-15 of ITAA97 sets out the income year in which a deduction may be made for an outgoing incurred in acquiring an item of trading stock. If the item becomes part of a taxpayer's trading stock on hand before or during the income year in which the outgoing is incurred, that outgoing is deducted in the year in which it was incurred.^[10] ITAA97, s 70-15(2) If it was not, a taxpayer may choose whether to deduct the outgoing in the first income year in which it becomes part of the taxpayer's trading stock on hand^[11] ITAA97, s 70-15(3)(a) or the first income year for which an amount is included in a taxpayer's assessable income in connection with the disposal of that item.^[12] ITAA97, s 70-15(3)(b)

B. Working out the outgoing in a non-arm's length transaction

10. Section 70-15 is drafted on the presumption that an item of trading stock has been acquired and there has been an outgoing in connection with its acquisition.^[13] Section 70-30 deals with the situation in which a taxpayer already owns an item otherwise than as trading stock but then decides to hold it as trading stock. Section 70-20 qualifies the amount that may be taken to be the outgoing when a taxpayer acquires trading stock in a transaction and incurs an outgoing directly attributable to its purchase or delivery and two other features are present. The first is that the taxpayer and seller of the item "… did not deal with each other at arm's length" and the other is that the amount of the outgoing is greater than the market value of what the outgoing was for i.e. the buying or obtaining delivery of the item. If this is the case, the amount of the outgoing is taken to be the market value for the purposes of the application of ITAA97 to both the taxpayer and the person selling the item to that taxpayer.

11. Section 995-1(1) of ITAA97 provides:

"In this Act, except so far as the contrary intention appears:

…

arm's length : in determining whether parties deal at arm's length , consider any connection between them and any other relevant circumstance."

12. The term "market value" has a meaning affected by Subdivision 960-S of Division 960 of ITAA97.^[14] ITAA97, s 995-1(1) Section 960-405 provides for the effect of Goods and Services Tax (GST) on an asset's market value and s 960-410 for the market value of non-cash items. Under the latter, anything that would prevent or restrict the conversion of a non-cash benefit to money is disregarded when working out the market value of a non-cash benefit. Apart from the modification, the expression "market value" is not defined.

13. In
MMAL Rentals Pty Ltd v Bruning,^[15] [2004] NSWCA 451 ; 63 NSWLR 167 ; Spigelman CJ, Mason P and Hodgson JA Spigelman CJ, with whom Mason P and Hodgson JA agreed, considered the meaning of the expression "fair market value" but also summarised the essential principles relating to "market value":

"A number of authorities suggest a distinction between a 'market value' test and a 'fair value' or 'fair market value' test. … The overall context will be determinative.

…

A test of a 'market value', whether in a statutory or contractual context, usually invokes the test long established and frequently applied in
Spencer v The Commonwealth of Australia (1907) 5 CLR 418 esp at 432 and 440-441 of a willing but not anxious purchaser and vendor, bargaining with each other. This approach was most recently expressed in a joint judgment of three judges of the High Court in
Marks v GIO Australia Holdings Ltd [1998] HCA 69, (1998) 196 CLR 494 at 514:

'…The value … is to be identified according to what price freely contracting, fully informed parties would have offered and accepted for it.'

It is convenient to refer to the Spencer's case formulation as the exchange value test (Spencer supra at 431.5 per Griffith CJ, as did Gleeson CJ in
Boland v Yates Property Corporation Pty Ltd [1999] HCA 64, (1999) 74 ALJR 209 at [79].)

Where the focus of the valuation process is on a 'market value', even in a context, as so often occurs, where there is no or little trading history in the relevant property, the approach will usually be quite different to that which arises where a 'fair value' is required to be determined. The range of relevant circumstances to be taken into account is not as wide and regard is not had to the particular history of the commercial or personal relationships between the prospective vendor and purchaser of the property to be valued.

… A 'fair market value' may diverge from a 'market value' for numerous reasons, e.g. where property is thinly traded, or the parcel is small, or there exist market distortions."^[16] [2004] NSWCA 451 ; 63 NSWLR 167 at [53]-[58]; 177

14. As explained in Land Valuation and Compensation in Australia:^[17] RO Rost and HG Collins, 3 ^rd edition, 1984, reprinted 1996, Southwood Press Pty Ltd, Marrickville, Australia

"… Thus the land valuer is obliged to visualise the ideal sale, where both parties to the transaction are prudent, well informed, and unaffected by any abnormal influence that would deprive the sale of weight as a criterion of value.…"^[18] At 37

C. Meaning of "trading stock"

15. The expression "trading stock" is defined in s 995-1 to have the meaning given to it in s 70-10 of ITAA97 as modified by ss 124ZO and 124ZQ of the Income Tax Assessment Act 1936 (ITAA36).^[19] These modifications relate to shares in a PDF or pooled development fund and are not relevant in this case. Section 70-10 provides:

" Trading stock includes:

• (a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a *business; and
• (b) *livestock;

but does not include a *Division 230 financial arrangement."

As I have noted earlier, a "business" "… includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee".^[20] ITAA97, s 995-1(1)

D. Assessable income attributable to trading stock

16. A taxpayer's assessable income includes certain amounts attributable to trading stock. Under s 70-35(2), it includes any excess of the value at the end of the income year over the value at the start of the income year. Section 70-35(3) permits a taxpayer to deduct any excess of the value at the start of the income year over the value at the end of the income year. The values at the start and end of income years are worked out in accordance with the provisions of Subdivision 70-C of ITAA97.

17. Sub-division 70-D is concerned with assessable income arising from the disposal of, among other assets, trading stock. If a taxpayer disposes of trading stock in the ordinary course of business, the amount received for it is included in that taxpayer's assessable income as ordinary income.^[21] ITAA97, s 70-80(1)

18. If an item stops being a taxpayer's trading stock for certain other reasons, an amount is generally included in that taxpayer's assessable income to balance the reduction in trading stock on hand. That is a transaction on revenue account.^[22] ITAA97, s 70-80(2) The certain other reasons for which an item may cease to be trading stock are: a taxpayer may dispose the trading stock outside the ordinary course of business; the taxpayer's interests in it change; the taxpayer dies and the taxpayer stops holding it as trading stock.^[23] ITAA97, s 80-(3)

19. These reasons are expanded upon in Sub-division 70-D but only s 70-110 may have any relevance in this case:

"If you stop holding an item as *trading stock, but still own it, you are treated as if:

• (a) just before it stopped being trading stock, you had sold it to someone else (at arm's length and in the ordinary course of business) for its *cost; and
• (b) you had immediately bought it back for the same amount."

FACTUAL BACKGROUND

20. At Attachment A, I have set out significant events in their chronological order. In doing so, I have relied on the Commissioner's chart of those events but have modified and added to it. In this part of my reasons, I will look further into some of those events for they are relevant in resolving the issues raised by Lakes' application for review. They are uncontroversial but references to the evidence on which they are based are found either in the footnotes or against the relevant entry in Attachment A.

The Gasing Group

21. The Sanctuary Gasing Group (Gasing Group), which comprises some 70 companies, is a Malaysian based property developer experienced in developing prime commercial and residential real estate in Malaysia, North America, Europe, China and Australia. Those developments often featured a lake and green surrounds as well as a golf club. Champion Plastic Industries SDN BHD (Champion Plastics) was also a member of the Gasing Group.

22. The Gasing Group had holding companies. In Malaysia, it had established Exclusive Region Sdn Bhd (Exclusive Region) in 1993 and used this as the ultimate holding company. In Australia, a company that was later to be renamed "Sanctuary Holdings Pty Ltd" (Holdings) was incorporated on 14 September 1995.^[24] Originally, it was incorporated as Sanctuary Lake Pty Ltd but changed its name to Sanctuary Holdings Pty Ltd on 17 June 1996: ST documents, ST3 at 967-972 Mr Kuok Ing Ting and Mr Yeow Khoon (Michael) Tan, both of whom were associated with the Gasing Group, held all of the shares in Holdings on trust for Exclusive Region.

Incorporation of Lakes and Clubs

23. Sanctuary Lakes Pty Ltd (Lakes) is an Australian based member of the Gasing Group. It was incorporated on 3 June 1996 with Mr Yuh Lin Lee, Mr Kuok Ing Ting and Mr Tom Kotsimbos as directors. The two shares issued in Lakes were owned by Holdings.^[25] ST documents at 957-961

24. Sanctuary Clubs Pty Ltd (Clubs) was incorporated on the same day Mr Yuh Lin Lee, Mr Kuok Ing Ting, Mr Yeow Khoon (Michael) Tan and Mr Tom Kotsimbos as directors. The two shares issued in Clubs were owned by Holdings.^[26] ST documents at 962-966

The concept of the Sanctuary Lakes Resort

25. The Sanctuary Lakes Resort is a residential development at Point Cook in Victoria offering a "resort style" of living to its residents. What was encompassed in the concept of "resort style" varied over the years as work proceeded on the development and other problems and opportunities revealed themselves.

Setting the corporate and personnel structure in place

26. On 23 November 1995, the Sanctuary Lake Unit Trust (Trust) was established as a vehicle for providing debt capital to the Australian operating entities.^[27] Exhibit A at Exhibit KT-6 Its trustee was Sanctuary Nominees Pty Ltd (Nominees),^[28] Exhibit A at Exhibit KT-6 which is a subsidiary of Holdings.

27. On 28 June 1996, agreement was reached among seven investors (including Champion Plastics), Holdings as the Australian holding company and Exclusive Region as the ultimate holding company. The shares in Exclusive Region were held by the seven investors. Champion Plastics and three other investors each held a 20% interest, one held 10% and two each held 5%.^[29] Statement of Mr Ken Tan, Exhibit A at [37]

28. While the Gasing Group was the overall project manager, it appointed Asset Solutions Group Pty Ltd (Asset Solutions) as its Australian project manager. Asset Solutions was a land development consulting group. Mr Stephen Head was a director of Asset Solutions and he and Mr Yuh Lin Lee were appointed to undertake the daily activities and decision-making in relation to the project.

29. Mr Yuh Lin Lee reported to Mr Kenneth Tan, who has been a director and manager of the Gasing Group since 1995. Mr Kenneth Tan had overall responsibility for the project. His duties included liaising with Asset Solutions and other consultants, executive decision-making and financial review of the project. He liaised with the investors and their management and reported also to the board of the Gasing Group.

30. Another consultant appointed in connection with the project was Mr David Rennick, who was a partner at the time in Maddock Lonie and Chisolm, which is now known as Maddocks. Legal advice was sought principally from Maddocks although it was sought from other solicitors from time to time. Other consultants were Mr David Hunter of Coomes Consulting, civil and structural engineers, in relation to the planning and construction of the lake and Mr Garth Greenaway of Greenaway and Katz Pty Ltd in relation to the planning and marketing of the property. If there was "… an associated tax consequence to the transaction, then… [the Gasing Group] would probably have sought advice."^[30] Transcript at 67

The land and the section 173 Agreement

31. The vendor of the land, Laverton Heights Pty Ltd (Laverton) that ultimately became the Sanctuary Lakes development had previously obtained planning approval to subdivide it. As part of the approval process, Laverton had entered a Planning Agreement with the City of Werribee, Melbourne Water Corporation, Melbourne Parks and Waterways, the Commissioners of the City of Hobsons Bay and the Roads Corporation under s 173 of the Planning and Environment Act 1987 (Vic) (PE Act) (Section 173 Agreement) in relation to various parcels of land situated at Point Cook.

32. Section 173(1) of the PE Act provides that a responsible authority may enter an agreement with an owner of land in the area covered by a planning scheme for which it is a responsible authority. Under s 8A(1) of the PE Act, a municipal council is a planning authority for any planning scheme in force in its municipal district. An agreement made under s 173 must bind the owner to the covenants specified in the agreement.^[31] PE Act, s 174(1) It may provide for matters such as the prohibition, restriction or regulation of the use or development of the land or any matter intended to achieve or advance the objectives of the planning scheme.^[32] See generally s 174(2)

33. Section 181(1) provides that a responsible authority may apply to the Registrar of Titles (Registrar) to register an agreement under s 173 provided it does not relate to Crown Land. The Registrar must record it in the Register kept under the Transfer of Land Act 1958.^[33] PE Act, s 181(3) Registration means that the burden of any covenant in the agreement runs with the land affected.^[34] PE Act, s 182(a) The responsible authority may enforce the covenant against any person who derives title from the person who entered the covenant.^[35] PE Act, s 182(b)

34. Although I do not have any evidence of registration, I note that, under cl 21.3 of the Section 173 Agreement, Laverton agreed to do all things necessary to enable the City of Werribee, as the Responsible Authority, to enter a memorandum of it on the Certificate of Title under s 181. Under cl 21.1, both agreed that the agreement had been made under s 173 and that, during its term, "… the obligations imposed upon the Owner are intended to take effect as covenants which will be annexed to and run at law and in equity with the Land and bind the Owner."

Purchase of land

35. On 25 September 1995, Champion Plastics Industries Sdn Bhd (Champion Plastics) (a member of the Gasing Group) entered a contract that either it or its nominee purchase various parcels of land at Point Cook from Laverton. Champion Plastics paid a deposit of $2.175m. Having been nominated by Champion Plastics as its nominees on 13 June 1996, Lakes and Clubs paid the balance of $12.325m on 30 June 1996 and became the registered proprietors of the various parcels of land.

36. Lakes and Clubs purchased the land subject to the encumbrances shown in Item 1 of the Schedule to the contract. Among those encumbrances was the Section 173 Agreement annexed to the contract.^[36] Contract, cl 1.1 and Item 7 of Schedule: Exhibit A, Exhibit KT-2 That agreement was the subject of cl 9 of the Special Conditions of the contract. Under that clause, the purchaser acknowledged that the land was subject to the Section 173 Agreement.

Development of residential properties and the golf course

37. Lakes' primary role in the development was as the residential developer while that of Clubs was to develop the golf course, the club house and a limited amount of residential land that fell within the boundaries of the golf course.

38. The success of the project as a whole depended upon its successful marketing. That marketing focused on its golf course, its lake and its offering higher residential amenities than usual. The golf course was designed by Greg Norman and this fact featured in the promotional material for Sanctuary Lakes. The features that made Sanctuary Lakes attractive, required upkeep and two companies were incorporated to deal with that. One was to focus on the golf course and its associated facilities and the other on the remaining facilities.

Sanctuary Lakes Residents Association

39. Services over and above those offered by the council at the Sanctuary Lakes development were provided by the Sanctuary Lakes Residents Association. Those services related to landscaping, maintenance of the lake and general surrounds, sporting facilities, swimming pool and security. Each resident contributed approximately $1,000 for those services over and above the amount paid for council rates. In order to attract residents, Lakes had to ensure that those services were maintained as it was marketing the development as a prestigious and exclusive estate. Initially, it established a separate body corporate for each stage of its development. Difficulties arose because legislative restrictions meant that they could not spend money for services affecting property outside their geographical area of responsibility and so could not pool resources with other bodies corporate in the overall development.

Sanctuary Lakes Residents Association Limited

40. On 28 April 2000, SLRA was incorporated as a public company limited by guarantee. Mr Yuh Lin Lee, Mr Yeow Khoon (Michael) Tan and Mr Stephen Head were appointed as directors.^[37] ST documents, ST5 at 977-979 It was established to overcome the difficulties encountered by the individual bodies corporate.^[38] Exhibit B at [49] Services it provided were directed to maintaining facilities other than those related to the golf course.

41. Early modelling had recognised that its income would be small in the initial stages as a person was not liable to pay a fee to SLRA until he or she acquired a particular property. Despite that, it had been assumed that there would be sufficient funds from an early stage to cover necessary expenditure. That did not prove to be the case and SLRA required further funding. SLRA required assistance to overcome its funding shortfall and those funds were provided by Lakes on the basis that they were loans that had to be repaid^[39] Exhibit B at [50] and to be used as working capital.^[40] Evidence of Mr Kenneth Tan, Transcript at 156

Sanctuary Lakes Golf Club

42. Before the golf course had been completed, Clubs established an unincorporated association known as the Sanctuary Lakes Golf Club under its administration. It sold memberships in the unincorporated association conferring a right to play on the course when it was completed. The projected completion date was June 1999.^[41] Statement of Mr David Rennick, Exhibit B at [37] Clubs promoted the golf course and membership of it. Only a single class of membership was offered with an initial fee of some $28,000 to $30,000 followed by annual subscriptions. All membership fees were deposited in Maddocks' Trust Account.^[42] Exhibit B at [38]

43. Prospective members were reluctant to pay membership fees of that magnitude in exchange for what was effectively a licence to play granted by Clubs as one of the developers of the land. They were concerned that, were the development to fail, or the golf course to be sold, they would have no recourse against subsequent owners to enforce their right to play on the course.^[43] Exhibit B at [39]

Sanctuary Lakes Golf Club Ltd

44. On 13 October 1998, Sanctuary Lakes Golf Club Ltd (SLGC) was incorporated as a public company limited by guarantee. Much later, on 31 December 2002, it changed its name to Sanctuary Lakes Club Limited but I will refer to it throughout as SLGC. On incorporation, its directors were Mr Yuh Lin Lee (then also a director of Holdings and Lakes), Mr Yeow Khoon (Michael) Tan (Chairman of Gasing Group and then also a director of Holdings, Lakes and Clubs) and Mr Stephen Head (a director of Asset Solutions (an independent contractor in the development of Sanctuary Lakes).^[44] ST documents, ST 4 at 974-975 Each had been proposed by Lakes. Together, they comprised SLGC's initial Board and were required to resign from office at the first Annual General Meeting arising after the expiration of two years from the date on which all memberships had been sold.^[45] SLGC’s Constitution at [38.1.1]; T documents, T3 at 106-107 After that time, only members of SLGC were eligible to be directors and their candidacy had to be proposed and seconded by a member.^[46] SLGC’s Constitution at [38.3]; T documents, T3 at 107 Other than the three proposed by Lakes, directors could be removed on a resolution passed by the members of SLGC at a General Meeting. As no more than five directors could be appointed as the Board,^[47] SLGC’s Constitution at [37.1]; T documents, T3 at 106 the three directors proposed by Lakes maintained control of the Board and so of the SLGC.

45. The membership of SLGC comprised the Initial Members (i.e. the initial members at the time of incorporation), the Original Applicants (i.e. those persons who had applied for membership before incorporation and had paid or arranged to pay membership fees) and every other person admitted by the Board to membership.^[48] SLGC’s Constitution at [7.1]; T documents, T3 at 86

46. Clause 7 of the Constitution of SLGC provided for membership of the club. Apart from the three initial members, who were to be private members, membership was divided into two categories: Private Membership and Honorary Membership. Private Membership was limited to 1,000 members and, unless SLGC determined otherwise, Honorary Membership was limited to ten. The Memberships might be divided into any categories as SLGC determined. Other than Honorary Members, each member was required to pay annual Subscription Fees for the class of membership to which he or she belonged. That was the effect of cl 9.3 of the Constitution. Clause 9.2 provided for Membership Fees payable by applicants for membership.

47. Clause 43.1 of SLGC's constitution provided that "The control and direction of the Club and the management of its property and affairs is vested in the Board." The Board might exercise all of SLGC's powers provided they did not have to be exercised by the club in a General Meeting provided for in the Constitution.

48. On the basis of an exchange between Ms Schilling and Mr Kenneth Tan, I find that "By and large" SLGC "… conducted their own independent business activities without input in relation to those activities…"^[49] Transcript at 174-175 but that did not mean that they operated without regard to considerations affecting the development of Sanctuary Lakes as a whole. I find on the basis of a subsequent exchange between them that Lakes was kept very much informed of what SLGC intended in relation to its business activities. Lakes would be advised, for example, if SLGC proposed to have a restaurant or a spike bar. That was inevitable given that one of SLGC's directors was a director of Lakes and another a director of Clubs.

49. Membership and Subscription Fees were intended to provide a source of revenue for SLGC together with green fees, sales of food and drink from two outlets located in the Club House, functions and, to some extent, activities in the golf shop. This was the evidence of Mr Kenneth Tan.^[50] Transcript at 172-173 The recitals to the subsequent agreement between SLGC and Lakes confuse this evidence a little. I find that the sale of memberships turned out to be weaker than had been expected despite extensive promotion of the course as a Greg Norman designed golf course.^[51] Transcript at 69 SLGC also had to turn to Lakes for funding. As with SLRA, funding was provided on the basis that it was to be repaid. At this stage, there was no written agreement to that effect but I find on the basis of the evidence of Mr Kenneth Tan that Lakes advanced funds to SLGC for the purposes of providing working capital.^[52] Transcript at 75

SLGC enters sale and purchase/management agreement with Clubs

50. SLGC reached an agreement with Clubs on 30 June 1999 to purchase the land on which the golf course was being built but was, at the time, incomplete. The purchase price was $6.5 million.^[53] T documents, T4 at 127 The purpose of Clubs' disposing of its interest was:

"The disposal of the Site to the Principal is intended to provide a means for the Construction Manager to manage and conclude the development of the Site and to enable the Construction Manager to transfer the responsibility for the management and operation of the Golf Course to the Principal."^[54] T documents, T4 at 118

51. At the same time, SLGC agreed with Clubs that Clubs would be appointed as an independent contractor in the role of construction manager to manage and conclude the construction of the golf course by 1 December 1999 or another date agreed upon. Clubs provided its services for a fee which, under cl 6.3, would be "… the proceeds from the sale of 1000 memberships in the Sanctuary Lakes Golf Club less the purchase price payable pursuant to the Land Sale Contract." That fee was payable only after SLGC had paid the purchase price of the land.^[55] T documents, T4 at 123 The purchase price of the land was paid with an initial deposit of $1.00 followed by payment on 1 December 1999 of the amount held in Maddock's trust account on behalf of SLGC members as club membership fees and then by instalments as memberships were sold. Each instalment was equal to the membership fee paid by each new member and was payable to Clubs within seven days of receipt.^[56] T documents, T4 at 127-129

Actuarial valuation of membership sales

52. Lakes commissioned NSP Buck Pty Ltd (Buck) to prepare an actuarial valuation of the SLGC membership sales. Buck undertook the valuation on 1 July 2000 on the basis of discussions with Asset Solutions and relevant data it provided. It also discussed the matter with another valuer. ^[57] It was proposed that Lakes and Clubs would absorb the cost of the GST after that tax was introduced on 1 July 2000 in relation to the next 100 Gold and 100 Silver Memberships sold. The price of Diamond memberships were to be increased by 10% for GST from 1 July 2000: T documents, T 6 at 151.

53. At the time, Buck recorded, the sale of the memberships and their playing rights together with their sale price before and after 1 July 2000 were:^[58] T documents, T6 at 151 Amendments made to SLGC’s constitution increased the total number of memberships to 1,700; see [57] below

A total of $975,000 in membership fees was outstanding as at 31 May 2000. The majority of that sum was due from pending memberships allocated to two developers independent from the Sanctuary Lakes group. No GST was payable on those memberships. From 1 July 2000, it was proposed that the price of the Diamond membership would be increased from 1 July 2000 with those for Gold and Silver to follow with an increase of 10% on the pre GST price.

54. For the purpose of the valuation, Buck assumed that SLGC would not repay the advances made to it by Lakes.^[59] T documents, T6 at 153 It regarded each Diamond membership as a unit. A Gold membership was 0.6 of a unit and a Silver membership, 0.4 of a unit. On that basis, Buck found that, in the period from October 1996 to May 2000, the monthly sales ranged from zero to 18. The peak was reached when the golf course was opened in June 1999. Over the entire period, the average sales of memberships amounted to 6.7 per month. The 12 month moving average showed average sales of five to nine memberships each month.^[60] T documents, T 6 at 154

55. As to future sales, Buck assumed that it was appropriate to assume that seven Gold and Silver memberships would be sold each month and that six of the remaining 14 Diamond memberships would be sold each year. It determined a discount rate intended to reflect the return expected from an investor having regard to the level of risk associated with receiving revenue from future membership sales. Buck found it difficult to quantify that risk as there was no similar investment available for comparison. It noted that the success of the membership sales depended on the successful operation of SLGC and the reputation of the golf course and that "A positive aspect is the continued involvement of the Developer who has a significant interest in the success of the Golf Club."^[61] T documents, T6 at 157 Buck decided that a discount rate in the order of 20% was consistent with assumptions used for sales and prices and the risk associated with future membership sales. It attributed a figure of 10% to those that had already been sold as at 31 May 2000 as there was a lower risk of the membership fees' not being received.

56. The conclusion reached by Buck was that the actuarial value of future membership sales was $8,173,000 but, given the uncertainty of predicting sales, it also prepared a valuation based on lower and higher levels of sales and the consequent variation in the dates on which all of the memberships would be sold:^[62] T documents, T6 at 158

SLGC attempts to boost interest in its memberships

57. By 2000, SLGC's membership sales had not improved. Various options were considered to change that situation. In February 2000, SLGC amended its constitution to introduce new categories of membership.^[63] Exhibit A, Exhibit KT12 The number of memberships in each category was limited as before. Existing members now became Diamond members and their number was limited to 300. There would be 700 Gold members and 700 Silver with ten or more, as determined, Honorary members.^[64] Exhibit A, Exhibit KT12, cl 7 The membership fees were set at approximately $18,000 for Gold and $12,000 for Silver with more restricted playing rights than those enjoyed by members holding Diamond memberships.^[65] Exhibit B at [54]

58. The constitution provided for the transfer of memberships in accordance with cl 16. A person wishing to transfer a membership to another had to seek the approval of the Board which could give, or refuse to give, its approval. The Board was also bound by cl 16.4.1 which provided that:

"Until such time that all of the Memberships have been issued, the Board will only nominate a Transferee in preference to Memberships not yet issued after the sale of the three unissued Memberships in respect of each notice served under clause 16.2, from the date such notice is received by the Board."

SLGC was entitled to a fee from the member transferring membership. The amount of that fee was to be determined by the Board provided it did not exceed 10% of the greater of following: the current membership fee payable for unissued memberships (or the last membership fee paid if all have been issued); or the market value of the membership as determined by the Board.^[66] Exhibit A, Exhibit KT12, cl 16.6

59. Membership sales did not improve. By the end of May 2000, 286 of 300 Diamond, 8 of 700 Gold and 6 of 700 Silver memberships had been sold.^[67] Actuarial Valuation of Membership Sales by NSP Buck Pty Limited (Buck report), 1 July 2000; T documents, T 6 at 151

60. The management of SLGC was changed at some time before 6 August 2001 and probably in 2000 so that its Manager became Mr Stephen White. Asset Solutions also engaged Australian Resort Management Pty Ltd (ARM) to manage SLGC and SLRA. ARM was effectively administered by Mr Head of Asset Solutions^[68] Exhibit B at [56] but day to day responsibility for Lakes and Clubs lay with its General Manager, Mr Anthony Gurry and with Mr Stephen White, who had been appointed as Manager.^[69] Exhibit B, Exhibit DIR-2 at 3 New promotional strategies were implemented but sales did not improve and SLGC required continued financial support.

61. SLGC's accounts were prepared by Mr Jim Hammer, who was SLGC's Manager after Mr Stephen White resigned as Manager in November 2001. Mr Hammer reported to Mr Anthony Gurry. SLGC's accounts were audited by Stannard Colbourn & Angelini.^[70] Transcript at 175 They were dealt with separately from those of Lakes and Clubs.^[71] Transcript at 175

Loan agreement between SLRA and Lakes

62. On or about 18 August 2000 or some time later^[72] An unexecuted copy of the Loan Agreement shows “ 180800” as part of its reference. Mr Rennick gave evidence that this indicates the day that the document was created, varied or printed: Transcript at 210-211. Reference is made to the GST legislation and so that would suggest execution after it came into operation on or after 1 July 2000; Transcript at 214-215. but certainly "…after the advances to Residents Association for that matter, the golf club, reached a scary level, a concerning level",^[73] Transcript at 157 Mr Kenneth Tan gave instructions to Maddocks to prepare a loan agreement between Lakes and SLRA. In that agreement, they acknowledged that Lakes had previously lent funds to SLRA for the purposes of the operation and management of the Common Property in the development and that it agreed to do so in the future. SLRA agreed to repay the sums borrowed with interest five years after the sums were advanced.^[74] T documents, T 5 at 137-148 That repayment day was repeated in a report prepared by NSP Buck Pty Limited regarding the valuation of the memberships as at 1 July 2000. It reported that the proposed repayments would be made on the basis of SLGC's capacity to pay. SLGC's then current cash flow predictions as provided by Asset Solutions suggested that the first of the repayments could be made in 2006.^[75] Buck report at 4; T documents, T6 at 153

Loan agreement between SLGC and Lakes

63. On the basis of the evidence of Mr Tan, I find that Lakes had intended to support SLGC initially but not indefinitely.^[76] Transcript at 72 Its intention had been to limit its operating subsidy to SLGC to an amount of $5 million. The final instalment of that amount was to be paid in the 2000/2001 income year.^[77] Buck report at 4; T documents, T6 at 153

64. At about the same time as Lakes entered the loan agreement with SLRA, it entered an agreement on similar terms with SLGC.^[78] T documents, T 17 at 625-637 Mr Kenneth Tan's evidence, which I accept, was that:

"The Investors of course were looking to maximise the overall return on their investment. They wholly owned all the entities undertaking the development, and while each existed separately in a legal sense, they were all inextricably linked and economically interdependent, and in effect comprised a single economic entity. We therefore decided to structure Lakes' advances to the Golf Club as loans to preserve the possibility of repayment to Lakes on commercial terms in the future when the Golf Club had cleared its commitments."^[79] Exhibit A at [76]

65. In his oral evidence, Mr Kenneth Tan discussed the basis on which the agreement was prepared and entered. The following extracts represent his evidence:

"…because it was important for us to try and capture what was already happening between the entities, in some form of referenceable document. … there ought to have been an overarching document to guide the transactions…"

"… I think that when we put this agreement together, it followed basic format for loan agreements. That includes provisions as to interests, as to time period on there…"

"… it is intended to have effect. It provides - it provides that over-arching structure."

"… The ability of the golf club to repay the loan would not have come out of sales. It could, for example, have come out of an increase of public traffic. So long as the club could generate operating profits which is not inclusive of sale - the membership sales proceeds, then, yes, we would have attempted to call back the loan with interest."^[80] Transcript at 75-77

Meeting of the investors on 6 August 2001

66. The Sanctuary Lakes project was discussed at a meeting of the investors on 6 August 2001. The investors questioned various aspects of the development including SLGC and SLRA. They queried costs and performance of the project generally. The minutes of the meeting record that three options were considered in broad terms by the investors. The first was to continue as things were but to target low debt, payment of low dividends or a mix of debt reduction and smaller dividends. The second was to sell down by selling the whole project, super lots or equity with the object of reducing liability. The third was a balanced strategy to reduce debt to a level of between $6 million to $10 million but yet retain a level of debt that was not detrimental to the project as a whole. Consideration was still to be given to the sale of super lots "as a backup plan".^[81] Exhibit A at Exhibit KT-14 at 8-10

67. On the basis of Mr Kenneth Tan's oral evidence, I find that the investors were concerned to ensure that any changes in ownership did not create problems in the day to day operations of the project such as land sales, construction, the provision of services to residents and golf club members and the payment of trade creditors. Various offers came to be considered including one from Westbrook working with Mirvac and another from Stockland.^[82] Transcript at 57 and see also Exhibit A at [96] and Exhibit KT14 at 8-10

Ongoing funding issues for SLRA and SLGC in 2001 and 2002

68. By 19 November 2001, the number of memberships sold in SLGC numbered 289 (286 in May 2000) Diamond, 56 (8) Gold and 11 (6) Silver.^[83] Exhibit A, Exhibit KT-15 Despite that, there were still concerns about the reliance placed by SLRA and SLGC on subsidies. Mr Gurry was concerned to provide certainty to their regular suppliers and to the Australian Taxation Office (ATO).^[84] Exhibit A, Exhibit KT-15 Mr Gurry reported to Mr Kenneth Tan on the staffing changes and then advised that he had been spending most of his time on issues relating to SLGC and SLRA for three reasons:

"* The concerns and unrest caused by the 'selling due diligence process' which un-nerved residents and members.

* The need to work through a program to give more certainty in the subsidy scenario of the SLGC and SLRA as you discussed with Stephen Head.

* The continuing reform in culture and systems to reduce the subsidy reliance.

You would have seen the circular to you two weeks ago re the initiatives to implement and I am moving to implement once we receive the formal approval."^[85] Exhibit A at Exhibit KT-15

69. Mr Head expressed his concern about similar issues in his email to the directors of SLGC, SLRA, Mr Kenneth Tan, Mr Hammer and Mr Gurry on 28 February 2002. He had received a notice from the ATO demanding that he and the other directors of SLGC, personally pay its outstanding taxation liabilities. Mr Head attributed the problems of SLGC and SLRA to continual difficulties in forecasting the revenue they would generate. Those difficulties had, in turn, been caused by the developer's not selling memberships and residents' not building as quickly as forecast. Strategies had to be put in place, Mr Head continued, to ensure that both companies were solvent and trading lawfully, that certain persons were responsible for ensuring that was so and being accountable to the Board of each. Services should be contracted out, SLGC restructured as an unlisted public company so that its members become shareholders and have an investment, SLRA's fees become payable regardless of when land is built upon and residents encouraged to use food and beverage outlets.^[86] Exhibit A at Exhibit KT-16

70. Mr Gurry developed these points in his email of 2 April 2002 to Mr Head, Mr Yuh Lin Lee, Mr Rennick, Mr Michael Tan and Mr Cheah Min Loong. He sought to achieve various aims including those of efficiencies and economies from the use of plant, equipment and labour, contribution by SLRA members to SLGC as they enjoyed amenities provided by SLGC other than the golf course, removal of reliance on Lakes to fund ongoing operating losses, SLRA and SLGC's achieving solvency and SLGC's offering investment grade products.^[87] Exhibit A at Exhibit KT-17 at 1

71. The proposal involved the formation of a new company to replace SLGC. Shares in the new company would be offered to existing members of SLGC in exchange for their current memberships, transfer of SLGC's assets to a new unlisted public company, Sanctuary Lakes Club Pty Ltd (SLCA), cancellation of all loan agreements between SLGC and the developer in exchange for shares in SLCA and the reconstitution of SLGC as a golf club in the traditional sense with an elected committee and Captain. On the basis of the memberships purchased to that time, shares based on its holding 1,321 memberships would be issued to the developer and shares based on 434 memberships issued to existing members.^[88] Exhibit A at Exhibit KT-17 at [5] Mr Gurry noted that PGA LINKS Pty Ltd (PGA Links), which is a management company jointly owned by the Professional Golfers Association of Australia and LINKS Group Holdings had agreed to facilitate the creation of SLCA at no cost to SLGC, SLRA or the developer.

72. Under the proposal, SLCA would become the operator and agent of SLRA. Changes would be made to the fee structure. The existing debt between SLRA and the developer would remain but future amounts would be paid by the developer as body corporate fees and be structured as tax deductible expenditure.^[89] Exhibit A at Exhibit KT-17 at [6]

73. The new company, SLCA, would formally approach SLGC, SLRA and the developer and propose the issue of shares in SLCA to members of SLGC in exchange for all their current memberships, amendment of SLGC's constitution to ensure that SLCA was either the sole member or all of SLGC's assets were transferred to it and that SLGC be reconstituted as a golf club in the traditional sense. In addition, SLCA would propose:

"Cancellation of all loan agreements between SLGC and the Developer in exchange for the issue of shares in SLCA (i.e.: a debt for equity swap)".^[90] Exhibit A at Exhibit KT-17 at [4]

74. In relation to SLRA, it was proposed that:

"As part of the SLRA changes, it is proposed that the constitutional amendments will provide for the owner of the 'undeveloped residential land' at Sanctuary Lakes Resort to abide by specific infrastructure development standards and contribute a 'body corporate fee' in lieu of providing SLRA loans/subsidies. This will remove the ongoing legal obligations of the developer to fund operating deficits.…

The existing debt between SLRA and the Developer will remain. Future 'body corporate fees' paid by the developer will be structured as tax deductible expenditure of the Developer."^[91] Exhibit A at Exhibit KT-17, [6]

Sale of two parcels of land to Sunland

75. On 26 June 2002, Lakes and Clubs entered contracts with Marington Pty Ltd (Marington), which is one of the companies in the Sunland group of companies (Sunland) for the sale and purchase of parcels of land.^[92] T documents,T10 and T11 at 229-506

Deed of Arrangement between SLGC and Lakes

76. SLGC^[93] By now known as Sanctuary Lakes Club Limited and Lakes entered a Deed of Arrangement.^[94] T documents, T17 at 617-637 The copy of the document in the T documents is undated. Its effective date, as prescribed in cl 1, is 1 September 2002. SLGC would issue 527 memberships (246 Gold and 281 Silver) under its constitution to Lakes in full satisfaction of the amount of $10,236,191.68 then owing under the Loan Agreement between them.

Board meeting of Holdings on 18 November 2002

77. On 18 November 2002, the Board of directors of Holdings met. They recorded that 400 memberships had been sold at that time. Of those, 295 were Diamond, 92 were Gold and 13 Silver. The Board expressed concern for the funding of the annual subscriptions due on those that had not been sold. It discussed whether they should be disposed of en bloc to a third party and noted a proposal by PGA Links that it settle the annual subscriptions on their behalf in exchange for their being able to dispose of the memberships at any price they deemed fit. Mr Cheah Min Loong and Mr Harry Tan had previously rejected this proposal. It considered leasing memberships with a view to the lessees' purchasing memberships in the future. The Board considered a proposal to market the memberships and to commit an advertising budget to it and requested Mr Lee Yuh Lin to implement it on his return to Melbourne.

78. At the same meeting, the Board noted that the proposal to convert their memberships to shares had been presented to the members of the SLGC. The proposal had generally been well received. The Board also noted that the members of the SLGC were also told that:

"… the said shares to be 'paid' to the Malaysian investors were accompanied with assurances that the investors will not wantonly dump these shares, thereby reducing the value of the memberships.

Kenneth Tan reported that, from the shareholders'/investors' perspective, this conversion is beneficial as it severs the old relationship and moral obligation to provide subsidies. Post-conversion, the shareholders/investors will become mere members and be only responsible for the subscription of the following golf memberships:

Available memberships (and respective value) to be taken over by the shareholders:

5 Diamond	A$33,000
598 Gold	A$19,500
678 Silver	A$12,500"[95] T documents, T13 at 543-544

Deed of variation between SLGC and Clubs

79. The Deed of Variation executed by SLGC and Clubs on 30 June 2003 related to the management agreement they executed on 30 June 1999.^[96] T documents, T18 at 638-648 It recited the terms of the earlier agreement and stated that the current level of membership and subscriptions was insufficient to meet the ongoing funding requirements of SLGC. As a consequence, SLGC had considered reducing the price of its memberships in order to attract additional members but had decided that would have an impact on the return ultimately made by Clubs. Therefore, the recital concluded, SLGC and Clubs had decided that SLGC would pay the fees payable to Clubs in full by issuing to it 768 memberships being 5 Diamond, 356 Gold and 407 Silver memberships.^[97] This meant that, between them, Lakes and Clubs held 5 (of 300) Diamond, 602 (of 700) Gold and 688(of 700) Silver memberships.

Development Lease over remainder to Links

80. Mr Head is a director of Links Sanctuary Lakes Pty Ltd (Links). On 16 August 2002, Lakes and Clubs entered an agreement with Links.^[98] T documents, T16 at 507-536 Lakes and Clubs agreed to lease to Links the land comprised in the project other than land in Stage 23 of the development, land subject to the sale to Sunland and land already sold in earlier developments. The land was shaded red and shown on the plan at Annexure B to the agreement. A colour copy was also provided.^[99] Exhibit B On the basis of that copy and insofar as I can read it, I find that the land comprised land that had been designated as belonging to Stage 28 and bordering Stage 23 extended south along the border of the land running along Skeleton Creek to its southern boundary. Although difficult to read, I find that among the Stages included in that land are Stages 29, 30, 32 and 38. Some of them are bounded by the Lake and what appear to be Stages 42 and 43 protrude into that Lake. South of the Lake appear to be Stages that include Stages 11, 44 and 47.

81. Links was required to carry out the development works on the leased land in a manner generally consistent with the existing operation at the Sanctuary Lakes Resort.^[100] Development Lease at cl 5.2; T documents, T12 at 515 The development works comprised the creation of allotments and their subsequent sale.^[101] Development Lease at cl 14.1; T documents, T12 at 518 Links assumed all of Lakes' and Clubs' obligations in respect of any agreement under s 173 of the PE Act relating to the land in so far as it could be said that the agreement touches upon issues directly or indirectly relating to the works carried out by Links.^[102] Development Lease at cl 10.2; T documents, T12 at 518 It was required to use the land for the use specified in item 9 and, under item 7.3, was required to comply with all laws and any requirements of any authority in connection with the land and Links' use and occupation of it.

82. Clause 9.1 permitted Links to deal with its interest in the land at its complete discretion including assigning the lease.^[103] Development Lease at cl 9.1; T documents, T12 at 517 As each allotment was sold, it was agreed that the consideration received represented consideration for the freehold and consideration for the benefit of the leased land attributable to that allotment. The consideration was apportioned so that $1.00 was attributed to the freehold and the balance to the assignment of the lease.^[104] Development Lease at cl 9.2; T documents, T12 at 517

83. Links agreed to pay Lakes and Clubs rent in the manner specified in Clause 8 and a Lease Premium as specified in Annexure C.^[105] Development Lease at cl 3.1.2; T documents, T12 at 514 Annexure C provided that the Lease Premium was the sum of $28 million^[106] Development Lease at Annexure C, item 1; T documents, T12 at 529 and Item 7 in the Schedule provided that that the rental was $1.00 each year for 100 years.^[107] Development Lease at Schedule, item 1; T documents, T12 at 511 Links paid the Lease Premium in or about October 2002.^[108] Exhibit A at [115]. Clause 1 of Annexure C provided that the sum was not payable until Links had received a letter of offer from the financier referred to in cll 19 and 20. The agreement was subject to Links’ receiving a formal letter of offer from a financier by 31 August 2002 and its terms and conditions being acceptable to both Links and Lakes and Clubs. Clause 19 provided that Links could mortgage the land for the purpose of enabling Lakes and Clubs to repay its existing loans to the National Australia Bank or assisting Links to pay the Lease Premium or obtaining working capital. Lakes also agreed to pay to the SLRA an annual sum calculated on the basis that it would pay $10,000 for each developable area of land (i.e. not that land set aside for lakes and other public services and amenities) that is still registered in the name of Lakes and Clubs and that is not yet the subject of an executed contract of sale.^[109] Development Lease at cl 10; T documents, T 12 at 517

84. Under the Development Lease, Links also agreed to undertake, at its own cost and expense, the Staged Works^[110] Staged Works are the design and construction of all civil and service works in relation to Stage 23 land and Sunland land to a standard acceptable to the City of Wyndham so that it may issue a Statement of Compliance in relation to individual allotments; Development Lease at [1]; T documents, T12 at 513 required for the settlement of various contracts of sale executed in respect of Stage 23 land and the Sunland land. Lakes and Clubs agreed that it would remit the first $7 million to Links, retain the next $24 million (which included $14 million) from the sale of the Sunland land and remit any further amounts received to Links as compensation for costs it incurred to complete the Staged Works. If sales were not to proceed at a pace that allowed Lakes and Clubs to be paid within 12 months of the commencement of the agreement, they could excise allotments to the value of the amount owed to it.^[111] Development Lease at cl 14.6; T documents, T 12 at 519

85. Mr Kenneth Tan's evidence was that, although the Development Lease referred to the Sunland land, Links was never intended to undertake the development works. The sum of $7 million remitted to Links was intended to cover the cost of its developing Stage 23 and the sum of $24 million included the proceeds of $14 million from the sale to Sunland.^[112] See [75] above

Deposit of $1 million in Maddocks' Trust Account

86. On 29 January 2003, the sum of $1 million was deposited in Maddocks' Trust Account. This is the subject of [90(4)] below. In its return for the 2003 income year, Lakes declared it as income.^[113] T documents at 737-772 The sum of $1 million is recorded in Lakes' Balance Sheet for the 13^th period of the 2003 income year against the entry "Investments … Solicitors Trust A/c - Sunland'.^[114] ST documents, ST8 at 1011 and repeated at ST8 at 1036 The same amount with the same description is recorded for the same period of the 2004 income year.^[115] ST documents, ST8 at 1017

87. Links directed that $538,105.50 be paid out in 2004 and a further $16,848.35 be paid out in 2005.^[116] T documents at 841 Lakes has not claimed a deduction in respect of the funds disbursed in each of those years^[117] T documents at 841 but the Commissioner allowed a deduction in the 2004 income year for disbursements from the fund amounting to $528,609.^[118] Respondent’s Revised Statement of Facts and Contentions at [80] He determined that Lakes had failed to account for interest of $7,479 on the $1 million held in the fund and imposed a penalty of $525.75 being 25% of the shortfall for failure to take reasonable care.

Mr Kenneth Tan's notes of meeting with Links

88. Mr Kenneth Tan's notes of his meeting with the Links Group on 2 May 2003 dealt with a number of subjects. Among them were those relating to the SLRA debt then in the order of $3.4 million, s 173 agreement obligations, proposal to buy the SLGC memberships and the obligations to Melbourne Water with regard to the lake.^[119] Exhibit B, Exhibit KT-18

89. With regard to the SLRA debt of $3.4 million owed to Lakes, Mr Kenneth Tan noted:

• "- Gurrie advised that residents have raised concerns about indebtedness of SLRA to SL P/L
• - Head opined that probability of repayment is very slim
• - Exco will consider forgiving loans, subject to SLGC membership proposal from Head."^[120] Exhibit A at Exhibit KT-18, [20]

Proposal by Links to Lakes and Clubs on 7 May 2003

90. The proposal put by Links to Lakes and Clubs in a letter dated 7 May 2003 dealt with several matters: lease payments, SLGC memberships, club plant and equipment, outstanding civil and landscaping works, s 173 obligations, SLRA debt and documentation:

• (1) It was noted that the Stage 23 lots should be ready for settlement by late May or early June. Links would forward the sum of $10 million to Lakes and Clubs from Stage 23 settlements, which would conclude Links' major financial obligations to them in respect of the lease.
• (2) Links would pay $1 million cash at the same time as Stage 23 settled and Lakes and Clubs would transfer all memberships to Links. At the same time, Lakes and Clubs would pay Links the total amount they then owed to SLGC for the annual subscriptions on the memberships. Links would assume responsibility for past, present and future payments of the annual subscriptions. Links would pay a further $1 million to Lakes and Clubs one year after it had received the memberships and another $1 million a year later than that.
• (3) "You will pay us at the same time as Stage 23 settles $4.321 million … and we will then assume all your responsibilities for the construction and general installation of outstanding civil and landscaping works.…"^[121] Exhibit B, Exhibit KT-19 at [4]
• (4) When Stage 23 settled, Lakes and Clubs would pay Links a further $1.227 million and Links would assume full responsibility for their s 173 agreement obligations other than those relating to the first lake. Despite that, and on the understanding that it would not assume responsibility, Links agreed to assist Lakes and Clubs financially in respect of the rectification and improvement of the first lake if the works exceeded $1 million. Lakes and Clubs had set that amount aside in trust.
• (5) "You will release the Residents' Association from its obligations to repay to you the current debt. This release recognises the practical reality that the Association will not ever be in a position to repay. We understand it also creates a tax deduction for you."^[122] Exhibit B, Exhibit KT-19 at [6]

Meeting of Executive Committee of Lakes on 14 May 2003

91. Mr Cheah Min Loong and Mr Harry Tan were the members present at the meeting of the executive committee on 14 May 2003. Mr Kenneth Tan and Mr Tan Kuen Kuen were also present. The committee resolved to send copies of the minutes of this meeting and of the previous meeting on 22 April 2003 to the Investors by 19 May 2003.^[123] Exhibit B, Exhibit KT-20 at [1]

92. Among the matters reviewed was the proposal that had been made by Links and that was dated 7 May 2003:

"3. Proposal by Links

Item 1:	Agreed with proposed lease payments of $10 million from Stage 23 settlements
Item 3:	Lee Yuh Lin to pursue offer for construction equipment from Links.
Item 4:	Further tidying up/explanations required for outstanding civil and landscaping works.
Item 5:	Agreed to S 173 obligations of $1,275,800.
Item 6:	Investors to decide later on the debts due from Resident Association. This item should be independent from 'wrap up' with Links.
Item 2	Golf Club Memberships - Noted that as at 31/3.2003 the unsold memberships comprise of 2 Diamond, 588 Gold and 697 Silver.

Action: Before Investors' meeting on Monday, 19 May to determine a) how much is owing in subscriptions & b) how much is yet to be received for the sale of club membership which we can use to offset the subscription.

Meanwhile, to request for a higher consideration of $4.0 million for the unsold club membership

Action: Ken to draft reply for Mr Harry Tan to approve and to forward reply to Links on the same day of this meeting, based on the following:

To thank Stephen Head for his letter, to accept certain items, to concede to letting him have the maintenance equipment and to request for a higher value for golf membership. To inform that Resident Association debt be dealt with separately.

4. Deeds of Variation and Arrangement

In the Deed of Arrangement, to replace the section on golf membership with that narrated in the Deed of Variation."

Response by Mr Head

93. On 15 May 2003, Mr Head sent an email to Mr Harry Tan stating:

"I have now read your May 14 response to my proposal. To assist things through (and make life easier for all of us), I accept your point in relation to the Golf Club membership payment. I therefore agree to the figure being $4 million over three years.

Please understand Harry, the increase in this payment now forms part of the 'overall package' offer I have forwarded. Please try to explain to your Board that it is a package deal which means it will be very difficult to reconcile if it is separated into individual items. I would therefore urge the Board to accept the whole package to avoid us having to go back to the drawing board and reconsider individual items.

…"^[124] Exhibit B, Exhibit KT-21

Supplementary agreement between Links and Lakes and Clubs

94. Links and Lakes and Clubs executed an agreement referring to their earlier Development Lease agreement and reciting that some matters had not been addressed in it (Supplementary Agreement).^[125] T documents, T15 at 550-601 It bears the date "6/5/2003" and what appears to be initials appear below the "6". The numbers "6" and "5" appear to be written over numbers "30" and "6" respectively.

95. Among the matters addressed in the Supplementary Agreement, was the obligation Links had assumed under the Development Lease agreement in relation to Lakes' and Clubs' obligations under the Section 173 Agreement.^[126] See Supplementary Agreement at cll 4.2 and 4.3; T documents, T15 at 556-557 and see [31]-[34] above as to Lakes’ and Clubs’ assuming those obligations. Those obligations were set out in cl 4.2 in relation to the land that was subject to the agreement. They reflect the obligations assumed by Lakes and Clubs when purchasing the land to undertake various works in relation to the wetlands and their maintenance, drainage, physical infrastructure, open space requirements and site rehabilitation works.

96. It was agreed between Lakes and Clubs and Links that:

• "5.2.1 Sanctuary Lakes and Sanctuary Clubs remain responsible for the obligations of the owner as per the specific obligations outlined in Clause 4.2.1 to 4.2.8 above up to the amount of $1,275,800.
• 5.2.2 the amount referred to in clause 5.2.1 shall be paid by Sanctuary Lakes and Sanctuary Clubs to Links on the balance of sale proceeds from the Stage 23 Land.
• 5.2.3 The parties acknowledge and agree that in addition to the amount referred to in clause 5.2.1 Maddocks shall hold the sum of $1,000,000 on behalf of Sanctuary Lakes and Sanctuary Clubs, which shall be applied at the direction of Links towards the satisfaction of the Sanctuary Lakes and Sanctuary Clubs obligations pursuant to the section 173 agreement, including but not limited to the ongoing maintenance requirements of Melbourne Water with respect to the Lake.
• 5.2.4 The balance of such monies referred to in clause 5.2.3 (if any) shall be released upon the issue of a Certificate of Completion of each of the items set out in clause 14 of the section 173 Agreement or upon confirmation by Links that the monies are no longer required to be held."^[127] T documents, T15 at 557

97. The Supplementary Agreement went on to provide that, on the payment of an Option fee of $1.00, Lakes and Clubs granted Links an option to purchase all residual land that was the subject of the lease. The terms and conditions of the sale were those set out in cl 8. No consideration other than the Option Fee was mentioned.

98. Clauses 14.5, 14.6 and 14.8 were amended by cl 10 of the Supplementary Agreement. Showing the original wording with the amendments in bold, it now read:

• "14.5 In consideration for the payment of the Lease Premium the Landlord agrees that it will account to the Tenant for all proceeds in respect of the sale of the Allotments on any portion of the Land (including the Sunland Group Land and Stage 23 Land) and agrees to hold such proceeds on trust for the parties. The proceeds will be distributed in accordance with Clause 14.6.
• 14.6 The Tenant hereby agrees and undertakes at its own cost and expense to complete the Staged Works required for settlement of various contracts of sale executed in respect of the Stage 23 Land and the Sunland Group Land and the Landlord agrees that it will subject to clause 14.8 below remit the first $7 million of such proceeds in respect of such sales to the Tenant after which the Landlord shall retain absolutely for itself the next $24 million $10 million and thereafter any balance shall be remitted to the Tenant as compensation for costs incurred to complete the Staged Works. If the sales do not allow for the full payment to the Landlord of $24 million within 12 months of the Commencement of this agreement (shortfall) then the Landlord may at its absolute discretion excised from the Land the subject of this Lease a number of the unsold Allotments which have a value equal to the amount of the shortfall. Upon the excising of such Allotments the obligation to pay the shortfall will have been satisfied.

  Where Allotments are chosen for excision from the Land the subject of this Lease by the Landlord in satisfaction of the shortfall the value of the Allotments for this purpose shall be based on price lists available to the general public at the material time less 10%.

• 14.7 It is expressly agreed by the parties that the formal letter of offer referred to in Clause 20 must contain provisions which will facilitate the transfer of the Allotments chosen by the Landlord free of all liens and encumbrances.
• 14.8 For the avoidance of doubt, in respect of the Sunland Group Land, it is expressly agreed that the amount up to $14 million shall be retained by the Landlord on settlement of the relevant contracts of sale and the Landlord is responsible for the costs on the creation of any titles created for the Sunland Group Land ."

99. With regard to SLGC, it was acknowledged that Lakes and Clubs held a large number of memberships. Lakes and Clubs agreed to consent to an amendment of the Constitution of SLGC so that no more than five memberships could be released or sold without the written approval of SLGC's Board. They would direct their representative on SLGC's Board to vote to approve the amendment. Lakes and Clubs would not sell the memberships they held to another developer without Links' prior written approval.^[128] Supplementary Agreement at cl 13; T documents, T 15 at 560-561

Loose Ends agreement

100. The recitals to what has been called the "Loose Ends Agreement" dated 30 June 2003 note that there has been a Development Lease and a Supplementary Agreement "to address matters not included in the Lease."^[129] T documents, T16 at 604 They continued:

"Since the Supplementary Agreement was entered into further matters have arisen that require clarification and the parties have agreed to enter into this agreement to address these matters."^[130] T documents, T16 at 604

101. One of those matters related to the transfer of memberships held by Lakes and Clubs in SLGC in return for the sum of $4 million to be paid in accordance with cl 3.2. That provided that:

• "3.2.1 the sum of $1,000,000 shall be paid on the date Links receives $7m and Sanctuary Lakes received $10m from settlement of Stage 23 land at which time the memberships shall be transferred to Links;
• 3.2.2 the sum of $1,000,000 shall be paid not later than 12 months from the date upon which Links receives the memberships;
• 3.2.3 the sum of $1,000,000 shall be paid not later than not later than [sic] 24 months from the date upon which Links receives the memberships;
• 3.2.4 the remaining $1,000,000 shall be paid not later than 36 months after the date on which the memberships are received by Links."^[131] T documents, T16 at 606

102. For the purposes of clause 3, Links was deemed to have taken transfer of the memberships remaining unsold as at 1 May 2003. Links would assume all responsibilities for those memberships from that day. Lakes and Clubs would settle all amounts owed to SLGC in respect of annual subscriptions relating to those memberships for the period up to 30 April 2003.^[132] Clause 3.3, T documents, T16 at 606

103. Clause 6 of the Loose Ends Agreement dealt with s 173 obligations under the PE Act:

• "6.1 In accordance with clause 5.2 of the Supplementary Agreement, Sanctuary Lakes and Sanctuary Clubs agreed to remain responsible for the obligations of the owner pursuant to Section 173 Agreement up to the amount of $1,275,800. Payment of this amount is to be made from the proceeds of the settlement of Stage 23 land.
• 6.2 In exchange for Sanctuary Lakes' and Sanctuary Clubs' paying Links the amount referred to in clause 6.1, Links shall assume all of Sanctuary Lakes' and Sanctuary Clubs' obligations outlined in clause 4.2 of the Supplementary Agreement save and except for any obligations that relate to the rectification or improvement works including the ongoing maintenance requirements of Melbourne Water with respect to the Lake. The parties acknowledge in accordance with clause 5.2.3 of the Supplementary Agreement that Maddocks holds a sum of $1,000,000 to be applied towards the maintenance of the Lake.
• 6.3 Whilst the parties acknowledge that Sanctuary Lakes and Sanctuary Clubs remain responsible for maintenance of the Lake, Links agrees that it will assist Sanctuary Lakes and Sanctuary Clubs financially with such rectification works exceeds the amount held in trust referred to in clause 6.2.
• 6.4 Sanctuary Lakes and Sanctuary Clubs acknowledge that any financial assistance by Links is not to be construed in any way as Links assuming the responsibilities of Sanctuary Lakes and Sanctuary Clubs with respect to the Lake."^[133] T documents, T16 at 607-608

104. Clause 7 dealt with SLRA's debt to Lakes with cl 7.2 providing that "Sanctuary Lakes agrees to forgive the debt."

105. Clause 5 refers to the responsibilities of Lakes and Clubs under the Development Plan for the costs of Development Works outlined in Annexure A to the Loose Ends Agreement. Annexure A outlined work in Stages that were not the subject of the earlier Development Lease. Clause 5.2 stated that:

"Links will assume the responsibility for the Development Works in exchange for payment of the sum of $4,134,000.00"^[134] T documents, T16 at 607

Under cl 5.3, Lakes and Clubs were required to pay that sum to Links from the settlement proceeds from the Stage 23 land. On 29 August 2003, Links issued an invoice for that amount to Lakes.^[135] T documents, T21 at 660

Lakes' records of loans to SLGC and SLRA

106. Lakes' Statements of Financial Position for the income years ending 30 June 2002, 2003 and 2004 show the way in which it recorded the loans made to SLGC and SLRA in those years and in the previous 2001 income year. The relevant entries are made under "Receivables" under the general heading "Non Current Assets":

107. In a letter dated 21 July 2005, Bentleys mri (Bentleys), chartered accountants and business advisors, wrote to the ATO in response to correspondence from and a meeting with its officers. It dealt with the cost of goods sold by Lakes, being the sales by Stage of the development, and the cost of goods sold by SLGC, being the sale of memberships.^[139] ST documents, ST8 at 988-989 Attached to its letter was a note relating to the loan and sale of memberships:

"

" Losses on Sale of Land/Loans Forgiven
Amount as per Financial Statements 30 June 2003	$8,436,342
Being Cost of purchase of 527 SLGC Memberships	10,064,142
Less : Receipt for sale of Memberships	1,627,800
Net Tax Loss on Sale of Memberships	$8,436,342

• (1) Sanctuary Lakes in their pursuits of developing and selling Golf Course housing estates, took the economic decision to keep on making advances (as marketing/development costs) to Sanctuary Lakes Golf Club ('SLGC') (an unrelated party) to keep the Club afloat as to be able to sell properties at a profit.

  Costs were capitalised with a view to eventually collect [sic] these amounts once the Golf Club became profitable (refer Promissory Note).

  Under the Deed of Arrangement between Sanctuary Lakes Club and Sanctuary Lakes (unrelated) Clause 2, Sanctuary Lakes was to issue Golf Club memberships in satisfaction for the release of SLGC from all liabilities. Therefore, the Loan Balance of $10,064,142 forms the cost of the Memberships purchased. These memberships were then sold to Links Sanctuary Lakes for $4,000,000. As at 30 June 2003, only $1,627,800 of this $4,000,000 had been received.

• (2) In accordance with Clause 3, Agreement dated 2003, Sanctuary Lakes was to be paid 527/1295 of $4,000,000 (refer Clause 1 or [sic] Deed of Arrangement).

  Year ending 30 June 2003, ie: 527/1295 × $4,000,000 = $1,627,800.

NB:

The loan write off should NOT have been disclosed as a Loan Forgiven."^[140] ST documents, ST8 at 1025

108. The financial records that I have do not disclose the advances' being recorded as marketing costs at any relevant time. Mr Kenneth Tan confirmed that this was so.^[141] Transcript at 101

Club's records of dealings with SLGC

109. Clubs' Financial Statements for the income years ending 30 June 2002, 2003 and 2004 show the way in which it recorded the loans to SLGC and the sale of SLGC memberships. The relevant entries are made under "Receivables" under the general headings "Current Assets" and "Non Current Assets":

CONSIDERATION: ISSUES RELATING TO THE ASSESSMENT

ISSUE 1 : Is Lakes entitled to claim a deduction in the 2003 income year for a loss of $8,436,342.00 incurred on the sale of memberships in SLGC?

Summary of parties' submissions

110. Mr Sest's submissions are directed more to a critique of the Commissioner's submissions than putting forward a case directed to demonstrating how Sanctuary Lakes may discharge its burden of proof. I understand that Mr Sest is submitting that I should have regard to the whole of the transactions in which Lakes was engaged. I should not ignore Lakes' agreement to permit Links to be substituted as the purchaser of the Sunland land should the sale to Marington not proceed. Lakes' income from the sale of Stage 23 land under the Development Lease and associated agreements should not be ignored and nor should its income from the lease premium under the Development Lease granted to Links. The Development lease contained "best endeavours" provisions to achieve and complete the transactions and outcomes contemplated and the Supplementary and Loose Ends Agreements contained provisions ensuring compliance by both Links and Lakes. Mr Sest referred particularly to cll 23.1 and 23.3 of the Development Lease which he said anticipated that Lakes and Links would continue to use their best endeavours to achieve and complete the transactions and outcomes it contemplated. The oral evidence was to the effect that the oral agreement to exchange the memberships for the debt was made after the Gurry report of 2 April 2002 and before the meeting of the Board of Holdings on 19 November 2002.^[144] Transcript at 117, line 4; 120, line 38; 120, line 18; and 121, line 37. The Deed of Arrangement itself had an effective dated of 1 September 2002. In any event, the precise dates of the agreements do not matter. What is important is that all agreements were entered in the 2003 income year.

Consideration

A. Regard to be had to the whole context

111. I agree with Mr Sest's submission that I should have regard to the whole context in which the transactions were conducted. The authorities that have considered s 8-1(1) or its predecessor, s 51(1) of ITAA36 have decided that I must have regard to the circumstances and transactions in order to determine the character of an outgoing made by a taxpayer.^[145] See [285]-[305] below Those circumstances and transactions are not, however, necessarily limited in time to events following the acquisition of the memberships in SLGC. Taking the case of Western Gold Mine as an example, the High Court looked to the taxpayer's circumstances and intentions that preceded the disposition of the mining leases to the larger company. Even in the case of Nevill, in which future savings to the employer were all important in characterising the lump sum payment made to Mr Nevill on the cancellation of his contract of employment, the High Court looked to the employer's intention in engaging Mr Nevill in the first place. Both his engagement and his termination were directed to business efficiency. His engagement was directed to his employer's generating a greater income and his termination to its saving outgoings.

B. The context

112. In this case, the wider circumstances begin with the nature of the development at Point Cook that was to become Sanctuary Lakes. It was envisaged as a high quality residential development with the attraction of a lake and waterways and a golf course designed by an internationally known golf course designer and former golfer. These were features that were featured in its promotional material and so, I find, an important part of the marketing of the residential land at Sanctuary Lakes.

113. Neither the ultimate holding company, Exclusive Region, nor the Australian holding company, Holdings, actually carried out the development work. They established a corporate structure to undertake that. Lakes and Clubs were the two companies with responsibility for the development of the land and the facilities. The concept of the development as a resort style development with facilities to suit continued to be the vision. Lakes developed the majority of the development. The golf course remained part of the vision and Clubs worked on its development. Clubs marketed memberships in an unincorporated association while the golf course was still under construction. It sold memberships at that time. The memberships conferred on their owners a right to play on the golf course when it was completed. Clubs received the membership fees which were held in Maddocks' Trust Account.

114. On the basis of the findings of fact I have already made above, I find that, if they had ever had it, Lakes and Clubs had long since given up any notion of remaining responsible for the ongoing maintenance of the golf course or of the residential development once they had developed them. They had envisaged that maintenance would, by some means, become the responsibility of the residents in so far as the Lake and waterways were concerned and of the members of a golf club and/or those who played on it so far as the golf course was concerned. They established SLGC and SLRA as companies limited by guarantee to begin the process of transition of financial responsibility from themselves to the residents and a group I will describe as "the golfers".

115. There were insufficient residents and golfers to provide the funds necessary to carry out the work necessary to complete or maintain the common or general areas in the residential part of the development or to complete and maintain the golf course. Residents provided funds in the form of service fees payable to SLRA and golfers in the form of their membership and ongoing annual subscriptions. SLGC and SLRA turned to Lakes for funding. Instead of one or other of Lakes or Clubs funding their employees or contractors to undertake the work as they had done before the establishment of SLGC and SLRA, Lakes now provided the funds to those two entities in the form of loans.

116. SLGC continued to face difficulties in funding its activities and in marketing its memberships. It was against that background that SLGC and Lakes came to enter the Deed of Arrangement. I am not satisfied that, at that stage, Lakes had in mind anything more than the way in which it could reduce or eliminate what it saw as its exposure to the ongoing financial drain represented by SLGC.

117. I make that finding while also finding that the investors were considering various options regarding the future of the project and their involvement in it. As I have found above,^[146] See [66] above three options were considered by the investors at a meeting on 6 August 2001. They were continuing the project as it was but reducing debt, selling the whole project, super lots or equity in order to reduce their liability or reducing their debt but continuing the project as a whole with the sale of super lots as a possible option.

118. The Deed of Arrangement has an effective date of September 2002 but is undated. Whether it was signed on the effective date or at some time before, its negotiation would have preceded that date. Taken in isolation from other events for the moment, its being signed and its content is consistent with any one of the three options considered by the investors in August 2001.^[147] In summary they were: (1) continue as things were but to target low debt, payment of low dividends or a mix of debt reduction and smaller dividends; (2) sell down by selling the whole project, super lots or equity with the object of reducing liability; and (3) adopt a balanced strategy to reduce debt to a level of between $6 million to $10 million but yet retain a level of debt that was not detrimental to the project as a whole. They are as consistent with a proposal to sell the whole project to another developer as with a proposal to keep the whole project or to sell super lots. Its negotiation post-dates Mr Gurry's report to the directors of SLRA and SLGC on 2 April 2002. That proposes the exchange of memberships for the cancellation of the debt.

119. Mr Rennick has given evidence in his statement that Links was not willing to acquire the Sanctuary Lakes development while SLGC and SLRA were so deeply indebted to Lakes and Clubs. He was aware from his participation in the negotiations with Stockland and for possible listing on the Australian Stock Exchange that concern about that debt was an inhibiting factor. It was a hurdle to the exit strategy proposed by Mr Michael Tan and the investors.^[148] Exhibit B at [72]-[73] He put these matters this way in his statement:

"68. The proposed transfer to Links was accompanied by a number of factors which led to a complex and piecemeal disposition. Those factors included the following:

• (1)-(3)…
• (4) I know from my involvement in many discussions with Stephen Head that he was opposed to Links acquiring an interest in the project when the Golf Club and the Residents' Association had large outstanding debt obligations to Lakes and Clubs."^[149] Exhibit B

"72. As mentioned, it was necessary for Michael Tan and the foreign investors to address the debts of the Golf Club and the Residents' Association before any disposition could take place. As I have said, it was clear that Links was not willing to acquire the Sanctuary Lakes development whilst these two entities, vital to the ongoing success of the development, were so deeply indebted to Lakes and Clubs. Indeed I am aware from my participation in the negotiations with the Stockland Group, and the work I did for the possibility of listing on the Australian Stock Exchange, that similar concerns about those debts were a factor that inhibited the pursuit of those two alternate dispositions."^[150] Exhibit B

"78. The strong attitude of Links against continuing to carry the debt-burdened Golf Club (and Residents' Association) is further exemplified in Stephen Head's later communications of 7 May 2003 and 15 May 2003. … In them Stephen Head insisted on the forgiveness of the debt owed by the Residents' Association, and that any amount Links would pay for the golf club memberships had to be part of a 'package deal'. Also in recognition of the intricate and integrated nature of the overall development, Stephen was adamant that it was impossible to reconcile the terms of the proposed transaction if assets and liabilities were to be separated into individual items."^[151] Exhibit B

120. Ms Schilling drew Mr Rennicks' attention to these passages and the correspondence to which they referred. She asked him about the timing of events in the following exchange:

"… I wondered in terms of timeframe whether you had a view as to when those debts, and specifically the debt that was owed by the golf club, was resolved by way of the exchange for the memberships, because you clearly, in the witness statement, appear to have formed the view that was prior to the arrangement with Links? --- The point I think I'm making in the statement is that the debts that were then outstanding for both Sanctuary Lakes Residents Association and the club were of significance to a purchaser, any purchaser, and had a significant impact on value and needed to be addressed in that acquisition.

Yes? --- And were then subsequently dealt with, I think, and so the timing - I'm not sure of the timing of it - but the issue was it was an ingoing issue for many months prior to - and for probably many years, actually, prior to the acquisition by the Links Group.

Right? --- And so the issue really would have had to be dealt with."^[152] Transcript at 221-222

121. Ms Schilling drew Mr Rennicks' attention to matters of timing first in relation to SLGC and later in relation to SLRA. A letter subsequently written by Maddocks to the ATO on 3 April 2006 said:

"Although the Residential Development and the Golf Course Development were linked in many ways, they were still stand alone developments that were meant to generate independent profits. Accordingly, it was decided that each development would be conducted in different, albeit related, companies.

In the case of Clubs its business or profit making undertaking or scheme was the undertaking of the Golf Course Development which included the development of the golf course and related facilities and the development of the residential land within the precincts of the golf course. Clubs' residential land (Stage 8) contained some of the most valuable residential lots. Clubs never intended to and did not operate a golf club business. It was anticipated that the profit from the Golf Course Development would be made from the receipt of membership fees and the proceeds from the sale of the golf course land and the residential land that it owned."^[153] T documents at 868

In cross-examination, Mr Rennick confirmed that Clubs was intended to generate profit through the sale of memberships as well as through the sale of land.^[154] Transcript at 205

122. I have turned also to the written material for guidance and to Mr Head's involvement for he was to become a director of Links. Certainly, Mr Head was involved in the discussions about Lakes' ongoing concerns regarding the funding of SLGC and of SLRA. In an email sent on 28 February 2002 to the directors of SLRA and SLGC and copied to Mr Kenneth Tan among others, he put forward possible ways in which those concerns could be resolved. His doing so was entirely consistent with his being a director of SLRA and SLGC and he specifically stated that he was writing in that capacity. At the time, he was also a director of Asset Solutions, which was an independent contractor in the development of Sanctuary Lakes and which had been appointed as the project's Australian project manager. Together with Mr Yuh Lin Lee, Mr Head was responsible for the daily activities and decision-making in relation to the project.

123. It might be thought that his doing so was also consistent with his preparing, through Links, to take over the project. On the evidence that I have - and I have none from Mr Head for he was not called - there are two things that militate against this thought. The first is that Links was not incorporated and he did not become its director until 9 July 2002. That was the same date on which it entered the Development Lease with Lakes and some five months after his email to the directors of SLRA and SLGC. It could be said that it takes five months to put the pieces in place. That may be so but I cannot forget that Mr Head said that he was specifically writing in his capacity as an "honorary director" of both SLRA and SLGC. The substance of his email does not suggest any motive beyond the desire to put a management structure in place that could deliver results, ensure that SLRA and SLGC were solvent, make the memberships in SLGC attractive in a market place in which golfers have "plenty of choice" and change the fee arrangements for future owners of residential lots. That might have been in the best interests of what was to become Links but Mr Head has not given any indication that he is thinking more broadly. In fact, the catalyst for his writing the email is more likely to have been the notice he had received the night before from the ATO than any plan in relation to what might or might not have been his long term ambitions to take over the project. That notice had demanded that he and the other directors of SLGC, personally pay its outstanding taxation liabilities.

124. Mr Head might have thrown some light upon the matter to show that negotiations were taking place or even that he was investigating the possibility of taking over the project through a corporate vehicle yet to be established. He was not called. There may be good reasons for that and I do not rely on the case of
Jones v Dunkel to draw any inference from the fact that he has not been called. What I do find is that, in his absence, I cannot attribute intentions to him beyond those that I can draw from the words he has written.

125. The second thing that may militate against it is that the investors had certainly begun to implement their plan to divest themselves of the project to some extent. That is clear from the fact that Lakes sold part of its parcels of land to Marington and Lakes and Clubs sold other parcels to it (i.e. the Sunland land) on 26 June 2002. Negotiating and completing a sale of that size could reasonably be expected to have taken some time to come to fruition. It is consistent with the exit strategies discussed by the investors nearly a year earlier on 6 August 2001. The Sunland land was land undeveloped by Lakes. It would be expected that, if the investors were also implementing the option of divesting themselves of that part of Sanctuary Lakes that had been developed or was in the course of being developed that some reference would be made to it in the material I have been given. Instead, the only material that I have makes no reference to it.

126. Having regard to all of the material, I am not satisfied that the Deed of Arrangement was part of a broader transaction to enable the investors to divest themselves of responsibility for the project and pass it to Links. That transaction was to come later and it cannot affect the characterisation of the dealings involving the transfer of the memberships from SLGC to Lakes under the Deed of Arrangement.

127. The debt of $10,064,143.00 owed by SLGC to Lakes was an asset owned by Lakes. It exchanged that asset for a total of 527 memberships in SLGC as Maddocks wrote to the Commissioner in their letter dated 3 April 2006.^[155] T documents, T32 at 871 Those memberships are also assets and the amount of the debt represented their cost. They were described by Bentleys as "goods" in their letter to the Commissioner dated 21 July 2005.^[156] ST documents, ST8 at 1024-1025 As shown in the attachment to Bentleys' letter at [107] above, the Loan Balance of $10,064,142 formed the cost of the memberships. All that had changed was the form of the asset held by Lakes. It could no longer look to SLGC for repayment of a debt but, subject to the restrictions in SLGC's constitution, the memberships could be transferred to other persons.

C. The purpose for which Lakes held the memberships

128. The minutes of the Board meeting of Holdings held on 18 November 2002 reveal that the directors were not quite sure what to do with the memberships they had acquired. They were aware that annual subscriptions would be due on each and funding needed to be provided to meet it.^[157] T documents, T13 at 543 Consideration was given to allocating the memberships to individual shareholders in Lakes and Clubs, disposing of them en bloc to a third party and leasing them to family and friends in the hope that they would be encouraged to purchase the memberships. The directors rejected a proposal that Links settle the annual subscriptions on its behalf in exchange for the full freedom to dispose of them at any price it deems fit. They adopted a proposal to commit $3,000.00 each month to advertising the memberships for sale on the basis that "… the risk is minimal compared to the sales potential".^[158] T documents, T13 at 543

129. On the assumption that Lakes would sell or transfer the memberships for the fees that were payable to SLGC had they been issued by SLGC to an individual member and not allowing for Goods and Services Tax, Lakes would receive a little less than $8 million. There seems to be an assumption in the minutes of the meeting of Holdings on 18 November 2002 that the memberships could be bought and sold. That may be so but, if it is, it cannot be said that Lakes' right to sell would be unfettered. It would be limited by the terms of SLGC's constitution, which required the Board's approval to a transfer. The fetter on the Board's not being permitted to approve any transfer until three unissued memberships had been sold had been effectively removed by SLGC's having issued 527 memberships to Lakes on 30 June 2002 and, on the same day, having issued 768 memberships to Clubs in variation of its previous obligation to transmit to Clubs the membership fees from 1,000 memberships issued after 30 June 1999. Given the number of memberships already sold and the limit of the memberships to 1,700, the fetter was, for all practical purposes effectively removed.^[159] 1,295 memberships were issued to Lakes and Clubs. Given that the total number of memberships was limited to 1,700, that meant that approximately 400 were held in private hands (as recorded in Holdings’ minutes) leaving only 5, if that many, unissued by SLGC.

130. Commitment of an advertising budget suggests that the decision was made to hold the memberships for sale. That view is supported by the evidence of Mr Kenneth Tan to that effect given in cross-examination.^[160] Transcript at 126, lines 9-15 It is also supported by the spread sheet that he prepared and is headed "Analysis of Anticipated Membership Sales and Subscriptions".^[161] T documents, T14 at 548-549 and Transcript at 124-125 The document is undated but begins from the position of membership sales in March 2003 and proceeds on an assumption that five Gold and five Silver memberships so that all are sold by September 2014.^[162] T documents, T14 at 548-549 The substance of the spread sheet is consistent with Mr Kenneth Tan's evidence, which I accept, that he prepared it in February or March 2003.^[163] Exhibit A at [130] I also accept his evidence that the spread sheet was subsequently provided to investors to help them to consider whether to sell the memberships progressively or to sell them all immediately.^[164] Exhibit A at [130]

131. Holding the memberships for sale is also consistent with the nature of the project as a whole. Lakes was not established for the purpose of trading memberships but it was part of a corporate structure put in place to develop Sanctuary Lakes. I have already found that the golf course was a marketing feature of Sanctuary Lakes. Entities were established to meet the needs of the project as it proceeded. Therefore, Clubs established an unincorporated association under its administration and marketed memberships in that unincorporated association conferring a right to play on the course when it was completed. The golf club was later restructured.

132. Whatever the structure, Holdings, Lakes and Clubs, as well as the investors, all continued to have an interest in the continuing viability of the project. Having set in place a structure that enabled SLGC and SLRA to satisfy the debts they owed Lakes and Clubs, they had to remain financially viable into the future. Apart from dining facilities, possibly green fees and the like, a major source of SLGC's future funding would come from the annual subscriptions payable on the memberships it had issued. It is apparent from the minutes of the meeting of Holdings' Board that it saw the need to shift the liability for those annual subscriptions on to other people rather than its, or presumably Lakes, carrying it into the future. That would have been counterproductive to the strategy that had been adopted to remove Lakes from the responsibility of financing SLGC's activities.

133. Lakes' Profit and Loss Statement for the 2003 income year shows under the heading "Other income" the entry of "Golf Membership $1,627,800.00" and under the heading "Other expenses" the entry of "Golf Club Memberships $10,064.141.68".^[165] ST documents, ST8 at 1007-1008 The memberships remaining unsold at the conclusion of the 2003 income year are not included in Lakes' assets in the Balance Sheet. The Balance Sheet would appear to be incomplete in this regard but the Profit and Loss statement supports a finding that, at least in the 2003 income year, Lakes treated the memberships as trading stock.

134. Having regard to all of the material and of the findings I have made, I am satisfied that Lakes held the memberships for the purpose of selling them. Sale of those memberships had not been part of their daily business to that point but it was part of the strategy engaged in by Holdings, Lakes and Clubs to bring the project at Sanctuary Lakes to completion. They were separate entities but each did what was necessary at the time in order to achieve the intended outcome. It is clear from the Board meeting of Holdings, for example, that the directors discussed what was to be done about the memberships without acknowledgment that they were owned by what is, in law, an entity separate from it. Clubs took over the role of service provider to SLGC. The fact that Lakes had not traded in memberships before it entered the Deed of Arrangement does not detract from its doing so after that time. That was the role it now had to play and it became part of its ordinary course of business. They became its trading stock.

D. The memberships as trading stock

135. The consequence of my finding is that s 70-25 means that Lakes' outgoing in acquiring the memberships cannot be regarded as an outgoing of capital or of a capital nature but, more importantly, the amount of the deduction it may claim is regulated by Subdivision 70-B of ITAA97. That means that, if Lakes is to claim the whole of the $10,236,191.68 as the outgoing attributable to its acquisition of the memberships, it and SLGC must have dealt with each other at arm's length. Having regard given to the expression "arm's length" in s 995-1(1) of ITAA97, whether Lakes and SLGC did so can only be determined after considering any connection between them and any other relevant circumstance. I have set out the law above and it is to the effect that, whether two parties have transacted with each other on an arm's length basis, must be determined on an objective basis having regard to all relevant circumstances. It is not determined simply by reference to whether they have an arm's length relationship for a relationship of that sort and an arm's length transaction are two different things.

136. Mr Sest has addressed his submissions on this issue on the basis that I must have regard to the ultimate sale to Links because the initial acquisition was undertaken with that in mind. I have already made a finding that is contrary to that assumption.

137. Mr Sest also submitted that:

"… If… The Tribunal is minded to accept the Commissioner's claim that the 'market value' of the 527 memberships at the time of the acquisition is the subsequent price paid for them by Links ($1,627,800), then Lakes incurred the subject loss or outgoing of $8,436,342 at the time it acquired them (1 September 2002). That loss or outgoing remains deductible in the 2003 year under s 8-1.…"^[166] Applicant’s submissions at [214]

The trading stock provisions do not apply and/or do not prevent the deductibility of the loss.

138. Mr Sest's submission is addressed to s 70-20 of ITAA97. It depends on my accepting that the price at which the memberships were sold to Links, or some other price less than $10,236,191.68, represented their market value. Only if it did does s 70-20 come into play and permit the sum of $10,236,191.68, which was Lakes' outgoing, to be treated as the memberships' market value. Mr Sest pointed to the Commissioner's submission at [45(e)] of his Submissions that the sale of the memberships to Links was "properly indicative" of their market value.

139. On the material that I have, I am not satisfied that this is the case. Furthermore, I am not satisfied of what the market value of the memberships was at any time. The only valuation evidence that I have is an actuarial valuation but that is not a market valuation. The sale of the memberships to Links does not obviously have the hallmarks of a sale that has taken place between a willing but not anxious purchaser and vendor bargaining with each other. The sale of the memberships had continued to be slow and Lakes was concerned about its liability to pay the ongoing subscriptions due on the memberships, most of which remained unsold. Lakes was a willing vendor but I am not satisfied that it was not an anxious vendor. Links was a willing purchaser and there is no reason to think that it was an anxious purchaser.

140. Even if Lakes was not an anxious vendor, I am not satisfied that the price Lakes and Links agreed upon could be said to be the price that a fully informed and willing but not anxious, vendor would reach with a similarly disposed purchaser when freely contracting with each other. I have formed that view after considering the minutes of the Board meeting of Lakes on 14 May 2003 and Mr Head's email to Mr Harry Tan on 15 May 2003. Mr Head accepted that Links would pay $4 million payable over three years for the SLGC memberships. That was an increase from the total of $2 million that he had originally offered together with meeting all past, present and future subscriptions but Mr Head emphasised that the offer was part of an "overall package". Mr Head told Lakes that it would be very difficult to reconcile the package if separated into individual items. That means that neither Links' original offer nor its amended offer can be regarded as representing its offer for the memberships alone. It cannot be taken as the price paid by Links for the memberships let alone a reflection of their market value.

141. Lakes has not satisfied its burden of proof on this issue. It cannot succeed even though the Commissioner has adopted a particular view of the quantum of the memberships' market value. As Gauci decided, the Act does not place any onus on the Commissioner to show that the assessments were correctly made.

ISSUE 2 : in 2003 income year, is Lakes entitled to deduct all or any of the sum of $1 million deposited in Maddocks' Trust Account on 29 January 2003?

Summary of parties' submissions

142. On behalf of Lakes, Mr Sest submitted that it was entitled to deduct the sum of $1 million paid into Maddocks' Trust Account as it had paid it in satisfaction of a liability it had incurred to Links under cll 4.2 and 5.2.3 of the Supplementary Agreement. Clauses 5.2.2 and 5.2.3 provided for the time of the performance of that obligation but the fact that the time of the performance of the liability was deferred did not affect the fact that liability had been incurred from the commencement date of the Supplementary Agreement i.e. 16 August 2002. This is the proper interpretation of both the Development Lease and the Supplementary Agreement considered in the surrounding circumstances.

143. Both the Supplementary and Loose Ends Agreements addressed matters expressly and directly relevant to the operation of the Development Lease. These matters included the discharge of s 173 obligations which continued to fall upon Lakes but which would be discharged by Links. Observance of these obligations was critical to Lakes' preserving the lease premium and the income it expected to receive from Stage 23. Had Lakes not entered into the two later agreements, it would have run the risk that its income from both sources would have been unduly diminished either through disputation as to the performance of the Development Lease or, ultimately, litigation.

144. Further or alternatively, if payment of the sum of $1 million were to represent a prepayment, Lakes has taken advantage of a commercially realistic benefit being the discharge of its obligations under s 173 of the PE Act by Links.

145. On behalf of the Commissioner, Ms Schilling submitted that the proper construction of the Development Lease, the Supplementary Agreement and the Loose Ends Agreement was that the money paid into Maddocks' Trust Account was held on behalf of Lakes and Clubs. Lakes' liablity to pay the money did not come into existence until Links directed that it be paid out of the fund.

Consideration

146. I agree with Mr Sest that Lakes and Clubs were under an obligation to pay the sum of $1 million into Maddocks' Trust account and, without more, am satisfied that they were the beneficial owners of that money at that time. Links had assumed all of Lakes' and Clubs' obligations in respect of any agreement under s 173 of the PE Act relating to the land in so far as it could be said that the agreement touched upon issues directly or indirectly relating to the works carried out by Links.^[167] Development Lease at cl 10.2; T documents, T12 at 518 At that time, Lakes and Clubs were under no obligation to pay Links in exchange for its adopting their obligations or to reimburse Links for its expenses. Lakes and Clubs only assumed an obligation to do so under the Supplementary Agreement. Its obligation was to pay $1 million into Madgwicks' Trust Account. Without more, they remained the beneficial owners of that money. That is the effect of cl 5.2.3 which provided that it was held on their behalf.

147. That finding does not determine whether or not the $1 million was deductible in the 2003 income year. Even if it is held on Lakes' and Clubs' behalf and they are its beneficial owner, it will be deductible if they had committed themselves to paying it to another even though they remain the beneficial owners in the meantime. On my understanding of the Supplementary Agreement, Links was not entitled to any part of the $1 million at the outset. Rather, the money, or part of it, was to be applied at Links' direction towards the satisfaction of Lakes' and Clubs' obligations under s 173 of the PE Act. That is the effect of cl 5.2.3.

148. Lakes and Clubs were only able to recover any part of the $1 million in the trust fund if a Certificate of Completion had been issued in respect of each of the obligations under s 173 of the PE Act or if Links confirmed that the monies were "no longer required to be held". That is the effect of cl 5.2.4 of the Supplementary Agreement. Confirmation that the monies were "no longer required to be held" is consistent with a finding that the monies had been set aside to satisfy Lakes' and Clubs' obligations under s 173 of the PE Act. Setting money aside does not mean that the funds had been committed to Links at that time. It does not mean that the monies are properly characterised as a prepayment of a future obligation. What it showed was the maximum amount of money that Lakes and Clubs would commit to its s 173 obligations if required to do so. It does not show that it committed itself to any payment at the time of payment of the monies into the trust account. Commitment to pay Links only came about when Links gave Maddocks a direction to apply the monies, or part of them; not before. Links' direction was not a mere matter of timing of performance of an obligation but a matter of creating the obligation.

149. It follows that I am not satisfied that the sum of $1 million paid by Lakes into Maddocks' Trust Account on 29 January 2003 was deductible by Lakes under s 8-1(1) of ITAA97.

ISSUE 3 : Is Lakes entitled to an income tax deduction in the 2003 income year for the amount of $3,410,252 being the write-off of advances (incorrect) made by Lakes to SLRA?

Summary of parties' submissions

150. Mr Sest submitted that Lakes had extended loans to SLRA to enable it to remain viable to facilitate land sales and so generate income from them. As the loans were intended to provide SLRA with working capital, the debt should be characterised as an item on revenue account. Links required forgiveness of the debt and this was formalised in the Loose Ends Agreement. Mr Sest referred to the witness statement of Mr Rennick at [68(4)] and [72],^[168] See [119] above the email from Mr Gurry addressing issues relating to the debts owed by SLGC and SLRA and "… concerns and unrest caused by the 'selling due diligence process' which un-nerved residents and members".^[169] Exhibit B, KT-15

151. He referred also to what he described as "concessions" by the Commissioner in his Submission on Evidence and Penalties at [57(h) and (i)]:

"In summary, the evidence before the Tribunal in relation to the circumstances surrounding Lakes' acquisition of the Memberships is consistent with [sic] following scenario:

• (a)-(g)…
• (h) it can be inferred that Lakes' intentions with respect to the memberships changed as negotiations with Links proceeded in May 2003, and the priority became, in the words of Mr Tan, to achieve a ' clean exit' from the development (TR 163 line 41); and
• (i) Lakes therefore took what they could for the Memberships from Links."

Mr Sest acknowledged that these paragraphs referred to Lakes' intention with regard to SLGC but submitted that a "necessary consequence is that it operates as a concession also in relation to this Issue…".^[170] Applicant’s Submission in Reply at [130]

152. Mr Sest submitted that the matters addressed under Issue 1 are also relevant here. It makes no difference that Issue 1 concerned the SLGC memberships and this issue, being Issue 3, concerns the SLRA debt. Regard must be had to Lakes' income from the sale of Stage 23 land under the Development Lease and associated agreements as well as its income from the lease premium under the Development Lease granted to Links. Regard needs to be had to Lakes' agreement to substitute Links as the purchaser for the Sunland land should it not be sold to Marington. The Development lease contained "best endeavours" provisions to achieve and complete the transactions and outcomes contemplated and the Supplementary and Loose Ends Agreements contained provisions ensuring compliance by both Links and Lakes.

153. On behalf of the Commissioner, Ms Schilling submitted that any contention that there was a nexus between Lakes' receiving the Development Lease premium and its forgiving SLRA's debt could not be sustained. She pointed to the fact that the Development Lease had been executed on 18 August 2002 and the fact that the lease premium was paid on that date. Lakes, on the other hand, did not forgive SLRA's debt until late in May 2003. Even if it could be established that there were a nexus, the outgoing made by Lakes was a capital outgoing.

Consideration

154. I do not read the Commissioner as having made a concession in the paragraphs to which Mr Sest refers. A "concession" is "something conceded or allowed" and so something admitted to be true or correct.^[171] Chambers 21st Century Dictionary, 1999, reprinted 2004, Chambers The Commissioner's contention that the evidence is consistent with a scenario that includes as its components the matters referred to in [57(h) and (i)] is not admitting that they are true or correct. It is an assertion or a point that the Commissioner makes on the evidence as he understands it to be; nothing more.

155. I have already found that the Loan Agreement between SLRA and Lakes was executed on or about 18 August 2000. It provided for repayment of the loan with interest and was treated as a loan which SLRA could be called upon to repay. Proposals such as that of Mr Gurry on 2 April 2002 regarding restructure recognised that the debt existed. At the same time, I find that it was recognised that repayment was beyond SLRA's capacity. That is based on Mr Kenneth Tan's notes of his meeting with Links on 2 May 2003. It is consistent with Mr Head's statement to Mr Harry Tan when he wrote to him on 7 May 2003.

156, I have looked also to Mr Rennick's evidence to the effect that Mr Head insisted on Lakes' forgiving SLRA's debt and to the documentary evidence on which he relies i.e. Mr Head's letters of 7 and 15 May 2003. On the basis of Mr Head's letter of 7 May 2003, I find that he noted that Lakes would release SLRA from its obligation to repay its current debt. Although I have set it out above, I will repeat the paragraph:

"You will release the Residents' Association from its obligations to repay to you the current debt. This release recognises the practical reality that the Association will not ever be in a position to repay. We understand it also creates a tax deduction for you."

It is a carefully worded paragraph. All that it does is note what Lakes proposes to do. It does not suggest that Links requires Lakes to take this action or that forgiveness of the debt is in any way relevant in Links' affairs.

157. That this is all it does is consistent with the fact that Links had already committed itself to its obligations under the Development Lease on 16 August 2002 but with effect from 9 July 2002. It was not in a position to require Lakes to undertake any action as a condition of its proceeding with its obligations under the Development Lease.

158. The debt owed by SLRA is to be contrasted with the memberships. Links had put forward a proposal to take over the memberships transferred to Clubs. At the time, Clubs was incurring ongoing membership fees. Links put forward a proposal that would relieve Clubs of those fees while dealing with other matters of concern to it in relation to matters arising under the Development Lease and ongoing project. As recorded in the minutes of the meeting of the executive committee, Mr Cheah Min Loong and Mr Harry Tan, specifically responded to each of the proposals put forward by Mr Head. The response to Item 6 dealing with the SLRA debt was that it would be treated independently from the "wrap up" with Links. I do not have the letter written by the investors to Mr Head on 14 May 2003, the same day as the executive meeting, but I am satisfied that it would have advised him that the SLRA debt would be dealt with separately. Indeed, the meeting resolved to direct Mr Kenneth Tan to write to Mr Head to that effect. Therefore, the matters that formed the "whole package" to which Mr Head referred in his email to Mr Harry Tan on 15 May 2003 would have been all of the matters in his proposal excluding the SLRA debt.

159. I have examined the earlier material to see whether the ongoing debt owed by SLRA had played a part in Links' deciding whether or not to enter the Development Lease. Mr Rennick suggested that the debts had been of ongoing concern for many years. That I accept. I also accept that it may have affected potential purchasers such as Stockland, to which he referred, and caused problems with listing Lakes on the Australian Stock Exchange as Mr Rennick said, but I also find that Lakes and Clubs were able to sell the Sunland land to Marington. Whether, and to what extent, the debt had an impact on the sale I cannot ascertain but it was clearly sold.

160. I have looked also at the statement made by Mr Gurry on 19 May 2001 that residents and members of SLGC had "… concerns and unrest caused by the 'selling due diligence process' which un-nerved residents and members". If I understood the submission correctly, this is put forward in support of a contention that there were moves to sell the project or part of it at this time. There might well have been a "selling due diligence process" going on at this time for the investors had, at their meeting on 6 August 2001, been looking at three options including options to sell some or all of the project. That does not lead me to find that forgiveness of the debt would be a condition of any sale that might occur and certainly not a condition of the transactions that were negotiated between Lakes and Clubs and Links and became the Development Lease, Supplementary Agreement or the Loose Ends Agreement.

161. The fact that cl 7 of the Loose Ends Agreement provides that "Sanctuary Lakes agrees to forgive the debt" does not lead to any different conclusion. It is not expressed as a condition of the contract. Had Lakes failed to forgive the debt, it might be that Links could have claimed damages but that does not alter the fact that Links had, in or about October 2002, undertaken to pay the $28 million Lease Premium. That was long before 30 June 2003 when the Loose Ends Agreement came into effect.

162. It follows that I am not satisfied that forgiveness of the debt would be a condition of any sale that might occur and certainly not a condition of the subsequent agreements that were negotiated between Lakes and Clubs, on the one hand, and Links on the other. Therefore, there is no connection between Lakes' incurring the loss when writing off the advances to SLRA and its gaining assessable income in the form of the Development Lease premium. The sum of $3,410,252 cannot be claimed as a deduction under s 8-1(1) of ITAA97. I do not need to consider Ms Schilling's alternative submission that Lakes' outgoing was a capital outgoing.

ISSUE 4 : Is Lakes entitled to a deduction of $4,134,000 in the 2003 income year in respect of its obligations to undertake development works under cl 5.2 of the Loose Ends Agreement (too limited)?

Summary of parties' submissions

163. Mr Sest submitted that the Commissioner failed to take into account the whole context of the agreement. That must be done in order to determine deductibility and is an exercise not limited to juristic rights. Mr Sest submitted that, by entering the Loose Ends Agreement, Lakes had committed itself to making the payment.

164. Ms Schilling submitted that, properly construed, Lakes was not under any obligation to pay the sum of $4,134,000.00 until it received settlement of the proceeds from Stage 23 land. I must interpret the Loose Ends Agreement on an objective basis. The subjective motives or intentions of the parties are irrelevant.

Consideration

165. Lakes paid the sum of $4,134,000.00 to Links and it is clearly an outgoing for the purposes of s 8-1 of ITAA97 but the question is: when was the outgoing incurred? Did Lakes incur the outgoing on 30 June 2003 (the 2003 income year) or on 29 August 2003 when Links issued an invoice to Lakes for $4,134,000.00 "Representing fee for outstanding works pursuant to Clause 5.2 of the second Supplementary Agreement dated 30 June 2003" and Lakes paid it (the 2004 income year). The answer to the question depends upon the interpretation of the Loose Ends Agreement and not upon a commercial view of the matter. That is apparent from the majority judgment of the High Court in Coles Myer. The liability must arise in the year of income in which it is claimed as a deduction as an outgoing under s 8-1. A timing affecting the discharge of a liability does not necessarily mean that the liability did not arise at an earlier time. That is illustrated by cases such as RACV Insurance and Merrill Lynch.

166. That means that I must go back to the words of the Loose Ends Agreement and particularly to cl 5 dealing with the sum of $4,134,000.00. Clause 5.1 acknowledges that Lakes and Clubs remain responsible for the cost of the Development Works. The Development Works are listed in Annexure A to the Loose Ends Agreement together with their cost estimate and comments. The list included all remaining civil works for Stages 25A, B, C and D together with work such as Sunland Boulevard, pedestrian bridge abutments for Stage 7, Skeleton Creek Treatment landscaping and Sanctuary Lakes Boulevard entry road works. Under cl 5.2, Links " will assume responsibility for the Development Works in exchange for the payment of the sum of $4,134,000.00" (emphasis added). Under cl 5.3, Lakes and Clubs "shall pay the sum referred to in clause 5.2 to Links from the settlement proceeds from the Stage 23 land " (emphasis added).

167. The effect of these clauses is that Links did not assume responsibility for the Development Works until it received the money. In the meantime, Lakes and Clubs remained responsible for those works under the Development Plan. Clause 5.3 required Lakes and Clubs to pay the money from the settlement proceeds from Stage 23 land. Under the contract, they cannot pay the money from any other source.

168. I have no doubt that Lakes intended to pay the money and Links intended to assume responsibility for the Development Works when it did but Lakes' liability to pay the money is determined by the contract. Its liability did not arise until it had sufficient proceeds from the sale of the Stage 23 land to pay the money. Although I do not consider it a relevant consideration in interpreting the contract, I note that the interpretation I have adopted is consistent with Links' proposal in its letter to Lakes of 7 May 2003.^[172] The proposal was that “You will pay us at the same time as Stage 23 settles $4.321 million … and we will then assume all your responsibilities for the construction and general installation of outstanding civil and landscaping works .…” (emphasis added).

169. When did Lakes (and Clubs) have sufficient proceeds from the sale of Stage 23 land? On the basis of the proposal put by Links to Lakes and Clubs in a letter dated 7 May 2003, I find that none of the Stage 23 lots had yet been settled when the Loose Ends Agreement was signed on 30 June 2003. At that time, it was noted that they should be ready for settlement by late May or early June 2003. That is not inconsistent with Mr Kenneth Tan's evidence that the first of the Stage 23 lots had been sold in May 2002. I understand Mr Tan to mean that a contract of sale had been entered. Settlement of the sale of land refers to payment and transfer of title, which are provided for in the contract of sale and subject to its terms, but take place separately from it. That they had not been settled is also consistent with Mr Tan's evidence at [116] of his statement that the "additional sums up to $24m from the sale of Sunland land and the Stage 23 Land, reflecting development profits, by virtue of clauses 14.6 and 14.8 of the Development Lease … were not received in the 2003 financial year."

170. This evidence is consistent with my finding that the proceeds from the sale of the Stage 23 land were not received until after the 2003 income year. That is not contradicted by the document headed "Sanctuary Lakes Joint Venture Stage 23 Flow Chart". It bears a reference suggesting that it was sent by facsimile to an unknown recipient on 31 July 2003. The payment of $4,134,000 is referred to as one of the deductions to be made from the amount of $11,100,000.00 otherwise owing from Links to Lakes and Clubs. Reference is made to an invoice but no number of that invoice is given. A handwritten note referring to the payment reads: "Split Refer Schedule at back".^[173] T documents at 954 No Schedule appears in the material I have. The invoice is dated 29 August 2003 and requires payment, together with GST, "C.O.D.", which I take to mean Cash on Delivery or immediately.

171. Having regard to this material, I am satisfied that the Stage 23 proceeds referred to in the Loose Ends Agreement were not received until after 30 June 2003. Therefore, Lakes' obligation to pay the amount of $4,134,000.00 did not arise in the 2003 income year but in the 2004 income year. That means that Lakes was not entitled to claim the amount as a deduction in the 2003 income year.

ISSUE 5 : Is Lakes entitled to a deduction of $1,275,800 in the 2003 income year for expenditure in relation to obligations under s 173 of the Planning and Environment Act 1987 (Vic) incurred under cl 5.2 of the Supplementary Agreement (too limited)?

Summary of parties' submissions

172. On behalf of Lakes, Mr Sest submitted that payment of the sum of $1,275,800.00 under the Supplementary Agreement was to be paid from the proceeds of the sale of Stage 23 land. The payment was made to Links which assumed Lakes' obligations arising under s 173 of the PE Act in respect of the land Lakes leased to Links. Those obligations remained those of Lakes but Links indemnified Lakes in respect of their discharge. Mr Sest submitted that regard had to be had to the whole context. On a fair reading of the obligations imposed on Links and Lakes, their imposition did not wait upon the time of payment but arose directly and immediately upon their entering the Development Lease as amended by the Supplementary and Loose Ends Agreements. Links had taken over as developer and its rights and obligations were not deferred until Lakes received the proceeds of the Stage 23 proceeds. Postponement of the time at which their obligations were to be undertaken does not postpone the obligation itself, Mr Sest submitted.

173. Ms Schilling submitted that neither the Supplementary Agreement nor the Loose Ends Agreement imposed any express liability on Lakes to pay Links the sum. They do not merely prescribe a time for payment as contended by Lakes; they do not prescribe a time at all. While the Stage 23 settlement proceeds were to be the source of the payment that was to be made, no liability to pay came into existence until the proceeds were received.

Consideration

174. The Development Lease did not address Lakes' obligations under s 173. They were addressed for the first time in the Supplementary Agreement. Clause 5.2.1 states that Lakes and Clubs remain responsible for the obligations of the owner for the obligations specified in cl 4.2.1 to 4.2.8 of the agreement up to the amount of $1,275,800.00. Clause 4.2 specifies works such as wetland works, drainage works, public open space requirement works and site rehabilitation works and specifies the particular clause of the s 173 agreement setting out the obligations undertaken by Lakes and Clubs. Clause 5.2.2 provides that the amount of $1,275,800.00 will be paid to Links from the balance of sale proceeds from the Stage 23 land. At no time in the Supplementary Agreement is an obligation imposed upon, or does Links undertake, to perform the work necessary to fulfil the obligations of Lakes and Clubs under the s 173 agreement.

175. Clause 6.1 of the Loose Ends Agreement summarises Lakes' and Clubs' agreement to remain responsible for their obligations under the s 173 agreement up to the amount of $1,275,800.00. It then states that "Payment of this amount is to be made from the proceeds of the settlement of Stage 23 land." No reference is made to whom the payment is to be made but, reading the clause with cl 5.2.2 of the Supplementary Agreement, it must mean that the payment is to be made to Links.

176. Clause 6.2 then moves to a subject not dealt with in the Supplementary Agreement. It reads:

" In exchange for Sanctuary Lakes and Sanctuary Clubs paying Links the amount referred to in clause 6.1, Links shall assume all of Sanctuary Lakes' and Sanctuary Clubs' obligations outlined in clause 4.2 of the Supplementary Agreement save and except for any obligations that relate to the rectification or improvement works including the ongoing maintenance requirements of Melbourne Water with respect to the Lake. The parties acknowledge in accordance with clause 5.2.3 of the Supplementary Agreement that Maddocks holds a sum of $1,000,000 to be applied towards the maintenance of the Lake." (emphasis added)

The clear meaning of the clause is that Links does not acquire any obligations in relation to Lakes' s 173 obligations until it is paid the sum of $1,275,800.00. That does not occur until some time after Links issued an invoice for that amount on 29 August 2003 and so in the 2004 income year.

177. If it be thought that the obligation arose upon Lakes' receiving the proceeds from Stage 23, I repeat my earlier conclusion that I am not satisfied that it did so in the 2003 income year. Rather, it arose in the 2004 income year.

CONSIDERATION: ISSUES RELATING TO PENALTIES

178. The outcome of my consideration is that I affirm the Commissioner's objection decision on each of the issues. That means that I must consider his decision to impose administrative penalties. In this case, Lakes bears the burden of proving according to s 14ZZK of the TA Act that the Commissioner's imposition of penalties is excessive.^[174] Federal Commissioner of Taxation v White (No 2) [2010] FCA 942 ; (2010) 117 ALD 335 ; [2010] ATC 20-205 at [18]; 339-340; 11,322 per Gordon J citing Hart v Federal Commissioner of Taxation [2003] FCAFC 105 ; (2003)131 FCR 203 ; 53 ATR 371 at [38]; 210; 380 per Hill and Hely JJ. Lakes may satisfy that burden in various ways. It may, for example, in relation to a particular issue establish on the balance of probabilities that it did not make a statement that was false or misleading in a material particular, that such a statement did not result in a shortfall amount or that it did not fail to take reasonable care or that the shortfall amount did not result from a failure by the taxpayer or the taxpayer's agent to take reasonable care to comply with a taxation law.

The Commissioner's decision

179. The Commissioner reached the following decision on each of the issues raised in this case:

Liability to an administrative penalty

180. A taxpayer is liable to an administrative penalty if any of the four circumstances set out in s 284-75 of the TA Act applies. That section was amended by the Tax Laws Amendment (2010 Measures No 1 Act) 2010 with effect from 4 June 2010^[175] Act No 56 of 2010, s 3 and Schedule 6, items 59-67 and see s 2, item 16 but those amendments do not relate to earlier income years. Only those in ss 284-75(1) and (2) of Schedule 1 to the TA Act are relevant in this case. Section 284-75(1) provides that a taxpayer is liable to an administrative penalty if that taxpayer makes:

• "(a) … a statement to the Commissioner …; and
• (b) the statement is false or misleading in a material particular, whether because of things in it or omitted from it; and
• (c) you have a shortfall amount as a result of the statement."

181. As it was enacted in the income years in issue in this case, s 284-75(2) provided that a taxpayer was also liable to an administrative penalty if that taxpayer made:

• "(a) … a statement to the Commissioner …; and
• (b) in the statement, you treated an income tax law as applying to a matter or identical matters in a particular way that was not reasonably arguable; and
• (c) you have a shortfall amount as a result of the statement."^[176] Paragraph (c) was repealedd by Act No 56 of 2010

182. The amount of the administrative penalty is calculated in accordance with s 284-85(1) of the TA Act.

A. Statement false or misleading in a material particular: the law

183. The Commissioner has taken the view that Lakes has made statements that were false or misleading in a material particular and so is liable to an administrative penalty. For the purposes of s 284-75(1), I do not need to consider whether Lakes made those statements knowing them to be false or misleading; only that they have been made. I cannot read that additional requirement into either the words themselves or into the section as a whole.

184. I am supported in my conclusion by the judgment of Drummond J in
Kajewski v Federal Commissioner of Taxation^[177] [2003] FCA 258 ; [2003] ATC 4375 when he considered s 223(1)(a)(i) of ITAA36. That section has been repealed but was expressed in terms similar to s 284-75(1) of the TA Act. His Honour said:

"121. A taxpayer makes a false or misleading statement in a return within s 223(1)(a)(i) if a return which the taxpayer furnishes to the Commissioner in obedience to s 161(1) contains a statement that is erroneous or incorrect: no element of deceitful or dishonest conduct on the part of the taxpayer or anyone else needs to be established. This is the position where the return containing the false statement is prepared by the taxpayer's agent and the taxpayer is not aware of the falsity.…"^[178] [2003] FCA 258 ; [2003] ATC 4375 at [121]; 4,402 See also Pearson v Deputy Commissioner of Taxation [2009] FCA 558 ; (2009) 74 ATR 437 at [23]; 442 when Spender J said: “The word ‘false’ in the former s 223 means ‘wrong ’: Reliance Finance Corporation Pty Ltd v FCT (1987) 87 FLR 305 . It is not necessary for the respondent to show that the statement was deliberate or fraudulent : Federal Commissioner of Taxation v Turner (1984) 15 ATR 379 .”

185. In view of my findings, on Issues 1, 2, 3 and 5 in this case, I have also decided that Lakes' statements to the Commissioner in relation to them when claiming deductions were wrong and so false within the meaning of s 284-75(1) of the TA Act.

186. What is meant by the expression "false or misleading in a material particular " (emphasis added) was considered by the Full Court of the Federal Court in
Minister for Immigration v Dela Cruz^[179] [1992] FCA 71 ; (1992) 34 FCR 348 ; 110 ALR 367 ; 26 ALD 663 ; Black CJ, Davies and Neaves JJ (Dela Cruz) in the context of s 20(1) of the Migration Act 1958. In summary, that section applied to a person who had made a statement to an officer or person exercising powers under that legislation in respect of an entry or visa that was false or misleading in a material particular. The Full Court said:

"… The term 'material' requires no more and no less than that; the false particular must be of moment or of significance, not merely trivial or inconsequential.

… In the context of s 20(1), a statement will be false or misleading in a material particular if it is relevant to the purpose for which it is made …. A statement will be relevant to that purpose if it may - not only if it must or if it will - be taken into account in making a decision under the Act as to the grant of the visa or entry permit in respect of which the statement is made.

For present purposes, it is sufficient to say that a statement made to an immigration official by a person seeking to enter Australia, which conveys a false or misleading impression of the person or of his or her circumstances, would be false or misleading in a material particular. Immigration officials are entitled to seek and to be told the truth about a person applying to enter Australia, so that they may be in a position to evaluate the application made to them. They may consider it desirable to ask further questions about the subject matter of the statement made to them and, with answers to further questions, the statement may be more useful. But it does not follow that, without further questions, the statement is not material in the sense in which the word is used in s 20(1)."^[180] [1992] FCA 71 ; (1992) 34 FCR 348 ; 110 ALR 367 ; 26 ALD 663 at [12]-[14]; 352; 371; 666

187. The principles established in Dela Cruz seem equally applicable in this case. A statement claiming a deduction when none is claimable is false in a material particular. Disclosure of a taxpayer's taxable income is a fundamental aspect of a taxpayer's obligation under the ITAA36 and ITAA97 to pay the amount of tax that he or she should properly pay. It is the base line from which the Commissioner carries out his functions under that legislation. A taxpayer may properly reduce what would otherwise be the amount of taxable income for any year of income by claiming a deduction. The proper assessment of a taxpayer's taxable income lies at the heart of the assessment of the tax that is, or is not, payable on it. Speaking in general terms, false statements about amounts that may be deducted from that taxable income strike at the heart of that process.

188. That does not mean that every false claim for a deduction is false "in a material particular". Regard must be had to the impact of the false statement upon the assessment of a taxpayer's taxable income and tax payable upon it.

B. Statement false or misleading in a material particular: consideration

189. On the view that I have taken, Lakes' claim for deductions in relation to Issues 1, 2, 3 and 5 were wrongly made. Therefore, its claim for deductions were made on an incorrect understanding of the law and so on the basis of false statements. Each of those statements had a significant impact upon the assessment of its taxable income and so the tax that would otherwise be payable upon it. They were false in a material particular. Therefore, I have concluded that Lakes is liable to an administrative penalty under s 284-75(1) of the TA Act.

C. Statement not reasonably arguable: the law

190. When used in the TA Act, the expression "reasonably arguable" is given its meaning by s 284-15 in Schedule 1 to the TA Act:^[181] ITAA97, s 995-1

• "(1) A matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about^[182] The word “about ” was inserted by Act No 75 of 2005, s 3 and Schedule 2, item 3 with effect from 29 June 2005 as likely to be correct as incorrect, or is more likely to be correct as incorrect, or is more likely to be correct than incorrect.
• (2) To the extent that a matter involves an assumption about the way in which the Commissioner will exercise a discretion, the matter is only reasonably arguable if, had the Commissioner exercised the discretion in the way assumed, a court would be about^[183] The word “about ” was inserted by Act No 75 of 2005, s 3 and Schedule 2, item 4 with effect from 29 June 2005 as likely as not to decide that the exercise of the discretion was in accordance with the law.
• (3) Without limiting subsection (1), these authorities are relevant:
  • (a) a *taxation law;
  • (b) material for the purposes of subsection 15AB(1) of the Acts Interpretation Act 1901;
  • (c) a decision of a court (whether or not an Australian court), the *AAT or a Board of Review;
  • (d) a *public ruling.^[184] Paragraph (d) was repealed by the Tax Laws Amendment (Improvements to Self Assessment Act) 2005 , Act No 161 of 2005, s 3 and Schedule 2, item 27 in relation to things done on or after 1 January 2006. It formerly read “(d) a public ruling within the meaning of Part IVAAA”. "

191. Hill J considered this provision in
Walstern Pty Ltd v Federal Commissioner of Taxation^[185] [2003] FCA 1428 ; (2003) 138 FCR 1 ; 54 ATR 423 ; 2003 ATC 5,076 (Walstern) in the context of s 222C of ITAA36.^[186] Section 226K of ITAA36 provided that penalty tax would be imposed if, among other criteria, “when the statement was made, it was not reasonably arguable that the way in which the application of the law was treated was correct ”. Section 222C(1) provided that “For the purposes of this Part: (a) the correctness of the treatment of the application of a law; (b) … is reasonably arguable if, having regard to the relevant authorities and the matter in relation to which the law is applied …, it would be concluded that what is argued for is about as likely as not correct .” Of the word "about" he said:

"… The word 'about' indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued which of the two positions is correct so that on balance the taxpayer's argument can objectively be said to be one that while wrong could be argued on rational grounds to be right."^[187] [2003] FCA 1428 ; (2003) 138 FCR 1 ; 54 ATR 423 ; 2003 ATC 5,076 at [108]; 27; 445; 5,095

192. This meaning would seem to be equally applicable to s 284-15 of the TA Act. The section is intended to engage a decision-maker in balancing the taxpayer's argument against that found to be the correct argument. A decision-maker is intended to conduct that test in an objective fashion. That is underlined by the reference in the opening words of the section that "it would be concluded" that what is argued for is as likely to be correct as incorrect, or is more likely to be correct than incorrect. As Hill J said:

"… the two arguments … will be finely balanced. The case must thus be one where reasonable minds could differ as to which view, that of the taxpayer or that ultimately adopted by the Commissioner was correct. There must, in other words, be room for a real and rational difference of opinion between the two views such that while the taxpayer's view is ultimately seen as wrong it is nevertheless 'about' as likely to be correct as the correct view. A question of judgment is involved."^[188] [2003] FCA 1428 ; (2003) 138 FCR 1 ; 54 ATR 423 ; 2003 ATC 5,076 at [108]; 27; 445; 5,095

193. His Honour also pointed to the steps to be taken in reaching a conclusion as to whether a matter is reasonably arguable:

• "2. The decision-maker considering the penalty must first determine what the argument is which supports the taxpayer's claim.
• 3. That person will already have formed the view that the claim is wrong, otherwise the issue of penalty could not have arisen. Hence the decision-maker at this point will need to compare the taxpayer's argument with the argument which is considered to be the correct argument.
• 4. The decision-maker must then determine whether the taxpayer's argument, although considered wrong, is about as likely as not correct, when regard is had to 'the authorities'."^[189] (2003) 2003 ATC 5076 at [108]; 27; 445; 5,095

194. Justice Hill's judgement was considered and applied in
Pridecraft Pty Ltd v Federal Commissioner of Taxation^[190] [2004] FCAFC 339 ; (2004) 213 ALR 450 ; 58 ATR 210 at [108]; 476; 236 per Sackville J with whom Ryan and Sundberg JJ concurred by the Full Court. A differently constituted Full Court considered Walstern in
Allen (Trustee), in the matter of Allen's Asphalt Staff Superannuation Fund v Commissioner of Taxation^[191] [2011] FCAFC 118 ; Keane CJ, Greenwood and Middleton JJ (ASS Fund) and it preferred the approach taken by Stone and Allsop JJ in
Cameron Brae Pty Ltd v Federal Commissioner of Taxation^[192] [2007] FCAFC 135 ; (2007) 161 FCR 468 ; 243 ALR 273 ; 67 ATR 178 ; Stone and Allsop JJ; Jessup J dissenting (Cameron Brae). The argument before the Full Court in Cameron Brae turned on a question of statutory interpretation centring on s 82AAE of ITAA36 and s 8-1 of ITAA97. The majority, Stone and Allsop JJ, concluded:

"In our view, the question of construction and interpretation of s 82AAE was reasonably open and arguable. No authority squarely covered it. The proper interpretation depended upon the construction of s 82AAE informed by a full appreciation of the statutory history. The argument about the applicability or satisfaction of s 82AAE was arguable. That question can be seen as subsuming s 8-1, if it were answered one way. If it be necessary to decide, we are also prepared to conclude that the issue as to the characterisation of the outgoing as capital or revenue was arguable. Whilst in our view it is clear that it was a payment of a capital nature, the question is open to debate in the sense of being arguable."^[193] [2007] FCAFC 135 ; (2007) 161 FCR 468 ; 243 ALR 273 ; 67 ATR 178 at [70]; 488; 291; 197

195. The Full Court in ASS Fund said:

"… The approach taken by Stone and Allsop JJ in Cameron Brae, with which we respectfully agree, is somewhat less strict than that suggested by Hill J in Walstern. On the approach in Cameron Brae, while a Court may come to a clear view on a question of statutory construction adverse to a taxpayer, that view is not decisive against the conclusion that the taxpayer's position was reasonably arguable.

Their Honours in Cameron Brae at [70] further treated as relevant the circumstance that "no authority squarely covered" the question of statutory construction on which the case turned and that the proper interpretation of the legislation in question depended upon "a full appreciation of the statutory history".

The present case, like Cameron Brae, and in contrast to Walstern, turns on questions of statutory construction. Walstern was a case where the erroneous position advanced in a taxpayer's return was founded upon an unreasonable view of, or a disregard for, the facts. See Walstern at [113].

In this case, as in Cameron Brae, the questions of statutory construction on which the case turns were free from authority squarely covering the point. And as our reasons on the substantive issues show, the taxpayers' position was debatable. There is another consideration which is relevant here.

It should, we think, be borne in mind is that the legislature itself considered that the taxpayers' position was sufficiently arguable to warrant the replacement of s 273(7) of the ITAA 1936 by subdivision 295H of the ITAA 1997. That the legislature considered it prudent to shore up the Commissioner's position in this way gives the Commissioner's insistence that the outcome of the present case was clear beyond rational argument a somewhat pharisaical quality.'^[194] [2011] FCAFC 118 at [75]-[79]

D. Statement not reasonably arguable: consideration

196. While authorities such as of
Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation^[195] (1981) 144 CLR 616 and see FN306 below and
Federal Commissioner of Taxation v James Flood Pty Ltd^[196] (1993) 47 FCR 561 and see [268] and [275] and FNN 302 and 306 below might seem unequivocally to favour the Commissioner's position in this matter, I am mindful of cases such as
Commissioner of Taxation v Woolcombers (WA) Pty Ltd^[197] (1993) 47 FCR 561 and see also [266] and [275] below (Woolcombers). A case such as Woolcombers opens the door to the argument put on behalf of Lakes in relation to Issue 5.^[198] In summary, the issue is whether Lakes was entitled to a deduction in the 2003 income year for expenditure incurred under cl 5.2 of the Supplementary Agreement in relation to obligations under s 173 of the PE Act. In view of that, I find that there was room for a rational argument that, viewed objectively, Lakes was entitled to a deduction in relation to that issue. Therefore, Lakes is not liable to an administrative penalty under s 284-75(2). That makes no difference for it is already liable to such a penalty under s 284-75(1).

The amount of the administrative penalty

197. Now that I have decided that Lakes is liable to an administrative penalty, the next step is to work out the amount of that penalty. It is worked out according to s 284-85 of the TA Act. The first step is to work out the base penalty amount under s 284-90.^[199] TA Act, Schedule 1, s 284-85(1) If that amount is not increased under s 284-220 or decreased under s 284-225 of Schedule 1 of the TA Act, the base penalty amount is the amount of the penalty.^[200] TA Act, Schedule 1, s 284-85(1) The Commissioner has not sought to increase the base penalty under s 284-220. Lakes did not rely on s 285-224 and this is appropriate as I do not have any evidence that it made its claim in a way that agreed with advice given by the Commissioner or accorded with general administrative practice under the law.

A. Working out the base penalty: the shortfall amount - the law

198. Section 284-90 turns, in part, on whether a taxpayer has a shortfall amount and, if so, its amount. In the context of this case, a taxpayer has "a shortfall amount if an item in this table applies to you. That amount is the amount by which the relevant liability … is less than or more than it would otherwise have been." That is the effect of s 284-80(1). Only one of the items of the table found in the section may be relevant to Lake's circumstances. Item 1 provides that a taxpayer has a shortfall amount if "A tax-related liability of yours for an accounting period … worked out on the basis of the statement is less than it would be if the statement were not false or misleading."

B. Working out the base penalty: the shortfall amount - consideration

199. Lakes' claims for deductions meant that its tax-related liability was less than it would have been had those claims not been based on false statements. Therefore, Mr Knox has a shortfall amount.

C. Working out the base penalty: the amount - the law

200. Once it is decided that a taxpayer has a shortfall amount, the amount of the base penalty is worked out according to the table at s 284-90 of the TA Act. That section contains seven situations and determines the base penalty amount for each. Only two of them, items 3 and 4, are relevant:

201. The meaning of "reasonably arguable" as referred to in item 4 is that given in s 284-15 in Schedule 1 to the TA Act and I have considered that above.^[201] See [190]-[195] above

202. Failure to take reasonable care is at the heart of Item 3. What amounts to reasonable care was considered by Senior Member Sweidan in Re Hutson and Commissioner of Taxation:^[202] [2009] AATA 574 ; [2009] ATC 10-099

• "104. Reasonable care is determined objectively. As to the Trust, it is the care that a reasonable person, in the same circumstances as the Trust, would be likely to exercise in making the statement: MT 2008/1 at [27]-[29].
• 105. Regard must be had to the nature of the obligation requiring the exercise of reasonable care and the particular circumstances in which the taxpayer under that obligation finds itself, i.e. what would be done by a reasonable person in the circumstances of the Trust:
  Confidential v Commissioner of Taxation [2008] AATA 415 at [57] & [60].
• 106. It thus involves consideration of the relative size of the shortfall, type of item, complexity of the law and underlying transactions and the difficulty or expense to avoid the risk of making an error. The Commissioner's position is that it is necessary to consider the personal attributes of the taxpayer and what care a reasonable person with those attributes would have taken in the taxpayer's particular circumstances: MT 2008/1 at [45].…"^[203] [2009] AATA 574 ; [2009] ATC 10-099 at [104]-[106]; 3,006-3,007

For the reasons I gave in Re Sinclair and Commissioner of Taxation,^[204] [2010] AATA 902 at [78]-[90] I agree with Senior Member Sweidan's analysis.

D. Working out the base penalty: the amount - consideration

203. Lakes has submitted that there was no failure to take reasonable care. Its returns were accompanied by relevant extracts from its accounts, which had been audited, and it had maintained appropriate accounting systems. In its objection, Lakes also added that its accounts had been prepared by Bentleys and had been reviewed by three of Bentley's senior staff, the auditor and Lakes' public officer.

204. It has not produced any evidence from the persons to whom it referred. I cannot, therefore, make any findings about the manner in which they considered the matter. Lakes' submissions would seem to be based on the premiss that its audited financial statements are in some way determinative of the matter. I refer, for example, to its submission that:

"The application of the 'trading stock' provisions is a novel approach to the circumstances of this matter as a whole. The Commissioner's submissions continue to refer to documents that do not represent its audited financial statements…".^[205] Applicant’s Submissions in Reply at [181(3)]

205. A person carrying on a business must, under s 262A(1) of ITAA36, "… keep records that record and explain all transactions and other acts engaged in by the person that are relevant for any purpose of this Act." The records that must be kept include two types of documents. The first includes those that are relevant for the purpose of ascertaining the taxpayer's income and expenditure. The second includes those that contain particulars of any choice, estimate, determination or calculation made by the taxpayer under the Act. In the case of an estimate, determination or calculation those particulars must show the basis on which and method by which the estimate, determination or calculation was made.^[206] ITAA36, s 262A(2)

206. Lakes' accounts are an integral part of this documentation. They provide information about its business for a whole range of purposes including Lakes' day to day business needs, the requirements of its investors and shareholders and the demands of the law. A requirement to keep records of the sort found in its accounts cannot, however, lead to the conclusion that the accounts become the sole determinant of what a taxpayer should claim as a deduction. Regard must be paid to the law which regulates such a claim. To accept the premiss implicit in Lakes' submissions is to accept a proposition that the Commissioner must not question a taxpayer's accounts or the propositions of law that may have shaped the information recorded in them. That cannot be for the Commissioner must apply and comply with the law as he determines it to be having regard to the legislation as interpreted by the Courts. A taxpayer is similarly bound to comply with the law and so could reasonably be expected to have some regard to it independently of any other material, including its accounts, which it will take into consideration in making its claim.

207. On the material that I have and in the absence of any evidence regarding any particular steps that Lakes took to ensure that it did not make a statement false in a material particular, I am satisfied that its shortfall amounts resulted from a failure by it or its agent to take reasonable care to comply with a taxation law.

Remission

A. The law

208. Section 298-20 of Schedule 1 to the TA Act provides that the Commissioner may remit all or part of a penalty. Section 298-20 does not set out any guidelines as governing the exercise of the discretion. Given the provisions relating to the imposition of penalties, there would clearly need to be circumstances that could be regarded as mitigating the taxpayer's behaviour in some way while bearing in mind the purpose for which income tax is imposed and paid and the role of ITAA36, ITAA97 and the TA Act in supporting that purpose. As Collier J said in
Federal Commissioner of Taxation v Dixon (Trustee):^[207] (2007) ATC 4748 ; [2007] FCA 1079

"… while the purpose of a penalty regime is obviously to deter infringement of the law, particularly in an environment of self-assessment, the importance of conduct of taxpayers in attempting to comply with the legislation and their taxation obligations is clear from the legislation itself and … Explanatory Memorandum 2000. …"^[208] (2007) ATC 4748 ; [2007] FCA 1079 at 4,762; [47]

B. Consideration

209. The taxation scheme is now based on a philosophy of self-regulation. A taxpayer such as Lakes submits returns on the basis that they contain information that is correct and on the understanding that the Commissioner will not, unless conducting an audit, generally question it in making an assessment on the basis of it. In light of these matters and with one exception, I do not consider that there are grounds for remitting the penalty and affirm the Commissioner's decision regarding penalty. The one exception relates to its claim in relation to Issue 5. I have found at [196] that there was room for a rational argument that, viewed objectively, Lakes was entitled to a deduction in relation to that issue. In view of the object of the penalty regime, that seems to me to justify the remission of the penalty imposed in relation to its claim for a deduction of $1,275,800 in the 2003 income year for expenditure in relation to its obligations under s 173 of the PE Act.

DECISION

210. In view of the findings I have made and the decisions I have reached on each of the issues, I affirm the Commissioner's objection decisions dated 23 December 2009 and 23 February 2010 disallowing Lakes' objections to assessments of income tax. Except in relation to Issue 5, I also affirm the Commissioner's objection decisions relating to the imposition of penalties payable in respect of the 2003 income year. In relation to Issue 5, I set aside the Commissioner's decision. That means that no penalty is imposed in relation to Lakes' claim for a deduction of $1,275,800 in the 2003 income year for expenditure in relation to its obligations under s 173 of the PE Act.

ATTACHMENT A

211. CHRONOLOGY OF EVENTS

ATTACHMENT B

CONSIDERATION: PRELIMINARY ISSUES

212. In its written submissions in reply to the Commissioner's written submissions dated 6 and 15 November 2011, Lakes raised five preliminary issues about the Commissioner's submissions:

• (1) Except for a concession in relation to Issue 1,^[209] Issue 1 is whether Lakes is entitled to claim a deduction in the 2003 income year for a loss of $8,436,342 incurred on the sale of memberships in the Sanctuary Lakes Golf Club? the Commissioner has failed to deal with the context in which the outlays were made. That context was the disposition to Links.
• (2) In making submissions on the evidence, the Commissioner has impugned the credit of Lakes' witnesses but has done so in breach of the rule in
  Browne v Dunn.^[210] (1893) 6 R 67 , HL
• (3) The Commissioner has relied on historical statements which are irrelevant.
• (4) It is incorrect to reject Mr Rennick's evidence on the basis of "a pedantic insistence on irrelevant material".^[211] Lakes’ Submissions in Reply at [A.3(4)]
• (5) The Commissioner's references to the evidence are selective and result in his making submissions that are misleading either in whole or in part.

213. Mr Sest has gone on to develop each of these submissions. Rather than examine each example he has given and decide whether or not he is correct, I think it better to set out my general approach to considering all of the evidence and the submissions whether made by Lakes or by the Commissioner.

The whole context

214. I have in mind the evidence given on behalf of Lakes that the transactions were intended to enable Lakes (and Clubs) to take itself out of the Sanctuary Lakes development altogether. I also have in mind that I am considering Lakes' liability to pay tax and that there is law governing the regard that I can give to the context and the intentions of those engaged in particular transactions.

Credit and submissions referring to the evidence

A. General approach to evidence

215. In Re Zheng and Minister for Immigration and Citizenship^[212] [2011] AATA 304 ; (2011) 121 ALD 372 (Zheng). I made some observations on the difficulties that I have with submissions that are based on a finding that a witness is "credible", that a witness's evidence lacks "credibility" or that a case is a "credibility case". At the heart of my difficulties is my view that such descriptions mask the task of fact finding which, together with finding the law, is at the heart of merits review. I have explained my view in Zheng and, although I adopt it as part of these reasons, will not repeat it.^[213] [2011] AATA 304 ; (2011) 121 ALD 372 at [64]-[76]; 394-399

216. In summary, the task of fact finding requires regard to be had to the whole of the evidence given by a witness and then to the place of that evidence in the context of the whole of the evidence given in the case. A single piece of evidence cannot be found to be false or a witness's evidence to be unreliable without there being some basis for doing so. That basis must be found in the whole of the evidence or, in some infrequent instances, on the basis of facts of which judicial notice can be taken. Evidence must be analysed by means of a deliberative approach to reasoning rather than an intuitive approach.

217. A deliberative process of reasoning has regard to the whole of the evidence and the pattern that the whole of the evidence makes. It necessarily incorporates an understanding of the evidence. That does not mean simply understanding the words that are used by a witness but understanding the way in which that witness may use words to convey a concept or to describe events.

218. The pattern sought by a deliberative process of reasoning may not be immediately apparent. That may be so because, for example, the pattern may not become apparent until the evidence is understood in its context be it cultural, social or occupational. It may be that the whole of the evidence fits into more than one pattern and neither is less likely than the other. The pattern will not be monochromatic and nor will it be evenly textured. Evidence comes in different forms and some will be regarded as more probative than other pieces of evidence. Therefore, the pattern or patterns that appear from the evidence will usually have many shades and various textures. If a particular piece of evidence fits none of the patterns, a deliberative process of reasoning will require that it be disregarded. That will be the reason and its credibility or not becomes an issue that has no relevance in the process.

219. This is a process that is more time consuming than an intuitive and instinctive approach to decision-making but as Kirby J said in
Whisprun Pty Ltd v Dixon^[214] [2003] HCA 48 ; (2003) 200 ALR 447 ; 77 ALJR 1598 when he was considering the evidence of Ms Dixon, who had been found to be not entirely truthful on some issues:

"… To do justice to both parties, the decision-maker was therefore obliged to enter upon a more detailed analysis: not to treat the case as a kind of sport, where a player whose credibility is damaged is inevitably judged the loser. Engaging in this kind of tournament can be comparatively easy for the skilled, repeat players. The obligation to assess the claim justly, according to the entirety of the evidence and according to law, is rather more difficult, tedious and time consuming. When our system of civil trials substantially replaced the intuitive decisions of lay jurors with the reasoned opinions of professional judges, a higher standard of manifest rationality was required. The elements of the game were replaced by a more serious evaluation of the evidence and the demonstration of just and lawful outcomes.…"^[215] [2003] HCA 48 ; (2003) 200 ALR 447 ; 77 ALJR 1598 at [123]; 478; 1620. The majority of the High Court in Whisprun saw the issue in terms of Ms Dixon’s credibility but limited that issue to “ … whether Ms Dixon was credible when she claimed to be suffering from symptoms that were consistent with that syndrome …” being Q fever infection and chronic fatigue syndrome arising from that infection; [2003] HCA 48 ; (2003) 200 ALR 447 ; 77 ALJR 1598 at [18]; 452; 1601-1602

B. The rule in Browne v Dunn

220. In
Allied Pastoral Holdings Pty Ltd v Commissioner of Taxation,^[216] [1983] 1 NSWLR 1 ; (1983) 83 ATC 4015 Hunt J stated the rule in
Browne v Dunn^[217] (1893) 6 R 67 in the following terms:

"It has in my experience always been a rule of professional practice that, unless notice has already clearly been given of the cross-examiner's intention to rely upon such matters, it is necessary to port to an opponent's witness in cross-examination of the nature of the case upon which it is proposed to rely in contradiction of his evidence, particularly where that case relies upon inferences to be drawn from other evidence in proceedings.…"^[218] [1983] 1 NSWLR 1 ; (1983) 83 ATC 4015 at 16; 4,027

221. This statement of the rule was accepted by the Full Court of the Federal Court in
3D Scaffolding Pty Ltd v Federal Commissioner of Taxation^[219] [2009] FCAFC 75 ; 2009 ATC 20-111 ; Emmett, Kenny and McKerracher JJ when it set out the manner in which the rule may operate in practice:

• "30. We accept that, as Hill J said in
  Jagelman v Federal Commissioner of Taxation 96 ATC 4055; (1995) 31 ATR 463 at 473:

  'Where the issues in the case are such that it would readily be apparent to a party that a particular imputation has been made, there will be no necessity to put that imputation to a witness who denies it and, in consequence, there will have been no denial of procedural fairness…'

• 31. Also pertinent to the present case are certain observations of Hunt J in Allied Pastoral. His Honour said at (at [1983] NSWLR at 22-3) that:

  'A challenge made to the evidence of a witness in the course of a final address may take place in various ways. The opposing party might ask the tribunal of fact simply to disbelieve that evidence; if he has led evidence in direct contradiction of the evidence of that witness, he may then ask the tribunal of fact to accept the evidence of his own witnesses in preference to that of the witness in question; or he may point to other evidence in the case, led by either party, which tends either to contradict the evidence of that witness or to destroy his credit. There are many reasons why it should be made clear, prior to final addresses and by way of cross-examination or otherwise, not only that the evidence of the witness is to be challenged but also how it is to be challenged. Firstly, it gives the witness the opportunity to deny the challenge on oath, to show his mettle under attack (so to speak), although this may often be of little value. Secondly, and far more significantly, it gives the party calling the witness the opportunity to call corroborative evidence which in the absence of such a challenge is unlikely to have been called. Thirdly, it gives the witness the opportunity both to explain or to qualify his own evidence in the light of the contradiction of which warning has been given and also, if he can, to explain or to qualify the other evidence upon which the challenge is to be based…."^[220] [2009] FCAFC 75 ; 2009 ATC 20-111 at [31]; 9,717-9,718

222. The rule was explained further by Gleeson CJ in
R v Birks:^[221] (1990) 19 NSWLR 677 ; Gleeson CJ, and McInerney J and Lusher AJ

"It is plain that their Lordships, while recognising and affirming a rule of practice in the terms in which they expressed themselves, also recognised the need for flexibility in its application. That need arises from the very nature of the subject matter which it concerns. The central purpose of the rule is to secure fairness in the conduct of adversarial proceedings. That consideration provides the best guide, both to the practical requirements of the rule in a given case, and to the consequences which may properly flow from its non-observance, including the remedies that are available to deal with the problem so created."^[222] (1990) 19 NSWLR 677 at 688 per Gleeson CJ with whom McInerney J agreed

223. There is no particular form of questioning that is required in order to comply with the rule. Lord Lane CJ said in
R v Fenlon:^[223] (1980) 71 Cr App R 307

"It need not be done in minute detail, but it is the duty of counsel to make it plain to the witness, albeit he may be a co-defendant, that is his evidence is not accepted and in what respects it is not accepted."^[224] (1980) 71 Cr App R 307 at 313

224. In Australia, the Queensland Court of Appeal said in
R v Foley:^[225] [2000] 1 Qd R 290

"The cases however do not clearly mark out how far counsel may go in putting the client's case in order to escape valid criticism if the evidence eventually goes beyond what has been foreshadowed. We do not think it possible to suggest a universal formula or principle that will tell counsel the amount of detail that may need to be put from case to case."^[226] [2000] 1 Qd R 290 at 291

If a matter is clearly in issue, there is no need to put that matter to a witness.^[227] Stern v National Australia Bank [2000] 171 ALR 192 ; (2000) 171 ALR 192 ; Hill, O’Connor and Moore JJ at [42]; 203

225. Even if a party does not comply with the rule in
Browne v Dunn, that does not mean that a court will prevent that party from leading evidence contradicting the evidence given by a witness. This matter was considered by McGarvie J in Victoria in
R v Allen^[228] [1989] VicRp 64 ; [1989] VR 736 (Allen) when he rejected a submission that he decline to allow the defence in a criminal trial to lead contradictory evidence in those circumstances. He drew a distinction between the application of the rule to the prosecution and to the defence.^[229] [1989] VicRp 64 ; [1989] VR 736 at 738

226. That is not a distinction that is drawn in civil cases. The point is illustrated by the case of
Dunn v Maritime Services Board^[230] [1998] NSWSC 250 ; Priestley, Powell and Stein JJA which raised the application of the rule in civil proceedings in the Compensation Court of New South Wales. The appellant, Mr Dunn, had put medical reports and X-ray films in evidence. Stein JA, with whom Priestly and Powell JA agreed, said:

"The second issue in the appeal concerns the application of the rule in
Browne v Dunn because none of the medical practitioners were cross-examined as to the content of the films. It is submitted that her Honour ought to have relied on the failure to cross-examine the doctors and, accordingly, have accepted their opinions. Failure to do so is said to be an error of law. It is perhaps unfortunate that it is rare, (or at least unusual) that a medical practitioner is called to give oral evidence in the Compensation Court (indeed also the District Court). This often leaves trial judges in a difficult situation where there is conflict in the medical reports. Here, neither side requested any medical practitioner to attend for cross-examination. The appellant was however challenged in cross-examination as to the history of complaints which he gave to the doctors. In particular, it was put to him that he had not informed any doctor of his surf club activities. The appellant was also confronted with the films, which he accepted, making various explanations.

One might ask, what was her Honour expected to do? The medical reports were not tendered until the close of evidence. One may assume that her Honour then read them, a task she would undertake, no doubt, in the light of the films and the evidence of the appellant. It seems to be somehow assumed that she should have ignored the films, and the appellant's acceptance of them, and accepted the conclusions of the medical practitioners based upon incorrect histories and without any knowledge on their part of the films. Alternatively, it is suggested that her Honour should have insisted that the doctors attend and, I assume, that she cross-examine them since no party had asked for them to attend for cross-examination. This exposes the difficulty in applying the rule in
Browne v Dunn in circumstances such as these. In any event, there is no requirement that the court must accept evidence not subject to cross-examination, especially if that evidence is contradicted by other evidence, see for example,
Bulstrode v Trimble [1970] VR 840.

Again, I am unable to detect any error of law in her Honour's approach to this issue. It was not for her to cross-examine the doctors. Even assuming it to be an error of law, it is difficult to perceive that it necessarily led to a miscarriage of justice in the particular circumstances of the case."^[231] [1998] NSWSC 250 ; Priestley, Powell and Stein JJA at [4] per Stein JA

227. In the context of Tribunal proceedings, the rule in
Browne v Dunn is relevant because, unless Parliament modifies its duty in a particular instance, it is bound by the rules of procedural fairness as are the courts. In
Haberfield v Department of Veterans' Affairs^[232] [2002] FCA 1579 ; (2002) 121 FCR 233 ; 72 ALD 333 when considering an appeal from the Tribunal Sackville J noted that the rule in
Browne v Dunn is an aspect of procedural fairness and applicable to the Tribunal. His Honour explained:

"… The task of the AAT is not necessarily limited by the issues identified by the parties. As was said by Brennan J in
Bushell v Repatriation Commission [1992] HCA 47; (1992) 175 CLR 408, at 425, in substance the AAT's review of the primary decision is inquisitorial in character, with the AAT under a duty to arrive at the correct or preferable decision on the material before it. Subject to the rules of procedural fairness, the AAT is entitled to inform itself on any matters relevant to the pleadings in such manner as it thinks appropriate: s 33(1)(c)."^[233] [2002] FCA 1579 ; (2002) 121 FCR 233 ; 72 ALD 333 at [59]; 245-246; 345

228. These observations were made in the context of the Tribunal's Veterans' Division. Unlike applications made in the Taxation Division for review of objection decision, applications for review the Veterans' Division do not impose a burden of proof on any party. The fact that a party carries a burden of proof makes no difference to the application of the rule in
Browne v Dunn.^[234] It was developed in the courts where the burden of proof applies. The Tribunal must still comply with its obligation under s 39 of the Administrative Appeals Tribunal Act 1975 (AAT Act) to "… ensure that every party to a proceeding before the Tribunal is given a reasonable opportunity to present his or her case…". This duty must extend to ensuring that each party has a reasonable opportunity to know the issues being relied on by another party and also the issues that the Tribunal itself regards as relevant. It must extend to ensuring that each has a reasonable opportunity to address those issues by means of presenting relevant material and making submissions. Giving the parties a "reasonable opportunity" to do so is one aspect of procedural fairness.^[235] Russell v Duke of Norfolk [1949] 1 All ER 109 at 118 cited with approval in Kioa v West (1985) 59 CLR 550 at 613 per Brennan J What amounts to procedural fairness "… in a given situation depends upon the circumstances. And it is not a one-sided business."^[236] Mobil Oil Australia Pty Ltd v Federal Commissioner of Taxation (1963) 113 CLR 475 at 504 per Kitto J

229. Section 33(1AA) of the AAT Act might be seen as encompassing within the duty it imposes on the decision-maker - the Commissioner in this case - a duty to comply with the rule in
Browne v Dunn. Compliance might be regarded as being drawn within a decision-maker's obligations to "… use his or her best endeavours to assist the Tribunal to make its decision in relation to the proceeding."^[237] AAT Act, s 33(1AA) I do not think that it should be regarded in that way. It is not drawn into a decision-maker's obligations to any extent greater than it already is. A decision-maker is required to present a case within a framework in which the Tribunal must accord procedural fairness to all parties. By assisting the Tribunal to meet its obligations it is, in part, meeting its obligation to assist the Tribunal to make a decision. An applicant working in the same framework is under no different obligation. The obligation in s 33(1AA) is, of course, wider than this and recognises the special role of the Tribunal in the broader context of administrative decision-making. That role does not arise in this particular case.

230. The rule in
Browne v Dunn is, then, a rule of practice and a rule of procedural fairness. It is not a rule of law. It does not carry with it the consequence that its breach will necessarily mean that the party failing to cross-examine, or question, a witness about matters on which he or she will later attempt to lead contradictory evidence or attack in submissions will be prevented from doing so. It does not mean that the Tribunal must make a finding of fact a particular way if the rule is not followed. Failure to follow the rule will be one part of the context in which and background against which evidence is considered and weighed in making findings of fact.

C. Mr Rennick's evidence

231. Ms Schilling has set out a number of references to Mr Rennick's evidence in Footnote 4 to [14] of the Respondent's Submissions on Evidence and Penalties dated 15 November 2011. Each reference, she submits, shows an instance on which Mr Rennick was unable to recall the details of what she described as "key dates and events". She referred also to the following exchange between herself and Mr Rennick:

"I'm just asking, just for the sake of understanding, do you retain your file notes in relation to this matter? --- Yes.

Did you have the opportunity to review those before ---? --- Although, that's 10 years ago. They might be gone. I'm not sure.

Right. I take that you didn't have the opportunity to review those file notes before? --- No, I didn't look at those. No."^[238] Transcript at 229, lines 25 to 32

232. Mr Sest has taken exception to Ms Schilling's further submission that:

"It can be inferred from Mr Rennick's lack of knowledge as to whether his file notes remained in existence that he did not refer to those notes in preparing his witness statement. In view of this fact the Respondent contends that the Tribunal should place no weight on Mr Rennick's unaided recollection of events that occurred in some cases more than 10 years ago. In particular, the Tribunal should be cautious in placing any weight upon Mr Rennick's evidence as to the timing of events surrounding the agreements between Lakes and Links, and the existence of a temporal relationship between the earning of the Lease Premium and the forgiveness of the SLGC and SLRA debts in the absence of more reliable and/or corroborative documentary evidence."^[239] Respondent’s Submissions on Evidence and Penalties at [15]

233. Mr Sest has referred to each of the transcript references identified by Ms Schilling in (a) to (r) of her footnote 4, transcribed the context in which it appeared in the transcript and, if there is a relevant paragraph in Mr Rennick's statement, cross-referenced it to the relevant paragraph. He has submitted that nothing was put to Mr Rennick that his evidence was unreliable because he had not referred to his file notes. That is, Mr Sest submitted, in breach of the rule in
Browne v Dunn.

234. I have read Mr Rennick's evidence and particularly the passages of transcript reproduced in Mr Sest's submissions. Mr Rennick's response to Ms Schilling's questions regarding dates was, on each occasion she identified, to the effect that he did not know, could not remember or did not have a recollection. I agree with Mr Sest that there were occasions on which Ms Schilling cross-examined Mr Rennick on matters not in his statement but that is to be expected. I also agree with Mr Sest that it could be said that his answers on each occasion were "not inconsistent" with what he said in his statement. The first two, (a) and (b) of footnote 4, provide two examples of passages relied on by the Commissioner. The first is said to be not inconsistent with [71], [75] and [76] of Mr Rennick's statement and the second not inconsistent with [71]. The transcript at lines 8 to 25 of page 216 of the transcript, which encompasses the two passages, follows Mr Rennick's acknowledgment that he was familiar with the Deed of Arrangement but that he had not been personally involved and had not been the supervising partner of Madgwicks involved in or supervising its preparation. Another partner had taken that role. The following exchange then took place between Ms Schilling and Mr Rennick:

"Now, do you - this particular transaction, were you involved in negotiating this transaction? --- I don't recall. I certainly would have been involved in it in some way, as the partner responsible for the project. Whether I was specifically involved in this arrangement I can't recall. I certainly remember the circumstances though.

Okay. So you don't specifically recall any negotiations that occurred in relation to it? --- No. I don't.

Okay. Do you have any memory of the time at which this transaction occurred? --- No. I don't.

Okay. Would you agree or disagree if I said to you do you consider it's likely to have been around October/November 2002? --- Well, the deal on the face of it says that it's effective on 1 September so I take it it would be around that date.

Around which date? --- Around the date that you mentioned. It would be around that date. I don't quite - I don't recall specifically the month that it was negotiated and discussed."

235. The relevant paragraphs from Mr Rennick's statement are:

"71. Subsequently a number of further matters, some of which were matters the subject of further negotiation and agreement, and others being particular points overlooked in the drafting of the development lease, were dressed as follows:

• (1) an agreement made in or around mid to late 2002 between the Golf Club and Lakes, which was subsequently reduced to writing and executed by way of deed entitled 'Deed of Arrangement' on 30 June 2003 ( the Deed of Arrangement );
• (2) an agreement made in or around mid to late 2002 between the Golf club and Clubs, which was subsequently reduced to writing and executed by way of deed entitled 'Deed of Variation' on 30 June 2003 ( the Deed of Variation );
• (3) an Agreement known as the 'Supplementary Agreement' entered into between Lakes and Clubs on the one hand, and Links on the other, on 6 May 2003 ( the Supplementary Agreement ); and
• (4) an Agreement known as the 'Loose Ends Agreement' entered into between Lakes and Clubs on the one hand, and Links on the other, on 30 June 2003 ( the Loose Ends Agreement ).

…

75. The transactions so entered were the oral agreements which were later embodied in the Deed of Arrangement and Deed of Variation respectively.

76. In relation to the transaction recorded and formalized in the Deed of Arrangement, Lakes agreed to discharge the Golf Club's debt of around $10m and to acquire a specified number of memberships (0 Diamond, 246 Gold and 281 Silver), all being issued pursuant to clause 7 of the Golf Club's Constitution."

236. While I agree with Mr Sest that Mr Rennick's answers in cross-examination are not inconsistent with his written statement, they do not take matters much further. The dates on which various entities entered agreements, be they oral or otherwise, have always been a matter in issue in this case.^[240] See, for example, the Respondent’s Revised Statement of Facts, Issues and Contentions dated 30 September 2011 at [41] referring to T documents, T32 at 870-871 and the Applicant’s Statement of Facts Issues and Contentions dated 22 August 2011 at [64]. It is clear from other passages from Mr Rennick's evidence that he had been involved in the Sanctuary Lakes' project from its inception until June 2003,^[241] Transcript at 196, lines 44-43 in discussions with Mr Michael Tan,^[242] Transcript at 197, lines 3-6 and 199, lines 38-39 attended board meetings, or some of them of Holdings and Lakes,^[243] Transcript at 199, lines 10-35 and "certainly responsible for the overall relationship and the overall project".^[244] Transcript at 200, lines 20-21 Understandably, he did not do all of the legal work himself because it was such a big project and a number of Maddocks' partners supervised different aspects of it.^[245] Transcript at 200, lines 15-18 He had a joint arrangement with another partner regarding the supervision of the Development Lease and was not personally involved in the preparation of the Deed of Arrangement and Deed of Variation. He could not recall who had given instructions for the preparation of the documents. While he was aware of them, they had been prepared in a section of Maddocks other than that for which he was responsible. He would, though, have approved of all of the arrangements before they were sent to the client.^[246] Transcript at 202, lines 37-45 and at 202, lines 1-2 As a director of SLGC, Mr Rennick did not give instructions regarding the acquisition of its memberships by Lakes.^[247] Transcript at 201, lines 25-46 and at 203, lines 1-5

237. Mr Rennick has not been involved in Lakes' taxation issues^[248] Transcript at 202, lines 4-21 and, as is clear from the passage I have set out at [231] above, has not reviewed any file notes that he took over the years in relation to negotiations in which he was involved, the instructions he received or those he gave to those preparing work at his direction or in conjunction with him. Given that the project and his involvement in it continued over several years and given the complexity of the project, it is not surprising that he does not recall detail. What is a little surprising is that he did not refer to his notes or check whether or not they still existed so that he could refresh his memory of events. There may be a reasonable explanation for his not doing so but none was revealed at the hearing.

238. I do not accept Mr Sest's submission that the rule in
Browne v Dunn required Ms Schilling to put to Mr Rennick that his evidence was unreliable before she could make a submission to that effect. Her questions were directed to the timing of events and their content whether he had dealt with them in his statement or not. She gave him the opportunity to respond with the information he recalled about their timing and content and to explain why he did not recall if he did not. The rule in
Browne v Dunn does not require her to go any further before she is entitled to make a submission of the sort that she made. I have not gone so far as to accept her submission but I repeat my view that Mr Rennick's evidence given from a memory and unaided by any notes, gives me little assistance, if any, beyond that I can already glean from the documents.

D. The rule in Jones v Dunkel

239. The Commissioner has referred to the case of
Jones v Dunkel,^[249] (1959) 101 CLR 298 at 308 (per Kitto J), 312 (per Menzies J) and 320-321 (per Windeyer J) (Dixon CJ and Taylor J dissenting) in which Windeyer J formulated the principles adopted by the court as:

""… the general principles as stated in Wigmore on Evidence 3rd ed. (1940) vol. 2, s. 285, p. 162 as follows: 'The failure to bring before the tribunal some circumstance, document, or witness, when either the party himself or his opponent claims that the facts would thereby be elucidated, serves to indicate, as the most natural inference, that the party fears to do so, and this fear is some evidence that the circumstance or document or witness, if brought, would have exposed facts unfavourable to the party. These inferences, to be sure, cannot fairly be made except upon certain conditions; and they are also open always to explanation by circumstances which made some other hypothesis a more natural one than the party's fear of exposure. But the propriety of such an inference in general is not doubted.'"^[250] (1959) 101 CLR 298 at 320-321

240. In more modern times, it has been succinctly restated by Buchanan JA in
R v Lao:^[251] [2002] VSCA 157 ; (2002) VR 129 ; Buchanan, Vincent and Eames JJ.A

"… when a party appears to be able to prove the true facts and fails to do so, in the absence of explanation, an inference which is open on the facts that is favourable to the other party may be more readily drawn."^[252] [2002] VSCA 157 ; (2002) VR 129 at [34]; 139

241. In Re Kumar and Minister for Immigration and Citizenship^[253] [2009] AATA 124 ; (2009) 107 ALD 178 ; 50 AAR 96 at [91]-[115]; 204-214; 123-134 (Kumar), I considered the nature of the Tribunal's various roles and the general application of the rule in
Jones v Dunkel. I will not repeat my consideration but note my conclusions:

• (1) The rule "… is directed to that part of the decision-making process in which the decision-maker must decide first whether evidence or material is probative before deciding the weight that should be accorded to evidence that is probative.…";^[254] [2009] AATA 124 ; (2009) 107 ALD 178 ; 50 AAR 96 at [106]; 211; 130
• (2) The rules of evidence are directed to the same end. The Tribunal is not bound by the rules of evidence;^[255] AAT Act, s 33(1)(c)
• (3) The Tribunal must proceed according to the rules of procedural fairness.^[256] Kioa v West (1985) 159 CLR 550 ; 60 ALJR 113 ; 62 ALR 321 Gibbs CJ, Mason, Wilson, Brennan and Deane JJ at 583-585; 127; 346-347 per Mason J and see also AAT Act, s 39(1) These rules encompass a requirement that the Tribunal, which is a body required to act judicially, must act on logically probative material.^[257] Minister for Immigration and Ethnic Affairs v Pochi (1980) 4 ALD 139 , Smithers, Evatt and Deane JJ 67-68; 689-690; 160 per Deane J, with whom Evatt J agreed That is so whether the Tribunal is regarded as acting in an adversarial or inquisitorial role;^[258] I have set out examples of the variations in Kumar [2009] AATA 124 ; (2009) 107 ALD 178 ; 50 AAR 96 at [93]-[103]; 205-210; 124-129 and
• (4) Whether acting in an adversarial or inquisitorial manner, the rule in
  Jones v Dunkel remains relevant in the Tribunal in assessing and weighing logically probative material.^[259] Kumar [2009] AATA 124 ; (2009) 107 ALD 178 ; 50 AAR 96 at [113]-[114]; 214; 133.

ATTACHMENT C

CONSIDERATION: DEDUCTIONS UNDER s 8-1

The scope of and distinction between the two limbs of section 8-1(1)

242. As I have mentioned, s 8-1(1) of ITAA97 has two limbs; a positive and a negative limb. Section 51(1) of the then Income Tax and Social Services Contribution Assessment Act 1936-1953 was drafted in terms that are not materially different from those of ss 8-1(1) and (2).^[260] Federal Commissioner of Taxation v Citylink Melbourne Ltd [2006] HCA 35 ; (2006) 228 CLR 1 ; 228 ALR 301 ; (2006) 80 ALJR 1282 ; (2006) 62 ATR 648 at [90]; 30; 321; 1299; 669 per Crennan J

243. In
John Fairfax Pty Ltd v Federal Commissioner of Taxation,^[261] [1959] HCA 4 ; (1959) 101 CLR 30 ; 32 ALJR 370 ; Dixon CJ, Fullagrar, Kitto, Taylor and Menzies JJ Fullagar J speaking of s 51(1) said:

"The two categories of s 51(1) are clearly not mutually exclusive, and it has indeed been said that 'in actual working' the addition of the second category 'can add but little to the operation of the leading words "losses or outgoings to the extent to which they are incurred in gaining or producing assessable income":' … But it was not denied that there may be cases which fall outside the first category and within the second. The first is directed to expenditure incurred in the actual course of producing assessable income … It is, primarily at least, concerned with expenditure voluntarily incurred for the sake of producing income. Its scope is not, of course, confined to cases where the income is derived from carrying on a business. The second may be thought to be concerned rather with cases where, in the carrying on of a business, some abnormal event or situation leads to an expenditure which it is not desired to make, but which is made for the purposes of the business generally and is reasonably regarded as unavoidable…"^[262] [1959] HCA 4 ; (1959) 101 CLR 30 ; 32 ALJR 370 at 40; 373 (citations omitted)

244. That lack of exclusivity means that, in order to come within the provisions of s 8-1(1), it is not enough simply to establish that the loss or outgoing has been incurred. It must also be a loss or outgoing of a revenue character and properly referable to the year of income in question.^[263] Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640 at 663 per Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ I will return to this under the negative limbs of s 8-1 below.

Relevance of recitals in contracts, agreements, deeds and the like

245. Recitals in documents such as contracts, agreements and deeds may act as an estoppel between the parties to those documents but they do not constitute conclusive proof of the facts they assert. They are simply part of the evidentiary material which I must consider.^[264] Federal Coke Co Pty Ltd v Federal Commissioner of Taxation (1977) 34 FLR 375 ; Bowen CJ, Nimmo and Brennan JJ at 385 per Bowen CJ

Corporate structures

246. When examining corporate structures, I have had regard to the caution given by Nimmo J in
Federal Coke Co Pty Ltd v Federal Commissioner of Taxation that separate corporate entities must be treated as independent entities. The fact that one corporate entity is a wholly owned subsidiary of another cannot operate to give a payment or receipt a character it would not otherwise have.^[265] (1977) 34 FLR 375 at 400 The character of that payment must be determined by reference to its character in the hands of the corporate entity receiving it.^[266] (1977) 34 FLR 375 at 388 per Bowen CJ

Characterisation depends on actual facts and not a rearrangement of facts

247. The preceding principle is related to that stated by Bowen CJ in Federal Coke:

"… [I]n taxation matters, the court is obliged to have regard to the actual facts and not to the equivalents. In cases where it is appropriate the court may apply a statutory provision such as s. 260^[267] Section 260 of ITAA36 provides that any contract, agreement, or arrangement made or entered into (whether orally or in writing) shall be absolutely void as against the Commissioner or in regard to any proceeding under ITAA36 in so far as it purports to have the purpose or effect of, in any way, directly or indirectly, altering the incidence of any income tax, relieving any person from the liability to pay any income tax or make any return, defeat, evade or avoid any duty or liability imposed on any person by the legislation, or prevent its operation in any respect. to get rid of a contract, agreement or arrangement and deal with the case in disregard of that element, but, where there is no statutory warrant for doing so, the court cannot disregard certain of the facts or re-arrange the facts or decide the case according to its view of the substance of the matter. It is not legitimate to disregard the separateness of different corporate entities or to decide liability to tax upon the basis of the substantial economic or business character of what was done…"^[268] (1977) 34 FLR 375 at 387

248. Putting it another way, a taxpayer's liability is not determined by reference to economic equivalence. Economic equivalence:

"… has been relied on to seek re-characterisation of a receipt or outgoing where there is more than one way to achieve the desired economic result and the taxpayer chooses the way which is the most tax effective. Anti-avoidance provisions aside, the courts have consistently rejected the doctrine of taxation by reference to economic equivalents, that is, by reference to the ways in which the transaction could or might have been done, as an aid to characterisation.…"^[269] Business & Research Management Ltd (in liq) v Federal Commissioner of Taxation (2008) 173 FCR 204 at 229 per Edmonds J

This means that it is impermissible to conflate "… separate transactions, albeit financially dependent separate transactions, and taxation by reference to the end economic result of that conflation."^[270] (2008) 173 FCR 204 at 230

The Tribunal's task

249. The Tribunal's task in reviewing an objection decision was explained by Foster J in
Eldridge v Federal Commissioner of Taxation:^[271] [1990] FCA 369 ; (1990) 90 ATC 4907 ; 21 ATR 897

"It is abundantly clear, of course, that even though the Tribunal does over again the work of the Commissioner, it does it in a significantly different way. Although it could be said to be part of an administrative hierarchy, its functions partake far more of the court than of the office desk.

It is clearly not cast in the role of the inquisitor. Although it does not act within the confines of formal pleadings, it is constrained in its inquiries and deliberations by the ambit of the taxpayer's objections. Although it is not bound by the rules of evidence (sec. 33(1)(c)) in reaching its decision it must act upon the evidence which is placed before it.…"^[272] (1990) 90 ATC 4907 at 4,921 per Foster J

250. In
Federal Commissioner of Taxation v Dalco^[273] [1990] HCA 3 ; (1990) 168 CLR 614 ; 90 ALR 341 ; 20 ATR 1370 ; 64 ALJR 166 ; 90 ATC 4088 (Dalco), Brennan J observed that the purpose behind an assessment, objection and appeal or review "… is to ascertain the true tax liability of the taxpayer under the substantive provisions of the Act."^[274] [1990] HCA 3 ; (1990) 168 CLR 614 ; 90 ALR 341 ; (1990) 20 ATR 1370 ; (1990) 64 ALJR 166 ; 90 ATC 4088 at 621; 344; 1373; 168; 4091 per Brennan J with whom Mason CJ, Dawson, Deane, Gaudron and McHugh JJ concurred. The case was concerned with s. 190(b) of the ITAA36 which was repealed and re-enacted in substance as s. 14ZZK(b)(i) of the TA Act by the Taxation Laws Amendment Act (No. 3) 1991, s. 112. Speaking of an appeal, but the principles are equally apt to a merits review in this Tribunal, his Honour continued:

"… It would be inappropriate for a court determining an appeal to make an order altering the tax liability assessed … unless the court were satisfied that the amount to which it proposed to alter the assessment represented the true tax liability of the taxpayer. Although the grounds of objection limit the grounds of appeal, the ultimate question for the court hearing the appeal is not whether the grounds have been made out but whether the amount assessed as taxable income is wrong. The burden which rests on a taxpayer is to prove that the assessment is excessive and that burden is not necessarily discharged by showing an error by the Commissioner in forming a judgment as to the amount of the assessment."^[275] [1990] HCA 3 ; (1990) 168 CLR 614 ; 90 ALR 341 ; 20 ATR 1370 ; 64 ALJR 166 ; 90 ATC 4088 at 621; 344; 1373; 168; 4091

251. Also in Dalco, Toohey J^[276] With whom Mason CJ, Dawson, Gaudron and McHugh JJ agreed explained:

"… A taxpayer does not necessarily discharge the onus of showing that an assessment is excessive, merely by showing that moneys treated by the Commissioner as income are in truth not the income of the taxpayer, though that may be a step in demonstrating his or her taxable income to be less than the assessment."^[277] [1990] HCA 3 ; (1990) 168 CLR 614 ; 90 ALR 341 ; 20 ATR 1370 ; 64 ALJR 166 ; 90 ATC 4088 at 631; 351-352; 1379; 173; 4097 per Toohey J

Burden of proof

A. Statutory provisions

252. Section 14ZZK of the Taxation Administration Act 1953 (TA Act) provides:

"On an application for review of a reviewable objection decision:

• (a) the applicant is, unless the Tribunal orders otherwise, limited to the grounds stated in the taxation objection to which the decision relates; and
• (b) the applicant has the burden of proving that:
  • (i) if the taxation decision concerned is an assessment (other than a franking assessment) - the assessment is excessive; or
  • (ii)…
  • (iii) in any other case - the taxation decision concerned should not have been made or should have been made differently."

B. Standard of proof unaltered: balance of probabilities

253. Section 14ZZK does not alter the standard of proof that generally applies in the Tribunal. That means that a person who bears a burden of proof may meet it by producing to the Tribunal evidence and other material that is relevant and probative and that satisfies it of the existence or non-existence of relevant factual issues on the balance of probabilities rather than simply on the basis of possibilities.

C. How a taxpayer may satisfy the burden

254. The case of
McCormack v Federal Commissioner of Taxation^[278] [1979] HCA 18 ; (1979) 143 CLR 284 ; 23 ALR 583 ; 9 ATR 610 ; 53 ALJR 436 ; 79 ATC 4111 illustrates the nature of a taxpayer's task in satisfying the burden. It does so in a case in which the Commissioner had treated the net profit from the sale of a property as assessable income on the basis that it arose from the sale of a property Mrs McCormack had acquired for the purpose of profit-making by sale within the meaning of s 26(a) of ITAA36 as it was then in force. Gibbs J explained Mrs McCormack's task:

"… The taxpayer bears the burden of proving that the assessment was excessive. To discharge that burden in a case such as the present he must prove affirmatively, on the balance of probabilities, that the property was not acquired for the purpose of profit-making by sale. The burden may be discharged by drawing inferences from the evidence. In some cases in which all the relevant facts are known, and there is no material upon which it might properly be concluded that the property was acquired for the relevant purpose, the inference may properly be drawn that the property was not acquired for the relevant purpose. But it is not enough, even when all the facts are known, that there is no material upon which it may be concluded that the property was acquired for the purpose mentioned in s. 26(a). If a taxpayer can succeed, simply because there is no evidence from which it can be concluded that the relevant purpose existed, that must mean that the burden of proving the existence of that purpose lies on the Commissioner. That in my respectful opinion would be to invert the onus of proof. The taxpayer will succeed if the proper inference from the evidence is that the property was not acquired for the relevant purpose, but if there is no evidence as to the purpose for which the taxpayer acquired the property the appeal must fail."^[279] [1979] HCA 18 ; (1979) 143 CLR 284 ; 23 ALR 583 ; 9 ATR 610 ; 53 ALJR 436 ; 79 ATC 4111 at [11]; 303; 597; 443; 622; 4,121

255. If all of the material facts were known and the amount of a taxpayer's taxation liability turned on the application of the law to those facts, the taxpayer could discharge the burden of proof by establishing that the Commissioner had erroneously included in the assessed taxable income an amount that should not have been included.^[280] Federal Commissioner of Taxation v Dalco [1990] HCA 3 ; (1990) 168 CLR 614 ; 90 ALR 341 ; 20 ATR 1370 ; 64 ALJR 166 ; 90 ATC 4088 at 625; 347; 1375-6; 170; 4094 per Brennan J

256. It is open to the taxpayer to attack the Commissioner's power to make an assessment^[281] McAndrew v Federal Commissioner of Taxation (1956) 98 CLR 263 ; 30 ALJR 464 at 270-271; 465-466 per Dixon CJ, McTiernan and Webb JJ or the calculation of the amount of an assessment. If the taxpayer chooses to attack the calculation of the amount of the assessment:

"… mere error in the formation of that judgment by the Commissioner does not warrant the setting aside of the amount assessed. Given the validity of the exercise of the power to make an assessment …, the ultimate question is whether the amount of the assessment is excessive. The amount of the assessment might not be excessive in fact, though the reasons which led to the assessment were erroneous.…"^[282] Federal Commissioner of Taxation v Dalco [1990] HCA 3 ; (1990) 168 CLR 614 ; 90 ALR 341 ; 20 ATR 1370 ; 64 ALJR 166 ; 90 ATC 4088 at 623; 345; 1374; 169; 4092 per Brennan J

257. Therefore, merely establishing on the balance of probabilities that the Commissioner has made an error cannot satisfy the taxpayer's burden of proof under s 14ZZK(b)(i) in relation to an assessment for the burden is to prove that "the assessment is excessive". The point was made in Dalco:

"… A taxpayer who shows on the facts that are known a mere error by the Commissioner in assessing the amount of the taxpayer's taxable income does not show that his objection should have been allowed or that the appeal against the assessment must be allowed.…"^[283] [1990] HCA 3 ; (1990) 168 CLR 614 ; 90 ALR 341 ; 20 ATR 1370 ; 64 ALJR 166 ; 90 ATC 4088 at 625; 347; 1375-6; 170; 4094 per Brennan J with whom Mason CJ, Dawson, Gaudron and McHugh JJ agreed

D. No burden of proof on Commissioner and no obligation to put forward material establishing a particular view

258. Referring to a similar burden formerly imposed on the taxpayer by s 190(b) of ITAA36, Mason J said in
Gauci v Federal Commissioner of Taxation^[284] (1975) 135 CLR 81 ; Bawick CJ and Jacobs JJ; Mason J dissenting (Gauci):

"The Act does not place any onus on the Commissioner to show that the assessments were correctly made. Nor is there any statutory requirement that the assessments should be sustained or supported by evidence. The implication of such a requirement would be inconsistent with s. 190 (b) for it is a consequence of that provision that unless the appellant shows by evidence that the assessment is incorrect, it will prevail."^[285] (1975) 135 CLR 81 at 89 and approved by Brennan J in Dalco [1990] HCA 3 ; 168 CLR 614 ; 90 ALR 341 ; 20 ATR 1370 ; 64 ALJR 166 ; 90 ATC 4088 at 624; 346-347; 1375; 4,093

259. His Honour also explained the rationale for imposing a burden upon the taxpayer when he said:

"… There is nothing inherently unfair in the provision which places the onus on the taxpayer to prove his case when the purpose for which an asset was acquired depends so much on his intentions and on circumstances of which he, rather than the Commissioner, has comprehensive knowledge."^[286] (1975) 135 CLR 81 at 89

260. In
Galea v Commissioner of Taxation,^[287] [1990] FCA 456 ; (1990) 90 ATC 5060 ; 21 ATR 1108 Hill J said:

"To the extent that the applicant seeks to rely upon the description of what the Commissioner did here as being an attempt to mount a positive case, it is not clear to me at all why this has any relevance. As is clear from Dalco, supra, and as the tribunal itself said, it was not necessary for the Commissioner to seek to establish affirmatively that the applicant's assessable income was at least a particular figure. The fact that the Commissioner sought so to do and failed has no bearing, at the end of the day, on the question whether the applicant has discharged the onus of showing, as he is required by s 190(b) of the Act to show, that the assessment is excessive. The Commissioner's failure to establish a positive case, if that is what he sought to do, leaves the tribunal in no different position than it would have been in if the Commissioner had not sought at all to advance a positive case."^[288] [1990] FCA 456 ; (1990) 90 ATC 5060 ; 21 ATR 1108 at [34]; 5,067; 1116 See also Vu v Commissioner of Taxation [2006] FCA 889 ; (2006) 63 ATR 341 at [9]; 344 per Finn J

AUTHORITIES RELATING TO THE POSITIVE LIMB: section 8-1(1)

"incurred in gaining or producing"

A. Must be incurred in course of gaining or producing assessable income

261. The requirement that the expense or outgoing must be "incurred in gaining or producing" a taxpayer's assessable income must be read as meaning "losses and outgoings in the course of gaining or producing assessable income."^[289] Amalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation ²⁸⁹ (Amalgamated Zinc) [1935] HCA 81 ; (1935) 54 CLR 295 ; 3 ATD 288 ; 9 ALJR 342 ; Latham CJ, Rich, Starke, Dixon, Evatt and McTiernan JJ at 303 per Latham CJ Determining whether particular expenditure has been incurred in gaining or producing assessable income is a question of fact^[290] Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation [1949] HCA 15 ; (1949) 78 CLR 47 ; 8 ATD 431 at [18]; 59; 437 but the basis on which that question of fact is determined was further explained by Gleeson CJ, Kirby and Hayne JJ in
Federal Commissioner of Taxation v Payne:^[291] [2001] HCA 3 ; (2001) 202 CLR 93 ; 177 ALR 270 ; 46 ATR 228 ; 75 ALJR 442 ; [2001] ATC 4027 ; Gleeson CJ, Gaudron, Gummow, Kirby and Hayne JJ

"Accepting, as one must, that 'the assessable income' referred to in s 51(1) is a broad concept, it may well follow … that '[t]he relevance of the expenditure should be determined having regard to the overall income producing activities of the taxpayer, and not by reference to individual sources of income'… That is not to say, however, that the kind of connection which s 51(1) requires between outgoing and income is other than the connection described as 'incurred in gaining or producing the assessable income'. The question is whether the outgoing was incurred in the course of gaining or producing actual or expected income. That is, is the occasion of the outgoing found in whatever is productive or expected income?"^[292] [2001] HCA 3 ; (2001) 202 CLR 93 ; 177 ALR 270 ; 46 ATR 228 ; 75 ALJR 442 ; [2001] ATC 4027 at [11]; 100; 273; 231-232; 445; 4030

262. This statement of principle was approved by the majority of the High Court in
Commissioner of Taxation v Day^[293] [2008] HCA 53 ; (2008) 236 CLR 163 ; 250 ALR 388 ; [2008] ATC 8,842 ; 70 ATR 14 ; 83 ALJR 68 as providing a "surer guide" as to whether a loss or expenditure has been incurred in the course of gaining or producing assessable income. The Honours observed that "Essential to the inquiry is the determination of what it is that is productive of assessable income."^[294] [2008] HCA 53 ; (2008) 236 CLR 163 ; 250 ALR 388 ; [2008] ATC 8,842 ; 70 ATR 14 ; 83 ALJR 68 at [31]; 179; 398; 8,851; 26; 77 per Gummow, Hayne, Heydon and Kiefel JJ

B. Must be incidental and relevant to gaining or producing assessable income

263. The loss or outgoing must be incidental and relevant to the gaining or producing of the taxpayer's assessable income. In
Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation^[295] [1949] HCA 15 ; (1949) 78 CLR 47 ; 8 ATD 431 ; Latham CJ, Rich, Dixon, McTiernan and Webb JJ (Ronpibon), the High Court said of the equivalent section in ITAA36, s 51(1):

"For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words 'incurred in gaining or producing assessable income' mean in the course of gaining or producing such income.…

… In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income."^[296] [1949] HCA 15 ; (1949) 78 CLR 47 ; 8 ATD 431 at 56-57; 435-436 and see also Commissioner of Taxation v Payne [2001] HCA 3 ; (2001) 202 CLR 93 ; 177 ALR 270 ; 46 ATR 228 ; 75 ALJR 442 ; [2001] ATC 4027 at [9]; 99; 272-273; 230; 444; 4,029 per Gleeson CJ, Kirby and Hayne JJ

264. Whether it will be incidental and relevant depends on the particular activities undertaken by the taxpayer or the activities of the business carried on for the purpose of gaining or producing assessable income.
Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation^[297] (1956) 95 CLR 344 ; Dixon CJ, Williams, Webb, Fullagar and Kitto JJ provides an example. While on the way to the bank to bank the previous day's takings, two employees of a department store were held up at gun point and robbed of £3,031. That sum was claimed as a deduction. The High Court said:

"… In the case of a large departmental store such as the taxpayer carries on, the ordinary course of business requires that, day by day and as soon as may be, the takings shall be deposited in the bank. It is as necessary to the conduct of the business as it is to place goods on the shelves or to deliver them to the customers. They are all operations in the course of gaining or producing the assessable income by means of carrying on the business.…

Banking the takings is a necessary part of the operations that are directed to the gaining or producing day by day of what will form at the end of the accounting period the assessable income. Without this, or some equivalent financial procedure, hitherto undevised, the replenishment of stock in trade and the payment of wages and other essential outgoings would stop and that would mean that the gaining or producing of the assessable income would be suspended.

… Properly understood the place which the banking of money takes in a merchandising business brings the operation within the principle thus stated. It is an essential, or at all events highly expedient, part of the conduct of the business, a necessary or recognised incident or concomitant, and is relevant as well as incidental to the end in view, the gaining of assessable income.^[298] (1956) 95 CLR 344 at 349-350 "

265. The Court gave a further example in drawing the connection between the loss or outgoing and its deductibility:

"… In
Commissioner of Taxation (NSW) v Ash …^[299] (1938) 61 CLR 263 ; 5 ATD 76 , Rich J said: 'There is no difficulty in understanding the view that involuntary outgoings and unforeseen or unavoidable losses should be allowed as deductions when they represent that kind of casualty, mischance or misfortune which is natural or recognized incident of a particular trade or business the profits of which are in question. These are characteristic incidents of the systematic exercise of a trade or the pursuit of a vocation.^[300] (1938) 61 CLR 263 ; 5 ATD 76 at 277 … Even if armed robbery of employees carrying money through the streets had become an anachronism which we no longer knew, these words would apply.…"^[301] (1956) 95 CLR 344 at 350-351

C. The loss or outgoing must have been "incurred"

266. The word "incurred":

"… 'Incurred' does not mean only 'defrayed, discharged or borne', but also includes 'encountered, run into, fallen upon'. It does not, however, include a loss or expenditure which is no more than 'impending, threatened, or expected' …. The expenditure must have been incurred in the course of gaining or producing the assessable income but it is not required that the purpose of the expenditure shall be the gaining or production of the income of that year. It is sufficient 'if the expenditure was made in the given year or accounting period and is incidental and relevant to the operations or activities regularly carried on for the production of income' …. It is not necessary that 'an actual disbursement' should have taken place. Although it is not enough if there is 'no debitum in praesenti solvendum in future … [or] inchoate liability in process of accrual but subject to a variety of exigencies…."^[302] Commissioner of Taxation v Woolcombers (WA) Pty Ltd (1993) 47 FCR 561 ; Beaumont, French and Foster JJ at 570 (citations omitted) See also Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 at 507 per Dixon CJ, Webb, Fullagar, Kitto and Taylor JJ

267. In the case of a contract and an obligation to pay, the relevant enquiry is with respect to the character of the liability to pay a price rather than with the nature of any interest that might be acquired in the subject matter of the contract.^[303] (1993) 47 FCR 561 at 574 As the Full Court of the Federal Court said in
Commissioner of Taxation v Malouf:^[304] [2009] FCAFC 44 ; (2009) 174 FCR 581 ; [2009] ATC 20-099 ; 75 ATR 335 ; Sundberg, Jessup and Middleton JJ

"… Every contract must be construed according to the intention of the parties, and upon taking a legal or jurisprudential approach, the contractual arrangements and surrounding circumstances must be considered in determining when the loss or outgoing has been incurred."^[305] [2009] FCAFC 44 ; (2009) 174 FCR 581 ; [2009] ATC 20-099 ; 75 ATR 335 at [45]; 594; 9,565; 347. Mr Sest, counsel for the applicant, drew my attention to Perri v Coolangatta Investments Pty Ltd (1982) 149 CLR 537 at 542 (Gibbs CJ); 552 (Mason J) and 557 (Wilson J), Gange v Sullivan (1996) 116 CLR 418 at 441 (Taylor, Menzies and Owen JJ), Commonwealth Homes and Investment Co Ltd v MacKellar (1939) 63 CLR 351 at 362 (Latham CJ) and Sandra Investments Pty Ltd v Booth (1983) 153 CLR 153 as authorities for the proposition that “… There is a presumption that, in the absence of a contrary intention, the parties to a contract intend to be immediately bound by it, so that a condition of postponement does not postpone the obligation itself, but merely its performance….”: Applicant’s Submissions at [156]. I do not read the authorities in quite the same way. Rather, I understand them to establish that each contract must be interpreted according to its own terms.

268. The "legal or jurisprudential approach" is to be contrasted with a commercial view, which is taken to be the incorrect view.^[306] Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640 at 662 per Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ at 662. The difference is illustrated by the case of Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation (1981) 144 CLR 616 , which concerned amounts provided in the taxpayer’s accounts for long service leave, and Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 , which concerned amounts provided in the taxpayer’s accounts for annual leave. The majority said that those decisions “… proceed on the footing that the Court concluded that liability was the ordinary liability to pay wages to an employee in respect of a period of employment in preference to the commercial view that the liability was a progressive one, being part of the cost of labour employed from day to day …”. The words "losses and outgoings incurred":

"… But they do not admit of the deduction of charges unless, in the course of gaining or producing the assessable income or carrying on the business, the taxpayer has completely subjected himself to them. It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time. It is probably going too far to say that the obligation must be indefeasible. But it is certainly true that is not a matter depending upon 'proper commercial and accountancy practice rather than jurisprudence'. Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by s. 51 (1) but it cannot be substituted for the test."^[307] Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 at 506-507 per Dixon CJ, Webb, Fullagar, Kitto and Taylor JJ

269. It follows that, while there must be a link between the losses or outgoings and the gaining or producing of assessable income, that link does not have to be a link forged in the same accounting period:

"… It is not the practice to institute an inquiry into the exact time at which it is hoped that expenditure made within the accounting period will have an effect upon the production of assessable income and to refuse to allow it as a deduction if that time is found to lie beyond the period.…"^[308] Amalgamated Zinc [1935] HCA 81 ; (1935) 54 CLR 295 ; 3 ATD 288 ; 9 ALJR 342 at 309 per Dixon J

From an accounting perspective, it is apparent that "… accruals based tax accounting and the jurisprudence in respect of the test for deductibility could not always be reconciled with a commercial or accounting approach."^[309] Federal Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35 ; (2006) 228 CLR 1 ; Gleeson CJ, Gummow, Kirby, Callinan, Heydon and Crennan JJ at [2006] FCA 35 ; (2006) 228 CLR 1 at [127]; 38 per Crennan J

270. This is illustrated by the case of
Commissioner of Taxation v Lau^[310] (1984) 6 FCR 202 ; Fox, Jenkinson and Beaumont JJ whose facts and outcome in this context are adequately described in the opening paragraph of the headnote:

"… That a taxpayer, who entered into a long-term commercial venture involving the growing of pine trees with a view to future sales of timber therefrom, was entitled to a deduction under s51(1) for a lump sum 'management fee' paid to the managers in return for recurring services to be rendered in connection with the venture for a period of twenty-one years.

…"^[311] (1984) 6 FCR 202 at 202 Justice Beaumont, with whom Jenkinson J agreed, explained that “… In this context, it is appropriate to refer to the contractual quid pro quo to determine the nature of the outgoing … and, prima facie, money out laid in return for such recurrent services are paid on revenue account. In my view, the circumstances that the fee is to be paid as a lump sum in advance is not sufficient to displace this presumption. The important considerations are the nature of the services to be rendered and the periodic manner in which they are to be rendered. In my opinion, the outgoings fell within s 51, been directed not to the profit-yielding subject of the taxpayer’s business but the process of operating it….”: (1984) 6 FCR 202 at 221.

271. Care must be taken to distinguish between a condition on whose fulfilment the formation, or continuation, of a binding contract depends and a condition on which the performance of a relevant obligation under that contract depends. In the latter case, non-fulfilment of the condition may not, under the particular terms of the contract, prevent a binding contract, and so an obligation's, coming into existence. "… Much will depend on the nature of the contractual arrangements. This involves looking at the circumstances in each case.…".^[312] Federal Commissioner of Taxation v Malouf [2009] FCAFC 44 ; (2009) 174 FCR 581 ; [2009] ATC 20-099 ; 75 ATR 335 at [45]; 593; 9,565; 347

272. This proposition is illustrated by the judgment of Lindgren J in
Merrill Lynch International (Australia) Ltd v Commissioner of Taxation^[313] [2001] FCA 1127 ; (2001) 113 FCR 79 ; 191 ALR 420 ; 47 ATR 611 (Merrill Lynch). The applicants rewarded their employees with annual bonus payments. Bonuses were described as "discretionary" but had become part of normal practice and an integral part of the employees' remuneration packages. The applicants' income year ended on 31 December. They claimed as deductions in the 1994 income year amounts that they had set aside progressively throughout 1994 to pay as bonuses in late January 1995. The aggregate amount of the bonuses was determined in mid January. Employees were not advised until a week or so later whether they would receive a bonus and, if so, the amount of that bonus before that time. The question was whether the applicants had incurred the bonuses as outgoings in the 1994 year.

273. Justice Lindgren considered the applicants' submissions to the effect that they were under an implied contractual obligation to exercise their discretion to pay bonuses in accordance with ordinary standards of fairness. Had they not done so, an employee would have been entitled to bring a proceeding in the then Industrial Relations Commission of New South Wales (IRC) seeking payment and the IRC would have been likely to grant relief. His Honour rejected both an implied contractual obligation and potential legal proceedings likely to result in the employees' relief as satisfying the requirement that, by the end of 1994, there was a legal liability to pay an outgoing. His reasons read in part:

"… Jurisprudential or legal analysis, which the authorities require, exposes a clear distinction between a legal right to be paid a bonus and the corresponding legal obligation to pay one on the one hand, and standing to apply for a discretionary remedy on the other. Even if it were very likely by the end of the tax year that a discretionary remedy would be granted if applied for, this is at most 'commercial certainty', and commercial certainty is distinct from a legal liability to pay, in respect of which there is an entitlement to a curial remedy as of right.…

…

It is not necessary for me to decide whether it was an implied term of all the contracts of employment between the applicants and their respective employees that the applicants would act reasonably, fairly and in good faith in relation to the discretion to pay a bonus. I will assume that it was. Nonetheless, the existence of the term would not have produced the result that by 31 December 1994 the applicants were liable to pay bonuses to their employees.

Under the general law, the curial remedies for breach of contract are unliquidated damages and the discretionary remedy of specific performance. Neither remedy can be equated with the existence by 31 December 1994 of a legal liability of the applicants to pay bonuses to their respective individual employees, let alone a legal liability to pay bonuses in the amounts which were in fact paid to them in late January 1994.

Quite apart from the issue of quantification, legal liability to pay an outgoing of a certain description is conceptually distinct from a liability in damages from breach of contract. A contractual promise 'to pay a bonus' is conceptually distinct from the contractual promise to exercise the contractual discretion reasonably, fairly and in good faith. In my opinion, at least the former would have to be found before it could be concluded that the applicants had completely subjected and definitively committed themselves to pay the outgoings sought to be deducted in the present case."^[314] [2001] FCA 1127 ; (2001) 113 FCR 79 ; 191 ALR 420 ; 47 ATR 611 at [93]-[97]; 108; 446-447; 636-637

274. With regard to the distinction between incurring a liability and discharge of that liability, the former must happen in the year of income in which it is claimed even though it may not be discharged until a later year.^[315] Federal Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35 ; (2006) 228 CLR 1 ; 228 ALR 301 ; (2006) 80 ALJR 1282 ; (2006) 62 ATR 648 Gleeson CJ, Gummow, Kirby, Callinan, Heydon and Crennan JJ at [122]-[126]; 36-38; 327-328; 1303-1304; 674-675 per Crennan J In
Federal Commissioner of Taxation v Citylink Melbourne Limited,^[316] [2006] HCA 35 ; (2006) 228 CLR 1 ; 228 ALR 301 ; (2006) 80 ALJR 1282 ; (2006) 62 ATR 648 Crennan J noted that:

"… A condition affecting the timing of the discharge of a liability (but not the creation of the liability) does not render the liability contingent in any business or commercial sense…"^[317] [2006] HCA 35 ; (2006) 228 CLR 1 ; 228 ALR 301 ; (2006) 80 ALJR 1282 ; (2006) 62 ATR 648 at [137]; 40-41; 299; 678 (citations omitted)

Earlier, her Honour had referred to the judgment of Deane J in
Coles Myer Finance Ltd v Federal Commissioner of Taxation^[318] (1993) 176 CLR 640 ; Mason CJ, Brennan, Deane, Dawson, Toohey, Gaudron and McHugh JJ (Coles Myer):

"Deane J considered that the critical question was whether the taxpayer was, as a practical matter, definitively committed or completely subjected to discharge of the liability in the future …. His Honour recognised that on some facts it would be apparent that a condition giving rise to a theoretical contingency could be treated, for practical purposes, as certain to be satisfied…"^[319] Federal Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35 ; (2006) 228 CLR 1 ; at [125]; 37-38

275. In the case of a contract for the purchase of wool in which the obligation to pay the purchase price, and the consequent passing of property, was to occur after delivery of the wool, the Full Court of the Federal Court said:

"In James Flood, the High Court said (at 506): 'It is probably going too far to say that the obligation must be indefeasible.'

In our view, much will depend upon the particular circumstances of the case at hand. If the defeasibility takes the form of a contingency such as drought or a similar frustrating event which would ordinarily be implied as a matter of business efficacy, it is difficult to argue that by reason of the existence of this contingency, no liability to pay the price has accrued."^[320] Commissioner of Taxation v Woolcombers (WA) Pty Ltd (1993) 47 FCR 561 (1993) 47 FCR 561 at 575

276. The nature of the business was relevant in
RACV Insurance Pty Ltd v Commissioner of Taxation^[321] [1975] VicRp 1 ; [1975] VR 1 ; Menhennitt J (RACV Insurance) when the taxpayer claimed as a loss or outgoing an amount that it had estimated and had set aside to satisfy claims that had yet to be reported to it. Justice Menhennitt accepted that the estimates were reasonable in light of the evidence he had regarding the insurance industry. This amount was allowable as a deduction under s 51(1) for:

"… in respect of compulsory third-party insurance claims a loss or outgoing is incurred by the authorized insurer when the events occur which impose on the authorized insurer a liability to indemnify the driver of the vehicle in respect of a claim by a third person for personal injury. Having regard to the fact that there is an unanswerable liability to indemnify the driver of the vehicle once the personal injury occurs, it seems to me that a loss or outgoing is incurred within the meaning of s 51(1) of the Act once the events giving rise to a liability occur and that the incurring of the loss or outgoing is not dependent on notice of the injury or of the accident or upon a claim being made by the driver for indemnity.…"^[322] [1975] VicRp 1 ; [1975] VR 1 at [16]. See also Commissioner of Taxation v Mercantile Mutual Insurance (Workers’ Compensation) Ltd [1999] FCA 351 ; (1999) 87 FCR 536 ; 162 ALR 130 ; 42 ATR 8 at [44]; 547; 140; 17 per Hill J

277. The outcome in RACV Insurance is to be contrasted with that in Merrill Lynch as Lindgren J did in delivering his judgment in Merrill Lynch. That case did not belong in the same category as RACV Insurance:

"… Because the amounts of the bonuses payable were inherently incapable of independent 'ascertainment' and were not, at the end of the tax year, capable of being 'estimated', in the sense in which those terms are used in the authorities. In the insurance cases mentioned, the taxpayers had promised to indemnify the insureds, and it was possible, by reference to objective criteria, for a court to determine the money amount which that promise required the taxpayers to pay and for an estimate to be made of that amount at tax year's end. The present case is different. The problem is not, as it was in RACV for example, simply that the amount required to be paid had not been ascertained by 31 December 1994. Even if the applicants had promised to pay their employees 'a bonus', the amount of it would have been inherently incapable of 'ascertainment' or of 'estimation' because the exercise by Merrill Lynch of its discretion was an essential step in the process of the determination of the amount."^[323] [2001] FCA 1127 ; (2001) 113 FCR 79 ; 191 ALR 420 ; 47 ATR 611 at [100]; 109;448; 637

What is encompassed in "assessable income"?

278. The High Court in
Fletcher v Federal Commissioner of Taxation^[324] (1991) 173 CLR 1 ; 103 ALR 97 ; 91 ATC 4950 (Fletcher) examined what was meant by "the assessable income":

"… [T]he reference … to 'the assessable income' is not to be read as confined to assessable income actually derived in the particular tax year. It is to be construed as an abstract phrase which refers not only to assessable income derived in that or in some other tax year but also to assessable income which the relevant outgoing 'would be expected to produce' …"^[325] (1991) 173 CLR 1 ; 103 ALR 97 ; 91 ATC 4950 at 16; 106; 4,957 (citations omitted)

279. The expenditure for which a deduction is claimed must be referable to assessable income gained or produced. That does not mean that it must be referable to the whole of the assessable income gained or produced by the taxpayer but it must be referable to some part of it.

280. The early case of
Federal Commissioner of Taxation v Munro; British Imperial Oil Co Ltd^[326] [1926] HCA 58 ; (1926) 38 CLR 153 ; Knox CJ, Isaacs, Higgins, Rich and Starke JJ (Munro) provides an example. Mr Munro owned various businesses as well as various buildings on Elizabeth Street in Melbourne, which he leased to tenants. He borrowed a sum of money and its repayment was secured by a mortgage over the Elizabeth Street property. Mr Munro used the money to purchase shares in a company he had established with himself and his sons as shareholders. He also advanced the company money. His intention was to use the company as a vehicle to start another business in Sydney. He argued that, whenever money was borrowed by a taxpayer on the security of a rent-producing property, the interest paid under the mortgage should be deducted from his assessable income, irrespective of the purpose to which the borrowed money was put.

281. All of the Judges rejected this argument. Knox CJ expressed his reasons in this way:

"In this case the assessable income of the taxpayer was in no way referable to the transaction with the bank out of which the liability to pay interest arose, and the loan by the Bank was in no way instrumental in or conducive to the production of the assessable income or that part of it which consisted of the rents of the freehold property. The respondent was, before the mortgage was given, entitled to the whole of these rents, and he did not gain them nor were they produced in consequence of the payment of interest. The interest was paid, not for the purpose of gaining or producing assessable income of the taxpayer, but for the purpose of satisfying pro tanto a debt which the taxpayer had incurred with a view, not to the production of his assessable income, but to the production of income by the company for the benefit of its shareholders. The debt having been incurred for a purpose wholly unconnected with the production of assessable income of the respondent, I think it impossible to say that the interest paid on the amount of the debt was money wholly and exclusively laid out or expended for the production of his assessable income."^[327] [926] HCA 58; (1926) 38 CLR 153 at 171

282. That does not mean that the whole of borrowed moneys must be referable to some part of the assessable income but some part must be. That part which is referable is deductible but not otherwise. Ronpibon provides an example. The High Court considered a claim for a deduction of expenditure incurred by a mining company in maintaining its office and the administration of its affairs in Melbourne. It had previously operated a mining operation in what was then called Siam but been forced to suspend operations because of the outbreak of war with Japan. The mining company had not derived any assessable income from mining but it had derived assessable income from investments.

283. The High Court considered s 51(1) of the ITAA36,^[328] Section 51(1) of ITAA36 provided: “(1)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. (2) Expenditure incurred or deemed to have been incurred in the purchase of stock used by the taxpayer as trading stock shall be deemed not to be an outgoing of capital or of a capital nature.” which is in terms similar to those of s 8-1(1) of ITAA97:

"… Instead of imposing a condition that the expenditure shall wholly and exclusively be for the production of assessable income the present s 51(1) adopts a principle that will allow of the dissection and even apportionment of losses and outgoings. It does this by providing for the deduction of losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income. In the second place it introduces an alternative ground or head of deduction; it allows the deduction of all losses and outgoings to the extent to which they are necessarily incurred in carrying on a business for the purpose of gaining or producing such income."^[329] [1949] HCA 15 ; (1949) 78 CLR 47 ; 8 ATD 431 at 55; 434-435. For a further example, see Commissioner of Taxation v McDonald (1987) 15 FCR 172 ; 87 ATC 4541 ; 18 ATR 957 ; Beaumont J. They agreed that Mrs McDonald would receive three quarters of the profits from it and Mr McDonald would indemnify his wife for any losses. In the relevant year of income, the losses amounted to $1,941 and Mr McDonald claimed a deduction of the whole amount in connection with the property business. Justice Beaumont examined the agreement made between Mr and Mrs McDonald, their lack of involvement in any activity related to the derivation of the income, Mr McDonald’s full time employment and Mrs McDonald’s full time commitment at home and decided that they were not engaged in a business activity. Rather, they had invested in a property and were co-owners in the investment. Each was entitled to one half of the income and to deduct one half of the losses. An agreement by a husband to adopt his wife’s losses was an agreement of a private or domestic nature and he could not be said to have incurred a loss or outgoing in gaining assessable income. What he had in fact done under the agreement was to give away a quarter of his assessable income to his wife.

Establishing the connection is one of characterisation

284. Speaking of s 51(1), the High Court said in the later case of Fletcher:

"The question whether an outgoing was, for the purposes of s 51(1), wholly or partly 'incurred in gaining or producing the assessable income' is a question of characterization. The relationship between the outgoing and the assessable income must be such as to impart to the outgoing the character of an outgoing of the relevant kind. It has been pointed out on many occasions in the cases that an outgoing will not properly be characterized as having been incurred in gaining or producing assessable income unless it was 'incidental and relevant to that end'…"^[330] (1991) 173 CLR 1 ; 103 ALR 97 ; 91 ATC 4950 at 17; 106; 4,957 (citations omitted)

Determined by reference to circumstances and character of advantage sought by taxpayer

285. It is necessary to examine the circumstances and transactions in order to determine the character of the advantage sought by the taxpayer in making the outgoings. Although the case of
Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd^[331] [1978] HCA 32 ; (1978) 140 CLR 645 ; 21 ALR 59 ; 78 ATC 4412 ; 52 ALJR 640 ; 8 ATR 879 ; Gibbs ACJ, Stephen and Aickin JJ; Jacobs and Murphy JJ dissenting (Battery Makers' case) turned on whether the amounts paid by a taxpayer were of a revenue or capital nature and so is a case to which I will return, it is also relevant in illustrating the approach taken by the courts in determining the character of a loss or outgoing. If the amounts paid by the taxpayer were revenue, they would be fully allowable deductions under s 51(1) but not otherwise. A series of transactions amongst associated companies led to the taxpayer company leasing a factory and office building that another company had leased initially from the Housing Trust of South Australia (Housing Trust). The Housing Trust built the factory and office building. Under the agreement between the Housing Trust and the other company, it, or an associated company, was given an option to purchase the property. An associated company, Property Options, did exercise the option. Under the agreement between it and the Housing Trust, the purchase price was an amount that decreased annually in proportion to the amount of the initial capital outlay which the Housing Trust was to recoup in the rent paid by the taxpayer company. The taxpayer company claimed the whole of the rent as an allowable deduction from its assessable income.

286. Gibbs ACJ explained:

"… The real problem in the case is not to determine the character of the advantage sought, once it has been identified, but to decide what was the advantage sought by the taxpayer by making the payments. If the only advantage sought was the right to possession under the lease, and was called 'rent' really answered that description, clearly the outgoings were entirely of a revenue nature. If on the other hand one advantage sought by the outgoings was the acquisition of a capital asset (the land and buildings), the fact that the payments were called 'rent', and were made periodically, would not necessarily prevent them from being in part outgoings of a capital nature…"^[332] [1978] HCA 32 ; (1978) 140 CLR 645 ; 21 ALR 59 ; 78 ATC 4412 ; 52 ALJR 640 ; 8 ATR 879 at [14]; 655; 65-66; 4,417; 643; 884

287. Gibbs ACJ went on to characterise the transactions:

"It is clear that by making the payments the taxpayer itself did not acquire any interest in the land or buildings except that of a lessee. The only binding arrangement between the taxpayer and the Trust was that embodied in the lease, under which the taxpayer had the rights and interests of a lessee and nothing more. The taxpayer was not granted any option to purchase, and it had no right to enforce the option granted to Property Options.…"^[333] [1978] HCA 32 ; (1978) 140 CLR 645 ; 21 ALR 59 ; 78 ATC 4412 ; 52 ALJR 640 ; 8 ATR 879 at [15]; 655; 66; 4,417; 643; 884

"… However in the present case there is no evidence on which it could be found that the taxpayer could benefit from the exercise of the option. Property Options was not a subsidiary of the taxpayer, and there is no evidence that Property Options was intended to hold the land and buildings for the taxpayer, or would be likely to share with the taxpayer any profits which might accrue as a result of the exercise of the option. Indeed the probability is that any financial benefit from the transactions would enure for the benefit of the parent company, Chloride Group Ltd, and not for the taxpayer."^[334] [1978] HCA 32 ; (1978) 140 CLR 645 ; 21 ALR 59 ; 78 ATC 4412 ; 52 ALJR 640 ; 8 ATR 879 at [15]; 656; 66; 4,417; 643; 884

288. The taxpayer company was a member of a group of companies and knew that the lease to it was part of a wider scheme to benefit another company in the group. Gibbs ACJ indicated that:

"… a taxpayer may derive an advantage if someone else, such as a subsidiary, acquires an asset. But the fact that someone else incidentally derives an advantage of a capital kind in which the taxpayer does not share is not enough to give the outgoings the character of capital.…"^[335] [1978] HCA 32 ; (1978) 140 CLR 645 ; 21 ALR 59 ; 78 ATC 4412 ; 52 ALJR 640 ; 8 ATR 879 at [17]; 656-657; 67; 4,418; 643; 885

289. The question that must be asked is: "What was the expenditure for?" It is answered by reference to "… the nature of the advantage from a practical and business point of view…".^[336] [1978] HCA 32 ; (1978) 140 CLR 645 ; 21 ALR 59 ; 78 ATC 4412 ; 52 ALJR 640 ; 8 ATR 879 at [19]; 659; 69; 4,419; 644; 887 per Gibbs ACJ Furthermore,

"… An examination of the legal rights obtained is essential to the characterization of expenditure notwithstanding that in some cases it may not alone be sufficient to complete the process, because absence of enforceable rights is not decisive of the revenue character of a business outgoing.…"^[337] [1978] HCA 32 ; (1978) 140 CLR 645 ; 21 ALR 59 ; 78 ATC 4412 ; 52 ALJR 640 ; 8 ATR 879 at [3]; 662; 71; 4,421; 645; 889 per Stephen and Aickin JJ

The relevance of the taxpayer's motive or purpose

290. The High Court in Fletcher went on to consider the relevance of the taxpayer's motive or purpose in making an outgoing and the proper characterisation of that outgoing. Justice Hill elaborated on the issue in
William John Crawford v Commissioner of Taxation^[338] [1993] FCA 647 ; 27 ATR 326 ; Gummow, von Doussa and Hill JJ (Crawford):

"… As that and other cases make clear, the question of whether an outgoing is deductible requires there to be identified the essential character of that outgoing. In the process of characterisation, the end which a taxpayer subjectively has in view in incurring an outgoing may, as the High Court points out, constitute an element and possibly the decisive element in the process of characterisation. However, as the Court in that decision also pointed out, the process of characterisation will commonly proceed without reference to the subjective thought processes of the taxpayer. In the normal case the objective relationship between an outgoing and assessable income earned will, without more, suffice to characterise the outgoing as one incurred in gaining or producing assessable income."^[339] [1993] FCA 647 ; 27 ATR 326 at 334

291. This is illustrated by the earlier case of
John v Federal Commissioner of Taxation^[340] (1989) 166 CLR 417 ; Mason CJ, Wilson, Brennan, Dawson, Toohey and Gaudron JJ (John's case). Mr John was a member of a partnership which bought and sold shares. The partnership bought shares in a number of companies which subsequently declared dividends arising from the revaluation or sale of assets not acquired for the purpose of resale at a profit. At the same time as they declared dividends, those companies issued bonus shares to their shareholders crediting those dividends as payment for the bonus shares. These events had been arranged by the partnership's professional advisers with a view to obtaining a taxation advantage. The dividends were not assessable income in the hands of the partners under the law as it then stood. In assessing liability to pay taxation, the partnership was entitled to offset the amount of dividends credited in payment for the bonus shares as they became part of their trading stock. By offsetting the dividends credited, the partnership would show a loss on its books and, under s 92(1) of ITAA36, each partner could claim, as an allowable deduction, a share of that loss proportionate to his or her interest in the partnership. That is what Mrs John did.

292. The majority of the High Court said:

"It is readily understandable that, if no income has been gained or produced and a question arises as to whether the occasion would be expected to produce assessable income, consideration of the purpose for which expenditure was outlaid might not be wholly irrelevant. It may be too that even where income is produced 'the purpose for which the advantage occasioning the loss or outgoing is sought may be evidence a sufficient relationship with the income-earning process':
Handley v Federal Commissioner of Taxation^[341] (1981) 148 CLR 182 at 189-190 …, per Stephen J. But the cost of a step taken in the process of gaining or producing income must be regarded as an outgoing or taken into account in calculating the loss (if any) incurred, whatever purpose or motive may have attended all or any of the steps involved.

On the assumption that the dividends declared and credited in payment of the bonus shares were or are to be treated as the cost of their acquisition, they fall within the first limb of s 51(1)…"^[342] (1989) 166 CLR 417 at 426-427

293. The reference to their falling within the first limb of s 51(1) must be understood as a reference to their having been necessarily incurred in gaining or producing income. It is not a reference to the cost having been necessarily incurred in gaining or producing assessable income. The majority noted that "… a loss or outgoing incurred in producing exempt income is never a loss or outgoing incurred in producing assessable income. The categories are mutually exclusive…".^[343] (1989) 166 CLR 417 at 427

294. More recently, the Full Court of the Federal Court said in
Spassked Pty Ltd v Commissioner of Taxation^[344] [2003] FCAFC 282 ; (2003) 136 FCR 441 ; 203 ALR 515 ; 54 ATR 546 ; Hill, Gyles and Lander JJ (Spassked):

"… two tests may be applied when determining whether interest on a borrowing is deductible. One is to look at the use to which the borrowed funds are put. The other is to look at the purpose of the borrowing. However, normally, the purpose of the borrowing will be determined by reference to the use to which the borrowed funds are put, so that it will ordinarily be unnecessary to choose between the two tests."^[345] [2003] FCAFC 282 ; (2003) 136 FCR 441 ; 203 ALR 515 ; 54 ATR 546 at [65]; 465; 537; 569 per Hill and Lander JJ

295. Returning to Fletcher, the High Court expanded upon the place of the taxpayer's purpose and motive in making an outgoing:

"Nonetheless, it is commonly possible to characterize an outgoing as being wholly of the kind referred to in the first limb of s.51(1) without any need to refer to the taxpayer's subjective thought processes. That is ordinarily so in a case where the outgoing gives rise to the receipt of a larger amount of assessable income. In such a case, the characterization of the particular outgoing as wholly of a kind referred to in s.51(1) will ordinarily not be affected by considerations of the taxpayer's subjective motivation. If, for example, a particular item of assessable income can be earned by making a lesser outgoing in one of two possible ways, one of which is a loss or outgoing of the kind described in s.51(1) and the other of which is not, it will ordinarily be irrelevant that the taxpayer's choice of the method which was tax deductible was motivated by taxation considerations or that the non-deductible outgoing would have been less than the deductible one. In such a case, the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterize the whole outgoing as one which was incurred in gaining or producing assessable income. If the outgoing can properly be wholly so characterized, it 'is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent'.…

The position may, however, well be different in a case where no relevant assessable income can be identified or where the relevant assessable income is less than the amount of the outgoing. Even in a case where some assessable income is derived as a result of the outgoing, the disproportion between the detriment of the outgoing and the benefit of the income may give rise to a need to resolve the problem of characterization of the outgoing for the purposes of the sub-section by a weighing of the various aspects of the whole set of circumstances, including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. … Where that is so, it is a 'commonsense' or 'practical' weighing of all the factors which must provide the ultimate answer. … If, upon consideration of all those factors, it appears that, notwithstanding the disproportion between outgoing and income, the whole outgoing is properly to be characterized as genuinely and not colourably incurred in gaining or producing assessable income, the entire outgoing will fall within the first limb of s.51(1) unless it is either somehow excluded by the exception of 'outgoings of capital, or of a capital, private or domestic nature' or 'incurred in relation to the gaining or production of exempt income'. If, however, that consideration reveals that the disproportion between outgoing and relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective and that part only of the outgoing can be characterized by reference to the actual or expected production of assessable income, apportionment of the outgoing between the pursuit of assessable income and the pursuit of that other objective will be necessary."^[346] (1991) 173 CLR 1 ; 103 ALR 97 ; 91 ATC 4,950 at 18; 107-108; 4,957-4,958

296. This is illustrated by the case of
Trustees of Estate Mortgage Fighting Fund Trust v Federal Commissioner of Taxation,^[347] [2000] FCA 981 ; (2000) 102 FCR 15 ; 45 ATR 7 ; 175 ALR 482 ; 2000 ATC 4525 ; Hill J in which the trustees of the Estate Mortgage Fighting Fund Trust wrote to 18,025 beneficiaries of the Estate Mortgage Trusts (EMT). Those beneficiaries had lost money following the failure of EMT and the trustees sought to raise funds from them to pursue legal proceedings against entities involved in the Trusts. Among other claims, the trustees claimed that the mailing expenses incurred in, and that would be incurred in, writing to the beneficiaries were deductible. Justice Hill concluded:

"… Clearly the expenditure incurred here was for soliciting contributions to the trust which were of a capital nature, and prima facie the mailing expenditure had, whether in whole or part, is not necessary here to decide, likewise the character of capital rather than of an ordinary working expense.

…

… Here, the only explanation for the expenditure is the raising of subscriptions for the trust. None other is suggested. Recurrence, itself not a test per se, is not, in the relevant sense, present in the circumstances of this case. It is obvious from a reading of Sun Newspapers that not all expenditure which is not made once and for all will satisfy the description of expenditure as being recurrent. The real test, as suggested in Sun Newspapers, of 'recurrence' is one which emphasises the distinction between expenditure which is made once and for all and expenditure to meet a continuous demand. … While, no doubt, it was necessary to send letters out to potential beneficiaries of the trust to solicit money, that expenditure was not recurrent, in the sense used by Dixon J. It was expenditure to fund the trust or to provide details of the trust activities and as such it had the character of capital. It was not like rates on investment land, which is a typical example of recurrent expenditure."

297. The fact that a payment is not made directly to a person entitled to receive it does not necessarily mean that the payment assumes a different character. The question "'What was the object of the expenditure?' must be answered from a practical and business point of view."^[348] Federal Commissioner of Taxation v Foxwood (Tolga) Pty Ltd (1981) 147 CLR 278 ; Gibbs CJ, Mason, Murphy, Aickin and Wilson JJ at 285 per Gibbs CJ

Regard is to be had to the whole context in which loss or outgoing incurred

298. In characterising a loss or outgoing, it is necessary to look to the purpose for which it was incurred but also to that of the whole transaction of which it was a part. Therefore, in characterising a payment of £2,500 made to a managing director of a company in consideration of cancelling his contract of employment, regard had to be had to the immediate purpose for which that payment was made but also the wider issues relevant to the management of the business and its efficiency. This situation arose in
W Nevill & Co Ltd v Federal Commissioner of Taxation,^[349] (1937) 56 CLR 290 ; Latham CJ, Rich, Dixon and McTiernan JJ in which Rich J said:

"…The contention for the Commonwealth is that, as admittedly the object of making the lump sum payment was to save the future expenditure of the joint managing director's salary, it could not be exclusively and wholly laid out for the production of assessable income. For it was said to avoid expenditure and not to obtain assessable income. This argument seems to me to confine the investigation of the purpose to a stage later than that to which the taxpayer is entitled to go back. The taxpayer had committed itself at an anterior date to an expenditure on salaries for its managing directors. Its sole purpose in doing so was to earn income; but later the company found that in the prosecution of this purpose it had committed itself to a future expenditure unnecessarily large. It then negotiated what may be described as a commutation of future expenditure it had otherwise incurred. The commissioner cannot rivet attention on the last stage to the exclusion of the earlier stage of the course of dealing which leads to the total expenditure."^[350] (1937) 56 CLR 290 at 304. See also Dixon J at 307: “… [I]t is not correct to look only to the purpose actuating the expenditure in the state of facts in which it was resolved upon. The whole course of the transaction must be regarded. When an agreement was made by the company committing it to an annual expenditure for five years of £1,500 upon the managing director’s salary, that obligation was undoubtedly incurred ‘for the production of assessable income.’ The company thus undertook expenditure which, if it had gone on, would have been deductible. The purpose appears to me to govern the entire course of the transaction. On reconsideration, it appeared that the purpose would be better fulfilled by a rearrangement involving an expenditure made in commutation of that undertaken. Why should the original purpose be excluded from view and immediate purpose alone be considered? …”

299. Citing
Western Gold Mines (NL) v Commissioner of Taxation (WA)^[351] (1938) 59 CLR 729 ; Latham CJ, Starke, Dixon, Evatt and McTiernan JJ (Western Gold Mines), Mr Sest submitted that, in order to determine whether an item is to be classified as revenue or capital, it is necessary to "make a wide survey and an exact scrutiny of the taxpayer's activities". This passage, with the emphasis given to it by Mr Sest, is taken from the judgment of Dixon and Evatt JJ. Western Gold Mines (NL) sold mining leases to another company that had been formed to take over the leases. The other company was a larger company. Western Gold Mines (NL) received in consideration a sum of money and shares in the new company. The face value of the money and the shares exceeded the price it had paid for the acquisition of the mining leases and their development. Western Gold Mines (NL) retained the shares but the question was whether the excess constituted a profit on which it was liable to pay duty under relevant State law or whether the transaction amounted to an investment and was of a capital nature.

300. Those who formed the two companies had not been in the business of buying and selling mining leases. Rather:

"… When the appellant company was formed and the option was assigned to it, no one decided that the appellant company should not be the body to work the mine if it was decided to carry on mining operations indefinitely. The purpose was simply to explore, examine and then decide what was to be done. In September 1933, however, on a report that had been received, it was determined that capital must be raised from the public and, for this reason mainly, that a new company should be floated for the purpose of working the mine.

There is not much, if any, evidence in the materials laid before the court to show what, if any, other activities were pursued by the appellant company. … We should, we think, adopt the assumption that the transaction under consideration does not represent an example of a general business carried on, or intended to be carried on, by the appellant company in investigating, acquiring and then disposing of mining leases and the like. We should treat it as a single transaction forming no part of any actual or intended system or organized business. So treating it, the operation appears to us to be no more than the conversion of a capital asset into a new form. The striking fact is that the appellant company did not realize the 200,000 shares it obtained as consideration for the transfer of the leases and did not enter upon the sale to Triton Gold Mines No Liability for the purpose of converting its interests in the leases and mining reservation into money. The reason for floating the latter company was not to provide money for the appellant company, but to facilitate the raising of money for the working of the venture and to give the appellant company a new title to share in the success of the venture, namely, the 200,000 paid-up shares. It is true that the new title is a realizable asset, a marketable security. But the object was not to turn the marketable security into money. The uncertainty when the option was acquired as to what should be done and the insufficiency of the appellant company's nominal capital to work the mine on a large scale do not appear to us to show a scheme of profit-making by buying and selling. It is consistent with the intention to float a new company as was done in the event.

On the whole, we think that it was a capital transaction."^[352] (1938) 59 CLR 729 at 740-741

301. Both Nevill and Western Gold are illustrations of the more general approach set out by Lord Pearce in delivering the judgment of the Privy Council in
BP Australia Limited v Commissioner of Taxation:^[353] (1965) 112 CLR 386

"The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in borderline cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer 'depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process' (per Dixon J in Hallstrom's Case … As each new case comes to be argued felicitous phrases from earlier judgements are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken."^[354] (1965) 112 CLR 386 at 397 See also Tyco Australia Pty Ltd v Commissioner of Taxation [2007] FCA 1055 ; (2007) 67 ATR 63 at [46]; 74 per Allsop J, Commissioner of Taxation v Star City Pty Ltd [2009] FCAFC 19 ; (2009) 175 FCR 39 ; [2009] ATC 20-093 (Goldberg, Dowsett and Jessup JJ) at [18]; 46; 9,395 per Goldberg J and Rotherwood Pty Ltd v Commissioner of Taxation (1996) 64 FCR 313 ; Spender, Lee and O’Loughlin JJ

302. If the course of dealing includes contractual arrangements, regard must be had to those contractual arrangements and their interpretation. That brings me to cases such
Codelfa Construction Pty Ltd v State Rail Authority of NSW^[355] [1982] HCA 24 ; (1982) 149 CLR 337 ; 41 ALR 367 (Codelfa). In this case, Mason J said:

"The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible of more than one meaning. But it is not admissible to contradict the language of the contract when it has a plain meaning. Generally speaking facts existing when the contract was made will not be receivable as part of the surrounding circumstances as an aid to construction, unless they were known to both parties, although, as we have seen, if the facts are notorious knowledge of them will be presumed.

It is here that a difficulty arises with respect to the evidence of prior negotiations. Obviously the prior negotiations will tend to establish objective background facts which were known to both parties and the subject matter of the contract. To the extent to which they have this tendency they are admissible. But in so far as they consist of statements and actions of the parties which are reflective of their actual intentions and expectations they are not receivable. The point is that such statements and actions reveal the terms of the contract which the parties intended or hoped to make. They are superseded by, and merged in, the contract itself. The object of the parole evidence rule is to exclude them, the prior agreement of the parties being inadmissible in aid of construction, though admissible in an action for rectification.

Consequently when the issue is which of two or more possible meanings is to be given to a contractual provision we look, not to the action intentions, aspirations or expectations of the parties before or at the time of the contract, except in so far as they are expressed in the contract, but to the objective framework of facts within which the contract came into existence, and to the parties' presumed intention in this setting. We do not take into account the action intentions of the parties and for the very good reason that an investigation of those matters would not only be time-consuming but it would also be a rewarding as it would tend to give too much weight to these factors at the expense of the actual language of the written contract."^[356] [1982] HCA 24 ; (1982) 149 CLR 337 ; 41 ALR 367 at 352; 374-375 per Mason J, with whom Stephen and Wilson JJ concurred

The same views were expressed by the High Court in
Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd^[357] [2004] HCA 52 ; (2004) 219 CLR 165 ; 211 ALR 342 ; 79 ALJR 129 at [40]; 179; 351-352; 136 per Gleeson CJ, Gummow, Hayne, Callinan and Heydon JJ and, more recently, it endorsed the statement as accurately representing the law in
Western Export Services Inc v Jireh International Pty Ltd.^[358] [2011] HCA 45 ; (2011) 282 ALR 604 ; 86 ALJR 1 at [3]; 605; 2-3 per Gummow, Heydon and Bell JJ

303. Similar principles have been applied to the construction of a company's articles and memoranda of association but the reasoning leading to that conclusion is not framed in terms of Codelfa but in terms of ss 124 and 125 of the Corporations Act 2001. Those sections, Weinberg J said in
Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd^[359] [2006] FCAFC 144 ; (2006) 156 FCR 1 ; 236 ALR 561 ; Weinberg, Kenny and Lander JJ have signficantly weakened the case of a company's objects to be stated with absolute precision. Therefore, it was no longer possible to maintain the traditional view that surrounding circumstances could never be taken into account in construing a company's articles and memorandum of association. By the same token, the case for restraint in using surrounding circumstances as an aid of construction remained a powerful one. More flexible rules of construction now applicable in the interpretation of ordinary contracts should be applied with great caution in interpreting those company documents.^[360] [2006] FCAFC 144 ; (2006) 156 FCR 1 ; 236 ALR 561 at [55]-[56]; 13; 572 and see also [122]-[124]; 28; 587 per Kenny J and [254]-[255]; 50-51; 609 per Lander J

304. The principles have also been applied in the construction of trusts even though they are distinct from contracts. The two tasks are, however, closely related, Heydon and Crennan JJ said in
Byrnes v Kendle and the same considerations that limit recourse to surrounding circumstances and oral testimony in relation to contracts apply equally to trusts as to contracts.^[361] [2011] HCA 26 ; (2011) 243 CLR 253 ; 279 ALR 212 ; 85 ALJR 798 at [102]-[104]; 286; 238; 820 per Heydon and Crennan JJ

305. At the beginning of the hearing, there was some suggestion that a number of passages in the statements lodged on behalf of Lakes should not be admitted in evidence on the basis that they were directed to the subjective intention of the parties to the contract. Mr Sest opposed their excision from the statements on this ground. If the rules of evidence were to bind the Tribunal, I would have addressed the issue of admissibility and made a ruling. As they do not, I thought the better course was to admit the statements in their entirety but to rely on them only in so far as I am permitted to do so by the law as I understand it to be.

The timing of the expenditure for which deduction is claimed

306. As to the timing of the expenditure for which deduction is claimed, Latham CJ said in
Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation^[362] [1935] HCA 81 ; (1935) 54 CLR 295 ; 3 ATD 288 ; 9 ALJR 342 ; Latham CJ, Rich, Starke, Dixon, Evatt and McTiernan JJ (Amalgamated Zinc):

"… It is true that, in cases of continuing businesses, it has been conceded … that expenditure may be allowed as a deduction though it produces and is possibly designed to produce results in the way of income in a future year and not in the year in relation to which it is being assessed …. So it has been held that expenditure which has a direct relation to income of a past year can be deducted in a later assessment year where it is of such a character that, in a continuing business, it must be met from time to time as part of the process of gaining assessable income…".^[363] [1935] HCA 81 ; (1935) 54 CLR 295 ; 3 ATD 288 ; 9 ALJR 342 at 303-304; 293-294 per Latham CJ

In the same case, Dixon J said:

"… A very wide application should be given to the expression 'incurred in gaining or producing the assessable income'. But the words refer to the assessable income from which the deduction is to be made. In a continuing business, items of expenditure are commonly treated as belonging to the accounting period in which they are met. It is not the practice to institute an inquiry into the exact time at which it is hoped that expenditure made within the accounting period will have an effect upon the production of assessable income and to refuse to allow it as a deduction if that time is found to lie beyond the period. And, in the case of expenditure for which the taxpayer contracted a liability during an earlier accounting period than that in which it has matured, it is not the practice to consider whether its effect upon the production of income of a still continuing undertaking has already been exhausted … The expression 'in gaining or producing' has the force of 'in the course of gaining or producing' and looks rather to the scope of the operations or activities and the relevance thereto of the expenditure than to purpose in itself…

In the present case, the actual expenditure was met in the current year. But it was completely dissociated from the gaining or producing of the assessable income of that year … None of the assessable income arose out of the business in the course of which the taxpayer became liable to the charge. The sources from which the assessable income did arise included no operations in the course of which the payment was made. It was a payment independent of the production of the income, not an expenditure incurred in the course of its production."^[364] [1935] HCA 81 ; (1935) 54 CLR 295 ; at 309-310. See also per Rich and Evatt JJ [1935] HCA 81 ; (1935) 54 CLR 295 at 305 and per Starke J at 307

307. Crawford v Commissioner of Taxation^[365] [1993] FCA 647 ; (1993) 27 ATR 326 (Crawford) was a case in which Hill J analysed the judgments in Fletcher regarding the deductibility of interest payments and the timing of the outgoing, in the form of annual repayments of a loan, and the timing of the derivation of assessable income. The facts in Crawford showed a loan agreement with an obligation to pay interest. Futhermore, at the time the loan agreement was entered with the company, Dr Crawford thought that there was a great future for that company to profit from its investment in the Gladstone Industrial Park. That had ultimately proved to be the case. Referring first to the case of Fletcher, Hill J then said:

"… It was clear on the face of things that a significant, if not dominant, purpose of the taxpayers entering into the arrangement was the obtaining of a deduction for interest. That fact alone would not have disentitled the partnership and through the partnership the partners, to a deduction if the arrangement were such that in later years the annuity was to continue to be paid, and significant amounts of assessable income in consequence were to be derived."^[366] [1993] FCA 647 ; 27 ATR 326 at 335

308. The case of
Federal Commissioner of Taxation v Smith^[367] (1981) 147 CLR 578 ; Gibbs CJ, Stephen, Mason, Murphy and Wilson JJ provides another example. A medical practitioner employed by a hospital entered a contract of insurance to maintain his income at a certain level should he be incapacitated for work. He paid the premiums for each of three years and was injured. He received payments under the policy and claimed as a deduction the cost of the premium for the income year after he had returned to work. The Commissioner included the payments as his assessable income but disallowed his claim that the premium payment should be deducted. The majority decided:

"… The section does not require that the purpose of the expenditure shall be the gaining of the income of that year, so long as it was made in the given year and is incidental and relevant to the operations or activities regularly carried on for the production of income. What is incidental and relevant in the sense mentioned falls to be determined not by reference to the certainty or likelihood of the outgoing resulting in the generation of income but to its nature and character, and generally to its connexion with the operations which more generally gain or produce assessable income. It is true that the payment of the premium in June 1978 did not result in the generation of any income in that year, but there is a sufficient connexion between the purchase of the cover against the loss of ability to earn and the consequent earning of assessable income to bring the premium within the first limb of s 51(1).…^[368] (1981) 147 CLR 578 at 585-586

AUTHORITIES RELATING TO THE NEGATIVE LIMB: section 8-1(2)

309. In this section of my reasons, I will refer only to those authorities relevant in considering ss 8-1(2)(a) and (d) for ss 8-1(2)(b) and (c) are not relevant.^[369] There is no suggestion that what is claimed “… is a loss or outgoing of a private or domestic nature” (s8-1(2)(b)) or that it has been “… incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income” (s8-1(2)(c)).

Distinction between outgoings of a capital nature and of a revenue nature

310. The distinction between outgoings of a capital nature and outgoings of a revenue nature has been considered in a number of cases. In general terms, the distinction was described by Dixon J, as he then was, in
Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation^[370] (1938) 61 CLR 337 ; Latham CJ, Dixon and McTiernan JJ (Sun Newspapers case) when he said:

"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 earnings 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. Inland Revenue Commissioners (1930) SC 215, at p.220."^[371] (1938) 61 CLR 337 at 359-360

311. While the general distinction may be easy to state, Dixon J went on to say, the distinction may be difficult to determine in a practical situation. He reviewed the cases which had attempted to find some test or standard to determine whether outgoings are of a capital or revenue nature. He concluded:

"There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment."^[372] (1938) 61 CLR 337 at 363

312. This was explained further by the High Court in
GP International Pipecoaters Pty Ltd v Commissioner of Taxation^[373] (1990) 170 CLR 124 ; Brennan, Dawson, Toohey, Gaudron and McHugh JJ when it said:

"The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid…"^[374] (1990) 170 CLR 124 at 137

313. In the case of
Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation,^[375] (1953) 89 CLR 428 ; Williams ACJ, Webb, Fullagar, Kitto and Taylor JJ Fullagar J succinctly stated the relevant questions to be:

"(1) What is the money really paid for ? - and (2) Is what it is really paid for, in truth and in substance, a capital asset?"^[376] (1953) 89 CLR 428 at 454

This is consistent with the statement made by Dixon J some years earlier in
Hallstroms Pty Ltd v Federal Commissioner of Taxation:^[377] [1946] HCA 34 ; (1946) 72 CLR 634 ; Latham CJ, Starke and Williams JJ; Dixon and McTiernanJJ dissenting

"… What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process."^[378] [1946] HCA 34 ; (1946) 72 CLR 634 at 648

314. While bearing that in mind, care must be taken to ensure that one does not become myopic so that the question whether an outgoing is of capital or on account of revenue is determined with only the practical and business point of view in mind or with only the legal or jurisprudential form in mind. In
Federal Commissioner of Taxation v Broken Hill Pty Co Ltd^[379] [2000] FCA 1431 ; (2000) 179 ALR 593 ; Hill, Heerey and Merkel JJ. Ten years earlier, Hill J had made a similar point in Commissioner of Taxation v Cooling (1990) 22 FCR 42 ; 94 ALR 121 ; 21 ATR 13 at 53; 132; 23 (Broken Hill), Hill J said:

"Before turning to the remaining issues to be decided, I would wish to say something about the issue of substance and form. While, no doubt, questions such as whether a covenanted payment is an annuity will, having regard to historical matters, depend to some, perhaps a considerable, extent on the form which the parties have adopted…, it is not to be assumed that form must always prevail over substance. The law has moved somewhat from the rather rigid adherence to form to be found in cases such as
Inland Revenue Commissioners v Duke of Westminster [1936] 8 AC 1. This is not to say that legal rights are not important or even, in a case such as the present, determinative. It is merely to emphasise that the courts will always consider the substance of a transaction in characterising the character of the advantage which is sought to be obtained in determining whether an outgoing is on revenue account or whether, as here, on capital account and thus excluded from deductibility."^[380] [2000] FCA 1431 ; (2000) 179 ALR 593 at 606

315. The Privy Council made clear that the matter has to be considered from a wider perspective when it considered a similar issue in relation to New Zealand legislative provisions in
Europa Oil (N.Z.) Ltd v Inland Revenue Commissioner.^[381] [1976] 1 WLR 464 ; Viscount Dilhorne, Lord Diplock, Lord Edmund-Davies and Sir Garfield Barwick, Lord Wilberforce dissenting Lord Diplock, who delivered the judgement of the majority, said that:

"… it is not the economic results sought to be obtained by making the expenditure that is determinative of whether the expenditure is deductible or not; it is the legal rights enforceable by the taxpayer that he acquires in return for making it. The difficulty to which the section gives rise is not one of interpretation of the words it uses, but of the application of those words to particular transactions which may be entered into in the course of business where those contractual arrangements are complicated and involve a multiplicity of parties."^[382] [1976] 1 WLR 464 at 472

316. In looking at those arrangements:

"… the court was not bound by the description, such as 'price of goods,' attached to it in the taxpayer's own accounts or in a particular contract, if upon an analysis of the contractual arrangements taken as a whole under which the payment was made it appeared that its true legal character did not accord with that description."^[383] [1976] 1 WLR 464 at 472

317. In the Battery Makers' case, Gibbs ACJ expanded upon the passage I have just quoted and said that:

"Their Lordships could not have meant to suggest that in every case the character of an outgoing must be determined by having regard only to the contractual or other legal rights that the taxpayer acquired in return for it. That would indeed have been inconsistent with the principle stated by Dixon J. in Hallstrom's Case, and with cases too numerous to mention in which payments made 'voluntarily and on the grounds of commercial expediency' (to use the words of Viscount Cave L.C. in
British Insulated and Helsby Cables Ltd v. Atherton [1926] AC 205, at p.212) have been held deductible as outgoings of a revenue kind although the taxpayer obtained no legally enforceable rights in return for them. However it is unnecessary for the decision of the present case to consider whether the second
Europa Case ([1976] 1 WLR 464; [1976] 1 All ER 503) laid down a principle in terms too wide to be applied to s.51. … If on the other hand that statement needs qualification so far as Australia is concerned, the decisions in the Europa Cases, and indeed the dissenting judgments in those cases, support the conclusion that it is the advantage which the expenditure was intended to gain, directly or indirectly, for the taxpayer that is relevant in determining the character of the expenditure,…"^[384] (1978) 140 CLR 645 at 659-660

318. Hill J summarised the effect of the previous authority in the field when, in
Goodman Fielder Wattie Ltd v Federal Commissioner of Taxation,^[385] (1991) 91 ATC 4438 he said:

"The judgment in Sun Newspapers case makes it clear that it is necessary to consider carefully the nature of the business which carried on, so as to be able to distinguish between recurrent expenditure, that is to say 'expenditure which is made to meet continuous demand' (per Rowlatt J in
Ounsworth v Vickers Ltd [1915] 3 KB 267-273) and that expenditure which is made once and for all. A pharmaceutical company, the business of which includes continuing research and development as part of the continuous or constant demand for expenditure in its business, does not each time that expenditure is incurred make an outlay of capital or of capital nature. Its business, when properly analysed, includes its research and development, at least in the ordinary case. No doubt, there are matters of degree involved and in a particular case the research and development may be concentrated on a product so far removed from the day to day products of the taxpayer, that the expenditure cannot be properly seen as part of its working expenditure."^[386] (1991) 91 ATC 4438 at 4,449

319. Shortly before the Battery Makers' case was decided, the Full Court of the Federal Court had considered the issue in
Federal Commissioner of Taxation v Cliffs International Inc^[387] (1977) 77 ATC 4,564 ; Bowen CJ, Franki and Brennan JJ and had said:

"In determining whether an outgoing is of a capital nature, it is necessary to determine what it is incurred for. Sometimes one consideration may point clearly in one direction, while the other, and vaguer indications, point in a contrary direction. It has been said 'it is a common-sense appreciation of all guiding features which must provide the ultimate answer' (
B.P. Australia Limited v. F.C. of T. (1966) A.C. 224 at p.264).

A test frequently quoted is that of Lord Cave in
British Insulated and Helsby Cables Limited v. Atherton (1926) A.C. 205. His Lordship (at pp.213-214) said:-

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

This statement places emphasis on what is acquired as well as upon the character of the expenditure. It is a positive statement. It does not follow that the negative furnishes a test of what is not capital (see
John Fairfax & Sons Limited v. F.C. of T. (1959) 101 C.L.R. 30 at p.36)."^[388] (1977) 77 ATC 4,564 at 4,573. The Full Court’s judgment was reversed by a majority of the High Court on appeal but not in relation to this statement of principle: Cliffs International Inc v Commissioner of Taxation [1979] HCA 8 ; (1979) 142 CLR 140 ; 24 ALR 579 ATR 507 ; 53 ALJR 321 ; Barwick CJ, Jacobs and Murphy JJ; Gibbs and Stephen JJ dissenting.

320. In
Federal Commissioner of Taxation v Rothmans of Pall Mall (Australia) Ltd,^[389] (1992) 92 ATC 4508 Lockhart J considered whether a levy paid by a manufacturer of tobacco products to an industry association was deductible under s 51(1). The expenditure by the manufacturer was to defeat the passage of the legislation which would curtail sales and advertising of tobacco products and probably result in a loss of its market share. The legislation did not pose a threat to the existence of its business or to any of its capital assets. The Commissioner argued that the levy paid was a payment of capital expenditure as the taxpayer was seeking to obtain an enduring advantage, in the sense of the right to advertise in the manner in which it chose or, alternatively, as the payment was made to preserve the taxpayer's business.

321. After considering a number of cases including the Sun Newspapers case, to which I have referred, Lockhart J concluded:

"A company which manufactures and supplies tobacco products these days is under fire. Community attitudes towards smoking have changed considerably in recent times. Pressures are exerted upon legislatures, both Federal and State, to prohibit or reduce the sale and consumption of tobacco products. On the other hand, the market for the consumption of tobacco products is large. Pressure groups are at work. As legislatures react to public and scientific opinion there are repercussions on the business of the tobacco producers and suppliers. But this is today an ongoing part of the setting in which those companies carry on business. Expenditure of the kind with which this case is concerned is on revenue account. The capital of Rothmans' business was in no way increased by the expenditures in question. The expenditure arose from Rothmans' commercial activities in the course of carrying on its business. It was incidental to the carrying on of Rothmans' business. There is a clear relation between the expenditure and the carrying on of that business. It was incurred in carrying on its business and was not of a capital nature."^[390] Federal Commissioner of Taxation v Rothmans of Pall Mall (Australia) Ltd (1992) 92 ATC 4508 at 4,514

322. Mr Sest drew a comparison between the current case and that of
B.P. Australia Limited v Commissioner of Taxation of the Commonwealth of Australia.^[391] (1965) 112 CLR 386 ; Lord Reid, Lord Morris of Borth-y-Gest, Lord Pearce, Lord Upjohn and Lord Wilberforce B.P. Australia (BP) paid to certain service station owners lump sums to assist them to defray some of their expenditure or generally to assist them. In return, the service station owners promised to sell only BP's brand of petrol for a set number of years.

323. Lord Pearce, who delivered the judgement of their Lordships, noted that, in 1951, there had been considerable changes in the way in which petrol was marketed in Australia. Apart from the war years, various brands of petrol were sold in competition with each other at each service station. Each producer owned particular tanks and pumps at each service station and let them to the retailer at a nominal figure. In 1951, the Shell Company suddenly announced its intention of securing economy of distribution by introducing the "solo site service station plan" whereby it would supply petrol to service stations on the basis that those stations would deal exclusively with Shell. Within a few months of Shell's introducing its plan, BP had been asked to remove its pumps from over a quarter of the service stations it had previously supplied. BP then embarked on the arrangements I have outlined in the previous paragraph.

324. Lord Pearce noted that considerable emphasis had been placed on the fact that BP's whole existence was threatened by the events that had occurred during 1951 and continued:

"But this is not a decisive factor. Whenever a business finds that its trade rivals are getting ahead of it, its existence is threatened. The seriousness of the situation has, however, this much relevance, that it provided ample justification for capital expenditure in the reorganization of its business structure if that should be necessary or desirable. It demolishes any argument that the occasion was too trivial or too ordinary to enable counter-measures in the means of marketing to assume the structural quality of capital expenditure. But it still leaves unanswered the question whether the steps which were taken to meet the crisis were in fact of a capital or of a revenue nature."^[392] (1965) 112 CLR 386 at 393-394

325. His Lordship continued:

"Where a trader buys out a rival in order to secure his goodwill or to suppress it and so provide or maintain a clear field for his own enterprise over a substantial period, there is a definite prima facie towards a capital payment. But in the present case B.P. was not achieving a monopoly nor buying off competition nor obtaining any substantial area for its own domain. Although one retailer was tied to B.P., the retailer next door could still buy some other brand and the passing motorist could do likewise."^[393] (1965) 112 CLR 386 at 395

326. Lord Pearce considered this aspect further in relation to the advantage which B.P. sought to obtain when he said:

"The advantage which B.P. sought was to promote sales and obtain orders for petrol by up-to-date marketing methods, the only methods which could now prevail. Since orders were now and would in future be only obtainable from tied retailers, it must obtain ties with retailers. Its real object however was not the tie but the orders which would flow from the tie. To obtain ties it had to satisfy the appetite of the retailers by paying out sums for a period of years, whose amount was dependent on the estimated value of the retailer as a customer and the length of the period. The payment of such sums became part of the regular conduct of the business. It became one of the current necessities of the trade."^[394] (1965) 112 CLR 386 at 398

327. On this aspect, he later said:

"The benefit was to be used in the continuous and recurrent struggle to get orders and sell petrol. The agreements were not strictly 'bundles of orders' but they were the basis of them and made orders inevitable. The retailer was bound to sell none but B.P.'s petrol and to increase the sale of its products to the best of its ability. This means that in practice he was bound to give orders for petrol which B.P. was bound to supply. Although the price and time of delivery were not specified these would be implied by law as reasonable. No fresh consensus between the parties was necessary. All that was needed was that the retailer should specify from time to time what quantity he required. Thus the agreements merged in and became part of the ordinary process of selling. These facts point to the expenditure being a revenue item."^[395] (1965) 112 CLR 386 at 405

328. As in the other cases, Lord Pearce proceeded to look at the whole of the arrangements entered into and their purpose before concluding that, on balance, the relevant considerations tilted the scales in favour of the expenditure's being revenue and not capital outgoings.

329. The contrary conclusion was reached, but in quite different circumstances, by Gummow J in
W Whebe Pty Limited v Federal Commissioner of Taxation.^[396] (1993) 27 ATR 172 The question he had to decide was whether legal expenses incurred in respect of proceedings taken by the taxpayers in the Federal Court under the Petroleum Retail Marketing Franchise Act 1980 were in the nature of capital or revenue expenditure.

330. Gummow J found that the franchise agreements gave the taxpayers all the means necessary to carry on a business as a Caltex service station at two particular sites. At the time of the dispute between them and Caltex, the taxpayers had never carried on a business at either of the sites as anything other than as a Caltex service station. Gummow J concluded:

"In a sense, one might broadly have described the businesses of the taxpayers as that of service station operator. But the arrangements with Caltex in each case gave the taxpayer the vital means for the conduct of such a business. This was not merely the supply of product but the means of visible association with the goodwill and reputation of a major player in the petroleum industry. The business which existed under the aegis of the relevant agreements and the protection of the Franchise Act were two Caltex Service Stations and it was the severe threat to the continuation thereof which precipitated the litigation in this court.

Indeed, in the case of Chullora, what was at stake was the occupation of the site itself. Here Caltex had set about bringing to an end any business association between the taxpayer and that site on which its only operations were conducted. It is true that the Bankstown site itself was not in jeopardy and that arrangements later were made with BP Australia Ltd. But the business of the taxpayer as a Caltex Service Station was in jeopardy and the object of the expenditure here was, at the very least, to preserve that business and thereby avoid the need to replace it with another service station business.

Accordingly, the expenditures were of a capital nature, being in relation to the very business structures of the taxpayers."^[397] (1993) 27 ATR 172 at 180

331. In view of the principles in these cases, I must determine the character of an outgoing by determining the character of the advantage sought and must do so in light of all relevant matters including the nature of the taxpayer's business and the particular circumstances in which that outgoing was incurred.

Cost of trading stock is not an outgoing of capital

332. The effect of s 70-25 is that an outgoing incurred in connection with acquiring trading stock is not an outgoing of capital or of a capital nature. Section 8-1(2)(a), therefore, does not prevent the outgoing from being a general deduction under s 8-1. This is relevant in considering the first issue relating to the sale of the golf memberships.

A. Trading stock

333. The term "trading stock" was previously defined in s 6(1) of ITAA36 in similar terms to those currently used. The definition:

"… operates 'cumulatively upon the ordinary meaning' of trading stock …. What is important … is that it does not restrict that ordinary meaning. If goods are within the ordinary meaning of 'trading stock', they are, in the absence of a contrary intention, trading stock for the purposes of the Act.…"^[398] Federal Commissioner of Taxation v Suttons Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277 ; Gibbs CJ, Wilson, Deane and Dawson JJ; Brennan J dissenting at 281per Gibbs CJ, Wilson, Deane and Dawson JJ

334. The majority continued by considering the ordinary meaning given to the term "trading stock":

"The ordinary meaning of the term 'trading stock' upon which s 6(1) builds is that which is attributed to it by legal and commercial people for accounting and other purposes. That ordinary meaning has been held to include shares purchased and held for resale by a share trader … and land which a dealer holds as an object of his dealing … It is not necessary for present purposes however to explore the outer limits of the area covered by that ordinary meaning of the term. Its traditional and narrower denotation still lies at the centre of that meaning and is adequate for present purposes. That denotation is of goods held by a trader in such goods for sale or exchange in the ordinary course of his trade. When used in relation to 'a business' … that central meaning comprehends the goods held on hand in the business for the purpose of sale or exchange in the ordinary course of trade. The fact that the particular goods may not have been paid for or may not be owned by the trader does not preclude their being trading stock on hand in relation to his business if, notwithstanding lack of payment or ownership, they are legitimately held in the possession of the trader or as part of the body of stock to be sold or exchanged in the ordinary course of the trade of that business."^[399] (1985) 157 CLR 277 at 281-282

B. Whether person acquiring item claimed to be trading stock is engaged in trading items of that nature not irrelevant

335. The ordinary meaning of "trading stock" was referred to by the majority of the High Court in John's case who then considered the person dealing in that trading stock:

"… The definition looks to the nature of goods that may constitute trading stock and posits that they will constitute trading stock if acquired for any of the specified purposes, including sale. It presupposes that the person by whom they are produced, manufactured, acquired or purchased is or will be engaged in trade in those goods. But it does not render an enquiry into whether or not the person is or will be engaged in that trade irrelevant. A single transaction does not render a person a trader, although, of course, a single transaction may constitute an adventure in the nature of trade. Nor, we think, is a single item acquired for the purpose of manufacture, sale or exchange an item of trading stock, unless the purchaser is or will be engaged in trading goods of that nature. Thus it is relevant to inquire whether the person who acquires an item claimed to be trading stock is a trader in the sense that he is engaged or will be engaged in trading goods of the nature of the item acquired. … A person may be a trader notwithstanding that his business is described in more general terms. So much is implicit in the definition of 'trading stock'. A person's business may be that of manufacturer or producer yet he may be a trader in the goods manufactured or produced. Thus the relevant issue is not the nature of the business carried on, but rather whether the person is a trader in the goods which are claimed to be trading stock.

Whether or not a person is a trader seems to us to be a question of fact, albeit that in some cases the determination of that fact may depend on questions of impression and degree. If trading has not commenced or if there is no discernible trading pattern, the question of intention or purpose may be relevant in the sense that if there is an absence of intention or purpose to engage in trade regularly, routinely or systematically then the person may well not be a trader. A fortiori if some contrary or inconsistent intention or purpose is present. But if trading has commenced and the activities reveal a discernible trading pattern, then it seems to us that the motive for undertaking the activities or for undertaking a particular transaction cannot serve to characterize the person engaging in those activities as a non-trader, or as a non-trader in relation to a particular transaction."^[400] (1989) 166 CLR 417 at 429-430

336. John's case concerned, as I have said at [….] above, a partnership which bought and sold shares and whose activities could also be ascribed to a desire to obtain a taxation advantage. As a share trader, the bonus shares issued to them constituted trading stock if they were acquired for the purpose of sale. The majority explained that:

"The definition of 'trading stock', in speaking of the 'purposes of manufacture, sale or exchange', clearly predicates that one such purpose shall attend the acquisition of the item in question. The definition does not require that the relevant purpose be the sole or even the dominant purpose. In the present case the acquisition of the bonus shares was attended with the purpose, evident from the pre-arrangements made, that the shares should later be sold. That purpose having been present, the bonus shares were trading stock as defined in the Act, notwithstanding that the transaction may have been attended by another purpose. As such, by force of s 51(2) of the Act, the loss or outgoing incurred in relation to the shares cannot be characterized as an outgoing of capital or of a capital nature and hence non-deductible on that account."^[401] (1989) 166 CLR 417 at 430

C. Arm's length trading

337. In
Granby v Federal Commissioner of Taxation,^[402] (1995) 129 ALR 503 ; 30 ATR 400 Lee J reviewed authorities considering the meaning of the expression "at arm's length" concluding:

"The expression 'dealing with each other at arm's length' involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in a manner in which parties at arm's length would be expected to behave in conducting their affairs. Of course, it is relevant to that enquiry to determine the nature of the relationship between the parties, for if the parties are not parties at arm's length the inference may be drawn that they did not deal with each other at arm's length."^[403] (1995) 129 ALR 503 ; 30 ATR 400 at 506; 403

"Whatever the meaning of the expression may be in equity…; the term 'at arm's length' means, at least, that the parties to a transaction have acted separately and independently in forming their bargain. Whether parties not at arm's length have dealt with each other at arm's length will be a matter of fact. As Hill J stated in Furse^{[[amp ]lsqb;404]} Trustee for the Estate of the Late AW Furse No 5 Will Trust v Federal Commissioner of Taxation (1991) ATC 4007 at 4015, determination of the manner in which parties not an arm's length have dealt with each other requires 'an assessment whether in respect of that dealing they have dealt with each other as arm's length parties would normally do, so that the outcome of their dealing is a matter of real bargaining'."^[405] (1995) 129 ALR 503 ; 30 ATR 400 at 507; 403

338. In
ACI Operations Pty Ltd v Berri Ltd,^[406] [2005] VSC 201 ; (2005) 15 VR 312 Dodds-Streeton J summarised the principles to be drawn from a number of previous authorities when considering the meaning of the expression "bona fide arm's length" offer in a contract for the supply of packaging:

• "223 The above authorities indicate that an arm's length relationship is that of strangers, or parties who are unaffected by existing mutual duties, liabilities, obligations, cross-ownership of assets, or identity of interests which might: (a) enable either party to influence or control the other; or (b) induce either party to serve that common interest in such a way as to modify the terms on which strangers would deal.
• 224 The concept of an arm's length relationship is distinct from that of an arm's length dealing or transaction, despite the potential overlap. Unrelated parties may collude or otherwise deal with each other in an interested way, so that neither the dealing nor the resultant transaction may properly be considered arm's length.
• 225 Where the parties are not in an arm's length relationship, it is recognised that the inference may be drawn that they did not deal with each other at arm's length. It may further be inferred that the resultant transaction is not arm's length.
• 226 Related parties may nevertheless, in some circumstances, demonstrate a dealing which displaces the inference based on their relationship. They may engage in the disinterested bargaining characteristic of strangers, applying independent separate wills. The circumstances of the impugned transaction may be such that, despite the parties' connection or common interest, the interposition of some independent process (such as the sale of shares on the stock exchange) ensures that the transaction itself is arm's length, in the sense that it could equally have been concluded by unrelated parties, consulting their own self-interest and uninfluenced by any particular association or interest in common."

339. In
Commissioner of Taxation v AXA Asia Pacific Holdings Ltd,^[407] [2010] FCAFC 134 ; (2010) 189 FCR 204 ; Dowsett, Edmonds and Gordon JJ Dowsett J approved this passage and said:

• "24 The learned primary Judge also referred to the decision of Gyles J in
  Baxter v Commissioner of Taxation (2003) 196 ALR 519, identifying the proposition that the fact that a transaction is devised in a certain way so as to obtain a revenue advantage does not mean that the transaction is not at arm's length. I accept that the offer and acceptance of a proposal which has a tax-related attraction for the offeree may not necessarily lead to the conclusion that the transaction is not at arm's length. For reasons which I have given, the offer may well have been motivated by the offeror's self-interest. However, there will be cases in which one side accommodates the other simply because it is able to do so without loss or inconvenience to itself, or because there are extraneous reasons for wanting so to do. I use the word 'extraneous' in lieu of the word 'ulterior' used in Granby, but with the purpose of describing a motivation other than that of facilitating the proposed transaction.
• 25 Gyles J found difficulty with the proposition that parties at arm's length might become involved in transactions which were not at arm's length. I suspect that his Honour meant that the very fact of entering into a non-arm's length transaction means that the parties are not at arm's length for the purposes of that transaction. I agree with that proposition."^[408] [2010] FCAFC 134 ; (2010) 189 FCR 204 at [24]-[25]; 213

ATTACHMENT D

INDEX

340.