Softwood Pulp and Paper Limited v. Federal Commissioner of Taxation.

Menhennitt J

Supreme Court of Victoria

Judgment date: Judgment handed down 5 November 1976.

Menhennitt J.: This is an appeal from a decision of the Board of Review given on 1st day of August, 1973, Case E29
73 ATC 241. The appellant is Softwood Pulp and Paper Limited (formerly Harmac (Australia) Limited) (to which I shall refer as ``the taxpayer'' or ``the appellant''). The assessments against which appeals were taken to the Board of Review and from the Board of Review to this Court were in respect of income derived by the taxpayer during the years ended 30th June 1966, 1967 and 1969.

The taxpayer in respect of those years made claims for deductions pursuant to sec. 80 of the Income Tax Assessment Act (as amended), claiming that there were allowable deductions in respect of the preceding seven years. The deductions which were disallowed by the Commissioner were held by the Board of Review to be not proper deductions from income and accordingly the appeals to the Board of Review failed and the Commissioner's assessments were upheld. I shall describe in much greater detail the nature of the deductions claimed and the basis upon which they were claimed, but they were all claimed as being deductions pursuant to sec. 51(1) of the Income Tax Assessment Act.

All of the members of the Board of Review, namely Mr. Donovan, Chairman, and Messrs. Thompson and Todd, members, were of the view that what were claimed as deductions were not deductible because they were losses or outgoings of capital or of a capital nature. A majority of the Board of Review, namely the Chairman and Mr. Thompson, were also of the view that any losses and outgoings claimed did not fall within either limb of the first part of sec. 51(1) of the Income Tax Assessment Act, namely that they were not incurred in gaining or producing assessable income and were not necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

On the appeal before me it has been submitted on behalf of the taxpayer that all those conclusions were erroneous and that the amounts claimed as deductions fell within one or other or both of the first limbs of sec. 51(1) and were not losses or outgoings of capital or of a capital nature. For the Commissioner it has been submitted that all the conclusions reached by the majority of the Board of Review were correct, as was, it was submitted, the conclusion reached by all the members of the Board of Review, and that any losses or outgoings did not fall within either of the first two limbs of sec. 51(1), or, if they did, they were losses or outgoings of capital or of a capital nature. It was also submitted on behalf of the Commissioner that in respect of a very substantial item of what was claimed no loss or outgoing had been incurred by the taxpayer, and I shall refer to that in more detail.

The parties adopted the course, by consent, of placing before me all the evidence before the Board of Review on the basis that the evidence was to be treated as evidence before me, and it accordingly became an exhibit as such; and likewise all the exhibits that were tendered in evidence before the Board of Review were tendered in evidence before me as part of the proceedings. The proceeding before me is in the nature of an original hearing, or rehearing, and in those circumstances it is permissible for me to draw inferences from the evidence which is before me in the transcript. In drawing inferences I bear in mind, of course, the fact that I have not seen the witness who was called, there being in fact called for the taxpayer on the appeal before the Board of Review only one witness, an officer of the taxpayer, one Paul Esmond Fitzgerald, who is the secretary of the taxpayer and a director and also its public officer.

The parties accepted, save insofar as they submitted to the contrary, findings of fact made by Mr. Todd, who dealt with the facts fully in his careful reasons for judgment, and from those reasons I take the following findings, which I understand to be accepted by the parties. Those findings include findings that in respect of the year ended 30th June 1962 the taxpayer claims that the Commissioner should have allowed as deductions the sum of $91,925; that in relation to the year ended 30th June 1963 he should have allowed $3910 as allowable deductions; that in respect of the years ended 30th June 1964 and 1965 the deductions which should be allowed are $132 and $102 respectively; and that in relation to the year ended 30th June 1967 the amount claimed by the taxpayer and which it is said should have been allowed is $135,221. Having made that reference to the deductions I shall not again refer to them by their years, but deal with them under a series of headings or categories that were referred to in his reasons by Mr. Todd.

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It is convenient at this stage to record at the same time the income earned by the taxpayer. No income of any kind was earned by the taxpayer prior to the year ended 30th June 1965. In the next two years small amounts of income were earned. There was apparently no income earned in the year ended 30th June 1968. In the year 1969 there was a marked change, the income produced amounting to some $276,000, principally from trading profits. What the taxpayer did was to act as purchasing agent for a group of companies in relation to the acquisition of stores, and it also engaged in the process of de-barking timber. The bulk of the profit earned was in relation to the purchasing of stores. Mr. Todd found, and there was no dispute as I understood this, that the adoption of measures which led to the taxpayer earning this profit (that is in the year ended 30th June 1969) was not unconnected with the fact that the taxpayer was thought to be the respository of losses which could be offset against such profits for tax purposes, that is losses covered by sec. 80 in the preceding seven years.

I shall make certain findings of fact based on the evidence, including the exhibits. The whole matters in controversy arise out of a proposal to establish at Mount Gambier in South Australia a mill complex which would produce a certain kind of paper and craft board and the like, to which I shall refer in more detail. The idea for the establishment of the mill emerged late in 1959 and early 1960 when one E.A. Alstergren, who became the Chairman of the taxpayer, was overseas and had discussions with a Canadian company, MacMillan, Bloedel & Powell River Ltd., (to which I will refer as ``MacMillan''), which was a well-established company in the kind of industry which Alstergren discussed with officers of MacMillan. In Australia at the time paper and associated products in three categories was being produced. Fine paper was being produced by Associated Pulp & Paper Mills Ltd., based in Tasmania (to which I shall refer as ``APPM''); paper for newsprint was being produced by a company associated with the newspaper companies; and the third category of paper and like products was being produced by Australian Paper Manufacturers Ltd., which was producing brown paper, craft board and like products. The area which it was contemplated would be penetrated by the contemplated new company was in the kind of products that were made by Australian Paper Manufacturers Ltd. (to which I shall refer as ``APM'').

The taxpayer company was not incorporated until 30th August, 1961, and some of the events to which I shall refer occurred in 1960 and in 1961 before 30th August 1961. Responsibility for certain outgoings was assumed by the company on its incorporation and no point has been made on behalf of the Commissioner of the fact that these expenses were indeed incurred before the company was incorporated. Accordingly I shall make no further reference to that aspect, but deal with the case on the assumption that any losses or outgoings that were indeed incurred by the taxpayer company, if they are otherwise shown to be incurred, are to be treated as losses and outgoings incurred by the taxpayer.

Alstergren, in effect, raised with officers of MacMillan the suggestion that it might be interested in promoting a new company to make paper and other products in the general range of the kind of products made by APM. MacMillan was sufficiently interested to send to Australia a survey team of its officers, who reportedly sufficiently favourably to result in further investigations being made. Late in 1960 agreements were made with local suppliers of raw material for them, in effect, to not commit their supplies produced beyond 31st October 1963 until after 31st October 1961. The object of these arrangements was to ensure that if the project went on there would be available supplies of timber. The timber contemplated as being used was pinus radiata, of which there were forests already growing and established near Mount Gambier.

MacMillan, as part of its investigations into the matter, consulted and employed a Canadian firm of investigating experts called Sandwell & Co. (to which I shall refer as ``Sandwell''), and Sandwell produced certain reports to MacMillan, which were presumably passed on to the persons who were interested in forming a company in Australia to produce the products in mind. One report of 3rd March 1961 was a detailed and comprehensive technical and economic report and the basic opinion expressed in that report was that the project was technically and economically feasible, and there was set out in the report a likely time span under the headings of

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``Engineering'' on the one hand and ``Construction'' on the other. More reports emerged during 1961, including a report of 30th June 1961, in which Sandwell again expressed the opinion that the project had developed to the point where economic and technical feasibility had been established and an option obtained on a suitable site. That, in fact, was true, an option had been obtained on an appropriate site.

The Government of South Australia was interested in the matter in a dual sense. It was interested as the owner of pine forests which would be used by the proposed company if it were established. It was also doubtless interested in the establishment of a new industry in South Australia and the Premier himself displayed an active interest in the matter. Among other things, enabling legislation was passed by the Parliament of South Australia and it ratified an agreement made with the taxpayer, to which I will subsequently refer.

The original proposal was that a pilot company should be formed to carry out feasibility investigations, but having regard to the reports which had been received it was decided that the same company should be both the pilot company and the proposed company to run the mill, and accordingly the taxpayer company was incorporated on 30th August 1961. It is a matter of significance, to my mind, that the estimated cost of the whole project was at the time £14,000,000, which figure was revised later to £15.5 million. At the stage of incorporation, and indeed up till the time of the events to which I shall refer when MacMillan indicated that they were no longer interested in the matter, the only capital contemplated as being issued, and which was in fact issued, was 100,000 £1 shares, which it will be seen, of course, is a very small proportion of 14 or 15.5 million pounds.

On 25th August 1961 two local experts in Australia, namely Rodger and Bednall, left Australia for Canada and the United States, primarily looking into questions of de-barking and wood utilisation. This was done at the instance of the taxpayer. Bednall returned to Australia on 5th October 1961 and Rodger returned on 30th October 1961.

There are, in a diary, some three pages of manuscript notes by Rodger, but Bednall produced a report covering the period 25th August to 5th October 1961 and in it refers to the activities of both Rodger and himself. The chapter headings of that report are:

  • A. Itinerary.
  • B. Pulp Mill and Sawmilling Inspection.
  • C. Inspection of Forest Areas.
  • D. Discussions on Queries from Messrs. Ingram and Willington.
  • E. Conversion Factors and other Statistics.
  • F. Summary and Recommendation.

It is, I think, revealing to refer to some aspects of the summary. It had a number of sub-headings in turn, and the first was ``BARKERS'', in which there was a discussion of barking and in the course of which it is said:

``It cannot be stressed too strongly, however, that the barking operation itself would be termed the pivotal point of successful chip production, and without a competent trained operator, results could very well fall far short of expectations.''

And then at the end of that paragraph it was said:

``On general principles it seems it would be a mistake to get the largest size barker possible for the normal log intake, and that it would be preferable to by-pass the few over-size logs rather than pay capital expenses (and subsequent difficulty with small logs) required for a big barker.''

The next heading was ``B. CHIPPERS,'' and that commences:

``There did not appear to be a great deal of difference in the performance of chippers, and decision on which make to use would probably have to be left to our sawmilling staff.''

The next headings were ``C. SCREENS'', ``D. TRANSPORT OF CHIPS TO PLACE OF DEPOT''. ``E. OTHER POINTS'', and finally came the ``RECOMMENDATION'', which I will read in full, as follows:

  • Mr. Rodger and myself saw quite enough and learned quite enough to see the need for a thorough examination of our problem generally here, before individual recommendations could be made for the purchase of equipment involving many thousands of pounds.

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  • As I said before, one of our departmental problems is to fit adequate equipment into an existing installation, and for that purpose we should have a qualified engineer and experienced pulp equipment man to advise on it, and I would strongly recommend, and in fact consider it essential, that private forestry owning companies and ourselves combine in paying the expenses of such a man to come to Australia for a visit of, say, 3 or 4 weeks, to advise us in detail of the difficulties which we will inevitably encounter.
  • I discussed this possibility with Mr. E. Shorter, a prominent executive of the MacMillan, Bloedel & Powell River Company, and he assured me that if the company were asked, he would make such a man available. The man in question is Mr. Harry Tarrant, in whose company we were for several days, and who, I feel, would give us valuable advice.
  • This will need discussion with the other forest owning companies at an early date, in order that, if approved, the recommendation can be put into effect in the shortest possible time.

I refer to those recommendations as indicating the earliness of the stage which the whole proposal had reached. Because even on this question of barking, nothing more than advice that an expert should be obtained and come out was recommended, although the report itself indicates that that course would be justified and that an appropriate barker could be used, but what kind and on what basis, was thought to require the views of an additional expert.

On 9th November 1961 the enabling Act of Parliament to which I referred received the Royal assent. On the following day, the statutory meeting of the taxpayer was held. And on 21st December 1961, 50,000 shares were allotted to MacMillan, 25,000 to one Australian promoter and 24,995 shares to another Australian promoter, the remaining 5 subscriber shares being held beneficially for that company. Those shares were issued for cash, but that was the only capital that was ever issued in respect of the company which contemplated a capital of fourteen to fifteen million pounds. At that meeting a number of accounts were passed for payment.

In January and February 1962, Sandwells prepared plans for purposes to which I shall refer. In addition to the investigations made by Sandwells, samples of the timber which it was contemplated would be used by the mill, were sent to MacMillan for the purpose of testing. In a letter dated 1st October 1963 from the solicitors for MacMillan to the taxpayer, there is a convenient description of activities which went on in Canada in 1961 and in 1962 up to 16th of February. And the parties agreed that apart from the categorisation of these matters which it was said were matters of controversy, the actual description of what occurred in that letter is accepted as accurate, and indeed nothing has been drawn to my attention in the evidence, or in the findings of Mr. Todd, which appears to me to be in any way really inconsistent with these statements. Accordingly I shall refer to them as being descriptions of what went on in Canada at the times I have referred to.

Referring to Sandwell & Co., it is said that they were consulting engineers. They were responsible for the original feasibility study and participated in negotiations with the South Australian Government and private suppliers. Their function was to produce detailed estimates of capital costs, operating costs and revenues to show that the proposal was economically sound.

In the autumn of 1961, which I take it means the Australian autumn of 1961, MacMillan appointed a committee to examine Sandwell's report and see that every material fact which was to be relied upon was solidly based on indisputable evidence, so that when MacMillan was ready to approach the sources of capital and when the taxpayer was ready to issue a prospectus they would be able to produce an iron-clad case. The committee was not satisfied with some of the estimates in Sandwell's feasibility study and it decided that the best way to get better figures was to obtain firm bids for all the major components of the pulp mill. This made it necessary for Sandwell & Co. to make a preliminary design of the pulp mill so that specifications could be sent out for tender. This expenditure, it was said, was absolutely essential in order to obtain unshakeable evidence about the economic feasibility of the pulp mill. MacMillan said, and I have no reason not to accept this because it was, among other things, said in a letter put in evidence by the taxpayer, that prior to

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obtaining this evidence MacMillan were informed that all that could be said was that there had been intelligent guesses about the major costs from a thoroughly reliable firm of consulting engineers, namely Sandwell. After obtaining the evidence, if the project had gone ahead quickly, the sources of capital could have been given the additional assurance that firm bids had been obtained for the construction of all the major components and guarantees could have been given that the cost of the mill would fall within a very narrow range.

I make findings to the effect of what I have just said as being an appropriate summary of the part that Sandwell played in the matter.

So far as officers of MacMillan are concerned, various members of MacMillan travelled to Australia and they participated in negotiating wood supply contracts and the agreement with the State of South Australia, and they participated in making market surveys also.

I have said that samples of the timber contemplated to be used were sent to MacMillan for testing. I again read the summary of the object of the testing as expressed in the letter from Messrs. Oswald Burt & Co., and I shall refer also to the evidence of Mr. Fitzgerald on this point, because it seems to me that fundamentally they are saying much the same thing. Some of the samples were sent by air express. The samples of wood were brought from Australia, put through MacMillan's own pulp mill as a separate batch, the pulp therefrom was made into paper and that paper into cartons. The cartons were submitted to an independent laboratory in New York, which tested them in accordance with the standards generally adopted in the container industry in the United States. The object of all this was to prove that thinnings and chips from the pine forests in South Australia would actually make containers superior to those now being sold in Australia from other materials. That is a reference to containers being sold by APM. By accident one of the samples of wood delivered from South Australia was inadequate and in order to supplement it quickly Sandwell & Co. obtained a sample of similar wood grown under similar conditions from Chile. This testing, of course, involved the cost of freight of the samples and the cost of testing expenses.

Going to what Mr. Fitzgerald said, he said in evidence at p. 324 of the transcript: The tests were conducted to determine not what could be manufactured but what should be manufactured. He had said earlier in evidence that it was to see whether the company would be selling kraft paper, corrugated paper, paper appropriate for multi-wall sacks or something of that sort. He said:

``The feasibility study was based on the production of brown wrapping paper which may also be incorporated into multi-wall sacks, linen board and corrugated medium to make corrugated cartons. That was known because that was the market in which the company here, APM, was the more vulnerable.''

Further, in his evidence at pp. 325-6, he said:

``You know very well that you can make brown wrapping paper out of pine raw material, that is known to the world.

There are many types of brown paper wrapping, are there not? Some of them are thick, some thin, some have a high gloss, and they were testing the paper for that sort of thing.''

At pp. 334-5 he said:

``... you cannot make brown wrapping paper in a newsprint mill; you cannot make an unbleached kraft paper out of an acid process or sulphide mill. So the very broadest area is what we determine. Then the market determines the rest of it because the company would have to fight APM and this was an area in which they could fight them because this mill I think had a 62,000 ton machine capacity and Harris, the vice president of production at MacMillans, told me they could run that machine to make 85,000 tons of paper.''

On a related topic he said at p. 336:

  • ``One of the things they were testing was the burning properties of it'' (that is of the wood) ``because hardwood and softwood burn quite differently and in some cases the black liquor is distilled and in a distillation of black liquor you retrieve the chemicals which are used in the production of the pulp and there is a residue from the black liquor.''

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He said:

``They tested a number of things. They tested hardwood and softwood, but they certainly could not do this from a chip test. A lot of the stuff that was sent was chips. There were two shipments made I think on the Sierra and the Boogabilla which would be logs.''

And he was asked whether the test was for the purpose of determining what oil or other components would be required in the furnace for this particular mill. He said:

``Yes, this particular mill.''

He said:

``It would have something to do with the design of the furnace - not so much the design, but it would have something to do with the design of the furnace bearing in mind that they were also going to use hardwood.''

And he was asked at p. 338:

``They were tests prescribed for this particular mill at this time? - Obviously.

And they were needed to be done before you got into production? - Probably did not need to be done; probably prudent that they be done.''

Those portions of the evidence, I think, give an indication of what was involved in the testing at MacMillan.

That testing having been done, the reports having been made and further investigations of the kind I have referred to having taken place, the legislation, to which I will refer in more detail, having been enacted, on 16th February 1962 MacMillan sent a telegram which stated that it had lost interest in the project and was withdrawing its participation. It referred to ``the long difficult and unsuccessful forestry supply contract negotiations''. It is unnecessary for me for the purposes of this case to find whether or not that reason given was in fact the true reason or not. To me it appears to be irrelevant. The basic fact is that on 16th February 1962 MacMillan announced that they were withdrawing from the matter.

Efforts were made by and on behalf of the taxpayer to persuade MacMillan to change their mind or to interest another overseas promoter or promoters, without success. Indeed, the Premier of South Australia himself went overseas with a view to obtaining the interest of an overseas promoter, but he was unsuccessful, and that was where the matter ended so far as the proposal for the mill at Mount Gambier was concerned.

The only plans of the proposed mill which were ever prepared were the plans prepared by Sandwell for the purpose I have indicated of obtaining quotes in Canada, and they were plans which were, as stated in the letter, from Oswald Burt & Co., preliminary designs for the pulp mill. No plans were ever prepared in Australia by the taxpayer. No specific decisions or even proposals were made for plant and equipment. No sod was turned in the earth and all that had happened was what in substance I have described.

In considering the matters raised on the appeal there are certain basic facts which I now find. One is that MacMillan never committed themselves in any way to the project. They participated in investigations, but beyond taking 50,000£1 shares they never committed themselves to the project and never made a firm, let alone irrevocable, decision to go on with it.

The second fact is that the taxpayer itself never committed itself to the project. I make that finding of fact on the whole of the evidence. It was sought to suggest to the contrary from an answer given in evidence by Mr. Fitzgerald at p. 269, when he said:

``I very well recall Mr. Alstergren being authorised to inform the Premier of South Australia that MacMillan's were going ahead or that Harmac was going ahead. He never did advise the Premier.''

That is not evidence of an actual decision to go ahead, but an authorisation to inform the Premier of something, and it is not without its significance that Mr. Alstergren, who was the Chairman of the company, never did in fact advise the Premier accordingly. When one examines the terms of the legislation and the agreement that was entered into, that is not surprising, because if he had so advised the Premier, the consequences to the company might have been very serious.

However, I conclude that the taxpayer company never did decide to go ahead in any definitive sense with the matter, never recorded such a decision, from a

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contemporaneous letter written by Mr. Alstergren, the Chairman of the taxpayer. A letter had been written by MacMillan on 7th September 1962 to the taxpayer, in which MacMillan made a claim for expenses which it claimed were chargeable to the taxpayer and to which I will make much fuller reference. In the course of that letter Mr. Alstergren, the Chairman of the taxpayer, makes this statement:
  • ``I would furthermore like to draw your attention to the fact that at no stage was it understood that these companies'' (that is the two companies referred to, namely an Alstergren company and a Kauri company) ``would find any further capital until such a time as the project was definitely decided to be gone ahead with.''

It is clearly implicit in that statement that, because Mr. Alstergren was denying that those companies were under any obligation to find capital, he was asserting positively that it had not been definitely decided by anyone, the taxpayer or anyone else, that the project was definitely to be gone ahead with.

Counsel for the taxpayer relied in support of the submission that there was a decision by the taxpayer to go ahead with the company on the terms of the agreement ratified by the South Australian Act of Parliament, but an examination of that agreement makes it clear that the taxpayer was not committed under the agreement to go ahead, and on the contrary, whilst it was said that it would do certain things, it was given a very clear let out, which it in fact availed itself of. The agreement, in its first recital, recites:

  • ``WHEREAS the company'' (that is the taxpayer) ``proposes, with the approval of the State, to establish a pulp and paper mill near Mount Gambier and for that purpose has made certain preliminary arrangements:''

I emphasise those words ``preliminary arrangements''. It then went on to provide in cl. 3 of the agreement that -

``The company will construct and operate a pulp and paper mill within the Hundred of Gambier.''

And other clauses provided that -

``The State will if so requested by the company''

make certain provision in respect of land, roads, railways and the like.

But cl. 2(3) of the agreement is in these terms:

``If the company should find it is impracticable or inexpedient to construct a mill as provided in cl. 3 of this Indenture and on or before the thirtieth day of June, one thousand nine hundred and sixty-three gives notice of this fact in writing to the Treasurer of the State, the company and the State shall be discharged from their respective obligations under this Indenture and neither of the parties hereto will have any claim against the other with respect to anything arising under this Indenture.''

The time under that agreement was extended until the end of 1963 or thereabouts, and within that permitted time the taxpayer company did what it was permitted to do and gave notice pursuant to cl. 2(3), that it was impractical or inexpedient to construct the mill and was thereby released from all obligations under the agreement. Indeed, the land over which an option had been taken was taken up not by the taxpayer, but by MacMillan.

I reiterate my finding that the taxpayer never committed itself to go on with the project, never made a final definitive decision to do so.

The third basic fact which I find is what Sandwell were doing, and I have already made findings about that, that is what Sandwell were doing in their investigations.

The fourth basic fact is what MacMillan were doing, and again I refer to the findings I have made based upon the statements in the letter of Oswald Burt & Co. and the evidence of Mr. Fitzgerald.

The next basic fact is the conclusions to be drawn from the overseas visit and report of Messrs. Rodger and Bednall, and I have made findings as to what the purpose of that visit was. I should add to what I have already found that Rodger and Bednall doubtless acquired in the course of that overseas visit some technical knowledge which would have been of use to the taxpayer if the project had gone ahead.

The next basic fact I find to which I refer, and I have already found, is that of a company which contemplated a capital of 14 to 15

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million pounds, the only capital in fact subscribed was £100,000.

Based upon those findings and all the evidence and all the matters I referred to, I form the following conclusions and make the following findings. I find that what happened until the time when MacMillan withdrew were these things, and these are not necessarily in any order of importance.

One was that investigations took place to see whether the proposed paper mill would be economically feasible.

Secondly, investigations were made to endeavour to determine what products could be produced from the mill with the local wood supplies available with a view to forming conclusions as to what products could be produced to compete economically with the other producer, APM.

Thirdly, investigations were conducted aimed at reaching ultimate conclusions, although they were never in fact reached, as to what plant and equipment should be procured if the project went ahead.

Fourthly, the investigations, I conclude on all the evidence, were partly and to a significant extent designed to determine whether or not MacMillan at least would put capital into the project and whether it would go on with the project.

Fifthly, I conclude that what was done was aimed to and did in fact obtain certain technical information which would be of value to the taxpayer if the project became a real one and actually took place.

The next matter was that steps were taken to secure supplies of timber, produced locally, which would be necessary to enable the company to function if it were established.

Those appear to me to be the prime matters which were basic to and involved in the steps that were taken.

With that review of the facts, I turn to the amounts claimed as deductions. The total of the amounts claimed over the years is $230,494.99. A very substantial portion of that claim consists of a claim which it is said was a loss or outgoing incurred to MacMillan by the taxpayer. In the claim to which I have already referred and which was also attached to the letter from Oswald Burt & Co. dated 1st October 1963, MacMillan made a claim against the taxpayer for expenses which it said were chargeable to the taxpayer totalling $178,170.04. Of that amount the taxpayer is claiming as a deduction as part of the $230,494.99 the sum of $134,137.91, which it will be seen constitutes more than half of the total amount claimed. It is in respect of that figure of $134,137.91, that the Commissioner makes the specific submission that, quite apart from any other aspect, no loss or outgoing of that amount was at any time incurred by the taxpayer. The Commissioner concedes that the taxpayer incurred a loss or outgoing of the amount of $24,000 but denies that it was incurred in the 1967 year and denies that the taxpayer ever incurred losses or outgoings to MacMillan in the sum of $134,137.91.

For the purposes of my dealing, as I propose to do in the first instance, with the first two limbs of sec. 51(1) and the question whether any loss or outgoing was of capital or of a capital nature, I shall assume, without deciding, that that figure of $134,137.91 is to be included for the purpose of considering the other aspects of sec. 51(1). I do not decide that it is to be included, I ultimately decide the contrary, but for the purpose of considering the first two limbs of sec. 51(1) and the question of whether any losses or outgoings were of capital or of a capital nature, I approach the matter on the assumption that that sum were to be included.

On that basis, the claim has been dissected under fourteen headings, because those headings were categories referred to in the reasons of Mr. Todd, and it is convenient among other things to analyse the figures and their break-up in order to ascertain what are the major issues in the appeal before me.

I have already said that included in the figure of $230,494.99 there is included a figure of $134,137.91 being part of the claim made by MacMillan for $178,170.04. In fact, the taxpayer had made payments to MacMillan and parts of those payments are also included in the amounts claimed. By payments made on 13 February and 12 March 1962 in response to a claim by MacMillan, the taxpayer paid to MacMillan $36,619.48. That consisted of $26,690.57 being travelling expenses of MacMillan and associated personnel to Australia, and that refers to the visits to Australia that I have earlier mentioned, of MacMillan's officers early in the piece, and

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also salaries of MacMillan's officers, totalling $9,928.91. Those two figures total $36,619.48 and they are all claimed by the taxpayer as deductions.

Of the payments made on 13 February and on 12 March, 1962 to MacMillan, no portion thereof is claimed by the taxpayer as a deduction insofar as it consists of $60,339.60 for feasibility studies $2,398.49, part of travelling expenses for MacMillan personnel to Australia, and $453.55 for transcript of evidence before the Tariff Board, totalling $63,191.64.

The third payment made to MacMillan, which was on 4th October, 1962 is all claimed as an allowable deduction, and it is a sum of $26,667.94, which is a payment by MacMillan to Sandwell for feasibility studies. And that figure of $26,667.94 is all claimed.

Accordingly, if one totals the amounts paid to MacMillan which are claimed, and the amount claimed by MacMillan, which was part of the account for $178,170.04, one has the following three sets of figures: the first payments, $36,619.48, the third payment $26,667.94 and the amount of MacMillan's claim, which was in turn claimed as a deduction, namely $134,137.91. Those three groups of figures total $197,425.33.

It will be seen that those figures of amounts either paid to MacMillan, or claimed by MacMillan for tests done by Sandwell or tests done by MacMillan or overseas travel by MacMillan personnel and the like, total more than 85% of the total claim. The balance, namely amounts claimed by the taxpayer as deductions, amount to $33,069.66, which represents something between 14% and 15% of the total claim of $230,494.99. And the great bulk of the claim, namely slightly more than 85%, represents either amounts paid to MacMillan or amounts claimed by MacMillan and in part claimed by the taxpayer for, in substance, Sandwell's tests and the like, MacMillan's tests and MacMillan's staff expenses of travelling overseas.

Looking at the last item claimed, namely $134,137.91, the break-up of the amount claimed is, feasibility studies $86,228.95, travelling expenses for MacMillan personnel and the like to Australia $11,987.46, cost of sample tests $36,073.99, freight on samples $7,459.04, cables $1,522.02, transcript of evidence before the Tariff Board $548.72, office expenses $61.62 and there is then shown a credit of salaries, $9,742.89 which is very similar to, slightly less than, the earlier figure first paid of $9,928.91. So that in a sense those amounts of salaries are in effect almost wiped out by the credit, but it will be seen from what I have said as to the other break-up that what I have said is substantially correct, that it is mainly concerned with feasibility studies, overseas travel and tests of samples by MacMillan and associated matters. The other matters can truly be said to be incidental.

When one looks at the amounts that are paid by the company itself and claimed, totalling $33,069.66, it is in my view a correct analysis of them to say that they are all truly incidental to the other basic matters to which I have referred. The break-up of those figures is legal and accounting $4,194.04, and nothing has been shown to indicate that that is other than incidental to the other matters referred to; travel overseas $4,293.05, which includes the cost of Rodger's overseas trip; long term supply of raw materials, that is the steps taken by the company itself to obtain the long term contracts, about which I will say something specifically, $1,908.80. I merely make the comment in passing that those steps were, as I think I have already said, necessary to ensure supplies if a project ever got under way. The next figure is, samples overseas for testing $5,147.01, which is in the same category as sampling by MacMillan; professional fees $10,296.78, which include fees for Rodger and like matters and are concerned with the investigations of the kind I have mentioned; cables $491.93, an incidental matter; transcript of evidence before the Tariff Board $453.55, an incidental matter; office expenses $4,422.82, which was incidental to what had happened up to that date and is to be considered in the light of what had happened till that date; and travelling expenses within Australia $1,861.68, which is again to be considered in the light of how far the matter had developed when it finally was abandoned.

With those findings of fact and those analyses, I now turn to the matters in issue on this appeal and I reiterate that for the purpose of what I am saying, I am assuming, contrary to what I ultimately find, that there is to be included as a loss or outgoing incurred the figure claimed of $134,137.91, being part of

ATC 4450

the claim by MacMillan in 1962 against the company. I read the relevant portion of sec. 51(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.''

For any losses or outgoings to be deductible, they must either be incurred in gaining or producing the assessable income, or must be necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

As to the first limb as to what is meant by losses or outgoings to the extent to which they are incurred in gaining or producing the assessable income, the High Court has authoritatively defined the meaning of those words in decided cases, including
Amalgamated Zinc (de Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295 in the judgments of Latham C.J. at p. 303, Dixon J. at p. 309. What their Honours there decided can be conveniently referred to by the next judgment to which I will refer in which the Full Court of the High Court in a joint judgment of five judges adopted and applied what their Honours had said, that was in
Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at pp. 56-7 where Latham C.J., Rich, Dixon, Mc Tiernan and Webb JJ. said this in joint judgment:

``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 the assessable income' mean in the course of gaining or producing such income. Their operation has been explained in cases decided under the provisions of the previous enactments: see particularly Amalgamated Zinc (de Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295 at pp. 303-4, 307, 309, 310, and W.
Nevill & Co. Ltd. v. F.C. of T. (1937) 56 C.L.R. at pp. 300, 301, 305-306, 308.''

The critical words which were used by Latham C.J., and Dixon J. in the earlier case and are adopted by the court in the joint judgment are that the words ``incurred in gaining or producing the assessable income'' mean ``in the course of gaining or producing such income''.

In my opinion, none of the amounts claimed in this case, assuming that all or any of them were incurred by the taxpayer and some of them undoubtedly were, was incurred in the course of gaining or producing assessable income.

Everything that was done in this case, up till the time when the project ceased, was in my view entirely preliminary and directed to deciding whether or not an undertaking would be established to produce assessable income.

The project had not reached anything like the stage of doing anything in the course of gaining or producing assessable income. All that had happened was that certain tests had been made to ascertain whether or not the project would be feasible. Certain technical information had been acquired and certain steps had been taken to ensure that if the project did go ahead, supplies of timber, electricity, water and the like would be available. But that is as far as the project got. I reiterate that no one was committed, at all, to go on with the project, neither MacMillan nor the taxpayer nor anyone else. Nothing was done even to prepare plans or specifications for a mill, on the part of the taxpayer. What was done by Sandwell was for purposes of obtaining quotes for testing purposes. No decisions or even tentative decisions were taken even as to plant and equipment. In other words, the project did not approach in any way a situation which could be described as being the course of gaining or producing income. It was all completely anterior thereto and in those circumstances, it appears to me that any losses or outgoings which were in fact incurred by the taxpayer were in the course of investigations to see whether the project would be feasible, and the course of steps to ensure that if it did start there would be available supplies, and indeed so far as MacMillan was concerned in the course of it making up its mind whether it would go on with the whole matter at all. But they certainly were not, in my view, incurred in the course of gaining or producing assessable income.

ATC 4451

Accordingly, I conclude that the taxpayer has not established that any of the losses or outgoings incurred, or claimed to be incurred, fall within the first limb of sec. 51(1).

As to the second limb of sec. 51(1), the expression is ``losses or outgoings to the extent to which they are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income''.

The meaning of this expression was made clear by Menzies J. in
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1958-9) 101 C.L.R. 30 at p. 49, where his Honour said:

``Disregarding the application of the section to losses and considering the alternative head solely in its application to outgoings, there must, if an outgoing is to fall within its terms, be found (i) that it was necessarily incurred in carrying on a business; and (ii) that the carrying on of the business was for the purpose of gaining assessable income. The element that I think it necessary to emphasise here is that the outlay must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations.''

His Honour italicised and emphasised the words ``carrying on''.

It is unnecessary to decide at what point of time it can be said that a business is carried on. I am not to be taken as making any pronouncement on the submission for the Commissioner that until the actual business has commenced the second limb of sec. 51(1) has no application.

As the Chairman of the Board of Review pointed out, it is of no consequence so far as the second limb is concerned that no income was produced, and it is unnecessary for me to make any pronouncement on the question of whether or not a mill or factory must have actually started operating in the sense of the mill starting to turn before any outlay can be said to have been necessarily incurred in carrying on a business for the purpose of gaining or producing such income. It is unnecessary for me to decide that for the purposes of this case.

However, as far as this case is concerned, it appears to me to be clear that for all the reasons I have given in relation to the first limb, the losses or outgoings here claimed by the taxpayer were not necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

The critical point is that the company had not reached a stage remotely near the carrying on of a business. Even assuming that at some stage prior to the mill turning, the company could be said to be carrying on a business, in this case the company had not even approached the stage of making a decision about carrying on a business. All that had happened had been that certain investigations had been made to decide whether or not the business was feasible, and whether or not it was economically viable on a competitive basis, but nothing had been done which could be said to be carrying on a business or anything associated with or incidental to the actual carrying on of a business. Everything which was done was concerned with making a decision whether or not steps should be taken to set up a business, but no decision on even that matter had been reached.

Accordingly, for those reasons I conclude that the taxpayer has not established that any part of the losses or outgoings claimed was necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

I am fully alive to the point which has been frequently made that care must be exercised in placing any reliance upon English authorities having regard to the features of the English Tax Legislation which differ from our Income Tax Assessment Act. Nonetheless it appears to me that the conclusion I have stated it supported and pointed to by the decision of Rowlatt J. in The
Birmingham & District Cattle By-Products Co. Ltd. v. I.R. Commrs. (1919) 12 T.C. 92. His Lordship's conclusion in that case and his reasons relate to a situation which was much closer to commencing business than in the present case. I do not think in the circumstances that the presence of the word ``trade'' significantly affects his Lordship's conclusion, and his conclusion in that case as to the time when the company commenced to carry on its trade or business and when it did not, leads I think to the conclusion that this case is an a fortiori case and more clearly one in which any losses or outgoings which were incurred were not necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

ATC 4452

I turn, on the same basis as I have done in relation to the other two matters, to the third element in sec. 51(1), namely on the assumption that all the losses or outgoings claimed, including the $134,137.91 claimed by MacMillan, are to be treated as included. The question then is whether even if any losses or outgoings fell within either of the limbs of sec. 51(1), they are nonetheless not allowable deductions because they are losses or outgoings of capital, or of a capital nature. The authorities on this matter are well known and frequently referred to, but it is, I think, appropriate to repeat them before dealing with the matter. There is the well known and much cited statement of Dixon C.J. in John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1958-59) 101 C.L.R. 30 at pp. 34-35 where his Honour said:

``Perhaps the most important thing to notice in subsec. (1) is the character of the phrase `except to the extent to which they are losses or outgoings of capital, or of a capital nature.' Its character is that of an exception which necessarily presupposes the possibility of the subject matter excepted falling under the description that precedes it. In other words it is supposed by the subsection that a loss or outgoing incurred in gaining or producing the assessable income or in carrying on a business for that purpose may nevertheless be a loss or outgoing of capital.

Perhaps no better illustration of the importance of this can be found than the apparent judicial difference of opinion that, at all events on the surface, would seem to have arisen over the correctness of the decision of Lawrence J. (Lord Oaksey) in
Southern v. Borax Consolidated Ltd. (1940) 23 Tax. Cas. 597; (1941) 1 K.B. 111. For when in England the decision has been cited with approval the consideration that has been uppermost is the business character of the expenditure upon the litigation, the fact that it was undertaken in pursuance of the purpose of continuing the earning of profits. But when in Australia the decision has been said to be erroneous what has led us to say this has been the fact that the litigation obviously has concerned nothing but an affair of capital. We may have regarded the decision too much from the point of view of minds habituated to the principles expressed in sec. 51(1). But I cannot see how if that case were to be decided under sec. 51(1) the deduction there claimed could be allowed. The next thing to note about the words under discussion is that they are introduced by the expression `except to the extent to which'. This expression seems to require that a loss or outgoing that might otherwise be allowable as a deduction, must be scrutinized for the purpose of seeing if any part of it forms, to express it in a general phrase, an expenditure on account of capital. It means at least that dissection of an outgoing or loss is contemplated by sec. 51(1); possible even apportionment. In the present case however the whole deduction claimed appears to me to be of a capital nature and if this is so no question arises under these words.

In considering the form or structure of the Australian provision, it should not be overlooked that it was thought desirable to enact subsec. (2) of sec. 51. No one would suppose for a moment that the purchase of trading stock involved an outgoing which was not incurred in gaining assessable income or in carrying on the business for that purpose. Why subsec. (2) was thought necessary is because trading stock represents or perhaps one should say may represent what is still called circulating capital. But that fact alone probably would not have been thought to make subsec. (2) necessary; the evident reason why it was considered necessary or desirable was that (and this is the important point), outgoings of capital are treated by subsec. (1) of sec. 51 not as a category outside of and contradistinguished from the prima facie criterion of deductibility expressed in the earlier part of that provision but as a category of loss or outgoing capable of falling within the wider category established by that criterion and therefore made the subject of an exception which in the case of circulating capital needed qualifying or explaining.''

Another classical statement as to this portion of sec. 51 is to be found in a statement also of Dixon J. as he then was in the Sun Newspaper case, that is
Sun Newspapers Ltd. & Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-361, where his Honour said:

``The distinction between expenditure and outgoings on revenue account and on

ATC 4453

capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested. In a trade or pursuit where little or no plant is required, it may be represented by no more than the intangible elements constituting what is commonly called goodwill, that is, widespread or general reputation, habitual patronage by clients or customers and an organized method of serving their needs. At the other extreme it may consist in a great aggregate of buildings, machinery and plant all assembled and systemized 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 Colleries Ltd. v. I.R. Commrs. (1930) S.C. 215 at p. 220; (1929) 12 Tax Cas. 1248 at p. 1254. As general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue. The latter can be considered, estimated and determined only in relation to a period or interval of time, the former as at a point of time. For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose. But the practical application of such general notions is another matter. The basal difficulty in applying them lies in the fact that the extent, condition and efficiency of the profit-yielding subject is often as much the product of the course of operations as it is of a clear and definable outlay of work or money by way of establishment, replacement or enlargement. In the case of machinery, plant and other material objects, this is illustrated by the commonplace difficulty of saying what is maintenance and what are renewals to be referred to capital. But for the same or a like reason it is even harder to maintain the distinction in relation to the intangible elements forming so important a part of many profit-yielding subjects. For example, a profitable enterprise such as the sale of a patent medicine may depend almost entirely on advertisement. In the beginning the goodwill may have been established by a great initial outlay upon a widespread advertising campaign carried out upon a scale which it was not intended to maintain or repeat. The outlay might properly be considered to be of a capital nature. On the other hand the goodwill may have been gradually established by continual advertisement over a period of years growing in extent as it proved successful. In that case the expenditure upon advertising might be regarded as an ordinary business outgoing on account of revenue. More often than not an outlay of capital in establishing an organization or obtaining an asset of an intangible nature does not produce a permanent condition or advantage. Its effects are exhausted over a period of time. In such cases the commercial practice of writing off the expenditure against revenue over a term of years or making a reserve to replace exhausted capital lessens the importance of the contrast. But in the assessment of income for taxation purposes severe limitations are placed upon the application of such a practice, the allowance of which is exceptional.''

Applying those principles to the present case, I then ask whether if any of the losses or outgoings claimed fell within either of the first limbs of sec. 51(1), they are nonetheless losses or outgoings of capital or of a capital nature.

In my opinion, they clearly are. For the reasons that they were not losses or outgoings incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income, some aspects of this

ATC 4454

concept are difficult to apply for the basic reason that the losses or outgoings do not fall within sec. 51(1) at all, because they were concerned with an anterior stage, namely whether or not to establish a business, whether it would be viable, and what kind of business would be established, and for all the reasons I have given, the losses and outgoings do not fall, in my view, within sec. 51(1).

Insofar as they may be said to do so, contrary to what I have decided, it appears to me that they all fall within the concept of establishing or creating the profit-yielding subject. Insofar, for example, as technical information was acquired, insofar as options were obtained over land, insofar as arrangements were made for the supply of water, electricity and other essential matters, insofar as arrangements were made for the supply of timber by options which would enable arrangements to be made, all those matters appear to me to be establishing or creating the profit-yielding subject.

Insofar as the tests that were conducted pointed to the conclusion that the project would be profitable and competitive, they also appear to me to be part of the profit-yielding subject in the sense of information and facts which would be the basis for the whole project being gone on with. That in my view applies equally to the studies conducted by Sandwell and to the tests conducted by MacMillan.

On this aspect of the matter I am in substantial agreement with the conclusions of all the members of the Board of Review as expressed by Mr. Todd. It appears to me no part of the amounts claimed which, if they did otherwise fall within either of the first limbs of sec. 51(1), would not, in any event, be excluded from deduction on the basis that they are losses or outgoings of a capital nature.

What I have said is sufficient to dispose of the case, but there is in my view a substantial additional ground why the claim, in respect of the $134,137.91 claimed, must fail. Because, in my view, that was not a loss or outgoing which was incurred by the taxpayer at all.

As I have said, in September 1962 MacMillan made a claim against the taxpayer which was the subject of the letter dated 1st October 1963 from Oswald Burt & Co., the solicitors for MacMillan, to the taxpayer company. I have referred to the portions of that claim which are claimed by the taxpayer and for completeness I should say that the only portions of that claim which are not claimed by the taxpayer are $51.29 for legal and accounting, and $43,980.84 feasibility studies, which are acknowledged by the taxpayer to not be deductible anyhow.

The history of this matter is that as soon as the claim was made by MacMillan it was resisted by the taxpayer. The letter to which I have referred, of 14th September 1962 by Mr. Alstergren to Mr. Shaw of MacMillan, makes that clear. He says that the account has only just arrived and it was the first intimation he had of it, and that it would in effect be considered. Thereafter, the taxpayer took the firm and consistent view that it was a claim for which it was not liable. In its balance sheet for the year ended 30th June 1962 the taxpayer stated that the account, received by the company from MacMillan, has not been included in the accounts,

``This amount purports to be for expenses payable by the company.''

and similar statements, referring to the sum in terms of Canadian dollars, appeared in the balance sheets for each of the years ended 30th June, 1963; 1964; 1965 and 1966.

However, as Mr. Fitzgerald stated in evidence in relation to this matter, a dog-fight had been going on for years. At p. 338, he said:

``... this was a sort of running dog fight for years.''

He gave evidence that a basis of settlement, or indeed a settlement of this matter, had been in fact reached in 1965, because he said:

  • ``My recollection of this matter was that Mr. Harper'' (that is Mr. Harper of Arthur Robinson & Co.) ``indicated that MacMillan would settle on this basis and we agreed to it.''

and the basis there referred to was the payment of $24,000.

  • Q. "About approximately when would that have been?
  • - That would be probably in 1965."

What was, in substance, settled in 1965 was in fact made the subject of a deed of release made 29th September 1967 between MacMillan of the one part, and the taxpayer and Softwood Holdings Ltd., Kauri Timber Co. Ltd., and Mr. Alstergren. And the attitude

ATC 4455

of the taxpayer to this claim by MacMillan throughout is made clear by the recitals to that agreement which was executed by the taxpayer, which, in the second and third recitals, are in these terms:

``AND WHEREAS certain claims have been made against the Releasees'' (that is including the taxpayer) ``by the Releasor'' (which is MacMillan) "arising out of or in connection with the projected establishment by the Releasor and the Releasees or some one or more of them jointly of a paper board mill and/or a chip board mill in Australia and/or the investigations, surveys, reports and plans made or obtained by the Releasor in connection therewith and the expenses and costs incurred in relation thereto (all of which are hereinafter referred to as `the joint project')

AND WHEREAS the Releasees deny the validity of such claims by the Releasor

AND WHEREAS the parties hereto have agreed to settle their differences in manner hereinafter appearing"

And then after a further recital:

``NOW THIS DEED WITNESSETH that in consideration of the foregoing and of the sum of $24,000 Australian currency being paid to the Releasor by Harmac at the request and with the consent of the Releasees other than Harmac out of the amount standing to Harmac's credit with the State Savings Bank of South Australia and in further consideration of the sum of $367.95 Candian currency standing to Harmac's credit with the Imperial Bank of Commerce, Vancouver, Canada, being paid to the Releasor by Harmac also with the consent of the Releasees other than Harmac -

1. The Releasor, its successors in title and assigns doth hereby release, acquit and forever discharge the Releasees and each of them, their successors, executors, administrators and assigns from all actions, suits, claims and demands of whatever nature and whether sounding in contract or in other manner whatsoever which the Releasor may now have or but for the execution hereof would or might have against the Releasees arising out of or in any way connected with the joint project and/or any contract, agreement or obligation express or implied in any way relating or incidental thereto to the intent that all such actions, suits, claims and demands shall henceforth be released, acquitted and forever discharged.''

Despite the events to which I have referred, Mr. Fitzgerald, without the authority of any prior resolution of the Board of Directors of the taxpayer, and after the conclusion of the financial year 1967, made the following entry in the books of account of the taxpayer - there is an entry in Folio 12 of the Journal for the year for 30th of June 1967 for the Australian equivalent of Canadian dollars which is charged to the appropriate expense account, and purports to increase the liability of the total of trade creditors. And the narration reads:

``Taking up account of MacMillan Bloedel Powell River Limited.''

In the next year's accounts, on Folio 14 of the Journal, in respect of the year ended 30th June 1968, there is an entry whereby the balance, after the cash settlement of \ca\.24,000 and $CAN.367.95 is passed to the credit of a capital profits reserve account, being an amount of \ca\.153,865.58 described as ``Creditors discount reserve''. I repeat that the entry for the year 30th June 1967 was made without a prior resolution of the Board of Directors and the only way in which it was said to be ratified was by directors signing the balance sheet for the year ending 30th June 1967 after that date.

Mr. Fitzgerald's evidence is that the deed of release was not executed by the taxpayer until the month of December 1967 and I conclude from the date on the deed of release and from the evidence of Mr. Fitzgerald that it was executed earlier by MacMillan. All that Mr. Fitzgerald was able to say, eventually, was that that entry, the entry I have referred to in respect of the year 1967, was made some time prior to 29th September 1967 when the accounts for the year ending 30th June 1967 were signed. He acknowledged that it was definitely done after the 30th June 1967 and he said that the journal entry was prior to 29th September 1967 or on whatever date the Board meeting was held in that year to adopt the accounts, but beyond that, he was unable to go.

ATC 4456

I find as a fact that when the entry was made Mr. Fitzgerald and the taxpayer company knew full well that in substance the claim had been settled for $24,000 Australian, and that the only matter that remained was the formality of executing the deed. However, for the purposes of considering sec. 51(1), the relevant question is whether or not the amount claimed by MacMillan and which the taxpayer has in turn claimed as a deduction, namely the figure of $134,137.91, was a loss or outgoing incurred by the taxpayer within the meaning of the section.

The circumstances in which a loss or outgoing is to be regarded as being incurred were dealt with by the High Court in
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 at pp. 506-7, and in the course of the reasons of the joint judgment of Dixon C.J. and Webb, Fullagar, Kitto and Taylor JJ., their Honours said at pp. 506-7:

``For under our law the facts must satisfy the expression `losses and outgoings incurred'. These words perhaps are but little more precise than the word `established' or the expression used above `definitively committed'. 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.''

And later at p. 507:

``To repeat what has been said before in relation to an analogous provision in the Act of 1922-1934: `To come within that provision there must be a loss or outgoing actually incurred. `Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected.':
New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 C.L.R. 179, at p. 207.''

In my view it is clear in this case that the claim by MacMillan against the taxpayer for $178,170.04, of which the taxpayer has claimed as a deduction $134,137.91, was not a loss or outgoing incurred by the taxpayer. At no stage did the taxpayer subject itself to that claim, either completely or at all, except to the extent of the ultimate settlement for $24,000. At the most it falls within the language of the High Court as being a loss or expenditure which was no more than impending, threatened or expected. At all stages the taxpayer denied liability for the amount and that denial was not only asserted in correspondence and its annual balance sheets, it was also continued as its attitude at the time of the deed of the release, which was dated 29th day of September 1967 and executed by the taxpayer later that year, because therein the taxpayer denied the validity of the claims by MacMillan.

For the taxpayer it was submitted that this was a liability for work and labour done, but for there to be a liability for work and labour done it must be work and labour done at the express or implied request of the person liable, and this is the very thing which the taxpayer denied. It denied that it was responsible for these claims in the sense of claims arising out of the steps taken and the expenses incurred by MacMillan.

It is to be noted incidentally that, if the claim were one for work and labour done, it would have no connection whatsoever with the year 1967 and would be work and labour done in the years the subject of the claim, namely 1960 to 1962, and there would be no rational basis for including it as a liability in the 1967 year.

It was submitted in the alternative on behalf of the taxpayer that once the entry had been made in the accounts of the taxpayer in respect of the 1967 year the taxpayer was liable on an account stated. This submission proceeds on a misconception, in my view. Account stated in discussed in Chitty on Contracts (General Principles) 23rd ed. in para. 1778, where it is said:

``The term `account stated' is applied in at least three ways -

(i) To claim by one party to payment of a definite amount which is admitted to be correct by the other party,''

and there is no evidence that the entry in the accounts of the taxpayer was ever communicated to MacMillan so as to be an admission. The second meaning is -

ATC 4457

``(ii) Items in an account that may have been settled and agreed on the basis of some new valuable consideration received by the party who admitted that he owed the agreed sum,''

which is not this case. And the third category stated in Chitty is -

``(iii) A real account stated is one in which the account includes items on both sides and the parties have agreed that there shall be a set-off and only the balance shall be payable.''

It was submitted that on the basis of the entry in the books of accounts of the taxpayer MacMillan could sue the taxpayer on that entry. In my view this proceeds on the misconception that that entry constitutes an account stated because it was communicated as an admission. There is no evidence that it was ever so communicated and no evidence that there was any admission, and all the evidence points strongly the other way. Indeed, even after the accounts of the taxpayer were adopted by its directors, the taxpayer continued to assert that it denied the validity of the claims by MacMillan by executing the deed of release in December 1967 which contained that recital. If MacMillan had attempted to sue the taxpayer, relying upon the entry in the book if it happened to come to its notice, the release to which I have referred would have been a complete defence to the action, so that in no sense could it be said that the taxpayer had subjected itself to the claim, completely or at all, and at the very most the claim was one which was threatened.

I cannot but reach the conclusion that knowing full well that the claim was either settled or about to be settled, an entry was made in the books of the taxpayer for the sole purpose of attempting to claim it as a tax deduction, but in my view, and I find, that, for the purposes of the provisions of the Income Tax Assessment Act, that entry in the books was a complete nullity and completely lacked reality. For the taxpayer reliance was placed upon the decisions of Rowlatt J. the Court of Appeal and the House of Lords in The British
Mexican Petroleum Company Ltd. v. Jackson (His Majesty's Inspector of Taxes) (1931-1932) 16 T.C. 570. There could be no greater contrast than between the facts in that case and the facts in the present case. The whole basis of the decision in that case is a statement by the Commissioners in the case which appears in the report at p. 576, where it is said in para. 8:

``The beforementioned sums of £1.073,281 and £1,270,232 due and owing by the appellant company to the Huasteca Co. at 30th June 1921 and 30th September 1921 respectively were the agreed and admitted liability of the appellant company, the Huasteca company at these dates, and the amount of that liability was never disputed by the appellant company.''

I reiterate, there could be no greater contrast between that finding of facts and the finding of facts I have made in the present case, where at all stages the amount was disputed and never was it acknowledged or admitted, and that this was critical to the decision is to be found in the repetition of that fact in the speech of Lord Thankerton at p. 590 when his Lordship repeated that finding of the Special Commissioners, and Lord MacMillan, who gave the other speech apart from the concurring speech, made reference also to the same basic fact.

I should add that, because it arises directly out of the findings I have made and although it relates to a year that is not in question, lest it be said that it has got some relationship to the time when the acts were done in respect of which the claim was made by MacMillan, in my view the sum of $24,000 paid by the taxpayer in settlement of that claim is in itself not deductible in whatever year it was incurred. For the reasons I have earlier given, it did not fall within either limb of sec. 51(1), and it was also a loss or outgoing of a capital nature.

More than that, however, on the taxpayer's own concession, it is not established that it was a loss or outgoing of a deductible kind. The total claim made by MacMillan was for $178,170.04. The settlement was for $24,000. The taxpayer acknowledges that of the total amount of $178,170.04 two items are not deductible, namely feasibility studies to the claimed costs of $43,980.84 and legal and accounting $51.29. It is quite impossible from the release to say in respect of what the $24,000 was paid. It is quite consistent with the facts that it was paid in respect of some portion of the admitted non-claimable amount for feasibility studies, which was $43,980.84, and it is impossible from the release for the

ATC 4458

taxpayer to show that it was paid in respect of any item which even it claims as deductible, namely that it was paid in respect of any part of the $134,137.91 in respect of which a claim was made.

The conclusion I have so stated appears to me to accord with and be supported by the decision of the High Court in
Allsop v. F.C. of T. of T. (1964) 113 C.L.R. 341.

For all of the reasons I have given in my view the appeal should fail - for the three reasons I have given for all the amounts, and the additional reason I have given in respect of the $134,137.91, being part of the claim made by MacMillan.

I would just add this, that in respect of the procuring of supplies, for all the reasons I have given it did not fall within either of the limbs of sec. 51(1), it was of a capital nature being an essential arrangement to ensure that a business might eventually get under way. An argument was submitted on the basis of certain evidence of Mr. Fitzgerald that because samples and testing would be undertaken with a going concern, that led to the view that what was done by way of sending of samples and testing took on that character at the time it was done. In my view that is an erroneous analysis. The mere fact that something might be done during the course of running a business does not, in my view, establish that at the time it was done it was an outgoing incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income. At that stage the sampling and testing was done for the sole purpose of deciding whether the project was feasible and what kind of activity might be undertaken.

I should refer to a particular submission that was based upon information which Mr. Rodger gained in relation to de-barking, and it was submitted that this was deductible, having regard to the fact that in the 1969 year the company engaged in de-barking activities of an entirely different kind from those contemplated at the time when Rodger went overseas and the mill was contemplated as being one that might be erected and put into operation. I would adopt what Mr. Todd said in relation to that matter in para. 38 of his reasons when he said:

``Some stress was placed on the circumstances relating to Rodger's overseas journey in which he was engaged, inter alia, in a study of surface removal, and to the fact that such an activity was engaged in in the 1969 year with some production of income resulting therefrom. In fact the bulk of the taxpayer's income in that year was not produced from this source, and the ultimate operation which was carried out was not quite the same as had been originally contemplated. These points are however not of any consequence. The important point is that the expenditure incurred in relation to Rodger's study tour was incurred in and about and in the course of the process of establishing the business of the company and is, with all the other expenses to which reference has been made, to be regarded as an outgoing of a capital nature. It is worth noting that in any case the knowledge gained by Rodger was, for the taxpayer, all new knowledge and it seems to me that the gaining of new knowledge prior to the commencement of business is an affair of capital. It is the same as the assurance of raw materials, the setting up of marketing arrangements, the organisation of finance and all the other essential matters that had to be dealt with prior to launching the business.''

I agree entirely with that and I say further, that in my view, for the reasons I have given in relation to other matters, the expenses of Rodger going overseas, both by way of payment and travelling expenses and the like, for the reasons I have given, were not losses or outgoings incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income. The reasons I have given generally apply as much to what Rodger did as to the other investigations and tests and the like.

Accordingly, for all the reasons I have given, I am of the view that the appeal should be dismissed.

  • MR. MYER: The question of costs, your Honour.
  • HIS HONOUR: Yes, Mr. Myer?

    ATC 4459

  • MR. MYER: I would seek an order for costs in the circumstances.
  • HIS HONOUR: Have you anything to say, Mr Castan?
  • MR. CASTAN: No, I think not, your Honour, in relation to that.
  • HIS HONOUR: The order of the Court is, the appeal is dismissed. It is ordered that the appellant taxpayer pay the Commissioner's taxed costs of the appeal.

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