Case W19

PM Roach SM

Administrative Appeals Tribunal

Decision date: 20 January 1989.

P.M. Roach (Senior Member)

The applicant in this reference carried on business in the market place engaging in all facets of the business of an advertising agency. I shall refer to the applicant as ``AA''. During the year of income ended 30 June 1983 it derived assessable income in the sum of $244,713. Those revenues were generated by a diversity of operations including work in relation to the promotion of a major concert presented by a firm of producers (``WASH'') and featuring as entertainers a group known as the ``DT's''. (Bearing in mind the decision in
Hulton v. Jones (1910) A.C. 20, I hope that none of those fictional names - nor any other to follow - happen to be the name of any group or Association which might take offence at my use of the name.) As a result, in September 1982 an

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agreement was entered into whereby AA engaged others to produce a videotape of the performance for AA and WASH. Two films were contemplated. In October 1982 AA and WASH entered into a written agreement with the managing agent (``MAG'') of the DT's whereby AA and WASH were authorised to videotape record a performance of the DT's for the making of two videotape films. Copyright in the films and any soundtrack produced from them was to be owned by AA and WASH. Payment of royalties was to be made but was only to be payable out of the proceeds of sale after production costs were recouped. However, MAG had reserved to it certain rights of editing the videotapes.

The DT's performed in October 1982 and a videotape record of the occasion was made. To quote the statement of agreed facts:

``The quality of the recording was less than ideal.''

Nothing was stated as having been agreed about the quality of the performance, but the reputation of the DT's was such as to have made possible the commercial success of the videotapes.

2. Editing of the tapes was completed in January 1983 but only one film was completed. Endeavours to market the films had commenced as early as November 1982, but at 30 June 1983 had not generated any assessable income capable of being attributed to use either of the film or the soundtrack to the exclusion of any other activity of AA. However, I find - by inference in the statement of agreed facts and the income tax returns - that, by 30 June 1983, one of the two films contemplated had been completed and assembled in marketable condition; that the proposal for the second of the two films originally contemplated had been abandoned; that the direct costs of all production had amounted to $78,178; that other costs, not specifically recorded as directly attributable to any work of film production - e.g. at least audit and accounting fees; bank charges; electricity; filing fees; insurance; interest; leasing charges; motor vehicle expenses; rent; repairs and maintenance; staff amenities; and telephone and wages - had been expended on the production of the film. (As to the latter point, I observe that, if the film had generated income, but exempt income, it would have been necessary to at least apportion such expenses so that so much of them as was fairly attributable to the derivation of the exempt income would not have been allowable as deductions.)

3. I also find that as at midnight on 30 June 1983 the Minister of State for Home Affairs (Commonwealth) had not granted a Certificate of Approval in relation to the film for the purposes of sec. 124K of the Income Tax Assessment Act 1936 (``the Act''). For that reason the film did not constitute ``an Australian film'' within the meaning of the relevant provisions of the Act at the close of the year of income ended 30 June 1983.

4. Such a certificate issued from the Minister on 4 February 1984 and a copy of that was lodged with the Commissioner by AA when it presented its income tax return to 30 June 1983 on 17 April 1984. It was accepted for the Commissioner that that action of the Minister had the effect of retrospectively conferring on the film the status of an Australian film as at the previous 30 June 1983.

5. Attempts to market the film commenced as early as November 1982. They continued from that date but it was not until April 1984 that any contract for the marketing of the film was entered into. The purchaser was an Asian television group. That contract did not generate any assessable income derived prior to 30 June 1984, but it did result in assessable income being derived in the following year.

6. I find that the costs of attempting to market what had been produced were not included in the sum of $78,178 identified as the cost of the film; and that those costs of marketing were claimed, and allowed, as deductions against assessable income in the years in which they were incurred. I find nothing remarkable in that. The costs of production were acknowledged in the circumstances of the case to be the costs incurred in producing a capital asset - the profit-yielding subject; and the marketing costs last referred to were those of operating, or attempting to operate, that profit-yielding subject.

7. The question for determination is as to the significance for fiscal purposes of those events as to the $78,178. It is accepted that, despite the role of AA as an advertising agent and despite the fact that, in the course of that activity, it produced films for its own

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``in-house'' use and in the course of service to clients, in circumstances whereby the cost of producing those films was deductible, the direct costs of production of the film in question constituted an affair of capital. In my view, that is the correct conclusion (cf. the reasons for decision in NT86/505 [reported as Case W2,
89 ATC 107]). I also accept that the costs of attempting to produce two films was entirely an affair of capital but that the entirety of the capital outlaid in the attempt to produce the two films is properly to be considered as the cost of producing the one film which eventuated. Thus, the circumstances of AA in relation to the production of the film were somewhat similar to the circumstances of a manufacturer who contracts out for the construction of an item of production plant planned and designed by operatives of the manufacturer but which ultimately results in bringing ``on-line'' a capital item of plant to be used in the expanded production processes of the manufacturer. In each case some of the costs of bringing the asset into operation are likely to have been borne on revenue account; only the direct costs of production have been borne on capital account; the former expenses have been claimed and allowed as deductions allowable pursuant to sec. 51(1) of the Act; and any claim to have deductions in relation to the direct costs depends upon the applicability of other provisions of the Act - most commonly sec. 54.

8. AA acknowledges that sec. 51(1) does not confer any entitlement to a deduction in relation to the direct costs of film-making because the making of the film was an affair of capital. Further, it concedes that it is not entitled to any deduction pursuant to sec. 54 of the Act on account of depreciation because the film does not constitute ``plant or articles'' within the meaning of that section. However, it claims that, as the film constituted ``industrial property'' within the meaning of Div. 10B of Pt III of the Act, it is entitled to deduct the entire costs of the film pursuant to the provisions of that Division. That is not disputed. Further, it claims that, by reason of the film being an ``Australian film'' as defined by the Act, it is entitled to write off its outlay of $78,178 over two years rather than over a period of 25 years (sec. 124U(1)), such as would have been its entitlement had the film not been an ``Australian film''. That is not disputed. Thirdly, it claimed to be so entitled commencing with the year of income ended 30 June 1983 or 1984. Both claims were disputed by the Commissioner. On that basis, in its returns of income to 30 June 1983 and 1984, it had claimed deductions of $39,089.

9. The claims so made were disallowed by the Commissioner and resulted in objections being taken by AA. The stated reason for disallowance at that time was:

``Deduction for film investment expenditure has been disallowed as no income has been produced by the film in the year of income.''

That resulted in AA requesting an independent review of the Commissioner's determinations upon the objections. The matters were referred to the Tribunal. At that point the Commissioner stated his intention to also rely on arguments based on ``fiscal nullity''; sham; sec. 260 of the Act; and sec. 82KL. At the hearing no attempt was made to rely on such further arguments. In addition, it was only at the hearing that the Commissioner's representative announced that the Commissioner had determined that the objection in relation to the year of income ended 30 June 1984 should be allowed.

10. The basis upon which the Commissioner acted in disallowing the claims originally made was that the deductions sought were only allowable to an owner who:

``... in the year of income or a previous year of income, has used the unit of industrial property of which he is the owner... for the purpose of producing assessable income.''

(sec. 124L)

By making the concession which was made at the commencement of the hearing in relation to the year of income ended 30 June 1984 the Commissioner was acknowledging that, to satisfy that test, it was not necessary that assessable income be derived during the first year of income in relation to which the deduction is claimed; and that it would be sufficient that the owner had so ``used'' the industrial property by bargaining contractually for the generation of, and gaining the right to, assessable income. On that basis, it is said that the entitlement of the applicant commenced with the year of income ended 30 June 1984 and flowed over into the year following. I was not advised whether the applicant had taken

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appropriate steps to ensure that, should that view of the matter as now taken by the Commissioner be upheld, AA would be granted appropriate further relief in relation to the year of income ended 30 June 1985.

11. So it was, that the only issue left for determination was whether the test of use for the purpose of producing assessable income had been satisfied by the events which occurred during the year of income ended 30 June 1983.

12. In endeavouring to discern the meaning intended by the Parliament when it used the phrase:

``... has used the unit of industrial property... for the purpose of producing assessable income...''

it is appropriate to have regard to the basic structure of the Act as interpreted by the Courts. One decision of the High Court of Australia of particular significance is that in
Carden's case (Commissioner of Taxes (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. (1938) 63 C.L.R. 108). The issue to be there determined was whether a ``cash receipts'' or ``accruals'' basis of accounting was the more appropriate basis for the assessment of the income tax liability of a medical practitioner. The question arose for determination under the Taxation Act 1927-1935 of South Australia. That legislation, like the Income Tax Assessment Act of 1936, was cast in such short form as to be hardly recognisable on superficial acquaintance as a forerunner to the Income Tax Assessment Act (Cth) as we know it in the late eighties. Dixon J. (as he then was) made a number of statements of particular importance. He said:

``In the present case we are concerned with rival methods of accounting directed to the same purpose, namely the purpose of ascertaining the true income. Unless in the statute itself some definite direction is discoverable, I think that the admissibility of the method which in fact has been pursued must depend upon its actual appropriateness. In other words, the enquiry should be whether in the circumstances of the case it is calculated to give a substantially correct reflex of the taxpayer's true income.''

(at p. 154);

``Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form''

(p. 155);

``The reasons which underlie the practice of estimating for taxation purposes the income from trade or manufacture by means of a commercial profit and loss account consist in the impracticability of computing income in any other way and in the adoption for fiscal purposes of recognized commercial principles''

(p. 155).

13. In the application of those principles in taxation law it is necessary, as his Honour said, to have regard to the provisions of the statute lest those provisions indicate that some other standard is more appropriate. When one turns to consider the provisions of the Act, the starting point must be sec. 48 which provides:

``In calculating the taxable income of a taxpayer, the total assessable income derived by him during the year of income shall be taken as a basis, and from it there shall be deducted all allowable deductions.''

14. In this case it is only necessary to consider the latter provision. The provisions of the Act providing for ``allowable deductions'' are numerous, but two are of special and general importance. They are sec. 51 of the Act, which provides for the deduction of revenue losses incurred in the course of carrying losses incurred in the course of carrying on business for the purpose of producing assessable income, but (inter alia) excluding losses of capital or of a capital nature; and sec. 54 of the Act which allows that there may be depreciation of the capital cost of ``plant or articles... owned by a taxpayer and used by him for the purpose of producing assessable income or... which has been installed ready for use for that purpose and is during that year held in reserve by him...''. In neither case does the Act provide that there must be a direct or immediate nexus between the outlay, or the benefit obtained by reason of the outlay, and assessable income. As the High Court of Australia pointed out in
Herald & Weekly Times Ltd. v. F.C. of T. ((1932) 48 C.L.R. 113), an argument that payment by a newspaper publisher of damages and legal expenses occasioned by the publication of defamatory matter is ``in no sense productive expenditure, directly or indirectly'' is not a proper basis for denying deductibility. As was said by Gavan Duffy C.J. and Dixon J. (at p. 119):

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``When it appears that the inclusion in the newspaper of matter alleged by claimants to be defamatory is a regular and almost unavoidable incident of publishing it, so that the claims directly flow from acts done for no other purpose than earning revenue, acts forming the essence of the business, no valid reason remains for denying that the money was wholly and exclusively expended for the production of assessable income.''

Further to that, their Honours took the view that it was not appropriate to require that a nexus be established between assessable income and the expenditure in the one year. Their Honours said (at p. 118):

``No point is made of the fact that the publication took place in the former year, and properly so. The continuity of the enterprise requires that the expenditure should be attributed to the year in which it was actually defrayed.''

15. But the Act goes further. It not only recognises that losses may have been incurred in particular years - a situation which arises whenever the allowable deductions exceed the assessable income (sec. 48) - but it also makes provision for such losses to be carried forward to future years so as to constitute allowable deductions of those years. However, such general observations cannot resolve the present problem for the issue is not about a revenue loss such as might fall to be considered under sec. 51. Nor is it to be resolved simply by reference to sec. 54 of the Act because the film did not constitute ``plant or articles''.

16. But, of those two provisions, sec. 54 is more closely allied to Div. 10B of the Act. Each provides for a system of amortisation of capital expenditure; each provides for a system of fixing the rate of amortisation; and, by reason of specific provisions, each allows that, in certain circumstances, an accelerated rate of amortisation may be allowed.

17. To satisfy the requirements of sec. 54(1), it is sufficient that either one of two tests be met: that the plant or articles be ``used... for the purpose of producing assessable income'' or ``has been installed ready for use for that purpose''. Neither test requires that the plant or articles shall have actually produced assessable income as assessable income derived by the taxpayer or even that such ``use'' of the plant or articles as there may have been was certain to occasion or even likely to occasion the derivation of assessable income in any later year. But no analysis of the depreciation provisions of itself will directly resolve the issue before me.

18. The film in question was a capital asset and, therefore, did not give rise to any allowable deduction pursuant to sec. 51(1) of the Act. The film did not constitute ``plant or articles'' within the meaning of sec. 54(1) of the Act and, therefore, gave rise to no allowable deduction by way of the depreciation provisions. In the circumstances, unless an allowable deduction arises by reason of the provisions of Div. 10B (Industrial Property), the applicant will not have any right to any allowable deduction in relation to the cost of the film in any year.

19. In my view, the arguments for the Commissioner are incorrect. Further, the nature of the Commissioner's error is reflected in the adjustment sheet which accompanied the 1983 assessment. It seems then to have been thought that a prerequisite to deductibility was the derivation of some income arising from the use of the film. In consequence, in two consecutive years claims were disallowed because it did not then appear that any assessable income had been derived within the years in which the claims were made. Later that view was revised and the Commissioner came to accept that it was sufficient that a right to future income had arisen which, in fact, generated assessable income in a following year. Further, it was conceded in argument - correctly in my view - that entitlement to a deduction in the 1984 year would have been no less if the assessable income then in prospect in the following year had not eventuated.

20. In my view, such an approach misses the entire point. The question is not whether the use of a film produced income, or the right to income. The question is whether the owner ``has used (the film)... for the purpose of producing assessable income''. In my view it never was necessary that a direct nexus should be established between the use of the film and identifiable assessable income attributable to that use. If the film had been used to promote the image of AA; or to simply entertain its clients; or as an ``in-house'' teaching aid (even if only to instruct staff as to experiences to be avoided), it would have been used ``for the

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purpose of producing assessable income''. In my view the significance of the reference to ``the year of income or a previous year of income'' preceding the reference to use of the unit is only to indicate that no ``unit of industrial property'' exists until such a unit of industrial property exists; but that, once it exists, the right of amortisation commences once the unit of industrial property is put to use for the purpose of producing assessable income. I am satisfied that, from as early as November 1982, AA was seeking opportunities to derive assessable income by use of the film, but at that early day no deduction was allowable because the film did not then exist as ``a unit of industrial property''. However, once the film was complete as a ``unit'', once it existed as a marketable item, it was being ``used... for the purpose of producing assessable income''. Initially, that use was not productive of income, but none the less, like depreciable plant or articles used to manufacture an unsuccessfully marketed product, its use was ``for the purpose of producing assessable income''. That, in the circumstances, qualified AA for the deductions it claimed.

21. In consequence of the foregoing, the orders of the Tribunal will be that the objection decisions of the Commissioner under review shall be varied and that, taxable income shall be reduced by the sums of $39,089 in each of the years of income ended 30 June 1983 and 1984.

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