Anderson v. Federal Commissioner of TaxationJudges:
The question for determination in these references is whether certain deductions ought to be made from the declared income of the applicant, James Outram Anderson, in calculating his taxable income in the years ended 30 June 1979 and 30 June 1980. The claims arise out of losses said to have been made by Taren Point Traders, a partnership of which the applicant was a member, in connection with film investments.
The applicant first became interested in the possibility of film investment in early 1979. At that time he was carrying on practice as a solicitor in the Sydney suburb of Bexley. In the course of work performed on behalf of a client he met David Ettridge and Andrew King, two men employed by a company known as Tasman Developments Limited (``Tasman''). They informed him that Tasman was a Melbourne-based company which put together partnerships to make films. Each syndicate consisted of a maximum of 20 people. Each partnership made three films: an ``A'' class feature film suitable for theatre release, a shorter ``B'' class film for theatre or television and a short ``C'' class film, such as an educational film, for limited audiences. The total cost of the three films was $1,000,000. The partners were required to contribute a total of $150,000. The balance of $850,000 was provided by Media Finance Services Pty. Limited (``Media Finance''). The moneys provided by Media Finance were provided by way of non-recourse loan, Media Finance's only right being to receive the proceeds of the exploitation of the films by way of recoupment of the loan. No partner was personally liable for any shortfall. Mr Ettridge claimed that Tasman held counsel's opinion to the effect that the full sum of $1,000,000 was a tax deduction available to the members of the partnership.
(Mr Ettridge and Mr King did not tell the applicant that only 6% of the total budgeted cost of the films was to be spent upon the actual production of films. By an agreement made during December 1975 between Tasman and Andromeda Productions Pty. Limited (``Andromeda'') Tasman had undertaken to procure persons to enter into contracts with Andromeda for the production of films on the basis that each set of participants would obtain one film from each of the categories ``A'', ``B'' and ``C'' in return for a total fee of $1,000,000. In return Andromeda agreed to pay Tasman a commission of 94% of the fees received from the participants. The two persons who executed that agreement on behalf of Andromeda were two members of a Melbourne firm of solicitors, Clemens Lucas & Mulvany. That firm also acted for Tasman and for the various partnerships which were eventually created pursuant to the arrangement between Andromeda and Tasman.)
Mr Anderson contacted a number of people, mostly clients, and a meeting was arranged for 16 May 1979 at his home. Approximately 30 to 35 persons attended. They included Mr Ettridge and Mr King, who repeated the outline of the scheme previously given to Mr Anderson. They also showed a video tape relating to Andromeda. Either Mr Ettridge or Mr King said that Andromeda would produce the films for the partnership once it was established.
The evidence does not suggest that any decision was made on 16 May. Over the following few days the applicant had a conversation with a film producer and his solicitor. He was informed that non-recourse loans were common in the film industry. The producer explained that, in such a case, the production company would pre-sell the film rights to a distribution house like Paramount or Warner Brothers. The applicant also met Phillip Tiernan, a partner in Clemens Lucas & Mulvany. Mr Tiernan was a director of Andromeda and was actively involved in the partnership's scheme. Mr Tiernan gave to Mr
ATC 4984Anderson some promotional material concerning Andromeda.
Mr Anderson decided to join a film partnership. A meeting was called for 28 May 1979. Before that date, on 23 May 1979, a preliminary meeting was held. Mr Anderson, several of his clients and representatives of Tasman attended. Mr Anderson was elected as chairman of the meeting. The meeting resolved to form a partnership known as ``Taren Point Traders'', that the partnership would enter ``the business of Making, Producing and Marketing of Films, according to the contract with Andromeda Productions'' and that the documentation relating to the partnership be completed that day.
During the following few days Mr Anderson received powers of attorney from numerous people authorising him to: enter into the partnership agreement on their behalf; enter into such transactions as he thought expedient, including the borrowing of money and the giving of security; to vote at meetings, and to execute documents. Mr Anderson tabled these powers of attorney at the meeting of 28 May. At that meeting a partnership, consisting of 20 named persons, was formally constituted. The draft partnership agreement was approved. The name ``Taren Point Traders'' was adopted. A bank account was approved. Messrs Clemens Lucas & Mulvany were appointed solicitors to the partnership. A management committee, consisting of Mr Anderson, another investor and Mr Tiernan, was appointed. The meeting approved an application for finance from Media Finance and the execution on behalf of the partnership of a power of attorney in favour of John Terence Brown, a solicitor practising on Norfolk Island, and an agreement with Andromeda.
Following the meeting a number of documents were executed. It is not necessary to set out their terms in full. The partnership agreement recited an agreement ``to enter into partnership in the business of promoters, makers and marketers of feature films, documentary films, educational film material, for general distribution through theatres, television stations, schools and other educational institutions including the purchase and sale of the same and interests therein''. The partnership was to commence forthwith and to continue for five years. The capital of the partnership was to consist of $150,000, that sum being contributed by the 20 named partners in the proportions set out in a schedule to the agreement. That schedule shows Mr Anderson as having contributed $5,000.10, a contribution which entitled him to a 3.3334% interest in the partnership. (In fact Mr Anderson contributed only $3,000 from his own funds. The balance of $2,000 was paid by one K.J. Crawford. Mr Crawford had wished to become a partner, but there were already 20 prospective partners, so Mr Anderson agreed that he would take a 2% interest beneficially and hold an interest of 1.3334% on behalf of Mr Crawford.)
The partnership agreement included lengthy machinery provisions. It is sufficient to note the important role given to the management committee. Clause 10(d) provided:
``The whole of the business of the partnership shall be subject to the control of the management committee which shall have the full power to make all decisions of or in any way related to the partnership and the partnership business and to bind the partnership in all respects subject to any directions which may be given to it by all the partners unanimously.''
An application was made by the parties to Media Finance for a loan of $851,000 for five years. No details of the security were provided. None the less the document stated:
``I/WE the abovenamed applicant HEREBY APPLY for a loan on the security set out above.
I/WE understand that any loan granted pursuant to this application will be upon terms that require the payment of interest and a payment by reference to the profits generated by the media production or productions forming the security offered for the loan but that repayment of any loan granted in such circumstances will be a non-recourse loan in that MEDIA FINANCE SERVICES PTY. LTD. will rely on its security for recovery of the liability for principal and interest payable thereunder.''
The third document executed on 28 May was a power of attorney whereby the partners appointed Mr Brown their attorney to execute the original form of a loan agreement between them and Media Finance. A copy of the
ATC 4985proposed agreement was annexed to the power of attorney. It contained an agreement by Media Finance to advance $851,000 to the partnership, the advance being repayable on 28 May 1984. The borrowers agreed to pay interest at the rate of 13% per annum, the first payment of interest being due on 28 May 1980. The borrowers further agreed that the loan moneys were ``to be applied by the borrowers solely in connection with the business of promoting, producing and marketing of films carried on by the borrowers''. For the purpose of securing the loan the borrowers charged the partnership assets, ``and in particular the benefits to the borrowers under any agreement'' between them and Andromeda. Clause 8 was a non-recourse provision, in these terms:
``8. NON-RECOURSE BY LENDER - The lender hereby covenants and agrees that, notwithstanding any other provision in this agreement, in the event of any default by the borrowers in the payment of any moneys payable hereunder whether by way of principal, interest, premium, duty, fee or other payment whatsoever or in the due observance of the terms and conditions on the part of the borrowers contained herein the lender shall have no recourse or remedy in pursuance of its rights hereunder against the borrowers or any of them personally except to the extent of the value of the assets of the business of the borrowers specifically subjected to the charge herein recorded.''
Clause 11 provided that, in addition to other moneys payable under the agreement, Media Finance should be entitled to receive a premium equal to 10% of the ``gross proceeds derived by the borrowers arising out of the exploitation of any and all relevant films''.
Finally, disbursement orders were executed. The order addressed to Mr Brown authorised him, upon receipt of the sum of $851,000 from Media Finance, to disburse that amount, and the enclosed $149,050, by paying Andromeda $1,000,000 and himself $50 as ``legal fees of acting as agent upon disbursement of funds''. Media Finance was authorised to disburse its advance of $851,000 by making payment to Mr Brown.
At about that same time the partnership entered into an agreement with Andromeda. That agreement is not in evidence but there is available a revision of the agreement which was adopted in September 1979, retrospective to 25 May 1979. On 26 September 1979 the applicant wrote a letter to one of the other investors, Dr P. Schiller, in which he itemised the changes which had been made. So it is possible to reconstruct the form of the original agreement.
The agreement was to run for five years from 22 June 1979. In return for an annual fee of $1,000,000 Andromeda was to produce each year one ``A'' category film, two ``B'' category films and one ``C'' category film. The films were to remain the property of Andromeda. Andromeda was to use its best endeavours to arrange for the exploitation of the films and to pay to the partners 95% of the proceeds of exploitation.
An important aspect of the agreement was that, in certain situations, it could be terminated by the partnership. I set out cl. 8(c), (d) and (e) of the agreement, in which ``the Producer'' is Andromeda and ``the Promoters'' are the partners:
- (c) In the event that during any twelve months period during the continuance of this agreement, the Producer fails to enter into an agreement or agreements to the reasonable satisfaction of the Promoters for the exploitation as aforesaid of all of the films produced pursuant to this agreement during that period, then payment of the annual fee payable by the Promoters to the Producer in respect of the subsequent annual period may be deferred until such time as agreements for the exploitation of all of the films produced in the twelve-monthly period first referred to in this paragraph have been entered into to the reasonable satisfaction of the Promoters.
- (d) Without limiting the generality of the foregoing the Promoters may fail to be reasonably satisfied as to agreements for the exploitation of the films in any twelve-monthly period if such agreements do not provide for the payment within three years from the respective dates of such agreements of amounts at least equal to the annual fee payable in respect of such twelve-monthly period.
- (e) If after the expiration of twelve months from the date upon which the films to be produced during any twelve-monthly period have been produced the Promoters fail to be reasonably satisfied as to the exploitation of such films within the terms of Clause 8(d) hereof then the Promoters may, if they so determine, terminate this agreement by giving the Producer seven days' written notice of termination and the Producer's engagement hereunder will be forthwith determined.''
Shortly after 28 May steps were taken to remit to Mr Brown in Norfolk Island a total sum of $149,050.
On 22 June 1979 Mr Brown effected a round robin transaction, the details of which are set out in exhibit 8. Apart from the cheques totalling $149,050, all of the relevant cheques were drawn by Mr Brown upon bank accounts held by the various participants with the Commonwealth Trading Bank, Norfolk Island. The participants included a company controlled by Mr Brown known as Wharton Finance Limited. The relevant bank statements show that the accounts of Wharton Finance, Media Finance and Andromeda had only a nominal credit balance, of a dollar or two, at the relevant time. Deposits had to be made to match the cheques.
The effect of the transaction, in summary, was that Wharton Finance advanced $851,000 to Media Finance. That sum was linked up with the $149,050 held by Mr Brown in his trust account to create a fund of $1,000,050 out of which a $50 fee was retained by Mr Brown and $1,000,000 was paid into the Andromeda account. Out of that account $60,000 was paid to Clemens Lucas & Mulvany. Having regard to the fact that this amount was 6% of the total receipt, it seems likely that this sum was received by the solicitors on behalf of Andromeda. Following this, Mr Brown's trust account was replenished with $940,000. $88,000 was paid from that account to Clemens Lucas & Mulvany. According to the evidence of Mr J.M. Lucas, a partner in Clemens Lucas & Mulvany, this sum was received by that firm on behalf of Tasman. The result of this payment was to leave a balance of $852,000. Out of this amount a fee of $1,000 was paid to Mr Brown. The balance of $851,000 was paid to Wharton Finance to recoup its original outlay. Thus the sum of $851,000 simply passed intact through several hands. $60,000 was apparently taken by Andromeda. The remaining $89,050 was absorbed in fees or profit to Tasman.
On 25 June 1979 Messrs Clemens Lucas & Mulvany reported the settlement of the transaction to Mr Anderson, and, presumably, to his partners as well. Their report provides an excellent example of the misleading nature of a half-truth:
``At settlement, we advise that Mr. J.T. Brown solicitor received into his trust account upon your behalf a payment from Media Finance Services Pty. Ltd., of the sum of $851,000.00 and that this sum together with the further sum of $149,000.00 forwarded by your partnership was duly paid to Andromeda Productions Pty. Ltd., making the total first annual payment due under your contract of $1,000,000.00. In addition, a fee of $50.00 was payable to Mr. Brown for handling the transaction upon your behalf.''
Shortly before the Norfolk Island transactions, on 19 June 1979, a further meeting of the partners was held. Mr Tiernan attended, along with Heather McPherson of Andromeda. There was discussion about various films which Andromeda contemplated producing and the partners who were present were asked to record their selections. Subsequently on the same day, the management committee selected three films.
On 2 July 1979 Andromeda forwarded a report on planning for these films, indicating early shooting dates. However, those expectations were not met. In subsequent reports problems were identified. The chosen ``A'' category film had to be abandoned. The ``C'' category film also was changed. Some of the partners became anxious. Finally, on 20 March 1980 the partnership chose films called ``Hard Knocks'' and ``Jazz Ballet'' as its ``A'' and ``C'' category films respectively. At the time ``Hard Knocks'' was in an advanced stage of production and ``Jazz Ballet'' was already completed. Apparently, Andromeda had recently purchased both titles, production being complete, or substantially complete. The evidence does not disclose details of their production.
ATC 4987At this same meeting concern was expressed at the possibility of interest becoming due to Media Finance before funds were available. The meeting resolved to seek an extension of time. An extension of two months was granted.
A partnership meeting was held on 16 September 1980. Amongst other decisions the partners decided to terminate forthwith their agreement with Andromeda and to ratify the sale of their rights to the selected ``B'' category film, ``Childern's Stories'' for $1,738.13. Two days later they held a further meeting at which they decided to sell ``Hard Knocks'' for $150,000 and ``Rythmetrics'' (formerly ``Jazz Ballet'') for $4,000. They also decided to accept an offer from Media Finance to accept $146,300 in full settlement of all moneys owing to it under the loan agreement. The various decisions made at these meetings were carried into effect, the necessary agreements being made with the purchasers of the films and with Media Finance.
In mid-June 1981 steps were taken to dissolve the partnership. A deed of dissolution was executed on 22 June 1981.
The taxation claims
Clemens Lucas & Mulvany arranged for the lodgment of a partnership tax return in the name of Taren Point Traders for the year ended 30 June 1979. This return showed income of $100 - the source of which was not revealed - and expenses of $1,000,520 made up of accountancy fees of $10, legal expenses of $500 and ``Fee paid - As per Attached Production and Marketing Contract'' of $1,000,010. No contract is attached to the copy of the tax return which is in evidence but the reference was apparently to the agreement between the partnership and Andromeda.
The partnership return allocated the loss of $1,000,420 between the members of the partnership, ascribing to the applicant $33,348.
In his return of income for the year ended 30 June 1979 the applicant claimed as a deduction from his taxable income the sum of $20,009 being a loss sustained as a member of Taren Point Traders. Particulars of the claim were set out in a schedule:
``Item 11 - Partnerships etc.
Due to limitations to the number of parties trading in Taren Point Traders taxpayer invested $5,000.00 capital, $3,000.00 of which was beneficially owned by taxpayer and $2,000.00 of which was owned by Kevin James Crawford.
Accordingly taxpayer claims only 60% of the loss attributed to him in the partnership return as lodged.
Sum shown $33,348
Claim 60% $20,009''
The claim made by the applicant, based upon a 2% interest in the partnership, is consistent with a total partnership loss of $1,000,450; a figure slightly different from that claimed in the partnership return. The discrepancy is not explained by the evidence but it does not matter. What is clear is that the applicant claimed by way of deduction not only his contribution to the partnership but also his proportion of the loan made by Media Finance. So the deduction claimed was some 6.66 times the amount outlaid.
The partnership tax return for the year ended 30 June 1980 was also arranged by Messrs Clemens Lucas & Mulvany. The return showed income of $1,739 from the sale of films. This item presumably referred to ``Children's Stories'', which had apparently been sold by the management committee before 30 June. Various expenses were claimed: a total of $315 by way of administration fees, bank charges and fees; and interest of $113,055. This yielded a net loss of $111,631. Assets were shown as ``cash at bank'' of $1,030 and liabilities at $963,081, of which $962,401 was said to be due to Media Finance. It is not clear how that figure was calculated. If one were to add the interest of $113,055 to the original loan of $851,000 and deduct $1,739, the result would be $962,316. The partnership tax return allocated $3,721 of the loss of $111,631 to the applicant.
Consistently with the course taken by him in 1979, the applicant claimed as a deduction only part of the loss attributed to him in the partnership return, in this case $2,233.
In his notices of assessment, issued to the applicant in connection with the respective taxation years, the Commissioner of Taxation disallowed the claim to deduct the two sums of $20,009 and $2,233. In the 1979 assessment the Commissioner imposed additional tax of $1,439.49 for lodgment of an incorrect return. It is agreed that this tax cannot be sustained. In
ATC 49881980 the Commissioner also disallowed a claim to deduct $10,000 under sec. 124UA of the Act in connection with a film ``Repco Reliability Trial''. This matter has since been compromised between the parties, it being agreed that the applicant is entitled to a deduction of $1,500. The orders made by me will reflect these two agreements between the parties.
The applicant objected to the disallowance of his claims to deduct his share of the partnership losses. Those objections were themselves disallowed and the applicant appealed to the Supreme Court of New South Wales in connection with each of the relevant years. Since these appeals had not been dealt with prior to the transfer of jurisdiction to this Court on 1 September 1987 - see the Jurisdiction of Courts (Miscellaneous Amendments) Act 1987 - the question whether the deductions are permissible now falls for determination in this Court.
The argument put on behalf of the applicant is that the two sums are deductible pursuant to sec. 51(1) of the Income Tax Assessment Act. That section reads:
``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.''
Counsel for the applicant relies on both limbs of sec. 51(1). He contends that the losses claimed by the partnerships were incurred in gaining or producing assessable income, or alternatively were necessarily incurred in carrying on a business for the purpose of gaining or producing such income. Counsel says that the losses were not of a capital nature because it was always contemplated that the partners would obtain income by selling films. The films purchased pursuant to the arrangement with Andromeda should be regarded, in effect, as trading stock.
Counsel for the respondent makes three replies to this claim. First, he disputes that the losses were deductible under sec. 51. He says that the losses were not suffered in the course of incurring or gaining assessable income or in carrying on a business for that purpose; and that, in any event, the losses were of a capital nature. Secondly, counsel contends that, if the losses were otherwise deductible under sec. 51, the claim to deductibility would be lost because they were incurred under a tax avoidance scheme to which Subdiv. D of Div. 3 of the Act applies (sec. 82KH-82KL). Finally, it is submitted that the relevant transactions constituted a sham.
I have reached the view that the losses claimed by the applicant were not deductible under sec. 51. Consequently, it will not be necessary for me to deal with the other submissions of counsel for the respondent.
The relationship between the expenditure and the gaining of assessable income
In considering the position under sec. 51, a question common to both taxation years is whether the partnership incurred the claimed losses in gaining or producing assessable income or in carrying on a business for that purpose. Apart from a few hundred dollars expenses, the whole of the claimed losses related to the $1,000,000 payment to Andromeda and the interest payable to Media Finance on the loan of $851,000, which loan was applied in part payment of that $1,000,000. The $1,000,000 payment was made pursuant to the agreement between the partnership and Andromeda. Ostensibly, it was made in return for the production of films by Andromeda for exploitation for the substantial benefit of the partners. On its face, the transaction presents as a legitimate business dealing undertaken for the purpose of earning assessable income. However, the applicant conceded in cross-examination that, from the outset, the project was presented to him as a tax scheme. A flow chart was produced by Mr Tiernan to him which set out the position of a taxpayer who wished to generate a loss of $50,000. That document is in evidence. It is headed: ``Example: Loss required by T.P. = $50,000''. The chart shows a contribution of $7,500 by T.P. (taxpayer) to P.S. (Partnership). This is described as ``15% of loss sought''. The chart also shows a loan of $851,000 from a lending company to the partnership and a contract for services between the partnership and the production company for a fee of $1,000,000. Other details, consistent
ATC 4989with the actual arrangements, are set out above the note:
``P.S. Claims any loss suffered under Section 21 and discloses assessable income received. Each partner claims share of loss under Section 52.''
At about this time the applicant was also shown opinions by two counsel dealing with the tax position. They are not in evidence.
During the course of his cross-examination Mr Anderson was asked about his expectations of earning assessable income.
``Q. How high did you rate, if at all, the likelihood of successful films, that is one that made profits for the partnership?
A. Well, all I can say is that it was mentioned that one in 50 might be a successful strike rate.
Q. At that time, even now, do you have an idea of approximately, by reference to production costs, how much a film must earn to get you to a break-even point?
A. How much a film must earn?
Q. Must earn, using production costs...?
A. Expressed as a percentage of the production costs?
Q. Of production costs?
A. No. I have heard figures later. I did not know then.''
Shortly afterwards, after an objection, I sought to clarify the position with a question:
``Is that a fair statement, Mr Anderson? You said that at the time you had no real idea about these matters of what sort of return you needed for the investors in the film to make any money?''
Mr Anderson replied:
``I think that is correct, your Honour. I would say that as being a person who had brought together a number of friends and some of whom were clients who were making noises about outdoing one of their colleagues who had had a successful venture with another film that I was committed to take a piece of the action as it were. I think indifference is probably a pretty fair word to describe my approach to the investment.''
One problem about that answer is that, as he said, the applicant had himself brought the group together. It is possible to understand a person being persuaded by friends to join them in a film-making project, for reasons related to the making of films and not for its tax advantages, even though that person might have an imperfect understanding of the likelihood of success. It is more difficult to accept that a person, especially a solicitor, would encourage his friends and clients to join him in a business venture without having some understanding of its likely profitability, unless the true position was that the potential earnings of the business were essentially irrelevant. As Mr Anderson conceded, the flow chart postulated a situation whereby contributors would incur deductions equal to 6.5 times their contributions so that, depending upon an individual taxpayer's marginal rate, the tax deduction would render the investment profitable even if no income was earned. Having regard to the occupations of the partners, as shown in the partnership agreement, it may safely be surmised that most, if not all, of the partners were exposed to the prospect of paying tax at marginal rates sufficiently high to make this statement true of them.
In his affidavit, read in this proceeding, Mr Anderson claimed some interest in becoming involved in film production. I cannot accept this statement. In fact neither Mr Anderson nor his partners became involved in the production of any of the films. It was never intended that they should. Their role was restricted to the provision of finance and the making of a selection from a limited list of titles provided to them by Andromeda. None of the parties made any creative or marketing contribution. Moreover, had Mr Anderson been genuinely interested in film production, as distinct from tax saving, he would, I think, have shown much greater curiosity than he did. Mr Anderson said in evidence that he believed that Andromeda and Media Finance were connected only by an agreement that the latter provide finance to persons wishing to deal with the former and that they were separately controlled and at arm's length. He conceded that making films was, at the time, ``an extremely iffy business''. Although he thought that a producer might recoup its losses by a spectacular success, he conceded that this would hardly
ATC 4990apply to Media Finance, which at best would get back its advance, interest and a 10% premium. But he asked no questions about that. According to the applicant, some of the investors did question the benefits to be taken by Tasman from the transaction. Mr Anderson said that the Tasman representatives avoided answering these questions, which caused him concern. Asked why, then, he proceeded he replied:
``Speaking for myself - well, I accepted and I cannot say that I was told this, but I accepted an inference that a situation would never arise when Media was really exposed for the very good reason that from day one the partnership would technically be in default under its finance agreement, and that therefore if Media happened to make a huge money winner it would simply exercise its rights against the film anyway.''
This answer suggests a perception by the applicant that the partners would never make enough money to pay Media Finance. A fortiori they would never make a commercial profit. So the only financial attraction in the project was its perceived tax advantages.
If the applicant and his partners had been genuinely interested in the possibility of making money by the exploitation of the rights over the films to be made under the agreement, they would have insisted on knowing how much was to be spent upon those films. The budget of a film is a matter which, at least within some limits, must directly affect its quality; and therefore saleability. Consequently, it would have been important for them to know how much of their investment was to be diverted away from actual film-making. If the purpose of the investment had been the production of films for the generation of assessable income, I believe that the investors would have insisted on knowing much more about the arrangements between Tasman and Andromeda.
The appropriate finding is that the whole of the expenditure incurred by the applicant as a member of Taren Point Traders was incurred for the purpose of earning a taxation deduction. It may be that Mr Anderson had an incidental purpose of obtaining some acquaintance with the film industry; but, if so, this was an entirely subsidiary purpose. Even if Mr Anderson had such a subsidiary purpose, there is nothing to indicate that this subsidiary purpose extended to the gaining of assessable income. Nowhere in the contemporaneous documents is there anything to indicate that this was in prospect.
A question arises as to the relevance of the purpose of the applicant in determining whether the expenditure falls within either limb of sec. 51(1). This matter has been considered in a number of cases in this Court:
Magna Alloys and Research Pty. Ltd. v. F.C. of T. 80 ATC 4542; (1980) 33 A.L.R. 213,
Ure v. F.C. of T. 81 ATC 4100; (1981) 34 A.L.R. 237,
F.C. of T. v. Ilbery 81 ATC 4661; (1981) 38 A.L.R. 172,
F.C. of T. v. Creer 86 ATC 4318; (1986) 65 A.L.R. 485. In Ilbery Toohey J., with whom Northrop and Sheppard JJ. agreed, said at ATC p. 4667; A.L.R. pp. 179-180:
``When the High Court in
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 47, said at p. 56:
- `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'
that was not to exclude the notion of purpose. As Brennan J. pointed out in Magna Alloys at p. 4547:
- `Though purpose is not the test of deductibility nor even a conception relevant to a loss involuntarily incurred, in cases where a connection between an outgoing and the taxpayer's undertaking or business is effected by the voluntary act of the taxpayer, the purpose of incurring that expenditure may constitute an element of its essential character, stamping it as expenditure of a business or income-earning kind.'
Conversely, I would add, purpose may stamp the outgoing as one having no relevant connection with the gaining or producing of assessable income.''
In their joint judgment in
John v. F.C. of T. 89 ATC 4101; (1988) 83 A.L.R. 606 Mason C.J., Wilson, Dawson, Toohey and Gaudron JJ. had occasion to consider the relevance of purpose in sec. 51. At ATC p. 4105; A.L.R. pp. 611-612 they said:
Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1948-1949) 78 C.L.R. 47 it was stated by the Court (at
ATC 4991p. 56) that `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'. In F.C. of T. v. Ilbery 81 ATC 4661; (1981) 38 A.L.R. 172; 58 F.L.R. 191, Toohey J. said (at ATC pp. 4666-4668; A.L.R. pp. 179-180; F.L.R. p. 200) by reference to the above statement from Ronpibon Tin that `that was not to exclude the notion of purpose'. His Honour added that `purpose may stamp the outgoing as one having no relevant connection with the gaining or producing of assessable income'.
Although the first limb of sec. 51(1) speaks of a loss or outgoing `incurred in gaining or producing the assessable income', a loss or outgoing may be so incurred notwithstanding that no income has been gained or produced in the period in which the loss or outgoing is claimed to be deductible. The test of deductibility under that limb, as laid down in Ronpibon Tin, is that `it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income' (at p. 57).
It is readily understandable that, if no income has been gained or produced and a question arises as to whether the occasion would be expected to produce assessable income, consideration of the purpose for which the expenditure was outlaid might not be wholly irrelevant. It may be too that even where income is produced `the purpose for which the advantage occasioning the loss or outgoing is sought may evidence a sufficient relationship with the income-earning process':
Handley v. F.C. of T. 81 ATC 4165; (1981) 148 C.L.R. 182, per Stephen J. at ATC pp. 4168-4169; C.L.R. pp. 189-190. But the cost of a step taken in the process of gaining or producing income must be regarded as an outgoing or taken into account in calculating the loss (if any) incurred, whatever purpose or motive may have attended all or any of the steps involved.''
It will be observed that their Honours referred to Ilbery without disapproval. Their conclusion that, under some circumstances, ``consideration of the purpose for which the expenditure was outlaid might not be wholly irrelevant'' echoes the view expressed in Ilbery. But the final sentence of the quoted passage makes clear that purpose may not be decisive.
As I understand the principles enunciated in Ilbery and John, in doubtful cases of voluntary expenditure purpose may be relevant, even decisive, in determining whether there is the necessary nexus between a particular outgoing and the gaining or producing of assessable income. In other cases the position will be so clear that purpose is of no consequence. Thus, if particular expenditure was clearly incurred in the gaining or producing of assessable income, it is deductible notwithstanding that the money may have been spent with some other purpose in mind. Conversely, if there was no actual nexus between the expenditure and the gaining or producing of assessable income, a purpose of gaining or producing assessable income will not suffice. In the vast majority of cases, no doubt, purpose and actuality will coincide.
In the present case, as it seems to me, the outgoings incurred in 1979 were not incurred in gaining or producing assessable income. I do not reach this conclusion because of the fact that there was no assessable income in that year. In itself, that would not matter. It would be enough that the outgoings were incurred in the course of gaining or producing assessable income in subsequent years. But when one considers that circumstance in conjunction with the purpose of the expenditure - tax avoidance - the conclusion becomes irresistible.
Carrying on a business for the purpose of gaining assessable income
The second limb of sec. 51 requires consideration of the question whether the expenditure was incurred in carrying on a business for the purpose of gaining or producing assessable income. In relation to this limb the applicant's case encounters two difficulties. First, as it seems to me, it cannot be said that the partnership, or the applicant personally, was carrying on a business of film investment. In
Hope v. Bathurst City Council 80 ATC 4386 at p. 4390; (1980) 144 C.L.R. 1 at pp. 8-9 Mason J. discussed the meaning of the phrase ``carrying on... the business'', admittedly in a different statutory context. His Honour referred to one meaning attributed to the word ``business'', in the Shorter Oxford
ATC 4992Dictionary, viz.: ``A commercial enterprise as a going concern''. He added the comment: ``It is the words `carrying on' which imply the repetition of acts and activities which possess something of a permanent character''. Referring to the phrase ``carrying on the business of grazing'', Mason J. said:
``It denotes grazing activities undertaken as a commercial enterprise in the nature of a going concern, that is, activities engaged in for the purpose of profit on a continuous and repetitive basis.''
The notions of continuity and repetition were also picked up in John, in relation to the question whether or not a person is a trader. In their joint judgment, at ATC p. 4107; A.L.R. p. 614, their Honours said:
``If trading has not commenced or if there is no discernible trading pattern, the question of intention or purpose may be relevant in the sense that if there is an absence of intention or purpose to engage in trade regularly, routinely or systematically then the person may well not be a trader. A fortiori if some contrary or inconsistent intention or purpose is present.''
In the present case there was no pattern of continuity or repetition. The sole transaction entered into by the partners was the transaction which gave rise to the alleged losses. It is true that the agreement with Andromeda was for a term of five years and that it required films to be produced in each of those five years, in return for payments of $1,000,000 in each of those years. But no attempt was ever made to raise a second $1,000,000. The partners realised that they could easily extricate themselves from the obligation to make further payments. It seems that nobody took seriously the obligation to make a payment after the initial $1,000,000. As the partners had not expressed dissatisfaction pursuant to cl. 8(c) of their agreement with Andromeda by 22 June 1980, Andromeda was entitled to receive a second payment on that day. But no request for payment was ever made. The applicant was asked about this matter during the course of his evidence, it being pointed out to him that Media Finance had not committed itself to provide finance after the first year. At first he said: ``the production agreement was contracted, as I recall it, on a year to year basis''. When it was suggested that this was not so, he said:
``A. Yes. The term is stated as five years, but in the loan agreement I seem to recall that it was a tripartite agreement and in the event of any default by any party, the other parties had the right of cancellation. That was my recollection of it. I do not have the loan agreement in front of me, your Honour, I cannot answer that.
Q. Was this something that you addressed your mind to at the time?
A. At the time, yes.''
Under the circumstances it cannot be said that the partnership was carrying on a business.
Secondly, the word ``purpose'' does occur in the second limb. For expenditure incurred in the carrying on of a business to be deductible, it must be incurred for the purpose of gaining or producing assessable income. Expenditure incurred by a business for the purpose of generating tax losses does not fall within the second limb.
Losses or outgoings of a capital nature
Counsel for the respondent contends that, even if the loss sustained in 1979 fell within one of the limbs of the opening words of sec. 51(1), the deduction is excluded by the concluding words of the subsection, as being losses or outgoings of a capital nature. He refers to the well-known exposition of Dixon J. in
Sun Newspapers Limited v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-360:
``The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested. In a trade or pursuit where little or no plant is required, it may be represented by no more than the intangible elements constituting what is commonly called goodwill, that is, widespread or general reputation, habitual patronage by clients or customers and an
ATC 4993organized method of serving their needs. At the other extreme it may consist in a great aggregate of buildings, machinery and plant all assembled and systematized as the material means by which an organized body of men produce and distribute commodities or perform services. But in spite of the entirely different forms, material and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a `profit-yielding subject', the phrase of Lord Blackburn in
United Collieries Ltd. v. Inland Revenue Commissioners (1930) S.C. 215, at p. 220; (1929) Tax Cas. 1248, at p. 1254.''
Counsel argues that the payment made by the partnership to Andromeda was on capital account. He contends that the effect of the agreement was to give to the partners the copyright of the films to be produced thereunder. This was a capital asset, says counsel, capable of exploitation by the sale of particular rights - for example, the television reproduction rights within a particular geographical area and period of time, the cinema rights, etc. - or the granting of licences for the reproduction of the film. In the words adopted by Dixon J. in Sun Newspapers, the copyright was a source of income, a ``profit-yielding subject''.
There is room for argument as to whether the agreement made with Andromeda before 30 June 1979 gave the copyright of the films to the partners. I think that the better view is that they did not acquire the copyright. This was probably the result of a drafting oversight, because the situation was reversed in the amended agreement made in September 1979. However, I do not think that this affects the substance of the argument. Whether or not they obtained the copyright of the films, the partners certainly acquired the right to exploit the films for their own benefit, less 5% for Andromeda. The purchase of this right was a purchase of a source of income. The $1,000,000 payment was an affair of capital. (I note that this conclusion is similar to the result reached by the Administrative Appeals Tribunal in a case involving similar facts: see Case W2,
89 ATC 107.)
My conclusion is, I think, supported by consideration of the matters mentioned by Dixon J. in Sun Newspapers in distinguishing between payments on capital and revenue account. At p. 363 his Honour listed three matters:
``(a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.''
As to (a), the payment procured for the partners a lasting right to exploit the films commercially. As to (b), that right was intended to be used recurrently, as opportunity offered, by licensing particular persons to use the films in particular ways. Finally, in connection with (c), the right was obtained by a once-only payment of a substantial sum.
I cannot accept the submission of counsel for the applicant that the right which was acquired by the partners under the agreement was in the nature of trading stock. Trading stock is goods - or, perhaps occasionally, services - acquired for the purpose of resale at a profit. The profit is intended to be earned by the resale of that which was originally acquired. This is not the present case. That which was acquired by the partners was the right to commercially exploit the selected films. It is true that it was always open to the partners to sell that right, as indeed they did, in respect of all three films. But both the partnership agreement and the partnership's agreement with Andromeda envisaged that the right acquired from Andromeda would be exploited by the grant from time to time of limited rights to use the films, with the partners retaining the general right of exploitation. The right which was acquired was a capital asset. It did not lose that character simply because, like most other capital assets, it was capable of sale.
It follows from the above that, whether or not the 1979 losses fall within one or other of the two limbs of sec. 51(1), the claim to a deduction for that year must fail.
The interest liability
The substantial claim made in the year ended 30 June 1980 relates to interest payments. Losses or outgoings incurred due to interest
ATC 4994payments would normally be regarded as falling to revenue account; and I would see no reason for taking a different view in the present case. Consequently, if the expenditure falls within either of the limbs in the opening words of the subsection, the 1980 claim is not defeated by its concluding words.
However, counsel for the respondent argues that no relevant loss or outgoing was incurred. The argument is put on two bases. The first basis is that, in the relevant taxation year, there was neither a payment of interest nor an accrual of liability. It is not quite correct to say that there was no payment. As already indicated, the sum of $1,739, being the proceeds of the sale of the rights to ``Children's Stories'' was paid to Media Finance. If the claim fell within one of the two limbs of sec. 51(1), the applicant would be entitled to a deduction equal to 2% of that amount. But otherwise the contention is correct. The balance of the interest, $111,316, was unpaid. That, in itself, would not be decisive. A taxpayer is entitled under sec. 51 of the Income Tax Assessment Act to deduct an outgoing ``definitively committed'' in the relevant year of income. But there must be a present liability for that outgoing: see
Nilsen Development Laboratories Pty. Ltd. & Ors v. F.C. of T. 81 ATC 4031; (1981) 144 C.L.R. 616 and two subsequent decisions in the Full Court of this Court,
F.C. of T. v. Australian Guarantee Corporation Limited 84 ATC 4642; (1984) 2 F.C.R. 483 and
F.C. of T. v. Lau 84 ATC 4929; (1984) 6 F.C.R. 202. Leaving aside the question whether the applicant was ever definitively committed to pay Media Finance, he was not so committed in the taxation year ended 30 June 1980. Before the liability to make payment arose, Media Finance agreed to postpone the performance of that obligation until 22 August 1980. So no liability arose until after the end of the taxation year.
The second basis of the argument does not depend upon the extension of time for payment. The proposition is put that the applicant was never committed to make any payment by way of interest. Although a loan was made by Media Finance to the partners, none of the partners was exposed to any personal liability in respect thereof. Accepting the proposition that a loss or outgoing, within the meaning of sec. 51(1), may take the form of a liability incurred by a taxpayer, counsel argues that this principle has no application to a case where no personal liability is in fact incurred. In such a case, it is said, there is no loss or outgoing until the money is paid.
I think that this latter submission is correct. It furnishes an additional reason for rejecting the claim made in connection with the 1980 taxation year.
The appeals ought to be upheld only to the extent necessary to give effect to the agreements between the parties which I have mentioned. Otherwise, they ought to be dismissed.
As to costs, the respondent ought to be ordered to pay any costs related exclusively to the conceded items. Additionally, it appears that counsel for the applicant was informed of the abandonment of the claim to additional tax only a couple of days before the hearing commenced. Some allowance should be made for work done by him in anticipation of the need to argue that matter. I think that an appropriate allowance would be a figure equal to one-third of the appropriate brief fee; but, of course, excluding any refresher or conference fees. Otherwise, the applicant should pay the costs of the respondent.