Federal Commissioner of Taxation v. Raymor (N.S.W.) Pty. Ltd.

Davies J

Gummow J
Hill J

Full Federal Court

Judgment date: Judgment handed down 18 June 1990.

Davies, Gummow and Hill JJ.

The appellant, the Commissioner of Taxation appeals against a judgment of a Judge of this Court, Lockhart J., allowing appeals by the respondent, Raymor (N.S.W.) Pty. Ltd. in respect of assessments to income tax for the

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years of income ended 30 June 1984 and 30 June 1985 [reported at 89 ATC 5173].

The facts

The relevant facts, which are not in dispute, can be shortly stated.

The respondent sells and distributes plumbing goods and accessories throughout Australia. Among the products so sold is copper tubing, the majority of which it purchases from Metal Manufacturers Ltd. (``MML'') for resale. As a result of conversations that took place between Mr W.M. Kelly, the managing director of the respondent and Mr Allen, the group general manager, finance and a director of MML, an agreement was entered into on 30 June 1983 (``the 1983 agreement''). Substantially similar agreements were entered into on 29 June 1984 (``the 1984 agreement'') and on 27 June 1985 (``the 1985 agreement'') between the two companies. Each was concerned with the purchase of copper tubing with payment to be made by the respondent in advance of delivery. In the 1983 conversations Mr Kelly indicated that the respondent would only enter an agreement on the basis that MML would ensure delivery of the order as and when the respondent required it. In reply to a query of Mr Allen, Mr Kelly said that delivery of the order would be completed in three or four months or perhaps a little more.

Subsequently Mr Allen advised Mr Kelly that MML could not hold the price of copper over the period of the agreement. Mr Kelly then suggested that a clause be inserted in the agreement allowing for the rise and fall in the price of copper, but that otherwise the price would be held. Mr Kelly negotiated a discount off the normal price at which the respondent bought copper tubing (that price itself being a discounted price reflecting the fact that the respondent was a large purchaser of copper products) being an overall discount of 8.5%.

Accordingly, subject to a rise and fall clause, the 1983 agreement provided for the sale by MML to the respondent of a stipulated quantity of copper tubing of a particular quality for a total price of $661,351.83 less a discount of 8.5% ($56,214.91) leaving a balance of $605,136.92 which amount was paid on or before 30 June 1983. As already indicated, substantially similar agreements were entered into between the parties in the following two years. It is with the subsequent agreements that the appeals are concerned.

It is sufficient here to set out the relevant operative provisions of the 1984 agreement:

``1. The Vendor agrees to sell and the Purchaser agrees to purchase the goods described in the Annexure hereto (hereinafter called `the goods') in the quantity and quality and at the prices shown therein.

2. All goods shall remain at the risk of the Vendor until they have been delivered to the Purchaser in accordance with Clause 3 save that only those goods which have been delivered to the Purchaser shall be at the risk of the Purchaser.

3. The Vendor shall deliver the goods to the Purchaser in the quantity specified in the Annexure hereto. Delivery shall take place at such times and places as are nominated to the Vendor from time to time by the Purchaser or one of its responsible officers.

4. The Purchaser shall be deemed to have accepted (as to description, quality and quantity) the goods forming a delivery when the Purchaser or one of its responsible officers acknowledges to the Vendor that the Purchaser has accepted such goods or where the Purchaser retains such goods for fourteen (14) days or more without the Purchaser or one of its responsible officers advising the Vendor or one of its responsible officers that the Purchaser has rejected them.

5. In the event of rejection of the whole or any part of the goods forming a delivery:

  • (a) the Purchaser shall be entitled to either require the Vendor to make a further delivery of goods in accordance with the Annexure to replace those rejected or to require the Vendor to issue a credit note in favour of the Purchaser in an amount equal to the price of the goods rejected.
  • (b) the Vendor shall upon re-delivery of the rejected goods to the Vendor be at liberty to deal with the goods as the Vendor see fit.

6. Neither the Vendor nor the Purchaser shall be liable for failure to deliver or receive respectively the goods or any part

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thereof at the point of delivery due to strikes, lockouts, disputes with workmen, fires, floods, civil commotion, accidents, plagues, epidemics or other unavoidable accidents or hindrances of whatsoever kind. In the event of the Vendor failing to deliver any of the goods for any reason specified in this Clause, then the amount paid by the Purchaser under this Agreement in respect of such undelivered goods, shall be applied by the Vendor in or towards payment of any amount due or becoming due by the Purchaser or any of its associated companies to the Vendor on any other account as may from time to time be directed by the Purchaser.

7. As consideration for the goods sold by the Vendor pursuant to the terms of this Agreement and as specified in the Annexure hereto the Purchaser shall pay to the Vendor on the execution of this Agreement the total purchase price as specified in the Annexure hereto of Six hundred thousand, one hundred and thirteen dollars and sixteen cents ($600,113.16) (the receipt whereof is hereby acknowledged by the Purchaser).

8. The parties acknowledge that notwithstanding the payment made pursuant to Clause 7 hereof, the price of each item of goods set out in the Annexure hereto may be subject to variation in accordance with the provisions of this Clause and in the event of any such variation being required to be made hereunder then the parties will make the appropriate financial adjustment in accordance with their normal trading terms. The price of each item of goods set out in the Annexure hereto shall be varied in the event of the Australian Copper Price increasing above or falling below $1,560.00 per tonne at the date of delivery of each item of goods in which event the price for such item shall become the Vendor's List Price as applicable at that time determined by reference to the Australian Copper Price at the date or such delivery and discounted by 8½%.

9. If the Purchaser wrongfully refuses to accept any of the goods the Vendor shall be entitled to terminate this Agreement and thereafter sue the Purchaser for breach of contract and resell all or any of the goods or any part thereof as owner. The deficiency (if any) arising on such resale and all expenses of and incidental to such resale shall be recoverable by the Vendor from the Purchaser as liquidated damages provided that proceedings for the recovery thereof be commenced within twelve months of the termination of this Agreement.

10. If the Vendor wrongfully refuses to supply any of the goods the Purchaser shall be entitled to terminate this Agreement and thereafter sue the Vendor for breach of contract. The cost of purchasing similar goods from another supplier and all expenses of and incidental to such purchaser shall be recoverable by the Purchaser from the Vendor as liquidated damages provided that proceedings for recovery thereof shall be commenced within twelve months of termination of this Agreement.

11. Except as otherwise provided in this Agreement the Purchaser shall have no right to terminate this Agreement.''

The annexure to the 1984 agreement states the total price as being $655,861.38 less a discount of 8.5% ($55,748.22), with a balance of $600,113.16. A cheque for this sum was paid to MML on 29 June 1984. It might be mentioned that this cheque, as was also the case with the next year, was drawn on the account of Raymor Australia Pty. Ltd. which in the two relevant years of income acted as a banker for the group of related companies of which the respondent was a member and was paid on behalf of the respondent and treated as a liability of the respondent. Nothing however turned upon this and the appellant accepted that the payment was a payment of the respondent made by it on 29 June 1984.

Delivery of stock pursuant to the agreement commenced in early July 1984 and continued over a period of several months.

On 27 June 1985 the respondent and MML entered into the 1985 agreement for the purchase of copper tubing. Pursuant to this agreement payment of the purchase price, amounting to $584,388.61 after discount (in this year 15.25%), was made on 27 June 1985 in the same fashion as the payment in the previous year was made. Again it was accepted that the amount of $584,388.61 was made by the respondent on 27 June 1985.

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Delivery of stock pursuant to the 1985 agreement commenced in early July 1985 and continued for several months thereafter.

In the years of income 1985 and 1986 the price of copper rose from time to time so that, pursuant to the agreement, further amounts became payable by the respondent to MML under the rise and fall clause. These amounts were shown as part of the respondent's costs of stock and were allowed as a deduction to the respondent in the years in which they were paid. They are not in dispute.

What is in dispute is the deductibility of the amount of $600,113.16 and $584,388.61 respectively in the 1984 and 1985 income tax years. Both amounts were disallowed and in assessments said to have been made to protect the revenue no deduction was allowed at all for these amounts in the 1985 and 1986 years of income, notwithstanding that in accordance with the appellant's submissions the amounts were properly deductible in these years. The result is that the respondent was afforded no deduction at all for amounts exceeding $1,000,000 paid by it for its trading stock.

It was accepted that neither of the agreements entered into in the 1984 or 1985 years of income was a sham.

His Honour found, and this finding was not disputed before us, that there was a commercial advantage perceived by the respondent in making the prepayments under the agreements in question. This advantage was MML's assurance that the respondent would receive the copper tubing from MML as and when required by the respondent so that the respondent could honour its commitments to its customers as well as gaining a tax advantage by entering into the agreements and making the payments under them. No submission was made to us that the perception by the respondent that there were tax advantages in the entering into of the agreements operated to disallow to the respondent deductions in the years of income.

The Commissioner conceded that the copper tubing when supplied became trading stock of the respondent when delivered to it and that it was in fact sold by the respondent to its customers in the ordinary course of its business. What was submitted, however, was that whenever payment was made pursuant to a contract to purchase trading stock requiring that payment to be made, no deduction was allowable for that payment until such time as the stock was delivered pursuant to the contract and so came to be on hand so as to be brought into the trading account pursuant to the trading stock provisions of the Income Tax Assessment Act 1936 (sec. 28-31).

This argument was rejected by his Honour below and it is from this judgment that the appellant appeals. His Honour found that the payments in question were deductible respectively in the 1984 and 1985 years when they were made under sec. 51(2) of the Act. Although his Honour does not say so expressly it follows from his Honour's reasons that independently of sec. 51(2) the payments were also deductible under sec. 51(1) of the Act without reference to sec. 51(2). In our view his Honour was plainly correct in so deciding.

The statutory provisions

Section 51(1) and (2) provide as follows:

``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.

51(2) Expenditure incurred or deemed to have been incurred in the purchase of stock used by the taxpayer as trading stock shall be deemed not to be an outgoing of capital or of a capital nature.''

The Commissioner's submissions

For the Commissioner it was submitted that income tax was an annual levy directed at the ascertainment of the taxable income of a taxpayer in an annual accounting period, the year of income: sec. 17, 48. The Act, it was said, in the trading stock provisions, essentially reflects accounting concepts by allowing as a deduction the value of trading stock on hand at the beginning of a year of income and bringing into account the value of trading stock on hand at the end of the year of income so that the excess of the value of trading stock on hand at the end of the year of income over the value of such stock at the beginning of the year is assessable income: sec. 28(2). Likewise if the

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value of trading stock on hand at the beginning of the year of income exceeds the value of such stock on hand at the end of the year of income the amount of such excess is an allowable deduction: sec. 28(3). Expenditure incurred in the year of income for the purchase of trading stock is an allowable deduction: sec. 51(1) and (2). The proceeds of sales made in the year will be assessable income: sec. 25(1).

The scheme of the Act roughly equates the general accounting treatment where sales are treated as income from which are deducted the cost of sales and there is brought to account the difference between opening and closing stock: cf.
Commr of Taxes (S.A.) v. Executor Trustee & Agency Co. of South Australia Ltd. (1938) 63 C.L.R. 108 at pp. 155-156.

So much may readily be accepted.

Next it is said that this statutory scheme requires that where an outgoing is incurred for trading stock, that trading stock must be on hand at the end of the year of income. Otherwise there would be, it was said, great distortion in the trading account. A like consideration it may be noted underlies the conclusion that when trading stock is sold on terms and ceases to be on hand at the end of the year of income, the whole of the purchase price must be brought to account as income in the year of sale, notwithstanding that the purchase price has not been received in whole or in part:
J. Rowe & Son Pty. Ltd. v. F.C. of T. 71 ATC 4001 at p. 4008; (1970-1971) 124 C.L.R. 421 at p. 434 per Walsh J. at first instance, at 71 ATC 4157 at p. 4160; (1970-1971) 124 C.L.R. 421 at p. 450 in the judgment of Menzies J. with whom Barwick C.J. and Gibbs J. agreed and in the judgment of Gibbs J. at ATC p. 4161; C.L.R. p. 452. However, as the passages noted indicate, the result in that case depended to a considerable extent upon accounting evidence relevant to the derivation of income rather than to the consequence of distortion. If in the present case the distortion suggested, if there be a distortion, is to be avoided, it will be because the amounts prepaid are excluded from deductibility under the provisions of sec. 51(1) and (2) of the Act. Hence it is to these subsections that we must turn.

The principal submission for the Commissioner was that the outgoings in question were properly to be characterised as having been incurred in the years of income not for trading stock or in the purchase of trading stock but for the right to acquire trading stock in the future. So seen they were, it was submitted, on capital account and excluded from deductibility under sec. 51(1). It was said that the right to acquire the future stock ``matured'' at the time of delivery into trading stock (a revenue asset) and that at that time the outgoing could then properly be characterised as an outgoing incurred in the business of the respondent not being on capital account. It was then that the expenditure, albeit effected by payment in the preceding year of income, could properly be characterised, it was submitted, for the first time as being expenditure incurred in the purchase of stock and so meet the test of deductibility.

By way of a subsidiary argument, reliance was placed upon the fact that the two relevant contracts each provided for the price to be determined by MML at the time of delivery subject only to the qualification that that price should be the MML's list price applicable at the time ``determined by reference to the Australian Copper Price at the date of such delivery'' subject to the agreed discount of 8.5% or 15.25% as the case may be. The full significance of this subsidiary argument was not fully explained. However, by implication, the ascertainment of the precise price was relevant to the point in time when the outgoing for trading stock was incurred. The Commissioner however sought to use this subsidiary argument in aid of the principal argument and as reinforcing it because, it was said, the prepayments secured to the respondent merely a promise by MML that in the future it would deliver to the respondent the specified goods and treat the purchase price - which would then, but not until then, be ascertained - as satisfied.

The law

A loss or outgoing to be deductible under sec. 51(1) must be incurred in the year of income. What is meant by the word ``incurred'' in this context has been the subject of considerable discussion in the cases. Central to that discussion is the classic statement of Dixon J. in
New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 C.L.R. 179 at p. 207 referred to with approval by the Court in
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 at p. 507. His Honour there said:

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``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.''

Some propositions are now well established. Outgoings may be incurred though the sum in question has not been paid or the liability discharged: New Zealand Flax Investments Ltd. and James Flood Pty. Ltd. (supra). An outgoing may be incurred notwithstanding that it may be defeasible:
Commonwealth Aluminium Corporation Ltd. v. F.C. of T. 77 ATC 4151 at pp. 4160-4161, cited with approval in
F.C. of T. v. Australian Guarantee Corporation Ltd. 84 ATC 4642 at p. 4645; (1984) 2 F.C.R. 483 at p. 487, per Toohey J.;
R.A.C.V. Insurance Pty. Ltd. v. F.C. of T. 74 ATC 4169; (1974) 22 F.L.R. 385 and
Commercial Union Assurance Co. of Aust. Ltd. v. F.C. of T. 77 ATC 4186; (1977) 32 F.L.R. 32. An outgoing may be incurred notwithstanding that the amount of that outgoing is payable in the future. It is not necessary that the outgoing be one both due and owing at the time it is ``encountered'': James Flood Pty. Ltd. (supra) at p. 507, F.C. of T. v. Australian Guarantee Corporation Ltd. (supra). However, ``a liability which has not `come home' in the year of income, in the sense of a pecuniary obligation which has become due'' will not have been incurred until the year of income in which there is a presently existing liability.
Nilsen Development Laboratories Pty. Ltd. & Ors v. F.C. of T. 81 ATC 4031 at p. 4034; (1980-1981) 144 C.L.R. 616 at p. 623 per Barwick C.J. and at ATC p. 4037; C.L.R. p. 627 per Gibbs J. As the Australian Guarantee Corporation case demonstrates, evidence of commercial and accountancy practice may be relevant in determining whether an outgoing is referable to the accounting period in which it is claimed although such evidence will not be a substitute for the words of sec. 51(1) itself: per Toohey J. at ATC p. 4649; F.C.R. pp. 492-493, per McGregor J. at ATC pp. 4656-4657; F.C.R. pp. 501-503; see also
Hooker Rex Pty. Ltd. v. F.C. of T. 88 ATC 4392 at pp. 4399, 4409-4410; (1988) 79 A.L.R. 181 at pp. 189, 203. It may be noted that in the present case no evidence of this kind was adduced by the Commissioner.

It follows, therefore, that at the point of time at which the respondent bound itself as a party to each of the contracts, and so became committed to pay the amount shown in each contract to MML, it incurred the respective amount, notwithstanding that its obligation could be increased or reduced under the rise and fall provisions of the contract (cl. 8). Payment thereafter was strictly irrelevant to the time at which the outgoing was incurred. It merely operated to discharge in the year of income the outgoing already incurred in that year. In this sense it is strictly incorrect to speak of the payment here in question as a prepayment. A presently existing obligation had arisen and had been discharged.

A mere payment made in the absence of an obligation to make it might well not, in the circumstances of a particular case, be an outgoing incurred, but there is no case to which counsel for the Commissioner could refer us or which our own researches have been able to locate where it has been held that an outgoing has been incurred in a year later than the year where the liability arose and was discharged. Nor would we expect such a case to exist. This might well suggest that if the Commissioner's principal submission be accepted in the present case, the outgoing for trading stock would never be deductible at all.

In support of his principal submission the Commissioner relied upon the well-known cases of
Kauri Timber Co. Ltd. v. Commr of Taxes (N.Z.) (1913) A.C. 771;
Stow Bardolph Gravel Co. Ltd. v. Poole (1954) 35 T.C. 459 and
Hood Barrs v. Commr of I.R. (1957) 37 T.C. 188 at pp. 202-204.

In Kauri the taxpayer had, prior to the years in question, acquired by purchase or lease properties with standing timber upon them or had purchased timber with the right to cut and remove it. The taxpayer claimed to be entitled to deduct from the gross proceeds of its business the value of the standing timber cut and used during the years in question. What was acquired by the taxpayer were in each case interests in land and were plainly capital assets. The deductions claimed as equivalent to

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depreciation were disallowed as involving losses of capital.

In Stow Bardolph the taxpayer, which carried on business as dealers in sand and gravel, purchased two unworked deposits. What was purchased was again an interest in land, the gravel in situ and the right to take it away rather than the gravel itself which had to be excavated from the land. In these circumstances, the cost of acquiring the deposits was a capital outgoing, the taxpayer having acquired not the raw material for its business but ``the means of obtaining that raw material''.

The taxpayer in Hood Barrs who commenced business as a timber merchant and sawmiller in 1947, shortly thereafter purchased standing timber pursuant to agreements which conferred upon him a right to enter the land and cut and remove the timber. Again what was purchased was an interest in land in the nature of a profit a prendre. The taxpayer did not purchase the trees themselves which remained until severance the property of the vendor. The case was indistinguishable from Stow Bardolph. Lord Morton adopted at p. 208 the words of Jenkins L.J. in that case as setting out the correct principle.

``Is this a case of a purchase of the raw material of the trade, or of the stock-in-trade in which a particular trader deals, or is it a case of a purchase of a capital asset from which the Taxpayers will be able to derive raw material or stock-in-trade as and when the requirements of the Taxpayers' business make it expedient to do so?''

Relying on those words, the Commissioner seeks to persuade us that on the facts of the present case the respondent purchased for the outlay in each year of income a capital asset (a chose in action) from which it was able to derive tubing being its stock-in-trade as and when the requirements of its business made it expedient so to do. None of the cases cited is in our opinion helpful in a resolution of the present appeal. Each of the cases cited depended upon the peculiar nature of the assets acquired as being interests in land. Indeed the Privy Council in
BP Australia Ltd. v. Commr of Taxation (1966) A.C. 224 at p. 269 dismissed Kauri Timber and Stow Bardolph as relating to the difficult area of mining cases. As their Lordships said at p. 270 of Stow Bardolph:

``... principles governing extraction industries have little relation to the present case.''

The same can be said of the case before this Court.

The classic test for resolving the distinction between capital and income is that enunciated by Dixon J. in
Sun Newspapers Ltd. & Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 363:

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

Earlier in the judgment (at p. 362) his Honour had said, as was pointed out in the judgment of their Lordships in BP Australia Ltd. v. Commr of Taxation (supra) at p. 261:

``... the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely.''

Here the character of the advantage sought was the acquisition of trading stock for delivery within a short time after the date the contract was entered into. As a matter of fact, delivery was completed within several months of the date of the contract. It is a misleading half-truth to say that what the taxpayer acquired was merely a contractual right to obtain delivery of stock in the future. The answer to the first question posed by Dixon J. is not to be obtained by a jurisprudential analysis of the process of entering a contract. It can be said of every payment pursuant to a contract that it secures to the payee the contractual rights under the contract. In that sense every payment made under a contract confers upon the payee a chose in action which can be described as an asset and

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which contractual right is discharged by the performance of the contract. But such an analysis is of no assistance in the resolution of whether a particular outgoing is on capital or revenue account. Rather as Dixon J. said in
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634 at p. 648 the answer:

``... depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.''

A recent example of an application of his Honour's dictum in Hallstroms (supra) is to be found in the decision of the Full Court of this Court in
McLennan v. F.C. of T. 90 ATC 4047.

The contractual rights conferred upon the respondent were not in any real sense of lasting advantage to the respondent. They did not enlarge the capital structure of the respondent's business. Rather the payments were to meet the regular demand of the respondent's business. In the sense used in the cases each of the payments was recurrent:
Ounsworth v. Vickers Ltd. (1915) 3 K.B. 267;
Vallambrosa Rubber Co. Ltd. v. Farmer (1910) S.C. 519.

To the extent that it is useful to consider whether the sums paid under the contract were payable out of fixed or circulating capital, an expression perhaps more meaningful to economists who have studied Adam Smith than to lawyers, that enquiry too supports the respondent's case. What was said by the Privy Council in the BP case at pp. 265-266 is equally applicable to the facts of the present case:

``Fixed capital is prima facie that on which you look to get a return by your trading operations. Circulating capital is that which comes back in your trading operations. The sums in question were sums which had to come back penny by penny with every order...''

Dixon J.'s second test leads also in the same direction. The benefit obtained was trading stock or even on the Commissioner's case the right to require delivery of trading stock to be used in the continuous business of the respondent. The contracts and payments made thereunder were part of the normal business activity of the respondent of purchasing tubing and selling it to its customers.

The method of payment does not point in any other direction. While it is true that because the payments were made in advance of delivery and at the end of each year of income in question, so that in one sense if each year of income is to be looked at discretely the payment was made in relation to a benefit to mature in the next year, the ordinary business of a trader in goods does not cease on the last day of a year of income and commence on the first day of the next year. The operations of the business of a trader are a continuous process. The payments do not have a once and for all quality that might stamp them with the character of capital.

It is to be noted that in BP at pp. 273-274 their Lordships said:

``An advance payment for a period is not unusual in many revenue matters (e.g., purchase of stock). These payments were not current payments made annually over the period of benefit but on the other hand it was clear that they would have to be made again at intervals of a few years. In a durable company of this nature recurrent five yearly payments certainly cannot be said to have a `once for all' quality. Had the payments been for one or two years they would point towards revenue; had they been for 20 years they would point towards capital.''

These comments are equally applicable to the present case.

It follows in our opinion that the payments here in question were on revenue and not on capital account and were accordingly deductible under sec. 51(1) without need to resort to sec. 51(2).

But the question is not without direct authority on the very point sought to be argued by the Commissioner. A similar argument was made and rejected in
F.C. of T. v. Walker 84 ATC 4553.

In Walker the taxpayer had been a partner of two partnerships. The facts surrounding the first partnership (Wentara Lodge Cattle Breeders) were that the partners had ``leased'' six pure-bred cattle which were to be operated upon so as to gain a maximum number of 48 progeny. An amount of ``rental'' was payable

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at the commencement of this lease which was in substance to procure the ultimate progeny. In the second year of income the taxpayer was a member of a partnership styled ``Columba Park Charolais Cattle Breeders''. The partners entered into a document referred to as a ``deed of management'' pursuant to which the manager was to procure operations to be performed on donor animals owned by the partnership and produce a guaranteed number of 48 calves. Although the form of documentation in each partnership differed, the commercial substance of each was the same, namely that the partners contracted for the acquisition in the future of calves for use as trading stock in the partnership business. The Commissioner made the same argument as that made before us and cited the same cases in support of it.

It was found as a fact that at the time each payment was incurred by the partners, they were carrying on a business which necessarily involved the breeding up of a substantial herd of valuable pure-bred cattle and the continued breeding of them for sale. In the view of Fisher J. that finding was of ``prime importance, and if accepted... virtually concludes these appeals'' (at p. 4560). In answer to the submission of the Commissioner that the outgoings were on capital account, his Honour, although not elaborating upon the submissions made, said at p. 4562:

``This contention is answered by the conclusion that the partnerships were carrying on business operations. Pursuant to and in the course of these activities they were taking steps to acquire and build up trading stock. It cannot be said that they were acquiring capital assets or enlarging the permanent structures of the partnerships.''

Davies J. found it unnecessary to deal specifically with the argument put by the Commissioner. His Honour said at p. 4564:

``The crux of the appeals is whether or not, during the subject years, the taxpayer... and the persons with whom he was associated in the subject arrangements, carried on business. If they did carry on business, the contentions put by the Commissioner of Taxation against the fiscal effects of the arrangements and of the acts done were unsound, as Fisher J. has explained.''

Neaves J. dissented, having taken a different view of the facts. Nothing said by his Honour, however, would cast doubt upon the deductibility of the outgoings there in question had it been correct to conclude that the parties were carrying on business.

Faced with Walker's case the Commissioner was forced to rely upon his subsidiary submission that the fact that pursuant to the agreements MML was entitled to vary the contractual price for the tubing led to a different result. It was not suggested, nor could it have been suggested that the power to vary the contract price within the limits contained in cl. 8 of the contract rendered the contract too uncertain: cf.
Upper Hunter County District Council v. Australian Chilling & Freezing Co. Ltd. (1968) 118 C.L.R. 429;
Godecke v. Kirwan (1973) 129 C.L.R. 629 and
Meehan v. Jones (1981-1982) 149 C.L.R. 571.

Once, however, it is appreciated that an outgoing may be deductible notwithstanding that it may be defeasible, there can be no logical reason why an outgoing pursuant to a contract may not be deductible notwithstanding that the ultimate price payable upon delivery of the goods the subject of a contract may be varied upwards or downwards to reflect the increased cost of the goods. If the price increases, as it did in each of the years in question, the additional amount incurred on delivery will be deductible in the year in which delivery occurs. If it decreases, the amount credited or refunded to the purchaser will form part of the proceeds of business of the trader in the same way as would an exchange gain which results in a lesser amount of Australian dollars becoming payable for stock. Such amounts are assessable income pursuant to sec. 25(1) of the Act:
International Nickel Australia Ltd. v. F.C. of T. 77 ATC 4383; (1976-1977) 137 C.L.R. 347. Indeed the judgments in that case, and particularly that of Gibbs J. at ATC p. 4386; C.L.R. pp. 352-353, provide convincing further authority, if such be needed, for rejecting the Commissioner's principal submission as well.

It is unnecessary in the light of our view that the outgoings in the present case were on revenue account to consider in detail the provisions of sec. 51(2) of the Act. It follows

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from what we have said that the outgoings here in question were expenditure incurred in the purchase of stock used by the taxpayer in the years of income following each payment so that even if the outgoings were on capital account, sec. 51(2) would have operated to allow to the respondent a deduction.

Section 51(2) may at first glance seem curious. In almost all cases that can be envisaged, expenditure incurred on trading stock in the ordinary sense of that term (cf.
F.C. of T. v. St Hubert's Island Pty. Ltd. (in liq.) 78 ATC 4104 at pp. 4112-4113; (1978) 138 C.L.R. 210 at pp. 226-228 per Mason J.) will be on revenue account. In
John Fairfax & Sons Pty. Ltd. v. F.C. of T. 11 A.T.D. 510 at p. 511; (1959) 101 C.L.R. 30 at p. 35 Dixon C.J. said:

``In considering the form or structure of the Australian provision, it should not be overlooked that it was thought desirable to enact sub-s. (2) of s. 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 sub-s. (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 sub-s. (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 sub-s. (1) of s. 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.''

There was no provision equivalent to sec. 51(2) in the prior legislation, notwithstanding that, for example, there was an absolute prohibition against the deductibility of losses and outgoings of capital or of a capital nature: sec. 25(e) of the Income Tax Assessment Act 1922. No reported case is to be found under the previous legislation, nor in the United Kingdom, New Zealand or Canada which ever suggested that expenditure on trading stock in the ordinary sense of that expression was on capital account, even if the outgoing were the first purchase of the business.

The Australian Royal Commission on Taxation (Third Report 1934) (the Ferguson Commission) which recommended the introduction of sec. 51(2) provides no support for the view that expenditure on trading stock would be seen as being on capital account.

There is another and more likely explanation which is hinted at obliquely in the report of that Commission. Certain kinds of stock, of which sheep used in the business of a trader in wool and milk-producing cows are the most obvious examples, are not trading stock in the ordinary sense of the word. A purchaser of such sheep trades in wool, not in the sheep themselves; a purchaser of a milk-producing cow trades in milk not cattle. The amount paid for the purchase of such animals would be on capital and not revenue account:
Webster v. D.F.C. of T. (W.A.) (1926) 39 C.L.R. 130;
F.C. of T. v. Wade (1951) 84 C.L.R. 105 at p. 113 (in the joint judgment of Dixon and Fullagar JJ. and at p. 115 in the judgment of Kitto J.).

The 1936 Act brought about an amendment to the definition of ``trading stock'', previously sec. 4 of the 1922 Act, by inserting into that definition ``livestock'' coincidentally with the introduction of sec. 51(2):
All States Frozen Foods Pty. Ltd. v. F.C. of T. 90 ATC 4175 at p. 4176. Thereafter expenditure on milk cows and sheep purchased for wool production became an allowable deduction notwithstanding that such expenditure would have been excluded from deductibility under sec. 51(1) as being of a capital nature.

In Walker as in the present appeal, the Commissioner sought to argue that sec. 51(2) had no application unless the trading stock purchased was on hand at the end of the year of income. In Walker, although not before us, the Commissioner submitted at first instance that the word ``used'' in sec. 51(2) required this result, it being necessary that the stock be used in the year of income. That submission was rejected by Lusher J. who also held, in our respectful opinion correctly, that sec. 51(2) was not a code of deductibility. Apart from the word ``used'' in sec. 51(2), there is nothing in the wording of sec. 51(2) which would suggest

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that it is only expenditure incurred on trading stock delivered in the year of income and thus on hand that falls within its terms. We would be slow to read so much into the subsection.

Finally, we should note that despite the Commissioner's submission to the contrary, there is no necessary requirement under the Act that expenditure on trading stock will only be deductible if the stock represented by it has been sold or is on hand at the end of the year of income. In
Farnsworth v. F.C. of T. (1949) 78 C.L.R. 504 the taxpayer produced fruit which was pooled with the fruit of other growers pursuant to a marketing scheme. The fruit was held by the High Court not to be on hand at the end of the year of income. The taxpayer had, according to the report, claimed outgoings in the year of income although no detail of that claim is given. There is no suggestion in the judgment that the costs of growing the fruit were not an outgoing deductible in the year incurred although related to fruit not on hand.

If, as was suggested, the result of the present appeal being allowed were to produce ``an anomaly'', or ``a gateway'' through which many might enter upon tax avoidance that submission may be answered by saying that it is a matter for the legislature. We do note that both sec. 82KJ and 82KL of the Act deal with certain prepayments in the context of a ``tax avoidance agreement'' as defined in sec. 82KH(1). The application of sec. 82KJ was not argued below and an application to amend the grounds of appeal to permit it to be raised before us was disallowed by Beaumont J. in
F.C. of T. v. Raymor (N.S.W.) Pty. Ltd. 90 ATC 4347. The general anti-avoidance provisions of Pt IVA of the Act might also in an appropriate case have some application.

Finally, in 1988, Parliament inserted Subdiv. H of Div. 3 of Pt III of the Act (sec. 82KZL-82KZO) to prevent deductibility of certain prepayments the benefit of which is to be received later than 13 months of the incurring of the expenditure. While that Subdivision has no direct relevance to expenditure on trading stock, it serves to reinforce the view that the fact that the expenditure is incurred in advance of services to be rendered or advantages received under a contract (including a contract for the purchase of trading stock) is no bar to deductibility.

The appeal will be dismissed with costs.

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