FC of T v WOOLCOMBERS (WA) PTY LTDJudges:
Full Federal Court
Beaumont, French and Foster JJ
Woolcombers (WA) Pty Ltd (Woolcombers) was incorporated in Western Australia in 1947. From 1947 to 1973, its principal activity was cleaning greasy wool to remove dirt and vegetable matter in a scouring and combing operation. The buying and selling of wool was a secondary function. However, since 1973 the company's sole business has been that of a wool trader.
Woolcombers is one of about 50 companies in the G.H. Michell Group, the ultimate parent company of which is G.H. Michell Holdings Pty Ltd. The principal business of the Group is international wool trading, although in order to support that activity it is involved in the early stage processing of wool, including top-making, carbonising and scouring. Other operations of the Group include tanning, pastoral activities and merchant banking. Prior to 1973, Woolcombers did not buy wool from woolgrowers but at auction and from other
ATC 5171dealers. In 1973, it commenced buying wool from woolgrowers. It did and still does this in one of two ways, described in the evidence of its manager, Mervyn Edmond Yelverton. The first is the spot contract. This involves the purchase of the wool clip at the time of shearing, or after it has been shorn, for immediate or prompt delivery. The second is by way of contract to purchase a woolgrower's wool clip several months, often up to six or nine months, prior to shearing for delivery in the future when the wool has 12 months growth. Contracts in this class are known as forward contracts. They are either fixed or variable contracts. In a fixed contract, the price per kilogram for the wool is fixed at the time of the contract. In a variable contract, a base price per kilogram for wool is agreed on the assumption of an average micron level and yield specified in the contract. In such a case the contract also specifies an amount for each 0.1 micron or per cent of yield by which the base price is to be varied up or down if the average micron or yield of the wool as delivered differs from that specified in the contract. In the 1988 income year, 323 of the forward contracts were fixed price contracts and 31 were variable price contracts.
The contracts were made according to standard terms contained on a printed form of contract prepared by Woolcombers. In each case, the contract was executed by the woolgrower and by a woolbuyer as Woolcombers' agent. The woolgrower agreed to set an approximate date for shearing and a date on which the wool would be delivered. Each contract contained an estimate of the number of bales to be produced, which was based upon the size and composition of the flock and the number of bales produced in the preceding season.
It is appropriate to refer to some key clauses in the standard form of contract. The opening clause was in the following terms:
``WOOLCOMBERS (W.A.) PTY. LTD. (THE PURCHASER) agrees to purchase and... of... (THE SELLER) agrees to sell to the Purchaser at the price and otherwise upon the terms and conditions hereinafter contained, the Wool (THE WOOL) shorn or to be shorn from all the sheep on the Sellers property at the time of signing the Contract, whether the bale quantity is over or under the estimated or approximate quantity.''
The conditions of sale on the reverse of the standard form included the following:
Property in the Wool the subject of this agreement shall pass from the Seller to the Purchaser upon Payment as hereinafter defined.
(a) The Seller shall be deemed to have received payment in full of the purchase price, upon the delivery or posting to the seller, or to the Agent of the Seller, or to any person holding a lien, bill of sale, charge or encumbrance for the Purchaser's cheque for such amount as due hereunder, after making such deductions (if any) as in the opinion of the Purchaser are authorised or permitted by this Contract.
(b) Payment shall be made... days after the date of completion of delivery at the store of the Purchaser.
2(A) (a) Where the Purchaser has made an agreement to sell the wool the subject of this contract to a third party (here called `the buyer'), and the Purchaser is unable to deliver the wool to the buyer because of industrial action then subject to this clause the purchaser may suspend payment of the money due to the seller under this contract; (sic)
(b) The purchaser may suspend payment under this clause until the industrial action ceases; (sic)
For the purpose of ascertaining the weight of the wool sold under this agreement, the purchaser may take delivery thereof prior to payment of the Purchase Price, but shall not acquire any right of ownership in the wool. Neither shall the Purchaser be entitled to re- handle the wool in any way which would mean a loss of identity of that wool, or be permitted to ship any of the said wool prior to making payment in full to the Seller. (sic)
The Seller warrants and agrees that the wool delivered shall:-
(e) in the event that the seller needs to dispose of the sheep described above by reason of drought, flooding or disease then the seller shall forthwith advise the buyer in writing of such necessity. The Seller shall be entitled to dispose of such number of sheep as may be agreed by the parties hereto and failing agreement within twenty eight (28) days of the notice having been given as aforesaid then the parties shall refer the matter to two arbitrators appointed and acting in accordance with clause 8 hereof. (sic)
Save as provided in (3) hereof the seller shall indemnify the purchaser for any loss or damage direct, indirect or consequential suffered by the purchaser as a result of the seller's failure. (sic)
- (a) to deliver the wool or any part thereof to the purchaser before the agreed delivery date or at all.
- (b) to deliver the wool in the condition as warranted.
6. FREIGHT INSURANCE:
The wool shall be at the risk of the seller until shorn from the sheep's back, however by mutual agreement between the parties of this contract the purchaser shall be responsible for the insurance of the wool once shorn. (sic)''
Save for one exception, between 1976 and 1988, all the forward contracts entered into by Woolcombers were completed by the woolgrowers. In the one exception, the woolgrower sought and obtained a release from the contract. Wool purchased by Woolcombers during this time was resold to associated corporations in the G.H. Michell Group. It was used by them to meet export commitments. In respect of the 1988 income year, there was no evidence that Woolcombers earned income from the resale of the wool it was entitled to receive under the forward contracts or from the sale of its interests in those contracts. In the 1989 income year, about 40% of the wool sold by Woolcombers was wool delivered to it under forward contracts made with woolgrowers in the 1988 income year. It is not in dispute that the use of forward contracts formed a necessary part of Woolcombers' business and served the needs of the G.H. Michell group by fixing an acquisition price for the wool and thus providing a hedge against unfavourable movements in the market price before export contacts fell to be performed. The forward contracts were also of benefit to woolgrowers who could plan their affairs on the security of Woolcombers' commitment to pay a price which was not subject to market fluctuations before or after shearing.
In its income tax return for the 1988 income year, Woolcombers estimated its liability, at 30 June 1988, to woolgrowers under the forward contracts as executed in that year at $57,140,156. The reasonableness of that estimate is not in issue. The amount paid to woolgrowers under those contracts in the 1989 income year was $55,373,863. It was asserted from the bar table, and was not in dispute, that prior to the 1988 income year, Woolcombers claimed as a deduction under s. 51(1) of the Income Tax Assessment Act 1936 (Cth) payments made under the forward contracts performed in the year of income. However, for the financial year ended 30 June 1988, it additionally claimed as a deduction the estimated payment under forward contracts entered into in that year. On this basis, it declared a net loss of $54,952,825 in its return. In an assessment issued on 29 June 1989, the Commissioner disallowed the deduction and assessed a taxable income of $2,187,331. On 29 August 1989, Woolcombers lodged a notice of objection to the assessment, claiming that the full amount of $57,140,156 in respect of amounts payable on forward purchase contracts for wool should be treated as an allowable deduction under sub-s. 51(1) of the Act for the year ended 30 June 1988. The objection was disallowed and Woolcombers requested that the decision be referred to this Court for determination.
On 26 May 1993, Lee J. ordered that the decision of the Commissioner of Taxation disallowing the objection to the assessment be set aside and that a decision allowing that objection to the extent of $56,254,140 (allowing for a subsequent correction of error in calculation) be substituted. The Commissioner now appeals against that decision [
Woolcombers (WA) Pty Ltd v FC of T 93 ATC 4342].
Accounting treatment of the claimed deduction
Before turning to the reasons for judgment of the learned trial judge and the issues for determination in this appeal, it is desirable to refer briefly to the question of the treatment in the 1988 accounts of the commitments made under the forward contracts entered into in that income year. The accounts which were lodged with the taxpayer's 1988 income tax return did not disclose the estimated liability as a trading expense in the profit and loss account. There was no entry in the balance sheet disclosing any asset or liability in respect of the contracts. However, in the ``Notes to and Forming Part of the Accounts'' the following appeared:
" 1988 1987 $ $ 11. CURRENT LIABILITIES -- CREDITORS AND BORROWINGS --------------------------------------------------- Bank overdrafts -- unsecured 2,738,413 809,803 Trade creditors 163,503 487,813 Intercompany 323,421 1,611,538 Liability for forward wool purchase contracts (refer note 1.7) 57,341,410 -- ---------- 60,566,747 2,909,154 Less undelivered wool relating to forward wool purchase contracts (refer note 1.7) 57,341,410 -- ---------- --------- 3,225,337 2,909,154" ---------- ---------
This note was cross-referenced to an entry in the balance sheet under the heading ``CURRENT LIABILITIES'' which disclosed creditors and borrowings as at 30 June 1988 of $3,225,337. Note 1.7 referred to in Note 11 was in the following terms:
``1.7 Forward Purchase Committed Wool Contracts
The company enters into contracts with wool growers for the forward purchase of wool when grown and shorn. The liability to make payments under these contracts have been recognised in the financial statements and is stated at the price the company is committed to pay under the contract (sic). An offsetting asset, representing this wool receivable under the forward purchase contracts has also been recognised in the financial statements, being stated at cost.
At 30th June, 1988 the company was committed to forward purchase wool clip contracts valued at $57,341,410. The above treatment represents a change in accounting policy during the year which has no effect on operating profit before income tax.''
Woolcombers called as expert witnesses, in relation to the proper accounting treatment of the forward contract liabilities, Professor Robert Walker, Professor of Accounting at the University of New South Wales, and Mr Donald Humphreys, managing partner of the Perth office of Ernst and Young, Chartered Accountants. The Commissioner relied upon the evidence of Professor Philip Brown, Professor of Accounting at the University of Western Australia, and Mr Gregory Nairn, an audit partner in the Perth office of Price Waterhouse, Chartered Accountants. In respect of that evidence, his Honour found that the witnesses agreed that, at the relevant time, no accounting standard applied to put beyond issue, in accounting terms, how Woolcombers' commitments under the forward contracts should be reflected in the accounts. His Honour identified as the point of difference between the witnesses the question whether, absent the inclusion of the effect of the forward contracts in the profit and loss account of Woolcombers, it was appropriate to treat the estimated liability under the contracts as an ``incurred expenditure'' and not to offset that sum by the value of the ``asset'' represented by the right to
ATC 5174receive the wool under the contracts. Summarising the effect of the evidence, his Honour said [at 93 ATC p 4347]:
``The expert evidence adduced by the Commissioner was to the effect that the estimated liability could not be recognized as an `expense' under generally accepted accounting practice. In particular, Professor Brown considered that unless an `expense' could be identified it could not be said that an outgoing had been incurred for the purpose of sub-s. 51(1) of the Act. It was his opinion that, in accounting terms, an `expense' would not arise until the wool, described as an asset, had been received and sold, the `reduction of the asset' leading to recognition of an `expense'. It was also said that this proposition was further supported by the application of the accounting rule, the `matching principle', which required an `expense' to be `matched' with revenue to which the expense related. The taxpayer's witnesses maintained that proper accounting practice required recognition in the accounts of the liability represented by the estimate of the payments to be made by the taxpayer under the forward contracts.''
His Honour held that evidence from expert accountants does not supply the proper construction of sub-s. 51(1) of the Act but may assist the Court to identify, and to understand the commercial significance of, the facts to which the sub-section, duly construed, is to be applied. His Honour did not in terms accept the evidence of one witness over that of another.
The reasons for judgment
After setting out the factual findings and discussing the expert evidence, his Honour referred to sub-s. 51(1) of the Income Tax Assessment Act 1936 and characterised its construction as a ``jurisprudential analysis'' and not a construction assisted by the application of commercial principles. He accepted that commercial and accountancy practice may assist in ascertaining the true nature and incidence of an item claimed as a loss or outgoing under the sub-section and that the manner of application of the sub-section will depend upon the particular facts of each case. His Honour referred to authority, including the judgment of the High Court in
Coles Myer Finance Limited v. FC of T 93 ATC 4214; (1992-1993) 176 CLR 640 which had been delivered between the hearing of the appeal and the delivery of his Honour's judgment. Reference was made to cases involving the insurance industry and consideration of whether the liability of insurers to meet insurance claims could be properly characterised as an outgoing under sub-s. 51(1) -
RACV Insurance Pty Ltd v. FC of T 74 ATC 4169;  VR 1 and
Commercial Union Assurance Company of Australia Limited v. FC of T 77 ATC 4186; (1977) 32 FLR 32. Cases involving the deductibility of a claimed accruing liability of an employer to pay money to employees for periods of annual and long service leave were also mentioned -
Nilsen Development Laboratories Pty Ltd & Ors v. FC of T 81 ATC 4031; (1980-1981) 144 CLR 616 and
FC of T v. James Flood Pty Ltd (1953) 10 ATD 240; (1953) 88 CLR 492. In those cases, the incurred obligations were treated as properly falling into the year of income in which the payments were made, the payments being in the manner of a continuing obligation to pay wages. His Honour regarded those cases, however, as distinguishable from the present case. The submission of the woolgrower to a contractual provision that restricted the woolgrower's right to dispose of sheep without the agreement of Woolcombers reflected a mutual intention that Woolcombers would obtain enforceable contractual rights upon execution of the contract and undertake a commensurate liability. His Honour referred to the indemnity provision, clause 4, and went on to say [at 93 ATC p 4349]:
``The result of the contractual provisions was the imposition of a clear liability on the taxpayer to pay for the woolgrower's woolclip. Although it may be said that the effective time for payment did not arise until the wool had been shorn and the quantum or payment decided by the weight of wool shorn, neither circumstance made the obligation a mere `theoretical contingent liability'. The liability of the woolgrower to indemnify the taxpayer upon formation of the contract made it clear that it was intended that a correlative liability be imposed upon the taxpayer at the same time to pay the woolgrower for the woolclip. There was an accrued obligation or present liability imposed on the taxpayer by a definite contractual commitment.''
New Zealand Flax Investments Ltd v. FC of T (1938) 5 ATD 36; (1938) 61 CLR 179
ATC 5175, the Coles Myer decision (supra) and
Ogilvy & Mather Pty Ltd v. FC of T 90 ATC 4836, his Honour said of the obligation imposed on Woolcombers:
``It was more than `an impending, threatened or expected' expenditure not then grounded in a commitment in the form of a liability to pay.''
As a matter of jurisprudential analysis, Woolcombers' present contractual commitment to buy and pay for the woolclip was a liability to pay an ascertainable sum at a later date undertaken by Woolcombers in the course of the conduct of and for the purpose of its business and the binding nature of that commitment satisfied the meaning of the word ``incurred'' as used in sub-s. 51(1) of the Act. Reference was made to
FC of T v. Australian Guarantee Corp Ltd 84 ATC 4642; (1984) 2 FCR 483. It was not in issue that, ``if incurred'', the outgoing was necessary for the purpose of gaining or producing assessable income.
The remaining question considered by his Honour was whether the outgoing thus held to be incurred was properly referable to the 1988 year of income. In accepting that s. 51 of the Act does not require a taxpayer to match the loss or outgoing incurred to income gained or produced in the income year, his Honour characterised the judicially generated requirement that the loss or outgoing be ``properly referable'' or ``properly attributable'' to the income year as requiring the loss or outgoing not to be ``so anomalous to the revenue operations of the taxpayer as to effect a distortion in the result of those operations in the relevant income year''. After referring to various of the authorities, his Honour found that payment of the outgoing incurred in the 1988 income year would coincide with the receipt of income from the sale of the stock in the 1989 income year. There was no basis on those facts for apportionment of the outgoing, which remained constant from the time at which it was incurred. It was either not allowable as a deduction in the 1988 income year, not being properly referable or attributable to that year of income, or was allowable in full. If allowed, the result of the deduction in that year might appear as a distortion of the taxpayer's operations on the revenue account, but that would not be an outcome caused by the introduction of an anomalous outgoing extraneous to the taxpayer's usual revenue operations. His Honour noted [at 93 ATC p 4351] that the liabilities under the forward contracts were not treated as trading expenses in the profit and loss statement of the taxpayer and also noted that no provision had been made in the accounts for the 1988 income year for that estimated liability:
``However, the fact remained that as at 30 June 1988 a revenue outgoing had been incurred relevant and integral to the taxpayer's revenue operations, notwith- standing that at the relevant time for assessing the revenue outcome of the taxpayer's business no stock on hand or revenue ingoing was available to be matched against the outgoing. The accounts did `recognize' an estimate of the liability in a note to the accounts. The estimate of the extent of the liability incurred in the accounting period was calculated pursuant to a method designed to provide a fair view of that liability in the accounts. If the estimated liability referred to in the accounts is treated as an incurred outgoing within the meaning of sub-s. 51(1) of the Act, the allowable deductions for that year of income will be substantially increased but that increase will be a consequence of due conduct of the taxpayer's business and not an anomalous event in the revenue operations of the taxpayer calculated to distort those operations by inflation of allowable deductions.''
His Honour held therefore that Woolcombers' obligation under the forward contracts was an outgoing incurred in the 1988 year of income within the meaning of s. 51 of the Act as it then stood, being a binding contract in the form of a liability to pay and being properly attributable to the year of income.
The Commissioner submitted that there were three prerequisites for deductibility under s. 51(1):
- (a) the incurring of the liability in the year of income;
- (b) the outgoing being of a revenue nature; and
- (c) the incurring of the loss or outgoing in the year of income by the loss or outgoing being ``properly referable'' or ``properly
ATC 5176attributable'' to the particular year of income.
It was submitted that his Honour's decision had been in error in relation to his determination that the liability had been incurred in the year of income and that it was properly referable to the year of income. It was contended that 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 pecuniary liability. In each contract, the delivery of the wool was said to be a condition precedent to the performance of Woolcombers' obligation to make payment under the contract. No present liability to make a payment would accrue until after the wool was delivered. That event did not occur in the year of income. And even if during the year of income, Woolcombers had incurred a liability to pay for the wool, that liability did not become a present liability, or an accrued obligation, until the wool was delivered and payment became due. If those arguments were rejected, then, it was submitted, the Commissioner's appeal should be allowed in any event on the basis that the alleged outgoing was not properly referable to the year of income for which it was claimed. To be properly referable to the year of income, it was said, an outgoing is not required to be specifically matched to the assessable income which the outgoing produces, but looks to the point at which, or the period during which, the benefit of the liability is put to profitable advantage in the taxpayer's income-producing activities. It was only in the 1989 income year that the benefit of the liability in respect of acquiring the trading stock was put to profitable advantage. The requirement that a claimed deduction be properly referable to the year of income was said not be limited to circumstances where ``anomalous events'' have occurred, which are ``calculated to distort'' a taxpayer's revenue operation. His Honour's approach was said to be inconsistent with that of the High Court in the Coles Myer case, above. Woolcombers had not recognised the outgoing as a liability on the face of its balance sheet and did not deduct the amount of the forward purchase contracts as an expense in its profit and loss account in the year of income. It was accepted that accounting principles and practice were relevant, persuasive and perhaps determinative on the timing of deductions, i.e. the extent to which the loss or outgoing was incurred in the particular year of income. There was no accounting principle or practice which would treat the amount of the forward purchase contract as an expense in the year of income. The concept of the ``matching principle'' would arise only after it had been determined that there was a legal liability by way of a presently existing pecuniary liability.
It was submitted for Woolcombers that the correct approach to determining its entitlement to a deduction under s. 51(1) is the ``legal or jurisprudential analysis'' rather than a commercial view. The Coles Myer case, above, was relied upon in this respect. The making of each contract was said to have generated rights and obligations such that, in the 1988 year of income, Woolcombers had more than a contingent, pending, threatened or expected obligation to pay for the wool. It had become definitively committed to pay for the wool at the time each contract was entered into. Accordingly, at that time a present liability had arisen. Delivery of the wool was not a condition precedent to the liability to pay. It was a condition precedent to performance by Woolcombers of its obligation -
Perri v. Coolangatta Investments Pty Ltd (1982) 149 CLR 537. Payment was said to be ``strictly irrelevant'' to the time at which the outgoing was incurred. The cases were said to make it clear that neither the fact that payment was not made until the next year of income nor the fact that the obligation to make payment might be described as defeasible would prevent the present existence of the liability. To be ``incurred'' within s. 51(1), it is not necessary that the outgoing be both due and owing at the time it is encountered. Payment by Woolcombers of the purchase price of the wool under the contract was a matter of commercial certainty and was said not to be subject to any contingency which would be regarded as such in the world of ordinary business affairs. Woolcombers accepted that accountancy practice may assist in ascertaining the true nature and incidence of an item as a step towards determining whether it answers the test laid down by s. 51(1), but it could not be substituted for that test. In this case, the accounting evidence reinforced the conclusion that the liability for the amount in question arose in the year of income. In relation to the
ATC 5177decision in the Coles Myer case, Woolcombers submitted that that case dealt with the unusual situation in which a deduction is sought for a net loss or outgoing, the gross amount incurred not itself being deductible. The Justices in the High Court were said to have restricted their comments to such losses or outgoings. In the present case, Woolcombers seeks a deduction for the gross amount, not some net amount referable thereto. In particular, it was submitted that the Coles Myer decision, above, did not overrule, sub silentio, the long line of authority which establishes that ``the assessable income'' in s. 51(1) means assessable income of the taxpayer generally without division into accounting periods. In this respect, reference was made to
AGC (Advances) Ltd v. FC of T 75 ATC 4057; (1975) 132 CLR 175 and
Tooheys Ltd v. The Commr of Taxation for NSW (1922) 22 SR (NSW) 432. The cases relied upon by the Commissioner for the ``timing'' principle were said all to have involved a deduction for interest or an amount in the nature thereof. Those cases do not lay down an additional requirement for deductibility of all outgoings. Interest is in a special category in that liability for it accrues on a daily basis. The Commissioner's submissions were said to be no more than an attempt to substitute some sort of ``matching principle'' for the statutory criterion. The question could not be answered by asking when accountants would treat the outgoing as an ``expense''.
Conclusions on the appeal
It is convenient to refer first to the relevant principles and then to apply those principles in the present circumstances.
(a) The relevant principles
For present purposes, the relevant principles with respect to the meaning and operation of the first limb of s. 51(1) are well settled. ``Incurred'' does not mean only ``defrayed, discharged or borne'', but also includes ``encountered, run into, or fallen upon''. It does not, however, include a loss or expenditure which is no more than ``impending, threatened, or expected'' (New Zealand Flax Investments Ltd. v FC of T, above, per Dixon J. at ATD 49; CLR 207). The expenditure must have been incurred in the course of gaining or producing the assessable income but it is not required that the purpose of the expenditure shall be the gaining or production of the income of that year. It is sufficient ``if the expenditure was made in the given year or accounting period and is incidental and relevant to the operations or activities regularly carried on for the production of income'' (
W. Nevill & Co. Ltd. v FC of T (1937) 4 ATD 187; (1936-1937) 56 CLR 290 per Dixon J. at ATD 196; CLR 305; see also A.G.C. (Advances) Ltd. v FC of T, above, per Barwick C.J. at ATC 4064; CLR 185, per Mason J. at ATC 4070-4072; CLR 195-8). It is not necessary that ``an actual disbursement'' should have taken place. Although it is not enough if there is ``no debitum in praesenti solvendum in futuro... [or] an inchoate liability in process of accrual but subject to a variety of contingencies''. (FC of T v James Flood Pty. Ltd., above, per Dixon C.J., Webb, Fullagar, Kitto and Taylor JJ. at ATD 245; CLR 507-8.)
These principles were applied in
FC of T v Raymor (N.S.W.) Pty. Ltd. 90 ATC 4461; (1990) 24 FCR 90 in circumstances which provide some analogy for present purposes. The respondent sold goods which included copper tubing. In June of 1984 and 1985 it executed agreements with one of its suppliers. Each provided for the sale to the respondent of tubing of a specified quality and quantity, the delivery of the tubing to the respondent on dates to be nominated by it, and the payment of the purchase price, in the case of the June 1984 agreement, $600,113.16, and in the case of the June 1985 agreement, $584,388.61, on the execution of the agreement. Each agreement provided that notwithstanding payment, the price was subject to the date of delivery. The purchase price was paid in accordance with each agreement. Delivery under the June 1984 agreement started in July 1984 and continued for several months. Delivery under the June 1985 agreement started in July 1985 and continued for several months. It was held that when the respondent bound itself to pay the purchase price shown in each agreement, it then incurred that amount as an outgoing, notwithstanding that the price could be varied under the rise and fall provisions in the agreement. It was further held that payment of the price was irrelevant to the time at which the outgoing was incurred. The Court (Davies, Gummow and Hill JJ.) said (at ATC 4467; FCR 97):
``... 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,
ATC 5178notwithstanding 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.''
Their Honours went on to say (at ATC 4470; FCR 101):
``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.''
It was also held in Raymor (at ATC 4471-4472; FCR 103) that there was no necessary requirement under the Act, in particular by virtue of s. 51(2) being treated as a code of deductibility, that expenditure on trading stock will be deductible only if the stock represented by it has been sold or is on hand at the end of the year of income.
In 1991, a new s. 51(2A) was introduced as a result of this decision. The new provision, as the Explanatory Memorandum explained, would ``bolster'' the operation of the law by deferring deductions under section 51 for expenditure on trading stock where section 28 cannot apply, because the stock is not on hand, but a deduction should not be allowed, because the stock has not been sold. The Explanatory Memorandum referred to the existing law, in a way in which is pertinent for our purposes, as follows:
``5.12. In these circumstances, subsection 51(2A) will deny the deduction otherwise allowable under subsection 51(1) in the year the expenditure was incurred. Instead, subsection 51(2A) will allow a deduction for that expenditure under subsection 51(1) only when the stock first becomes trading stock on hand of the taxpayer. In practical terms, a deduction for trading stock will be available under section 51 in the year it is first on hand, for the purposes of section 28 of the Act, at year end or, if it is sold before the end of the year it first becomes stock on hand, in that year. This means a deduction for expenditure on trading stock under section 51 may be spread over more than one year of income.
5.13. For instance, a taxpayer might enter into a contract on 30 April 1992 to buy 1,000 widgets at a cost of $1 per widget. Under the present law, the taxpayer would be entitled to a deduction of $1,000 under section 51 in the 1991-92 income year.''
In Coles Myer, the taxpayer, acting as a financier to a group of companies, during the year ended 30 June 1984, drew and sold, at less than face value, bills and promissory notes, a significant proportion of which were outstanding at 30 June 1984. In its return for that year, the taxpayer claimed a deduction for the difference between the face value and the sale price. The Commissioner disallowed the claim on the footing that no loss or expenditure was incurred until the instruments were paid out in the next year. It was held by the majority (Mason CJ, Brennan, Deane, Dawson, Toohey and Gaudron JJ) that the total cost should be apportioned; and that, having regard to the relatively short life of the bills and notes, apportionment on an accounting straight line basis was appropriate. McHugh J. was of the opinion that the losses, in both cases, were incurred in the 1984 year.
Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ said (at ATC 4221; CLR 663):
``But it is not enough to establish the existence of a loss or outgoing actually incurred. It must be a loss or outgoing of a revenue character and it must be properly referable to the year of income in question. So it was that in New Zealand Flax the taxpayer was not entitled to deduct all payments of interest in future years
ATC 5179notwithstanding that it had incurred a liability to pay them in the accounting period under assessment.''
Referring to New Zealand Flax, Deane J. said (at ATC 4225; CLR 671):
``Obviously, the fact that a liability to make a future payment is theoretically contingent or defeasible is a relevant consideration. For the purpose of ascertaining taxable income on an accruals basis, however, it will not of itself be decisive against deductibility under s. 51(1) unless, in the circumstances of the particular case, the contingency or defeasibility precludes the liability from constituting, or giving rise to, a `loss or outgoing' which has been `incurred' in the sense explained by Dixon J. in the above passage, that is to say, `encountered, run into, or fallen upon' as distinct from being `no more than impending, threatened, or expected'. In that regard, it is important to bear in mind that Dixon J.'s explanation of the import of the words `loss or outgoing... incurred' in a taxation provision which relevantly corresponded with s. 51(1) was propounded by his Honour in the context of determining the deductibility of a liability to pay interest at a future time which his Honour expressly recognized as being theoretically `contingent'. Indeed, the actual decision of the court in New Zealand Flax was that so much of that contingent liability to pay money in the future as was `referable' or `properly attributable' to the tax year in question was deductible as a `loss or outgoing' which had been `incurred'.''
McHugh J. said (at ATC 4227-4228; CLR 676):
``The [High] Court has insisted that, for the purpose of s. 51(1), a loss or outgoing is not incurred until there is a presently existing liability to pay a pecuniary sum, no matter how certain it is from a business viewpoint that an expense was incurred or accrued during the year of income. By reason of this interpretation, accountancy and business practice is only a guide as to whether a loss or outgoing has been incurred.''
As has been noted, the majority of the High Court held in Coles Myer that, as in New Zealand Flax, an apportionment was appropriate. In the latter case, Dixon J. said (at ATD 50; CLR 208):
``In my opinion the most satisfactory way of dealing with the appeal is to set aside the assessments and to remit them to the Commissioner for re-assessment, so as to enable him to include only bond moneys received in the accounting periods and to allow whatever part, if any, of the deductions claimed for future interest and deferred commission appears referable to the accounting periods under assessment.''
As Hill J. pointed out in Ogilvy & Mather Pty. Ltd. v FC of T, above, the facts in New Zealand Flax were complex, involving a scheme which required a complicated accounting exercise to be undertaken for the purpose of applying the precursor of s. 51(1). The statement by Dixon J. that certain items be ``referable'' to a particular accounting period is to be viewed in that special context.
(b) The application of the foregoing principles in the present circumstances
In our view, Lee J. was correct in his analysis of the effect of the contractual provisions, that is to say, as has been noted, that ``[t]here was [here] an accrued obligation or present liability imposed on the taxpayer by a definite contractual commitment''. It follows, in our view, that an ``outgoing'' was ``incurred'' within the meaning of s. 51(1) in the 1988 year; and that no apportionment was appropriate.
It is convenient to deal with each of these conclusions in turn.
(i) Was there an accrued obligation or present liability imposed by a definite contractual commitment?
As has been said, under the express terms of the ``forward'' contract, Woolcombers agreed to purchase and the seller agreed to sell the wool shorn or to be shorn there described for the price specified. Under the conditions of sale, payment was to be made a specified number of days (usually 14) after delivery (cl. 2(b)). For the purpose of ascertaining its weight, Woolcombers could have taken delivery of the wool prior to payment, but without acquiring ``any right of ownership in the wool'' (cl. 2(B)). The wool was ``at the risk of the seller until shorn from the sheep's back'' (cl. 6). As we have seen, there were several force majeure provisions: First, in the event of industrial action, Woolcombers might suspend payment (cl. 2(A)). Secondly, in the event of a drought or a need to dispose of sheep by reason
ATC 5180of flood or disease, in default of agreement as to the number of sheep affected, the whole question of performance of the contract, including the possibility of partial performance, was referred to arbitration (cl. 3(e)).
It is not necessary for present purposes to analyse the exact nature of the interest in the wool on the sheep's back which was acquired by Woolcombers under the agreement. It would seem that, at law, Woolcombers did not acquire any property in the wool, at least until it was shorn. Sutton, ``Sales and Consumer Law in Australia and New Zealand'' (1983) (treating this type of transaction for the purposes of transfer of property as a sale of ``unascertained and future goods'') writes (at 260-1):
``There is a widespread practice in Australia of the sale of crops to processors for some seasons ahead at an agreed price, or for the sale of wool `on the sheep's back' many months before it will be ready to be shorn. The contract usually requires the seller to harvest the crop or shear the wool and to deliver it to the buyer's store where the price is ascertained and payment is made. The goods will be unascertained and future goods, and unless there are statutory provisions dealing with the particular crop in question, or unless there are special provisions in the contract itself dealing with the passing of property, title will pass to the buyer on unconditional appropriation of the goods to the contract by the seller, usually on harvesting or shearing or, at the latest, on delivery to the carrier for transmission to the buyer.''
But whilst property would not pass at law, it is clear that equity would protect the legitimate interests of Woolcombers from the time the contract was entered into (see
Bank of New South Wales v Spencer (1964) W.A.R. 18 at 22;
Re Puntoriero; Gagie v Nickpack Pty. Ltd., Full Federal Court, 3 June 1992, unreported, at p. 11; ``Commercial Law and Personal Property in New South Wales'', 10th ed. (1992) by J.W. Carter, Patricia Lane, Gregory J. Tolhurst and Elisabeth M. Peden at 119, 121; Sykes and Walker, ``The Law of Securities'', 5th ed. (1993) at 696-8; 712-3; Duncan and Willmott, ``Real and Personal Securities'' (1990) at 142-3; 173; Atkins, ``Bills of Sale, Liens and Stock Mortgages in New South Wales'' (1939) at 137, 143; generally, as to equity's protection of the legitimate interests of a purchaser under a contract of sale, see
Stern v McArthur (1987-1988) 165 CLR 489, per Deane and Dawson JJ. at 522-3).
But it is not necessary to pursue this complex question. For present purposes, the relevant inquiry is with respect to the character of Woolcombers' liability to pay the price rather than the nature of its interest, if any, in the wool. As has been said, we agree with the analysis of that liability made by Lee J. That conclusion is consistent with the express terms of the contract to which we have referred.
On behalf of the Commissioner, it is said that because delivery of the wool was a condition precedent to the performance of Woolcombers' obligation, no present liability to make a payment accrued until after the wool was delivered, that is, in the 1989 year.
In support of this contention, the Commissioner relies upon the reasoning in Nilsen, above. But, in our opinion, that case, which turned upon the precise effect of the terms of the industrial awards providing for long service and annual leave, can provide no real analogy here. The present case, in our view, must depend upon the terms and effect of the contracts made by Woolcombers.
Ogilvy & Mather, above, which is also relied upon by the Commissioner, may be distinguished. The taxpayer was an advertising agency. Under the Media Council rules, it ``guaranteed'' its clients' advertising costs. A claim was made to deduct the price of advertising orders whose non-cancellation period commenced before the end of the year of income, but publication of which occurred after the end of that year of income. The claim was disallowed because, on the true construction of the rules, unless and until publication occurred, the agent was not liable.
As Toohey J. pointed out in Australian Guarantee, above (at ATC 4645-4646; FCR 487-8), it is a question of construction of the instrument in hand whether it does, or does not, give rise to a present liability notwithstanding that the time for payment has not arisen. In our opinion, the analysis of liability of the agent made in Ogilvy & Mather depended upon the exact terms of that relationship; it cannot govern the circumstances of the present case.
The Commissioner further sought to rely upon the reasoning in
Staunton v Wood  117 E.R. 1025. In that case it was pleaded that
ATC 5181the plaintiffs had agreed to sell to the defendants certain goods for a specified price per ton, ``the said goods to be delivered forthwith by the plaintiffs to the defendants at the works, and the said price to be paid by the defendants to the plaintiffs in cash in fourteen days from the time of the making of the said contract''. In a count in assumpsit, the breach assigned by the plaintiffs was non-payment after 14 days. The defendants pleaded that a reasonable time, according to the tenor of the contract, for the delivery of the goods, within which reasonable time the goods according to the tenor of the contract might and ought to have been delivered, elapsed before the expiration of 14 days from the making of the contract; and that although the defendants were always ready and willing to accept the goods and pay for them, of which the plaintiffs had notice, and were requested to deliver the goods, yet the plaintiffs would not deliver the goods. There was a general demurrer. Giving judgment for the defendants, Patteson J. said (at 1026):
``We... are of the opinion that, according to the statement of the contract in the declaration itself, the delivering of the goods was a condition precedent. Every contract must be construed according to the intention of the parties, which in the present case the demurrer calls upon the Court to ascertain. We think it manifest that, by the use of the word `forthwith,' as to the delivering of the goods, in connexion with the payment in fourteen days, the parties intended that the goods should be delivered at some time within the fourteen days.''
Again, the case depended upon the true interpretation of the particular language of the contract.
The Commissioner also relied upon the ``force majeure'' provisions, in particular, cl. 3(e), as an indication that no liability to pay the price accrued to Woolcombers until delivery. We have difficulty accepting this submission, especially as a term to similar effect as cl. 3(e) would ordinarily be implied in a contract of this kind in any event (see
Howell v Coupland  L.R. 9 Q.B. 462; Meagher, Gummow and Lehane, ``Equity Doctrines and Remedies'', 3rd ed. at 195-6).
In James Flood, the High Court said (at ATD 244; CLR 506):
``It is probably going too far to say that the obligation must be indefeasible.''
In our view, much will depend upon the particular circumstances of the case at hand. If the defeasibility takes the form of a contingency such as drought or a similar frustrating event which ordinarily would be implied as a matter of business efficacy, it is difficult to argue that by reason of the existence of this contingency, no liability to pay the price has accrued.
We agree with Lee J., for the reasons he gives, on the present question.
(ii) Assuming a commitment of the kind stated in (i) above, was an outgoing incurred here in the 1988 year?
In our view, once the conclusion in (i) above is arrived at, as we have, it must follow, in accordance with the settled construction of s. 51(1), that an outgoing was incurred when the contract was entered into.
(iii) Was an apportionment necessary or appropriate?
As has been said, the complexity of the scheme in New Zealand Flax called for an inquiry of the kind there ordered. In our opinion, there is no such complexity here. In Coles Myer, because of the special nature of the financing transaction, it was held, by the majority, that apportionment was appropriate. Likewise, in the financial arrangements considered in Australian Guarantee, apportionment of the total sum of the interest was proper. But there are no similar features in the present matter, which concerns a relatively simple forward contract for sale without any financing aspect; no question arises here of a liability accruing daily, as interest does, or otherwise accruing periodically.
In our view, no case for any apportionment has been made out by the Commissioner. The subject liability was incurred, in its entirety, in the 1988 year.
For these reasons, we would dismiss the appeal, with costs.
THE COURT ORDERS THAT:
1. The appeal is dismissed.
2. The appellant pay the respondent's costs.