Hallstroms Pty Ltd v Federal Commissioner of Taxation

72 CLR 634

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(Judgment by: Dixon J)

Hallstroms Pty Ltd v Federal Commissioner of Taxation

Court:

Judges: Latham CJ
Starke J

Dixon JMcTiernan J
Williams J

Subject References:
Taxation and revenue
Income tax
Assessable income
Deduction
Expenditure
Capital or revenue
Outgoings

Legislative References:
Income Tax Assessment Act 1936 No 27 - ss 51(1); ss 196

Hearing date: 1 August 1946; 2 August 1946
Judgment date: 7 October 1946

MELBOURNE

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Judgment by:
Dixon J

List of Judges

DIXON J. In reference to a question whether a payment belonged to capital or to revenue Lord Greene M.R. said in Inland Revenue Commissioners v British Salmson Aero Engines Ltd ^[F17] , at p. 498 that there had been many cases where the matter of capital or income had been debated. "There have been" he said, "many cases that fall on the border-line. Indeed, in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons." Other judges have been less explicit concerning the barrenness of the attempt to find reasons and instead have described the distinction as amounting to a question of fact. If this be right, there would seem to be no firm ground for interfering with the conclusion of the Board of Review, whose decision cannot be appealed from unless it involves a question of law. The reasons given by the members of the Board contain the appropriate citations from the customary authorities and I can discover in them no misapprehension of principle. It is true that in some of the reasons the word "right" is used to describe the liberty to use an invention when a patent expires and the patentee fails to obtain an extension, and it is also true that the successful opposition to the extension is described as a proceeding to acquire the right to carry on business by the use of the invention. But, even if the freedom to use the invention as of common right ought not to be so denominated, it is certain that the Board understood the legal nature of a patent and spoke thus only of the defeat of the attack upon this nascent liberty which the application for an extension of the monopoly threatened.

For myself, however, I am not prepared to concede that the distinction between an expenditure on account of revenue and an outgoing of a capital nature is so indefinite and uncertain as to remove the matter from the operation of reason and place it exclusively within that of chance, or that the discrimen is so unascertainable that it must be placed in the category of an unformulated question of fact. The truth is that, in excluding as deductions losses and outgoings of capital or of a capital nature, the income tax law took for its purposes a very general conception of accountancy, perhaps of economics, and left the particular application to be worked out, a thing which it thus became the business of the courts of law to do. The courts have proceeded with the task without, it is true, any very conspicuous attempt at analysis, but rather in the traditional way of stating what positive factor or factors in each given case led to a decision assigning the expenditure to capital or to income as the case might be. It is one thing to say that the presence among the circumstances of a case of a particular factor places the case within a specific legal category. It is another thing to infer that the absence of the same factor from some other case necessarily places that case outside the category and gives it an opposite description. But towards that kind of fallacy human reasoning constantly tends, and the decisions upon matters of capital and income contain much reasoning that is quite human. My own opinions upon the question I have attempted to explain in Sun Newspapers Ltd v Federal Commissioner of Taxation ^[F18] and I shall not re-state them. I shall treat the passage to which I refer as incorporated in this judgment. Once more, however, I shall endeavour to apply what I conceive to be the principles that determine whether an outgoing is on account of capital or of revenue. As a prefatory remark it may be useful to recall the general consideration that the contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.

The facts upon which the case before us must be decided present in a somewhat unusual aspect the elements or factors governing the distinction. The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.

The situation of the taxpayer, a company, was briefly this. The business of the company had been the manufacture and sale of household refrigerators. The business had suffered a decline because it had encountered the competition of a different and better kind of refrigerator. The decline was so severe that the company would have had to go out of business or into some other form of manufacture. The rival refrigerator was based upon different principles and involved a quite new construction. It made the taxpayer's refrigerator obsolete and, although much more costly, it rendered the sale of the latter impracticable wherever gas or electric power was available. It was the commercial expression of an invention covered by a patent, but the patent was soon to expire. The company, in anticipation of the date of expiry, re-organized its production in order to manufacture a new refrigerator according to the invention. The company entered into contracts for the supply of the new refrigerator, and, moreover, it went into actual production. Then it was faced with an application on the part of the patentee for an extension of the patent. If an extension had been granted, it would have been unlawful for the company to pursue any part of the programme for which it had undertaken the reorganization of its business and it was only by defeating the application that it was enabled to produce and sell the refrigerator embodying the invention and carry into effect the preparations for the manufacture and sale of the new apparatus.

The purpose of expending the money upon the opposition proceedings was to enable the taxpayer company to complete and carry into effect plans for re-organizing its manufacturing and selling business for the production and sale of an entirely different refrigerator. Thus, while a transition was being effected from the one form of product to the other as the subject of the company's business, a question arose whether a legal restriction upon the company's right to carry the change into effect and conduct the business in accordance with the change had come to an end or the restriction was to be extended. The expenditure was directed to ensuring that there should be no renewal of the restriction. This appears to me to go to the character and organization of the profit-earning business and not to be an incident in the operations by which it is carried on. I think that it is an affair of capital.

It is, of course, true that if the acquisition of a proprietary right had been the purpose, as for example the acquisition of the patent, had it been extended, or of a licence thereunder, there could have been no question that the cost of acquisition was a capital expenditure (Desoutter Bros. Ltd v J. E. Hanger & Co Ltd ^[F19] ). But, otherwise, I do not see wherein lies the importance of the fact that what the company aimed at and secured was the prevention of the prolongation of a monopoly restrictive of what otherwise would be the common right of the company to use the invention.

The use of the invention was a matter of special and lasting importance to the company, and to prevent the revival of the monopoly restricting it meant an economic or business advantage of greater value than the acquisition of an item of intangible property. The reason why the purchase of an asset such as the patent, if extended, would have been so clearly a matter of capital is, I think, only because of the greater ease with which its character and purpose are recognizable, its duration can be measured and its value estimated.

Once there is a clear appreciation of the actual place in the business of the company which the existence, expected termination and threatened extension of the patent took, then I think the difference between, on the one hand, gaining or preserving a freedom to use the invention as of common right and, on the other hand, acquiring the exclusive right of user which the extended patent would have conferred ceases to be significant in deciding whether the expenditure belonged to capital or revenue. What is an outgoing of capital and what is an outgoing on account of revenue 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. The fact that, on the defeat of the application of the patentee for an extension, it was open to others as well as the company to set up as manufacturers of refrigerators embodying the invention was, comparatively speaking, of little moment to the company. At worst it meant the risk of possible future competition with some additional manufacturer. What did matter was that the company should be enabled to place its business on a fresh foundation, by turning over to the production of a refrigerator according to the invention, and thus compete with the proprietor of the expired or expiring patent. It was for that purpose that the expenditure was incurred. The obstacle which was finally removed by the defeat of the application to extend the patent was much more than a hindrance or difficulty in the operations carried on by means of the company's established plant and its selling and general business organization. It was an obstacle to a readjustment affecting the company's plant, its product, its course of selling and its business organization. The legal expenses incurred in the final removal of this obstacle, or in preventing its continuance, ought not, therefore, to be regarded as an outgoing in the course of and as an incident to the carrying on of the profit-earning operations of the business, that is working the plant and organization according to an existing form and arrangement.

To adapt and add to some expressions used by the Chairman of the Board, it is concerned with the reform of or the more effective establishment of the organization by which income will be produced (the profit-yielding subject) and not with the means whereby that organization will be used for that purpose.

I am, therefore, of opinion that the expenditure was an outgoing of a capital nature and that the decision of the Board of Review disallowing the claim to deduct it is right.

The taxpayer placed great reliance upon two cases supporting an opposite conclusion. The first is Southern v Borax Consolidated Ltd ^[F20] . In that case the taxpayer carried on a business consisting in the mining, manufacture and sale of borax and other mineral products. A branch of its business, actually conducted in the name of a Nevada corporation, included land in Mormon Island, near Los Angeles, California, upon which for the purposes of the business wharves and buildings had been erected. In order to put itself in a position to require payment of tolls for the use of the wharves, the City of Los Angeles brought an action in the Federal District Court against the taxpayer and the Nevada corporation, claiming that the taxpayer's title to the land and buildings was invalid and that they were in fact the property of the city. Part of the land consisted of foreshore and the city contended that a grant of foreshore was invalid. After six years of litigation a new trial was ordered. It was said that, if the city succeeded, the taxpayer would have to pay tolls amounting to 40,000 dollars per annum, probably retrospectively. A claim was made to deduct the cost of the litigation, up to the order for a new trial, as a business expense, in computing the profits of the taxpayer. The deduction was allowed by the Commissioners and their decision was upheld by Lawrence J. Upon the facts as they appear from the case stated set out in the report ^[F21] I do not think that this decision can be supported. The costs were incurred in order to retain a capital asset of the company employed in the business as fixed capital and to avoid the payment, in consequence of its loss, of a charge upon revenue of indefinite duration. Next to the outlay of purchase money and conveyancing expenses in acquiring the title to the land, it would be hard to find a form of expenditure in relation to property more characteristically of a capital nature.

The basis of the decision of Lawrence J. may be seen from two passages in his judgment. In the first, his Lordship said: "In my opinion the principle which is to be deduced from the cases is that where a sum of money is laid out for the acquisition or the improvement of a fixed capital asset it is attributable to capital, but that if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to revenue, being in substance a matter of maintenance, the maintenance of the capital structure or the capital assets of the company" ^[F22] . The first or positive statement contained in this passage is open to no substantial objection, but the second, the converse and negative proposition that if no alteration is made in the capital asset by the payment it is a revenue expenditure, appears to me to have no foundation in principle or authority. No alteration in a fixed capital asset was effected by the outlay that was in question in what has become the leading case upon the subject (British Insulated and Helsby Cables Ltd v Atherton ^[F23] ) and there was none, to take one or two examples only, in English Crown Spelter Co Ltd v Baker ^[F24] ; in Countess Warwick Steamship Co Ltd v Ogg ^[F25] in Collins v Joseph Adamson & Co ^[F26] (at all events as to one of the two payments) and in Henderson v Meade-King Robinson & Co Ltd ^[F27] , at p. 105. The New Zealand decision in Commissioner of Taxes v Ballinger & Co Ltd ^[F28] seems much in point and is quite opposed to the view of Lawrence J.

The second passage in the judgment of Lawrence J. reads thus: "It appears to me that the legal expenses which were incurred by the respondent company did not create any new asset at all, but were expenses which were incurred in the ordinary course of maintaining the assets of the company and the fact that it was maintaining the title and not the value of the company's business does not, in my opinion, make it any different" ^[F29] .

It is possible to find in this statement two reasons not necessarily interdependent. One is the lack of any fresh acquisition of assets. That, in my view, does no more than put aside one possible state of facts in which the payment would have certainly been of a capital nature. The other is that the defence of the title against impeachment amounted to maintenance, the costs forming part of the business expenditure in the ordinary course upon maintaining the company's assets. An analogy which suggests itself is the cost of restoring the front door of the business premises after an attempted entrance by bandits. No ground was disclosed in the case stated, as set out in the reports, and none exists in the known customs or propensities of Californian city authorities, for supposing that the company was exposed to regular or recurrent attacks upon the validity of its title. His Lordship probably did not doubt that the purpose of the litigation was to decide once and for all whether the taxpayer had or had not a valid title; but, as appears from the first of the foregoing passages cited from his judgment, his Lordship regarded outlays making no alteration in a fixed capital asset as amounting in substance to a matter of maintenance. I should have thought that the decided cases illustrated the fact that these are not exhaustive alternatives. A decision of the Canadian Supreme Court that is entirely at variance with the view of Lawrence J. is the Minister of National Revenue v Dominion Natural Gas Co Ltd ^[F30] .

The second case upon which, during the argument of this appeal, counsel for the taxpayer placed great reliance is Kellogg Co of Canada Ltd v Minister of National Revenue ^[F31] . The legal expenses there in question were those of defending successfully an action against the taxpayer and one of the traders through whom the taxpayer distributed its products. The action was for infringement of the trade marks of the plaintiff, a rival manufacturer, and the defence was the invalidity of the registration. It was held that the costs were deductible as a business expense on account of revenue. The full judgment of Maclean J. in the Canadian Exchequer Court draws the line in accordance with the English authorities which are ordinarily cited in such questions and negatives in the facts the indicia of a payment on account of capital commonly looked for. He concluded "That" (the payment of legal expenses) "was an involuntary expense, not a disbursement incurred once and for all, or for the benefit of a trade, within the meaning of such cases as I have earlier discussed. Again, this is not a case of a payment made once and for all in substitution of a `recurring' annual payment, as no such payment was ever made by Kellogg, and equally true is it, I think, that the expenses here were not incurred for the purpose of earning future profits" ^[F32] .

The gist of the short judgment of the Canadian Supreme Court on appeal is contained in the statement of Duff C.J. that "in the ordinary course legal expenses are simply current expenditures and deductible as such. The expenditures in question here would appear to fall within this general rule" ^[F33] . I see nothing in this decision but an application of principle to particular facts.

I have dealt with the two foregoing cases at length, not because I think that in the stream of authority they have any special importance, but because the appellant's argument depended so much upon them.

In my opinion the appeal should be dismissed.