Guinea Airways Ltd v Federal Commissioner of Taxation

(1950) 83 CLR 584 (Dixon J - 22 December 1949 - (decision appealed))
[1950] HCA 60 (Dixon J - 22 December 1949 - (decision appealed))
(1950) 83 CLR 584 at 588 (Full Court - 13 November 1950)
[1950] ALR 913 (Full Court - 13 November 1950)

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(Judgment by: Dixon J (decision appealed))

Between: Guinea Airways Ltd
And: Federal Commissioner of Taxation

Court:

Judges:
Dixon J (decision appealed)Latham CJ
McTiernan J
Webb J
Fullagar J
Kitto J

Hearing date:
Judgment date: 22 December 1949 (Dixon J); 13 November 1950 (Full Court)

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Judgment by:
Dixon J (decision appealed)

This is an appeal from an assessment to income tax for the financial year ending 30th June 1943 based on income derived during an accounting period of twelve months ending 28th February 1942. The appellant, an incorporated trading company, carried on the business of transporting passengers and goods by air in Papua and New Guinea. The base for its air services was Lae in New Guinea. There it had hangars workshops stores and other buildings. On 21st January 1942 the Japanese Air Force bombed Lae and the company's building stores and equipment were destroyed. Among the property destroyed were large quantities of spare parts for the airframes and engines of the company's aeroplanes. In accordance with the common practice of air transport services the company maintained a large stock of spare parts. The spare parts were stored in bins whence they were drawn as occasion required. In addition to the stock of spare parts for aeroplanes the company also carried at Lae a store of equipment and other things needed for the maintenance of the depot. This too was destroyed. In respect of its various losses as a result of the bombing at Lae the company claimed compensation under the National Security (War Damage to Property) Regulations. In pursuance of reg. 38 the War Damage Commission assessed the amount of the loss and recorded it. At that time under reg. 38 (3) the amount of compensation assessed and recorded was to be tentative only and did not become payable until the end of hostilities, when it might be reviewed. The law was afterwards changed by S.R. No. 4 of 1945. The amount at which the War Damage Commission recorded the loss in respect of spares for aircraft was 19,570 pounds and the loss in respect of general stores 7,510 pounds. The aircraft stores stood in the books of the company at a figure which may be taken to be 25,361 pounds and the general stores at 7,702 pounds. The difference is in the one case 5,791 pounds and in the other 192 pounds, making in all 5,983 pounds.

This difference the company claims to deduct from its assessable income in arriving at the taxable income of the accounting period. The accounts in which stood the respective figures of 25,361 pounds for aircraft stores and of 7,702 pounds for general stores consisted in the one case of an assets account known as the Aircraft Spares Account and in the other of an analogous account called the General Stores Account. When aircraft spares were purchased and taken into store at Lae the Aircraft Spares Account was debited with the cost into store consisting of the prime cost together with freight insurance duty and other charges. When spare parts were drawn and issued from the store for use, an amount was charged against running costs consisting of the cost into store of the spare parts so issued with ten per cent added. The corresponding credit of the amount so charged was divided into two. The added ten per cent was credited to an account called the Reserve for Depreciation Aircraft Spares New Guinea Account. The cost into store was credited to the assets account called the Aircraft Spares Account. The result would be that the debit balance of this latter account should show the cost into store of the aircraft spares which had been taken into the bins and had not been issued.

The same system of accounting was applied to the General Stores Account. In the balance sheet of the company apparently it was the practice to show the total of the debit balances of the two accounts on the assets side under "Inventory: Spare Parts: Stores etc. less Depreciation". But at what figure does not appear, since the balance sheet in evidence is compiled as at 28th February 1942 after the bombing and shows the war damage claim as an asset. It was not explained why the War Damage Commission recorded the amount of compensation at 5,983 pounds less than the book value of the spare parts and stores but there is something to suggest that the amount disallowed represents articles that had been in stock so long as to be obsolete or to have depreciated, possibly through deterioration.

The sum of 5,983 pounds which the company claims to deduct from its assessable income may thus represent a loss in value that had in fact accrued, but had not been ascertained, before the bombing. It may however represent part of the existing value of what was destroyed by the bombing, a part that the company has failed to recover from the War Damage Commission.

In either view the company claims that the loss is deductible under s. 51 of the Income Tax Assessment Act 1936-1942. In my opinion this contention of the company must fail on the ground that the loss was a loss of capital or of a capital nature.

The company had formed or built up a reservoir of spares for aircraft and of stores of considerable size and value and maintained it as part of its permanent establishment. It does not appear whether it had been built up gradually or formed initially, but it is immaterial which way it was done. To maintain an available stock of spares and stores at a proper level the requisite amount of capital must be committed to the purpose. The ingredients in the stocks might change. Spares would be drawn and new spares taken into store in the ordinary course of business. But the stock of spares remained. The existence of the stock of spares was a feature of the permanent organization of the enterprise. It formed part of the general equipment. When spare parts were issued and taken into use, it was right no doubt to debit the cost to running expenses, though whether for purposes of income tax the ten per cent could be added is another matter. But it by no means follows that the spare parts constituting the reservoir represented anything but capital. Moreover the stocks did not represent circulating capital. Money was not laid out in the purchase of spare parts and then recovered, together with a profit, on their resale.

Stock in trade, because of its nature and function, is valued at the beginning and end of an accounting period and if any part of it is lost or destroyed in the interval the loss is reflected in the comparison of the two values. But the permanent stock of spare parts and stores forms part of the profit yielding subject, as Lord Blackburn called it in United Collieries v. I.R.C. (1929) 12 TC 1248 , at p 1254 ; cf. Sun Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 CLR 337 , at pp 359-363 . In Abbott v. Albion Greyhounds Ltd. [1945] 1 All ER 308 it was agreed that the cost of buying greyhounds for the purpose of filling gaps in the kennels of a dog racing company was a deductible expense, but a distinction was drawn between that and raising or increasing the establishment, which, as I read it, Wrottesley J. considered would involve a capital expenditure, as the Crown said. The racing life of a dog is less than two years. But the dogs were not the company's stock in trade to be valued. That case provides an illustration of the principle.

The stores and the spare parts have not gone into use or consumption. The sums of 7,702 pounds and 25,361 pounds which the company said was their value was money locked up in the bins and the stores with the stocks of spares and other things they always contained. The reservoir of spare parts and stores is from a business point of view an entity existing independently of the changing identity of the elements forming it. The loss that the company has suffered simply represents part of the value of the entity. There has never been any attempt in the company's accounts to treat the expenditure incurred in establishing it, or in building it up, as a revenue expenditure. No debit was made to revenue account until a spare part was issued and went into use. No part of the 25,361 pounds or the 7,702 pounds is or has been reflected in profit and loss. For these reasons I think that the loss is one of capital or at all events is of a capital nature and cannot be deducted under s. 51.

The commissioner relied upon further answers to the company's use of s. 51 in support of its claim to the deduction. But, as I accept the commissioner's view that the loss is an affair of capital, it is unnecessary to discuss them.

On behalf of the company, however, some reliance was placed on s.59. Section 59 could not apply unless the spares or the stores, as the case may be, were brought within s. 54. Even if they could be treated as "plant" within that provision, which I doubt, I do not think that it could be said that that thay had been used during the year for the purpose of producing assessable income or had been installed ready for use for that purpose. These, or one of them, form essential conditions of the application of s. 54.

In my opinion the claim to deduct the loss fails. The appeal will be dismissed with costs.

From this decision Guinea Airways Ltd. appealed to the Full Court.