Case W22

Members:
P Gerber DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 2 February 1989.

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Dr P. Gerber (Deputy President)

The applicant is an advertising agency (henceforth referred to as ``the agency'') which derives its income in part from acting as a broker for advertisers who wish to place advertisements in the media (television, radio, print). The applicant is an accredited member of the Media Council of Australia (MCA) which is the Australian media accreditation authority. The rules governing accreditation of advertising agents define ``Accredited Agent'' as meaning ``an advertising agent which has been granted and which holds current accreditation pursuant to these rules''. As a member of the MCA, the applicant is subject to its advertising code of ethics, a breach of which can lead to cancellation or suspension.

2. The booking system employed by the agency was neatly summarised by Mr Maxwell, of learned counsel for the applicant: ``The agency will, in advance, book media time with a media outlet, being time which, at the date of the booking, is identified for use by a particular client for a particular advertisement''. Once an advertisement has been screened (using television as the example throughout), the agency invoices its clients for, say, $100, being the cost of screening the advertisement. The media, in turn, invoices the agency. There are thus two invoices and, in due course, two payments. The advertiser pays the agency $100 within (hopefully) the period agreed upon (generally 30 days after the advertisement has been screened - see standard ``letter of agreement'', infra); the agency pays the media $90 within (again hopefully), the period agreed upon (generally 45 days after the advertisement has been screened - see r. 24(a) of MCA Rules, infra). The difference of $10 in the example quoted above constitutes the agency's 10% commission - the source of its profit. The method of payment to the media, adopted by the agency is a form of accounting self-help or ``short hand'', representing a deduction of the commission owed by media to agency. In accounting terms agency has ``incurred'' a liability of $100 and ``derived'' income of $10. If each advertiser pays on time, there is a mere flow-through of funds, so that the agency has no recourse to its own funds to pay the media because, as has been noted above, there is provided a 15 day time interval between the agency being paid by its advertisers and its commitment to pay the media. (The word ``commitment'' has been carefully chosen as being neutral, since it was submitted on behalf of the respondent that the agency was not liable for the cost of advertising booked on behalf of advertisers and/or, if there was such a liability, it was not ``incurred'' in the year in which it was claimed as a deduction.)

3. A standard ``letter of agreement'' between advertiser and agency provides for payment between advertiser and agency:

``AGENCY will bill ADVERTISER at gross cost for all media plus a service of fee of 7.5 percent. Where MEDIA do not allow AGENCY commissions of 10 percent or more, AGENCY will charge ADVERTISER 19.44 percent of nett, less commission allowed by MEDIA if any, to bring AGENCY remuneration to the equivalent of 17.5 percent of gross MEDIA expenditure. ADVERTISER will pay AGENCY'S advertising account within 30 days of the end of the month in which AGENCY'S advertising appears (e.g. June account will be paid by July 31).''

4. The MCA Rules provide for the obligation by the agency to pay the media for advertising costs incurred. Thus r. 18 provides:

``Each accredited agent shall accept responsibility for the payment of its client's accounts in respect of all orders received from or through the accredited agent.

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Signature to an advertising order shall be by the accredited agent and signature `for and on behalf of' his client will not be accepted.''

Time for payment is provided by r. 24(a):

``An accredited agent will be liable for payment of all advertising placed... and such payment will be due from him or it... not later than the thirtieth day of the month following that in which such advertising is published. If payment is not made on or before the fifteenth day of the second month following that in which the advertising is published,... no commission shall be allowed by the Media Proprietor to the accredited agent.''

5. Provision is also made in the rate cards (the media's periodic price list) for the eventuality of cancellation, a feature heavily relied on by the respondent. The documentary evidence disclosed that as between advertiser and media, a booking may, in some circumstances, be cancelled. However, such cancellation must be in writing and given not less than 70 days before the advertisement is due for screening. It was established in evidence that the term ``media booking subject to non-cancellable'' 70 days before the advertisement is due to be screened. This is no doubt a sensible commercial arrangement since no media can afford to have advertisers ``chopping and changing''. This does not mean that the advertiser is prevented from cancelling - obviously he can request that the advertisement be simply not run - what it does mean is that a post-70 days cancellation carries its own potential penalties. The evidence for the applicant goes further, and witnesses were called who asserted that once the threshold into the ``non-cancellable'' period is crossed, the media looks to the agency for payment, subject to certain practices or conventions within the industry. The respondent, on the other hand, asserts that in reality, such ``liability'' is more apparent than real.

6. Turning to the facts of this case, unlike most taxpayers, this applicant has chosen to end his accounting period on 31 December of each year. The financial/calendar years in dispute are 1984 and 1985. For the year 1984, the applicant objects to the disallowance by the Commissioner of a deduction for ``media bookings subject to non-cancellation''; and for 1985 the applicant asserts - unusually - that it has not been taxed enough.

7. To understand the applicant's position one must go back to an earlier fiscal period. In the year ended 31 December 1982, there was in the applicant's accounts a figure of $21,215 under the heading ``Media Bookings subject to non-cancellation''. On 31 December the following year (1983) that figure was $771,414. The applicant then took the difference between these two figures ($750,199) and claimed it as an allowable deduction in that tax year under sec. 51(1) on the basis that it represented a liability for advertising booked on or before 31 December 1983 which had, by the effluxion of time, become ``non-cancellable'' and was thus ``incurred''. At the end of the 1984 year, the balance in the media bookings subject to non-cancellation had increased to $1,270,467, and so a deduction of the difference ($499,053) was claimed and disallowed. However, by 31 December 1985, the balance was only $1,079,144, thus reversing the trend of annually increasing non-cancellable media bookings. The difference between the 1985 and 1984 balance ($191,323) was thus added back as part of the company's assessable income. Hence, and unusually, the applicant says that it has not been assessed enough in that year. Setting out the accounts year by year:

         Year                  Balance,                  Deduction
                        non-cancellable media             claimed
                               bookings
                                   $                         $
         1982                   21,215
         1983                  771,414                   750,199
                               -------
         1984                1,270,467                   499,053
                             ---------
         1985                1,079,144                  (191,323)
                             ---------
      

8. It was not contested that the MCA only grants accreditation to those agencies which are able to demonstrate and maintain certain secure ratios of assets and liabilities. It follows that accreditation attests to an agency's financial viability and that a loss of accreditation would have severe commercial consequences. If the MCA rules govern the conduct of accredited agencies - as I find they do - it follows that the agencies have accepted a liability for payment to the media. A similar view was adopted by the Trade Practices Tribunal in Appeal Hearing No. 2 of 1976. In those

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proceedings, the Tribunal noted that ``accredited agents are responsible for payment of all their clients accounts...''. The question whether, in the circumstances, the media can also look to the advertiser for its charges is therefore beside the point. But the question still remains: has the agency ``incurred'' an expenditure on the facts as found above?

9. I commence my investigation into the law by adopting the useful summary applied by Menhennitt J. in
R.A.C.V. Insurance Pty. Ltd. v. F.C. of T. 74 ATC 4169. In that case, the taxpayer, an insurance company, brought into its accounts in the one tax year as ``losses incurred'' not only those claims which had been paid, but claims which arose in the sense of being claims of which the company had been merely notified. In finding for the taxpayer his Honour observed at pp. 4179-4180:

``The conclusions I have stated appear to me to accord with the authorities. What do and do not constitute losses and outgoings incurred is dealt with in the following passage from the judgment of Dixon C.J., Webb, Fullagar, Kitto and Taylor JJ. in
F.C. of T. v. James Flood Pty. Ltd. 88 C.L.R. 492 at pp. 506 to 508 -

• `For under our law the facts must satisfy the expression `losses and outgoings incurred'. These words perhaps are but little more precise than the word `established' or the expression used above `definitively committed'. But they do not admit of the deduction of charges unless, in the course of gaining or producing the assessable income or carrying on the business, the taxpayer has completely subjected himself to them. It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time. It is probably going too far to say that the obligation must be indefeasible. But it is certainly true that it is not a matter depending upon `proper commercial and accountancy practice rather than jurisprudence'. Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by sec. 51(1) but it cannot be substituted for the test.
• To repeat what has been said before in relation to an analogous provision in the Act of 1922-1934: `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.';
  New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 C.L.R. 179 at p. 207. Nothing that was decided in
  W. Nevill & Co. Ltd. v. F.C. of T. (1937) 56 C.L.R. 290 was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable... But whatever be the rationale of the decision of the point, clearly enough it is not based on a view that no outgoing could be incurred until actual payment was made. It is one thing, however, to say that it is not necessary, for the purposes of sec. 51(1), that an actual disbursement should have taken place. It is another thing to say that in the present case the taxpayer had incurred a loss or outgoing in the year of income in respect of the pay of its men during the annual leave to be taken in the ensuing accounting period by employees whose service had not as yet qualified them for annual leave. In respect of these employees there is no debitum in praesenti solvendum in futuro. There was not an accrued obligation, whether absolute or defeasible. There was at best an inchoate liability in process of accrual but subject to a variety of contingencies.'

The decision in that case was that there was no loss or outgoing incurred in respect of payment for annual leave pursuant to an award until the leave became due. Considerable significance was placed by the Court upon the provisions of the award which made it clear that nothing was payable until twelve months had been served and it was held that no loss or outgoing had been incurred in respect of an incomplete portion of a twelve months

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period which arrived at the end of a financial year. It was in relation to that situation that the Court said that there was no debitum in praesenti solvendum in futuro and no accrued obligation whether absolute or indefeasible.''

10. While it is true that the wider construction given to the term ``accrued obligation'' in Flood's case was questioned by Barwick C.J. in
Nilsen Development Pty. Ltd. & Ors v. F.C. of T. 81 ATC 4031, his caveat can have no bearing on a case - as here - where the liability ``has come home''. Indeed, in Nilsen, his Honour (at p. 4035) adopted as correct the language of Sir John Latham in
Emu Bay Railway Co. Ltd. v. F.C. of T. (1944) 71 C.L.R. 596 where, at p. 606, he indicated that to satisfy the word ``incurred'' in sec. 51(1), it is sufficient to say that the liability must be ``presently incurred and due though (it may be) not yet discharged''.

11. I am satisfied that this case is wholly governed by the reasoning of Menhennitt J. in the R.A.C.V. case which, on this aspect, has withstood the test of time. Having concluded that the arrival of the 70 day non-cancellable period has the effect of creating a present or current indebtedness which must be paid in the future, it follows that the loss is ``incurred'' at that point in time. There and then the agency has crossed the Rubicon and what may happen on the other side is not to the point. It may well be that in some circumstances the debt is forgiven, or may be subject to what was referred to as a ``drop and charge'', the latter involving some renegotiation between the media and agency which may - and no doubt often does - result in the advertisement still being screened, albeit in a less popular slot. Be that as it may, it can have no effect on the outcome of this application. Much time was thus needlessly taken up with witnesses, called to depose as to the practice in the industry with respect to ``non-cancellable'' bookings and, not unusually, there was substantial disagreement. Their testimony on the consequences of bookings cancelled beyond the ``non-cancellable'' period - ranging, as it did, from being an obligation ``almost always enforced against the agency'' to ``hardly ever'' - is, in my view, irrelevant. If, as happens, a booking is forgiven in the subsequent year, the appropriate adjustment will no doubt be reflected in the agency's accounts.

12. I am therefore satisfied on the evidence that the basis of accounting adopted by the taxpayer is appropriate to reflect its true income, year by year.

13. For the above reasons I consider that the objection should be allowed in each of the years now under review. The decision of the Tribunal is that the objection decisions be set aside.