CASE 55/95

Members:
BJ McMahon DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 3 October 1995

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BJ McMahon (Deputy President)

The applicant had a long career in the Royal Australian Navy. He retired in 1988 with a senior rank. During the Second World War, he was involved as a junior officer in a naval engagement which resulted in heavy losses. According to a Foreword included in the s 37 documents, the experience made a deep impression on the applicant. The telling of the

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ATC 455

story of that engagement was to be repeated at various times during his career.

2. After his retirement, he decided to write a book about the engagement, the people involved, the decisions they made and the lessons to be learned by commanders from the events of that battle.

3. Research for the book began in 1990. At that time the applicant was not resident in Australia for tax purposes, but in England. His naval pension, being sourced in this country was, of course, liable to Australian taxation.

4. He claims to have incurred certain expenses in connection with the writing of the book in the financial years 1991, 1992 and 1993. This claim was first made on 27 October 1994 by a tax agent who does not appear to have participated in the appeal process.

5. It took the form of a request which was ``made to reopen the assessment notices and allow the expenses and thus reduce the taxable income as shown below''. There followed columns showing the applicant's taxable income as assessed in l991 and 1992, the amount of authorship expenses said to have been incurred during those 2 years and the resulting reduced income. The same treatment was accorded to figures for 1993 although, at that stage, an assessment had not been issued for that year.

6. It came on 8 December 1993 and showed the applicant's income as returned to be the same as the 1993 income referred to in the letter. If the letter was taken into account by the assessor, the request to reopen (or amend the return) was clearly not acceded to. Instead, the letter appears to have been dealt with for the first time in a letter from the Commissioner dated 7 March 1995 which, omitting formal parts, is in the following terms-

``Consideration has been given to your amendment request of 27 October 1994 for the years ended 30 June 1991 to 30 June 1993 inclusive.

You are advised that the expenses claimed in respect of researching a book proposed to be published and in respect of which no royalties will be received until income year 1994/95 are considered to be expenses of a capital nature and accordingly not deductible under subsection 51(1) of the ITAA.

Further, royalties derived by a non-resident are subject to a final withholding tax under sec. 128B(2B) from the commencement of the non-resident's 1993/94 year of income. Income subject to withholding tax is therefore excluded from assessable income under sec. 128D, and accordingly any expenditure in connection with this will not be deductible under subsection 51(1) of the ITAA.

For these reasons, we are unable to allow your claim. Your request for amendment has therefore been disallowed and the assessments for the years 1991 to 1993 are accordingly confirmed.''

7. In its terms, it does not purport to be a decision given in response to an objection. The parties, however, appear to have treated it as such in relation to the 1993 year notwithstanding the fact that the objection came before the assessment was issued. It is the decision which this Tribunal has been asked to review.

8. So far as the l991 and 1992 years are concerned, the respondent by letter of 14 June 1995, which in some respects appears to be inconsistent with the letter of 7 March 1995, took the view that objection rights for assessments for the 1991 and 1992 years had expired. No attempt appears to have been made to apply for an extension of time. No attempt appears to have been made in the second letter to deal with the applicant's agent's letter in its own terms as a request to amend the original returns. However, the applicant (for whatever reason) agreed eventually to withdraw the application to this Tribunal in respect of the years 1991 and 1992 and a formal withdrawal was signed for that purpose. Applications relating to those 2 years bear the Tribunal references NT95/139 and 140. Pursuant to s 42A(1B) of the Administrative Appeals Tribunal Act 1975 the effect of lodgement of that notification was that the Tribunal was take to have dismissed the applications without proceeding to review the decisions. Such a dismissal, of course, does not constitute any considered decision on the issues, nor does it raise any form of issue estoppel.

9. The only matter remaining for decision, therefore, is whether the so-called objection decision rejecting a claim for deduction for expenses in the 1993 year was correct.

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10. Some face to face conferences were held but before this matter could be listed for an oral hearing, the applicant was obliged to return to England. The parties were therefore asked whether they would consent to the Tribunal deciding the matter on the material before it. The Tribunal may inform itself of the relevant facts in any way that may seem appropriate, subject always to the requirements of the Act and of procedural fairness. Where one party is unable to attend the usual form of oral hearing conducted by the Tribunal, it is not uncommon to decide questions ``on the papers'' with the consent of both parties. In the present case, consent was given subject to conditions. Both parties reserved the right to make additional submissions which were received in due course. The applicant was not legally represented and, in accordance with Tribunal practice, was not required to comply fully with the General Practice Direction. As a result, no affidavit of facts was prepared or filed. Nevertheless the facts necessary for the present decision are, in my opinion, not in real dispute and may be adduced from probative material already in the file.

11. The following expenses are said to have been incurred in the 1993 year. No issue of substantiation has been raised by the respondent. I have no reason to doubt that they were in fact incurred. They are attached as a schedule to the letter of 27 October 1994 from the applicant's then tax adviser-

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  ``Postal charges
    --------------
Stamps                                                         $53.48
Other charges                                                  $30.63

Telephone charges
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Telephone calls                                               $263.81
Rental and Service Charge on 20% useage for book               $53.02
FAX                                                           $134.73

Duplication charges
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Photocopying                                                  $246.46

Stationary [sic]
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Computer paper, discs etc                                      $70.06

Transport to Australia from London of papers
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Freight and Customs Charges                                   $374.89

Expenses associated with use of word processor
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Purchases in November 1989 for $950. Depreciation at
25 percent per year. Value July 1992 $456. Used on
book matters for 90% of the time. Depreciation 1992-93.       $103.00
                                                              =======

TOTAL CLAIMED FOR 1992-93.                                   $1330.08''

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12. The book was published in Australia and elsewhere in the 1995 financial year. According to the letter of 27 October 1994, the applicant expected to receive royalties during that year.

13. The claim was rejected and the reasons for rejection were set out in the letter which I have quoted. The reasons for the decision given in the s 37 statement are as follows-

``1 A non-resident cannot claim expenses under subsection 51(1) or Division 10B of the ITAA in respect of income subject to withholding tax under subsection 128B(2B) of the ITAA.

2 Section 128D of the ITAA excludes from assessable income royalties upon which withholding tax has been paid.

3 Any income that may be derived by the taxpayer from the book `[title]' will be royalty income (see section 6 of the ITAA)''

14. I will deal first with aspects concerned with Division 10B and s 128B of the Income Tax Assessment Act. Section 124L sets out the preconditions for the application of the Division. Relevantly, it is alleged by the Commissioner to have possible application in the present circumstances because the applicant

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is the first owner of the copyright and he incurred expenditure of a capital nature directly in producing the work. Sub-sections 124M, 124S and 124U provide a scheme for allowing deductions in those circumstances based on calculations of the residual value of a copyright and its effective life. The deductions are not allowable however unless the work is used in the production of assessable income.

15. The Commissioner takes the view that the income anticipated from royalties to be derived from the sale of the book will not be assessable, because such royalties will be subject to withholding tax provisions. These are set out in s 128B and provide for a regime of deduction of withholding tax at a flat rate with no provision for allowable deductions. Section 128D provides that where withholding tax is payable, the net income is not to be included in the assessable income of a person. The Commissioner reasons that as the applicant is a non-resident, any royalties which will flow in the future from the sale of copies of the book will be subject to withholding tax. The balance that will be remitted to him will not be assessable income. Consequently he will not be deriving assessable income which would allow him to claim deductions under Division 10B, even if it could be said that he had acquired the copyright through the incurring of expenditure of a capital nature.

16. In my view, this is a flawed approach to the assessment. There is in fact no evidence concerning the arrangements made between the applicant and his publisher. It may well be that the first copyright was sold for a lump sum. It may also be that no royalties are payable until production costs are recouped (if ever). There is simply no basis upon which either the Commissioner, or I, can safely say that royalties will be paid to and received by the applicant in the future. More importantly, however, the chain of reasoning depends upon a continuation of the applicant's status as a non-resident.

17. In his submissions, the applicant claimed that in the 1995 year he was in fact a resident of Australia. There is no evidence before me one way or the other to support or reject such an assertion and I make no finding on his status for the 1995 year. Such a claim, however, does point up the danger of assuming that an existing state of affairs will continue indefinitely.

18. The objection decision is predicated on the basis that the applicant will continue to be a non-resident in the indefinite future and certainly while there is a prospect of royalties to be paid. Unless this assumption is made, the whole process of reasoning breaks down. In my view, it is not appropriate to deal with an objection upon predications and unwarranted assumptions as to the future residence of the applicant. It is inappropriate to say, in effect, that because the Commissioner considers that you will continue to reside in England, it is likely that any royalties you may earn in the future will be subject to withholding tax and that therefore you will not have any assessable income in respect to those royalties and that therefore the Division 10B deductions are not available to you. This is in effect what the Commissioner has done.

19. The same assumption as to continued non-residence has been made in addressing the question whether the expenses are deductible under sub-section 51(1). It is said that as the expenses were incidental and relevant to the earning of income which (the Commissioner assumes) will not be assessable, it follows that the sub-section which makes available for deduction losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, is not available to the applicant. As I have said, it is not safe for the Commissioner to assume that moneys to be paid to the applicant in the future will not be assessable income. There is no reasoned basis upon which such a conclusion can be founded.

20. In my view, the applicant's claim must be regarded as one to be decided in accordance with the normal tests of s 51(1), the claim being for a deduction incurred in the 1993 year. Provided the expenses are otherwise deductible, the fact that they were incurred before income was derived does not, in itself, determine the issue of deductibility adversely to the applicant. This has now been made clear by a Full Court of the Federal Court in
Placer Pacific Management Pty Limited v FC of T 95 ATC 4459. It was a position that was expressed, obiter, by the High Court earlier in
AGC (Advances) Ltd v FC of T 75 ATC 4057. Were the expenses in the present case otherwise deductible?

21. The first observation to make concerning the expenses is that they do not appear to be of a capital, private, or domestic nature. The ``essential character'' of the expenses, outlined above, clearly confines them to a revenue rather

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than a capital account. There have been many decisions which have found the ``essential character'' test useful starting with
Charles Moore & Co (WA) Pty Ltd v FC of T (1956) 11 ATD 147; (1956) 95 CLR 344 to the more recent case of
FC of T v Edwards 94 ATC 4255. In the present circumstances, there can be little doubt that the nature of the expenses, the subject of the claim, have the essential character of expenditure incurred in the course of gaining or producing what must be assumed to be assessable income. The essential character test is also applied to determine if expenditure is of a capital, private, or domestic nature (see for example
FC of T v Cooper 91 ATC 4396 per Lockhart J at 4400 to 4402).

22. The Commissioner submitted that the expenses could be viewed as preparatory to the income earning activity and relied on the often cited dicta of Menzies J in
FC of T v Maddalena 71 ATC 4161. It is true that in the present circumstances the expenditure was incurred before the anticipated stream of income began. Nevertheless the character of the expenses indicate that they are by no means preparatory. It is not unreasonable to assume, for example, that the claim for expenses associated with the use of a word processor is a sufficient indication that in the year in question the applicant was actually writing the book. He was not preparing to write the book. The nature of the other expenses claimed indicate that they also arose from a working situation and were not moneys outlaid in accordance with the Maddalena principles.

23. The Commissioner also argued that because the expenses were incurred in relation to the production of a book, copyright of which is owned by the applicant, the relevant items must be regarded as expenditure incurred in the acquisition of an item on the capital account. In my view, this argument can not be sustained. What is capital expenditure is always a matter of fact. It can not be said that everything spent by an author which is incidental and relevant to his work must be regarded as capital expenditure because one day he will finish and thereby create a capital asset, the copyright of which he will own. The items involved are not in their nature items of capital expenditure. They are not directed to the construction of a capital asset, even though one may result incidentally from the expenditure of the amounts claimed. The expenses have the classical revenue characteristics referred to by Dixon J in
Sun Newspapers Limited v FC of T (1938) 5 ATD 23; (1938) 61 CLR 337 as being recurrent, repeated, or continual.

24. I do not consider that the second limb of s 51 has any application in the present circumstances. In that respect, I agree with the submissions made by the Commissioner. There was a statement by the applicant in his submissions that part of the book had been published separately in a periodical in 1991. This was not evidence that could be tested, however, and in any event does not, in my view, affect the correct conclusion to be drawn on this aspect. The book is the applicant's first work as an author. There is no evidence that he is likely to write other works. There is no evidence to suggest that this may be the beginning of a business. There is no evidence of the ``significant commercial purpose or character'' which distinguish a pursuit of profit or gain from the pursuit of an interest (
Thomas v FC of T 72 ATC 4094 at 4099; 46 ALJR 397 at 401). What evidence is before me indicates that the applicant has drawn upon his reflections and research in relation to one incident that has concerned him for a number of years, and has pursued the recording of that interest with vigour. This does not constitute the carrying on of a business, or even evince an intention of carrying on a business in the future.

25. If the sums claimed are to be deductible, the claim must be founded upon the first limb of s 51. Looked at at the time the claim was dealt with by the decision-maker, it seems to me irresistible that the deduction should be allowed. There is a clear connection between the expenses and the anticipated income to such an extent that the expenses may justifiably be described as working expenses. As I have said, I see no basis for the operation of the exclusionary words of s 51, nor for any reasonable basis for assuming that the working expenses were incurred in deriving anticipated non-assessable income. There is, of course, no connection between these working expenses and the applicant's other Australian income, the naval pension. In my view, however, there is clear evidence of connection to the necessary degree between the incurring of the expenses claimed and a reasonable anticipation of gaining of assessable income in the future. That being so, I consider the applicant is entitled to his deduction. The objection decision is set

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aside and the matter is remitted to the respondent with the direction that an Amended Assessment be issued for the year ended 30 June 1993 allowing as a deduction the sum of $1330.08.

26. It will be noted that matters Nos NT95/139 and NT95/140 are taken to have been dismissed pursuant to s 42A(1B) of the Administrative Appeals Tribunal Act 1975.