Edited version of your private ruling

Authorisation Number: 1012501796454

Ruling

Subject: Timing of deduction for payment

Question 1

Whether Company C has incurred a loss or outgoing for purposes of section 8-1 at the time when a decision-maker makes a decision.

Answer

Yes.

Relevant facts and circumstances

Company D is a member of the income tax consolidated group of Company C.

Company D and Company B are in dispute as to the application of certain contractual terms which relate to a few years.

Company D obtained appropriate professional advice in support of its position that the terms did not render Company D liable to a payment.

Company D and Company B undertook negotiations which were unsuccessful in resolving the dispute.

A decision-maker for this matter decided that Company D was liable to pay Company B

Company D paid the amount to Company B.

Prior to the decision, Company B did not recognise a liability in its accounts arising from the contractual terms.

Relevant legislative provisions

Section 8-1 Income Tax Assessment Act 1997.

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified.

Incurred

There is no statutory definition of the term 'incurred'. Taxation Ruling TR 97/7: Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioner's view as to the meaning of 'incurred' for the purposes of section 8-1.

ATO-view

Paragraphs 5, 6 and 22 of Taxation Ruling TR 97/7 state:

5. As a broad guide, you incur an outgoing at the time you owe a present money debt that you cannot escape. But this broad guide must be read subject to the propositions developed by the courts, which are set out immediately below.

6. The courts have been reluctant to attempt an exhaustive definition of a term such as 'incurred'. The following propositions do not purport to do this, they help to outline the scope of the definition. The following general rules, settled by case law, assist in most cases in defining whether and when a loss or outgoing has been incurred:

(a) a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitively committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. That is, subject to the principles set out below, it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum;

(b) a taxpayer may have a presently existing liability, even though the liability may be defeasible by others;

(c) a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation (based on probabilities);

(d) whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise;

(e) in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid.

22. The determination that an outgoing has been incurred depends on a jurisprudential analysis of whether there is a presently existing pecuniary liability, having regard to the terms of the contract and other arrangements giving rise to that liability, rather than a commercial view of the arrangements - refer James Flood (CLR at 506); Nilsen Development Laboratories (CLR at 624); and see also FC of T v. Citibank Ltd & Ors 93 ATC 4691 at 4699; (1993) 26 ATR 423 at 432-433 ( Citibank Ltd & Ors ); Ogilvy and Mather Pty Ltd v. FC of T 90 ATC 4836 at 4842; (1990) 21 ATR 841 at 848; Coles Myer (ATC at 4221; ATR at 103).

Additional Commissioner's views are set out in Taxation Determination 94/18: when has a taxpayer incurred, for the purposes of subsection 51(1) of the Income Tax Assessment Act 1936, additional interest payable pursuant to a court order directing that interest be paid on a compound basis and overruling an earlier court order which required the payment of a lesser amount of interest?

Paragraphs 1-3 of Taxation Determination TD 94/18 state:

1. The High Court has made it clear in such cases as Coles Myer Finance Pty Limited v FC of T 93 ATC 4212; 25 ATR 95, Nilsen Development Laboratories Pty Ltd & Ors v FC of T 81 ATC 4031; 11 ATR 505, and FC of T v James Flood Pty Ltd (1953) 88 CLR 492 that generally a loss or outgoing will not have been incurred for the purposes of subsection 51(1) [of the Income Tax Assessment Act 1936] unless there is a presently existing pecuniary liability in the year in which the deduction is claimed.

2. Whether there is a presently existing pecuniary liability is a question which must be determined in light of the particular facts of each case, and especially by reference to the terms of the contract or arrangement under which the liability is said to arise ( Nilsen Development Laboratories, James Flood Pty Ltd, and Ogilvy and Mather Pty Ltd v FC of T 90 ATC 4836; 21 ATR 841).

3. In the case of court orders this will depend on whether the court is seeking, in the order, to interpret a particular document (or to declare how the law has always operated in respect to a particular transaction) or whether it is seeking to create a right to interest which did not previously exist. In the former case the interest will generally be incurred in the year in which the document and the law creates the right to interest. In the latter case the interest will be incurred in the year in which the Court orders that the interest be paid, provided that the interest payable on this basis is subject to reasonable estimation as at the end of the company's year of income (Commonwealth Aluminium Corporation Ltd v FC of T 77 ATC 4151 at 4161; 7 ATR 376 at 386).

Relevant case law

The Commissioner's view that a taxpayer has not definitively committed' to nor was 'completely subjected' to an amount under dispute, and therefore has not incurred the amount, reflects case law including the following part of the judgment of Menhennit J of the Supreme Court of Victoria in Softwood Pulp and Paper Limited v Federal Commissioner of Taxation 76 ATC 4439 at 4456:

The circumstances in which a loss or outgoing is to be regarded as being incurred were dealt with by the High Court in F.C. of T. v. James Flood Pty. Ltd. (1953) 88 CLR 492 at pp. 506-7, and in the course of the reasons of the joint judgment of Dixon C.J. and Webb, Fullagar, Kitto and Taylor JJ., their Honours said at pp. 506-7:

"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."

And later at p. 507:

"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 CLR 179, at p. 207."

In my view it is clear in this case that the claim by MacMillan against the taxpayer for $178,170.04, of which the taxpayer has claimed as a deduction $134,137.91, was not a loss or outgoing incurred by the taxpayer. At no stage did the taxpayer subject itself to that claim, either completely or at all, except to the extent of the ultimate settlement for $24,000. At the most it falls within the language of the High Court as being a loss or expenditure which was no more than impending, threatened or expected. At all stages the taxpayer denied liability for the amount and that denial was not only asserted in correspondence and its annual balance sheets, it was also continued as its attitude at the time of the deed of the release, which was dated 29th day of September 1967 and executed by the taxpayer later that year, because therein the taxpayer denied the validity of the claims by MacMillan.

The Commissioner's view also reflects the decision of Newton J of the Supreme Court of Victoria in Commonwealth Aluminium Corporation Limited v Federal Commissioner of Taxation 77 ATC 4151 where a loss or outgoing is or may be defeasible. A deduction that is defeasible is incurred where the taxpayer is completely subjected to the loss or outgoing. Newton J stated at 4160 4161:

For the purposes of the present case it is sufficient to say that in my opinion the authorities establish that a liability will be a loss or outgoing which has been ``incurred'' within the meaning of sec. 51 [of the Income Tax Assessment Act 1936], even though it remains unpaid, provided that the taxpayer has completely subjected itself to the liability: see Flood's case (supra) at p. 506. In my opinion the authorities also establish that for this purpose a taxpayer can completely subject itself to a liability, notwithstanding that the quantum of the liability cannot be precisely ascertained, provided that it is capable of reasonable estimation: see Texas Company (Australasia) Ltd. v. F.C. of T. (1940) 63 CLR 382 at pp. 465-6 per Dixon J.; and R.A.C.V. Insurance Pty. Ltd. v. F.C. of T. 74 ATC 4169 at pp. 4176-77; (1975) V.R. 1 at pp. 8-9: compare Henderson v. F.C. of T. 70 ATC 4016 at pp. 4018-19; 119 CLR 612 at pp. 647-8 per Barwick C.J.; and Commr. of Stamps (W.A.) v. The West Australian Trustee Executor and Agency Co. Ltd. (1925) 36 CLR 98 especially at pp. 104-105 per Knox C.J.

and at 4163:

… an existing liability may be a loss or outgoing, which has been ``incurred'' within the meaning of sec. 51 [of the Income Tax Assessment Act 1936], notwithstanding that it is defeasible, provided that the taxpayer has otherwise completely subjected itself to the liability.

Current dispute

The liability arises from dispute as to the application of certain contractual terms between Company D and Company B. Ordinarily, a taxpayer that is a party to a contract where the interpretation of terms in the contract is the subject of litigation is definitively committed to any obligations such as amounts payable pursuant to the terms of the contract; cf. paragraph 3 of Taxation Determination 94/18. The Commissioner expects in this scenario that any liability that may arise as a result of a decision as to the correct interpretation would be provided for in the taxpayer's accounts.

However, for the purposes of section 8-1, where a taxpayer disputed the relevant contractual terms, the taxpayer may demonstrate that it was not 'definitively committed' to nor was 'completely subjected' to the loss or outgoing that might arise when the dispute is resolved; paragraph 6(a) and Example 7 of Taxation Ruling TR 97/7 which reflects the judgment of Newton J in Commonwealth Aluminium Corporation.

The Commissioner accepts that Company D (and therefore the head company of the consolidated group, Company C) has not definitively committed to nor been completely subjected to the amount in dispute prior to the decision.

Consistent with the Commissioner's view at paragraph 6(e) of Taxation Ruling TR 97/7 the payment by Company D (in accordance with the decision) means that Company C (as head company) 'incurred' the payment notwithstanding that it remains the subject of dispute.

Therefore, for the purposes of section 8-1, Company C incurred the liability in the year of income in which the decision was made.