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Article Excerpt
[Federal Commissioner of Taxation v The Myer Emporium Ltd ('Myer') marked a significant change in approach in tax jurisprudence. Since 1987, virtually every case dealing with the characterisation of receipts' as income or capital has cited Myer, usually at some length. But it is going too far to suggest that Myer transformed the way in which income is characterised. The decision in Myer reflects a reduced emphasis on formalism and legal technicalities, the mainstream approach of the courts. Under that approach, the characterisation of amounts as income or capital is determined as a matter of commercial substance, and not by subtleties of drafting, or by unduly literal or technical interpretations. While some prominent cases could have been decided the other way on their facts, it is inherent in the fact-intensive distinction between income and capital that hard cases will arise which are capable of being decided either way. This circumstance does not detract from the enduring importance of the decision in Myer.]
CONTENTS I Introduction II The Concept of Income III Tax Jurisprudence in the 1970s IV The Decision in Myer V Applying the Decision in Myer VI The Commissioner's Taxation Ruling VII Lease Incentives VIII Capital Gains Tax IX A New Tax Climate? X Conclusion
I INTRODUCTION
It is almost 20 years since the High Court handed clown its decision in Federal Commissioner of Taxation v The Myer Emporium Ltd ('Myer'). (1) It is therefore easy to forget that the decision aroused real controversy and apprehension amongst tax practitioners. The decision was seen as a landmark in tax jurisprudence and the immediate reaction was that a reappraisal of traditional distinctions between revenue and capital was required. (2) As late as 1993, one experienced practitioner claimed that the decision had greatly enlarged the concept of income. (3)
The fear that the decision would be destructive of traditional doctrine has abated. So much so that in 2002, a commentator expressed the view that '[i]n retrospect ... the decision [was] merely illustrative of a more pragmatic and realistic understanding by the judiciary of modern business and its many facets and is quite consistent with the general approach now taken by the courts.' (4)
From this distance, it is possible to see, much more clearly, that the controversy that initially surrounded the Myer decision was the product of the era that immediately preceded it; rather than that of any remarkable extension or innovation worked by the decision in terms of traditional tax jurisprudence. The decision remains a landmark in tax jurisprudence; it is important for the cogency and practicality of its reasoning, and for a shift in approach that returned tax jurisprudence to its roots.
II THE CONCEPT OF INCOME
The Income Tax Assessment Act 1936 (Cth) ('ITAA 1936') has never contained any definition of 'income' or, for that matter, 'capital'. The closest it comes is to define 'income from personal exertion' and 'income from property'. (5) Both definitions presuppose that income has a recognised meaning. (6)
Much the same approach has been adopted in the Income Tax Assessment Act 1997 (Cth) ('ITAA 1997'). Section 6-5(1) provides that assessable income includes 'income according to ordinary concepts, which is called ordinary income'. There is no further definition of 'ordinary income'. As stated in the Explanatory Memorandum to the Income Tax Assessment Bill 1996 (Cth), Parliament has left it to the courts to develop principles for determining what is 'ordinary income'. (7)
In Scott v Federal Commissioner of Taxation, Jordan CJ said:
The word 'income' is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts. (8)
In a similar vein, the High Court observed in Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation that '[t]he word "income", being used without relevant definition, is left to be understood in the sense which it has in the vocabulary of business affairs'. (9)
In ordinary usage, income is conceptualised as a flow that is detached from capital. In the United States Supreme Court case Eisner v Macomber, Pitney J resorted to mixed metaphors to explain the dichotomy between income and capital:
The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. (10)
This dichotomy was deeply entrenched in Australian law well before 1987, as it was in the United Kingdom and New Zealand. However, it has not avoided criticism. In 1986, Ross Parsons suggested that the taxation system would be much more efficient and predictable if it embraced economic concepts which draw no distinction between gains on revenue and capital account. (11) In 1998, the Review of Business Taxation considered that economic income provided the ideal taxing base, on the grounds that the same economic transaction should be taxed in the same way regardless of its particular form. (12) But neither the Commonwealth Parliament nor the courts have followed that path. In Montgomery, the majority judgment of Gaudron, Gummow, Kirby and Hayne JJ resisted the notion that the courts should adopt the concepts of gain or realised gain that are favoured by economists. (13)
The terms 'income' and 'capital' do not have definite or comprehensive meanings in the world of business affairs. As a result, it has been left to the courts to work out the precise boundaries of these concepts on a case-by-case basis. As Dixon J said in Hallstroms Pty Ltd v Federal Commissioner of Taxation ('Hallstroms'), the courts have proceeded 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.' (14)
In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation, (15) a unanimous High Court canvassed the basic principles which determine whether receipts or outgoings are on revenue or capital account. They held that '[w]hether or not a particular receipt is income depends upon its quality in the hands of the recipient ... [a] receipt may be income in the hands of a payee whether or not it is expenditure of a capital nature by the payer.' (16)
Similarly, the use to which a receipt is put is not determinative of its character as a 'taxpayer may apply income in the acquisition of a capital asset or, conversely, apply a capital receipt to discharge a liability of a non-capital nature.' (17) The High Court then observed:
To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment. (18)
As to outgoings, the Court said:
The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid. (19)
This passage picks up the principal factor identified by Dixon J in Sun Newspapers Ltd v Federal Commissioner of Taxation. (20) Dixon J also referred to two other factors: first, the manner in which the advantage is to be used, relied upon or enjoyed; and secondly, the means adopted to obtain the advantage, that is to say by providing a periodical reward or outlay to cover its use or enjoyment or by making a final provision or payment so as to secure future use or enjoyment. These three principles were approved and applied by the Privy Council in BP Australia Ltd v Federal Commissioner of Taxation [No 2] ('BP Australia') (21) and they have been applied repeatedly in Australia since 1938.
In BP Australia, the Privy Council made the following cautionary observations:
The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. (22)
The same kind of cautionary note was struck in Montgomery (23) and Federal Commissioner of Taxation v CityLink Melbourne Ltd. (24)
The effect of all these authorities was summarised by the late Justice D G Hill in 1995 when he said, extrajudicially, that the
determination of capital and income, whether in the field of assessability or deductibility, will involve a close examination of all the circumstances, a common sense appreciation of all guiding factors and a balancing of all relevant considerations. (25)
To set the scene for a discussion of Myer, it is helpful to identify some factors relevant to the characterisation of income and capital receipts that were established by the case law prior to 1987. In a variety of situations, net amounts were recognised as ordinary income. Examples of these situations include:
* profits of an investment company where the shares in question were not trading stock; (26)
* exchange gains and losses; (27) and
* profits from the sale of land not purchased for the purposes of resale at a profit, but sold as a business activity. (28)
Another line of authority recognised that a receipt paid in substitution for other receipts which had the character of ordinary income may take on the character of the substituted receipt. (29) This principle was applied with caution because a sum of money is not to be treated as ordinary income simply because it was computed or measured by reference to loss of future income. (30)
In several English cases, receipts derived in isolated business transactions were held to be assessable as ordinary income. (31)
Finally, there was a line of authority to the effect that the proceeds of a mere realisation of a capital asset would not constitute ordinary income, even if the realisation was carried out in an enterprising way so as to secure the best price. On the other hand, profits derived in a business operation or commercial transaction carrying out a profit-making scheme are income. (32)
The traditional approach to the determination of income and capital avoids the risk that propositions of law will be expressed in terms that prove to be unduly wide, but it has other problems. In Hallstroms, Dixon J observed that it is one thing to identify particular factors which have been recognised in past cases as tending to support a specific legal characterisation, but it is fallacious to infer that the absence of a particular factor from the case at hand necessarily places that case outside the relevant category and gives it an opposite description. (33) There is also a risk that subsequent cases will treat factors that are in truth factual criteria as if they were propositions of law. (34) More broadly, the traditional approach is so heavily dependent on the characterisation of the facts in each case that the process of drawing a distinction between income and capital is difficult and uncertain in borderline cases. (35)
III TAX JURISPRUDENCE IN THE 1970S
The significance of Myer cannot be fully appreciated without recognising that there were a number of decisions during the 1970s in which legal technicalities appeared to triumph over substance. Two main lines of authority illustrate this proposition.
The first concerns s 26(a) of the ITAA 1936 which was subsequently re-enacted as s 25A. The provision was introduced to overcome the effect of Jones v Leeming in which the House of Lords held that an isolated transaction with a profit-making intent did not give rise to the receipt of income on ordinary principles. (36) In 1930, in introducing the Bill that inserted s 26(a), the Treasurer said that the section was a statutory declaration of the approach which for many years had been accepted as settled law in Australia. (37) The first limb of s 26(a) directly targeted the decision in Jones v Leeming, (38) and the second limb can be traced to Ruhamah Property Co Ltd v Federal Commissioner of Taxation (39) and Californian Copper. (40) Despite the origins of s 26(a) and the fact that the House of Lords had overturned Jones v Leeming in Edwards v Bairstow, (41) Australian courts in the 1960s and 1970s were disposed to accept technical or semantic arguments that limited the reach of s 26(a). (42) The first limb of s 26(a) was construed so as to require that the property sold to yield a profit...
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