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Whether expenditure is on capital or revenue account is an age old question of taxation considered in the Australian decision in FC of T v Citylink Melbourne Limited 2006 HCA 35.
In this decision a 5:1 majority of the High Court of Australia dismissed the Federal Commissioner's appeal against the decision of the Full Federal Court allowing Citylink Melbourne Limited ("Citylink") deductions in the 96 - 98 income years for more than A$220m in "concession fees" payable to the Victorian State Government ("the State") by 2034. This outcome was described by the judge of first instance as one that would normally only be expected in a taxpayers' heaven.
Background
The Melbourne City Link Project was a significant infrastructure project contracted by the State to Citylink to design, construct and manage. For the duration of the project, the State conceded all rights necessary, so that Citylink could undertake the city link project. At the end of the project, the State will resume its right to operate the road links. Citylink is required to pay concession fees for the rights necessary to undertake the project to the State for the duration of the project . Citylink is also required to pay rent in respect of the land on which the roads and infrastructure were built. Although the concession fees were payable semi-annually in arrears, Citylink could pay them by issuing concession notes. There were conditions precedent before the concession notes could be presented for payment and, as long as certain debt, including debts to third party lenders, was owing, payments under the concession notes were owing but not due for payment. The project financial model anticipated that the State would commence redeeming the concession notes, which were not interest bearing, between the year 2013 and the end of the project. As the High Court later noted, the arrangement was essentially a licence to use capital assets for the period of the concession, at the end of which the assets in question are surrendered to the State. The applicable legislation in Austraqlia, which is similar to the equivlaent provision in the Income Act 2007, allows a taxpayer to deduct from its assessable income any losses or outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.
The questions before the High Court were when were the concession fees incurred? and were the fees properly categorised as outgoings of a capital nature or outgoings on revenue account?
Lower court decisions
The judge at first instance (Transurban City Link v FC of T 2004 ATC 4084) determined that Citylink incurred the outgoings in the 96�"98 income years, because the unconditional liability to pay the concession fees was satisfied when Citylink elected to issue concession notes. However, his Honour found the concession fees to be an outgoing of a capital nature, because they were properly characterized as outgoings expended "on the structure within which the profits were to be earned" rather than outgoings expended in gaining or producing Citylink's assessable income as a "part of the money earning process" (para. 191).
On appeal, the Full Court agreed that the outgoings were referable to the income years but, as the fees were payable for the right to conduct Citylink's business for the duration of the project, the fees were properly characterized as an outgoing on revenue account: Citylink Melbourne Ltd v FC of T 2004 ATC 4,945.
High Court (Majority Crennan J, with whom Gleeson J, Gummow J, Callinan J and Heydon J)
The majoity agreed, in noting that the result was "peculiarly dependent upon the particular facts and circumstances" found that the concession fees satisfied the test of deductibility at full face value in respect of each of the income years in which they were claimed as deductions. Were the concession fees incurred in the years of income? Crennan J found that Citylink was definitively committed and had completely subjected itself to the losses or outgoings which the concession fees represented. Consequently, a condition affecting the timing of the discharge of the liability did not render the liability contingent. Were the concession fees referable to the years of income? The Commissioner submitted that the concession fees represented future expense, because the payment of the fees would be met from future assessable income. Stating that the concession fee arrangements made it clear that the gains referable to the concession fees "come home" in the relevant income years, Crennan J went on to note that "... the legislation does not require that the purposes of an outgoing be the gaining or production of income in the year in which the outgoing is claimed as a deduction" (para 143). In Coles Myer Finance Ltd v FCT (1993) 176 CLR 640, the High Court said that it was not enough to establish the existence of a loss or an outgoing actually incurred. That loss or outgoing must be "properly referable" to the income year in question. Although Coles Myer's liability to pay was a presently existing liability, the amount in question was not payable until the subsequent year of income. Therefore, the deduction for the expense was apportioned over two years. Apportionment The Commissioner also submitted in the alternative that if the concession fees were incurred every year, each concession fee should be spread from the date on which it was incurred until the date of payment. Rejecting this argument, Crennan J noted, distinguishing Coles Myer, that the semi-annual liability did not secure Citylink's rights for future years. Instead, each concession fee, like any periodic licence fee, was payable for a period and other concession fees became due in successive years. Accordingly, straight line apportionment was not appropriate. Were the fees on capital account? In considering whether the concession fee was a matter of capital or revenue, Crennan J started by citing Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T (1938) 61 CLR 337 at p 363: "There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making final provision or payment so as to secure future use or enjoyment." In concluding that the concession fees were on revenue account, Crennan J analogised the concession fees to licence fees and stated that: "The concession fees are only payable during the terms of the concession period. [Citylink] does not acquire permanent ownership rights of the roads or lands used. All rights granted ... revert to the State ... Unlike periodic instalments paid on the purchase price of a capital asset, the concession fees are periodic licence fees in respect of ... infrastructure assets, from which [Citylink] derives its income, but which are ultimately surrendered back to the State." (para 154)
Dissenting judgment
In the sole dissenting judgment, Kirby J found that Citylink acquired the right to place itself in a position to derive revenue for its business in the future. The advantages for which the concession fees were payable were expressed to be of a permanent and enduring character. The advantages secured were a capital asset that was an indispensable part of Citylink's profit-yielding structure. Kirby J, emphasizes the importance of applying the statutory provisions. Although His Honour acknowledged that there was dicta to support Citylink's arguments, he propounded the importance of why, when presented with the new and unusual circumstances, such as in the case at hand, it was important to return to the statutory text.