Copyright © 2014 LexisNexis. This article is made available per the publisher's Content Sharing policy.The recent High Court decision in AusNet Transmission Group Pty Ltd v FCT1 which was an appeal from the Full Federal Court decision known as SPI PowerNet Pty Ltd v FCT2 has again confirmed the general principles concerning the distinction between characterising an expense as revenue or capital. The real issue though appears to relate to how to apply such well known principles to modern commercial situations

Blissenden, Michael

Kenny, Paul

Flinders Academic Commons

Archived at the Flinders Academic Commons: http://dspace.flinders.edu.au/dspace/ ‘This is the peer reviewed version of the following article: 2014 Budget, policy versus politics: seven or 126 taxes? (2014) 1(1) TAX 7which has been published in final form at https://advance.lexis.com/api/permalink/22e3b7f8-58eb-40cb-a9c4-932637c3cc35/?context=1201008&federationidp=SFHJ6R50981Copyright © 2015 LexisNexis. This article is made available per the publisher's Content Sharing policy.  Characterising expenditure as revenue orcapital — is the distinction becoming clearer?Michael Blissenden UNIVERSITY OF WESTERN SYDNEY, Dr Paul Kenny FLINDERSUNIVERSITY and Sylvia Villios UNIVERSITY OF ADELAIDEThe recent High Court decision in AusNet Transmis-sion Group Pty Ltd v FCT1 which was an appeal fromthe Full Federal Court decision known as SPI PowerNetPty Ltd v FCT2 has again confirmed the general prin-ciples concerning the distinction between characterisingan expense as revenue or capital. The real issue thoughappears to relate to how to apply such well knownprinciples to modern commercial situations.BackgroundThe following background to the facts of the case isdrawn from the article by Bill Mavropoulos in ATLB2(4).3 It should also be noted that SPI PowerNetchanged its name to AusNet Transmission group.The Victorian Government, through their ElectricityCommission, originally owned the businesses that pro-vide Victorians with electricity. In the 1990s the gov-ernment decided to privatise part of these businesses. Inorder to examine relevant outgoings, it is important togain a broad understanding of the way this privatisationprocess was conducted.The first thing to understand is, broadly, who ownedthe electricity businesses before the privatisation. TheElectricity Commission originally owned three relatedbusinesses as shown in the diagram below:The businesses did three things:• generated electricity;• transmitted it to where it is used; and• distributed it as appropriate.This issue of deductibility arose with reference to theprivatisation of the transmission business. In anticipa-tion of the privatisation, a state owned company (PowerNet Victoria Pty Ltd (PNV)) was set up. A licence inrespect of the rights to run the transmission business wasprovided to the state owned company.The licence asset was then sold to the taxpayer (SPIPowerNet). However, a number of key events occurredprior to the sale of the license to SPI PowerNet. First, animpost was declared on the holder of transmissionlicences for a finite period of time in Victorian legisla-tion (s 163AA of the Electricity Industry Act 1933(Vic)). This impost was broadly designed to ensure aprivatised transmission business did not earn too muchprofit from the transmission business in question. Sec-ond, this impost became a condition precedent to thecontract and warranties were made in respect of thisobligation by the parent company of SPI PowerNetbefore the asset sale agreement could be executed. Thiscan be represented diagrammatically below:The transmission licence imposts were then thesubject of protracted legal argument in relation towhether they were deductible under s 8–1 of the IncomeTax Assessment Act 1997 (Cth) (ITAA 97). The FullFederal Court held, by majority, that the imposts inquestion were capital in nature. The High Court grantedspecial leave to appeal and also ordered that the appel-lants name be changed to AusNet Transmission GroupPty Ltd for the court’s record.australian tax law bulletin December 2015192High Court decision — overviewThe High Court, by a majority of 4–1, dismissed theappeal. French CJ, Kiefel and Bell JJ delivered a jointjudgment holding that the impost imposed on AusNet, asthe holder of an electricity transmission licence pursuantto a state legislative framework, should be characterisedas capital and hence precluded from deductibility unders 8–1 of the ITAA 97.The joint judgment only dealt with the question of thecharacterisation of the payment of the impost as beingcapital in nature. As the joint judgment held that thepayments made were capital in nature (which was thebasis of the appeal by AusNet) then there was no need todetermine whether the payments satisfied the positiverequirement of s 8–1 of the ITAA 97. Only the dissent-ing judgment of Nettle J dealt with the positive require-ments of s 8–1. In [132]–[135] Nettle J dealt with thecontention that the payments were not incurred in thegaining or producing of assessable income. His Honourmade short work of the contention by the Commissionerthat the charges were not incurred in the gaining orproducing of assessable income because they werecalculated by reference to AusNet’s expected profits. Itwas clear, according to Nettle J, that this line ofreasoning should be rejected outright and that it wasquite obvious that, as the holder of a licence, AusNetwas bound to pay the charges for business purposes.Although the majority judgments do not deal with theissue of the positive limbs of s 8–1, it seems to be quiteevident that the particular requirement had been satis-fied. In particular it is evident in the judgment of GagelerJ that the underlying rationale for the payment of thecharges was in relation to the commercial context withinwhich the specific expenditure was made, including thecommercial purposes of the taxpayer in having becomesubjected to any liability that is discharged by themaking of that expenditure.4Capital/revenue distinctionThe importance of the High Court decision lies in thediscussion concerning the distinction between capitaland revenue for s 8–1 purposes. The majority jointjudgment made reference to the well-known passagesabout the characterisation of capital and revenue laid outby Dixon J in Associated Newspapers Ltd v FCT5(Associated Newspapers) and interestingly made refer-ence to the fact that both parties relied on the well-established principles.Of real interest is the fact that the majority jointjudgment then focused on the clarifying comments byDixon J in Hallstroms Pty Ltd v FCT6 that the distinctiondepends upon what the expenditure is calculated toeffect, from a practical and business point of view.7 Suchan emphasis on the practical and business point of viewis reflected in the decisive reasoning by the majorityjoint judgment. Their Honours stated that:8AusNet did not pay the charges in order to reimburse theState for excess revenue it might generate as licence holder.From a practical and business point of view, the assumptionof the liability to make the expenditure was calculated toeffect the acquisition of the transmission licence and theother assets the subject of the Asset Sale Agreement.Of more interest is the approach by Gageler J on thesame point. His Honour made it clear throughout thejudgment that the distinction depends upon what theexpenditure is calculated to effect from a practical andbusiness point of view.9 In determining that the paymentwas of a capital nature, Gageler J stated: “In my view,from a practical and business perspective, the expendi-ture was expenditure which AusNet was required tomake in order to acquire the transmission licence andother assets.”10 Even the dissenting judgment of Nettle Jwas premised on the practical and business point ofview.11For practitioners advising business taxpayers, theHigh Court judgment has strongly reinforced the prac-tical and business approach and has given clear guidancethat this is the appropriate analysis required. This isparticularly the situation where there is no clear author-ity on point, as was the situation in the AusNet case. Soalthough each matter is dependent upon the particularfacts and circumstances of that case, it is considered thatthe High Court is signalling a clear approach to be takenfor business taxpayers which builds upon the well-known and universally applied principles identified byDixon J in Associated Newspapers.Characterisation of the expenditure —statutory or contractual obligationThis is a critical aspect of the case. AusNet’s propo-sition was that the total purchase price, which did notinclude the s 163AA charges, was the amount expendedby AusNet to acquire the assets. The licence fees weredescribed as future licence fees, payable by the buyer,pursuant to the contractual obligation of the asset saleagreement.The majority joint judgment rejected this argument.Instead by entering the asset sale agreement, the tax-payer assumed the statutory liability under s 163AA ofthe Electricity Industry Act. By agreeing to acquire thetransmission licence and the other assets, there was anacceptance of the statutory liability as imposed under thelegislation. Gageler J was very clear on this point. HisHonour agreed with:12… the joint reasons for the majority judgment that cl 13.3(d) [of the asset sale agreement] imposed a contractualobligation on Ausnet to make the expenditure which wasindependent of the statutory liability imposed on AusNetunder s 163AA of the Electricity Act.australian tax law bulletin December 2015 193The statutory liability was applicable to whoever heldthe transmission licence and it was “an ‘impost’ rel-evantly payable by the holder of the TransmissionLicence to the Treasurer in amounts and at timesspecified in the Order in Council”.13 The holding of atransmission licence was a condition precedent to thecompletion of the asset sale agreement. As was said bythe majority in their joint judgment:14The promise [in cl 13.3(d) of the asset sale agreement] wasconsideration moving from AusNet … and was necessaryto secure not only the transmission licence but the otherassets that were the subject of the sale.Again “from a practical and business point of view,the assumption of the liability to make the expenditurewas calculated to effect the acquisition of the transmis-sion licence and the other assets… The transmissionlicence was an intangible asset, but was properly viewedas part of the structure of the business. Without it,acquisition of the rest of the assets was pointless”.15In short the imposts, whenever they were levied, werea direct consequence of the cost to AusNet of securingacquisition of the transmission licence and other assets.The obligation to pay the imposts was inherently linkedto the statutory requirement that, to run an electricitybusiness, there was a need to have a transmissionlicence. Those imposts were to be payable by the holderof the transmission licence, in amounts and at timesspecified in the Order in Council and were not a periodicpayment referable to the holding of the transmissionlicence.ConclusionThe High Court decision has confirmed the principlesto be applied in characterising expenditure as eithercapital or revenue. In particular the practical and busi-ness perspective of the expenditure should be emphasisedand the commercial context in which the payment hasbeen made. Practitioners would do well to take heed ofthis approach when advising business clients.The High Court decision is also important in recognis-ing that a statutory requirement, as a condition precedentto a contractual obligation, can be the cause of thepresent and existing obligation in respect of the outgoingand that the method concerning the amounts and timingof the imposts, as specified by the legislative framework,does not make the expenditure a recurring revenuepayment. This is an important lesson for taxpayers andtheir advisers.This paper has been subject to an independentreview.Michael BlissendenDeputy DeanUniversity of Western SydneyM.Blissenden@uws.com.auwww.uws.edu.auDr Paul KennyAssociate Professor Taxation LawFlinders Business SchoolFlinders Universitypaul.kenny@flinders.com.auwww.flinders.com.auSylvia VilliosLecturerAdelaide Law SchoolUniversity of Adelaidesylvia.villios@adelaide.edu.auwww.adelaide.edu.auFootnotes1. AusNet Transmission Group Pty Ltd v FCT (2015) 322 ALR385; 89 ALJR 707; [2015] HCA 25; BC201507278.2. SPI PowerNet Pty Ltd v FCT (2014) 220 FCR 355; [2014]FCAFC 36; BC201402371.3. Bill Mavropoulos “The convenient fiction — deductibility andcapital” (2015) 2(4) ATLB 67.4. Above n 1, at [74].5. Associated Newspapers Ltd v FCT (1938) 61 CLR 337; [1939]ALR 10; BC3900038.6. Hallstroms Pty Ltd v FCT (1946) 72 CLR 634; [1946] ALR434; BC4600017.7. Above n 1, at [22].8. Above n 1, at [66].9. Above n 1, at [73].10. Above n 1, at [80].11. Above n 1, at [140].12. Above n 1, at [81].13. Above n 1, at [83].14. Above n 1, at [59].15. Above n 1, at [66].australian tax law bulletin December 2015194

Characterising expenditure as revenue or capital - is the distinction becoming clearer?

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Characterising expenditure as revenue or capital - is the distinction becoming clearer?

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