Nethercott, Les --- "Editorial" [1999] JlATax 16; (1999) 2(4) Journal of Australian Taxation 192

Editorial

Associate Professor Les Nethercott

With the recent Full High Court decision in FC of T v Montgomery 99 ATC 4749, the income/capital issue has been re-examined. By a majority of 4:3, the Full High Court held that lease incentive payments received by a Melbourne law firm as an incentive to move their office premises were assessable income. It is now over ten years since the landmark decision in FC of T v The Myer Emporium Limited 87 ATC 4363. In this respect, the first strand of Myer has become an important principle in expanding the concept of income by bringing to account as income, gains made from extraordinary transactions. In particular, the often-cited quote states that:

... if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, not withstanding that the transaction was extraordinary judged by the reference to the ordinary course of the taxpayer's business. (87 ATC 4367)

At the time the decision was handed down, the first strand of Myer appeared to extend the ordinary concept of income by bringing to account as income, gains made by an extraordinary transaction so long as the taxpayer's intention when entering into the agreement was to make a profit or gain from the transaction. In this respect, the decision in Montgomery raises but does not really resolve the issue of where the income/capital line should be drawn.

Briefly, the taxpayer was a partner of a law firm, Freehill Hollingdale and Page, whose offices were located at BHP House. Due to a refurbishment of the building, and in order to prevent disruption, the firm relocated to 101 Collins Street.

In the course of entering into a new lease agreement, and as part of an incentive to move, the firm received approximately $29m to relocate its premises.

In reversing the Full High Court decision, the majority held that:

... the firm used or exploited its capital to obtain the inducements in the course of carrying on its business, albeit in a transaction properly regarded as singular or extraordinary.

In coming to this view, the Court made reference to the Myer decision in demonstrating that a singular transaction in business, even if unusual or extraordinary, when judged by reference to the transactions in which the taxpayer usually engages, can generate a revenue receipt.

Despite the fact that the taxpayer's move to new premises was occasioned by a health risk from asbestos and the desire to prevent disruption to their business, the Court focused on the firm's ability to exploit their position. In particular, the Court observed that by adding to their capital structure, the taxpayers were also in a position to add another benefit in the form of a lease inducement payment. In this respect, the Court observed that receipts came in or were derived from the separate use, benefit and disposal of the firm and its members as they saw fit. As a result, the Court held that the lease incentive payments were seen to be of an income nature.

The dissenting judges determined that the amounts did not represent a profit or gain, rather that the occasion of the receipt was for the taxpayer entering into and undertaking the obligation of a lease which formed part of the capital structure.

While the decision appears to resolve the assessable nature of lease incentive payments, it still leaves unanswered the question of what comes within the ordinary concept of income. Moreover, the problem of where to draw the line between something which is of an income nature or capital nature is still unclear. It would seem that even though a receipt may relate to a firm's capital structure, when the wider business activity of the firm is examined, it may nevertheless be on revenue account.

It is suggested that the decision in Montgomery has not really resolved the issue of how the income/capital distinction should be made. In particular, a problem arises in determining whether a firm is passively adding to its capital structure, or is instead actively using it to bring in revenue.

It is in this respect that the issue of what is on income or capital account still remains unresolved, not only in respect of lease incentive payments but also in the case of any other activity, however extraordinary, which relates to the use of a firm's capital-making structure.

August 1999