Case: Warner Music Australia Pty Ltd v Commissioner of Taxation (1996) 70 FCR 197
Outcome: followed
Assuming, contrary to my finding, that there was a loss in the 1988 or 1989 tax years, and accepting that by some time prior to December 1994, it was improbable that the trust debts, upon which the loss was based, would ever be called up, it is necessary to determine the tax consequences. The Commissioner submits that I should apply by analogy the decision of Hill J in Warner Music Australia Pty Ltd v Commissioner of Taxation (1996) 70 FCR 197. In that case the taxpayer was, in November 1985, served with two sales tax assessments for the periods from 1 January 1982 to 31 May 1985 and from 1 February 1982 until 31 May 1982. The assessments were in the amounts of $599,087.72 and $564,544.69, together with additional tax in each case. The taxpayer objected to the assessments and sought an extension of time in which to pay. The extension was disallowed, and the decision to disallow challenged pursuant to the Administrative Decisions (Judicial Review) Act 1977 (Cth) (the "ADJR Act"). The Commissioner sought to recover the debt in the Supreme Court of New South Wales. The proceedings under the ADJR Act were resolved by consent orders in 1987. The dispute between the parties was ultimately settled in 1991. The Commissioner agreed to accept $650,000 in full satisfaction of the taxpayer's liability under the two assessments, waiving all rights to recover the amounts initially assessed, without admitting the correctness of the taxpayer's arguments. The taxpayer then claimed the total amounts assessed, excluding the additional tax, as income tax deductions for the year ended 30 November 1985. The Commissioner allowed the claim. The unpaid liability for sales tax had not previously appeared in the taxpayer's accounts, but it had been noted in the directors' report, with an indication that there had been an objection, and that in the opinion of the directors no amount was payable. In subsequent years similar notes appeared. The Commissioner sought to include that part of each assessment which he had foregone as income received by the taxpayer in the 1991 tax year. 80 In June 1987 two further sales tax assessments were issued for the periods 1 June 1984 to 30 June 1985. One was for $4,197,209.20 with additional tax. The other was for the amount of $87,210 with additional tax. The amounts assessed were not paid. An extension of time was sought. The Commissioner refused the application, and an application was made pursuant to the ADJR Act. The taxpayer lodged objections against both assessments. The objections were overruled. The taxpayer appealed, in respect of the larger assessment to this Court, and in respect of the smaller, to the Administrative Appeals Tribunal. The proceedings concerning the refusal of the extension of time were settled upon the taxpayer agreeing to pay $1 million to the Commissioner who agreed not to commence recovery proceedings with respect to the balance until the proceedings had been determined. The proceedings in this Court were determined in favour of the taxpayer, as were the proceedings in the Administrative Appeals Tribunal. The Commissioner refunded the amount of $1 million to the taxpayer. The taxpayer claimed income tax deductions for the 1987 year in the amounts of the two assessments. The claims were allowed. The taxpayer returned the amount of the refund as assessable income. The Commissioner assessed that amount to income tax. 81 Expert accounting evidence was led concerning the proper accounting treatment of the disputed sales tax assessments. In order to understand the reasons given by Hill J, it is necessary to know something about that evidence. 82 One accounting witness said that once a sales tax assessment had been issued and become payable, liability should be recognized in the balance sheet of the taxpayer, whether or not the assessment is challenged. The witness then considered whether the assessment should be an "expense" item in the profit and loss account, and whether there should be a corresponding "receivable" item in the balance sheet, representing the contingent right to have the assessment expunged in the event of a successful objection and appeal. Hill J said at 202: It is, no doubt, obvious that the question whether a receivable should have been recognised in the balance sheet involved a question of judgment, depending upon factors such as the likelihood of success in contesting the assessment. Also relevant, no doubt, would be matters such as materiality and prudence in the preparation of the accounts. If (the taxpayer) had had a high expectation of success for its objection, in (the accountant's) view this would have justified recognition of a receivable in an amount equal to the liability. In such a case it would, no doubt, be wrong to recognize the liability as an expense in the profit and loss account.' 83 The same accountant said that in the event of forgiveness or waiver of the liability, the initial entry recording the liability should be reversed and any corresponding asset written back. 84 Another accounting witness said that in a relevant United States standard, the definition of liability had, as the key issue, 'whether management believed that payment of the amount of the liability was probable, either at the time of the original assessment or subsequent thereto.' Of this proposition, Hill J said at 203: 'It is clear from his evidence that there could, at least, be occasions, in his view, where there could be an offsetting asset which, if the view was taken that the whole of the assessment was capable of being overturned on appeal, could be equal in amount to the amount of the liability. ... In other words, if a taxpayer owed the Commissioner a sum of money and the taxpayer believed that it would be wholly successful on appeal so that there was a receivable in an amount equal to the amount of the assessment, the two amounts could be netted off. ...' 85 The Commissioner advanced the proposition that: '... the Court should recognise a general principle of taxation law that the assessable income of any taxpayer should include the gain or benefit derived by that taxpayer by the reduction or extinction of a liability in respect of which a deduction had been allowed under the Income Tax Assessment Act 1936 (Cth) ... in a previous year.' 113 Either of two approaches might be appropriate for present purposes. The first is that adopted by Hill J in Warner Music . His Honour there treated forgiveness of a debt as a gain which, if of a revenue nature, should be treated as income. If that approach were adopted in the present case, it would presumably be necessary for the Commissioner, if he still may, to re-assess the taxable income of the trust in one or more of the years prior to 1995 to reflect such gain. That gain would then go in reduction of the accumulated losses. The result would be that by December 1994, and probably by 30 June 1994, the accumulated losses would have ceased to exist. 114 The second approach, which I favour, would be to recognize that the trust debts and accumulated losses were over-valued in the accounts of the trust as at December 1994, and as at 30 June 1994 (after the right of indemnity had allegedly been released by Nommack (No 75). By that time, at the latest, they were worth nothing and should have been taken out of the accounts. That was so whether one treated the release by Nommack (No 75) as being effective or relied upon the history of the matter. It was factually incorrect to assert that the trust had suffered any loss as a result of the Elizabeth Street project, notwithstanding the position as it may have appeared in 1988 or as Mr Arnold saw it in 1994. To adopt the language of the accountants in Warner Music , management's belief as to the probability of the company having to pay the relevant debts proved to be unduly pessimistic. Such an approach is, in my view, more attractive than is any attempt to apply the Warner Music approach to the present case. 115 The Commissioner submitted that the trust debts may, in any event, have been, at relevant times, statute-barred. The submission was not developed in detail. The debts may have been incurred in New South Wales where, as I understand it, there are both procedural and substantive bars after expiry of the limitation period. It was suggested that the creditor was in Western Australia or Victoria. For procedural purposes, it may be that Queensland law should be applied. This "choice of law" question was not addressed. In any event, since 1990, the debts have been consistently acknowledged in the books of the trust. 116 The Commissioner also submitted that the Sydney trust had ceased to exist at some time prior to 1994, by virtue of there being no property subject to its terms. It is not sufficient for the Commissioner to assert this fact and leave it to the taxpayers to disprove the assertion. Given the virtually indisputable facts which demonstrate that the trust was established and had property, one would readily infer that it continued to exist in the absence of evidence to the contrary. It is likely that the settled fund of one dollar was lost, however a debt of $1,700 remained due by Nommack (No 41). Whilst it may have been written off at some time since 1994, I cannot infer that it had been extinguished prior to that date. It may not have been worth much, but it may have had some value. Secondly, the trust's books of account are still in existence. They are trust property. Thirdly, any beneficiaries may have some right of recourse against Nommack (No 75) as trustee, arising out of the Elizabeth Street project. It is not every day that a trustee, acting properly, loses such a substantial amount so quickly and with such apparent ease. I am not persuaded that the trust has ever been without assets. I am also not persuaded that any changes of trustee or of beneficiaries terminated the trust or effected a resettlement. Such changes were contemplated by the trust deed.