FEDERAL COURT OF AUSTRALIA

Watson as trustee for the Murrindindi Bushfire Class Action Settlement Fund v Commissioner of Taxation [2019] FCA 228

ORDERS

THE COURT ORDERS THAT:

1.    The application to appeal from the respondent’s objection decision dated 1 March 2018 be dismissed.

2.    Unless the parties apply to the Court for an alternative costs order within two business days of the date of these orders, the applicant pay the respondent’s costs of and incidental to the application to appeal.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

MIDDLETON J:

1    The proceeding before me concerns deductions claimed by the court-appointed scheme administrator of the Murrindindi Bushfire Class Action Settlement Fund (the ‘Fund’) in the financial year ended 30 June 2016 (the ‘relevant year’).

2    During the relevant year, the named applicant (‘Mr Watson’), acting in his capacity as scheme administrator of the Fund (the ‘Taxpayer’), derived $8,355,722 in interest income (the ‘Interest Income’) by virtue of the moneys comprising the Fund being deposited in a series of term deposits and other interest-bearing bank accounts. The Taxpayer also incurred $4,341,327 in costs and expenses (the ‘Outgoings’) during the relevant year in the course discharging his duties as scheme administrator.

3    In calculating the net income of the Taxpayer, the respondent (the ‘Commissioner’) assessed the Taxpayer on the Interest Income but disallowed the deduction of the Outgoings. The Taxpayer had claimed that he was entitled to deduct the Outgoings from his assessable income pursuant to s 8-1 of the Income Tax Assessment Act 1997 (Cth) (the ‘1997 Act’).

4    On 28 March 2018, the Taxpayer applied to this Court to appeal from the Commissioner’s objection decision dated 1 March 2018 in which the Commissioner disallowed the Taxpayer’s objection dated 20 December 2017.

FACTUAL BACKGROUND

5    On 7 February 2009, Victoria suffered its worst bushfires in modern history which later came to be known as the Black Saturday bushfires. Two of the bushfires, which were separately known as the Murrindindi Bushfire and the Kilmore East/Kinglake Bushfire were alleged to have been caused by the negligence of AusNet Electricity Services Pty Ltd (‘AusNet’) and others. This proceeding is solely concerned with the settlement of the litigation relating to the Murrindindi Bushfire.

6    On 7 August 2012, a class action was commenced by Mr Robert Liesfield on behalf of the victims of the Murrindindi Bushfire against AusNet and others in the Supreme Court of Victoria (the ‘Supreme Court’) under Part 4A of the Supreme Court Act 1986 (Vic). On 15 October 2014, Mr Liesfield was substituted by Dr Kathrine Rowe as the representative plaintiff. Maurice Blackburn acted as the solicitors for the plaintiff group members, with Mr Watson being the principal with carriage of the matter.

7    On 6 February 2015, on the day the trial was due to commence, the parties to the class action agreed to settle the proceeding by entering into a Deed of Settlement, the operation of which was subject to approval by the Supreme Court as required by s 33V of the Supreme Court Act 1986 (Vic). The Deed of Settlement provided that the defendants would pay amounts totalling $300 million to a ‘Reserve Fund’ within 90 days and, once the Deed of Settlement was approved by the Supreme Court and the plaintiffs’ legal costs and disbursements (approximately $20 million) were paid out, the remainder of the Reserve Fund (approximately $280 million, being the ‘Distribution Sum’) would be transferred to an interest-bearing bank account opened by Maurice Blackburn for the purposes of ultimate distribution to group members.

8    On 27 May 2015, the Supreme Court made orders approving the Deed of Settlement and the associated Settlement Distribution Scheme (the ‘SDS’) which according to its preamble, established:

… a procedure for distributing the sums to be paid by the Defendants to the Murrindindi Bushfire Class Action pursuant to a settlement of the class action approved by the Supreme Court of Victoria.

9    Mr Watson was appointed as the trustee of the Fund and as scheme administrator pursuant to cl A3 of the SDS, which provided as follows:

A3    Scheme Administrator

A3.1    The Scheme Administrator will be the principal in charge of the Class Actions Department of Maurice Blackburn, or another principal nominated by him.

A3.2    The Scheme Administrator and the Administrator Staff in discharging any function or exercising any discretion conferred by this Scheme:

(a)    shall do so as lawyers required by the Court to administer this Scheme fairly and according to its terms, as a duty owed to the Court in priority to any obligation to any individual Claimant; and

(b)    shall have the same immunities from suit as attached to the office of a judge of the Supreme Court of Victoria.

10    Mr Watson had considerable experience in the administration of settlement schemes of this kind. He had earlier been appointed as scheme administrator of the materially identical Kilmore East/Kinglake Bushfire settlement distribution scheme, and had previously managed or supervised more than 20 other settlement distribution schemes administered by Maurice Blackburn.

11    Importantly, and as will become relevant later in these reasons, the terms of the SDS did not require Mr Watson, when acting in his capacity as scheme administrator (being the ‘Taxpayer’ in this proceeding as defined above), to derive a return on the Distribution Sum or for the Fund. Indeed, the Taxpayer’s only responsibility in respect of the investment or financial management of the Distribution Sum was to deposit it in an interest-bearing bank account. In this respect, the terms of the SDS were very prescriptive: aside from choosing between various Australian banks and different deposit terms, the Taxpayer was contractually obliged to invest the Fund by depositing the Distribution Sum in an interest-bearing bank account with an authorised deposit-taking institution.

12    After assessing the funding needs of the Fund over the short and long term, the Taxpayer invested the Distribution Sum in a series of term deposits and other interest-bearing bank accounts across a number of different ‘Big 4’ Australian banks which, in the Taxpayer’s view, would provide the highest level of security. As part of this process, the Taxpayer consulted with Maurice Blackburn’s in-house finance team regarding different investment options and requested that they obtain and negotiate rates with various banks to see which could provide the best rate for the relevant term. The Taxpayer considered available interest rates, deposit terms, and the present and future liquidity needs of the Fund and concluded that because interest rates were expected to fall, it would be prudent to deposit a large portion of the moneys in a long term deposit (even though the rates on long term deposits were lower than on shorter term deposits). Accordingly, at the outset the Taxpayer deposited $240 million into a 12-month term deposit, $35 million into a 3-month term deposit, and the remainder (approximately $6 million) into a controlled money account in order to meet the ongoing expenses of the administration of the SDS.

13    As the administration progressed and the term deposits matured, the Taxpayer made further decisions regarding the reinvestment of the Distribution Sum at least every three months. When making these decisions, the Taxpayer re-evaluated available interest rates and reassessed the liquidity needs of the Fund.

14    The main object of the Taxpayer’s duties as scheme administrator was to oversee the assessment of claims made by group members of the class action. The SDS relevantly provided that:

(1)    group member claims were to be classified as personal injury and dependence claims (‘I-D’) or economic loss and property damage claims (‘ELPD’) claims, with the assessment procedure to differ based on the category of the claim;

(2)    $34 million was to be allocated to the payment of I-D claims, and the balance to the payment of ELPD claims; and

(3)    I-D claims were to be assessed by barristers and medical practitioners engaged by the Taxpayer for that purpose, and ELPD claims by ‘ELPD Assessors’, being solicitors, barristers and professional loss assessors or adjustors appointed by the Taxpayer.

15    Relevantly, the Taxpayer’s duties as scheme administrator were all carried out subject to the overarching supervision of the Supreme Court. For instance, cl J1 of the SDS provided that if there was an issue that arose in connection with the administration of the SDS, the Supreme Court could be called upon to make appropriate directions to resolve that issue:

J1    Supervision by the Court

J1.1    Where the Scheme Administrator considers that:

(a)    the procedures to be followed in the implementation of this Scheme are wanting or in doubt; or

(b)    an issue has arisen in connection with the administration of this Scheme which are [sic] appropriate for directions by the Court;

the Scheme Administrator may, by correspondence addressed to the Associate to the Judge or Associate Judge supervising the administration of this Scheme, apply to the Judge or Associate Judge for directions.

J1.2    Save where the Court upon an application pursuant to clause J1.1 requires otherwise, the Scheme Administrator need not give notice of the application to Claimants.

16    As envisaged by the terms of the SDS, the Taxpayer established a team of ‘Administrator Staff’ to assist him in discharging his obligations under the SDS. The Administrator Staff mostly comprised lawyers from Maurice Blackburn, the number of which waxed and waned over time in response to the business requirements of administering the SDS. Over the course of the administration of the SDS, up to 49 staff were engaged, as well as legal counsel and other third parties.

17    In keeping with the approach he had applied to previous scheme administrations, the duties carried out by the Taxpayer included:

(4)    ongoing development, implementation and monitoring of internal processes for assessing claims, including the development of IT system requirements and infrastructure and the recruitment, training and supervision of Administrator Staff;

(5)    delegating to staff the responsibilities to perform the functions necessary and convenient for the efficient implementation of the SDS;

(6)    engaging barristers, medical practitioners and processional loss assessors or adjustors to assist in the assessment of claims;

(7)    managing and administering the Fund, including estimating costs and the process for distribution;

(8)    liaising with organisations regarding workflow and assessment rates, and taxation of interest accrued on the Distribution Sum;

(9)    implementing practices to monitor and estimate the costs of administering the Fund; and

(10)    investing the Distribution Sum while the assessment of claims proceeded.

18    As previously mentioned, the Outgoings incurred by the Taxpayer in the course of administering the Fund totalled $4,341,327. The Outgoings comprised almost entirely of Maurice Blackburn staff costs (in the form of billable hours) in relation to a variety of different tasks such as depositing the Distribution Sum, establishing systems and internal processes to assist in the administration of the Fund, and assessing and handling group members’ I-D and ELPD claims. The Outgoings were also made up of other professional fees paid to legal counsel, medical practitioners and loss assessors who were also engaged to assist in the administration of the Fund.

19    Under cl A4 of the SDS, all of the costs of administering the Fund that were approved by the Supreme Court were to be paid from the interest on the Distribution Sum as the first port of call. Only if such interest was insufficient to pay the administration costs could the corpus of the Distribution Sum be used to pay the administration costs. Clause A4 relevantly provided as follows:

A4    Scheme Costs

A4.1    Notwithstanding any other provision of this Scheme, and without reducing any other rights which the Scheme Administrator might have:

(a)    all costs, expenses, taxies [sic], levies, duties, charges, fees or other imposts or obligations arising in connection with the administration of this Distribution Scheme (including without limitation the creation, retention, investment or disbursement of any part of the Distribution Sum) shall be paid from the Distribution Sum held by the Scheme Administrator from time to time; and

(b)    the Scheme Administrator and the Administrator Staff shall be indemnified from the Distribution Sum against all liabilities (including without limitation any liabilities described in (a) above) arising from or in connection with the administration of this Scheme.

A4.2    Administration Costs of and incidental to this Scheme shall be paid from the Distribution Sum, and shall be paid from Interest before reducing the principal compensation sums payable to the Claimants. Where the Interest (including from any of the Settlement Reserve Funds and the Settlement Distribution Fund) in either of the I-D Claims Fund or ELPD Claims Fund is insufficient to meet any payment of the Administration Costs in accordance with this clause and clause A4.1, the Interest from the other fund may be applied.

20    In the Supreme Court’s reasons for approving the SDS, Emerton J referred to cl A4.2 of the SDS above and noted (in Rowe v AusNet Electricity Services Pty Ltd [2015] VSC 232 (‘Rowe’) at [143]):

The Scheme provides for the costs incurred by the Scheme Administrator and staff in connection with the assessment of claims to be paid out of the settlement sum. These administration costs are to be paid in the first instance, and hopefully entirely, from interest accruing on the settlement sum.

(Emphasis added)

21    Her Honour’s statement in Rowe was based on evidence given on behalf of Maurice Blackburn before Emerton J that it was anticipated that the costs of the administration would be largely, if not entirely, covered by the interest earned on the Distribution Sum. The Taxpayer monitored whether this was likely to be achieved throughout the administration process.

22    As the administration of the SDS progressed, the Taxpayer sought regular Supreme Court approval of the costs and expenses incurred in administering the Fund pursuant to cl I1 of the SDS which provided as follows:

I1    Approval of Scheme costs

I1.1    Fees payable in respect of work performed by the Administrator Staff pursuant to this Scheme shall be paid at rates set out in Schedule B [a schedule of rates of payment for Administrator Staff which were decided upon as part of the Supreme Court’s decision in Rowe].

I1.2    All fees and disbursements payable to any person pursuant to this Scheme shall be:

(a)    identified in a report to the Court in any disbursement from the Distribution Sum to the person claiming the costs or disbursements; and

(b)    disbursed from the Distribution Sum upon and to the extent of approval by the Court.

23    The Supreme Court, aided by an independent costs referee, ultimately approved all of the costs incurred by the Taxpayer (including the Outgoings in full) in the relevant year, which were all paid out from the interest that accrued on the Distribution Sum.

24    Finally, although a portion of the Distribution Sum has been withheld from distribution to group members pending the outcome of this proceeding, once the entirety of the Distribution Sum has been distributed, the Taxpayer’s obligations under the SDS relevantly come to an end:

B4    No obligations after final distribution

B4.1    Upon the final distribution of the Distribution Sum in accordance with this Scheme the Scheme Administrator shall have no further liability in respect of the Distribution Sum or the implementation or administration of this Scheme.

PROCEDURAL HISTORY

25    This proceeding is a consequence of the tax return lodged by the Taxpayer for the relevant year.

26    On 25 October 2017, the Taxpayer lodged an income tax return for the relevant year in which he declared the Interest Income but did not claim any deductions for the Outgoings. On 1 November 2017, the Commissioner issued a Notice of Assessment to the Taxpayer in accordance with the tax return lodged. On 20 December 2017, the Taxpayer objected to the assessment and claimed that he was entitled to deduct the Outgoings from the Interest Income which would in turn reduce his (ie the Fund’s) tax liability. On 1 March 2018, the Commissioner issued an objection decision disallowing the Taxpayer’s objection in full. And finally, on 28 March 2018, the Taxpayer applied to this Court under s 14ZZ of the Taxation Administration Act 1953 (Cth) to appeal from the Commissioner’s objection decision.

ISSUE FOR DETERMINATION

27    The issue for determination in this proceeding is whether the Taxpayer is entitled to deduct the Outgoings from the assessable income of the Fund in the relevant year, being the Interest Income. This turns on:

(1)    whether the Outgoings were either:

(a)    incurred in gaining or producing the Taxpayer’s assessable income; or

(b)    necessarily incurred in carrying on a business for the purpose of gaining or producing the Taxpayer’s assessable income; and

(2)    whether the Outgoings were capital in nature.

28    The Taxpayer’s application to appeal from the Commissioner’s objection decision can only succeed if (1) is answered in the affirmative and (2) is answered in the negative.

LEGISLATION

29    The Taxpayer is for income tax purposes the trustee of a trust estate being the Fund: s 995-1 of the 1997 Act.

30    The Taxpayer was assessed by the Commissioner pursuant to Div 6 of Part III of the Income Tax Assessment Act 1936 (Cth) (the ‘1936 Act’), and more specifically, s 99A of that Act. Section 99A(4) provides for the net income of a trust estate to be taxed at the highest personal marginal tax rate of 47% in circumstances where during the relevant income year no beneficiary of the trust was presently entitled to a share of the income of the trust estate. As there were no beneficiaries so entitled in the relevant year, the parties accepted that the Taxpayer was liable to pay tax (or ‘answerable as taxpayer’ pursuant to s 254(1)(a) of the 1936 Act) on the net income of the Fund.

31    The ‘net income’ of a trust estate is defined by s 95 of the 1936 Act as:

… the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions…

32    In calculating the net income of the Taxpayer, there was no dispute between the parties that the Interest Income was assessable income of the Fund.

33    Section 8-1 of the 1997 Act relevantly provides:

(1)    You can deduct from your assessable income any loss or outgoing to the extent that:

(a)    it is incurred in gaining or producing your assessable income; or

(b)    it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

…

(2)    However, you cannot deduct a loss or outgoing under this section to the extent that:

(a)    it is a loss or outgoing of capital, or of a capital nature; …

34    Section 995-1(1) of the 1997 Act relevantly provides:

“business” includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

35    As noted above at [27], the issue for determination in this proceeding is: (1) whether the Outgoings fall within either of the two positive limbs of s 8-1(1) of the 1997 Act, as being either: (a) incurred in gaining or producing assessable income (the ‘first positive limb’); or (b) necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income (the ‘second positive limb’); and (2) whether the Outgoings are of a capital nature (as opposed to of a revenue nature) for the purposes of s 8-1(2)(a) of the 1997 Act.

SUBMISSIONS

36    The Taxpayer contended that he was entitled to deduct the Outgoings because the Outgoings were allowable deductions under either of the two positive limbs of s 8-1(1) of the 1997 Act and the Outgoings were not of a capital nature.

37    The Taxpayer made separate submissions in respect of each limb of s 8-1(1), and made discrete submissions in respect of the capital versus revenue account issue.

First positive limb

38    The Taxpayer submitted that the Outgoings were incurred in gaining or producing the assessable income of the Fund, being the Interest Income.

39    Relying on the High Court’s decision in Commissioner of Taxation (Cth) v Anstis (2010) 241 CLR 443, the Taxpayer sought to characterise his ‘income producing undertaking’ as ‘the investment of the [Fund]’, which he considered to be ‘integrally connected’ with his incurring of the Outgoings.

40    In Anstis’s case, the Court considered whether expenses incurred by a student recipient of statutory youth allowance income were deductible. The majority of the Court (comprising French CJ, Gummow, Kiefel and Bell JJ) held at 146 [30]-[31] that:

[30]    Essential to the inquiry of deductibility is the identification of that which is productive of the assessable income. To put it another way, one must ask how the assessable income was (or was expected to be) gained or produced. Contrary to what the Full Court said, the respondent was not “paid to undertake [study]” and that was not required to be so for the deductions to be allowable. Rather, as Ryan J said, the assessable youth allowance income received by the respondent was gained or produced by her entitlement to that payment consequent on the determination by the Secretary that she qualified for the payment. That statutory right to payment would be retained by her, without reduction, non-payment, suspension or cancellation, so long as she maintained her qualification for the payment by satisfying the activity test by undertaking full-time study so defined.

[31]    The reason or motive of the respondent for incurring those education expenses, which could be characterised, for example, as obtaining a qualification to undertake future employment as a teacher, is not determinative of the question whether they were incurred in gaining or producing income. The occasion of the outgoings was to be found in what the [student recipient of youth allowance income] did to gain or produce, by establishing and retaining her entitlement to, the receipts provided by the terms of the social security legislation.

(Emphasis added, citations omitted)

41    The Taxpayer argued that in the present case, he gained or produced the Interest Income by his administration of the SDS – which involved both the investment of the Distribution Sum and the assessment of group member claims for the purposes of the distribution of the Distribution Sum – and that he would continue to derive the Interest Income for so long as he continued to administer the SDS. In the words of the Court in Anstis’s case, the occasion of the Outgoings was to be found in what the Taxpayer did to gain or produce the receipts, being his administration of the SDS.

42    The Taxpayer also sought to rely on the High Court’s decision in Commissioner of Taxation (Cth) v Day (2008) 236 CLR 163 which concerned the deductibility of legal expenses incurred by an officer of the public service in the course of defending allegations relating to breaches of standards of conduct.

43    In Day’s case, the majority (comprising Gummow, Hayne, Heydon and Kiefel JJ) observed that the word ‘in’ – which features in the first positive limb of s 8-1(1) but has in decisions such as Commissioner of Taxation (Cth) v Payne (2001) 202 CLR 93, been treated as reading ‘in the course of’ – does not ‘require a direct connection between the expenditure in question and an activity itself productive of income’ (at 176 [21]). Applying this approach to the facts of the case before them, the majority held that a broad approach should be adopted when identifying the ‘bundle of tasks to be performed and duties to be observed’ that are productive of a taxpayer’s assessable income (at 180 [33]). The majority concluded that what was productive of the taxpayer’s income was ‘to be found in all the incidents of his office’ (at 182 [37]).

44    The Taxpayer submitted that the comments of the majority in Day’s case were apposite in respect of the present case. Here, the Taxpayer’s derivation of the Interest Income arose by reason of the terms upon which he administered the Fund, namely, the requirement that the Distribution Sum be deposited in interest-bearing accounts. The ‘incidents of his office’ as scheme administrator, dictated by the same documents that required him to hold the Distribution Sum in interest-bearing accounts, also obliged the Taxpayer to perform the task of administering the SDS, to which the Outgoings solely related.

Second positive limb

45    Separately, the Taxpayer contended that the Outgoings were necessarily incurred in the business being carried on by the Taxpayer for the purpose of gaining or producing the Interest Income. In oral submissions, the Taxpayer clarified that its case was put principally on this second positive limb. The Taxpayer ultimately advanced its argument on the second positive limb by addressing two questions.

Was the Taxpayer conducting a business?

46    First, and in reliance on the Full Court’s decision in Federal Commissioner of Taxation v Radnor (1991) 102 ALR 187 at 190, the Taxpayer contended that it was settled law that trustees (such as the Taxpayer) were capable of carrying on a business.

47    Second, the Taxpayer addressed the question of whether he was in fact conducting ‘a business for the purpose of gaining or producing [his] assessable income’. Here he argued that he was carrying on such a business which was described as ‘a business in administering the [SDS] including the integral investment activities’.

48    The Taxpayer submitted that this ‘business’ involved all of the activities summarised above at [17] of these reasons, including the consideration of different investment options, the enlisting of Maurice Blackburn staff, and the engagement of third parties (such as barristers and professional loss assessors or adjustors) on arms-length commercial terms, all of which were said to be indicative of a business.

49    In making this submission, the Taxpayer placed particular emphasis on the High Court’s decisions in Spriggs v Commissioner of Taxation (Cth) (2009) 239 CLR 1 and Commissioner of Taxation (Cth) v Stone (2005) 222 CLR 289. The Taxpayer also sought to rely on the New Zealand Supreme Court’s decision in G v Commissioner of Inland Revenue [1961] NZLR 994 (‘Re G’), which was cited with approval by the High Court in Stone’s case.

50    In Spriggs’ case the Court relevantly held (at 19 [59]):

The existence of a business is a matter of fact and degree. It will depend on a number of indicia, which must be considered in combination and as a whole. No one factor is necessarily determinative. Relevant factors include, but are not limited to, the existence of a profit-making purpose, the scale of activities, the commercial character of the transactions, and whether the activities are systematic and organised, often described as whether the activities are carried out in a business-like manner.

(Citations omitted)

51    While emphasising that no single factor is determinative, or that the absence of any particular factor is disqualifying, the Taxpayer submitted that the various activities and duties that he performed meant that his conduct substantially addressed the relevant factors set out in Spriggs’ case, with the result being that his activities were indicative of the conduct of a business. Specifically, the Taxpayer claimed that:

(1)    he was ‘vastly experienced in administering schemes of this kind’;

(2)    he invested the Distribution Sum and ‘made regular changes to the investment of the [Distribution Sum] so as to maximise the returns’;

(3)    he engaged up to 49 people to assist him in the administration of the SDS;

(4)    the administration of the SDS was ‘conducted on a commercial basis, including by engaged skilled professional staff, support staff, counsel and independent contractors on a commercial basis’;

(5)    he ‘established databases for the management and administration’ of the SDS;

(6)    there was a high level of organisation in the conduct of the administration of the SDS; and

(7)    there was a high degree of repetition and regularity in the conduct of his activities.

52    During the course of oral submissions, it became apparent that one of the relevant factors set out in Spriggs’ case that was not readily satisfied by the Taxpayer’s activities was ‘the existence of a profit-making purpose’. In response, counsel for the Taxpayer relied on a number of cases including Stone’s case and Re G to support the proposition that properly understood a ‘profit-making purpose’ is simply the relevant taxpayer’s ambition, or hope or expectation, of eventually turning a profit from the relevant undertaking.

53    In Stone’s case – which concerned whether the sponsorship fees and other bonuses received by a Queensland police officer for her extra-curricular athletic exploits meant the officer was conducting a business – the Commissioner submitted that a ‘profit motive is unnecessary in determining the existence of a business’. This, it was submitted, was ultimately accepted by a majority of the High Court (comprising Gleeson CJ, Gummow, Hayne and Heydon JJ) insofar as the Court held (at 304-5 [54]-[55]) that:

[54]    Taken as a whole, the athletic activities of the taxpayer during [the year of income] constituted the conduct of a business. …

[55]    … If a taxpayer has a view to profit, the conclusion that the taxpayer is engaged in business may easily be reached. If a taxpayer’s motives are idealistic rather than mercenary, the conclusion that the taxpayer is engaged in a business may still be reached: cf [Re G] [1961] NZLR 994. The “wide survey and exact scrutiny” of a taxpayer’s activities that must be undertaken may reveal, as it does in this case, that the taxpayer’s activities constituted the carrying on of a business.

(Emphasis added)

54    In Re G, the New Zealand Supreme Court considered whether the activities of an evangelistic preacher who supported himself and his family entirely from unsolicited donations from his followers constituted the carrying on of a business for the purposes of income tax legislation. The Court concluded (at 999) that:

… the essential test as to whether a business exists is the intention of the taxpayer as evidenced by his conduct, and that the various tests discussed in the decided cases are merely tests to ascertain the existence of that intention.

55    Understood in this sense, the Taxpayer submitted that its ‘intention’ (or hope or expectation) that the costs of administering the Fund would be less than the interest that accrued on the Distribution Sum (in other words, that the administration costs could be paid out entirely from the interest) was indicative of the carrying on of a business.

56    Finally, relying on the decision in Tweddle v Commissioner of Taxation (Cth) (1942) 180 CLR 1, the Taxpayer also submitted that the ‘business’ of administering the SDS could not, or should not as a matter of legal principle, be artificially separated into two categories of activities: those that earned assessable income (ie the depositing of the Distribution Sum into interest-bearing accounts) on the one hand, and those that incurred expenses such as the assessment of group member claims for the ultimate purpose of distribution of the corpus of the Distribution Sum on the other hand. In Tweddle’s case, the High Court held (at 7) that taxing statutes must ‘operate upon the result of a taxpayer’s activities as it finds them’. This it was argued was especially so in the circumstances of this case in light of the fact that the entirety of the Taxpayer’s role as scheme administrator arose under the same constituent documents.

Were the Outgoings ‘necessarily incurred’ in carrying on the Taxpayer’s business?

57    Having contended that it was conducting a business in administering the SDS, the Taxpayer addressed the question of whether the Outgoings were ‘necessarily incurred’ in the carrying on of that business.

58    On this point, the Taxpayer submitted that it was not necessary to be able to trace a direct connection between items of expenditure and his assessable income in order to be entitled to deduct the Outgoings under the second positive limb. As described in Toohey’s Ltd v Commissioner of Taxation for NSW (1992) 22 SR (NSW) 432 at 440, this would be ‘as hopeless a task as trying to find which lump of coal put into a steamer’s furnace was responsible for a particular blast from the whistle’. Rather, on the Taxpayer’s submission, the correct approach required looking at the Taxpayer’s business as ‘a whole set of operations’. Under the terms of the SDS this involved undertaking activities which gave rise to the Outgoings on the one hand, and undertaking other activities which gave rise to the derivation of the Interest Income on the other.

59    In making this submission, the Taxpayer again referred to Spriggs’ case in which the High Court reiterated (at 18 [55]) that the ‘essential question’ is whether or not ‘the occasion of the outgoing’ is found in ‘whatever is productive of the assessable income’, as distinct from being found in the assessable income itself. The Taxpayer claimed that in this case the conduct that was ‘productive of the assessable income’ was the administration of the SDS taken as a whole. Day’s case was also referred to as support for the Taxpayer’s submission, where it was said (at 180 [33]):

That no narrow approach should be taken to the question of what is productive of a taxpayer’s income is confirmed by cases which acknowledge that account should be taken of the whole of the operations of the business concerned in determining questions of deductibility.

60    The Taxpayer argued that in keeping with the High Court’s comments in Day’s case, the correct approach was to first identify the relevant business (in this case, administering the SDS), then identify the various activities that are conducted in the course of that business (ie both the investment and distribution of the Distribution Sum), and finally, ask oneself whether the relevant outgoings were incurred in the course of carrying on the business.

61    Separately, the Taxpayer contended in its written submissions that, in general, the relevant taxpayer is the best judge of whether expenses are ‘necessarily incurred’ in the course the taxpayer’s business or undertaking, relying on the comments of Fullagar J in Commissioner of Taxation (Cth) v Snowden & Willson Pty Ltd (1958) 99 CLR 431 at 444. However, as was pointed out, the facts of this case featured an even higher level of scrutiny. The Taxpayer argued that the scrutiny of the Supreme Court (and the independent costs referee) demonstrated even more than usual that each of the Outgoings was ‘appropriate or adapted for the business being carried on by the Taxpayer in administering the SDS, and that each Outgoing was dictated by the business ends of the SDS.

62    The Taxpayer concluded that in light of the above, it followed that the Outgoings were ‘necessarily incurred’ in the course of conducting his business.

Capital nature of the Outgoings

63    Finally, the Taxpayer submitted that the Outgoings were not of a capital nature for the purposes of s 8-1(2)(a) of the 1997 Act.

64    The Taxpayer relied on the decision of the Federal Court in Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183, in which Brennan J (as his Honour then was) at 191 said:

When the question is whether expenditure has the character of capital or of a revenue payment … the advantage for which the expenditure was incurred must be identified and the manner in which it “is to be relied upon or enjoyed” must be considered. … If the advantage can be sufficiently identified by reference to a contract, and the taxpayer's undertaking is known, the connection between the incurring of the expenditure and the undertaking is manifest, and it would be otiose to refer to the purpose of incurring the relevant expenditure. But purpose is relevant to describe an element of connection between expenditure and a taxpayer's undertaking or business in cases … where the occasion of the expenditure … is not manifestly to be found in whatever is productive of assessable income or in whatever would be expected to produce assessable income, or in the carrying on of a business.

(Citations omitted)

65    The Taxpayer submitted that in the present case, the occasion of the Outgoings was to be found in the carrying on of the business or undertaking, and that because the Outgoings were periodical and recurrent expenses (insofar as they were incurred to meet the continuous demand of group members to assess and process individual claims) they were not of a capital nature.

CONSIDERATION

66    For the reasons that follow, I reject the submissions of the Taxpayer and find that the Outgoings fall into neither the first nor second positive limb of s 8-1(1) of the 1997 Act (and are, in any case, capital in nature for the purposes of s 8-1(2)(a) of the 1997 Act). I therefore dismiss the Taxpayer’s application to appeal against the Commissioner’s objection decision dated 1 March 2018. However, before addressing the parties’ submissions, it is useful to make some introductory observations.

67    The task of the Court is to apply the facts in this proceeding to the relevant legislation, guided appropriately by relevant High Court and Federal Court authority. I have not found it helpful or necessary to consider foreign authorities which deal with different statutory settings and factual circumstances: to do so in light of the issues before me would distract from the task of the Court, or worse, lead the Court into error.

68    The task of this Court is to have regard to the activities of the Taxpayer in the year of income and properly characterise those activities. In my view, these activities cannot be divorced from the setting in which they occurred. While by no means determinative, the circumstances of the Supreme Court’s involvement in supervising and scrutinising the Taxpayer’s activities is an inescapable fact in the characterisation of the activities undertaken by the Taxpayer in the relevant year. A survey of those activities cannot be undertaken without keeping in mind, when considering the various indicia referred to in Spriggs’ case, the very reason for the establishment of, the role of, and activities then undertaken by, the Taxpayer.

First positive limb

69    As noted above at [43], in order for expenses to be deductible under s 8-1(1)(a), those expenses must be incurred in the course of gaining or producing the taxpayer’s assessable income. According to Anstis’s case and Day’s case (as referred to by the Taxpayer), this exercise is to be conducted without adopting an overly narrow view as to either the directness of the connection between the expenses claimed and the income earned, or what specific tasks in the broader ‘bundle of tasks’ performed by the taxpayer were productive of his or her assessable income.

70    This approach is also supported by the cases referred to by the Commissioner, namely the Full Court’s decision in Commissioner of Taxation v Firth (2002) 120 FCR 450 in which Hill J (writing separately but reaching the same conclusion as Sackville and Finn JJ) stated (at 452-3 [6]):

The positive tests require that there be a connection between the loss or outgoing on the one hand and the assessable income or business on the other. The nature of that connection has been expressed in different ways in the cases. It is sometimes said that there must be a “perceived connection” between the loss or outgoing and the assessable income or business: Commissioner of Taxation (Cth) v Hatchett (1971) 125 CLR 494 at 499. In other cases it has been said that the expenditure must be “incidental and relevant” to the operations or activities regularly carried on by the taxpayer for the production of income: Ronpibon Tin NL v Commissioner of Taxation (Cth) (1949) 78 CLR 47 at 56, Commissioner of Taxation (Cth) v Smith (1981) 147 CLR 578 at 586. These ways of describing the connection that is a necessary prerequisite to deductibility are but part of the process of identifying the essential character of the expenditure in order to determine whether a particular loss or outgoing is in fact incurred in gaining or producing the assessable income or in carrying on a business which more directly contributes to the gaining or production of the assessable income: Lunney v Commissioner of Taxation (Cth) (1958) 100 CLR 478 at 499.

71    Applying this approach, the Outgoings do not, in my view, bear a sufficient connection with the Interest Income, or indeed the activities which more directly gained or produced the Interest Income, such that it could be said that the Outgoings were, in the language of s 8-1(1)(a), ‘incurred in gaining or producing the assessable income’ of the Fund.

72    It was put by the Taxpayer that the activity which gained or produced the Interest Income was ‘the administering of the SDS’, which entailed both the investment of and the process for distributing and paying out the Fund. In reliance on Tweddle’s case and others, the Taxpayer contended that these sub-tasks of investment and distribution could not be separated.

73    It is obvious that in the circumstances of this case and the existing case law, the Taxpayer has an interest in characterising his activities as broadly as possible so as to encompass what is plainly his primary task (being the assessment of the entitlements of individual group members covered by the SDS and if found so entitled, the distribution of the Distribution Sum to entitled group members), and what may be described as an incidental task of depositing the Distribution Sum into an interest-bearing bank account for so long as it took the Taxpayer to administer the Fund.

74    The expenses for which the Taxpayer claims the deductions, such as the costs of assessing the entitlements of individual claimants, relate to the distribution of the Fund, not to the derivation of income from bank deposits. Indeed, it appears that only one or two of the many hundreds of time entries recorded by Maurice Blackburn staff (the costs of which form a substantial part the Outgoings) relate to the consideration of ‘investment’ options and the depositing of the Distribution Sum in interest-bearing deposits.

75    While I am mindful that s 8-1(1)(a) of the 1997 Act does not require that there be a direct connection between the expenses that are sought by to be deducted by the taxpayer and the activities which more directly gained or produced the taxpayer’s assessable income, it does require a connection that is sufficient or of some weight.

76    As identified by the Commissioner, the Full Court’s decision in Trustees of the Estate Mortgage Fighting Fund v Commissioner of Taxation (2000) 102 FCR 15 is of particular assistance in this regard. Charged with determining whether or not the costs incurred by a trustee in mailing out leaflets to solicit monetary contributions from persons who had lost capital in failed mortgage estate investments were deductible against the interest income of the trust, Hill J held that the expenses did not have a sufficient connection to the interest income. After noting that where a taxpayer is subject to interest as a cost, that interest can ordinarily be deducted from the taxpayer’s assessable income, his Honour stated (at 29 [25]):

But that is not the true where the relationship to the soliciting of funds which represent the capital of the trust, even where, to the extent that capital is not expended, it is invested at interest. In my view the outgoings in question both lack the necessary connection with the activities which gained or earned the interest income of the trust (at least in whole) and this is so notwithstanding that without those funds, interest would not have been earned.

(Emphasis added)

77    The emphasised part of Hill J’s comments is especially pertinent in the context of the Taxpayer’s contentions in this case. In written and oral submissions, the Taxpayer claimed that he would, as scheme administrator, continue to derive income from the interest accruing on the moneys for so long as he continued to administer the Fund as if to suggest that this demonstrated the sufficiency of the requisite connection between the Taxpayer’s Outgoings and Interest Income.

78    As was contended by the Commissioner, this approach erroneously reduces the statutory test in s 8-1(1)(a) to a ‘but/for’ test which has been rejected in other decisions: Lunney v Commissioner of Taxation (Cth) (1958) 100 CLR 478 at 501 and Commissioner of Taxation v Cooper (1991) 29 FCR 177 at 197. Never was the payment by the selected banks of the interest that accrued on the Distribution Sum conditional on the Taxpayer’s performance of his broader obligations under the SDS, aside from holding the Distribution Sum in interest-bearing deposits.

79    Accordingly, I do not find that the Outgoings fall within the first positive limb of s 8-1(1)(a) of the 1997 Act.

Second positive limb

80    As was articulated in Spriggs’ case (at 19 [59]), determination of whether a business is being carried on is a matter of fact and degree, and requires consideration of ‘the existence of a profit-making purpose, the scale of activities, the commercial character of the transactions, and whether the activities are systematic and organised’. I address each of these factors below in reverse order. In doing so, it is important to recall that no one factor is determinative, and each must be viewed in the overall context of the Taxpayer and his activities in the relevant year.

Systematic and organised?

81    It is plainly apparent that the activities engaged in by the Taxpayer in the course of administering the SDS were systematic and organised and conducted in a business-like manner of the kind that would be expected from a law firm of the size and resources of Maurice Blackburn. As detailed in his affidavit sworn 26 July 2018, Mr Watson in his capacity as scheme administrator carried out or caused to be carried out a range of systematic and orderly activities relating to the administration of the SDS. Among others, these included:

(1)    enlisting the assistance of a sizable team of lawyers, trainee lawyers, paralegals and administrative staff which were employed by Maurice Blackburn to assist in discharging Mr Watson’s obligations as scheme administrator;

(2)    with the assistance of that team, developing systems and procedures to assess the individual entitlements of group members and monitor the general progress of the administration of the SDS;

(3)    engaging (in addition to the Maurice Blackburn staff assisting on the matter) a large number of barristers, medical practitioners and other independent loss assessors pursuant to the SDS to determine the I-D and ELPD claims of each group member according to a uniform criteria;

(4)    engaging KPMG to review and audit data relating to the assessment and distribution process; and

(5)    calculating and forecasting the expected costs of the administration process and reported that information to the Supreme Court as part of Mr Watson’s regular reports on the progress of implementing the SDS.

82    Indeed, based on correspondence exchanged between the Commissioner and representatives of the Taxpayer, it appears that it was not even in dispute that the Taxpayer’s activities in the course of administering the SDS were systematic and organised. On 23 August 2018, representatives of the Taxpayer wrote to the Commissioner to request test case funding for this proceeding. In a response dated 7 September 2018, Assistant Commissioner Marcus Ryan of the Australian Tax Office refused to grant test case funding but at [20] of his response stated:

I agree that there is a considerable scale of activity, repetition and continuity and there is an apparent application of ordinary commercial principles in carrying out your role as Scheme Administrator.

83    At the hearing, counsel for the Taxpayer claimed this amounted to an admission of fact from a representative of the Commissioner in support of the Taxpayer’s position. Whether or not this is so (about which I express no view), it was apparent to me that the Spriggs’ case indicium of whether or not the relevant activities were ‘systematic and organised’ (or indeed another Spriggs’ case indicium of the scale of the activities) were not topics of significant disagreement between the parties.

Commercial character?

84    The commercial character of the activities claimed by the Taxpayer is to be doubted. There are two of considerations which lead me to reaching this view.

85    First, and as contended by the Commissioner, all of Mr Watson’s activities in his capacity as scheme administrator were subject to the strict supervision by the Supreme Court. In this respect, cll J1 and I1 of the SDS, extracted above at [15] and [22] respectively, are of particular relevance.

86    Ordinarily, activities of a commercial character involve a businessperson exercising their discretion as to which transactions to pursue and at what cost. The Taxpayer enjoyed no such discretion. The Taxpayer could not charges fees or disbursements against the Fund without first reporting to and obtaining the approval of the Supreme Court. Further, the Taxpayer had no means by which he could derive any revenue under the terms of the SDS beyond holding the Distribution Sum in an interest-bearing account for so long as it took the Taxpayer to administer the SDS.

87    Second, as already outlined above at [51], there were activities that Mr Watson undertook which may be characterised as being commercial in nature, such as the employment of staff or the engagement of independent assessors to assist in administering the SDS, but it is critical to appreciate the capacity in which these activities were undertaken. In this regard it is important not to confuse Mr Watson’s role as a principal of Maurice Blackburn and Mr Watson’s other role as scheme administrator. From the perspective of the taxing statute, only the latter of Mr Watson’s roles is relevant. In that role, Mr Watson was not undertaking a commercial activity. He was administering the SDS as an officer of the court and as a part of the settled Murrindindi Bushfire proceedings.

88    On these bases, I do not consider that the activities of the Taxpayer, properly identified, were of a commercial character.

Scale of activities?

89    The scale of the Taxpayer’s activities, like the systematic and organised character with which the activities were carried out, did not appear to be challenged by the Commissioner and is not doubted by this Court.

Profit-making purpose?

90    Lastly, I am not persuaded that there existed a profit-making purpose which motivated the Taxpayer’s activities.

91    The Taxpayer submitted that during the settlement approval process before the Supreme Court and throughout the administration of the SDS, he (and indeed the group members of the settled Murrindindi Bushfire proceeding) had anticipated or had an expectation that the interest that accrued on the Distribution Sum would exceed the costs of administering the Fund. This expectation was communicated by Maurice Blackburn first to the representative plaintiff and later to other group members in the proceeding, and save for some uncertainty regarding the impact of an adverse tax finding which is the subject of this proceeding, it was expressed by Mr Watson in his regular reports on the progress of the administration of the SDS to the Supreme Court. This was reflected in Emerton J’s comments in Rowe at [143], referred to at [20] of these reasons.

92    However, this is in my respectful opinion not the same as a profit-making purpose in the ordinary, commercial sense of that phrase as has been applied in other cases.

93    In this case, the Taxpayer’s ‘purpose’ in respect of the Interest Income extends no higher than the intention to derive as much interest as possible having regard to the need to maintain the highest levels of financial security. As was put by the Commissioner in the course of oral submissions, this is not a profit making purpose in the ordinary, commercial sense of that phrase because the other side of the ledger – the costs – are driven by completely separate considerations. In that sense, the Taxpayer was not in a position where he was weighing up the earning or derivation of interest income on one side of the equation with the costs of administering the Fund on the other, and actively either seeking to maximise the income and minimise the costs in the manner that a businessperson might ordinarily do in a typical commercial operation. Rather, in my view, the Taxpayer had different considerations in mind:

(1)    in respect of the income, Mr Watson attested to the fact that in investing the Distribution Sum, he considered it his ‘principal duty’ to ‘ensure the security of the funds’; and

(2)    in respect of the costs, Mr Watson attested to the fact that in administering the SDS he needed to control the costs of the administration but, critically, only to the extent that doing so was consistent with his ‘obligations to ensure that the process was fair and appropriately conducted’.

94    Put another way, the production of assessable income by the Taxpayer was a mere incident of the Taxpayer’s pursuit of his overarching purpose or motivation to dutifully discharge his obligations under the SDS, principally being the administration of the SDS according to its terms.

95    I am mindful of the Taxpayer’s reliance on Stone’s case, which was said to stand for the proposition that a taxpayer whose activities do not generate receipts by design (but rather as an incidence of the taxpayer’s pursuit of some other objective) may nevertheless be found to be carrying on a business. It may be accepted that a profit motive is unnecessary in determining the existence of a business.

96    As earlier referred to at [53] of these reasons, the majority of the High Court in Stone’s case held (at 304-5 [54]-[55]):

If a taxpayer’s motives are idealistic rather than mercenary, the conclusion that the taxpayer is engaged in a business may still be reached. The “wide survey and exact scrutiny” of a taxpayer’s activities that must be undertaken may reveal, as it does in this case, that the taxpayer’s activities constituted the carrying on of a business.

(Citations omitted)

97    In this case, it is that ‘wide survey and exact scrutiny’ that leads me to the conclusion that the activities engaged in by the Taxpayer did not constitute the carrying on of a business.

Capital nature of the Outgoings

98    In light of the conclusion I have expressed in the preceding paragraphs, I need not come to a view as to whether or not the Outgoings were of a capital nature for the purposes of s 8-1(2)(a) of the 1997 Act as that section is only engaged in circumstances where either or both of the positive limbs in s 8-1(1) are satisfied, and in my view they are not.

99    However, in any event, I find that the Outgoings were of a capital nature for the purposes of s 8-1(2)(a) of the 1997 Act and are therefore not deductible.

100    As referred to by counsel for the Commissioner, the judgment of Dixon J in Sun Newspapers Ltd v Commissioner of Taxation (Cth) (1938) 61 CLR 337 at 363 sets out three criteria to be considered in determining whether costs or expenses are on capital or revenue account:

… (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 a final provision or payment so as to secure future use or enjoyment.

101    I agree with the Commissioner contention that the ‘advantage sought’ by the Outgoings was to ensure that the moneys of the Fund were permanently distributed to group members pursuant to the SDS. Indeed, as earlier referred to at [8] of these reasons, the object of the SDS was to establish a procedure for distributing the Distribution Sum to group members pursuant to the settlement of the class action approved by the Supreme Court, and that, under the very terms of the SDS, once the final distribution was made, the scheme administrator’s task under the SDS was complete (see [24] above).

102    As noted above at [65], the Taxpayer submitted that because the Outgoings were periodical and recurrent expenses they were not of a capital nature. While it is clear from the time entries recorded by Maurice Blackburn staff that the Outgoings were incurred on a recurrent basis, all of the Taxpayer’s efforts and the efforts of the broader Administrator Staff (to which the Outgoings largely relate) were put towards the final goal of distributing the entirety of the Distribution Sum to group members so as to discharge the scheme administrator’s duties under the SDS. When put in this context, the regular incurring of costs and expenses are mere steps on the path towards the ultimate destination being the completed settlement of the litigation relating to the Murrindindi Bushfire.

CONCLUSION

103    For the foregoing reasons, the Taxpayer’s application to appeal from the Commissioner’s objection decision dated 1 March 2018 is dismissed. I will also order that unless the parties apply to the Court for an alternative costs order within two business days of the date of my orders, the applicant pay the respondent’s costs of and incidental to the application to appeal.

Associate:

Dated:    28 February 2019