RSM Australia

ATO denies deduction: The case for critical comparisons when establishing precedent

When landmark ATO cases come to mind there is no doubt that the decision handed down by the High Court in FCT v Myer Emporium Ltd (1987) 18 ATR 693 (Myer) would make the top ten.

The decision prompted a revolution in the perception of when gains were to be treated as ordinary income, becoming renowned as ‘the Myer principle’. However, on 20 July 2018, the Federal Court in Greig v FCT [2018] FCA 1084 (Greig’s case) may have instantaneously unwound a precedent established over the better part of three decades.

This begs the question – have the ATO ‘truly’ won?

THE MYER CASE

In Myer, the taxpayer was the parent company in a group which carried on business predominantly in the areas of retail trading and property development. As part of a group reorganisation in March 1981, the taxpayer lent funds to a subsidiary. Three days later, as had always been intended, the taxpayer assigned to a finance company its right to receive the interest payable over the remainder of the loan period. As consideration for the assignment, the finance company paid the taxpayer an amount in a single sum.

The Commissioner treated this lump sum as assessable income for the year ended 30 June 1981.

On appeal, both the Supreme Court of Victoria and the Full Court of the Federal Court of Australia held that the amount was a non-assessable capital receipt. It seemed that Myer Emporium Ltd.’s defence was that the profit the company made from the transaction was not ordinary income because the transaction was outside the ordinary course of the company’s business.

However, the Commissioner then successfully appealed to the High Court. The High Court held that simply being outside the ordinary course of the company's business was insufficient; the amount was income according to ordinary concepts as the transaction gave rise to a profit arising from the carrying on of a profit-making undertaking or scheme.

GREIG’S CASE

In Greig’s case, the individual taxpayer was denied a deduction under ordinary deduction principles for losses incurred while trading in a single listed security. It was claimed that the trading undertaken was in accordance with a “Profit Target Strategy” that constituted a “business operation or commercial transaction”, and therefore aligned with the Myer principle.

The Court accepted that even though a profit-making purpose was present, the hope or expectation that the shares would increase in value did not make the purchase of the shares a business operation or commercial transaction; the share losses were not “incurred in gaining or producing … assessable income” and therefore non-deductible under ordinary concepts.

This idea of requiring the transaction or operation to be carried out as a business operation or commercial transaction is further reinforced in the ATO’s Taxation Ruling 92/3. In the ruling, the ATO provides the following list of matters for consideration when deciding whether an isolated transaction amounts to a business operation or commercial transaction:

(a)          the nature of the entity undertaking the operation or transaction;

(b)          the nature and scale of other activities undertaken by the taxpayer;the Geig case

(c)           the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

(d)          the nature, scale, and complexity of the operation or transaction;

(e)          the manner in which the operation or transaction was entered into or carried out;

(f)           the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

(g)          if the transaction involves the acquisition and disposal of property, the nature of that property; and

(h)          the timing of the transaction or the various steps in the transaction.

IN SUMMARY

The Greig case serves as a clear reminder that when attempting to apply principles derived from previous cases, the facts of the cases must always be critically compared.

On one hand is the complexity of the Myer case with its multiple business operations entering into an isolated transaction with a profit-making intention. The other is Mr Greig, an individual taxpayer seeming to only invest in shares – yet influenced by the enduring impression of the Myer decision and attempting to rationalise that this was a revenue transaction.

A critical outcome is that the ATO cannot have it both ways; while losses previously treated as revenue will provide them with future wins, profits that have previously been treated as revenue are suddenly treated as capital, which may leave the ATO feeling less triumphant. Being classified as capital, the gains will now be subject to the capital gains tax provisions, giving individual taxpayers an entitlement to claim the general 50% CGT discount.

But wait, there’s more. Of note is that Mr Greig has subsequently appealed to the Full Court, the outcome of which is eagerly anticipated.

For more information

For more information and questions on 'the Myer principle' or the Greig case, please contact your local RSM office.