MLC Limited v Deputy Commissioner of Taxation (2002) FCA 1491
The Federal Court has determined that 'building allowance' deductions are not clawed back by the operation of section 82(2) of the Income Tax Assessment Act on the sale of the property concerned. The ATO now accepts that this is the law.
In the same case, the Court made some useful observations on the concept of 'reasonable care' in the context of penalty tax.
Clawback of building allowance
Division 10D of the Income Tax Assessment Act 1936 (ITAA 1936), introduced in 1982, provided a deduction for capital expenditure on buildings to be used for non-residential rental purposes. The measure was designed to provide an incentive to ensure that structures used for non-residential income producing purposes remained up to date. Equivalent provision to those in Division 10D of ITAA 1936 are now to be found in Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997).
Section 82 can be described as a section which seeks to prevent 'double dipping' in relation to deductions. Subsection 82(1) is a general provision which applies where deductions are available under more than one provision of the Act, whereas subsection 82(2) applies particularly to the calculation of profits on the sale of property.
In March 1999 the ATO issues Taxation Determination TD 1999/1 which stated to the effect that building allowance deductions were excluded by section 82(2) from the calculation of any assessable profit or deductible loss arising from the sale of the property concerned. The example given in the determination postulated the construction of a building for $60m and its subsequent sale for $70m. It also postulated that, at the time of the sale, the taxpayer had claimed building allowance of $2m. According to the determination, the assessable profit was $12m being the $70m sale proceeds less both the original construction costs of $60m plus the $2m of claimed building allowance deductions.
The MLC cases involved the sale of major CBD buildings in Sydney, Canberra and Perth by insurance companies, MLC Limited and MLC Lifetime Company Limited (MLC). The ATO issued amended assessments for the years in which the sales occurred, being 1996 and 1997, giving effect to its view as to the operation of section 82(2) in relation to around $3.3 million of deductions claimed by the company under section 124ZH.
During the interlocutory stages, the ATO indicated that it would rely on both sections 82(2) and 124ZG(4) as supporting the clawback. However, the 124ZG(4) point was not pressed at the hearing.
Hill J gave judgment on 29 November 2002 and allowed MLC's applications.
The key points on the interaction of section 82(2) and Division 10D/Division43 in the judgment were as follows: In relation to section 82(2) the judge said:
'Thus subsection (2) was enacted to ensure that a taxpayer, entitled to a deduction for expenditure which he or she incurred, should not in essence obtain a second deduction for that expenditure by taking that expenditure into account on the cost side of the equation in computing a profit (or loss) where that profit would be brought into assessable income.'
While he described the operation of the building allowance as follows:
'It is to give a deduction for what in essence is amortisation on a fixed percentage basis for expenditure on the construction of or in certain cases extensions to buildings used to produce assessable income and thereby encourage the construction (or extension) of new commercial buildings. The amortisation, while calculated by reference to the expenditure incurred, is not given only to the person who expended the money. The criterion relevant to the deduction is not that the taxpayer has expended the money, although clearly someone must have. The criterion for the allowance is use of the building as non-residential premises for the purpose of gaining assessable income.'
In other words, sections 82(2) operates where expenditure incurred by the taxpayer has been allowed as a deduction. Under building allowance, the deduction is given to the person who uses non-residential premises for the requisite purpose. While the deduction is calculated by reference to the amount of relevant expense incurred, the recipient of the deduction, at any particular time, may not be the person who incurred the relevant expense. The taxpayer could, for instance, be a lessee of the premises.
The Judge pointed out that the incentive which building allowance is intended to provide would 'obviously be cut down if the deduction is clawed back when the building is sold'. While the allowance would be given, the only advantage would be one of timing.
Shortly after the judgment, the ATO indicated that it did not propose to appeal. On 26 March 2003, it withdrew TD 1999/1. In doing so, it summarised the decision in the MLC case as follows:
'(The) case held that the criterion for the deduction for building allowance under Division 10D of the ITAA 1936 (rewritten as Division 43 of the ITAA 1997) is not expenditure incurred but the use of the building as non-residential premises for the purposes of gaining assessable income. As a consequence, the Court held that the building allowance deductions are not excluded by the operation of subsection 82(2) of the ITAA 1936 in the calculation of any assessable profit or deductible loss arising from the sale of the property.'
The amended assessments in this matter imposed penalty tax on MLC under Section 226G of the ITAA36. Section 226G provides to the effect that if a taxpayer had a tax shortfall for a year and the shortfall was caused by the failure of the taxpayer or a registered tax agent to take reasonable care to comply with taxation legislation, then the taxpayer is liable to pay additional tax by way of penalty. The supposed lack of reasonable care relied upon was the failure to include the adjustment which, in ATO's view, was required to be made in MLC's tax returns by reason of the application of section 82(2) to the building allowance that had been received.
Although, given the judge's view on the principal issue, he was not required to do so, he determined the 'reasonable care' issue against the possibility of an appeal. In finding for the companies, Hill J said:
'In my view the present is … a case where on the facts it cannot be said that there was a failure to exercise reasonable care… Here, the taxpayer through its accountants had made an enquiry and been told that the view it took, a view taken in good faith and highly arguable, was correct. The view was one held generally in the insurance industry. It is true that it could have sought a binding ruling from the Commissioner, but clearly failure to seek a ruling will not in every case be equated with failure to exercise reasonable care. Indeed, if it were, the Commissioner would be so inundated with applications for rulings that he would be unable to give answers to them. A taxpayer who relies upon expert advice as here where the advice is held generally in the industry and does not conflict with any statement made by the Commissioner [the relevant tax returns had been made prior to the issuance of TD 1999/1] and indeed is confirmed by enquiry of the ATO is not required to obtain a ruling to guard against an allegation that the taxpayer has not exercised due care.'
The 'enquiry of the ATO' referred to was made by phone by MLC's accountants. In this connection, Hill J warned that it was unwise for taxpayers to make oral enquiries of officers of the ATO and it was also equally unwise for officers to answer those enquiries verbally. It was, he said, highly desirable that any dealings between the taxpayer and the ATO on complex matters be in writing.
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