In brief - The High Court has decided that the purchase price of gaming machine entitlements in Victoria was not deductible in Commissioner of Taxation v Sharpcan Pty Ltd [2019] HCA 36

While the decision is mainly relevant to buyers of gaming machine entitlements and similar rights, it has general relevance to business operators as it considers the distinction between capital and revenue outgoings and the operation of the "blackhole" provisions. It is the first time the High Court has considered the blackhole provisions.

Commissioner successfully appeals finding that purchase price of gaming machines was deductible

Sharpcan was the sole beneficiary of a trust. The trustee of the trust purchased a hotel from Tattersall's Limited which had 18 gaming machines.

Under the Victorian gaming machine legislation, Tattersall's was the authorised operator of the gaming machines, so the trustee did not purchase the gaming machines. Tattersall's continued to operate the machines after the purchase of the hotel and the trustee received a percentage of the income.

Later, the Victorian government changed the legislation so that gaming machine entitlements would be allocated directly to gaming venue operators.

The gaming machine entitlements were auctioned and the trustee was the successful bidder for 18 gaming machine entitlements. As a result, the gaming capacity of the hotel was unchanged.

Each gaming machine entitlement allowed the trustee to operate one gaming machine for 10 years and could be sold.

The purchase price was payable in instalments over six years. Failure to pay an instalment could cause the gaming machines to be forfeited.

The trustee claimed the purchase price as a deduction under either section 8-1 of the Income Tax Assessment Act 1997 (Cth) or section 40-880 of the Act.

The Commissioner disallowed both claims and Sharpcan appealed to the Administrative Appeals Tribunal which found that the purchase price was deductible under section 8-1.

The Commissioner appealed to the Full Federal Court. A majority of the Court held that the purchase price was deductible under section 8-1 or section 40-880.

The Commissioner then appealed to the High Court, which in a joint judgement held that the purchase price was not deductible under section 8-1 or section 40-880.

Revenue or capital outgoing

The High Court held that the purchase price was not deductible under section 8-1 because it was a capital outgoing.

The principles applied by the High Court were:

  • the distinction between a revenue and capital outgoing primarily depends on what the outgoing is intended to effect from a practical and business point of view
  • this normally requires consideration of how the thing acquired will be used and whether the acquisition is a once and for all outgoing to acquire something of enduring advantage or a periodical outgoing to cover the use and enjoyment of something
  • an indicator that an outgoing is capital is that the thing acquired is necessary for the structure of the business

The gaming machine entitlements were assets of enduring value which allowed the trustee to continue to conduct gaming activities at the hotel for 10 years. Although the purchase price was paid in instalments, it was in the nature of a once and for all outgoing for the acquisition of an enduring asset. It was not a series of regular and recurrent payments for the use of an asset.

It did not matter that:

  • the trustee intended to recoup the purchase price from the income produced by the gaming machines
  • the purchase price reflected the value of the expected income stream from the gaming machines
  • the hotel business would have been significantly prejudiced or failed if the trustee had not purchased the gaming machines, or
  • a change in law forced the trustee to purchase the gaming machines

Blackhole provisions

The object of section 40-880 is to provide deductions for business expenditure that is not deductible under the other provisions of the Act, subject to some exclusions. The relevant exclusions in this case were:

  • expenditure incurred in relation to a lease or other legal or equitable right, and
  • expenditure that could be taken into account to work out a capital gain or a capital loss

The exclusions do not apply if the expenditure is incurred to preserve (but not enhance) the value of goodwill by acquiring a legal or equitable right that has no value independent of its effect on goodwill. The application of section 40-880 depended on whether the purchase price was incurred for this purpose.

The High Court found that the purpose of the expenditure was to acquire the gaming machine entitlements as assets to be used in the hotel business.

The value of the gaming machine entitlements was not solely attributable to the effect that the gaming machine entitlements had on goodwill.

The gaming machine entitlements were assets which could be individually identified and quantified in the accounts of the business and had a separate value to goodwill. The value was in their capacity to generate gaming income and that they could be sold.

As the purchase price was incurred in relation to the gaming machine entitlements which were legal rights, and the purchase price was included in the capital gains tax cost base of the gaming machine entitlements, the exclusions applied to deny deductions under section 40-880.

This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2019.

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