FEDERAL COURT OF AUSTRALIA INCOME TAX - Deductions - Lump sum payment by bank to Commonwealth for exclusive right to make subsidised loans to ADF personnel - Character of advantage sought by payment ‑ Capital or revenue expenditure. Income Tax Assessment Act 1936 (Cth) s 51(1) GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 applied Mount Isa Mines Ltd v Federal Commissioner of Taxation (1992) 176 CLR 141 applied BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386 considered Murray v Imperial Chemical Industries Ltd [1967] Ch 1038 cited Inland Revenue Commissioners v Longmans Green & Co Ltd (1932) 17 TC 272 cited Anglo‑Persian Oil Co v Dale [1932] 1 KB 124 cited Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 applied Broken Hill Theatres Pty Ltd v Federal Commissioner of Taxation (1952) 85 CLR 423 cited Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 applied United Energy Ltd v Federal Commissioner of Taxation (1997) 97 ATC 4,796 cited Trade Practices Commission v Ansett Transport Industries (Operations) Ltd (1978) 32 FLR 308 cited Federal Commissioner of Taxation v Raymor (NSW) Pty Ltd (1990) 24 FCR 90 cited Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213 cited Hancock v General Reversionary and Investment Co [1919] 1 KB 25 cited Commissioner of Taxes v Nchanga Consolidated Copper Mines Ltd [1964] AC 948 cited Foley Brothers Pty Ltd v Federal Commissioner of Taxation (1965) 13 ATD 562 cited NATIONAL AUSTRALIA BANK LIMITED (ACN 004 044 937) v THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA VG 330 OF 1997 NORTHROP, FRENCH AND SUNDBERG JJ 11 DECEMBER 1997 MELBOURNE IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY VG 330 of 1997 ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA BETWEEN: NATIONAL AUSTRALIA BANK LIMITED (ACN 004 044 937) AppELLant AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGES: NORTHROP, FRENCH AND SUNDBERG JJ DATE OF ORDER: 11 DECEMBER 1997 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. The appeal be allowed. 2. The orders made by the primary judge be set aside and in lieu thereof it be ordered that the respondent's decision disallowing the appellant's objection dated 6 September 1993 to the amended assessment dated 2 August 1993 be set aside, and the matter be remitted to the respondent for reassessment in accordance with the Court's reasons. 3. The respondent pay the appellant's costs of the appeal and of the appeal to the primary judge. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY VG 330 of 1997 ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF AUSTRALIA BETWEEN: NATIONAL AUSTRALIA BANK LIMITED (ACN 004 044 937) Appellant AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGES: NORTHROP, FRENCH and SUNDBERG JJ DATE: 11 decEMBER 1997 PLACE: MELBOURNE REASONS FOR JUDGMENT THE APPEAL In its 1991 income year the appellant ("the Bank") paid $42 million to the Commonwealth for the exclusive right, for a period of fifteen years, "to participate as the lender under the Scheme". The Scheme is the scheme of housing loan assistance established by the Defence Force (Home Loans Assistance) Act 1990 (Cth) ("the HLA Act") under which subsidies are paid to eligible members of the Australian Defence Force ("ADF") in respect of their home loans. The respondent ("the Commissioner") disallowed the Bank's claim to a deduction for this amount, and disallowed the Bank's objection to its amended assessment. The Commissioner accepted that the payment was incurred in gaining or producing the Bank's assessable income and was necessarily incurred in carrying on its business for the purpose of gaining or producing such income within s 51(1) of the Income Tax Assessment Act 1936 (Cth), but considered that the payment was of a capital nature. The Bank's appeal to the Court against the disallowance was dismissed: (1997) 97 ATC 499. The present appeal is against that decision. DEFENCE FORCE HOUSING ASSISTANCE Since the end of the First World War the Commonwealth has provided housing assistance to veterans in the form of low interest loans. The loans were made under the Defence Service Homes Act 1918 (Cth). In more recent times that assistance has been extended to all ADF personnel who have served a minimum period. Until 1985 the assistance took the form of loans provided by the Commonwealth itself. In 1985 the Defence Service Homes Act scheme was closed to ADF personnel who enlisted after 15 May 1985, and a new scheme was established for them. The portfolio of existing loans was put out to tender in 1988. A number of institutions, including the Bank, put in bids. The successful bidder was Westpac Banking Corporation. The new scheme was to operate in the following way. Instead of the Commonwealth being the lender, an approved institution would have the exclusive right to make advances. ADF personnel who satisfied particular requirements would be eligible to receive a 40 per cent subsidy on interest costs on loans of up to $40,000. They would also have to meet the institution's ordinary security and other lending criteria. In August 1989 the Commonwealth called for registrations of interest in an "Exclusive Franchise to Provide Subsidised Home Loans". THE BANK'S BID In the course of preparing a bid the Bank made detailed calculations, with actuarial advice, as to the profits that might reasonably and conservatively be obtained from the franchise. Mr Stephen Coulter produced a computer model showing the profits the Bank could expect to make, assuming a return upon the loan funds employed at differing costs. The calculations were made for each year over a period of 40 years on the assumption that the specified term of a loan would be 25 years, and that the Bank would be making such loans for each of the 15 years in the franchise period which the Commonwealth was offering. Mr Coulter's calculations assumed that in 1991 there would be 2000 loans of $70,000 each. This was the median figure for housing loans. To the extent that loans exceeded $40,000 they would not be subsidised, but it was assumed that most borrowers would seek the excess from the Bank. On the basis of figures provided by the Commonwealth, Mr Coulter assumed that in each of the remaining years of the franchise there would be 4000 loans. In calculating the cumulative value of loans, account was taken of "separations" ‑ borrowers who were expected to leave the ADF after taking out a loan (25 per cent), again based on information supplied by the Commonwealth. The model also included assumptions as to other products, such as personal loans and credit cards, which the Bank could expect to sell to new customers who had been acquired under the scheme. The model then calculated the profit to the Bank on four different bases. The first was the marginal cost of borrowing the funds necessary to make the loans (ie the wholesale rate paid by the Bank). The second was the average cost of the Bank's overall borrowings. The third, "base level profits", was calculated as the profits upon the equity required by the Bank to support the loans. Mr Coulter explained that the money which the Bank lends may be borrowed, but in its overall operations there is a minimum amount which the Bank must have as equity. The equity may be expressed as an average amount spread across the Bank's portfolio. The fourth was based on the average profitability of a customer multiplied by the assumed number of ADF personnel who would take up loans. The average profitability figure was $3006. The model discounted each profit figure to a net present value equivalent using an after tax discount rate of 18 per cent. The results were: Profit based on marginal cost $55,053,473 Profit based on average cost $173,199,678 Base level profit $49,135,612 Profit on a per customer basis $76,011,980 The Bank took the lowest of these figures as a conservative estimate of likely profit, and decided on a bid of $42 million. In the course of negotiations with the Commonwealth the Bank expressed a desire that whatever amount it agreed to pay should be spread over the period of the franchise, calculated by reference to the number of loans obtained, rather than be payable as a lump sum at the inception of the agreement. However the Commonwealth made it clear that only an up‑front lump sum would be acceptable. The Bank put in its bid, and after some revision it was accepted. DEFENCE HOME LOANS CONTRACT On 5 November 1990 the Bank and the Commonwealth entered into an agreement entitled "Defence Home Loans Contract" ("the agreement"). It has the following recitals: A. The Commonwealth wishes to introduce, with effect from 15 May 1991, a Scheme to assist certain Members and former Members of the Defence Force and their spouses to meet repayments on Housing Loans provided to them by the lender under the Scheme. B. The Bank provides Housing Loans in its ordinary course of business and has offered to be the lender under the Scheme. C. Assistance will be provided in the form of Subsidy payments by the Commonwealth paid to the Bank for the benefit of persons entitled to the Subsidy and their spouses where appropriate. D. Entitlement to Subsidy will be determined by the Commonwealth in accordance with the Act. Clause 1.1 contains a number of definitions. "Act" is defined as the HLA Act, "Franchise Term" as the period from 15 May 1991 to 31 December 2006, and "Scheme" as "the scheme of Housing Loan assistance established by the Act and this agreement". Clause 3 is as follows: FRANCHISE The Commonwealth hereby grants to the Bank: (a) during the Franchise Term the exclusive right to participate as the lender under the Scheme; and (b) in respect of Subsidised Loans advanced during the Franchise Term the exclusive right to receive Subsidy for the benefit of Subsidised Borrowers, or Subsidised Borrower and Joint Borrower, as the case may be, and the Bank accepts these grants. Under cl 4.1 the Bank agreed to pay the Commonwealth (a) forty‑two million ($42 million); (b) for each of the periods set out in Clause 1 of Schedule A a payment calculated in accordance with the formula .... Application of the formula produces a dollar amount for each year of the franchise term in which the number of loans exceeds a minimum: 1400 in the first half year of the term and 2800 in each full year. The agreement contains detailed provisions dealing with applications for loans under the Scheme and payment of subsidy by the Commonwealth. A would‑be borrower obtains an Entitlement Certificate (cl 5.2). Where the Commonwealth determines that a member is entitled to a Certificate, it forwards the Certificate to the branch of the Bank nominated by the member (cl 5.2.4). The member then lodges with the Bank loan application documents, an application for payment of subsidy, and the Entitlement Certificate. When the applicant satisfies the lending criteria and provides security in accordance with cl 5.12, the Bank makes a subsidised loan of the amount sought in the application (cl 5.4.1). "Subsidised loan" is defined as a Housing Loan made by the Bank under Clause 5 in respect of which: (a) Subsidy is being paid; (b) a right to be paid Subsidy has been established; or (c) Subsidy will be paid provided the requirements of the Act are satisfied. After making the loan the Bank forwards the documents to the Commonwealth (cl 5.4.2). Clause 5.4.3 provides that nothing in the agreement prevents the Bank making a housing loan to a person who has not obtained an Entitlement Certificate, or obliges the Commonwealth to pay subsidy in respect of a loan until the provisions of cl 7.1 have been satisfied. Under cl 5.13 the loan agreement is to be in the terms set out in Sch D, the maximum rate of interest is to be the "Benchmark Rate" (the market rate for housing loans), the term is to be 25 years, the amount of the loan is to be within the range prescribed by the Act, and the loan is to be a credit foncier loan repayable by monthly instalments of principal and interest, less payment of subsidy to the Bank by the Commonwealth. Under cl 7.1 the Commonwealth agrees to pay "Subsidy to the Bank in accordance with the Act and this Agreement". By cl 7.2 the Bank agrees to "receive and deal with the Subsidy payments for the benefit of the Subsidised Borrowers ... in accordance with the Act and this Agreement". The agreement received legislative approval by s 9 of the HLA Act. Section 21 provides that subsidy is payable to the Bank on a loan made by the Bank in accordance with the agreement. The HLA Act also lays down conditions of eligibility for subsidised loans under the Scheme. The basic requirement is six years full‑time service in the ADF. THE SCHEME IN OPERATION The first subsidy payments under the Scheme were made in July 1991. The Scheme is managed by the Defence Housing Authority. In conjunction with the Bank the Authority conducts presentations two or three times a year at ADF establishments throughout Australia, at which criteria for eligibility, the application process, subsidy arrangements and other issues are explained. The Scheme is advertised in ADF brochures and newspapers, and posters are placed in Housing Management Centres and ADF Orderly rooms. The Authority pays the subsidy amount to the Bank each month. The Bank credits the subsidy to each relevant home loan account. The performance of the Scheme has been disappointing for the Bank. The reasons include the fact that recruitment to the ADF has declined significantly, and that as interest rates and inflation have declined, the attraction of the interest subsidy has decreased in comparison with the rental allowance provided by the Commonwealth. The extent of the underperformance can be gauged by the fact that whereas the Bank's computer model assumed that there would be 10,094 subsidised loans for 1995, there were in fact only 1665. THE BANK'S BUSINESS The Bank is one of the four major trading banks in Australia. As at 30 September 1994 its assets totalled $125.9 billion. It had approximately 49,163 employees and 1307 branches and other outlets. Lending on real estate mortgages has become the Bank's largest lending sector. Between 1991 and 1994 mortgage lending increased from 22 to 38.4 per cent of the Bank's loan portfolio. Home loan lending also increased over this period. As at 30 September 1994 the Bank's market share of the owner/occupied housing market was 15 per cent. Since the mid 1980s the home loan market has become the major retail banking focus of the Bank. Deregulation of the Australian banking system, which came into effect at about this time, has meant greatly increased competition between the banks. Banks no longer dole out rations of credit to customers who earn it by making deposits over a qualifying period. Rather they are "marketeers" of credit. Unlike the Commonwealth Bank, which has a long history as a savings bank, the Bank had to develop innovative and specialised strategies in an attempt to attract customers, and increase its share of the home loan market. One such strategy was the promotion of the National Tailored Home Loan in 1990. The Loan differs from the traditional credit foncier loan in that fluctuations in interest rates are matched to the capacity of the borrower to repay. The structure of the Loan can minimise both its term and the cost of the finance, by allowing for annual repayment increments which are likely to remain within the rate of inflation. The new product utilises a computer system known as the National Home Loan simulator, and is targeted at young people without children (who are purchasing their first family home), single people (who are purchasing a flat or apartment), and couples with older children (who are upgrading their first family home). The Bank spent approximately $5 million in early 1990 on radio, television and newspaper advertising of the product. The product has contributed to a significant increase in the Bank's marginal share for home loans, from 7.98 per cent in September 1989 to 13.16 per cent in August 1995. Another major initiative is the introduction of "segmentation". This means directing the Bank's marketing strategy towards particular segments of the community which are likely to produce the most valuable long term relationships for the Bank. The development of a marketing strategy based on customer management and customer segmentation, instead of product management, has been driven by a perception that it is better to focus on customers and their needs rather than on products. The home loan customer segment has become one of the Bank's primary target segments. Home loans are a key relationship product between a bank and its customers, because the purchase of a home is generally a customer's most significant and long term purchase. Once a bank has acquired someone as a home loan customer, it is likely that the bank will come to provide other products to that customer. Other initiatives have been implemented to attract home loan customers. One is targeting University campuses with financial services packages tailored to the needs of tertiary students. University campuses are a source of valued long term customers, and the Bank has branches on approximately 27 campuses throughout Australia. Another initiative encourages professionals such as accountants and solicitors to refer their clients to the Bank. The Bank offers specially tailored financial packages to such clients. The Bank also offers a programme to large organisations whose staff can obtain home loans at concessional rates, or relief from fees and charges which accompany the establishment of a home loan. Against this general background, the opportunity to gain exclusive access to the segment of the market constituted by ADF borrowers was seen by the Bank as completely consistent with its strategy. In 1990 there were about 70,000 members of the ADF. Another attraction was that ADF members are by and large located at Army, Navy and Air Force bases throughout Australia and other Defence establishments. Therefore specialised products for this segment of the market can be provided at a limited number of branches. Training, administration and other costs which would be required if products had to be available throughout the entire Australian branch network, are considerably reduced. The Bank also engages in advertising and sponsorship to raise and broaden its profile so that it can continue to attract customers. Some marketing strategies have tangible commercial benefits to the Bank, such as sponsorship of the Institute of Chartered Accountants through the Institute's seminars, conferences and newsletters. The sponsorship is used to develop a closer working relationship with chartered accountants. This will help the Bank obtain referrals, and attract to it the accountants' own business. The Bank's aim is to lift its share of the small and medium business market. An ongoing sponsorship relationship creates a high profile for the Bank with a particular customer segment, and encourages brand loyalty in that segment. There are sponsorships with less immediate tangible commercial benefit, such as support for Australia's Commonwealth and Olympic Games bids. In some circumstances the Bank links its sponsorship of events to the development of specific products. For example in May 1995 the Bank launched a National Heart Bonds product, which was linked to its $100,000 sponsorship of the National Heart Foundation. In an eight week period the Bank raised $127.2 million in funds. Similarly, to coincide with the Bank's donation of $160,000 to the Australian Olympics Committee, it launched an Olympic Bonds programme, which raised $97.8 million in funds. Haydn Edward Park, Group Manager, Media and Public Relations, who has been with the Bank for over thirty years, gave evidence about the Bank's sponsorship activities to the effect described above. He said that the Bank tries to target particular market segments with its sponsorship activities. He expressed the view that in paying $42 million for the right to be the exclusive lender under the Defence Home Scheme, the Bank was employing the same philosophy which it pursues in all its marketing, advertising and sponsorship activities, namely spending money in order to generate business for a market segment which the Bank considers a worthwhile source of profitable customers. Most sponsorships have a significant marketing and commercial application, in that the entities or events which the Bank sponsors are chosen because there is already a customer relationship between the Bank and the sponsored party which the Bank wishes to enhance, because the sponsored party is an opinion leader, or because the membership or participants in a sponsored activity constitute a customer segment with which the Bank has, or desires to obtain, a customer relationship. Another way of attracting customers is the Bank's Switching Costs programme under which sought‑after customers of other banks are attracted to the Bank by the offer of reimbursement of stamp duty, titles office charges and financial institutions duty incurred in transferring their accounts. LOAN REFERRAL COMMISSIONS Evidence was given by Michael James Ullmer, Chairman, Banking and Finance Industry Group of Coopers & Lybrand, that it is common in the financial services industry for banks and other financial institutions to pay commissions to third parties who introduce business to them. Banks and finance companies also pay commissions to motor car dealers and retail stores who introduce consumer credit finance. Such arrangements have been a feature of the home loan industry for a number of years and are becoming more common. A mortgage broker referring home loans to a mortgage provider might typically receive between $200 and $700 per loan. A bank is prepared to pay commissions because the interest margin (actual profit) derived over the life of the home loan more than covers the commission paid. In addition the bank may be successful in selling other products to the customer, which will further contribute to its profits. Mr Ullmer expressed the opinion that in order to compute the quantum of a single payment in respect of business to be introduced over a period of time, rather than separate commission payments as each new loan is originated, a mortgage provider would have to estimate, on a prudent basis, the amount of the business likely to be introduced, the interest margin it would receive, and the servicing and other costs it would incur, so as to determine the present value of the anticipated profit stream. Commenting on Mr Coulter's calculations, Mr Ullmer said that it appeared that the calculation of the lump sum payment to be offered to the Commonwealth had been derived primarily from the present value of the interest margin expected to be derived from the home loans. Having examined the agreement, Mr Ullmer said that it has the substance of the loan referral arrangements he had described. The lump sum paid to the Commonwealth represents a prepayment of the total amount payable under the agreement. He would expect it to be accounted for as such, namely by first recording the prepayment as an asset in the balance sheet, and then progressively amortising it as an expense in the profit and loss account in a fashion related to the income expected to be derived from the loans. Mr Ullmer also referred to a practice common in the life insurance industry where the costs of originating life policies are first deferred in the balance sheet and recognised as an expense in the profit and loss account on a basis related to the premium income expected to emerge in respect of the policies. The major component of the costs deferred are commissions paid to sales agents in respect of the policies. Actuarial computations are performed to establish the basis upon which the amortisation of the deferred acquisition costs will be matched against the related premium income. Mr Ullmer was of the opinion that deferred acquisition costs related to the origination of life insurance policies have the same essential characteristics as the sum paid by the Bank to acquire the right to originate home loans to ADF personnel, in that they are both made in the expectation of securing future income streams. The payments are made up‑front, and require estimations as to the likely levels of revenue to be derived. PRIMARY JUDGE'S REASONING It appears to have been common ground before the primary judge, as it was before us, that the question for the Court is what payment of the $42 million was calculated to effect from a practical or business point of view, and that the character of the advantage sought by the Bank is the chief, if not the critical, factor in determining the character of the payment under s 51(1): GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 at 137 and Mount Isa Mines Ltd v Federal Commissioner of Taxation (1992) 176 CLR 141 at 149. The primary judge's approach to the case can be summarised as follows: · The advantage sought was the exclusive right to make home loans to a significant segment of the market for home loan borrowers, that segment being members of the ADF who were or would become eligible for subsidised loans under the HLA Act. · The right obtained was in the nature of a monopoly over that particular class of business. · The right the Bank obtained was comparable to the acquisition of goodwill: the positive right to have the Commonwealth direct this particular class of business to it. There was also a negative element of goodwill in that the agreement excluded competitors from that class. · The payment was a once and for all payment. · The payment was not comparable with advertising, promotional or marketing expenses because the custom of the relevant segment of the market had been "bought"; the borrowers had no choice but to deal with the Bank. · The fact that Mr Coulter's calculation which led to the quantification of the payment was a genuine and conservative attempt to estimate the profits it was hoped would accrue from the outlay, was not determinative of the character of the payment, because many classes of expenditure that would undoubtedly be on capital account have that character (eg the purchase price of a mine might be based on an estimate of profits over the life of the mine). · The fact that the payment was directed to increasing the Bank's revenue and profit was irrelevant, because s 51 assumes that there will be outgoings incurred in the gaining of assessable income but which are nevertheless of a capital nature. · BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386 was distinguishable. The Bank made one large payment which secured a captive market for 15 years with consequent benefits extending up to a further 25 years beyond that. No part of the payment came back to the Bank from the Commonwealth in the way that the lump sum came back from BP's dealers in the form of petrol purchases. BANK'S SUBMISSIONS (a) minimum royalty The Bank's principal argument on the appeal was that the payment is analogous to a minimum royalty. It was part of the consideration calculated by reference to the quantum of anticipated products sold (loans made), the character of the advantage sought being the sale of the loans and the earning of income on them. Reliance was placed on the observations of Lord Denning MR in Murray v Imperial Chemical Industries Ltd [1967] Ch 1038. The question there was whether a lump sum paid in exchange for covenants not to compete was a capital or income receipt. At 1052 Lord Denning said: Each case must depend on its own circumstances. But it seems to me fairly clear that if, and in so far as, a man disposes of patent rights outright (for example, by an assignment of his patent, or by the grant of an exclusive licence) and receives in return royalties calculated by reference to the actual user, the royalties are clearly revenue receipts. If, and in so far as, he disposes of them for annual payments over the period, which can fairly be regarded as compensation for the user during that period, then those also are revenue receipts. ... If, and in so far as, he disposes of the patent rights outright for a lump sum, which is arrived at by reference to some anticipated quantum of user, it will normally be income in the hands of the recipient .... But if, and in so far as, he disposes of them outright for a lump sum which has no reference to anticipated user, it will normally be capital.... For the Bank it was submitted that the entirety of the consideration agreed to be paid to the Commonwealth was referable to the anticipated quantum of loans. The Commonwealth estimated that there would be 4000 subsidised loans each year. The $42 million component of the price covered the first 2800 loans in any twelve month period, and a specific amount was payable for each loan above that number up to a ceiling of 4500. Reliance was also placed on Inland Revenue Commissioners v Longmans Green & Co Ltd (1932) 17 TC 272. This too was a capital or income receipt case. The taxpayer acquired from a French author the exclusive right of translation and publication in English of a book written in French, and agreed to pay 500,000 francs for the right to sell 28,000 copies of the "best edition" of the book. The agreement provided for annual payments, at a proportionate rate, for copies of the best edition sold in excess of 28,000 and for a royalty of ten per cent on the published price of all copies of any cheaper edition. Only 7000 copies of the book were in fact sold, and no cheaper edition was published. The taxpayer was assessed in respect of the 500,000 francs. Finlay J held that the payment was assessable as an amount of or on account of royalties. His Lordship said that had anything been paid in respect of the cheaper edition, or had there been sales of the best edition exceeding 28,000, the amount payable would have been royalties. His Lordship then turned to the 500,000 francs and at 283 said: The whole difficulty ... is that [the consideration] is expressed in the form of a lump sum payment and it is a lump sum payment in respect of any number of copies up to 28,000. ... If ... the whole English rights of translation and publication had been transferred ... for a lump sum, I think that it probably would be right to say that that sum would not be assessable as a royalty. Here, of course, it is clear that that is not what is done. I have already held that (c) is clearly a royalty and I think (b) is a royalty. Now it would not be an impossible but a remarkable result if, in respect of 28,000 copies, the remuneration paid were not liable to tax, but beyond the 28,000 copies, or in any cheap edition, the remuneration suddenly became liable to tax. ... What they did, I think, was this. They said that 28,000 copies was the number of copies which, taking the reasonable expectation ..., they thought would be sold; they then arrived at a figure which would represent the remuneration on each copy and that figure ... was 2s 9d a copy; and I am told ... that the 500,000 French francs for 28,000 ... works out at almost exactly the 2s 9d a copy. Therefore I think what they were doing was this. They were arriving at a royalty basis of 2s 9d a copy; they were taking an arbitrary figure of 28,000 as being what they thought as a reasonable expectation would be sold, and they stated in a lump sum the total of the 2s 9d's on that figure of 28,000 copies. They then, and of course it makes the matter much plainer, proceeded to deal with the further copies which might be and, as they hoped of course, would be sold, and dealt with then, I think, clearly on a royalty basis. I think that the true view is that, as to the whole, this was a ... payment for or on account of royalties in respect of this book. It was pointed out that for its $42 million the Bank had hoped to obtain 43,400 loans, that is $967 per loan, which is close to the $985 which is the first per loan amount payable under cl 4.1(b). (b) marketing expense It was also submitted that the payment was in the nature of a marketing expense, and that this was an "additional pointer" to the payment being on revenue account. Attention was drawn to the evidence that following deregulation of the banks they became "marketeers" rather than rationers of credit, and it was necessary for the Bank to evolve innovative ways of attracting customers to acquire its products. (c) reduction of expenditure John Thomas Gynther, a manager in the Bank's Major Project Management Division, gave evidence that there was no need to pursue the ADF market segment with additional advertising or marketing programmes, and this resulted in substantial savings to the Bank. It was submitted that a payment which saves expenditure that would have been deductible has the same revenue character as that saved. In Anglo‑Persian Oil Co v Dale [1932] 1 KB 124 the company had a contract with agents which regulated how its business was to be carried on in Persia and adjacent areas. It made a lump sum payment to terminate the contract, and the payment was held to have saved expenditure under the contract and to be deductible accordingly. See especially per Romer LJ at 147‑149. (d) calculation of payment The Bank placed reliance on the manner in which the payment was calculated. In substance Mr Coulter's approach was to work out the anticipated profit from the sale of the products, and allocate part of it to the Commonwealth as the purchase price before it was earned. It was said that this was a pointer in the direction of an outgoing on revenue account. COMMISSIONER'S SUBMISSIONS For the Commissioner it was contended that the payment secures the Bank a monopoly over a specific, valuable class of business, namely subsidised home lending to ADF members. The franchise meets all the criteria for defining the capital of a business. It is part of the business structure set up by the Bank for the earning of profit; an asset or advantage for the enduring benefit of the Bank's business: Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 358‑361. The franchise payment satisfies the criteria for defining a capital payment. It was a one‑off payment to secure the future use or enjoyment of a right, and the period covered by the payment was substantial: Sun Newspapers at 363; BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR at 399‑400. It was submitted that promotional activities, such as advertising and sponsorship, are undertaken in the hope of persuading potential customers who have a choice as to which bank to use to select the bank the subject of the promotion. The franchise payment was designed to deprive the relevant customer segment of that choice. It was said that the object of excluding or limiting competition is a characteristic of capital outlay: Sun Newspapers at 363‑364; Broken Hill Theatres Pty Ltd v Federal Commissioner of Taxation (1952) 85 CLR 423 at 434. CONCLUSIONS (a) character of advantage sought In order to determine whether an amount is of a revenue or a capital nature one has to "make both a wide survey and an exact scrutiny of the taxpayer's activities": Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740. Since deregulation the Bank has implemented various strategies in order to increase its share of the home loans market. One such strategy has involved targeting various segments of the market. Home loans are a major source of the Bank's income. More home loans means more income. From a practical and business point of view what the Bank sought to achieve by the payment was the expansion of its home loan customer base. The payments contemplated by cl 4.1(b) of the agreement would clearly have been on revenue account. Apart from being recurrent, the amount of each payment is related to the number of loans which exceeds a minimum number. Given that the $42 million and the recurrent payments are payable for the same advantage, it would be curious if the former were to be characterised as a payment of capital when it was computed on the basis of the number of expected loans. It is true that Longmans Green was concerned with the character of a receipt and not an outgoing. But the common sense point made by Finlay J is applicable whether the components of an overall consideration in respect of the same subject matter are to be characterised in a receipt or an outgoing context. (b) monopoly The primary judge was of the view that what the Bank obtained in exchange for its money ‑ the exclusive right to make home loans to members of the ADF who were or would become eligible for subsidies ‑ was in the nature of a monopoly. The advantage of being free from competition gave the money expended in obtaining it the character of a capital outlay: Broken Hill Theatres Pty Ltd v Federal Commissioner of Taxation (1952) 85 CLR 423; United Energy Ltd v Federal Commissioner of Taxation (1997) 97 ATC 4,796. A monopoly has been described as "the exclusive possession of the trade in some commodity": Trade Practices Commission v Ansett Transport Industries (Operations) Ltd (1978) 32 FLR 308 at 322. That was what was obtained by the taxpayer in United Energy Ltd. Customers who lived in the area to which the taxpayer supplied electricity had to deal with the taxpayer. But the Scheme does not prevent other banks from making loans to ADF personnel on terms which are competitive in an overall sense with those available under it. The other banks have not spent their $42 million, and could provide their own incentives. The Commonwealth cannot oblige ADF personnel to borrow from the Bank. The Commonwealth could encourage them to participate in other housing schemes, such as rental subsidy schemes. Indeed, one of the reasons for the Scheme's lack of success was the attractiveness of the Commonwealth's alternative rental subsidy scheme. All the Commonwealth has disabled itself from doing is providing subsidies to ADF personnel who arrange their home loans through a financial institution other than the Bank. In our view that did not confer a monopoly on the Bank, or even something "in the nature of a monopoly", over the loans of ADF personnel entitled to a subsidy. In any event, identification of precisely what name tag should be attached to the rights acquired by the Bank under the agreement is too narrow an inquiry, at least in a case such as this where the Bank acquired no monopoly in the true sense. In Federal Commissioner of Taxation v Raymor (NSW) Pty Ltd (1990) 24 FCR 90 at 99 the taxpayer entered into contracts for the purchase of trading stock and paid the full price in advance. The Commissioner contended that the payments were made to purchase a capital asset (a chose in action) and were therefore an outgoing of capital. Rejecting the contention the Full Court (Davies, Gummow and Hill JJ) said: It is a misleading half truth to say that what the taxpayer acquired was merely a contractual right to obtain delivery of stock in the future. The answer to the first question posed by Dixon J [in Sun Newspapers] is not to be obtained by a jurisprudential analysis of the process of entering a contract. It can be said of every payment pursuant to a contract that it secures to the payee the contractual rights under the contract. In that sense every payment made under a contract confers upon the payee a chose in action which can be described as an asset and which contractual right is discharged by the performance of the contract. But such an analysis is of no assistance in the resolution of whether a particular outgoing is on capital or revenue account. An inquiry as to whether what the Bank acquired under the agreement was in the nature of a monopoly obscures what in our view is the real question ‑ what was the ultimate advantage sought by the making of the payment? The answer, from a practical and business point of view, is that the Bank was hoping to sell more home loans and make a profit out of the interest derived from them. (c) goodwill The primary judge described the rights the Bank obtained under the agreement as "comparable to ... goodwill". However, no discrete item of goodwill was obtained as a result of the agreement. The Bank has been in the business of making home loans for a long time. The expenditure it incurs in marketing its product potentially enhances its goodwill. But it is generalised goodwill of the variety described by Brennan J in Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213 at 229: Though goodwill is a capital asset of a business it is frequently earned and maintained by the daily activities of those engaged in the business. The valuable if intangible asset of goodwill frequently grows out of activities the cost of which is a charge on revenue account. Mr Ullmer's evidence was that the Bank obtained no goodwill in any accounting sense as a result of the agreement. Although in accounting terms what he called the "prepayment" is an asset, because it defers expenditure the benefit of which is realised over a number of years, it is not equivalent to goodwill. He likened the prepayment to a lump sum paid to a car dealer to refer all business to a bank. The payment would appear as a deferred expenditure in the balance sheet and be brought to account in a way that matched the earnings expected to be derived from the loan contracts written with that dealer. In our view, the Bank did not by the payment acquire goodwill or anything in the nature of goodwill. Even if it did, it was goodwill of the type described by Brennan J in Magna Alloys, and the cost of acquiring it is not on capital account. (d) once and for all payment The $42 million was a once and for all payment. The absence of recurrence suggests that an outgoing is of a capital nature. But it is not conclusive: Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR at 362‑363 per Dixon J who referred to the Anglo‑Persian case as an example of a one‑off payment that was nevertheless deductible. Three features of the present case dilute the significance of the fact that the $42 million payment was not to be repeated. The first is that the Bank wanted to make periodic payments. That would have been consistent with the advantage sought by the expenditure ‑ income from the loans over the period of their existence. But the Commonwealth insisted on one lump sum payment in advance. However the character of the advantage sought by the Bank does not alter because the commercial realities of the situation dictated a payment of a lump sum rather than the periodic payments the Bank would have preferred to make. Cf Hancock v General Reversionary and Investment Co [1919] 1 KB 25 at 37‑38. The second feature is that the agreement contemplates that the initial payment would be followed by sixteen annual payments. The agreement thus envisages recurrence, though because the Scheme was not successful, only one payment was in fact made. The third feature is that had the sixteen annual payments been made, they would have been on revenue account. (e) altering the framework In Commissioner of Taxes v Nchanga Consolidated Copper Mines Ltd [1964] AC 948 at 960 Viscount Radcliffe spoke of "the importance of observing a demarcation between the cost of creating, acquiring or enlarging the permanent ... structure of which the income is to be the produce or fruit and the cost of earning that income itself or performing the income‑earning operations". And in Foley Brothers Pty Ltd v Federal Commissioner of Taxation (1965) 13 ATD 562 at 563 Kitto, Taylor and Menzies JJ said the "true contrast is between altering the framework within which income‑producing activities are for the future to be carried on and the taking of a step as part of those activities within the framework". The payment to the Commonwealth did not enlarge the framework within which the Bank carried on its ordinary activities of borrowing and lending money. It was incurred as part of the process by which the Bank operates to obtain regular returns by means of regular outlay, the difference between the outlay and the returns representing profit or loss. Not only was the payment made as part of the Bank's ordinary trading or income earning activities, it was made in the expectation that the amount would be recouped out of profits made from the loans and other bank products sold to ADF personnel who, it was hoped, would become the Bank's customers. (f) marketing expense The primary judge was not attracted by the marketing expense argument. He said that whereas a customer has a discretion as to whether to do business with an advertiser, ADF personnel who want a loan subsidised in accordance with the Scheme have no choice but to deal with the Bank. That is true as far as it goes. But for the reasons we have given, the Bank acquired no monopoly over ADF personnel who were eligible for subsidy. In our view the payment in question is in the nature of a marketing expense. It is like the lump sum loan referral commission considered by Mr Ullmer. The payment secured access to a new body of customers, and while the Bank had no monopoly over their business, there was at least the reasonable expectation that because of the subsidy most of them would deal with the Bank rather than with other lenders. Its nature as a commission or marketing expense points to the payment having a revenue rather than a capital aspect. It is true, as the primary judge pointed out, that even advertising expenses can be of a capital nature, as where the expenses are non‑recurrent and directed towards the establishment of a market for a new business or new product: Sun Newspapers (1938) 61 CLR at 360‑361. But the Bank's business is of long standing, and its existing framework well established. Any expense it incurs which is of an advertising, promotional or marketing nature will prima facie be on revenue account. (g) BP Australia The present case is in our view not unlike BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386. BP made payments to service station owners in order to obtain exclusive outlets for the sale of its products at those service stations. Agreements were entered into with the owners whereby BP, in consideration of the owners selling during a certain period only brands of petrol approved by it, promised to pay them lump sums to defray some of their expenses, or as assistance to them. BP claimed the amount of the lump sums as allowable deductions under s 51(1), but was assessed on the basis that the sums were capital rather than revenue expenses. The assessment was confirmed in the High Court by Taylor J, and on appeal by McTiernan, Windeyer and Owen JJ, Dixon CJ and Kitto J dissenting: (1964) 110 CLR 387. On appeal the Privy Council held that the lump sums paid were on revenue account and were therefore allowable as deductions. In the High Court, Kitto J at 412‑413 said: ... a promise by a service station operator not to deal with oil companies other than the appellant or its allies was only the negative side of the substantial positive advantage which it was the purpose and practical effect of the agreement to produce, namely the advantage of a practical certainty that the whole of the custom of the service station, for motor spirit, would be given to the appellant or its allies for the agreed period; and what the appellant really paid its money for was that positive advantage .... A payment made by a trader to a customer for the purpose of securing orders for a quantity of goods is prima facie part of the cost of selling the goods. In the present case, the Bank agreed to pay the Commonwealth $42 million (and annual amounts thereafter if the scheme was successful) in order to secure the practical certainty that most of those ADF personnel who qualified for a subsidy and wanted a home loan would become customers of the Bank. The payment was made for the purpose of attracting an additional class of borrower to whom the Bank could sell its product. The product was its standard home loan. It was not a subsidised loan, for the subsidy came from the Commonwealth and not the Bank. Dixon CJ at 410 said: ... in all the unexpected incidents of marketing throughout these years the company was engaged in an endeavour to obtain definite market among the public by one means or another and was doing so in the course of conducting its business of disposing of petrol which it was able to acquire or import. I do not think it was acquiring a capital asset or doing any more than so conducting its business on revenue account as to increase it and make it as certain as it could that the business was continuing and also would continue, if possible, to expand. The evidence here is that in the period since deregulation the Bank has been endeavouring to increase its market share by various strategies. The Scheme is one of them. Those strategies were implemented in the course of conducting its business of selling home loans and other products which generated its interest income. In the Privy Council the lump sums were described as "sums which had to come back penny by penny with every order during the period in order to reimburse and justify the particular outlays": BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR at 398. In the present case the Bank calculated that the amount it was prepared to pay would be recouped in full out of the profits it expected to derive on the loans made and associated products sold to ADF personnel. The Privy Council also said that "the only ultimate reason for any lump sum payment was to maintain or increase gallonage" (at 393). In our view the only reason for the lump sum payment here (and the contemplated annual payments) was to increase sales of the Bank's product. SUMMARY 1. From a practical and business point of view the advantage sought by the Bank in making the $42 million payment was the expansion of its home loan customer base and the earning of income from the loans. 2. The payment was part of the consideration for the "franchise" granted by the Commonwealth and was calculated by reference to the number of home loans the Bank expected to make to ADF personnel who qualified for subsidy. 3. The fact that the $42 million was a one‑off payment is not decisive against it being on revenue account since (a) the character of the advantage sought by the Bank did not alter because commercial realities made a lump sum, rather than periodic payments, unavoidable; (b) if the Scheme had been successful and the Bank had made successive payments under cl 4.1(b), those payments would have been on revenue account; (c) the $42 million and the cl 4.1(b) amounts were payable for the same advantage, and it would be odd if the former were to be treated as a capital payment when it was computed on the basis of the number of expected loans. 4. The payment was in the nature of a marketing expense: it was like a lump sum loan referral payment or commission which secured access to a new body of customers. 5. The payment did not enlarge the framework within which the Bank carries on its ordinary activities of borrowing and lending money; rather it increased the flow of the Bank's ordinary lending activities. 6. The Bank made the payment in the expectation that it would be recouped out of profits made from the loans and other bank products sold to ADF personnel. CONCLUSION For the reasons summarised under the preceding heading, the $42 million was an expense incurred on revenue account, and the Bank is entitled to a deduction in respect of it. The Bank's primary contention was that the full amount is deductible in the 1991 income year. Its fall back position was that the amount should be apportioned over an appropriate period to be determined on reassessment. Counsel for the Commissioner made no submissions in favour of an apportionment rather than an allowance in full in the 1991 year, and accordingly the deduction will be allowed in that year. ORDER The appeal should be allowed with costs. The orders appealed from should be set aside and in lieu thereof it should be ordered that the Commissioner's decision disallowing the Bank's objection dated 6 September 1993 to the amended assessment dated 2 August 1993 be set aside, and the matter be remitted to the Commissioner for reassessment in accordance with these reasons. The Commissioner must pay the Bank's costs of the appeal to the primary judge. I certify that this and the preceding sixteen (16) pages are a true copy of the Reasons for Judgment herein of the Court Associate: Dated: 11 December 1997 Counsel for the Applicant: D H Bloom QC and J W de Wijn Solicitors for the Applicant: Mallesons Stephen Jaques Counsel for the Respondent: P Buchanan QC and C M Maxwell Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 9 October 1997