The High Court has handed down its judgment in the Sharpcan litigation, a case that raises a well-trodden capital-or-revenue issue, but also touches on the untested ‘black-hole’ rules. The case highlights again the glaring omission of a regime for depreciating wasting intangible assets, and the difficult problems taxpayers can face trying to remedy that defect in our law. 


The case involved the classification of payments made to the Victorian government after the re-arrangement of the gaming industry in Victoria in 2009.

Prior to the re-arrangement –

  • Tattersalls conducted gaming in a hotel owned by the trustee,
  • the revenue derived from conducting gaming in the hotel was derived by Tattersalls as the gaming operator, and
  • the trustee ‘derived income … [referred to as ‘commissions’] in the form of a percentage of the net revenue from gaming, that is, the gross receipts less returns (payouts) to those persons playing the 18 machines.’

After the re-arrangement of the industry, gaming would now be conducted by the trustee on its own behalf, but for this purpose it needed to secure appropriate licences (called ‘Gaming Machine Entitlements’ [GMEs]) from the Victorian government. The issue in the case was the deductibility of $600,300, payable over 6 years in quarterly instalments, by the trustee to the Victorian government for GMEs to continue operating the 18 machines on its premises. GMEs were a form of licence created by statute, with a 10-year term, and were transferrable, though only to certain buyers. (They were, in fact, transferred by the trustee after the events which were the subject of this case.)

The ATO’s position was that the price paid in connection with each GME was not deductible under s. 8-1 as it was an outgoing of a capital nature, nor were the black-hole rules in s. 40-880 enlivened because that regime does not extend to, ‘expenditure that you incur to … enhance the value of goodwill.’ Whether the taxpayer’s outlay could be reflected in a capital loss suffered on the expiry of the GMEs was only indirectly addressed in the judgments. We return to this issue below.

Lower courts

At first instance, Pagone J accepted that the outgoings for the licenses were allowable as a deduction under s. 8-1. But if it had been relevant, in his view, the black-hole rules would not have been available because of the exception for expenditure to enhance the value of the goodwill of a business. In his view, the expenditure was intended to enhance goodwill by, ‘extending the number of years over which the trustee could expect to derive income ...’

A majority of the Full Federal Court agreed with Pagone J on the capital-or-revenue aspect of the case. But with regard to the black-hole rules, the majority said the regime was available because the trustee, ‘incurred the outgoing to preserve the value of goodwill … [even if] … the value of the goodwill ultimately was enhanced.’ Thawley J in dissent regarded the outlay as not deductible under s. 8-1: ‘the payments represented the purchase price of GMEs [and] GMEs were a capital asset.’ In his view the black-hole rules were not available because the outlay did not satisfy the test of incurred ‘to preserve (but not enhance) the value of goodwill.’

Buried in the judgments are numerous disagreements on points of detail, especially with regard to the black-hole rules:

  • is the test based on what the taxpayer intended or based on what actually happened; and if it is based on what was intended, how relevant is what actually happened to deciding what was intended,
  • whose purpose is relevant; is it a subjective or objective purpose; how influential must the impermissible purpose be, and
  • when is it the case that money spent to acquire some kind of right should be viewed as having ‘value to you [solely because of] the effect that the right has on goodwill’ and when is it the case that the right should be viewed as having its own intrinsic value?

The differences in judicial opinions no doubt explains why the High Court was willing to entertain the ATO’s appeal.

High Court

Section 8-1

Most of the High Court’s judgment is directed to the issue of deductibility under s. 8-1 and consists of a rebuttal of the reasons the majority in the Full Federal Court had found persuasive: the High Court repeatedly says, ‘it is not to the point that …’ to dismiss each argument. Instead, the High Court sees this as a very simple case:

The Trustee’s purpose in paying the purchase price of the GMEs was to acquire, hold and deploy the GMEs as enduring assets of the hotel business for the purpose of generating income from gaming. There can be no question that the purchase price was incurred on capital account.

This is a plausible, conventional and not unexpected position. But it is easy to understand the taxpayer’s frustration with that outcome. Prior to the re-arrangement of the gaming industry it derived (say) $100 being a share of Tattersalls’ net revenue, after various expenses had already been extracted. After the re-arrangement, it derived $120 on its own account but had to pay $20 to the Victorian government for a licence to keep earning the $120. So far as the taxpayer is concerned, the 2 outcomes are identical – it gets to keep $100 – but the tax system is incapable of delivering the same tax outcome for each situation.

Section 40-880

The High Court’s conclusion that s. 40-880 was not available to recover the outlay over 5 years is consistent with its position on s. 8-1. The Court said:

… because the GMEs were a kind of property and thus CGT assets, the purchase price of the GMEs could be brought to account under the Act in the first element of the CGT cost base of the GMEs.

That position makes it unlikely the black-hole rules could be enlivened: the regime exists to address outlays that do not enter cost base, and in the High Court’s view, the outlay did enter cost base. If, instead, the outlay had been classified by the Court as potentially part of the fourth element of cost base (ie, amounts spent to enhance the value of an existing asset, most likely the goodwill of the business) there would have been a plausible argument that the black-hole rules were enlivened because some outlays are specifically precluded from being added to fourth element. But once the High Court concluded that price paid for the GMEs formed part of the first element of the CGT cost base of the GMEs, s. 40-880 became irrelevant.

The twin problems for intangibles

From a policy point of view, the ‘correct’ answer to this case is obvious: the trustee should have been able to deduct the cost of the licences over 10 years under a depreciation-style regime. Unfortunately, our depreciation rules do not cover most classes of wasting intangible assets and so taxpayers understandably try to argue for immediate deductibility instead.

It is not news to the Government that there are shortcomings in the way we handle wasting intangible assets. In December 2015, the Government promised to improve the current rules by allowing taxpayers to self-assess the effective life of some classes of wasting intangible assets from 1 July 2016 (a proposal it withdrew in the 2018 MYEFO citing lack of support in Parliament). The proposal would not have expanded the classes of intangible assets that can be depreciated so it was not a complete remedy, but the measure was recognition of another defect in the current rules.

If the outlay is not immediately deductible, and there is no available depreciation regime, the obvious question is, what follows? One possibility is that the outlay is added to cost base and a capital loss is realised on the expiry of the GMEs. This would be less than ideal, but it is not a catastrophe. Unfortunately, even this outcome is not guaranteed.

If, as the High Court commented, the outlay is the first element of the cost base of the GMEs, the taxpayer might then run into problems with Div 124-C – it defers the capital loss suffered on the expiry of a statutory licence if the licence is renewed at the end of its life. In other words, the outlay might have led to a capital loss, but the loss would have been deferred until the taxpayer either gave up its gaming operations altogether, or sold the business.

If the outlay is, instead, more properly viewed as potentially forming part of the cost base of the taxpayer’s goodwill in its business, the taxpayer faced a different conundrum: just what did the 2006 amendments to the CGT and black-hole rules accomplish? The purpose of those amendments was to shift the treatment of some outlays out of CGT cost base and into the black-hole rules: the legislation was amended so that certain outlays could not be added to cost base, and the assumption was this denial would be sufficient to enliven the black-hole rules. This treatment was meant to apply to outlays on legal or equitable rights which had no intrinsic value but rather their main effect was to preserve the value of the goodwill of the taxpayer’s business.

The amendments were meant to work together; they were meant to resolve deficiencies not create ones. Unfortunately, the drafting bifurcates the two steps and opens the possibility of gaps: the outlay might be excluded from cost base, but not be shifted into s. 40-880. Deficiencies can arise because –

  • cost base is denied for, ‘capital expenditure … the purpose or the expected effect of which is to increase the … value’ of goodwill, while access to the black-hole regime is denied if the expenditure is incurred ‘to … enhance the value of goodwill’, and
  • access to the black-hole regime is subject to an additional requirement that, ‘the value to you of the right is solely attributable to the effect that the right has on goodwill.’

As it turned out, the High Court’s characterisation of the outlay meant it was not an example of the type of outlay to which the post-2006 amendments were meant to apply:

Here the GMEs were assets … which had a value quite apart from any contribution that they may have made to goodwill. That value resided in their capacity to generate gaming income and the fact that they could be sold and transferred to other venue operators, albeit subject to some restrictions and qualifications.

If GMEs had their own intrinsic value, then denying access to the black-hole regime was also plausible, conventional and not unexpected.