A humble Daylesford hotel is the latest battleground in the age-old capital v revenue tax battle.

In a win for hotels and pubs across Victoria, the Full Federal Court rejected the Commissioner of Taxation’s (Commissioner’s) appeal in Commissioner of Taxation v Sharpcan Pty Ltd [2018] FCAFC 163.

In deciding against the Commissioner, the Court found that a lump sum payment (albeit made under deferred payment terms) for gaming machine entitlements (GMEs) was deductible under section 8-1 of the Income Tax Assessment Act 1997 (1997 Act).

While seen as a win for pubs and hotels with gaming operations in Victoria, the outcome of this case should be treated with caution. It should be noted that the characterisation of expenditure as either revenue or capital in nature is highly fact dependent. In fact, this was one of the key findings of the majority in ruling in favour of the Taxpayer.

The Taxpayer (the trustee of a trust) operated a hotel which was an authorised venue containing 18 gaming machines. Due to legislative changes requiring authorised venues to hold GMEs in order to conduct gaming operations, the Taxpayer acquired 18 GMEs through a competitive auction process held in May 2010.

The Taxpayer had elected to pay for the GMEs under a deferred payment arrangement over six years beginning in May 2010. In bidding for the GMEs, the Taxpayer engaged an analyst to prepare a report setting out the maximum price the Taxpayer should pay to acquire GMEs while maintaining a reasonable rate of return.

The Taxpayer argued it was entitled to a deduction under section 8-1 of the 1997 Act for the amounts paid in acquiring the GMEs for the purposes of calculating the net income of the trust for the year of income ended 30 June 2010.

The Taxpayer’s alternative argument was that the outgoings were deductible over 5 years under section 40-880 of the 1997 Act.

In the Administrative Appeals Tribunal (AAT), Deputy President Pagone found that the gaming machine entitlement fees were on revenue account under section 8-1 of the 1997 Act, stating that the outgoings reflected the expected income stream from the use of the gaming assets which the GMEs permitted.

Whilst the payment for a right which is required as a condition for trading will sometimes be capital in nature, the payment for the right to trade will not always be an outgoing on capital account. In this case, the AAT found that the outgoing for entitlements in the trustee’s business was more like a fee paid for the regular conduct of a business than the acquisition of a permanent or enduring asset.

In upholding the Tribunal’s decision, the Full Federal Court confirmed that GMEs purchased due to legislative changes were rightly characterised as revenue expenditure.

The parties accepted that each GME was a CGT asset. Further, Justice Greenwood, with whom Justice McKerracher agreed, accepted that the GMEs were capable of being bought and sold subject to limitations inherent in the relevant legislative regime.

However, Justice Greenwood stressed that the character of the expenditure is to be examined in a manner that takes account of what the expenditure is calculated to effect from a practical and business point of view. That is, Justice Greenwood took a substance over form approach.

Although it was accepted by Justice Greenwood that there were factors which suggested the outgoing was of a capital nature, he concurred with many of the findings of the AAT and concluded that the outgoing was on revenue account.

A detailed review of the AAT decision can be found in Talking Tax Issue 106.