On 16 October 2019, the High Court in FCT v Sharpcan Pty Ltd unanimously allowed the ATO’s appeal disallowing the deductibility for payments made to acquire gaming machine entitlements.
The taxpayer was a beneficiary of a trust of which Spazor Pty Ltd (the Trustee) was a trustee. The Trustee operated a hotel business in Victoria which derived income from providing accommodation, selling food and beverages and gaming activities. On the hotel premises, there were 18 gaming machines operated by Tattersalls. The Trustee was paid an annual fee based on a percentage of income derived by Tattersalls.
In 2009, a new gaming machine licencing regime was enacted in Victoria which allowed the Trustee to purchase 18 gaming machine entitlements (GMEs), effectively cutting out Tattersalls. The acquisition of the GMEs was $600,300 payable over six years in quarterly instalments. The income from the gaming activities represented approximately 20% of the Trustee’s income. There was evidence to show that if the GMEs were not acquired, the hotel business would have been at risk of continuing.
The taxpayer contended that the Trustee was entitled to an outright deduction of $600,300 for the payment of the GMEs. Alternatively, the expenditure was deductible under section 40-880 as ‘blackhole expenditure’.
Section 8-1 deduction
The majority of the Full Federal Court upheld the AAT decision on the basis that the expenditure was incurred on revenue account “to preserve revenue from gaming and to preserve the contribution the gaming activities made to the derivation of revenue from other sources in the hotel business”.
The High Court disagreed with the Full Federal Court that the expenditure was deductible outright under section 8-1. The High Court stated that the determination of whether expenditure incurred is on capital or revenue account is dependent on “whether the outgoing is incurred to effect the acquisition of an enduring advantage to the relevant business”. It was held that the purchase price for the GMEs was a once-and-for-all payment of the acquisition of an asset of enduring advantage. Accordingly, the expenditure was on capital account and not deductible under section 8-1.
Section 40-880 deduction
The Full Federal Court had concluded that, if the expenditure incurred to acquire the GMEs was on capital account, it would have been deductible over five years under section 40-880. The expenditure would prima facie be excluded under this section as it could be included in the cost base (or reduced cost base) when working out any future capital gain or loss happening in relation to the GMEs. However, section 40-880(6) disregards this exclusion to the extent that it is incurred to ‘preserve but not enhance the value of goodwill’. The Full Federal Court held that the expenditure was indeed incurred to preserve the goodwill of the Trustee’s hotel business, and accordingly, should not be disallowed under section 40-880.
The High Court disagreed with this reasoning. It was concluded that the purpose of section 40-880(6) was to “confine deductibility for expenditure in relation to goodwill that could otherwise not be taken into account”. The GMEs were CGT assets and the expenditure incurred on these assets would form part of the GMEs cost base.
Further, the High Court found that the expenditure on the GMEs was to acquire the GMEs as assets used in the course of the Trustee’s hotel business. There was not sufficient evidence to establish that the GMEs were purchased to preserve but not enhance the goodwill of the hotel business.