Court decision

Healius – Who is the customer? Lump sum payments and the capital vs revenue distinction

By Michael Patane and Saxon Rose / 05 November 2020
16 min.
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Worthwhile read for: Business Owners, Business Advisers, Financial Advisors, Medical Practitioners Accountants, Taxation Specialists

Postscript as of 12 March 2021

On 4 March 2021, the High Court of Australia dismissed the taxpayer’s special leave to appeal application against the Full Federal Court’s decision in FCT v Healius [2020] FCAFC 173 (Healius). 

The Full Federal Court unanimously decided that the payments made to secure commitments from medical practitioners to operate from the taxpayer’s medical centres were not payments to win those medical practitioners as customers of the centres, but were deployed by the taxpayer to earn its revenue by attracting patients to its centres.

As the payments made were not part of the revenue earning process of the taxpayer, but instead added to its profit-yielding (capital) structure, they were on capital account and non-deductible.

In dismissing the appeal, the High Court noted the application of established principles of law to the facts in this case did not result in sufficient prospects of success to warrant special leave being granted.

In this regard, we note the distinction between a business’s structure and the activity of a business was recently examined by the High Court in Commissioner of Taxation v Sharpcan Pty Ltd [2019] HCA 36 (Sharpcan), as considered by the Full Federal Court in the Healius decision.

In Sharpcan, the High Court said an indicator that an outgoing is incurred on capital account is that what it secures is necessary for the structure of the business.

This draws from the various authorities also considered in Healius, which provide the basis for the Court advocating the following line of enquiry when determining the revenue or capital nature of outgoings:

  1. By reference to all of the circumstances, undertake an overall commercial evaluation of the activities of the taxpayer to determine what is the business of the taxpayer. This requires, “a practical commercial inquiry that requires a wide survey and exact scrutiny of the taxpayer’s activities”.
  2. The chief, if not critical factor, in determining the character of a payment is the advantage sought to be secured by the taxpayer in making the payment.
  3. The inquiry is primarily concerned with what the payment was truly for, as viewed by the taxpayer making the payment.

In articulating the above, the Court again emphasised the need for consideration of all the circumstances from a practical and business point of view, to identify the character of the advantage that the payment/outgoing seeks to secure.

As Dixon J (as his Honour then was) articulated with care in Sun Newspapers Limited v Commissioner of Taxation (1938) 61 CLR 337, distinguishing between the profit-yielding subject and the process of operating it in a practical sense can be difficult, but is nonetheless necessary.

If you would like further information or to discuss your own circumstances, please contact a member of our Taxation team.


Key points

  • The chief, if not critical factor, in determining the revenue or capital character of a particular payment (and hence its deductibility) is the advantage sought to be secured by the taxpayer by making the payment.
  • The above requires a practical, commercial inquiry as to what is the scope of the taxpayer’s business, by reference to the activities undertaken by the taxpayer and how those activities are directed at securing profitable revenue streams from customers.
  • In the Full Federal Court’s view, the primary judge adopted an unduly narrow conception of the taxpayer’s business, as the provision of administrative and other services to medical practitioners operating from the taxpayer’s medical centres, when in fact it involved activities of causing, ensuring and facilitating the provision of medical services to the public.
  • The amounts paid to secure commitments from medical practitioners to operate from the taxpayer’s medical centres were not payments to win those medical practitioners as customers of the centres, but were deployed by the taxpayer to earn its revenue by attracting patients to its centres.
  • The payments made were not part of the revenue earning process of the taxpayer, but instead added to its profit-yielding (capital) structure.

Decision of Full Federal Court on appeal

The Full Federal Court unanimously held in Commissioner of Taxation v Healius Ltd [2020] FCAFC 173 that lump sum payments made by the operator of medical centres, Idameneo (a wholly-owned subsidiary of the taxpayer who was formally known as Primary Healthcare), to doctors to conduct their practice at its centres were on capital account. The payments were made to enhance the profit-making structure of Idameneo’s business. Accordingly, the payments were not deductible from Idameneo’s assessable income.

In so deciding, the Full Federal Court allowed the Commissioner’s appeal against the single judge Federal Court decision in Healius Ltd v Commissioner of Taxation [2019] FCA 2011.

This case is the latest in a series of cases considering the capital versus revenue distinction and is a reminder that this old chestnut is still proving as hard to crack as ever!

Two interesting aspects of the decision are:

  1. The way in which the court described Idameneo’s business and who its customers were, for the purpose of characterising what the lump sum payments were for and hence the “advantage sought” to be obtained by paying the lump sum (as the critical factor in determining the capital or revenue nature of the payment); and
  2. The manner in which earlier case law providing a basis for payments to secure customers to be regarded as on revenue account were distinguished.

At the “heart of the appeal” was whether the payments generated:

“… part of the structure of Idameneo’s business that was then deployed for profit-making, or was the making of the agreements with each practitioner itself the profit-making activity of Idameneo?” 

From a tax perspective, the Court stated that the issue in dispute:

“… boiled down to a single question as to the proper characterisation of the advantage that Idameneo sought to obtain by paying the lump sum amounts on the basis of evidence …”.

Who is the customer? Are the doctors or patients Idameneo’s customers?

Idameneo paid 505 lump sum payments to doctors to bring their practices across to 18 new centres for, on average, a period of five years, together with a restraint of trade and agreement to follow a particular model of practice. The payments, including additional amounts paid to doctors to extend the term of the arrangements, totalled almost $158 million.

The Court stated at that in resolving the question of whether the payments made were on capital or revenue account, it was significant to determine the extent to which the nature of the business conducted by Idameneo was: 

  1. confined to securing practitioners who would pay fees to Idameneo for services; or 
  2. in fact extended to conducting the centres in a particular way so as to attract patients to the centres. 

If limited to (a) above, the practitioners would have the character of customers, and the payments were on revenue account. If extended to (b) above, the arrangements with the practitioners would form an essential part of what needed to be put in place (as part of the structure of Idameneo’s business) in order to earn revenue from patients, by attracting those patients (as the end customers) to the  centres. If so, the payments were on capital account. 

As the court acknowledged, “The difficulty posed is somewhat Janus faced”.

The primary judge (Perram J) found that the commercial reality of Idameneo’s arrangements suggested that the real business being conducted by Idameneo did not include the provision of health care services to the public, but was limited to the provision of services to practitioners to generate a revenue stream, as in (a), above. On that basis, His Honour concluded the lump sum amounts were paid to earn a revenue stream from each practitioner. The payments were made to secure customers as part of the profit-making activities of Idameneo and on revenue account, on the basis of a number of authorities (as referred to further below).

The Full Court thought differently about the commercial reality of Idameneo’s operations. The Court accepted the Commissioner’s submission Idameneo operated and managed the centres in a way that included the activities of causing, ensuring and facilitating services to the public. In the Court’s view, Idameneo needed the practitioners and the commitments secured in relation to mode of practice and restraints in order to be able to effectively operate its business. Together with the physical assets comprising each centre, those commitments formed the commercial infrastructure that was deployed by Idameneo to earn its revenue by attracting patients to its centres.

Significantly, Idameneo’s revenue was not confined to the payment of a licence fee for the provision of a place to practise and service fees for reception and other services. Rather, the arrangements required each medical practitioner to pay a percentage of their revenue. Consequently, Idameneo’s revenue was a function of the success of each centre in attracting patients.

Accordingly, the Court found that the manner in which Idameneo charged for services, taken together with the extent of the control that it had (as an essential part of its business model) over the way the  centres were run and the medical services that were available meant that its business was properly described as operating the  centres, as in (b) above.

To determine the scope of the business conducted by Idameneo the Court examined and referred to a number of activities which formed part of the business of Idameneo.

Are payments to secure customers deductible?

The Court noted that the advantage sought by the making of a payment is the chief factor in determining the character of the payment made and hence its capital or revenue account classification. In applying this principle, an understanding of the nature of the taxpayer’s business is required, as well as the identification of the scope of the profit yielding subject or structure of the business, being that which is deployed to earn profits rather than that which forms part of the business activity of earning profits.

The Court noted that the distinction between a business’ structure and the activity of a business had been recently considered by the High Court in Commissioner of Taxation v Sharpcan Pty Ltd [2019] HCA 36, where, in part, the High Court said, “an indicator that an outgoing is incurred on capital account is that what it secures is necessary for the structure of the business”.

The Court further considered authorities which provide that expenditure incurred as part of undertaking the business activity of securing and supplying customers is on revenue account and hence deductible. The cases referred to and considered by the Court included: BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386; National Australia Bank Ltd v Commissioner of Taxation (1997) 80 FCR 352; and Tyco Australia Pty Ltd v Commissioner of Taxation [2007] FCA 1055.

The Commissioner contended that the primary judge erred in finding analogies with the payments made in the above cases compared to the lump sum payments made by Idameneo. The Court agreed with this contention, stating that the primary judge’s findings were substantially influenced by his view about the nature of the business of Idameneo, particularly the view that the business was confined to providing services to the medical practitioners.

In particular, the Court held that the payments made to the practitioners could not be described as payments to gain the practitioners as customers of Idameneo of a kind analogous to the circumstances in the above cases. However, because of the significance of Idameneo’s arrangements with the practitioners for the operation of the centres, each of the above authorities was distinguishable.

Under the arrangements, Idameneo did not simply obtain a customer. It secured the practitioners as part of the infrastructure it needed in order to operate the centres according to its conception of how medical services should be provided to patients.

In concluding what the lump sum amounts were paid for, the Court observed that Idameneo needed the commitments from the practitioners of the kind provided for in the sale deed and the practitioner contract to fulfil its business structure. Until it had those commitments it could not begin to conduct the business.

Therefore, the Court considered, when Idameneo paid the lump sums to secure the relevant commitments it was not, like BP, paying for future custom. BP was already set up to provide petrol.

Likewise, the bank in National Australia Bank did not need to secure the contract with the Commonwealth in order to be in business.

Equally, Tyco did not need the assignment of the individual agreements that had been made by its authorised dealers in order to be in the business of providing security monitoring services. 

Accordingly, the lump sum payments in the present case were of a fundamentally different character to those made in the cases relied upon by the taxpayer. As the Court noted: 

"Its business activity was not focussed upon selling services to practitioners, it was focussed upon running the centres and attracting patients. In this regard the evidence about discussion in board meetings of Primary of the patient numbers and its regular release of that information to the investment market is significant. Once the structure was in place, the business did not depend upon securing sales of services to practitioners. It depended upon whether medical centres with the characteristics conceived and implemented by Primary were effective in attracting patients.
If all that Idameneo had done was to set up the centres and then secured practitioners as customers to occupy the centres and pay for services then term contracts with upfront lump sum payments might indeed be seen to be analogous to those made in BP Australia, National Australia Bank and Tyco. But, on the evidence, the lump sum amounts were not paid to secure the custom of the practitioners."

Then Court then acknowledged:

"The present instance is complicated to some extent by the fact that the practitioners’ commitments are both the means by which the necessary structure is secured and the mechanism by which sales of services to those practitioners will be secured. The significant point here is that the lump sums are paid for the commitments necessary to begin operating the Centre. The subsequent flow of revenue to Idameneo is a function of how successful the centre is in attracting patients, not any level of intrinsic demand of practitioners for services that is assured by the terms of the arrangements."

The Court then noted that the above analysis reflected the approach considered in Heavy Minerals Pty Ltd v Federal Commissioner of Taxation (1966) 115 CLR 512.

The approach to be taken to determine the revenue or capital nature of the amount

The Court acknowledged the difficulty posed in characterising the payments as revenue or capital outgoings, given that Idameneo,in a sense, acquired the medical practitioners as customers, but in another, and in the Court’s view, overriding sense, sought, and was able to profit from the custom of the practitioners' patients, commensurate with their level of custom.

Based on the authorities, the line of enquiry advocated by the Court in relation to determining the revenue or capital nature of the payments is as follows:

  1. By reference to all of the circumstances, undertake an overall commercial evaluation of the activities of the taxpayer to determine what is the business of the taxpayer. This requires, “a practical commercial inquiry that requires a wide survey and exact scrutiny of the taxpayer’s activities”.
  2. The chief, if not critical factor, in determining the character of a particular payment is the advantage sought to be secured by the taxpayer by making the payment.
  3. The inquiry is primarily concerned with what the payment was truly for, as viewed from the viewpoint of the taxpayer making the payment.

Having determined, from Idameneo’s business viewpoint, the payments were calculated to secure medical practitioners, so that it could conduct its business of facilitating the provision of medical services to the public, rather than secure the custom of each practitioner for a five year period, the payments were assigned to capital account. 

The Court has again emphasised the need for a consideration of all the circumstances from a practical and business point of view to identify the character of the advantage that the payment seeks to secure.

As Dixon J articulated with care in Sun Newspapers Limited v Commissioner of Taxation (1938) 61 CLR 337, distinguishing between the profit-yielding subject and the process of operating it in a practical sense can be difficult, but is nonetheless necessary.

Final observations

Nearly 100 years later, the difficulty articulated by Dixon J in Sun Newspapers Limited continues to be wrestled with before the Courts.

Is there a way to obviate the need to continue to wrestle with it? We're not sure there is, unless there is more fundamental reform of our tax system.

We remember in 1999, the Ralph Review of Business Taxation recommended the Tax Value Method. This method seemed to make the capital versus revenue distinction largely irrelevant, by only having regard to the taxpayer’s net cashflows and changes in (tax) asset and liability values. 

However, this recommendation seemed to disappear as quickly as it had arrived, as did the promise offered by the Rights to Future Income (RTFI) more recently in relation to treatment of customer contracts. 

The Taxation of Financial Arrangements rules introduced in 2009 did at least make the inquiry not necessary in relation to “financial arrangements”.

In the meantime, on a case by case basis, the answer lies in the eye of the beholder. Or to put it more bluntly, as Sir Wilfrid Greene put it in Commissioners of Inland Revenue v British Salmson Aero Engines Ltd [1938] 2 KB 482:

“... in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons.”

Perhaps by 2038, the 100th anniversary of Sun Newspapers and British Salmson Aero Engines, , there may be a new dawn.

If you would like further information or to discuss your own circumstances, please contact a member of our Taxation team.

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