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Federal Court of Australia - Full Court Decisions |
Last Updated: 20 December 2002
BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation [2002] FCAFC 433
TAXATION - assessable income- trading stock (being commodities) sold by taxpayers where part of the consideration subject to a bona fide dispute and not paid on invoice - disputed income derived when dispute settled and not when commodity supplied or invoiced- significance of evidence of business and accounting practice in determining when "income derived" - whether arbitration pursuant to contract was a condition precedent to recoverability- consideration of overseas case law discussing when income accrues in case of a bona fide dispute.
WORDS & PHRASES - "income derived, "consideration receivable", "claim of right"
Income Tax Assessment Act 1936 (Cth), s 25(1)
Petroleum Resource Rent Tax Assessment Act 1987 (Cth), s 24
Petroleum Resource Rent Legislation Amendment Act 1991 (Cth) s 21
Commercial Arbitration Act 1984 (Vic)
Anderson v GH Michell & Sons Ltd [1941] HCA 30; (1941) 65 CLR 543 distinguished
PMT Partners Pty Ltd (1995) 184 CLR followed
ABB Power Plants Ltd v Electricity Commission (NSW) (1995) 35 NSWLR 596 cited
Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Income Tax [1965] HCA 58; (1965) 114 CLR 314 followed
Barratt v Commissioner of Taxation [1992] FCA 271; (1992) 36 FCR 222 discussed
Henderson v Federal Commissioner of Taxation [1969] HCA 14; (1969-70) 119 CLR 612 considered
Gasparin v Commissioner of Taxation (1993) 50 FCR 73 considered
Commissioner of Taxation (Cth) v Australian Gas Light Co [1983] FCA 341; (1983) 74 FLR 13 distinguished
J Rowe & Son Pty Ltd v Federal Commissioner of Taxation [1970] HCA 57; (1970) 124 CLR 421 considered
Farnsworth v Federal Commissioner of Taxation [1949] HCA 27; (1949) 78 CLR 504 distinguished
All States Frozen Foods Pty Ltd v Commissioner of Taxation (1990) 21 FCR 457 cited
Federal Commissioner of Taxation v Squatting Investment Co Ltd [1954] HCA 2; (1953-4) 88 CLR 413 distinguished
Ritchie v Trustees Executors and Agency Co Ltd [1951] HCA 38; (1951) 84 CLR 553 considered
Federal Commissioner of Taxation v James Flood Pty Ltd [1953] HCA 65; (1953) 88 CLR 492 referred to
Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation [1981] HCA 6; (1981) 144 CLR 616 referred to
Coles Myer Finance Ltd v Federal Commissioner of Taxation [1993] HCA 29; (1992-3) 176 CLR 640 cited
GE Crane Sales Pty Ltd v Federal Commissioner of Taxation [1971] HCA 75; (1971) 126 CLR 177 cited
Point v Federal Commissioner of Taxation [1970] HCA 7; (1970) 119 CLR 453 cited
Franklin's Selfserve Pty Ltd v Federal Commissioner of Taxation [1970] HCA 33; (1970) 125 CLR 52 cited
North American Oil Consolidated v Burnett (1932) 286 US 417 considered
Cold Metal Process Co v CIR 17 TC 916, 932 (1951) cited
Minister of National Revenue v Benaby Realties (1967) 67 DTC 5275 discussed
Commonwealth Construction Company Ltd v The Queen (1984) 84 DTC 6420 discussed
MNR v Colford Contracting Co Ltd (1960) 60 DTC 1130 cited
Commonwealth-New Guinea Timbers Ltd v The Chief Collector of Taxes (1973) PNGLR 358 discussed
Ballarat Brewing Co Ltd v Commissioner of Taxation (Cth) [1951] HCA 35; (1951) 82 CLR 364 applied
London-Butte Gold Mines Co v Commissioner of Internal Revenue (Ct of Appeals, 10th circuit) (1940) 116 F (2d) 478 cited
BHP BILLITON PETROLEUM (BASS STRAIT) PTY LTD (ACN 004 228 004) v THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
V 423 of 2002
ESSO AUSTRALIA RESOURCES PTY LTD (ACN 091 829 819) v THE COMMISSION OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
V 424 of 2002
HILL, HEEREY & GYLES JJ
20 DECEMBER 2002
MELBOURNE
IN THE FEDERAL COURT OF AUSTRALIA |
|
VICTORIA DISTRICT REGISTRY |
V 423 of 2002 |
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
1. The appeal be allowed.
2. The respondent pay the appellant's costs of and incidental to the appeal.
3. The appellant be given leave to bring in minutes of proposed further orders on or before 7 February 2002.
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 |
V 424 of 2002 |
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN: |
ESSO AUSTRALIA RESOURCES PTY LTD (ACN 091 829 819) APPELLANT |
AND: |
THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT |
JUDGES: |
HILL, HEEREY & GYLES JJ |
DATE OF ORDER: |
20 DECEMBER 2002 |
WHERE MADE: |
MELBOURNE |
THE COURT ORDERS THAT:
1. The appeal be allowed.
2. The respondent pay the appellant's costs of and incidental to the appeal.
3. The appellant be given leave to bring in minutes of proposed further orders on or before 7 February 2002.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA |
V 423 OF 2002 & V424 OF 2002 |
VICTORIA DISTRICT REGISTRY |
|
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
BETWEEN: |
V 423 of 2002 BHP BILLITON PETROLEUM (BASS STRAIT) PTY LTD (ACN 004 228 004) FIRST APPELLANT V 424 of 2002 ESSO AUSTRALIA RESOURCES PTY LTD (ACN 091 829 819) SECOND APPELLANT |
AND: |
THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA RESPONDENT |
JUDGES: |
HILL, HEEREY & GYLES JJ |
DATE: |
20 DECEMBER 2002 |
PLACE: |
MELBOURNE |
HILL & HEEREY JJ:
1 The thirty-seven appeals, represented by file numbers V 423 of 2002 and V 424 of 2002, which are now before the Court and which involve two separate taxpayers all involve the same issue, although that issue arises in the context of two different taxation regimes. The issue can be stated thus: When is income from the sale of a commodity derived where a part of the consideration for the sale of the commodity is the subject of a bona fide dispute between the seller and the buyer both as to the question of the construction of the supply agreement and as to the application of that agreement to the particular circumstances of the case and the dispute is ultimately settled?
2 The commodity in question is both gas and ethane produced from the Bass Strait. There is no suggestion that any different result flows from the nature of the commodity. For this reason the commodity is here referred to as "gas" as if, in all cases, what was purchased and sold was gas.
3 The Commissioner of Taxation ("the Commissioner") submits that the income from the sale of the gas is derived either at the point of time the gas is delivered through the pipeline to the buyer or, alternatively, at the time the seller invoices the buyer for the gas delivered (there is a slight, but not significant difference in quantum between these two times.) Each of the taxpayers, BHP Billiton Petroleum (Bass Strait) Pty Ltd (ACN 004 228 004) ("BHP") and Esso Australia Resources Ltd (ACN 091 829 819), ("Esso") who are joint venturers in the Bass Strait Oil project, submit that it is only when the dispute between buyer and seller is resolved, so that it is known what the amount payable to the seller is, that the income from the sale of gas has been derived.
4 The statutory contexts in which the issues arise are the Income Tax Assessment Act 1936 (Cth) ("the ITA Act"), s 25(1) and the Petroleum Resource Rent Tax Assessment Act 1987 (Cth) ("the PRRT Act"), s 24. As will be seen the legislative provisions do differ. However, the parties argued the appeals on the basis that each of these acts produced the same result notwithstanding the different statutory provisions.
5 The appeals are each from the judgment of a Judge of this Court (BHP Billiton Petroleum (Bass Strait) v Commissioner of Taxation [2002] FCA 762) who found in favour of the Commissioner and held that in all the cases before her Honour the taxpayers derived the income, or in the case of the PRRT Act the consideration receivable, at the date of delivery of the gas. All the appeals were, by consent, heard together. Of the thirty-nine applications heard by her Honour two did not proceed on appeal.
6 The parties before her Honour proceeded on an agreed statement of facts supplemented by some affidavit evidence, particularly, the affidavit of an expert, Professor Walker, as to the proper accounting treatment to be adopted in the accounts of a corporation such as the appellants here. There was no cross-examination of either Professor Walker or any other deponent. Accordingly, it can be said that there is no dispute between the parties on any factual matter, although the Commissioner challenges the relevance of the accounting evidence.
The background facts
7 Esso and BHP Petroleum (North West Shelf) Pty Ltd ("BHPNWS") were jointly involved in the exploration and production of petroleum products in the Bass Strait. Contracting either jointly or independently the joint venturers or related companies entered into contracts for the sale of gas or ethane to six buyers: The Gas and Fuel Corporation of Victoria ("GFC"), the State Electricity Commission of Victoria ("SECV"), Hydrocarbon Products Pty Ltd ("HPPL"), Kemcor Olefins Limited ("Kemcor"), Huntsman Chemical Company Australia Pty Ltd ("Huntsman") and Mobil Oil Australia Limited ("Mobil"). Ultimately the rights and obligations of BHPNWS in a number of the contracts it entered into were assigned and novated to BHP prior to the events which gave rise to the disputes between seller and buyer. Nothing turns upon that assignment or novation. The various supply contracts are, for present purposes, identical in effect. Accordingly we shall deal only with one of them, namely that between the joint venturers (the contracting parties are Esso and Hematite Petroleum Pty Ltd who are there referred to as "sellers") and GFC, there referred to as "buyer".
8 Under this contract the buyer agreed to purchase and the sellers agreed to deliver daily and sell a quantity of gas stipulated in the agreement. Gas delivered became the property of the buyer at the point of delivery defined in the agreement. The actual amount delivered was to be determined by a measuring authority, which, we were told from the bar table was, in fact the sellers. The price payable is dealt with in Article XII of the Agreement. The buyers agreed to pay an annually determined amount for the gas in accordance with the contract. However, statements were to be prepared and issued by the sellers monthly and payment was to be made within fifteen days of receipt of a monthly statement. The monthly amount was to be calculated by the sellers on the basis of an agreed average price for gas supplied in the previous month. There was then provision in the twelfth month for an adjustment to be made to ensure that the amount to be paid reflected the annual contract amount.
9 The provisions of Article XII are complex and need not be dealt with in any detail. In summary the Article provided for a base price per therm, which was initially either 3.52 cents for gas delivered up to a particular quantity and 2.25 cents for gas delivered over that particular quantity. The base price per therm was subject to increase during the term of the agreement by reference to an escalation clause which took into account consumer price index movements. There was also provision for the price to be varied by agreement to a fair price and in the event of there being no agreement on a fair price the matter was to be referred to arbitration.
10 Particularly relevant for present purposes, however is clause 12.8 which provides:
"The payment for gas determined in accordance herewith shall be:(a) increased to take into account the full amount of any new royalties, taxes (other than income tax), rates, duties or levies imposed on Sellers after 1st January, 1975 and attributable directly to production of natural gas for Buyer or to the supply of gas to Buyer;
(b) increased to take into account the increase in amount resulting from any increase in the rate or any change in the basis of calculation of royalties, taxes (other than income tax), rates, duties or levies above the levels existing at 1st January, 1975 and directly attributable to the production of natural gas for Buyer or to the supply of gas to Buyer;
(c) decreased to take into account the decrease in amount resulting from any decrease in the rate or any change in the basis of calculation of royalties, taxes (other than income tax), rates, duties or levies below the levels existing at 1st January, 1975 and directly attributable to the production of natural gas for Buyer or to the supply of gas to Buyer;
Any such increases or decreases shall be effective upon the imposition thereof. In the event of any such increase or decrease Sellers shall provide Buyer with details of the increase or decrease and the method and distribution of such royalties, taxes, rates, duties or levies;
BUT Any increase in the amount of any royalty, taxes (other than income tax), rates, duties or levies above the levels existing at 31st May, 1974 attributable to any change in the basis of calculating the well-head value resulting from the review then current and undetermined at the date of this Contract shall not be taken into account.
For the purpose of this Clause, the expression "Income Tax" shall mean any tax of general application imposed on income, but shall not include any tax specifically imposed on income derived from the production and sale of natural gas or more generally, on income derived from the production and sale of petroleum and other minerals to the extent to which such tax is attributable to income derived by Sellers or either of them from the production of gas for Buyer or the supply of gas to Buyer."
Also relevant to the present dispute is Clause 23 which relevantly provided:
"23.1 Any controversy or claim arising out of or relating to this Contract or the alleged breach thereof shall be settled by arbitration in accordance with the Arbitration Act of the State of Victoria, and in accordance with the following:...
(c) the award shall be made in writing and signed by the arbitrators or the umpire as the case may require and shall be final and binding on the parties; the parties shall abide by the award and comply with the terms and conditions thereof; ..."
The change in the petroleum taxing regime
11 Prior to 1991 Esso and BHP were liable to pay royalties and excise duties on petroleum products recovered from Bass Strait. However by virtue of the Petroleum Resource Rent Legislation Amendment Act 1991 (Cth), ("the PRRL Amendment Act") which received the Royal assent on 26 June 1991, but which operated retrospectively from 1 July 1990 the obligation to pay royalties and excise duties ceased and in its place there was imposed petroleum resource rent tax, being a tax based on profits, rather than on production. The purpose was, so the then Federal Government announced to "remove the pressure for continual changes in excise rates as production declines or market conditions vary" (Budget Statement, 21 August 1990, para 4.6).
12 The PRRL Amendment Act, inter alia, amended the PRRT Act and applied it, as amended, to the Bass Strait field. Section 21 provided:
"Subject to this Act, tax imposed in respect of the taxable profit of a person of a year of tax in relation to a petroleum project is payable by the person."
13 The term "taxable profit" was to be calculated as the amount by which "assessable receipts" exceeded "deductible expenditure" and the amounts if any transferred under ss 45A and 45B of the PRRT Act. Neither s 45A or 45B is presently relevant. The term "assessable receipts derived by a person in a financial year in relation to a petroleum project" include "assessable petroleum receipts" in relation to a petroleum project. By virtue of s 24 the seller's assessable petroleum receipts are "the consideration receivable, less any expenses payable by the person in relation to the sale". Deductible expenditure can be said, generally, to be expenditure actually incurred in relation to the project in the financial year without differentiation between capital and income expenditure. Unlike the ITA Act there is no provision for writing off debts which may become irrecoverable. The Bass Strait field is a "petroleum project" for the purposes of the PRRT Act.
The disputes between buyers and sellers
14 After the changes proposed to be made to the PRRT Act were announced the sellers notified the buyers that they intended to pass on the impact of the PRRT to the buyers under clause 12.8 or equivalent clauses. They endorsed their standard monthly invoices with a note in the following (or equivalent) terms:
"The Federal Government has replaced the Royalty and Excise Regime with a Resource Rent Tax effective from 1 July 1990. The effect of this change on the gas price is currently being calculated and the Sellers reserve the rights to make appropriate adjustments to the gas price once the process of calculating the impact of the Resource Rent Tax has been completed."
15 The buyers disputed the right of the sellers to adjust the price payable for gas to take into account the rent resource tax after allowing for the change in royalty and abolition of excise. There followed an exchange of correspondence. At the heart of the dispute was a disagreement as to whether the resource rent tax was "attributable" to the production or supply of gas (or ethane) with the effect that the sellers were entitled to pass on the liability to the buyers under clause 12.8 or equivalent clauses. In some, but not all, agreements (the provisions of clause 12.8 of the agreement presently being discussed in an example) the word "directly" appeared immediately before the word "attributable"). The buyers argued that there should only be a reduction in the amount payable to take account of the effective abolition of royalties and excise but no increase to take account of the resource rent tax.
16 It took some time for the sellers to calculate the extent of the resource rent tax to be taken into account under clause 12.8. Claims were first made for additional monies payable around 13 November 1991. However, it seems that there were numerous calculations and recalculations of the amounts which continued until the dispute was ultimately resolved. In the correspondence (and before the learned Primary Judge and on the appeal) the amount of the adjustments were referred to as "pass-on amounts" and letters or invoices demanding payment were referred to as "pass-on letters" or "pass-on invoices". Similar terminology is used here.
17 The buyers did not pay any of the pass-on amounts claimed. In addition SECV and GFC initially, and other buyers subsequently, also withheld payment of the proportion of government royalties payable. This led to a claim by the buyers for interest in accordance with the contracts.
18 The dispute between the parties not only concerned the question whether clause 12.8 permitted a pass-on of a proportion of the resource rent tax but also the method by which the proportion was to be calculated. It was claimed that such details as to the methodology employed by the sellers did not satisfy the requirement of clause 12.8 or equivalent clauses and in any event that a different methodology should be employed.
19 The various disputes between the sellers and the buyers were referred to arbitration in accordance with the contracts. Only the SECV contract in fact proceeded to an award made by the arbitrator. The other disputes were ultimately settled after the award relating to the SECV contract had been made and an appeal to the Supreme Court of Victoria instituted.
20 In 1993 the sellers applied to the arbitrator for an interim award requiring that SECV pay the withheld royalties and interest. They were unsuccessful in this application.
21 The issues which arose on the arbitration, as set out in the award which was made on 30 November 1994 were as follows:
"1. Whether the tax imposed by the [PRRT Act] and the [PRRTA Act] falls within the description contained in clause 19.5(a)(i) of the [SECV Contract]... and can thus be passed onto the Buyer by way of an increase in the amount Buyer pays for the product supplied ["pass-on issue"].2. Assuming that there is a pass on, is the amount of the [PRRT] pass on itself an "assessable receipt" under Section 23 of the [PRRTA Act], so that such amount can be "grossed up", i.e. "so as to recover the tax upon the tax recovered?" ["gross-up issue"]
3. Assuming there can be a pass on, what is the fairest and most reasonable method to determine the difference between the assessable receipts received by Sellers for the supply of natural gas, and the deductible expenditure in respect of such receipts, so as to calculate the amount of taxable profit upon which the 40% [PRRT] is imposed? To ascertain that profit required the allocation of the costs of production of natural gas, which costs include joint costs of the production of both oil and gas. This required the identification and application of the fairest and most reasonable method of allocating such joint costs. Sellers contend such a method is the revenue allocation method. Buyer contended that this method was manifestly unreasonable and unfair, and should be rejected...["method issue"]
4. Assuming a pass on, there is the further question of the allocation of [PRRT] amongst customers. Relevantly Buyer takes approximately 13% of natural gas produced, and [the GFC] 82% and there are some other minor purchases ["customer issue"].
22 Ultimately these issues were decided adversely to SECV. It is unnecessary to discuss in detail the reasons given by the arbitrators for their conclusions. Suffice here to say that the arbitrators were of the view that the rent resource tax was "attributable" or "directly attributable" to the production of gas and accordingly could be passed on under the agreement. In respect of the gross-up issue, the arbitrators again found against the SECV on the basis that all of the monies received by the sellers were assessable for PRRT Act purposes. This meant that an adjustment was required on a gross-up basis so that there would be passed on to the buyers in full the net cost of any new impost. The arbitrators were further of the view that as SECV had not put up any other method of calculation, the method of apportionment of the resource rent tax adopted by the sellers was fair and reasonable. The arbitrators noted that the question of apportionment involved a matter of judgment. The sellers generally argued for an apportionment related to revenue from different areas of the field. The SECV claimed, inter alia, however, that the production of gas supplied to it resulted in little or no profit to the sellers because the gas was sourced from an unprofitable area and accordingly no tax or less tax should be apportioned to it. The SECV argument was rejected. Finally, the arbitrators were of the view that the dispute between the parties was a bona fide one, so that the provision for interest where non payment of the purchase price or part thereof came about other than by reason of a bona fide dispute was not applicable.
23 The consequence of the award was that the sellers became entitled to be paid under the equivalent of clause 12.8 the amount which they had ultimately claimed, except that they were not entitled to any amount for interest on the unpaid pass-on amounts.
24 SECV instituted proceedings in the Supreme Court of Victoria to challenge the validity of the award. The sellers also sought to argue against the arbitrator's rejection of the interest claim as well as to argue for an alternative basis in the event that SECV should succeed in having the arbitrators' award set aside. Applications for leave to appeal were heard by that Court. However, settlement was reached between the parties in November 1996 before the Supreme Court delivered judgment.
25 The settlement was reached in the context of the desire of the State of Victoria to introduce structural reforms and increased competition into the Victorian gas industry. Accordingly the parties agreed not merely to settle the claim for the pass-on amount for the past but also to settle claims for entitlements that would arise in the future. The settlement involved the payment of two lump sum amounts, one for the past claim and one for the future claim. The lump sum amounts were paid, respectively, to settle all:
"(a) amounts outstanding to [the sellers] on partially paid invoices for gas sold and delivered .... And unpaid invoices and letters of demand for the pass-on of PRRT in respect of gas sold and delivered to [the buyers] between 1 July 1990 and 31 October 1996 ...(b) future entitlements to pass on PRRT from 1 November 1996 pursuant to the [Supply Contracts] ...
26 The settlement, when reached did not merely include the buyers and sellers. Taxation was an integral part of the settlement and letters of understanding were entered into between the Australian Taxation Office and BHP and Esso in effect agreeing to the quantum of amounts but leaving it open to Esso and BHP to challenge in objection proceedings the question when income was derived from the sale of the gas for the purposes of income tax and when assessable receipts were derived for the purpose of the resource rent tax.
27 The disputes involving the two supply contracts to which Huntsman was a party were resolved by deeds of settlement dated 30 December 1994 and 13 February 1995 on a similar basis. Likewise the disputes involving Mobil and Kemcor were settled on 29 September 1994 and 17 February 1995 by two lump sum payments.
28 In due course the Commissioner issued assessments against Esso and BHP under the ITAA and the PRRT Act on the basis that under each Act there was a derivation of income or consideration receivable as the case may be, in respect of the pass-on amounts at the time of invoice. It is far from clear on the material before us precisely on what basis the assessments were really made, in so far as it would seem that invoices were issued, cancelled and reissued for different amounts at different times. It seems to be accepted by the parties that the total amount which was treated as assessable income derived for income tax purposes or consideration receivable for PRRT Act purposes over the period from the time the PRRT Act became retrospectively effective and the time settlement was reached between the respective vendors and purchasers did not exceed the total of the first of the lump sums agreed between the sellers and the buyers. It also seems to be the case that, excluding the interest claim, which was rejected by the arbitrator in the arbitration, the total figure was equal to the final invoices rendered to the buyers. The assessability of the second lump sum payable in each settlement, namely that paid for release of future pass-on amounts is not the subject of the present proceedings.
The evidence of Professor Walker
29 It is useful now, before considering the judgment appealed from to summarise, briefly, the evidence of Professor Walker.
30 Professor Walker is Professor of Accounting at the University of New South Wales. He has been a member of the Accounting Standards Review Board and a consultant to government as well as authoring many articles in the accounting field.
31 In summary, Professor Walker said that in his opinion it would only be appropriate to treat pass-on amounts as income for accounting purposes where the amount claimed would satisfy the tests for identification as an asset of the seller and the claim was capable of being measured with sufficient reliability for it to be recognised in the accounts of the seller at the end of an accounting period. Otherwise the appropriate or proper accounting treatment would not be to recognise the amount of the claim as giving rise to revenue. For this purpose assets were to be defined as a "future economic benefits controlled by the entity as a result of past transactions or other past events." It was Professor Walker's view that the sellers could not in the circumstances of the present case properly regard any claim for recovery of PRRT as representing an asset in terms of this definition; it was not controlled by the seller, nor could its value be measured reliably in the sense that term is used in accounting literature.
32 It is clear from Professor Walker's report, and it would hardly be surprising, that Professor Walker would not regard accounts of the sellers in the present circumstances to be true and correct should the sellers seek to bring to account as revenue the pass-on amounts during such time as the bona fide dispute between the sellers and the buyers existed.
The judgment appealed from
33 After setting out in some detail the provisions of the various contractual agreements her Honour noted the accounting treatment which Esso and BHP had adopted. Briefly it can be said that that accounting treatment was not consistent in that Esso initially included the pass on amounts invoiced as income, but discontinued the practice as and from the 1993 year, whereas BHP at no time included the pass on amounts as income until the year of settlement. Likewise the position taken by the Commissioner was not consistent.
34 Her Honour then turned to consider the case law concerning the derivation of income. The judgment notes, and indeed it was common ground, that normally income from the sale of gas under the supply contracts would be derived at the time the gas was supplied. Her Honour noted, also, that when the usual method of accounting for income was departed from, that was only where there was a need to have regard to the "truth and reality" of the situation.
35 However, her Honour, in considering the truth and reality of the situation rejected the submission that the pass-on provisions were so uncertain as to be unenforceable. Her Honour also rejected a submission that the entitlement under the pass-on provisions was incapable of quantification at the time the entitlement first arose or that the right to recover was dependent upon a further agreement between the parties, or upon a final arbitration award or in the event of an appeal, upon judicial determination.
36 In considering these submissions, her Honour proceeded to analyse the arbitration clause in the supply agreement by reference to the Commercial Arbitration Act 1984 (Vic). The submission to arbitration was not, her Honour said, merely a working out of the parties' contractual obligations. While the award declared the scope of the parties' contractual rights and obligations, these rights and obligations were initially created when the agreement was first made. Her Honour rejected a submission that on the proper construction of the arbitration clause the arbitrator's award was a condition precedent to the right of the sellers to the pass-on amounts or to enforce payment of those amounts. In her Honour's view, and having regard to what was said by the High Court in Anderson v GH Michell & Sons Ltd ("Anderson") [1941] HCA 30; (1941) 65 CLR 543 at 550 arbitration was not such a condition precedent. Nor was the right to the pass-on amounts inchoate, unenforceable until award or otherwise defeasible.
37 In her Honour's view the truth and reality of the situation was that when the sellers delivered the gas under the supply contracts they lost all dispositive power over the products and satisfied all conditions precedent to their right to recover the contract price including the pass-on amounts. Accordingly at delivery of the gas the sellers should be treated as having derived income from the pass-on amounts. Because there was an indefeasible debt which arose on delivery any problem of inability to deduct bad debts which the cases indicate might be relevant to issues of derivation did not arise.
38 Further, her Honour in effect rejected Professor Walker's evidence on the basis that, in her Honour's view, Professor Walker had wrongly regarded the pass-on amounts as not part of the contract price for the gas and therefore to be treated for accounting purposes differently than the contract price. His evidence did not, her Honour said, assist "...the Court in determining the truth and reality of the present situation since it is premised on the mistaken assumption that the pass-on amounts were separate from, and did not form part of, the Contract Price...". Her Honour referred, as well, to other difficulties which her Honour saw in Professor Walker's evidence. These "other difficulties" were:
"Just as the assertion of a legal entitlement to payment cannot of itself make that payment assessable for income tax purposes, equally the denial of a legal entitlement to payment cannot of itself make that payment non-assessable for income tax purposes. Yet this is the effect of Professor Walker's opinion, relying as it does on the impact of the disputes about the pass-on amounts as lessening the sellers' confidence in their claim. There is a difficulty in omitting any consideration relating to the merits of the seller' claim form the kind of analysis made by him. Moreover, Professor Walker's reliance on the taxpayer's own confidence (or lack of confidence) in a claim would, if correct, lend an unacceptable degree of unpredictability and potential irrationality to inquiries of the present kind. Finally, there is the difficulty referred to by Professor Walker himself at par 82, namely, that the revenues `attributable to or derived in earlier years would be recorded in a single year'."
The Commercial Arbitration Act 1984 (Vic)
39 Before her Honour, and before us, there was debate concerning the effect of the arbitration clause in the supply agreements and the provisions of the Commercial Arbitration Act 1984 (Vic) ("the Arbitration Act".) As already noted, the appellants sought to argue before her Honour that it was a consequence of the arbitration clause that no recoverable debt arose in favour of the vendors unless there was an arbitration which resulted in an award. On that basis, it was submitted, that arbitration was, in effect, a condition precedent to the coming into existence of an enforceable debt and for that reasons there was no derivation of income until, at the earliest, the arbitration had been concluded. The reference to "recoverable debt" in the argument echoed what had been said by Barwick CJ in Henderson.
40 Her Honour rejected the submission that the right to recover the pass-on amounts from the buyer was dependent either upon a binding award, a judicial determination on an appeal or further agreement. In her Honour's view the award did not create the right to the pass-on amounts, that right arose from the supply agreement itself. The arbitration was not, her Honour held, a condition precedent to liability or the commencement of an action. Her Honour referred to the decision of the High Court in Anderson at 554-5 in support of this view.
41 Reference was made in the course of argument before us to the decision of the High Court in PMT Partners Pty Ltd [1995] HCA 36; (1995) 184 CLR 301, a case decided on the provisions of the Commercial Arbitration Act 1985 (NT) which held, inter alia, that the parties to the particular arbitration agreement there under consideration were precluded from electing between court proceedings and arbitration before notice requiring arbitration was given and were thereafter precluded from taking court proceedings.
42 The particular arbitration agreement in PMT Partners provided that all disputes were to be decided in accordance with a procedure which involved the giving of a notice and thereafter arbitration. For present purpose the relevant language was "shall be decided as follows". Brennan CJ, Gaudron and McHugh JJ were of the view that the language of the agreement with the use of the word "shall" made it clear that the parties had provided "exclusively and exhaustively" for the procedures to be followed to resolve disputes between them. See too per Toohey and Gummow JJ at 323. Contrary to the view of the Court of Appeal of the Northern Territory there was an "arbitration agreement" as defined in s 4 of the NT legislation, that definition being, unless a contrary intention appeared "an agreement in writing to refer present or future disputes to arbitration". In consequence Court proceedings could not be commenced unless there had been notification in accordance with the arbitration clause.
43 The arbitration clause in the present supply agreements, Clause 23, is set out earlier in these reasons (para 10).
44 It is difficult to conclude that the present arbitration clauses are in any way less mandatory than those in PMT Partners. The Arbitration Act is virtually identical to the Northern Territory equivalent and for present purposes the definition of "arbitration agreement" in s 4(1) is the same. Section 33 of the Arbitration Act provides for arbitration awards by leave of the Court to be enforced in the same manner as a judgment and s 38 provides for what is, in essence, judicial review of an award on a question of law either with the consent of all parties to the arbitration agreement or with the leave of the Supreme Court in limited circumstances.
45 As discussed in the joint judgment of Gummow and Toohey JJ in PMT there had been conflicting view expressed in the New South Wales Court of Appeal in ABB Power Plants Ltd v Electricity Commission (NSW) (1995) 35 NSWLR 596 as to what constituted an "arbitration agreement" so as to preclude curial proceedings before arbitration. PMT would suggest that in the present case curial proceedings were precluded unless there was first an arbitration and that what was said in Anderson upon which her Honour relied was inapplicable to a clause drafted as the present clause was.
46 As presently advised it is difficult to see why any different conclusion could be drawn in the present case from that drawn in PMT Partners. However, the present case does not depend upon an answer to the question whether in this case arbitration was a condition precedent to the creation of a liability in the buyer to pay the seller. The case depends upon a broader principle, namely whether an amount which otherwise would be income is derived where it is the subject of a bona fide dispute which extends both as to whether any amount is payable and if some amount is payable the quantum of that amount. Accordingly it is not necessary to determine whether her Honour did err in holding that arbitration was not a condition precedent to there being a recoverable debt having regard to the decision of the High Court in PMT Partners
The derivation of income for the purposes of income tax
47 The question of when income is derived is one that falls to be determined in accordance with the general understanding among practical business people: Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation [1965] HCA 58; (1965) 114 CLR 314 at 318. As the full High Court (Barwick CJ, Kitto and Taylor JJ) there said:
"As Dixon J observed in Carden's Case : `Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form' . The word `gains' is not here used in the sense of the net profits of the business, for the topic under discussion is assessable income, that is to say gross income. But neither is it synonymous with `receipts'. It refers to amounts which have not only been received but have `come home' to the taxpayer; and that must surely involve, if the word `income' is to convey the notion it expresses in the practical affairs of business life, not only that the amounts received are unaffected by legal restrictions, as by reason of a trust or charge in favour of the payer - not only that they have been received beneficially - but that the situation has been reached in which they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived.The ultimate inquiry in either kind of case, of course, must be whether that which has taken place, be it the earning or the receipt, is enough by itself to satisfy the general understanding among practical business people of what constitutes a derivation of income. A conclusion as to what that understanding is may be assisted by considering standard accountancy methods, for they have been evolved in the business community for the very purpose of reflecting received opinions as to the sound view to take of particular kinds of items. This was fully recognized and explained in Carden's Case, especially in the judgment of Dixon J; but it should be remarked that the Court did not there do what we were invited to do in the course of the argument in the present case, namely to treat the issue as involving nothing more than an ascertainment of established book-keeping methods. A judicial decision as to whether an amount received but not yet earned or an amount earned but not yet received is income must depend basically upon the judicial understanding of the meaning which the word conveys to those whose concern it is to observe the distinctions it implies. What ultimately matters is the concept; book-keeping methods are but evidence of the concept."
48 In Arthur Murray it was held that as a matter of good business sense a recipient of fees paid in advance for services not yet rendered should not treat the amounts received as being income derived at the time of receipt. These amounts when received were subject to the contingency that they may have to be returned if the services were not performed. Hence it did not accord with the reality of the situation to hold that on receipt the amounts had the quality of income derived. Established accounting and commercial principles in effect required that the amounts should be credited to a suspense account and that they should only be treated as income when the services were in fact performed.
49 It is important to note that their Honours emphasised that the ITA Act laid down no test as to what was income in ordinary concepts and that accordingly that the word "income" was left to be understood in the sense it had in the vocabulary of business affairs.
50 One of the earliest High Court cases to consider what may be referred to as "tax accounting" was The Commissioner of Taxes (South Australia) v The Executor Trustee and Agency Company of South Australia Limited [1938] HCA 69; (1938) 63 CLR 108 ("Carden's" case) to which reference was made in Arthur Murray. In that case one of the questions which arose was whether a medical practitioner was required to bring to account for taxation purposes the actual receipts of his medical practice as and when received, or whether he was required to account for that income as and when the medical services were rendered. It was held that the former was in the circumstances of that case the correct treatment under the Taxation Act 1927-1935 (SA) under provisions equivalent to those now to be found in the ITA Act. Dixon J at 152 there made it clear that unless the legislature enacted some special provision the ascertainment of income should be governed by the principles recognised or followed in business or commerce. Absent such special provision the Court, when faced with different methods of accounting (cash or accruals) should look to determine which was calculated to give "a substantially correct reflex of the taxpayer's true income."
51 In a passage which is often quoted, Dixon J in Carden at 155 discussed accrual accounting in its application to income tax as follows:
"Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form.......
The computation of profits from manufacture and trading has always proceeded upon the principle that the profit may be contained in stock-in-trade and `outstandings.' Whether this is to be explained on some view that the purpose is to ascertain what is the detachable increase in circulating capital, or more simply on the ground of common sense and the teachings of experience, the result for the purposes of taxation is the same. The result is that a tax upon the profits or income of such a business must be understood as a tax upon the profits or income computed according to the system, because, according to common understanding and commercial principles, that is the method of determining the profits. The basis of a trading account is stock on hand at the beginning and end of the period and sales and purchases. In such an account book debts represent what before sale was trading stock and it is almost inevitable that they should be taken into consideration upon an accrual and not a cash basis."
52 It was not until 1970 that the High Court returned to the distinction between cash and accrual accounting for professional taxpayers in and held that accrual accounting was required for a large firm of accountants so as to give a correct reflex of the firm's income. It was held that the partnership derived income as and when the particular professional service was performed so that in accordance with the agreement of the parties or the general law the fee for that service was earned. It may be noted that the Court rejected the possibility of estimating the value of services partly performed but for which payment could not be demanded and treating that estimate as income. Further, while Barwick CJ, with whose judgment McTiernan and Menzies JJ agreed, used the word "recoverable" to described the point at which income was derived by the performance of services, his Honour emphasised that the time of derivation could not be delayed by reason of an arrangement between the firm and its clients under which time to pay was afforded to the clients.
53 The most recent case dealing with cash or accruals for professional practitioners was the decision of the full Court of this Court in Barratt v Commissioner of Taxation [1992] FCA 271; (1992) 36 FCR 222 where it was held that the fact that the Medical Practitioners Act 1938 (NSW) prevented medical practitioners from suing for their fees for a period of six months, during which time the fee might be reviewed, did not preclude a pathologist from deriving income at the time the pathology service was performed in a case where the accrual basis of taxation was, on the facts, otherwise appropriate. Gummow J, with whose judgment Northrop and Drummond JJ agreed, said at 231:
"No doubt a debt that is presently recoverable by action generally will be an amount `derived' in the relevant sense by the creditor. The creditor will have a present right to receive the amount in question, something both earned and quantified, without the presence of any element of contingency or defeasibility. At the other end of the scale, where the right of the taxpayer is contingent, there will be no derivation before the contingency is satisfied... Nor will there be derivation if the debt is yet to be quantified: see Farnsworth v Commissioner of Taxation...The present case is at neither extreme of the spectrum. But it is well to bear in mind that which is being sought is a method giving, for each year of income, a substantially correct reflex of the true income of the taxpayers, having regard to what Fullagar J called the truth and reality of the situation:"
54 It seems that throughout the six month period patients regularly made payments and had no regard to the six month period. This caused his Honour to conclude that the truth and reality of the situation was not to defer derivation for the six month period. Further, his Honour was of the view that the statutory provision which required the expiration of six months before suit did not stipulate the six months as a condition precedent to the coming into existence of a debt, but rather imposed an impediment upon the enforcement of a preexisting debt. However, according to his Honour Henderson should not be taken as having decided that no amount could be derived unless the amount was presently recoverable by action. At least in a case such as Barratt derivation would take place at the time the service was performed, whether or not there was still a period of six months which needed to expire before the pathologist could recover the amount by action.
55 In the case of a trader in goods income will normally, as the passage cited from Carden's case explains, be derived when the goods are sold. Once there has been a sale the goods which have previously been represented in the trader's account as stock in trade will, be represented in the account of the trader as a debt and this will be the case whether or not the purchaser of the goods has agreed to pay cash on delivery or on invoice or has contracted to pay for the goods on terms: J Rowe & Son Pty Ltd v Federal Commissioner of Taxation [1970] HCA 57; (1970-1) 124 CLR 421. Menzies J, with whose judgment Barwick CJ, McTiernan and Gibbs JJ in Rowe agreed, noted that to treat a retailer selling on terms as taxable on a cash basis would be opposed to ordinary principles of accounting, a proposition with which the evidence of Professor Walker would agree. As Gibbs J said in that case at 451-2:
"The expert evidence, which my brother Walsh accepted, showed that, from an accountancy and commercial point of view, it is unusual to bring into the accounts of a trader making sales on terms only the payments received or receivable in the year in question, and that to do so does not reveal the true position of the trading, whereas the Commissioner's method, of bringing into account, at the time when a contract of sale was made, the whole of the component representing the sale price of the goods, but not the component representing the additional consideration unless received or receivable during the income year, is in conformity with general accounting principles. The appellant contended that the evidence of the experts in accountancy showed a basis for arriving at profits but not a basis for determining the amount of `gross income derived' within s 25 of the Income Tax Assessment Act 1936, as amended (Cth). However for the reasons given by my brother Menzies, I agree that for taxation, as well as for business, purposes income of a trading business is derived when it is earned and the receipt of what is earned is not necessary to bring the proceeds of sales into account. When the Act gives no directions on the point, the question when income is earned, and the method of accounting to be adopted for the purpose of ascertaining the income, depend upon business conceptions and the principles and practices of accountancy. ... The method adopted should be that which is `calculated to give a substantially correct reflex of the taxpayer's true income'".
56 Rowe was followed in Gasparin v Commissioner of Taxation (1993) 50 FCR 73 by a Full Court of this Court (Jenkinson, Spender and von Doussa JJ) in holding that income of a land trader was derived when the contract was settled, and not at the date of contract. In that case there was no uniform accounting view and the Court was influenced by the fact that the taxpayer did not lose all dispositive power over the land until the contract was completed and accordingly it was only then that the land would cease to be trading stock of the trader. Further, if derivation took place at the date of contract and for some reason the contract was not completed there would be no bad debt which the taxpayer could write off under s 63 of the ITA Act. In this respect both Gasparin and Rowe placed emphasis on the role which s 63 plays in permitting debts which are commercially bad to be written off in circumstances where the debt has come about by virtue of the derivation of income before receipt.
57 The only case where derivation has been considered in Australia in the case of a commodity, gas, is Commissioner of Taxation (Cth) v Australian Gas Light Co [1983] FCA 341; (1983) 74 FLR 13. However, in that case the issue was whether the gas utility derived its income at the time it delivered gas to consumers or only when gas metres were read. It was held that the supplier did not derive as income unbilled gas delivered to consumers where meters were not read. The Court, comprising Bowen CJ, Fisher and Lockhart JJ summarised the cases decided until that time noting that each of them depended upon different circumstances and that the tests which each propounded could be seen as signposts. However, where a taxpayer operated under "exceptional circumstances" different principles could apply. Their Honours were of the view that the particular circumstances under which the utility operated brought about the result that unbilled gas had not matured into recoverable debts. The case provides little assistance in the present case because the outcome of it clearly depended upon the regulations governing tariffs under which the Respondent supplied gas to customers.
58 It is clear that there has been no case in Australia which has raised the issue presently before the Court. However, we were referred to three further cases in Australia as being of some assistance. The first Farnsworth v Federal Commissioner of Taxation [1949] HCA 27; (1949) 78 CLR 504 concerned the case where the taxpayer, a fruitgrower, delivered fruit to a packing company and that fruit became intermingled with the fruit of other growers. The packing company processed, packed and sold the fruit under the rules of an association of which the taxpayer and other fruit growers were members and on behalf of members. By the end of the year of income various progress payments had been made to growers and it was estimated that in addition the taxpayer would receive a further amount as net proceeds of sale of the fruit. It was held that the taxpayer had not derived this further estimated amount as income. And this was so, notwithstanding that the fruit had ceased to be stock on hand of the grower once it passed into the hands of the packer.
59 The significance of the case for present purposes lies in the following passage from the judgment of Dixon J at 519 where his Honour is considering an argument that the taxpayer should be assessed on an earnings basis, said:
"The sum expected to arise from the pool cannot be described as a debt. If the sum was not realized in the ensuing accounting period, the deficiency could not be brought within s 63. If the deficiency could be brought in as a loss or debit it must be on general principles of accounting. To bring it in somehow would be essential to a fair assessment. Yet the structure of theAct is hardly consistent with a debit which will not fall within any category of authorized deduction. It could not readily be brought within s 51....
I hesitate in the present case to lay down any proposition of universal application about anticipated dividends from pools of primary products. But it does seem to me that the natural solution of a case like the present, which is a simple case, is to ascertain the taxable income of the taxpayer on the basis of receipts and outgoings. After all, as was remarked by Mr Gibson, who dissented in the Board of Review, the payments were not `got or obtained' by the taxpayer before she received them. He said that the payments were undoubtedly assessable income derived by the taxpayer at, but not before, the respective times when the payments were received; they were required to be made to her under the rules adopted by the contract but the amounts and the times of the payments were at the discretion of the packers concerned. I agree in this view."
60 The case is quite distinguishable from the present case if only because, at the end of the year of income, the trader in Farnsworth had no debt into which the trading stock had been converted. However there are three propositions for which the case stands which do have some relevance. First, the case demonstrates, that even in the case of a trader in goods there may be circumstances where income will be derived on a cash basis. Secondly, the case shows that there will be circumstance where goods of a trader will have ceased to be on hand, but yet income will not yet be derived (cf All States Frozen Foods Pty Ltd v Commissioner of Taxation (1990) 21 FCR 457) and thirdly the case shows that in the case of a trader the fact that s 63 will not operate to allow a deduction of amounts which have been brought into account as income because they are not relevantly debts within the meaning of that section will be a relevant matter in considering whether income has truly been derived.
61 What distinguishes Farnsworth from the present case is that the question whether the trader would receive any amount of money for the stock and the quantum of the amount were discretionary, whereas in the present case and in the events which happened the vendors were found by the arbitrator to be entitled to particular sums. The question is thus whether that difference is relevant to the outcome. It may be said here that it has never been suggested that this Court should decide for itself whether the vendors here were entitled to any amount and if so the quantum of that amount. It need only, therefore, be said that the construction issue which the arbitrator decided in favour of Esso and BHP was not at all an easy one. Indeed, there were clearly arguments on both sides, particularly as to the question whether the rent resource tax was a tax directly on production. But it would only be if the Court deciding the taxation question itself decided the construction question and in favour of the vendors that there could be a final decision binding the vendors and the Commissioner as to whether there really was a debt. The alternative that accepts the arbitrator's decision as determinative of the question whether there was a debt and the quantum of that debt would hardly be correct and in any case would have no application to the case where the ultimate decision is one which is reached by the parties by way of a bona fide compromise. These matters point in the direction of treating derivation in the present cases as occurring only at the time compromise has been reached between the parties to the dispute and not before.
62 The second case to which reference was made is Federal Commissioner of Taxation v Squatting Investment Co Ltd [1954] HCA 2; (1953-4) 88 CLR 413. Under a war-time wool scheme between Australia and the United Kingdom Australian growers of wool supplied wool for appraisement and were duly paid the compensation money payable under the scheme. The scheme contemplated that there could be a further distribution of money to growers at a later date. After the war subsequent legislation provided for the establishment of a Wool Realization Commission which was to sell wool stockpiled and distribute profits to growers. The taxpayer received an amount in 1949 by way of an interim distribution as an additional payment made voluntarily although as an addition to the purchase price for the wool disposed of during the war. It was held that the additional payment was income of the taxpayer's business when received. It may be noted that it was never sought to be argued in the Privy Council that the payment in question was attributable to any income year other than the 1949 year, although the questions for consideration by the High Court included a question as to the income year in which the amount was derived. The High Court, by majority, held that the amount was not income and so did not have to decide the question whether the amount was derived in any year other than the 1949 year. However, the decision of the High Court in Ritchie v Trustees Executors and Agency Co Ltd [1951] HCA 38; (1951) 84 CLR 553, dealing with the same wool scheme made it clear that for trust law accounting purposes the amount should be seen to be derived at the time of receipt and not in the trust accounting period in which the sale of the wool occurred.
63 Squatting Investment, like Farnsworth is a case where there was no debt payable to the trader as at the end of the year in which the trading stock was sold or disposed of and can, thus, be distinguished for the same reason.
64 The third case is Ballarat Brewing Company Limited v Federal Commissioner of Taxation [1951] HCA 35; (1951) 82 CLR 364. That case concerned a brewing company which sold its products to customers on terms that the customer was to be entitled to a discount for prompt payment and a rebate on the agreed purchase price if certain conditions were fulfilled. It was rare that discounts or rebates were not in fact given to purchasers. The taxpayer took into its accounts the discounts and rebates in the year in which the sales of products to which they related were made. The Commissioner assessed on the basis that these amounts should only be taken into account in the year in which the discounts and rebates were in fact allowed. It was held that in the circumstances of the case where the discounts and rebates were so seldom disallowed the taxpayer's method of accounting was correct. It was further held that should a discount or rebate in fact not be allowed in a later year, then the amount allowed in the accounts for it in the former year should be added to sales in the year where the disallowance occurred.
65 Fullagar J who decided Ballarat Brewing regarded the problem as being what the correct figure was to ascribe to sales in the taxpayer's accounts. His Honour pointed out that this was not something about which the legislation made specific provision and hence the question was one which depended upon "the conceptions of business and the principles and practices of commercial accountancy". The reason his Honour accepted the approach of the taxpayer was that it brought to account the amount which the taxpayer, in the light of past experience, would almost certainly receive, whereas the Commissioner's approach brought to account as income in the year amounts which the taxpayer was almost certain not to receive. Accounts prepared on the basis suggested by the Commissioner would be misleading.
66 Perhaps the only relevance Ballarat Brewing has for the present case is that it adds to the quite substantial case law in which the High Court has made it clear that where the question at issue is the derivation of gross income that, being a matter for which the ITA Act makes no specific provision, the Court will have regard to the conceptions of business and the principles and practices of commercial accountancy. The case also makes it clear that the Court would be reluctant to apply to income tax a method of accounting which would produce a misleading result in the absence of a specific statutory provision which required that.
67 Before turning to the accounting evidence in the present case it is important to note that while the earlier cases, such as Carden, Arthur Murray and Henderson, may be thought to have suggested that business and accounting principles are to be applied by the Court in determining questions of derivation, some later cases, for example the Australian Gas Light Company case in this Court have made the point that accounting principles are not determinative, although they may be persuasive.
68 Certainly where the question is whether a loss or outgoing is incurred for the purposes of s 51(1) it is clear that accounting principles are not determinative, cf Federal Commissioner of Taxation v James Flood Pty Ltd [1953] HCA 65; (1953) 88 CLR 492, Nilsen Development Laboratories Pty Ltd v Federal Commissioner of Taxation [1981] HCA 6; (1981) 144 CLR 616. Indeed, in the latter case Barwick CJ expressed the view that the "prudence and commercial propriety of such a course [accruing annual or long leave] has little bearing on the question whether there is present in the year of income a loss or outgoing within the meaning of s 51(1)." Notwithstanding such cases it is clear even in the context of s 51(1) where a jurisprudential analysis prevails over a commercial view, that accounting and business practice will not always be irrelevant and may indeed provide useful assistance to the Court: Coles Myer Finance Ltd v Federal Commissioner of Taxation [1993] HCA 29; (1992-3) 176 CLR 640 at 666 per Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ.
69 It is not necessary in the present case to decide if there is really a difference between the emphasis put on accounting practices in the early cases and the views expressed in the later cases. It suffices here to say that on either view of the law the business and accounting practices assist the Court in the working out of the principles behind the statutory language of " income derived".
The principles and practices of commercial accountancy which operate here
70 As already noted her Honour regarded the evidence of Professor Walker as unhelpful. However, with respect to her Honour, she appears to have misunderstood that evidence, while nevertheless accepting that accounting evidence may be persuasive and "may in some cases assist the court".
71 The major reason for dismissing the evidence appears to have been her Honour's understanding that Professor Walker had in some way regarded the pass-on amounts as not being "part of the Contract Price", whereas it was her Honour's view, and correctly, that they were. The capital letters used by her Honour in the expression "Contract Price" make it clear that her Honour intended to refer back to that expression as defined by her Honour in para 4 of her Honour's reasons to be in effect the annually determined amount which the buyers undertook to pay to the sellers as calculated in accordance with the contract (in the contract here examined, clause 12).
72 Professor Walker had early in his discussion of the accounting principles made it clear that in the ordinary case, where no dispute existed, revenue from gas should be recognised at the point of delivery. He clearly accepted that the quantified amount payable under Clause 12 should be treated that way, but that the real question for decision was whether the pass-on amount was to be treated in the same way. The Professor did not, with respect to her Honour, at any point say that the Contract Price in the sense defined by her Honour, which clearly includes the pass-on amounts, should be taken as recognised as revenue at the time gas was delivered. Nor did he suggest that as a matter of law the pass-on amount was not part of the purchase price for gas that was payable under the contract. Clearly it was. With respect Professor Walker's opinion was not premised on any mistaken assumption as her Honour suggests. Indeed, senior counsel for the Commissioner had difficulty in supporting the criticism which her Honour made.
73 Nor, with respect, do we agree with the other difficulties which her Honour suggested existed with Professor Walker's approach in the passage which is set out at para 38 of these reasons.
74 It may be accepted that a mere denial of legal entitlement to payment will not operate to make an amount which is income derived by a taxpayer not assessable income of that taxpayer. (The way her Honour stated the difficulty has its own difficulty because it refers to a "payment" being non-assessable, when the problem occupying the Court in the present case arises precisely because there is no payment of an amount claimed. However, that is only a linguistic difficulty and the proposition made by her Honour can be restated as suggested). What is involved in the present case is more than a mere denial of liability. Here there is a bona fide dispute between buyer and seller as to liability as well as the quantum of that liability. That dispute was objectively bona fide. The arbitration upon which the claim depended and which ultimately led to settlement of it occupied thirty nine days of hearing at which the parties were represented by senior and junior counsel of considerable eminence. To the extent that it is necessary or appropriate for this Court to comment on the dispute it is obvious that the case of the purchasers for the position that there was no debt at all was more than just arguable, it was, to say the least, highly arguable. Finally, as the arbitrator pointed out in the award, the question of the method of calculation was one which depended upon judgment, rather than mere legal principle.
75 It is not clear whether Professor Walker regarded the appropriate accounting test as one depending upon the subjective view of the sellers as her Honour suggests. We do not consider what the outcome would be in a case where a seller believed there was a dispute, but objectively it could not be said that the dispute was bona fide. That is not the present case.
76 It is clear that the accounting position as stated by Professor Walker accords with common sense. Where the whole or part of the consideration for the sale of a commodity or goods is not the subject of dispute then clearly income is to be recognised to the extent of the undisputed amount as soon as the commodity or goods is or are delivered. Where, on the other hand, the whole or part of the consideration is the subject of a bona fide dispute, the disputed amount is not recognised as being an asset of the vendor so as to take the place of the stock previously on hand. Non recognition will particularly be the case where the value of the claim can not be reliably estimated. Indeed, if a company accounted otherwise, its accounts would clearly not give a full and true view. One has only to consider the question whether a company in the position of the taxpayers here could properly treat there as being a profit brought to account at the time gas was delivered out of which it could declare dividends to understand the difficulty of any other approach.
77 The present problem is one which arises where there is a need for an annual accounting (and income tax is an annual tax) and particularly where there is no or only limited ability to re-open the taxation accounts at a later time. Obviously if the taxation legislation permitted the Commissioner to reopen the accounts of a year of income so as to include as income amounts which were the subject of bona fide disputes in that year, or for that matter to reduce amounts brought to account in some contingent way as income then the issue presently before the Court would be of less importance. However, the power to amend assessments set out in s 170 of the ITA Act is somewhat limited.
78 The position contended for by the Commissioner obviously solves the problem of deferral which may be said to arise if, in a case such as the present, income is only derived when the dispute is settled. However, while the Commissioner's position clearly protects the revenue it creates considerable problems for a taxpayer.
79 If a company which is in a real dispute with a purchaser as to whether any part of the purchase price for goods is payable (and if it is how much is payable) is required to report the amount in dispute as income in the year goods are delivered, that company will be required to pay tax in accordance with the ITA Act thirty days from the date of assessment (unless some other later date of payment is nominated). The taxpayer will have no money from which to pay that tax and no right at least to defer payment, unless the Commissioner agrees to a deferral. Indeed, even if the taxpayer objects to the assessment the Commissioner may (again subject to any sympathetic treatment or stay which may be ordered by a Court) obtain judgment. The assessment will be conclusive evidence that the taxpayer is indebted to the Commissioner in the amount shown in it (s 177 of the ITA Act). Indeed, the Commissioner may, under current case law, proceed to wind up the taxpayer or, if an individual, make the taxpayer bankrupt and bring about a situation where the right of objection is effectively lost to the taxpayer. Interest will, in accordance with the Act become payable upon the outstanding tax unless it is remitted. Should the taxpayer report only a lesser sum than that which the taxpayer invoices and it should later turn out that the taxpayer is owed more than the amount reported, the taxpayer will be liable to additional tax up to twice the amount of the tax on the amount underreported.
80 Then there is the question whether the taxpayer would be entitled to a deduction under s 63 of the Act should it turn out that the taxpayer was not owed the amount claimed and which has been included in assessable income. Under the law as presently interpreted it would seem that the taxpayer could not. No deduction is available under s 63 if, at the time of write-off, there is actually no debt owed as might be said to be the case in the event that the taxpayer's claim to the invoiced amount was unsuccessful: GE Crane Sales Pty Ltd v Federal Commissioner of Taxation [1971] HCA 75; (1971) 126 CLR 177, Point v Federal Commissioner of Taxation [1970] HCA 7; (1970) 119 CLR 453, Franklin's Selfserve Pty Ltd v Federal Commissioner of Taxation [1970] HCA 33; (1970) 125 CLR 52. There might, for the same reason, be no ability of a taxpayer to obtain a deduction under s 51(1) of the Act, because the taxpayer would have incurred no loss if it should turn out that the taxpayer was never owed the amount claimed. While both s 63 and s 51(1) have been repealed and replaced in the Income Tax Assessment Act 1997 by ss 25-35 and 8-1 respectively, the problem averted to has not been the subject of legislative intervention.
81 None of these matters necessitate the conclusion that a taxpayer will always derive income when goods are sold even where the sale price is the subject of a bona fide dispute. Indeed, it may be said that the fact that there is hardship to a taxpayer may be the price to be paid to ensure that annual revenue is collected in a case where it turns out that the taxpayer is actually owed amounts by the purchaser. However, these methods do suggest that there are real questions of fairness to taxpayers that require consideration.
82 It is useful to consider now the situation in other common law jurisdictions where there is no ability to reopen the taxation accounts, namely Papua New Guinea, the United States and Canada.
The decision in Commonwealth-New Guinea Timbers Ltd v The Chief Collector of Taxes (1973) PNGLR 358
83 The decision in Commonwealth-New Guinea Timbers Ltd is worthy of note, not because it provides guidance to the outcome in the present case, but because it demonstrates the difficulties that might arise if the Commissioner's submissions are accepted. It must be said that the outcome and the principles relied upon are, as Professor Parsons observed in his work, "Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting" (1985) The Law Book Company Limited at para 11.224 "unacceptable."
84 The income tax legislation in Papua New Guinea at the time the Commonwealth-New Guinea Timbers case was decided was for present purposes identical to the ITA Act. The case was heard by a Full Court comprising Frost SPJ, Clarkson and Kelly JJ. The factual circumstance was the opposite of that involved in the present case in that the case concerned the situation where the taxpayer had brought into the tax accounts amounts the subject of dispute where the dispute was ultimately resolved adversely to the taxpayer.
85 The facts were relatively simple. The taxpayer claimed to be entitled to receive under an agreement with the Commonwealth of Australia a subsidy for timber exported from Papua New Guinea to Australia equal to any Australian customs duty payable on products so exported. The taxpayer included the amount of the subsidy which the Commonwealth refused to pay as income derived in the years it claimed the subsidy to have been payable. Ultimately the High Court of Australia held that the Commonwealth had no liability to make the payments. In that year the taxpayer wrote off the amounts shown in its accounts as owing by the Commonwealth. The taxpayer sought to have the accounts reopened and claimed a deduction for the amounts of subsidy not in fact paid. It was held that the amounts claimed from the Commonwealth were not income derived in the years they were claimed, for they had not been either earned or received in those years, they had not "come home" to the taxpayer. Further, in any event, commercial practice required the taxpayer to make a provision against the amount of the claim with the consequence that the taxpayer in its accounts did not recognise a profit. The Court held further that the taxpayer was not entitled to a deduction for the bad debt write off on the basis of GE Crane Sales Pty Ltd to which reference has already been made. The Court rejected also a claim for a deduction under the corresponding provision to s 51(1). Finally the Court held that it could not reopen the earlier assessments to excise the amounts which the taxpayer had in those years included as assessable income.
86 While the facts of the case are clearly different from the present case and particularly because the tax treatment of subsidies may be said to differ in any event from the treatment applicable to ordinary trading receipts from the sale of goods, the problem it exposes does suggest that unless a taxpayer is able to obtain a deduction once it has become clear that the claim brought to account as income has failed the consequences to the taxpayer are dire to say the least. It is, no doubt, for this reason that Professor Parsons in his work suggests that the Australian law should adopt as a model the law as laid down in the United States cases: see at 11.237.
The United States Cases
87 There is a general difficulty in applying the law as interpreted in United States cases to Australian taxation law, for the concepts in many areas are substantially different. However, they do provide an interesting comparison in the present context if only because they show how the Courts of that country have solved the kind of issue we have to decide.
88 For present purposes it is necessary only to know that the Internal Revenue Code, like the ITA Act, requires the computation of taxable income, a concept which commences with gross income, subject to inclusions and exclusions. Section 446 stipulates the general rule that taxable income is to be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. That is subject, however, to the qualification if the method used does not clearly reflect income, then the revenue may apply a method which does clearly reflect income. As can be expected the two bases available are cash and accruals. Where the accruals method is used income will be accrued when all events have occurred that fix the right to receive it and the amount can be reasonably estimated. Bittker, Federal Taxation of Income, Estates and Gifts, (2nd ed. 1992) at 105-68 notes that in the case of a taxpayer where inventory is the income producing factor accrual accounting is required.
89 The leading case for present purposes is North American Oil Consolidated v Burnet (1932) 286 US 417. The case concerned profits from an oil property where the title to the property was the subject of dispute. It was held that the company was not required to report the amounts the subject of dispute as income, since they were amounts the company might never receive. Ultimately the company became entitled to the money when the dispute concluded and it was held to be taxable in that year and it was held further to be immaterial for these purposes whether the company had returned its income on a cash or on an accrual basis.
90 The case is important for its statement of what has become known in the United States as the claim of right doctrine. That has never been the subject of decision in Australia and need only be noted. Under that doctrine, as stated by Brandeis J in the Circuit Court of Appeals for the 9th Circuit:
"If a taxpayer receives earnings under a claim of right and without restriction as to its disposition he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money and even though he may still be adjudged liable to restore its equivalent."
91 An appeal to the Supreme Court of the United States was dismissed by stipulation.
92 Bittker states the general principle to be applied in the United States to be that income will not accrue to a taxpayer where the right to it is disputed. After referring to North American Oil the learned writer cites a decision of the Tax Court, Cold Metal Process Co v CIR 17 TC 916, 932 (1951) where it was said that when adverse claims "are not advanced frivolously and are made in good faith, a taxpayer is not required to evaluate his chances of success for the purpose of determining whether an item is to be accrued." Bittker continues:
"Under this sensible principle, income accrues when the dispute is terminated by a compromise settlement or a final judgment of a court with jurisdiction over the matter - or earlier, under the claim of right doctrine, if it is actually received."
93 Cases to the same effect include London-Butte Gold Mines Co v Commissioner of Internal Revenue (Ct of Appeals, 10th Circuit) (1940) 116 F (2d) 478.
The Canadian Decisions
94 In Canada the Courts have taken a position similar to that of the United States in holding that a taxpayer who accounts for tax on an accrual basis is not required to include as income amounts which are the subject of real disputes.
95 So, for example, in Minister of National Revenue v Benaby Realties Limited (1967) 67 DTC 5275 a property developer was held not obliged to pay tax on compensation payable where two parcels of its land were expropriated in the year in which the expropriation took place, but only in the year of receipt after the quantum of compensation had been settled.
96 The statutory background in Benaby Realties for present purposes was s 85B(1)(b) of the Income Tax Act, RSC 1952 which provided that in computing income from business every amount receivable in respect of property sold or services rendered in the course of the business in the year was to be included notwithstanding that the amount was not receivable until a subsequent year unless the method adopted by the taxpayer for computing income from the business and accepted for the purposes of the legislation did not require that amount to be included.
97 The Supreme Court of Canada rejected an argument that the United Kingdom approach of reopening a trading account was available in Canada because there was no legislative authority for such a course. The Court held that where the right to compensation contained so many elements of uncertainty, both as to the right itself and the quantum it could not be regarded as a trade receipt for the purpose of ascertaining the amount to be included for tax in the fiscal year and thus was only assessable when the compensation was ascertained. And the same principle applied where there was a clear right to compensation and the only uncertain matter was the quantum of it.
98 The principle in Benaby was followed in Commonwealth Construction Company Limited v The Queen (1984) 84 DTC 6420, where it was held that service income subject to a dispute which was ultimately adjudicated upon by a Court was not derived in the year the services were performed, but in the year of adjudication and receipt. The fact that there was an appeal after payment was made was held not to affect the derivation, a matter which is irrelevant to the present case and reflects the United States claim of right doctrine. But until adjudication and receipt, at least, the amounts did not have the quality of income.
99 As is clear from these cases and MNR v Colford Contracting Co Ltd (1960) 60 DTC 1131 they depend upon the statutory language of "amounts receivable", language reminiscent of the words "consideration receivable" as used in the PRRT Act. The cases are, nevertheless, useful in showing how the problem presently before the Court is dealt with in Canada.
Conclusion
100 It is clear that there is no Australian authority which requires the conclusion that where there is a bona fide dispute a taxpayer on an accrual basis is obliged to account for trading income that is the subject of dispute in the year where goods are sold, if the taxpayer is a trader in goods or in the year when services are rendered, if the taxpayer derives income from services performed.
101 As should by now be clear a principle which requires the taxpayer to account for disputed income in the year goods are sold conflicts with accounting practice. That practice regards income to be derived when the dispute is concluded, whether through arbitration, litigation or settlement. The only justification for the principle for which the Commissioner here contends is one that proceeds on the fiction that a successful litigant was always going to be successful and was always going to receive the amount which the arbitral or litigation result achieves. The Court should be slow to adopt a fiction in preference for reality in a case such as the present. The deferral of derivation until the conclusion of the dispute (or perhaps receipt if that occurs earlier) avoids the difficulties which arise where the accounts of the year in which the trader sells goods can not be reopened and where the availability of a deduction for a bad debt may be the subject of doubt. It avoids too the unfairness to a taxpayer in being required to pay tax immediately where recoverability of what is owed to the taxpayer and which is the fund out of which the tax might be expected to be paid, is, as a result of a bona fide dispute, outside the control of the taxpayer. It accords with the common sense solution arrived at in both the United States and Canada where the tax law does not permit reopening of the tax accounts.
102 The Commissioner's submission that in the present case the taxpayers derived income at the time gas was delivered to purchasers for the purpose of the ITA Act should be rejected. Because the parties accept that no different result flows from the PRRT Act. It follows that the taxpayer likewise derived the consideration receivable from the sale of gas only when the dispute between the buyers and the taxpayers themselves was settled. The appeals should accordingly be allowed with costs.
I certify that the preceding one hundred and two (102) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justices Hill and Heerey. |
Associate:
Dated: 20 December 2002
IN THE FEDERAL COURT OF AUSTRALIA |
V423 OF 2002 & V424 OF 2002 |
VICTORIA DISTRICT REGISTRY |
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JUDGE: |
HILL, HEEREY & GYLES JJ |
DATE: |
20 DECEMBER 2002 |
PLACE: |
MELBOURNE |
GYLES J:
103 I have had the advantage of reading the reasons for judgment of Hill and Heerey JJ in draft. I agree that the appeals ought to be allowed. Those reasons, together with the careful primary judgment (BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation [2002] FCA 189) (there being no relevant challenge to the findings of primary fact), relieve me of the necessity of explaining the issues and how they arise. I agree with the substance of the reasons of Hill and Heerey JJ. However, out of deference to the primary judge and because I would like to make clear the limits of my decision, I will state my own opinion.
104 I agree that, generally speaking, where a commodity such as gas is sold and delivered and there is a genuine dispute as to liability on the part of an arm's length purchaser, no payment is received by the vendor from the purchaser and the vendor diligently pursues recovery, then no amount is derived on revenue account by the vendor unless and until the dispute is resolved. So much would follow from the unchallenged opinion of Professor Walker, and the sources, including accounting standards, to which he refers. I agree that such evidence is admissible and highly persuasive. Furthermore, Hill and Heerey JJ demonstrate that so much is in accordance with principle and consistent with the authorities, both in Australia and elsewhere.
105 The question is whether that general principle is to be applied in the present case and, if so, how. It is not clear to me that the primary judge would disagree with that general principle, or with the opinion of Professor Walker to that effect. Rather, I take the primary judge to have declined to apply that general principle to a case where the dispute on the part of the purchaser is as to only one element of the calculation of a total price. In those circumstances, the primary judge preferred to apply another, and more basic, general principle - namely, that (depending upon the contract and other circumstances) the price for a commodity which is delivered is derived on revenue account no later than the time of delivery. It seems to me that her Honour took the view that it is not possible to apportion or dissect the price or consideration for the supply of the gas under the present contracts. I do not agree with the submission of the appellants that, on its face, this can be seen to be an error in principle and contrary to authority. It can just as easily be asserted (as it was by counsel for the respondent) that the primary judge was applying orthodox principle.
106 The answer to the problem requires close attention to the contractual provisions. It was her Honour's view as to the construction of the contract which led her to reject the application of the opinion of Professor Walker to this case. I will take the contract with the State Electricity Commission of Victoria ("SECV") as the example to be considered. The contract is for the supply of the natural gas requirements for three power generating stations between 1 January 1981 and 31 December 1996. Naturally, the contract is complex, as it must accommodate the requirements of such a long-term commitment.
107 It is difficult to adequately summarise such a contract, and it is easy to oversimplify it. The Table of Contents gives something of a birds-eye view, and I append a copy to these reasons. Title to and the risk of loss of gas sold and delivered under the contract passed at the point of delivery (Article XIII). The contract included provisions dealing with measurement of the quantity of gas delivered at the point of delivery and the quantity taken by the buyer at billing meters installed adjacent to each of the buyer's facilities (Article XVII). Billing and payment is dealt with in Article XXII, which is as follows:
"BILLING AND PAYMENT22.1 On or before the 15th Day of each Month, Sellers shall deliver by hand to Buyer a Monthly Statement setting forth in detail the number of Therms taken by Buyer during the preceding Month determined as herein provided and the MDQ applicable for billing purposes for such preceding Month. The Monthly Statement shall be in accordance with the pricing provisions of Article XIX and shall include the amounts of Monthly Fixed Charge and Monthly Variable Charge payable and additional demand charges relating to Excess Gas and all necessary supporting data. The Monthly Statement shall also include a statement of the quantities of Make Up Gas taken during the Month to which it applies and the quantities of Make Up Gas remaining to be taken as at the end of that Month.
22.2 The amount due on a Monthly Statement shall be paid to Sellers or their duly authorised agent no later than 12 noon on the Due Date. The Due Date shall be the 14th day after the day on which such Monthly Statement was delivered or the bank business day immediately preceding the said 14th day if that day is a bank holiday. The Due Date shall be specified on the Monthly Statement.
22.3 If, by reason of the provisions of Clause 7.3, Buyer is required in any Year to pay Sellers for any Quantity of Gas not taken, the additional amount due shall be included in the Monthly Statement for the Month of December of that Year.
22.4 A Monthly Statement shall be deemed conclusive as between the parties if Buyer does not object thereto within 18 Months after the same shall have been rendered by or on behalf of Sellers.
22.5 If Buyer fails to make any payment hereunder on or before the Due Date, interest thereon may accrue and be invoiced by Sellers at Sellers' discretion at the rate of 1% per Month from the Due Date to the date of payment. If such failure to pay continues for 60 days after the Due Date, Sellers may thereafter, in addition to all other remedies, suspend deliveries hereunder and if such default continues for a further 30 days, Sellers may thereafter terminate this Part; provided, however, that Sellers shall not exercise either of such rights unless Buyer shall have failed to comply with a written notice from Sellers specifying the amount due and unpaid, which amount may include interest, and requesting Buyer to make payment thereof as aforesaid within 15 days after service of the notice upon it; and provided, further, that the provisions herein for charging interest, suspending deliveries, or terminating this Part shall not apply if Buyer's refusal to pay an amount claimed by Sellers is the result of a bona fide dispute and Buyer pays all amounts not in dispute.
22.6 Buyer and Sellers shall have the right to inspect and examine, at all reasonable times, such records and charts kept by the other pertaining to matters set out in Monthly Statements. Such records and charts shall be kept for at least six years from the end of the Year in which the Gas, to which the particular Monthly Statement relates, was delivered."
MDQ is the maximum daily quantity as defined by Article V.
108 Pricing is dealt with by Article XIX. Relevant parts of the Article include:
"19.1 (a) For the provision of Gas service on and after the first Day of January 1981 as herein provided Buyer shall be charged and shall pay (but subject always to Buyer's obligation to make the Minimum Annual Payment) a Monthly Fixed Charge (A) plus a Monthly Variable Charge (B) based on the Quantity of Gas taken by Buyer, exclusive of Make Up Gas, A and B being computed as follows:A. ...
B. The Monthly Variable Charge shall be computed by multiplying the total number of Therms deemed to have been delivered to Buyer in that Month as determined in accordance with Article XVII, exclusive of Make Up Gas, by the Unit Commodity Charge which shall be:
$[0.7 x (0.56 x 0.11 + 0.44 x Z) x Index x Quality of Service Discount Factor] per Therm
where "Z", "Index", and "Quality of Service Discount Factor" are as defined in Clause 19.3.
(b) The Monthly Fixed Charge determined as above shall be paid by Buyer to Sellers notwithstanding that Buyer is unable to take Gas hereunder due to circumstances of Force Majeure as defined in Article XXIV."
Make Up Gas is explained in Article VIII as follows:
"8.1 If the amount of Gas actually taken by Buyer in any Year is less than the Minimum Annual Quantity for that Year, Buyer may take the difference between the two quantities (herein called Make Up Gas) over the next succeeding four Years provided that in any Year in which Make Up Gas is taken, Buyer shall first have taken the Minimum Annual Quantity for that Year."
The critical provisions for this case are as follows:
"19.5 (a) The amount which would otherwise be payable for Gas pursuant to this Part shall be:
i) increased to take into account the full amount of any new royalties, taxes (other than income tax), rates, duties (including duties of excise) and levies imposed on Sellers after the thirty-first Day of December, 1980, and attributable to the production of natural gas or to the supply of Gas to Buyer;
ii) increased to take into account the full amount of any increase in royalties, taxes (other than income tax), rates, duties (including duties of excise) and levies imposed on Sellers above the levels existing on the thirty-first Day of December, 1980, and attributable to the production of natural gas or to the supply of Gas to Buyer;
iii) decreased to take into account the full amount of any reduction in royalties, taxes (other than income tax), rates, duties (including duties of excise) and levies referred to in i) and ii) above.
(b) Any such increase or decrease shall be effective upon the imposition thereof. Sellers shall provide Buyer with notice of any such increase or decrease, the method and distribution of such royalties, taxes, rates, duties (including duties of excise) and levies, and the amount and date as of which such increase or decrease is effective.
19.6 Make Up Gas, when taken, shall be free of further payment apart from:
(a) an amount or amounts to take account of the full amount of any new or increased or decreased royalties, taxes (other than income tax), rates duties (including duties of excise) and levies as aforesaid; and
(b) any amount or amounts of additional demand charge due pursuant to Clause 19.2 for Make Up Gas which is at the same time Excess Gas.
19.7 For the purposes of this Article the expression "income tax" shall mean any tax of general application imposed on income but shall not include any tax specifically imposed upon income derived from the production and sale of natural gas or on income derived from the production and sale of petroleum or more generally on income derived from the production and sale of petroleum and other minerals to the extent to which such tax is attributable to income derived by Sellers from the production of Gas for Buyer or the supply of Gas to Buyer."
109 Clause 7.3 is as follows:
"7.3 If the amount otherwise paid or payable by Buyer to Sellers for Gas supplied in any Year excluding amounts paid or payable as provided in Clause 19.2 is less than the Minimum Annual Payment for that Year, Buyer shall pay to Sellers the amount determined by subtracting the amount so paid and payable from said Minimum Annual Payment."
The Minimum Annual Payment is provided for by cl 7.1:
"7.1 The Minimum Annual Payment in respect of a particular Year shall be the amount calculated by adding to the sum of the Monthly Fixed Charges applicable in the Year under Clause 19.1 an amount determined by multiplying the Minimum Annual Quantity of Gas for that Year by the average of the twelve Unit Commodity Charges applying in each of the Months of that Year and used for calculation of the Monthly Variable Charge as set out in Clause 19.1."
The Minimum Annual Quantity of Gas is dealt with in cl 7.2, which it is unnecessary to set out. Excess Gas is that required by the buyer in excess of the applicable Minimum Daily Quantity (Article VI).
110 It follows from the terms of cl 19.5 that if Petroleum Resources Rent Tax ("PRRT") is attributable to the production of natural gas then the adjustment was effective from the date it was imposed. It also follows that the increase (and the decrease attributable to royalties and excise) affects the amount otherwise payable for gas. However, the clause is silent as to how the adjustment is to take place, save for the reference to the seller providing the buyer with notice of the method and distribution of such a tax. This would be simple enough in the case of a tax imposed by reference to units of production which were, or could be readily converted into, a therm as defined in the contract. The amount of tax per therm could be added to the Unit Commodity Charge as provided for by cl 19.1. However, PRRT is not imposed in that fashion, but, rather, by reference to taxable profit as defined. It is not at all clear as to how such a tax can be accommodated by cl 19.1. In particular, it is not clear how it could be accommodated in a fashion which would permit billing in accordance with Article XXII.
111 The question is even more vexed when the underlying facts are taken into account. PRRT is imposed in respect of a petroleum project, and here it was the Bass Strait Project. A description of that Project, which was accepted by the arbitrators, is as follows:
"From the claimants discovered documents that I have examined, it is apparent that gas and oil have produced from the Bass Strait fields for a period of more than twenty years. From the outset these fields have been developed and operated to produce multiple products. The facilities required to produce these fields have been designed, constructed, installed, operated and maintained for the purpose of producing saleable petroleum products from both the vapour and liquid production phases from the various off-shore petroleum deposits. The primary products derived from the production of these fields are sales gas and stabilised crude oil, emanating from some fourteen off-shore production platforms, two mono towers and two sub-sea completed fields. Sales gas is the primary constituent and derivative of the "vapour side" of the production system, whereas crude oil is the primary constituent and derivative of the "liquid" side of the system. Each phase requires a production train of considerable size, complexity and costs in order to produce the sales product. Both the vapour and liquid production phases require the on-going operation support and maintenance of these complex and costly facilities. Secondary products sourced from both the vapour and liquid phases include ethane, propane, and butane. The liquid and vapour phases are commingled for certain parts of the production process and are separated for other parts of the process. ...The produced hydrocarbons are transported to shore with three main oil pipelines delivering oil and associated gas to the crude stabilisation plant at Longford, and three main gas pipelines delivering gas and associated products to the gas plants at Longford."
112 Esso and BHP were joint venturers. Natural gas was one product of the Project. SECV took approximately 13% of the gas sold, the Gas & Fuel Corporation took approximately 82% and the remainder was sold to other miscellaneous buyers. The assessable receipts and deductible expenditure for the Bass Strait Project for the purposes of PRRT relate to the Project as a whole, and not to any part of it. Furthermore, the infrastructure is necessary for the production of oil and gas and, by and large, is not exclusively devoted to either. Profitability varied as between field and field within the Project. How then to apportion a tax on taxable profit of a project to one purchaser of some of the output of one product? In particular, how to do so consistently with Article XIX?
113 The position of the appellants, upheld by the arbitrators, was that the buyer should be charged with that proportion of the total PRRT that was attributable to the product supplied to that customer. The first step was to calculate the notional profit, for PRRT purposes, attributable to gas production upon which a notional part of the PRRT was levied. Costs which were not attributable to either product as such were apportioned according to the proportion of revenue earned by each product. The notional tax of 40% of that amount attributed to production of gas was then to be allocated to the particular buyer. This was done according to the proportion of the production of gas from Bass Strait which was taken in the relevant period by that customer.
114 It seems to me that this exercise would always have to be done retrospectively, as it would depend upon costs and revenue for an earlier period. Indeed, PRRT is returned and assessed on an annual basis. Thus, both at the time of delivery and at the time of the next monthly statement, it would not be possible to include an amount for tax which has been assessed. There is no flat percentage of volume or value which could be added to the price per therm even if the clause were construed widely enough to include tax payable in the future. I cannot see how a per therm increase could be fixed in advance. For the purposes of the arbitration, the claim for reimbursement was able to be judged in the light of the actual events which had occurred.
115 I should say that I have considerable reservations about the methodology of attribution of tax approved by the arbitrators. I also have reservations about the decision as to the so-called "grossing up". This, no doubt, in part reflects the difficulty in classing PRRT as a tax attributable (or, in the case of the Gas & Fuel Corporation contract, directly attributable) to the production of natural gas. It is not necessary or appropriate to come to any final view as to the merit of the respective positions of the buyer and sellers. Suffice to say that I do not regard the award in the SECV case as necessarily settling the controversy in that case in view of the proceedings challenging it which were on foot at the time of settlement, and, in any event, it would not bind other buyers. In my opinion, in those circumstances, the issue was not resolved until the deed of settlement was executed on 20 November 1996.
116 A recited basis for settlement was the wish of the Government of Victoria to introduce a number of changes relating to the regulation and operation of the gas industry in Victoria. Settlement appears to have been a means of clearing the decks before reform. Settlement of the SECV dispute was dependent upon and interrelated with settlement of the Gas & Fuel Corporation dispute. The settlement involved all claims for gas sold and delivered, including pass on of PRRT, between 1 July 1990 and 31 October 1996, and future entitlement to pass on PRRT from 1 November 1996, by one lump sum, although there was express dissection of the make up of the lump sum. The settlement was at least partly influenced by policy considerations and cannot be taken as reflecting the legal position. In my opinion, the deed of settlement is the source of the payments in issue in the real sense, although the claim which was settled was contractual. The buyer denied that there was any valid contractual claim at all, and that might very well have been so.
117 Was the primary judge correct in holding that if the contract price is appropriately treated as income derived by the sellers on the date of delivery of gas, then so too were the pass on amounts, and in holding that the assumption that the pass on amounts were separate from, and did not form part of, the contract price was mistaken?
118 The primary judge held that when the sellers delivered the gas to the buyer the sellers lost all dispositive power over the product and satisfied all conditions precedent to their right to recover all of the contract price, including the pass on amounts. In one sense, that is correct, on the assumption that cl 19.5 is applicable, as any increase is effective upon imposition of the tax. However, as I have endeavoured to explain, in the case of this tax it could not be calculated so that it could be included in the current Monthly Variable Charge at the time of delivery or at the time of the next Monthly Statement. Indeed, there is a question as to when PRRT is "imposed" within the meaning of cl 19.5.
119 In my opinion, it is not correct to regard the price for the gas as being one indivisible sum. The issue is not unlike an aspect of the argument in Roxborough v Rothmans of Pall Mall Australia Ltd [1999] FCA 1535; (1999) 95 FCR 185, which I endeavoured to deal with at [94]-[100] and [103]-[110] by reference, among others, to revenue cases. The point was dealt with by the majority in the High Court (Roxborough v Rothmans of Pall Mall Australia Ltd [2001] HCA 68; (2001) 76 ALJR 203) per Gleeson CJ, Gaudron and Hayne JJ at [12]-[19], Gummow J at [56] and [109], and Callinan J at [195]-[196]. It suffices to refer to the following passage from the reasons of Gleeson CJ, Gaudron and Hayne JJ at [17]:
"In a contract for the sale of goods, the total amount which the buyer is required to pay to the seller may be expressed as one indivisible sum, even though it is possible to identify components which were taken into account by the parties in arriving at a final agreed figure. The final figure itself may have been the result of negotiation, making it impossible to relate a cost component to any particular part of that figure. Or there may be other factors which prevent even a notional apportionment. But there are cases, of which the present is an example, where it is possible, both to identify that part of the final agreed sum which is attributable to a cost component, and to conclude that an alteration in circumstances, perhaps involving a failure to incur an expense, has resulted in a failure of a severable part of the consideration."
120 For present purposes, there is no one and indivisible sum, although cl 19.5 could result in a new price per therm. If the new tax had been based upon production in the normal way, capable of immediate application, then that result may have followed. Even so, the application of cl 19.5 is a separate and identifiable provision of the contract which gives rise to separate and divisible issues. There is nothing to prevent the issue which arose between the parties in relation to that clause being considered as a separate issue. When that is done, it can be readily appreciated that it is best approached in the manner lucidly explained by Hill and Heerey JJ.
I certify that the preceding eighteen (18) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gyles. |
Associate:
Dated: 20 December 2002
Counsel for the Appellants: |
J W de Wijn QC with J J Batrouney SC |
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Solicitor for the Applicant: |
Middletons Moore & Bevins |
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Counsel for the Respondent: |
J D Merralls QC with T P Murphy |
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Solicitor for the Respondent: |
Australian Government Solicitor |
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Date of Hearing: |
11 and 12 November 2002 |
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Date of Judgment: |
20 December 2002 |
TABLE OF CONTENTS
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- Recitals and General Provisions |
- Page 1 | ||
PART A |
ARTICLE |
I |
- Definitions and Interpretation |
- Page 6 |
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II |
- Term |
- Page 12 |
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III |
- Total Contractual Quantity |
- Page 13 |
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IV |
- Dedicated Fields |
- Page 15 |
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V |
- Maximum Daily Quantity |
- Page 17 |
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VI |
- Gas in Excess of MDQ |
- Page 18 |
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VII |
- Minimum Annual Payment |
- Page 20 |
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VIII |
- Buyer-s Make Up Entitlements |
- Page 22 |
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IX |
- Daily Nominations |
- Page 24 |
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X |
- Exchange of Forecasts |
- Page 25 |
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XI |
- Delivery of Gas: Rates and Variation of Rates |
- Page 27 |
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XII |
- Delivery Pressure |
- Page 29 |
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XIII |
- Title and Risk |
- Page 30 |
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XIV |
- Buyer's Purchase Obligations |
- Page 31 |
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XV |
- Curtailment or Interruption of Supply |
- Page 32 |
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XVI |
- Quantity Specification |
- Page 40 |
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XVII |
- Measuring and Testing |
- Page 41 |
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XVIII |
- Unaccounted for Gas |
- Page 46 |
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XIX |
- Pricing |
- Page 47 |
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XX |
- Price Redetermination |
- Page 52 |
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XXI |
- Reduced Basis |
- Page 55 |
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XXII |
- Billing and Payment |
- Page 58 |
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XXIII |
- Breach |
- Page 60 |
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XXIV |
- Force Majeur |
- Page 62 |
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|
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XXV |
- Arbitration |
- Page 65 |
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XXVI |
- Franchise Requirements |
- Page 67 |
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XXVII |
- Miscellaneous Provisions |
- Page 68 |
PART B |
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|
- Future Gas Requirements |
- Page 71 |
APPENDIX I |
|
- Contractual Load Curves |
- Page 75 | |
APPENDIX II |
|
- Field Maps and Logs |
- Page 78 | |
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URL: http://www.austlii.edu.au/au/cases/cth/FCAFC/2002/433.html