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Federal Court of Australia - Full Court |
Last Updated: 28 July 2009
FEDERAL COURT OF AUSTRALIA
Commissioner of Taxation v Star City Pty Limited [2009] FCAFC 19
CORRIGENDUM
COMMISSIONER
OF TAXATION v STAR CITY PTY LIMITED (ABN 25 060 510 410)
VID 1155 of 2007
GOLDBERG,
DOWSETT & JESSUP JJ
27 FEBRUARY
2009 (CORRIGENDUM 6 MARCH 2009)
MELBOURNE
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IN THE FEDERAL COURT OF AUSTRALIA
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VICTORIA DISTRICT REGISTRY
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ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF
AUSTRALIA
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BETWEEN:
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AND:
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DATE OF ORDER:
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27 FEBRUARY 2009
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WHERE MADE:
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CORRIGENDUM
1. Paragraph [42] – page 16 – last line
"account
the fact that he parties also had to agree ..."
The fifth word "he" should be replaced with the word "the" so as to
read:
"account the fact that the parties also had to agree that
..."
2. Paragraph [67] – page 23 (on top of page 24) –
second last line
"before the date of the Occupational Licence Agreement
and from her relevance to Codelfa ..."
The third last word "relevance" should be replaced with the word "reference" so as to read:
"before the date of the Occupational Licence Agreement and from her
reference to Codelfa ..."
I certify that the preceding two (2)
paragraphs is a true copy of the Corrigendum to the Reasons for Judgment herein
of the Honourable
Justice Goldberg
Associate:
Dated: 6 March
2009
FEDERAL COURT OF AUSTRALIA
Commissioner of Taxation v Star City Pty Limited [2009] FCAFC 19
TAXATION – Appeal against decision
to disallow an objection to a notice of assessment of penalty for tax shortfall
– Whether prepayment
of rent was a loss or an outgoing of capital or of a
capital nature – Whether prepayment of rent formed part of consideration
for grant of casino licence, use of casino site or exclusivity period –
Whether documentary evidence of circumstances surrounding
making of prepayment
irrelevant to proper characterisation of prepayment as loss or outgoing of
capital or revenue period –
Whether primary judge erred in ruling
documents tendered as inadmissible – Whether primary judge erred in
finding that schemes
did not fall within the definition of "scheme" in
s 177A(1) of Income Tax Assessment Act 1936 (Cth) – Whether
taxpayer obtained a tax benefit within the meaning of s 177C of Income
Tax Assessment Act 1936 (Cth) in relation to schemes.
Held – prepayment of rent was an outgoing of a
capital nature
Income Tax Assessment Act 1936 (Cth)
ss 51(1), 82KZM, 177A, 177C, 177D, 177F, 177F(1)(b), 226,
Pt IVA
Income Tax Assessment Act 1997 (Cth)
s 8-1
Casino Control Act 1992 (NSW) ss 6, 7, 9, 10, 114,
117
Taxation Administration Act 1953 (Cth) ss 14ZZO(b)(i), 284-145,
Pt 4-25
Broken Hill Pty Co Ltd v
Federal Commissioner of Taxation (2000) 43 ATR 204
considered
City Link Melbourne Limited v Commissioner of Taxation
[2004] FCAFC 272; (2004) 141 FCR 69 considered
Codelfa Construction Pty Ltd v State
Rail Authority of New South Wales [1982] HCA 24; (1982) 149 CLR 337 cited
Colonial
Mutual Life Assurance Society Limited v Federal Commissioner of Taxation
[1953] HCA 68; (1953) 89 CLR 428 applied
Commissioner of Taxation v Citylink Melbourne
Limited [2006] HCA 35; (2006) 228 CLR 1 applied
Commissioner of Taxation v
Cooling (1990) 22 FCR 42 considered
Commissioner of Taxation (Cth) v
Peabody (1994) 181 CLR 359 cited
Damberg v Damberg
[2001] NSWCA 87; (2001) 52 NSWLR 492 referred to
Esso Australia Resources Ltd v
Commissioner of Taxation (1988) 84 FCR 541 cited
Federal Commissioner
of Taxation v Broken Hill Pty Co Ltd [2000] FCA 1431; (2001) 179 ALR 593
considered
Federal Commissioner of Taxation v Consolidated Press Holdings
Ltd (2001) 207 CLR 235 referred to
Federal Commissioner of
Taxation v Hart (2004) 217 CLR 216 cited
Hallstroms
Proprietary Limited v Federal Commissioner of Taxation [1946] HCA 34; (1946) 72 CLR 634
referred to
Inland Revenue Commissioner v Duke of Westminster [1936]
AC 1 cited
JB Chandler Investment Company Ltd (in liq) v
Commissioner of Taxation [1993] FCA 641; (1993) 47 FCR 588 cited
Jupiters Limited v
Deputy Commissioner of Taxation (2001) 148 ATR 511
considered
Jupiters Limited v Commissioner of Taxation [2002] FCAFC 206; (2002) 118 FCR
163 referred to
Li Pei Ye v Crown Limited [2004] FCAFC 8 referred
to
Rotherwood Pty Ltd v Commissioner of Taxation (1996) 64 FCR 313
considered
Sun Newspapers Limited v Federal Commissioner of Taxation
[1938] HCA 73; (1938) 61 CLR 337 applied
Tyco Australia Pty Ltd v Federal
Commissioner of Taxation (2007) 67 ATR 63, [2007] FCA 1055 referred
to
COMMISSIONER
OF TAXATION v STAR CITY PTY LIMITED (ABN 25 060 510 410)
VID 1155 of 2007
GOLDBERG,
DOWSETT & JESSUP JJ
27 FEBRUARY
2009
MELBOURNE
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AND:
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THE COURT ORDERS THAT:
1. The appeal be allowed.
2. Subject to any further order the Court may make in relation to the
subject-matter of paragraph 4 of this order, the appeals
by the respondent
filed in proceedings numbered VID 915 of 1995, VID 916 of 1995,
VID 917 of 1995, VID 918 of
1995 and VID 920 of 1995 be
dismissed.
3. The order made by the Court on 14 May 2008 pursuant to s 50 of
the Federal Court of Australia Act 1976 (Cth) be discharged.
4. The parties file and serve within 14 days written submissions as to
what orders, if any, the Court should make in relation
to the level of penalties
imposed by the appellant by the notices of assessment, the subject of the
appeal.
5. The respondent pay the appellant’s costs of and incidental to the
appeal and the proceedings before the primary
judge.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal
Court Rules.
The text of entered orders can be located using eSearch on the
Court’s website.
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VICTORIA DISTRICT REGISTRY
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ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF
AUSTRALIA
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BETWEEN:
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AND:
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DATE:
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PLACE:
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REASONS FOR JUDGMENT
GOLDBERG J:
INTRODUCTION
1 This appeal arises out of the issue by the New South Wales Casino Control Authority ("the Authority") of a casino licence to Star City Pty Limited previously known as Sydney Harbour Casino Pty Limited ("Star City") on 14 December 1994. The licence was awarded to Star City as a result of a competitive tender process whereby offers for the licence were sought by the Authority. Ultimately two groups submitted offers, namely Star City and Darling Casino Limited. The tender process commenced in May 1993 and prospective bidders were required to lodge their financial offers by 22 April 1994. The casino licence commenced on 14 December 1994 for a period of 99 years. On the same day a number of agreements were entered into between the Authority, the Treasurer of the State of New South Wales, Star City and an associated company, Sydney Harbour Casino Properties Pty Ltd ("Properties"):
(a) The Permanent Site Lease Construction Lease between Authority and Sydney Harbour Properties Pty Ltd ("the Construction Lease");
(b) The Casino Duty and Community Benefit Levy Agreement;
(c) The Casino Exclusivity Agreement;
(d) The Occupational Licence Agreement – Permanent Site between Sydney Harbour Properties Pty Ltd and Authority;
(e) The Continuity and Co-operation Agreement.
A Facility Agreement was also executed on 22 April 1994 and the
Permanent Site Freehold Lease ("the Permanent Lease") was executed
in 1997. (I
refer to these documents collectively as the "Transaction Documents").
2 The combination of the lease of the temporary site for the casino, the Construction Lease, which commenced on 14 December 1994 and terminated on the date the Permanent Lease commenced, and the lease of the permanent site for the casino, the Permanent Lease, which lease commenced on 26 November 1997 and will terminate on 13 December 2093, gave Star City, in substance, a term of 99 years for the operation of the casino. By virtue of the provisions of s 7 of the Casino Control Act 1992 (NSW) a casino in New South Wales can only be carried on upon Crown land or land in respect of which the Crown has the exclusive right of occupation. 3 On 15 December 1994, Star City paid a lump sum of $120 million to the Authority in respect of rent paid in advance for the 12 years following the commencement of the Construction Lease in which rent was fixed at $15 million per annum. This lump sum payment was made pursuant to the following provisions in the Construction Lease:
1. The Rent payable for the twelve years following the Lease Commencement Date as defined in this Lease (which period is referred to as the "Primary Rental Period"), which will be payable under this Lease and the Permanent Lease ... will be $15,000,000 per annum.
2. Notwithstanding clause 1, the Parties have agreed that the rental payable during the Primary Rental Period shall be prepaid as set out in clause 3.
3. On or before 12 noon (Sydney time) on the date which is 21 days after Lease Commencement Date, [Properties] shall pay to the [Authority] an amount of $120,000,000 in immediately available and cleared funds in prepayment of the rental payable during the Primary Rental Period.
Importantly, the Construction Lease
contained the following provisions:
The Lessee shall pay the amounts referred to in Clause 2.1(a) commencing on the Lease Commencement Date and thereafter on each anniversary of the Lease Commencement Date PROVIDED ALWAYS THAT if the Lessor shall have made an election pursuant to Schedule 1 of the Permanent Site Construction Lease to have the rent payable during the Primary Rental Period prepaid and the Lessee shall have done so then for the balance of the Primary Rental Period no further rental shall be payable. The Parties agree that in respect of such payment the provisions of Section 144 of the Conveyancing Act 1919 shall not apply. Furthermore the parties agree that notwithstanding any other term of this Lease the one and only circumstance where rent paid in advance is liable to be refunded is if the Parties mutually agree to terminate this Lease and that rent paid in advance is to be refunded.
4 The Permanent Lease provided for a term of 96 years and 17 days commencing on 26 November 1997 and terminating on 13 December 2093. In cl 2.1(a) of that lease, Properties covenanted to pay the rent provided for in Sch 1 to the lease. Clause 2.1(b) of that lease provided:
Schedule 1 of that lease provided:
(a) The Lessor and the Lessee acknowledge that the Lessor made an election contemplated by clause 2 of Schedule 1 to the Permanent Site Lease (Construction Lease) and the Lessee made the payment contemplated by that clause. No rental shall be payable by the Lessee under this Lease in respect of the balance of the Primary Rental Period;
(b) In respect of the balance of the Term, rental will be payable at the rate of $250,000 per annum.
5 On 14 December 1994 pursuant to the terms of the Casino Duty and Community Benefit Levy Agreement, Properties on behalf of Star City paid to the Treasurer of New South Wales the non-refundable lump sum casino duty of $256,000,000 provided for in the agreement in consideration of the issue of the casino licence to Star City to operate a casino pursuant to the Casino Control Act. This amount of $256,000,000 was not refundable "in any circumstances". 6 Under the Casino Exclusivity Agreement, Star City was given, in substance, the exclusive right for 12 years to conduct specified gambling activities and wagering games, in effect a casino, in New South Wales. This exclusive right arose not by virtue of the grant of that right as such but rather as a result of the operation of s 6 of the Casino Control Act and cl 5.1 of the Casino Exclusivity Agreement between the Authority and Star City. Section 6 of the Casino Control Act provided that only one casino licence was to be in force under the Act at any particular time. Clause 5.1 of the Casino Exclusivity Agreement provided that if during the 12 year period from the commencement of the operation of the casino the State of New South Wales granted a licence to conduct the specified gambling activities and wagering games at any site in New South Wales to any person other than Star City, the Authority would pay an amount equal to the damages, costs and expenses suffered or incurred by Star City as a result of the granting of the licence to conduct such gambling activities and wagering games including loss of profits. 7 Star City claimed the prepayment of the rental of $120 million as a deduction under s 51(1) of the Income Tax Assessment Act 1936 (Cth) ("the 1936 Act") and s 8-1 of the Income Tax Assessment Act 1977 (Cth) ("the 1997 Act") and s 82KZM of the 1936 Act in respect of various components of the lump sum for years ended on and between 30 June 1995 and 30 June 2002. The appellant ("the Commissioner") disallowed the deductions, imposed penalties and contended that if the prepayment was deductible, the Commissioner would rely on the provisions of Pt IVA of the 1936 Act. Star City appealed against the disallowances, the primary judge allowed the appeals, set aside the Commissioner’s disallowances of Star City’s objections to the disallowances and ordered that those objections be allowed in full and that the assessments be amended accordingly. The Commissioner appeals from those orders.
PROCEEDING AT FIRST INSTANCE
8 The primary judge held that the prepayment of $120 million was made on revenue account and was not an outgoing of capital or of a capital nature and was therefore deductible under either s 51(1) or s 8-1. The primary judge also held that Pt IVA of the 1936 Act did not operate to deny the deductions claimed by Star City in respect of the prepayment. The Commissioner accepted that if the prepayment was deductible then Star City was entitled to claim a proportion of the deduction in each year of income in accordance with the formula in s 82KZM of the 1936 Act. 9 There was an issue before the primary judge as to whether the obligation to pay rent under the Construction Lease and the Permanent Lease was the obligation of Star City or Properties. The primary judge concluded, having regard to the provisions of the Occupational Licence Agreement, that the obligation to make the prepayment of the rental under the leases was an obligation of Star City. The Commissioner did not appeal the primary judge’s finding on this issue. 10 Before the primary judge the Commissioner submitted that the prepayment was on capital account and not on revenue account and therefore was not deductible. Applying the test for resolving the distinction between capital and revenue in Sun Newspapers Limited v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337 at 363 per Dixon J, the primary judge rejected the contentions of the Commissioner that the prepayment:
(a) formed part of the consideration for the grant of the casino licence;
(b) was made for the purpose of obtaining a lease for the permanent casino site;
(c) was made in order to obtain the exclusivity of the casino licence in the
first 12 years of the operation of the casino.
The primary judge
concluded that the rent was paid by way of a lump sum to secure the use of the
premises for the period to which
the payment related and did not secure any
enduring asset. It followed that the prepayment was therefore not an affair of
capital.
11 Before the primary judge the Commissioner relied on certain aspects of the surrounding circumstances and background to support his submission that the agreement pursuant to which the prepayment was made did not reflect the whole arrangement between the parties. The primary judge concluded that the surrounding circumstances and background were irrelevant to the proper characterisation of the prepayment because the advantage sought by the prepayment was capable of identification and characterisation by reference to the documents executed by the parties. The primary judge found that even if the surrounding circumstances and background were examined they did not alter the identification, or the character, of the advantage sought by the prepayment. 12 The Commissioner placed emphasis on the manner in which the negotiations between the Authority and Star City had proceeded leading up to the execution of the documentation and submitted that Star City and Authority did not undertake a real commercial negotiation. This submission was rejected by the primary judge who considered that, taken as a whole, the negotiations between the parties were properly described as "hard bargaining". 13 In relation to the Commissioner’s contention that Pt IVA applied, Star City did not dispute that each of the two schemes identified by the Commissioner was capable of being a scheme for the purposes of Pt IVA. Notwithstanding Star City’s concession that each scheme identified by the Commissioner was capable of being a scheme for the purposes of Pt IVA, the primary judge did not consider either scheme identified by the Commissioner was a scheme within the meaning of s 177A. This conclusion was challenged by the Commissioner in the appeal on the basis that, having regard to the concession made by Star City, it was not open to the primary judge to reach this conclusion. 14 The primary judge found that even if one or more of the schemes relied upon by the Commissioner was capable of being a scheme for the purposes of Pt IVA, Star City did not obtain a tax benefit in relation to it.
ISSUES ON APPEAL
15 The following issues arise on the appeal:
(a) was the prepayment of $120 million a loss or outgoing of capital or of a capital nature?
(b) did the prepayment form part of the consideration for the grant of the casino licence, the use of the permanent casino site or an exclusivity period of 12 years?
(c) were the circumstances surrounding the making of the prepayment, as recorded in documentary evidence, irrelevant to the proper characterisation of the prepayment as a loss or outgoing of capital or revenue account?
(d) did the primary judge err in ruling as inadmissible a number of documents tendered by the Commissioner?
(e) did the primary judge err in finding that the two schemes alleged by the Commissioner did not fall within the definition of "scheme" in s 177A(1) of the 1936 Act?
(f) did Star City obtain a tax benefit within the meaning of s 177C of the 1936 Act in relation to either of the schemes relied upon by the Commissioner?
(g) did the primary judge err in failing to find that the "alternative postulate" alleged by the Commissioner might reasonably be expected to have happened if the schemes had not been entered into or carried out?
THE PREPAYMENT
There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.
16 The principal submission of the Commissioner was that the prepayment was a loss or outgoing of capital or of a capital nature and was not deductible under s 51(1) of the 1936 Act or s 8-1 of the 1997 Act. There was no issue between the parties as to the test for determining the distinction between an income or revenue item and a capital item. The identification of the distinction between revenue and capital has been well settled for many years. In Sun Newspapers Limited v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337, Dixon J said at 363:
The questions which commonly arise in this type of case are (1) What is the money really paid for?--and (2) Is what it is really paid for, in truth and in substance, a capital asset?
17 In Colonial Mutual Life Assurance Society Limited v Federal Commissioner of Taxation [1953] HCA 68; (1953) 89 CLR 428, Fullagar J said at 454:
The characterisation of an outgoing depends on what it ‘is calculated to effect’, to be judged from ‘a practical and business point of view’. The character of the advantage sought by the making of the expenditure is critical. (Citations omitted)
18 These questions are to be answered not solely by reference to the documentation which records the obligation to make the payment but also by reference to the business and practical effects and consequences achieved. 19 The centrality of the identification of the "character of the advantage sought" to this test was recently restated by the High Court in Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35; (2006) 228 CLR 1 at 43. Crennan J (with whom Gleeson CJ, Gummow, Callinan and Heydon JJ agreed) said at 43:
The mere identification of the correct description of the legal rights obtained or transferred by any transaction is generally too narrow a focus for the answering of the question. This is especially so once it is recognised that almost every commercial arrangement based on contract can be analysed jurisprudentially from the perspective of buying and selling rights or choses in action. Such rights are merely the legal or juridicial building blocks of relationships built from business and practical activity. The enquiry as to whether an outgoing is on capital or revenue account looks to the business and practical effects and advantages sought in the whole context ... (Citations omitted)
20 The nature of the inquiry to be made in this context was considered by Allsop J in Tyco Australia Pty Ltd v Federal Commissioner of Taxation [2007] FCA 1055; (2007) 67 ATR 63 at 74, [2007] FCA 1055 at par [47] as follows:
21 The Commissioner’s case was that the Transaction Documents entered into by the parties indicated that, from a practical and business point of view, the characterisation of the advantage sought by Star City was not the quiet enjoyment of the relevant premises but rather was consideration for the grant of the licence and the right of exclusivity for the operation of the casino for 12 years. 22 Where the parties parted company, and relevantly when considering the primary judge’s reasons, was in relation to the material to which regard may be had in determining whether the payment under the leases was an item of income or capital. This was important because the Commissioner relied on what were described as the "surrounding circumstances" or "background" to support the contention that the prepayment was a capital payment, arguing that the leases pursuant to which the prepayment was made did not reflect the whole arrangement between the parties. 23 The primary judge made the following important findings:
(a) the prepayment payable and paid under the leases formed just one element of the business transaction;
(b) the "surrounding circumstances" or "background" relied upon by the Commissioner were irrelevant to the proper characterisation of the prepayment because the advantage sought by the prepayment was capable of identification and characterisation by reference to the leases and the Occupational Licence Agreement and, if necessary, the Transaction Documents as a whole;
(c) even if the "surrounding circumstances" or "background" were examined they did not alter the identification, or the character, of the advantage sought by the prepayment;
(d) taken as a whole, the negotiations between the parties were properly described as "hard bargaining";
(e) both the amount to be paid as rent and the terms on which rental would be
paid were points of critical centrality in the negotiations
between
Star City and the Authority and matters about which the Authority, not
Star City, had the ultimate decision.
24 Star City submitted that in the absence of any suggestion that any part of the documentation was a sham and any contention that the primary judge had erred in her conclusions as to the meaning and operation of the relevant documents, the characterisation of the prepayment could, and should, be determined by reference to the relevant Transaction Documents and principally the leases. 25 I do not accept that submission, and consider that the primary judge erred in concluding that the "surrounding circumstances" and "background" were irrelevant to the proper characterisation of the prepayment and that even if they were examined they did not alter the identification, or the character, of the advantage sought by the prepayment.
PRINCIPLES TO BE APPLIED
What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.
26 The starting point for my consideration is that the Court is not limited to the words and text of the leases, or indeed any of the Transaction Documents in characterising the nature of the prepayment and the advantage sought by its payment. The determination of that characterisation is to be undertaken from a practical and business point of view. That point of view is not confined to the words of the document pursuant to which the payment is made. As Dixon J observed in Hallstroms Proprietary Limited v Federal Commissioner of Taxation [1946] HCA 34; (1946) 72 CLR 634 at 648:
It seems to me, however, that little of the evidence relating to the contractual negotiations is relevant to the court’s inquiry on these appeals. As Hill J said in JB Chandler Investment Company Ltd (in liq) v FCT [1993] FCA 641; (1993) 47 FCR 588 at 598:
27 Star City relied on observations by Kenny J in Broken Hill Pty Co Ltd v Federal Commissioner of Taxation (2000) 43 ATR 204, where her Honour ruled as inadmissible the documentary record of the surrounding circumstances, including negotiations relating to the relevant purchase agreement in respect of which a deduction for the payment of interest was claimed. Her Honour said at 217:
Having regard to that observation (with which I agree) the evidence of contractual negotiations was of limited, if any, relevance to the question of deductibility. That is not to say that other evidence, of an objective kind, about the character of the payment made pursuant to s 1.1 of the purchase agreement, as, for example, the basis of valuation, was not relevant: it plainly was.[T]o accept that the circumstances in which a payment is made will be relevant to a determination of the character of that payment in the hands of a recipient is not to say that surrounding circumstances can be used to contradict the words of an agreement reached between parties bargaining at arm’s length as to what the consideration for a particular payment is to be, except in a case (and the present is not such a case) where it is claimed that the agreement is a sham and does not represent the true intention of the parties to it.
Kenny J’s ruling was approved on appeal: Federal
Commissioner of Taxation v Broken Hill Pty Co Ltd [2000] FCA 1431; (2001) 179 ALR 593 at
598-599, 612.
There are cases, and the present in my opinion is such a case, where the question what the payment was for falls to be determined by reference to the legal obligations or rights for which it is paid, that is to say, the question can be answered by reference to the agreement which operates to create the obligation to pay. The decision of the Privy Council in BP Australia Ltd v FCT (1965) 112 CLR 386 may have been another. There may be other cases where it is necessary to go outside the contractual rights and obligations acquired to find the true character of the outgoing. So in South Australian Battery Makers [(1978) [1978] HCA 32; 140 CLR 645], Gibbs CJ, commenting on the two Europa cases (Inland Revenue Commissioner v Europa Oil (NZ) Ltd [1971] AC 760 and Europa Oil (NZ) Ltd v Inland Revenue Commissioners (No 2) [1976] 1 All ER 503) said (at CLR 659; ALR 69):
28 Nevertheless the Full Court, on appeal, accepted that in determining the true character of an outgoing, a court is not limited to a consideration of the terms of the contractual documents which give rise to the payment of an outgoing. Hill J (with whom Heerey and Merkel JJ agreed on this issue) said at 601-602:
One may add in the light of more recent authority that there will be cases, and "interest" in the usual sense is an obvious example, where it will often be necessary to go outside the legal rights and obligations of the loan agreement to determine the advantage sought and, in some cases, the question of subjective motivation may have relevance: cf Fletcher v FCT (1991) 173 CLR 1. We have dwelt more than may be necessary on this question because, while I accept that mere reference to legal rights may be inappropriate in a particular case, the present is not such a case. The question of what the payment is for and the question of the advantage sought, are both matters that do not give rise to a need to go outside the legally binding agreement reached at arms length between BHP and GE. And, having looked at the precontractual negotiation material which her Honour, in my view, rightly rejected, there is nothing in it which gives me reason to go beyond the contractual terms of the agreement between the parties.The words of the judgments in the Europa Cases, like those of any judgment, must be understood in the light of the issues that fell to be decided. Their Lordships could not have meant to suggest that in every case the character of an outgoing must be determined by having regard only to the contractual or other legal rights that the taxpayer acquired in return for it. That would indeed have been inconsistent with the principles stated by Dixon J in Hallstroms’ Case, and with cases too numerous to mention in which payments made "voluntarily and on the grounds of commercial expediency" ... have been held deductible as outgoings of a revenue kind although the taxpayer obtained no legally enforceable rights in return for them.
On the particular facts of that case there was no reason to go beyond the
contractual terms of the agreement between the parties.
Before turning to the remaining issues to be decided, I would wish to say something about the issue of substance and form. While, no doubt, questions such as whether a covenanted payment is an annuity will, having regard to historical matters, depend to some, perhaps a considerable, extent on the form which the parties have adopted (Australia and New Zealand Savings Bank Ltd v FCT [1993] FCA 282; (1993) 42 FCR 535, referred to with approval on this point on appeal in Australia and New Zealand Savings Bank Ltd v FCT [1994] HCA 58; (1994) 181 CLR 466 and FCT v Australia and New Zealand Savings Bank Ltd [1998] HCA 53; (1998) 194 CLR 328), it is not to be assumed that form must always prevail over substance. The law has moved somewhat from the rather rigid adherence to form to be found in cases such as Inland Revenue Commissioners v Duke of Westminster [1936] AC 1. This is not to say that legal rights are not important or even, in a case such as the present, determinative. It is merely to emphasise that the courts will always consider the substance of a transaction in characterising the character of the advantage which is sought to be obtained in determining whether an outgoing is on revenue account or whether, as here, on capital account and thus excluded from deductibility.
29 Later in his reasons Hill J emphasised the need to consider substance over form in characterising the advantage sought by the payment of an outgoing. His Honour said at 606:
The question whether the sum of $6 million paid to Chancery Services was in the nature of a revenue receipt had to be determined by considering the circumstances relevant to the receipt of that sum by the payee and not by determining the character payment as paid by the payer: see Scott v Commissioner of Taxation [1966] HCA 48; (1966) 117 CLR 514 at 526; Hayes v Commissioner of Taxation [1956] HCA 21; (1956) 96 CLR 47 at 55. Of course, absence of consideration for the payment may make the motive of the payer a fact relevant to the characterisation of the payment received: Federal Coke Co Pty Ltd v Commissioner of Taxation [1977] FCA 3; (1977) 34 FLR 375 at 403 per Brennan J. Where a sum paid or received is described as the consideration for a contract, the description applied to the sum by the parties to the contract is to be given some weight but it does not follow that the character of the payment as made by the payer, or as received by the payee, is determined by that description: see Cliffs International Inc v Commissioner of Taxation [1979] HCA 8; (1979) 142 CLR 140. The description of the payment in the contract may be only part of a matrix of facts from which the character of the payment, as paid or received, is to be determined: see Reuter v Commissioner of Taxation (1993) 93 ATC 5,030 at 5,036; Commissioner of Taxation v Cooling (1990) 22 FCR 42 at 53 per Hill J. ... Chancery Services did not receive the payment for the surrender of the lease as consideration for the disposal of that asset under an independent transaction. The surrender was an integral part of an arrangement under which the payment of the surrender fee operated as an incentive to the parties associated with Chancery Services to enter a new long-term lease at an increased rental with like obligations undertaken by Freehills as sub-lessee.
30 The proposition that the characterisation of a payment of an outgoing is not necessarily to be determined only by reference to the contractual document pursuant to which it is paid, but may be determined having regard to the circumstances surrounding, and leading up to, the payment, is consistent with earlier authority. In Rotherwood Pty Ltd v Commissioner of Taxation (1996) 64 FCR 313 Lee J (with whom Spender and O’Loughlin JJ agreed) said at 323-324:
(See also Esso Australia Resources Ltd v Commissioner of Taxation
(1988) 84 FCR 541 at 565).
This however does not mean that in determining the legal effect of a contract between parties (and therefore the characterisation of the payment made under it as being income or capital), regard may not be had to the whole factual matrix of which the contract forms part. Nothing in what his Lordship said requires the conclusion that regard cannot be had to the whole context in which the agreement was made to determine the character of a receipt. In W T Ramsay v Inland Revenue Commissioners [1981] UKHL 1; [1982] AC 300, Lord Wilberforce with whom Lord Russell of Killowen, Lord Roskill and Lord Bridge of Harwich agreed, said of the principle in the Duke of Westminster case at 323:
31 In Commissioner of Taxation v Cooling (1990) 22 FCR 42, Hill J (with whom Lockhart and Gummow JJ agreed on this point) considered the submission of the Commissioner that the form of the transaction entered into by the parties was determinative of the character of the receipt in the hands of the taxpayer. Hill J noted the Commissioner’s reliance on the reasoning of the House of Lords in Inland Revenue Commissioners v Duke of Westminster [1936] AC 1 to the effect that the legal effect of the covenant between the parties determined for revenue purposes the character of the payments made. Hill J said at 53:
‘This is a cardinal principle but it must not be overstated or overextended. While obliging the court to accept documents or transactions, found to be genuine, as such, it does not compel the court to look at a document or a transaction in blinkers, isolated from any context to which it properly belongs ...’
The decision of his Honour involved the application of well established principles to facts which were not in dispute. No error has in our opinion been showed [sic] in his Honour’s reasoning or in the conclusion which he reached.
32 A relevant example of recourse to surrounding circumstances and background for the purpose of determining the characterisation of a payment made under a lease is to be found in Jupiters Limited v Deputy Commissioner of Taxation (2001) 148 ATR 511. The taxpayer operated a casino in Brisbane pursuant to the "Brisbane Casino Agreement" entered into with the State which contemplated the execution of a number of other documents including a financial agreement, a permit to occupy certain buildings during the construction period of the casino, a special lease for the occupation of the premises thereafter, a casino licence and a special facility licence under the Liquor Act 1992 (Qld). The agreement contained what the primary judge called an "exclusivity" provision which effectively provided the taxpayer with a gaming monopoly for ten years within a distance of 60 kilometres from the Treasury building. A financial agreement entered into between the parties provided for the payment of a premium of $45.1 million payable to the State in connection with the issue of the special lease and the casino licence and the special facility licence. The agreement provided for the payment of rental pursuant to the special lease of $50 per annum and also provided for the payment of a special rental of $7 million per annum in respect of the first ten rental years of the term of the special lease. 33 The taxpayer claimed as a deduction the $7 million paid as special rental in each of the relevant tax years which claim was disallowed by the Commissioner. 34 A principal issue in that proceeding was the conclusiveness of the contractual characterisation of the payments of the special rental. The taxpayer argued that because the Commissioner had not alleged fiscal sham or relied upon the tax avoidance provisions of the legislation it followed that as the parties to the financial agreement characterised the payments as "special rental" they should be treated as such for tax purposes. As authority for this proposition the taxpayer relied upon Federal Commissioner of Taxation v Broken Hill Pty Co Ltd [2000] FCA 1431; (2001) 179 ALR 593 at [31]- [32] and JB Chandler Investment Company Ltd (in liq) v Commissioner of Taxation [1993] FCA 641; (1993) 47 FCR 588. 35 Dowsett J observed that in Federal Commissioner of Taxation v Broken Hill Pty Co Ltd [2000] FCA 1431; (2001) 179 ALR 593, Hill J made it clear that there may be cases in which it will be necessary "to go outside the contractual rights and obligations in order to find the true character of the outgoing" and that the point in issue in JB Chandler Investment Company Ltd (in liq) v Commissioner of Taxation [1993] FCA 641; (1993) 47 FCR 588 was the effect of the decision in Commissioner of Taxation v Cooling (1990) 22 FCR 42. Dowsett J noted that the decision in Rotherwood Pty Ltd v Commissioner of Taxation (1996) 64 FCR 313 apparently contradicted the taxpayer’s submission. 36 Dowsett J concluded that the special rental was consideration for the exclusivity arrangements reached between the parties and that it was paid for the acquisition of a capital asset. On appeal, Jupiters Limited v Commissioner of Taxation [2002] FCAFC 206; (2002) 118 FCR 163, Dowsett J’s characterisation of the payment of the special rental as a capital outgoing was upheld by the Full Court. Relevantly, the Full Court noted at 169:
CONSIDERATION OF PRIMARY JUDGE’S REASONING
37 The primary judge correctly identified the relevant principles to apply in determining whether the amount of $120 million was an item of revenue or of capital and in determining the character of the advantage sought and the characterisation of the prepayment to the Authority. In particular the primary judge observed that an examination of the character of the advantage sought was assisted by asking two questions: What was the prepayment really paid for; and, is what it was really paid for, in truth and in substance, a capital asset? Her Honour accepted that the answer to these questions was not assisted by an analysis of the contractual rights secured under the contract, as distinct from the activity itself, but rather depended upon what the expenditure was calculated to effect from a practical and business point of view. 38 I consider that when her Honour came to apply these principles to the facts and documents before her, she fell into error by focusing on the rights created under the documents, in particular the leases, and did not give sufficient regard to what the prepayment was calculated to effect from a practical and business point of view. 39 It was not in issue that the amount of $15 million per annum was a fair market rent but that proposition does not automatically answer the question what was the character of the advantage sought by the prepayment. 40 The primary judge rejected the Commissioner’s submission that the following aspects of the Transaction Documents (either individually or collectively) supported the Commissioner’s contention that the character of the prepayment was a capital payment: • under the Construction Lease and the Permanent Lease (referred to as "the Freehold Lease" by the primary judge) the prepayment was a lump sum, non-refundable and paid rent in advance at an annualised rate of $15 million for each of 12 years; • under the Permanent Lease the rent payable by Star City after the Primary Rental Period of 12 years was $250,000 per annum; • the prepayment was paid at the same time and to the same entity as the "Specified Payment Amount" of $256 million.
... Unlike the vendors in Cliffs International and Colonial, here the State retains title to that part of the profit-yielding structure from which Star City derives its income; the Premises were merely made available for use by [Properties] for the duration of the Primary Rental Period. In addition to not receiving title to the Premises at the end of the lease term, [Properties] received no option to purchase (whether at a below-market price or otherwise), and it was not suggested that 99 years constitutes all or a major portion of the life of the Premises.
41 The primary judge accepted that the prepayment was a "one-off payment" and found that it was refundable "only in very limited circumstances". As against that, the primary judge took into account the fact that the lease was for 99 years and that Star City was committed to the operation of the Casino at the leased premises for the duration of the licence. I consider that it misstates or understates the significance of the refundable nature of the prepayment to say that it was refundable "only in very limited circumstances" and "if the parties mutually agreed to terminate the Lease". Not only did the parties have to agree to terminate the lease, they had to agree that "rent paid in advance was to be refunded". It is therefore not an accurate recording of the relevant terms of the leases to say that rent payable in advance was refundable in very limited circumstances. Rather, it was only refundable if the parties reached agreement to that effect. 42 When the primary judge said that the leases provided that the prepayment was refundable "if the parties mutually agreed to terminate the Lease" she failed to take into account the fact that he parties also had to agree that rent paid in advance was to be refunded. 43 The primary judge found that the fact that the rent was paid by way of a lump sum did not detract from the fact that the rent was paid to secure the use of the casino premises for the period to which the payment related, namely, 12 years. The primary judge then continued her reasoning (at [94]):
The Occupational Licence Agreement and the Leases, and if necessary the other Transaction Documents, read as a whole, do not suggest that the Prepayment was in the nature of a capital payment. The Prepayment did not create or secure any lasting interest. It was not a final payment made to secure a future benefit. It was, as is described, a payment for rent which is one of a number of recurrent expenses forming part of the ordinary flow of business expenditure of Star City.
44 It may be accepted that the terms of the leases provided that payment of the stipulated rent secured the use and occupation of the casino premises for the stipulated period of 12 years and that Properties did not acquire title to the premises or an option to purchase them. It may also be accepted that the payment of rent in a lump sum pursuant to the terms of the leases ensured that the use and occupation of the casino premises was secured and protected for 12 years. But acceptance of those matters in accordance with the primary judge’s analysis and reasoning follows from a focus and concentration upon the leases alone, to the exclusion of the other Transaction Documents and the surrounding circumstances. 45 The relevant question to ask in this context, as noted earlier, is – what was the lump sum of $120 million really paid for, and the answer is to be given having regard to a practical and business viewpoint. The character of the advantage sought by the lump sum prepayment is to be determined not solely by reference to the Transaction Documents. 46 Placed in the context of the Transaction Documents, the background to their execution and the surrounding circumstances, the fact of the prepayment being made in a lump sum was a significant matter to be taken into account in considering whether it was a payment on capital account. It was an indicium of a capital payment, to secure exclusivity of the right to conduct a Casino for 12 years. 47 The error in the reasoning of the primary judge was that she focused too narrowly and, in effect, exclusively on the specific lease documents which provided for the payment. 48 The primary judge reasoned that the prepayment did not secure any enduring asset, observing that neither Star City nor any other entity acquired the land or the buildings which comprised the premises. That reasoning confined and limited her enquiry to a consideration of the lease documents alone. Her Honour acknowledged that labels can never be determinative but accepted that the label in the leases was determinative – "the Prepayment was in this case, as it was described – a prepayment of rent". 49 The primary judge said at [99]:
In reaching this conclusion, the primary judge was limiting herself to
the label in the leases and did not look at the lump sum prepayment
through the
prism of the question – what was the payment truly for?
connected with the period of exclusivity of the casino licence ending at the point at which the rate of rental changes.
50 The primary judge failed to take into account, sufficiently or at all, not only that rent was prepaid in a lump sum but also that it was not refundable unless the parties agreed to terminate the lease and agreed to refund any part of the rent in respect of the unexpired term of 12 years. 51 It was also significant, in determining the character of the advantage sought by the lump sum prepayment that there was a significant disparity between the rate of the annual rental for each of the 12 years covered by the prepayment and the rate for the balance of the lease term. 52 The disparity was $15 million per annum for each of the first 12 years, (the net present value of which, at the relevant time, for the first 12 years was $120 million) as against $250,000 per annum for each year of the remaining 80 years. The primary judge did not accept (par [97]) that this difference revealed that the premises were of no more than nominal value during the first 12 years of the lease but rather accepted the proposition that the difference was:
If that be the explanation for the difference, as the primary judge
found, it was a most significant indicium of a capital payment.
53 It might be argued that the difference was explicable by reference to the period of exclusivity in the sense that the premises were more valuable during the first 12 years than in subsequent years because Star City had the exclusive right, unimpeded by any competition, to operate a casino on the premises for the first 12 years, whereas the premises would not be so valuable in subsequent years if Star City was faced with competition from other casinos at other premises. 54 If this be the explanation the primary judge had in mind then it still follows that the advantage sought by the lump sum prepayment was the obtaining of the exclusive right to operate a casino for 12 years.
CONSIDERATION OF DOCUMENTS REJECTED BY PRIMARY JUDGE
Permanent Site Construction Lease This is a Lease to be entered into between the [Authority] and [Properties] for the lease of the Permanent Casino Site during the period of construction of the Permanent Casino complex. Upon completion of the Permanent Casino complex, this Lease will be superseded by the [Permanent Lease] (see below). Permanent Site Freehold Lease This is a Lease to be entered into between [Authority] and [Properties] for the lease of the Permanent Casino Site for a term of 99 years. Rental payable under this Lease reflects in part a tax effective payment of part of the premium of the issue of the Licence to [Authority] and is determined as a part of the overall financial structuring of the bid.
The abovementioned Casino Licence is to be granted for a consideration consisting of a licence ‘premium’ which may be paid by the licence holder in a variety of means depending upon the optimum tax and commercial position for it and ongoing taxes and duties. Our client is proposing to pay portion of the licence premium as consideration for the grant of the licence and portion as rent pursuant to the ‘Permanent Site Leases’ referred to below. ... Permanent Site Lease. This Lease is the principle [sic] lease document and will expressed to be for a term of 99 years. We confirm your earlier advice that notwithstanding the connection between the Lease and the erection of improvement, Section 77 of the Stamp Duties Act will not apply as the term is for 99 years. We confirm that in clause 2.1 of the Lease, the Lessee may prepay a lump sum portion of the rental that would otherwise be payable over the term. We confirm that commercially, payment is intended to be a portion of the licence premium to be paid to the Authority. You will note however that under clauses 2.6 and 2.7 the commuted lump sum is refundable in circumstances of the early termination of the Lease.
the rental prepaid under the terms of the [Construction Lease] only reflects the value of the Permanent Casino site if a casino licence is issued and, as such, forms part of the premium paid by [Star City] to obtain the licence if the Authority determines that it will issue the licence to [Star City]. [Star City] will loan $120,000,000.00 to [Properties] for the purpose of allowing it to prepay the rental under the [Construction Lease] and [Properties] will only be able to repay that loan if the licence is granted.
the advantage sought by the Prepayment is capable of identification and characterisation by reference to the Leases and the Occupational Licence Agreement and, if necessary, the Transaction Documents as a whole.
59 The primary judge rejected the Commissioner’s reliance on these three documents as "surrounding circumstances" or "background" to the transaction in support of his characterisation of the lump sum prepayment as a capital payment. The primary judge held that the surrounding circumstances and background relied upon by the Commissioner were irrelevant to the proper characterisation of the prepayment because:
This line of reasoning and analysis was too restrictive and not in
accordance with the authorities and principles to which I have
referred in
pars [26]-[36]
above. The primary judge was in error in finding that the surrounding
circumstances and background were irrelevant to the characterisation
of the
prepayment and should not have restricted her reasoning and analysis to the
terms of the documents and their juridical nature.
In doing so she fell into
error: cf Rotherwood Pty Ltd v Commissioner of Taxation (1996) 64 FCR
313 at [27].
While it will often be relevant to ask what the money the subject of a deduction is paid for, in order to conclude whether the outgoing has the character of capital, generally, however, that question will be answered where the amount in question is consideration for obligations which the payee undertakes in favour of the payor, by having regard to the legal agreements entered into. Generally in such a case it will be unnecessary to go outside the legal agreement to determine deductibility. So it would ordinarily be unhelpful to have regard to precontractual negotiations in characterising an outgoing as capital in the same way as such evidence would ordinarily be unhelpful in construing the legal agreement entered into between the parties. The position may be different if it be asserted that the agreement does not record the true agreement of the parties -- whether because it is a sham in the legal sense of that expression or because it does not record the whole of the legal arrangement between the parties.
60 In support of the above line of reasoning the primary judge relied on the Full Court’s judgment in City Link Melbourne Limited v Commissioner of Taxation [2004] FCAFC 272; (2004) 141 FCR 69 at pars [44]-[45] and the High Court’s judgment in Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35; (2006) 228 CLR 1 at [120], [151] and [154]. These authorities do not support the primary judge’s line of reasoning. 61 In City Link in the Full Federal Court, the Court said at 84 (pars [44]-[45]):
This was the passage relied on by the primary judge. However the Full
Federal Court continued at [46]-[47]:
This however does not mean that in determining the legal effect of a contract between parties (and therefore the characterisation of the payment made under it as being income or capital), regard may not be had to the whole factual matrix of which the contract forms part. Nothing in what his Lordship said requires the conclusion that regard cannot be had to the whole context in which the agreement was made to determine the character of a receipt. ...
62 The passages cited by the primary judge in Commissioner of Taxation v Citylink Melbourne Limited [2006] HCA 35; (2006) 228 CLR 1 in the High Court (pars [120], [151] and [154]) do not bear upon, or relate to, the issue whether a court can or should have regard to the "surrounding circumstances" or "background" to a payment or transaction to determine whether a payment is on capital or revenue account when the advantage sought by the payment is capable of identification or characterisation by reference to the documents giving rise to or evidencing the payment. 63 In the present case there was no issue that any of the Transaction Documents was a sham. But there was an issue as to the label of "rent" which the parties had used to describe the lump sum prepayment of $120 million. In those circumstances, as recognised by the Full Federal Court in City Link Melbourne Limited v Commissioner of Taxation [2004] FCAFC 272; (2004) 141 FCR 69 at [46], and by the Full Federal Court in Federal Commissioner of Taxation v Broken Hill Pty Co Ltd [2000] FCA 1431; (2001) 179 ALR 593 at 601-602, labels are not determinative and surrounding circumstances may be resorted to determine the true characterisation of a payment in an appropriate case. I consider that the present case was one such case. 64 The primary judge nevertheless went on to examine the "surrounding circumstances" and "background". Her Honour considered the three documents relied on by the Commissioner and concluded at par [102] that they did not alter "the identification of, or the character of, the advantage sought by the Prepayment". In reaching this conclusion the primary judge fell into error. 65 The primary judge said that the three documents could not be said to constitute the "whole factual matrix of which the [Leases and the Occupational Licence Agreement] forms part". In making this observation the primary judge adopted and adapted a passage from the judgment of Hill J in Commissioner of Taxation v Cooling (1990) 22 FCR 42 in which his Honour, having considered Inland Revenue Commissioner v Duke of Westminster [1936] AC 1 in which it was said that the form of the transaction was determinative of the character of the payment made, said at 53:
66 The documents may not have constituted the whole factual matrix of which the Leases and Occupational Licence Agreement formed a part but that did not preclude the primary judge from having recourse to them for the purpose of determining the true character of the lump sum prepayment. In the passage adopted and adapted from the judgment of Hill J in Commissioner of Taxation v Cooling (1990) 22 FCR 42, Hill J was not stating that it was an all-or-nothing exercise when looking at the whole factual matrix of which the relevant document formed part. His Honour was identifying the area within which a court could have recourse. 67 The primary judge observed that the documents "by their nature and content" did not form part of the factual matrix. Her Honour reached this conclusion on the basis that none of them was sent by one contracting party to another contracting party and so was not relevant to the proper construction of the Transaction Documents. In reaching this conclusion the primary judge was adopting an approach, and undertaking an analysis, appropriate for determining the proper construction of contractual documents and the implication of contractual terms. This is apparent from the primary judge’s observation that the letter from Star City to the to the Treasurer of New South Wales dated 13 December 1994 did not and could not provide evidence of the objective factual background known to the parties at or before the date of the Occupational Licence Agreement and from her relevance to Codelfa Construction Pty Ltd v State Rail Authority of New South Wales [1982] HCA 24; (1982) 149 CLR 337 at 401. 68 This approach and analysis (which the primary judge also applied to the Explanatory Memorandum produced on 19 April 1994 and the letter written by Star City’s solicitors to the New South Wales Office of State Revenue on 27 April 1994), was too restrictive when considering what was the lump sum of $120 million really paid for; the character of the advantage sought by the prepayment, and the prepayment’s calculated effect from a practical and business point of view. Rather the approach and analysis to undertake was to examine the contents of these documents and ask whether, as statements attributable to or adopted by Star City in effect as admissions, bore upon or supported the proposition that the prepayment was on capital account. The primary judge was not restricted to examining only documents which had been communicated between the parties to the Transaction Documents. 69 The primary judge finally rejected the three documents on the basis that even if they did form part of the factual matrix, they were only part of that matrix and it was not open to either party to pick and choose from the factual matrix. This basis for rejection of the three documents also exposed an error in the primary judge’s reasoning. It is true that the whole of the surrounding circumstances, background and factual matrix to the Transaction Documents was available to Star City and the Commissioner in the sense that they could select from them matters which they regarded as relevant to the determination of the character of the advantage sought by the prepayment. But it was open to either party to identify and seize upon any particular circumstance or aspect of background or matrix in support of its contention so long as it was relevant to the determination of the character of the advantage sought by the prepayment. It would then be a matter of argument whether such circumstance or aspect could be relied upon without taking into other circumstances or aspects which were interrelated with it. It was incorrect to say that a party could not pick or choose from the factual matrix. 70 The statements in the three documents to which I have referred support the proposition that from a practical and business point of view, the characterisation of the advantage sought by the prepayment was the obtaining of the casino licence and a period of exclusivity of 12 years for operating a casino in New South Wales. The prepayment comprised part of the consideration for the obtaining of the casino licence and the period of 12 years exclusivity of that licence. So characterised, the prepayment was a payment of a capital and not a revenue nature. The primary judge erred in not taking the three documents into account in this way. 71 The prepayment was directed to the obtaining of the casino licence and the period of exclusivity which related to "the character and organisation of the profit-earning business and [was] not to be an incident in the operation by which it is carried on": Hallstroms Proprietary Limited v Federal Commissioner of Taxation [1946] HCA 34; (1946) 72 CLR 634 at 648; Jupiters Limited v Commissioner of Taxation [2002] FCAFC 206; (2002) 118 FCR 163 at 169.
COMMISSIONER’S SUBMISSIONS THAT FINDINGS OF FACT WERE ERRONEOUS
72 The Commissioner submitted that the primary judge made two findings of fact which were erroneous and which permeated her reasoning. These findings were:
(a) the successful bidder for the licence was always required to pay substantive rent (as opposed to nominal or peppercorn rent) for the lease of the permanent casino site. (The primary judge found that "from the outset, not only was the need for a lease recognised, but the [Authority] stipulated that rent was a matter for negotiation to be determined on a ‘fair’ market rent" and that "there are two considerations that remained consistent: the Casino would operate on leased land owned by the State and rent would be paid for use of those Premises");
(b) the amount of the Prepayment was fixed as the result of "hard bargaining"
between Star City and the Authority. (The primary
judge found that "both
the amount to be paid as rent and the terms on which rental would be paid were
points of critical centrality
in the negotiations between Star City and the
[Authority] and matters about which the [Authority] (not Star City) had the
ultimate decision. The Commissioner’s contention that the rent payable
during the ‘Primary Rental Period’ was
not the result of hard
bargaining is without foundation ...")
73 I do not consider that these two findings of fact were erroneous but they do not alter the conclusion I have reached that the prepayment was a payment of a capital nature. Having regard to the submissions made I consider it appropriate to explain why these two findings were not erroneous. 74 The Commissioner submitted that the first finding permeated her Honour’s reasons referring to pars [104], [112], [133], [137] and [152] of her reasons. According to the Commissioner’s submissions her Honour should have found that a lease over the permanent casino site was a consistent requirement of the bid process but that the payment of substantive rent (as opposed to nominal or peppercorn rent) under the lease agreement was not required so that it was open to Star City to pay only nominal rent if it chose to do so. 75 I do not agree that insofar as her Honour held that the successful bidder was always required to pay substantive rent (as opposed to nominal or peppercorn rent) for the lease of the permanent casino site that her Honour made an erroneous finding. In the passage in her Honour’s reasons relied upon by the Commissioner, her Honour did not draw a specific distinction between substantive rent as opposed to nominal or peppercorn rent. In par [104] of her reasons, her Honour noted that the "[Authority] stipulated that rent was a matter of negotiation to be determined on a ‘fair’ market rent. The possibility of ‘an up-front capitalised lease payment’ was expressly referred to together with the requirement for a net present value ("NPV") calculation to ensure that the rental was a ‘fair’ market rental." 76 In par [112] of her reasons her Honour noted that throughout the negotiations between the parties there were two considerations that remained constant. Those considerations were that the casino would operate on leased land owned by the State and that rent would be paid for the use of those premises. In pars [133], [137] and [152] of her reasons, her Honour repeated the same observation. 77 The Commissioner contended that there were three objective facts which demonstrated that the payment of substantive rent (as opposed to nominal or peppercorn rent) under the lease was not required. These facts were:
(a) neither Star City’s first offer or its supplementary offer contained any provisions for the payment of rent for the permanent casino site and both offers were accepted by the Authority as conforming bids. On 13 January 1994 Star City confirmed in writing to the Authority that the rent proposed for the permanent casino site was a nominal amount to be paid over the lease period. On this basis Star City was short listed by the Authority on the basis of a bid which contained no provisions for substantive rent for the permanent casino site;
(b) the final bid of the other contender for the licence, Darling Casino Limited, made no provision for rent for the permanent site and its bid was accepted as complying;
(c) the Authority evaluated the competing bids of Darling Casino Limited and
Star City on the basis of the total amount offered
by each party rather
than the component parts of each bid.
Payment of the rent under the lease of the Permanent Casino site would be a matter for negotiation, but will be determined on a ‘fair’ market rent basis with the option of paying by annual lease payments reviewable every two years and adjusted upwards in line with property value increases or by way of an up-front capitalised lease payment.
78 The Commissioner’s submission that the payment of substantive rent (as opposed to nominal or peppercorn rent) under the lease was not required is not borne out by the evidence and is not consistent with it. The initiating document in the process was an "Invitation Document" issued by the Authority in May 1993 pursuant to a direction issued by the Minister under ss 9 and 10 of the Casino Control Act. That document invited expressions of interest for the establishment and operation of a temporary casino to be followed by a permanent casino. It invited applications for a casino licence. In the section headed "Financial Information" there appeared in s 3.6 headed "Other Fees" the following:
79 In July 1993 the Authority issued a brief to applicants for the proposed casino complex. Part F was headed "CORPORATE AND FINANCIAL – CASINO COMPLEX". Section F1:5 was headed "OTHER FEES" and paragraph 5.3 provided:
5.3 LEASE OF PERMANENT CASINO SITE
5.3.1 A 99 year Lease of Permanent Casino Site based on a ‘fair’ market rent to be determined by an independent valuation.
5.3.2 Payment of the rent under the Lease of Permanent Casino Site would be a matter for negotiation, but will be determined on a ‘fair’ market rent basis with the option of paying by annual lease payments reviewable every two years and adjusted upwards in line with property value increases or by way of an up-front capitalised lease payment.
5.3.3 If Applicants are proposing to pay by way of an up-front capitalised lease payment, Applicants are required to forecast the ‘fair’ market rental on the Permanent Casino Site including an NPV calculation.
The rent paid in advance is not refundable to the developer upon termination of the Agreement for Lease unless the termination is by consent between the Authority and the developer.
80 Section F11: was headed "APPLICATION REQUIREMENTS" and it set out the tables applicants were required to complete. The tables included provision for the rental payment proposed for the lease of the permanent casino site. 81 Section G3:1.18 provided for the payment of rent in the following terms:
The lessee is obliged to pay total rent in advance and all rates, taxes and charges (including utilities) imposed or levied in respect of the Permanent Casino Site. The rent shall not be refundable if the Lease of Permanent Casino Site is terminated unless it is terminated by mutual agreement between the Authority and the lessee.
82 Section G4:1.3 related to the lease of the permanent casino site and provided:
... the payment must not be in excess of amounts which would otherwise be reasonable in the circumstances; for example, rental payments in excess of an appropriate market value rental will not be accepted by the [Authority] as forming part of the financial offer.
83 Star City’s first offer did not provide for any rental payment for the permanent casino site but provided for $102 million as the lease rental payments for the temporary casino premises. 84 In a supplementary offer submitted on 10 January 1994 Star City proposed a rent of $102 million which was proposed for the temporary casino only and the rent proposed for the permanent casino site was "a nominal amount to be paid over the lease period". 85 The prospective bidders were required to provide their financial offer on 22 April 1994. On 16 March 1994 the Authority issued Addendum No 36 which, in relation to financial offers, stated that:
... Taken as a whole, the negotiations between the parties are properly described as "hard bargaining". It would be wrong to approach that negotiation piecemeal and say of part of it that Star City was free to choose its own terms and in that particular respect simply because the particular point was not shown to be the subject of extended debate or negotiation. As it happens, however, both the amount to be paid as rent and the terms on which rental would be paid were points of critical centrality in the negotiations between Star City and the [Authority] and matters about which the [Authority] (not Star City) had the ultimate decision. The Commissioner’s contention that the rent payable during the "Primary Rental Period" was not the result of hard bargaining is without foundation: ...
86 The second erroneous finding of fact for which the Commissioner contended was that the primary judge held that the amount of the prepayment was fixed as the result of "hard bargaining" between Star City and the Authority. The Commissioner relied on pars [109] and [110] of the primary judge’s reasons for this proposition. But this is not what the primary judge said. Her Honour said at par [110]:
I agree with her Honour that I should not approach the negotiations
between the Authority and Star City on a piecemeal basis.
The financial
offer to be made by Star City to the Authority for the casino licence had a
number of components to it and it
was on the basis of the total amount offered
that Star City’s offer was to be evaluated.
CONCLUSION
87 In summary, I am led to the conclusion that the prepayment was a payment of a capital nature not deductible under s 51(1) of the 1936 Act or s 8-1 of the 1997 Act as the character of the advantage sought by the payment was the securing of the casino licence and the exclusive right to operate a casino in New South Wales rather than the quiet enjoyment of the casino site for 12 years. I have reached this conclusion by reference to the following factors: • the prepayment was not refundable if the lease was terminated unless agreement to that effect was reached between the parties; • the disparity between the rent payable in each of the first 12 years of the lease ($15 million) and the rent payable in each of the following 87 years of the lease ($250,000); • the period of exclusivity for the operation of a casino obtained by Star City; • the prepayment was a lump sum paid in advance; • the contents of the three documents relied on by the Commissioner referred to in pars [55] to [58] above.
Star City did not dispute that each scheme identified by the Commissioner was capable of being a scheme for the purposes of Part IVA.
88 As I have concluded that the prepayment of $120 million was a loss or outgoing of capital or of a capital nature and that the primary judge should have so found, it is not necessary for me to determine or resolve the issue whether Pt IVA of the 1936 Act operated to deny the deductions claimed by Star City with respect to the prepayment. 89 However I do wish to make an observation in relation to the primary judge’s finding that the alternative schemes within the meaning of ss 177A(1) and 177D of the 1936 Act relied upon by the Commissioner (referred to as a wide scheme and a narrow scheme) were not a scheme within the meaning of s 177A. Her Honour had said at par [122]:
The primary judge said at par [128]:
... it [the concession] was made because, your Honours, I felt that our case in relation to tax benefit and dominant purpose was so unanswerable that I was not going to bother with scheme.
90 It was not open to the primary judge to make this finding as, in the course of argument before the primary judge, counsel for Star City conceded that each scheme identified by the Commissioner was capable of being a scheme for the purposes of Pt IVA. 91 In the course of argument before the primary judge, counsel for Star City did not attack the formulation of the scheme identified by the Commissioner as a scheme. Counsel said "I take no issue about whether it is a scheme within the meaning of section 177A". As Star City had conceded that each scheme identified by the Commissioner was capable of being a scheme for the purposes of Pt IVA, it was not an issue in respect of which the primary judge was obliged to make a finding and it was not open to her to find that either scheme identified by the Commissioner was not a scheme within the meaning of s 177A. 92 In the course of argument before us, senior counsel for Star City accepted that he had made the concession that the schemes relied upon by the Commissioner were capable of constituting a scheme for the purposes of Pt IVA. Counsel said:
A member of the Court then said "therefore you conceded it" and senior
counsel responded "therefore I conceded it".
Nonetheless, in our view it would not be in the interests of justice to allow the appellant now to raise issues that were not pursued at trial because (as we infer) the appellant’s counsel made a deliberate forensic decision not to do so. Just as there are circumstances in which an appellant should not be permitted to resile from a concession on a matter of law, so there are circumstances in which an appellant should not be permitted to resile from a forensic decision not to rely on an argument, even if the argument raises only an issue of law. We think it material that the appellant refrained from pleading and arguing the matters referred to in the proposed notice of appeal partly because to do so might have cut across his factual claim. Having elected to fight the case on the factual basis he did, the appellant should not be permitted to advance a different case on appeal after his evidence has been rejected by the primary Judge.
93 Once the concession was made, it was no longer a live issue before the primary judge which she had to consider and resolve. 94 In Li Pei Ye v Crown Limited [2004] FCAFC 8, the Court said at par [79]:
I consider that observation to be applicable in the present
circumstances.
A party may admit allegations made in pleadings by the opposing party, and may do so either expressly or by non-traverse. The effect of such admissions is to narrow the issues in dispute: they can thus have the effect of restricting the evidence to be tendered and can prevent evidence being called to the contrary. The same is true of similar admissions designed to permit concentration only on what is bona fide in dispute, such as concessions by a solicitor before a trial (Ell v Hunter District Water Supply and Sewerage Board (1927) 27 SR (NSW) 437) or by counsel during a trial (Dunn v Brown (1911) 12 SR (NSW) 22) or admissions ordered by the court as an alternative to filing evidence to the contrary within a specified time (Coopers Brewery Ltd v Panfida Foods Ltd (1992) 26 NSWLR 738). A modern extension of these facilities is to be found in s 191 of the Evidence Act 1995. This permits the parties to agree facts; if they do so, no evidence is required to prove the facts and no evidence may be adduced to contradict or qualify them, unless the court gives leave.
95 In Damberg v Damberg [2001] NSWCA 87; (2001) 52 NSWLR 492, Heydon JA said at 519:
His Honour then said at 522:
Having regard to the concession made by counsel for Star City before
the primary judge, I do not consider that it was open to
the primary judge to
doubt the correctness of the concession made.
CONFIDENTIALITY ORDER
Until further order the Court orders, pursuant to s 50 of the Federal Court of Australia Act 1976 (Cth) that the document entitled ‘NSW TREASURY COMMENTS ON CASINO BIDS’ dated 2 May 1994 pp1094-1102 of Part C of the appeal papers in these proceedings may not be published without leave of the Court, except for the passages set out at pars [52]-[54] of the annexure to the reasons of the Honourable Justice Gordon.
96 In the course of the hearing of the appeal Senior Counsel for the Commissioner referred to a document in the appeal book entitled "NSW TREASURY COMMENTS ON CASINO BIDS". At the trial the primary judge had made a confidentiality order in relation to this document on the request of the Authority. In the annexure to her reasons for judgment the primary judge set out parts of this document which were not confidential as they were matters which were already in the public domain. On the request of the Commissioner, which was consented to by Star City, the Court made the following order:
The Court may, at any time during or after the hearing of a proceeding in the Court, make such order forbidding or restricting the publication of particular evidence, or the name of a party or witness, as appears to the Court to be necessary in order to prevent prejudice to the administration of justice or the security of the Commonwealth.
97 The Court granted the Authority leave to file submissions in relation to the continuation of the confidentiality order. The Authority filed an affidavit and written submissions, the substance of which was that the information provided by the licence bidders was provided under strict confidentiality guidelines and as there are bidding processes that still occur throughout the world for new casino licences, it is important that the commercially sensitive information contained in the document remain confidential "as it may result in this information being used inappropriately by competing bidders if released". In an affidavit affirmed by the Chief Executive Officer of the Authority, he said that "it [is] my understanding that at least one of the parties related to DCL is engaged in such bids". 98 The information contained in the document is not recent. Indeed, it is over fourteen years old. The order is sought pursuant to s 50 of the Federal Court of Australia Act 1976 (Cth) which provides:
99 I have read the document and do not consider that it is necessary to make the orders sought in order to avoid prejudice to the administration of justice or to the security of the Commonwealth. The document was created more than fourteen years ago and the material placed before the Court does not indicate that any part of that material may be relevant to any current commercial transaction contemplated or proposed by either of the two bidders for the licence. 100 I would propose that the order made by the Court for confidentiality on 14 May 2008 be discharged.
PENALTIES
101 The Commissioner imposed penalties, pursuant to s 226 of the 1936 Act in relation to the following years of income:
(in lieu of year of income ending 31
December 1997)
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$1,348,224.12 $10,633,555.08 |
These penalties represented 50% of the tax assessed.
102 The Commissioner also imposed tax shortfall penalties, pursuant to Part 4-25 of the Taxation Administration Act 1953 (Cth) ("the Administration Act") in relation to the following years of income:
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$2,040,000.00 $1,800,000.00 |
These penalties represented 50% of the tax assessed.
103 As the primary judge set aside the Commissioner’s disallowance of Star City’s objections to the relevant assessments and ordered that its objections be allowed in full, these penalties were set aside. In the course of her reasoning the primary judge noted that if Pt IVA did not apply there could be no penalties under s 226 of the 1936 Act or s 284-145 of the Administration Act and that even if Pt IVA did apply, at the most the appropriate penalty rate pursuant to s 226 and s 284-160(a)(ii) was 25%. 104 In his amended notice of appeal the Commissioner contended that the primary judge erred in finding that the relevant legislative provisions did not authorise the imposition of the penalties but the Commissioner did not address this issue in written or oral submissions. 105 Counsel for Star City in oral submissions noted that the Commissioner had not attacked the primary judge’s reasoning in relation to the issue of penalties and contended that if Pt IVA did not apply, no penalties should be imposed and that if Pt IVA did apply the Commissioner had not submitted that the primary judge was in error as to her conclusions as to the amount of the penalty. 106 I have concluded that the prepayment of $120 million was a loss or outgoing of capital or of a capital nature and that it is not necessary therefore to determine or resolve the issue whether Pt IVA of the 1936 Act operated to deny the deductions claimed by Star City. 107 It follows that the orders I propose, namely that the applications before the primary judge should be dismissed, have the result that the Commissioner’s disallowance of Star City’s objections against the relevant assessments are not set aside but are reinstated. That will reinstate the penalties of 50% of the tax assessed in respect of the four years of income referred to. But the imposition of those penalties depends upon there being a finding that Pt IVA operates to deny the deductions claimed by Star City. 108 In those circumstances, it seems to me that an order should be made in relation to the excision of the penalties imposed by the Commissioner. The parties should have fourteen days within which to file written submissions as to what orders, if any, the Court should make on this issue. 109 The appeal should be allowed. The applications before the primary judge should be dismissed and the respondent should pay the appellant’s costs of the appeal and the proceedings before the primary judge.
Associate:
Dated: 26
February 2009
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VICTORIA DISTRICT REGISTRY
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ON APPEAL FROM A SINGLE JUDGE OF THE FEDERAL COURT OF
AUSTRALIA
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BETWEEN:
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AND:
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DATE:
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PLACE:
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REASONS FOR JUDGMENT
DOWSETT J:
GENERAL
110 I have read the reasons prepared by Goldberg J. I agree with the orders which his Honour proposes and, generally, with his reasons. However I consider that the events leading up to the respondent’s ultimate success in the bidding process support his Honour’s conclusions and reasons. I discuss those events below. I shall endeavour to avoid the unnecessary repetition of aspects of the evidence to which his Honour has referred. 111 In 1994 a consortium (the "Consortium") successfully bid for the acquisition of a licence to conduct a casino on land in Sydney (the "permanent casino site") owned by, in effect, the New South Wales government (the "government"). The licence was eventually issued to Star City. Star City was previously known as Sydney Harbour Casino Pty Ltd. The composition of the Consortium changed during the bidding process. I shall generally use the term "Star City" to describe Star City and all other persons or companies acting on behalf of the Consortium or Star City in connection with the bidding process. The bidding process was conducted on behalf of the government by the Authority, a statutory body. For reasons associated with the conditions imposed upon Star City in connection with its finance, the permanent casino site was leased to Sydney Harbour Casino Properties Ltd ("Properties"). Both Star City and Properties are wholly owned subsidiaries of Holdings. Properties licensed Star City to occupy the permanent casino site. Star City undertook to meet Properties’ financial commitments. As part of its bid Star City had offered to pay two substantial lump sums to the Authority. One amount of $256 million (the "first payment") was to be payable 21 days after the issue of the casino licence. The second, in the amount of $120 million (the "second payment"), said to be prepayment of the rental for the permanent casino site, was to be payable at the same time. Star City paid both amounts. This case concerns the significance of the second payment for income tax purposes. 112 Pursuant to s 82KZM of the 1936 Act in the form in which it stood in relevant years, rent paid in advance could be, in effect, claimed as a deduction spread over up to ten years, such deductions being pursuant to s 51(1) of the 1936 Act or s 8-1 of the 1997 Act, depending upon the year in question. In various income years, from that ended 30 June 1995 until that ended 30 June 2002, Star City claimed parts of the second payment as deductions. Thereafter, it may have continued to do so, but that is not presently relevant. On 10 December 2003, pursuant to Pt IVA of the 1936 Act, the Commissioner disallowed the amount of $120 million as a tax benefit to Star City referable to deductions claimed in the year ended 31 December 1996 (in lieu of the year ended 30 June 1997), the year ended 30 June 2000 (for the substituted accounting period 1 January 1999 to 30 June 2000) and the years ended 30 June 2001 and 2002. The Commissioner issued amended assessment for those years. For the years ended 31 December 1996 and 30 June 2000, the amended assessments included assessments to additional tax pursuant to Pt VII of the 1936 Act. In connection with the years ended 30 June 2001 and 2002, the Commissioner subsequently issued notices of assessment of tax shortfall penalties pursuant to Pt 4-25 of the Administration Act. 113 Star City objected to the amended assessments, the imposition of additional tax and the tax shortfall penalty assessments. The objections were disallowed. On 17 June 2003 the Commissioner made further determinations pursuant to Pt IVA of the 1936 Act, disallowing the individual tax benefit derived in each year for which an amended assessment had been issued. It may have been thought that disallowance of the total sum of $120 million was not effective to disallow the amounts claimed in each year. Star City appealed against the Commissioner’s decisions. There were five such appeals dealing with the matters identified below:
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No VID 915 of 2005:
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amended assessment of taxable income and additional tax for year ended
31 December 1997
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No VID 916 of 2005:
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amended assessment of taxable income and additional tax for year ended
30 June 2000
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No VID 917 of 2005:
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amended assessment of taxable income for year ended 30 June 2001
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No VID 918 of 2005:
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amended assessment of taxable income for year ended 30 June 2002
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No VID 919 of 2005:
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assessment of tax shortfall penalty for year ended 30 June 2001
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No VID 920 of 2005:
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assessment of tax shortfall penalty for year ended 30 June 2002
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114 The Commissioner submitted below, and on appeal, that the claimed deductions were not losses or outgoings incurred by Star City or were losses of capital or of a capital nature. Alternatively, the deductions were properly disallowed pursuant to Pt IVA of the 1936 Act. The primary judge upheld Star City’s appeals.
ADMISSIBILITY
115 I have experienced some difficulty in addressing this matter because of the approach taken by the primary judge to the receipt of documentary evidence. Her Honour was concerned by the tender of five volumes of documents which she rejected, ordering the parties to address the admissibility of each document. As I understand it, the only issue concerning admissibility was relevance. It is difficult to identify the documents which were eventually received and those (if any) which were rejected. Thus the amended notice of appeal (paras 12 and 13) challenges rulings "[t]o the extent that the primary Judge held" certain documents to be inadmissible. On appeal, the Commissioner sought to deal with this problem by identifying a limited number of documents upon which he particularly relied. Star City submitted that the case should be decided by reference to the character of the payments as disclosed in the transaction documents but did not otherwise challenge the admissibility of the documents contained in the appeal record. 116 The primary judge attached to her reasons a summary of the relevant bidding process, observing that it was "a summary of the Bid process as I find it to have occurred". This suggests that all documents apparently forming part of that process were admitted into evidence, subject to any express rulings to the contrary. For reasons similar to those given by Goldberg J, those documents were relevant, both to the characterization of the second payment as being of a capital or revenue nature and to the Commissioner’s case pursuant to Pt IVA of the 1936 Act. The documents were also relevant to two "findings" made by her Honour and challenged on appeal. They concerned the significance of rental in the bargaining process and the extent to which Star City and the Authority bargained in their dealings. 117 At the hearing of the appeal, counsel for the Commissioner sought to avoid extended argument about admissibility by limiting the documents to which reference was made. However that approach proved to be less than satisfactory. In the end counsel submitted that the following documents were admissible: • all documents referred to in the Commissioner’s written submissions; • all documents listed in paras 13(a) to 13(o) of the amended notice of appeal; and • all documents referred to in the chronology attached to the Commissioner’s written submissions.
118 The matter is further complicated by the fact that some of these documents refer to others. It is difficult to see how one can deal with them without looking at the others, or why one should do so. In addition I suspect, without being certain, that further documents were referred to in the course of oral submissions.
THE BIDDING PROCESS
119 The bidding process commenced with the Invitation Document dated May 1993. The project involved the following elements: • lease of the permanent casino site to the successful bidder for 99 years; • construction and operation of a casino on that site; • conduct of a casino at a temporary site during construction of the permanent casino; • issue of a casino licence to the successful bidder, such licence to commence upon establishment of the temporary casino and end at a time to be agreed; • the successful bidder to hold the only casino licence in force in New South Wales (the exclusivity arrangements") for a period of 12 years (the "exclusivity period"); • the Authority to negotiate with the successful bidder:
... for the purpose of the Authority entering into binding contractual agreements on behalf of the State (subject to the Minister’s approval under the Act) to the effect that no other casino will be licensed to operate in the State of New South Wales within the period of 12 years from the date of commencement of the Casino operations at the Temporary Casino;
(This seems to have been intended to provide a basis for compensation in the event that Parliament legislated to permit more than one casino during the 12 year period.)
• payment of "casino duty" pursuant to the Casino Control Act which duty could be calculated in a number of different ways;
(The relevant minister had directed that the casino duty should include:
A once only non-refundable lump sum payment on the grant of the Casino Licence, the nature and timing of which is to be subject to a competitive bid. The lump sum payment will not necessarily be the determinant of a successful Application. However, benefits to the State arising out of the size and proposed timing of the payment will be significant factors in the Authority’s assessment of Applications.)
• payment of a community benefit levy pursuant to the Casino Control Act; and • payment of "other fees", the Invitation Document stating at para 3.6 that:
Invitees should be aware that a number of other monetary outgoings may be determined in relation to the Casino complex, e.g. special employee licences, statutory outgoings and specific development fees and contributions.
Payment of the rent under the lease of the Permanent Casino site would be a matter for negotiation, but will be determined on a "fair" market rent basis with the option of paying by annual lease payments reviewable every two years and adjusted upwards in line with property value increases or by way of an up-front capitalised lease payment.
Information as to fees referred to in this section will be set out in more detail in the Brief.
120 The treatment of site rental as merely one of a number of "other fees" suggests that rental was not of major concern, at least to the Authority. In those circumstances the large amount eventually offered and accepted as rent is, to some extent, surprising. 121 In the subsequent Brief at para 5.3, it was said that rent of the permanent casino site would be determined on a "fair" market rent basis, payable annually or by way of an "up front capitalised lease payment". Part F3 (headed "Financial Offer"), provided:
1.1 In considering Applications the Authority will have regard to the sufficiency of financial offers made. Those components of the Application to be taken into consideration for this purpose will be:
1.1.1 the amount offered as a non-refundable lump sum payment or payments;1.1.2 the forecast Casino Duty payable;
1.1.3 the forecast Community Benefit Levy payable;
1.1.4 such other financial benefits the Applicant may choose to offer.
1.2 The Application should clearly identify the amounts for each of Sections F:1.1.1, F:1.1.2, F:1.1.3 and F:1.1.4 above together with a total for the same.
1.3 One measure to be adopted by the Authority in its evaluation of the financial value of each Applicant’s offer will be the Authority’s assessment of the NPV [net present value] of each offer. The Application should include a detailed NPV calculation including any expected amounts for the Casino Duty and Community Benefit Levy indicating by item the gross value, proposed timing for payment, source of cash flows and an analysis of the cost of capital applied to compute the NPV for the period of 12 years from the date of commencement of Casino operations at the Temporary Casino.
Payments under the 99 year lease for the Permanent Casino Site are intended to be based on a fair market rent determined by an independent valuation. This would be extremely difficult because the value of the site would be based solely on the Casino, for which a "lump sum" has already been paid.
122 If rent were to have been a major part of the financial side of the transaction, one would have expected a reference to it at this point. On the other hand, the focus on the exclusivity period suggests that the exclusivity arrangements were considered to be an important aspect of the transaction, which importance would be reflected in the financial arrangements. I should add that in an attached "application snapshot", provision was made for inclusion of the terms of the lease, including terms as to rental. 123 Various potential bidders raised questions about the Brief. The Authority replied generally to them in a letter which was Addendum No 17 to the Brief, formulating various "questions", presumably derived from queries raised by such bidders, and then answering them. Question 12 was:
The payment of the rent under the lease of the Permanent Casino Site would be a matter for negotiation, but will be determined on a "fair" market rent basis with the option of paying by annual lease payments reviewable every two years and adjusted upwards in line with property value increases or by way of an upfront capitalized lease payment. The Authority has had discussions with the Valuer General for a valuation for land tax purposes. When the land tax amount is determined, all Applicants will be advised. The Applicants will have to submit a fair market value for the site in their applications to be submitted in November. Applicants may need to seek independent advice on the fair market value of the site.
124 The Authority responded:
"1. Land Value at 1st July 1992
125 The question seems to suggest that the real value of the proposed transaction lay in obtaining the licence (and, perhaps, the exclusivity arrangements) rather than in obtaining the premises. The Authority did not address that problem. A similar problem arises in connection with valuation material in this case, to which subject I shall return. 126 Subsequently, applicants were advised that the Valuer General had valued the temporary casino site, as at 1 July 1992, at $10 million and, as at 1 July 1993, at $13 million. These figures appear to have been generated at some time in the second half of 1993. The valuation was forwarded to Mr Vella at Star City in November 1993. At about that time the Valuer General received a valuation of the permanent casino site as follows:
(assuming a Residential/Business zoning) $30 million*
2. Land Value at 1st July 1993This value will be used for Council Rates 1 July, 1994 – 1 July, 1995
(assuming a Residential/Business zoning) $40 million*
This value will be used for Land Tax in the calendar year 1994
* A Land Value for rates and taxes must reflect the highest and best use of the site. Therefore if a premium for the site is indicated (for a Casino Complex) when the agreed lease is analysed, such premium will need to be added to this value.
3. Assuming that the Casino Complex proceeds then the Land Value in 1998 (based on the assumption that a premium will be applicable, but subject to the proviso the exact amount of the premium is not currently able to be predicted) would be about $80 million #.
# This figure is obviously subjective as it is extremely difficult to assess a value five years into the future."
... The Authority has now received advice from Treasury that their preference is for lump sum cash payments payable in accordance with the Brief requirements. Any arrangements involving discounting of instalment payments to establish equivalent lump sum payments may in their opinion fall within Loan Council guidelines. Applicants which include in their 10 January 1994 Financial Offer the non refundable lump sum payment in tax efficient forms involving instalments must in addition provide the Financial Offer they are prepared to make strictly in accordance with the requirements of the Brief, i.e. on the 15%; 30%; 55% payment timetable. ...
127 This valuation was supplied to the Authority and to bidders, including Star City. 128 On 22 November 1993 Star City submitted its first offer. On 10 January 1994 a supplementary offer was submitted. Between those dates, the Authority issued Addendum No 25 to the Brief and possibly other addenda. Addendum No 25 dealt with the possibility raised by bidders that the non-refundable lump sum payment might be paid in "various tax efficient forms". The Authority observed that:
It is not clear whether the fact that discounting fell within Loan Council guidelines meant that it was acceptable or not for bid purposes. The 15%; 30%; 55% payment timetable (the "15-30-55 Payment Schedule) was to become a recurring motif in the bidding process.
129 The following summary (excluding the extreme right hand column) appeared in the offer dated 22 November 1993, under the heading "Financial Offer". The figures in the right hand column come from the supplementary offer. No provision was made for the payment of rental for the permanent casino site. Mr Vella suggested in his affidavit that both offers were designed to keep Star City in the contest for short listing and were not necessarily indicative of its likely final offer. The summary (with the added figures from the supplementary offer) was as follows:
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$ million
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$ million
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1.
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Payment within 21 days of the issue of the Licence
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35.0
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45.5
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2.
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Payment before the commencement of the operation of
Temporary Casino |
15.0 |
19.5 |
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3.
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Lease rental payments for the Temporary Casino
Premises |
102.0 |
102.0 |
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4.
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Supplementary Profits tax on the Temporary Casino
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54.0
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54.0
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Total cash offer
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206.0
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221.0
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NPV July 1994
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185.0
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200.0
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5.
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Value to New South Wales Government of residual
building works on temporary casino site |
51.2 |
51.2 |
The "super rent" proposed for the Temporary Casino appears to incorporate the rental stream for both the Temporary and Permanent Casinos. Please clarify that the "super rent" payment stream is in lieu of annual rental payments for both the Temporary and Permanent Casinos for the entire period of the respective leases.
130 In a document attached to the November offer, Star City also set out the net present value of its proposal "[e]xclusive of payment for Casino Licence and Residual Value of Temporary Casino Improvements". It then set out various amounts to be paid during the first 12 years of the casino’s operation, including casino duty and community benefit levy. These were payments to be made in addition to those in the Financial Offer, implying that the proposed consideration for the issue of the licence and (presumably) the exclusivity arrangements was included in the Financial Officer. There was no reference to rental for the permanent casino site, either in the Financial Offer or in the attachment. 131 As part of the supplementary offer, Star City provided a list of assumptions. In that list it noted that land tax had been assessed on the permanent casino site on its 1993 value of $40 million, and that rates had been assessed on its 1992 value of $30 million. In cash flow documents supplied with the supplementary offer, rent was shown as an outgoing to be incurred only during the anticipated period of occupation of the temporary casino site and not during the term of occupation of the permanent casino site. The question of the tax treatment of rent for the temporary casino site was expressly addressed in Appendix C to the offer of 10 January 1994. In the "Notes to Financial Offer" it was said that such rent would be payable monthly. On 11 January 1994, following discussions on 10 January 1994, Star City wrote to the Authority indicating that "... should the Authority not wish to accept the payments in the form set out in our letter of 10 January then this Consortium would be prepared to pay in a lump sum the equivalent of the July 1994 value as stated in the schedule." 132 The Authority subsequently requested details of a number of aspects of the offer. One such request was:
In answer to your request, we advise as follows:
133 Mr Vella responded on 13 January 1994 as follows:
1. The rent proposed for the Temporary Casino is solely for the Temporary Casino and will be paid whilst the Temporary Casino is operating.
...The rent proposed for the Permanent Casino site is a nominal amount to be paid over the lease period.
For your information we have included in our operating projects the payment of land tax for the Permanent Casino.
134 It seems that at this stage Star City intended to pay only nominal rental for the permanent casino site. The term "super rent" may suggest that the Authority perceived that the amount offered as rental for the temporary casino was more than fair market rental, even if applied to the whole of the 99 year term. However that says nothing about Star City’s intention. On 24 January 1994 the Authority announced that Star City was on a short list of bidders and issued Addendum No 27 to the Brief. On 25 January 1994 the Authority advised Star City that it wished to discuss various matters including the payment of duty, the sufficiency of the proposed lump sum payment and other financial benefits offered, including any lump sum rental payment. There is no evidence as to any subsequent discussions or as to the issues which the Authority wished to raise concerning lump sum payments. It may have wished to discuss Star City’s proposal that it pay rent for the temporary casino. There is no suggestion that the Authority asked Star City to amend its bid to offer rent for the permanent casino site. In my view that is a matter of some importance in this case. 135 The documentation which would give effect to the proposed development had been described in a general way in the Brief. It seems that copies of at least some of the draft documentation became available to Star City prior to 15 March 1994. One such document was the second draft of the Casino Duty and Community Benefit Levy Agreement (the "Duty Agreement") which was dated 24 February 1994. On 15 March 1994 Arthur Andersen wrote to Star City concerning the deductibility for tax purposes of amounts to be paid to the Authority pursuant to the Duty Agreement. According to the Invitation Document, duty was to be payable pursuant to the Casino Control Act. The Casino Control Act did not so much impose an obligation to pay duty as require that such payment be negotiated between the casino operator and the Treasurer. In the absence of agreement the Treasurer could determine the duty payable: see s 114. Section 117 provided examples of the ways in which duty might be calculated. The draft Duty Agreement provided for payment of two amounts described as the "First Specified Amount Duty" and the "Second Specified Amount Duty". The "First Specified Amount Duty" was defined to mean "the non-refundable lump sum casino duty referred to in clause 4 in the amount of $[...]". The Second Specified Amount Duty meant "the casino duty referred to in clause 4 in the amount of $[...] and commuted to a non-refundable lump sum net present value amount of $[...]". 136 Clause 4 provided as follows:
4.1 The Licensee shall pay to the Authority the First Specified Amount Duty and the Second Specified Amount Duty.
4.2 The First Specified Amount Duty is due and payable by way of instalments of the following percentages on the following dates:
(a) at least 15% on or before the date which is 21 days after the Licence Issue Date;(b) at least 30% on or before the Temporary Casino Commencement Date; and
(c) the balance on or before the Permanent Casino Commencement Date.
4.3 The Second Specified Amount Duty is due and payable by way of instalments in the percentages (amounts) and on the opposite and corresponding dates specified in Column 1 and Column 2 of Schedule 2 respectively.
4.4 The Treasurer and the Licensee have agreed to commute the Second Specified Amount Duty in the amount of $[...] to a net present value amount of $[...] payable on [...].
4.5 Once due and payable the First Specified Amount Duty and the commuted net present value amount of the Second Specified Amount Duty are not refundable in any circumstances and if any right to a refund or credit shall arise in the future in relation to the same the Licensee waives such right.
Clause 4.1 of the Agreement provides that the Licensee shall pay to the New South Wales Casino Control Authority ("the Authority") the First Specified Amount Duty and the Second Specified Amount Duty. The First Specified Amount Duty is due and payable by way of three instalments in accordance with the time frame set out in cl 4.2 of the Agreement. We understand this amount was originally designed to represent a payment premium for the grant of the Casino licence. Clause 4.3 of the Agreement provides that the Second Specified Amount Duty is due and payable by way of instalments in accordance with the percentages/amounts and corresponding dates to be specified in Schedule 2 to the Agreement. We understand that this amount was originally intended to represent payment for rent over the period of the licence but that, in subsequent negotiations with NSW Treasury, the NSW Treasury have indicated that they would prefer that the Second Specified Amount Duty be viewed as representing a tax payable by the Licensee of the Casino, not necessarily based upon the gross revenue or turnover the Casino. Clause 4.4 of the Agreement provides that the Treasurer and the Licensee have agreed to commute the Second Specified Amount Duty to a net prevent value amount to be payable on a date yet to be specified. Once due and payable, the First Specified Amount Duty and the commuted net present value amount of the Second Specified Amount Duty are not refundable.
137 In Arthur Andersen’s letter of 15 March 1994, after referring to the draft Duty Agreement, the writer observed:
(Original emphasis.)
However, the classification of the Second Specified Amount Duty as either of capital or revenue nature is not so clear. As outlined above, the Second Specified Amount Duty will represent a tax levied on the licensee of the Casino. If these payments were made by the Company on a periodic basis over the duration of the licence then the payments would probably not be considered as being of a capital nature and would be deductible to the Company on the basis that they would be incurred in the carrying on of the Company’s Casino business for the purpose of producing assessable income. However, the fact that the payment is commuted and the manner in which it is documented in the Agreement raises a significant risk that the payment will be considered to be of a capital nature and, as such, non-deductible to the Company.
138 The second last paragraph quoted above poses difficulties. They arise from the fact that the evidence does not disclose how the structure of the second draft of the Duty Agreement was developed. In particular, it is not clear whether it was drafted to reflect the structure of Star City’s bid or to reflect the Authority’s requirements. As a result, one cannot tell whether Arthur Andersen meant that the Authority, Star City or both had intended that the Second Specified Amount Duty be for rent. It seems unlikely that the Authority had such an intention in view of its expressed desire that the Second Specified Amount Duty be "viewed as representing a tax". The matter may have been discussed at the meeting following the Authority’s letter of 25 January 1994. Perhaps Star City had said that it "originally intended" that one of the lump sum payments in its first bid represent rent, but the Authority had indicated that it would prefer that it be duty. There seems to have been no suggestion by the Authority that if Star City paid the Second Specified Amount Duty, a further sum should be offered as rent. 139 Arthur Andersen then discussed deductibility of the two amounts for tax purposes, concluding that the First Specified Amount Duty would represent payment of a premium for the grant of a licence, would be of a capital nature and therefore would not be deductible. The advice continued:
140 At this point the writer seems to have been treating the Second Specified Amount Duty as a tax rather than as rent. After discussing the law relating to the distinction between capital and revenue for income tax purposes the writer suggested that the commutation of the Second Specified Amount Duty to a single, net, present value sum weighed against its being of a revenue nature. He then discussed the possibility that the First Specified Amount Duty and the Second Specified Amount Duty might be treated differently for tax purposes. The writer’s classification of the First Specified Amount Duty as being a payment of a premium for the grant of the casino licence was apparently based upon recitals A to E of the second draft of the Duty Agreement which provided:
A. Contemporaneous with execution of this Deed, the Authority granted the Licence to the Licensee.
B. Pursuant to section 120 of the Act, it is a condition of Licence that the Licensee must pay any duty levy or interest due and payable under Part 8 of the Act.
C. Pursuant to section 114(2)(a) and section 115(2)(a) of the [Casino Control Act], the Treasurer and the Licensee have reached agreement as to the amount of casino duty and amount of casino community benefit levy to be paid pursuant to Part 8 of the Act and the times and manner (including the nature of the securities and indemnities to be given to the Authority (on behalf of the State) to secure the payment of those amounts) in which the same are due and payable.
D. Pursuant to section 119(3) of the Act, the Treasurer has determined the rate of interest as the Penalty Rate (as later defined).
E. The Treasurer and Licensee have reached agreement on the terms of this Deed.
Clause 4 of the Agreement outlines the requirement for the Licensee to pay both the First Specified Amount Duty and the Second Specified Amount Duty in accordance with specifications contained in that clause. There is no mention in clause 4 (or elsewhere in the Agreement) as to what each of the payments relate to. The only guide is the First recital from which an inference might be drawn that the Second (as with the First) Specified Amount Duty is consideration for the grant of the licence. This is problematic given that, as mentioned above, the character of a payment for income tax purposes is determined having regard to what the amounts paid related to. Accordingly, in the event of a dispute, it would be left for a Court to ascertain what each of the payments related to. Furthermore, since the First Specified Amount Duty is clearly of a capital nature and since, on the face of the agreement, there is nothing to distinguish the First Specified Amount Duty from the Second Specified Amount Duty, there is a risk that both payments could be viewed as being of a capital nature.
141 Arthur Andersen considered that these recitals applied to the First Specified Amount Duty so as to make it a payment on capital account but that their application to the Second Specified Amount Duty was "not so clear". The letter continued:
A possible alternative to the above arrangements in respect of the Second Specified Amount Duty would be to exclude this payment from the Agreement and to agree that the Licensee would pay a minimum amount of rent on a periodic basis over the duration of the licence. The Company could then arrange for an independent party (eg a financial institution) to make an offer to purchase the stream of rental payments from the New South Wales Treasury for a fixed/specified amount. This offer could be submitted as part of the Company’s tender documents. The NSW Treasury would still obtain the benefit of an up front lump sum payment in respect of the rentals and the Company could then obtain a deduction on a periodic basis for its rental payment. The above arrangements would however probably be more difficult to establish if the payments were classified as a tax upon turnover of the Casino as there would be some degree of uncertainty associated with the amount of taxes likely to be derived, given that the tax will be based on Casino turnover.
142 It was then suggested that:
The Authority will only accept financial benefits which meet the following tests: • they are cash benefits;
143 Clearly, Arthur Andersen was suggesting that rent be paid (effectively in advance) in lieu of the Second Specified Amount Duty. It is difficult to avoid the conclusion that such suggestion was designed to enable payment of a significant lump sum, which payment would be arguably tax deductible. As I have said, there was no suggestion that the Authority, in seeking to ensure that the Second Specified Amount Duty was a tax rather than a payment of rental, also sought the payment of rent. 144 On 16 March 1994 the Authority released Addendum No 36 to the Brief. In attachment 2 to that document, headed "Financial Offers", it referred to Part F3:1.1.4 of the Brief (which is set out above), concerning "such other financial benefits as the Applicant may choose to offer" (emphasis added). Addendum No 36 asserted, with respect to "such other financial benefits", that:
- 15% - 21 days after the Licence Issue Dates; - 30% - on or before the Temporary Casino Commencement Date; and - 55% - on or before the Permanent Casino Commencement Date• they are certain as to amount and timing; ie fixed amounts must be specified as well as the proposed dates of payment;
• if the amounts specified are proposed to be paid on a date or dates other than in accordance with the following payment schedule, being:
(the "15-30-55 Payment Schedule")
the offer must include an option for the Authority to obtain payment of a commuted present value of the proposed payment stream in accordance with the 15-30-55 Payment Schedule. The amount which would be payable in accordance with the 15-30-55 Payment Schedule must be clearly specified and a detailed calculation showing the gross amount, proposed payment dates, discount rate and present value must be provided.
• the amounts offered must be expressed as being non-refundable irrespective of when they are paid, that is, irrespective of whether the amounts offered are paid on the Applicant’s proposed payment terms or the 15-30-55 Payment Schedule.
• the payments must not be subject to any reduction in the event that an income tax deduction is not obtained by the Applicant for any proposed payment, that is, the tax risk for payments which are potentially deductible by Applicants must remain with the Applicant.
• the payments must not be in excess of amounts which would otherwise be reasonable in the circumstances; for example, rental payments in excess of an appropriate market value rental will not be accepted by the Authority as forming part of the financial offer. The Authority will not become involved in artificial financial arrangements.
• The payments must not be expressed to be revenue dependent (for example, additional duty which is expressed as a percentage of revenue). All duty payments which are linked to revenue will be treated as forming part of the forecast casino duty payable and considered under Part 3:1.1.2.
Reference is made to the meeting held on 15 March 1994 in your offices with the CWDC (City West Development Corporation – a government agency). We wish to confirm your verbal advice in the meeting that the full rental to be charged if the temporary casino is located on Wharves 12 and 13 will be assessed by the Authority as being part of the premium offered by this Consortium.
145 Addendum No 25 had imposed certain conditions in connection with the up front payment, which payment had been contemplated in both the Invitation Document and the Brief. Addendum No 36 imposed conditions upon other financial offers which might be made by bidders. In particular it required that it have the option to demand payment of all offered periodic payments (including rent) pursuant to the 15-30-55 Payment Schedule. Addendum No 36 demonstrates that the Authority was interested in maximizing the "up front" payments to be received in connection with any bid. It also demonstrates that rental was merely another possible aspect of the proposed arrangements. As I have said, in its first bid, Star City had not offered rent for the permanent casino site, and the Authority had not asked Star City to include such an offer. Clearly, if a bidder "chose" to offer to pay rent, it was not to exceed market rental. I assume that the Authority was concerned that bidders might seek to inflate the rental in expectation of a tax benefit and did not wish to be involved in such conduct. However we were told in argument that the Loan Council may have been concerned about inflated rental payments. In any event, if a bidder were to offer rent, it was, at the option of the Authority, to be payable in advance on the 15-30-55 Payment Schedule and non-refundable. 146 To this point, as far as the evidence goes, the only valuation of the permanent casino site available to Star City was that performed for the Valuer General. Mr Vella said that at the time at which he saw that valuation, he had not turned his mind to the amount of rent to be paid. However he had "always realised that the obligation to pay rent would be a separate obligation from the obligation to pay a licence fee". If he meant that he had always expected to pay more than nominal rental, then such belief was, at least at face value, inconsistent with the first bid and his letter of 13 January 1994. He said that the valuation at $80 million did not "register in my mind [as] being of any particular significance". He believed that there was no valuer in Australia who could have valued "a development site for a casino of this major scale and location with any accuracy". Nonetheless, Star City subsequently relied on an "indicative assessment" prepared in Arthur Andersen’s Sydney office. Mr Vella thought that the figure of $80 million was "likely to be conservative". If rental were a significant aspect of the bid, one would have expected some attempt to ascertain an appropriate rental range before even a tentative bid. Further, one might have expected the topic to have been mentioned in the bid as another source of revenue for the Authority. Finally, if the Authority were anxious to ensure that it obtained no less than (as opposed to no more than) fair market value, one might have expected it to have obtained its own valuation, unless it was happy with the Valuer General’s valuation. Perhaps it did so, but there is no evidence of it. 147 On 16 March 2004 Mr Vella wrote to the Authority as follows:
The letter has been annotated [presumably by an officer of the
Authority]:
Mr Vella has been informed that the rent will not form part of the premium.
Under the proposed alternative, [Properties] would enter into a 99 year lease with the NSW Government for the premises upon which the Casino is to be located. [Properties] would then sublease the premises to [Star City]. For the first 12 years of the lease term (i.e. the period coinciding with the exclusive licence,) the rental payments would be approximately $15 million per annum. The rental payments would be approximately $250,000 for the remainder of the lease term. The lease would, however, contain two prepayment options providing for rental payments in respect of the first 12 years of the lease to be prepaid on certain dates at a discount to reflect the time value of money. The prepayment options would be exercisable within a short period, say 3 months, after the commencement of the lease. Exercise of the first prepayment option would result in the company prepaying the first 12 years rental on a single specified prepayment date, say, one month after exercise. Exercise of the second prepayment option would result in the prepayment of the first 12 years rental over three specified prepayment dates; being the dates of commencement of construction of the temporary casino, commencement of operation of the temporary casino and commencement of operation of the permanent casino, respectively.
148 On 17 March 1994 Arthur Andersen again wrote to Star City concerning the Second Specified Amount Duty which, as the writer again observed, had been originally intended to represent payment for rent over the period of the licence. It was suggested that an alternative approach would be to "more explicitly recognise the payment as a rental payment". The letter continued:
Periodic payments of rent will generally be regarded as being of a revenue nature and deductible to [Star City] on the basis that the payments will have been incurred by [Star City] in the carrying on of their business for the purpose of producing assessable income. Therefore, [Star City’s] rental payments in respect of years 13 to 99 (inclusive) of the lease term should be deductible to [Star City] on an annual basis. Provided the proposed payments for which [Star City] will become liable under its lease agreement are genuine lease rental payments incurred for the quiet possession and enjoyment of the lease premises, we believe that it is arguable that the prepayment under the prepayment option exercisable under the lease should also be of revenue character and hence deductible notwithstanding that the period for which prepayment is made is 12 years. In order to be considered as a genuine lease rental payment, we suggest that the rent should be reasonable justifiable on principles which an independent valuer would use in the given circumstances. If the rental payments under the lease agreement could not be so reasonably justified, an inference may be raised that the purpose for which the rental payments were agreed to be paid was something other than the quiet possession and enjoyment of the leased premises.
149 The writer advised:
(Original emphasis.)
Notwithstanding the above, it should be noted that the area of law concerning the extent to which a prepayment of a normally revenue expense could assume a capital nature is far from clear. Accordingly, there remains some risk that the ATO could seek to treat the prepaid rental as of a capital nature and, as such, non-deductible. This would be on the basis that the prepayment of the first 12 years’ rental lacks a significant (although not necessarily determinative) characteristic of a revenue nature, namely, that of periodicity.
150 The advice was subject to the following disclaimer:
To cover the event that the rental payments would become refundable in the future (whether by operation of law or by a judgment of a Court), [Star City or an associated company], would agree to indemnify the Authority for any loss which it suffers should the rental payments actually become refundable. This indemnity would be secured by way of bank guarantee.
151 The approach set out in this letter was, more or less, that adopted in Star City’s successful final bid. It was a refined version of the suggestion made in Arthur Andersen’s letter of 15 March 1994. It is, perhaps, curious that a process which commenced with the perception that the Authority wanted the Second Specified Amount Duty to be a tax rather than rent (see Arthur Andersen’s letter of 15 March 1994) should so quickly have become a process for making such payment look more like rent. The advice addressed the inevitable tension between maximizing the up front payments and taking advantage of the tax benefits usually available in connection with rental payments for commercial premises. The tie to the exclusivity period suggests a perception that the land would have a greater value (or would justify a higher rental) during the exclusivity period. Arthur Andersen’s proposal was qualified by the suggestion that the "rent" be "reasonably justifiable on principles which an independent valuer would use in the given circumstances". That this requirement (that rental be justifiable on valuation principles) was raised by way of qualification to the more general proposal suggests that the primary objective was not the payment of fair market rental, but the payment of a substantial up front amount. 152 On 21 March 1994 Messrs Dunhill Madden Butler, solicitors, issued an explanatory memorandum regarding the documentation and structure of the proposed transaction. There were to be two leases of the permanent casino site – the Construction Lease and the Permanent Site Lease, later described as the Permanent Lease. The former was to operate during construction of the permanent casino. The second was to commence on the completion of construction. According to the memorandum, rental pursuant to the Construction Lease was to be nominal. Concerning the Permanent Lease, it was said that "Rental payable under this Lease is yet to be agreed, and is determined as a part of the overall financial structuring of the bid." It was also said that, "[r]ental which will be payable under these leases is currently the subject of negotiation and ultimately the amount and manner of payment may reflect payments to be made in respect of the premium for the issue of the Licence." It is important to note that in an earlier draft of this document (dated 18 March 1994) the solicitors had said that under both leases, only nominal rental would be payable for the permanent casino site. This suggests that between 18 and 21 March 1994, the solicitors first became aware that the bid might include an offer of a substantial amount by way of rental, possibly reflecting a premium for issue of the casino licence. 153 On 31 March 1994 Arthur Andersen sent two letters to Star City. The first concerned the possible acquisition of a licence to use the copyright in certain Olympic Games intellectual property held by the Sydney Olympic Games Organizing Committee ("SOGOC"). The second letter concerned the possibility of making a tax deductible gift to "a qualifying authority". The proposed gift was to be made with the stated intention that it would be "included as part of the bid for acquisition of a licence to operate the Sydney Harbour Casino and would be consequent upon the Company being granted the Casino licence". 154 On 6 April 1994 Arthur Andersen sent a further letter. It set out six "alternatives" which had apparently been discussed at a meeting on that day. The first was, in effect, that mentioned in the letter of 17 March 1994. It was said, concerning this proposal, that:
As you would be aware, the Brief contemplates the payment by the Applicant of a "Fair Market Value Rent" either annually or as a commuted lump sum. Attachment 2 to Addendum No.34 defines the characteristics that payments must possess to be considered as forming part of the Financial Offer.
155 The second alternative was that the Authority construct the temporary casino and lease it to Properties. (It had been intended that the successful bidder would build the temporary casino on either private land or land leased from the Crown). The lease would contain a prepayment option under which the rental for the temporary casino could be prepaid in an amount sufficient to enable the Authority to fund such construction. Again there would be an indemnity in favour of the Authority for any loss which it might suffer in the event that rental repayments became refundable. 156 The benefit to be derived by the Authority from this approach is not entirely clear. Presumably, the rent would have been substantially higher than reasonable ground rental. The Authority would have the benefit of a substantial up front payment, but it would have to expend moneys in building the temporary casino. It may be that the offer reflected the perception that the Authority (or the government) had an immediate need for cash. 157 The third option also involved a lease of the temporary casino premises to Properties. Rent under the lease would accrue annually. The rental would be paid in two ways – a proportion would be paid by cash payments on due dates whilst the remainder would be "paid" by Properties performing certain work on the leased premises. Again, there would be an indemnity against loss by the Authority. Once again the precise commercial benefits are a little difficult to identify. Alternative 4 was the SOGOC copyright licensing proposal discussed in the letter of 31 March 1994. It was suggested that it would be valuable for Star City to align itself with the Olympic Games. Perhaps the government’s commitment to the Olympic Games had led the Authority (as proxy for the government) to seek to maximize up front payments. If so, then payment to SOGOC may have met the government’s needs. Alternative 5 involved an agreement with the government for the use of exclusive naming rights over certain Olympic facilities, with prepayment options. Alternative 6 involved an agreement to bear the annual operating costs of the Authority for the first five years of the casino’s operation. Payments could be made in advance. 158 It is not entirely clear whether all of these alternatives were intended to be possible alternatives to the Second Specified Amount Duty. However they all demonstrate that Star City was looking for various ways in which to make payments to the Authority or other government instrumentalities, preferably by way of up front payments. 159 On 7 April 1994 Arthur Andersen again wrote, identifying three further alternatives, alternatives 7, 8 and 9. Alternative 7 involved the payment of a supplementary annual licence fee during the occupation of the temporary casino, again with provision for prepayment. Alternative 8 involved a head lease over the permanent casino site from the Authority to an independent lessee nominated by Properties, which lease would provide for a premium to be paid upon grant. There would then be a sublease from the head lessee to Properties, providing for rental payments for the first 12 years, the rent being an unspecified number of million dollars. Thereafter the rental would be at a different amount per annum, but apparently not in the order of millions of dollars. Alternative 9 involved concurrent leases over the permanent casino site. 160 Star City forwarded copies of Arthur Andersen’s letters dated 6 and 7 April 1994 to the Authority. The Authority responded on 8 April 1994. Concerning alternative 1 (the payment of rental) the Authority said:
The Treasury have verbally advised the Authority’s consultants that payments of the type contemplated under Alternative 1 will be acceptable provided that they are supportable as being a "Fair Market Value Rent". In proposing payments in excess of the Valuer General’s upper estimate of $80 million as the value of the Casino Site as a casino, you will need to provide appropriate third party evidence from a qualified source. Treasury also advised that a proposed payment should not grossly exceed the above assessment of $80 million.
[Star City] are well aware of the probity requirements relating to the Casino and the exhaustive process that had been followed to ensure that on the announcement of the Preferred Applicant, the Authority knows who it is dealing with.
161 The reference to Addendum No 34 should probably be to Addendum No 36. Alternatives 2, 4, 5, 6 and 7 were said to be not acceptable to the Authority. Little interest was shown in alternative 3. As to alternatives 8 and 9, it was said that:
The casino duty payable pursuant to this Agreement, during the period of 12 years commencing on the date upon which casino operations commence at the Temporary Casino, is payable in 3 forms:
162 Nothing in the material explains the Authority’s requirement that the proposed rent not "grossly" exceed the Valuer General’s valuation of the freehold title. Perhaps it was thought that it would look odd if a lessee were to pay more up front by way of rental for a 99 year lease than the freehold title was worth. In the same letter the Authority advised that the Duty Agreement had been redrafted. As the letter was dated 8 April 1994, this was a reference to the third draft, also dated 8 April 1994. The requirement to pay the Second Specified Amount Duty had been deleted and the preamble re-drafted to recite the proposed payment of the First Specified Amount Duty payable pursuant to cl 4 and the Casino Duty – Base Amount, payable pursuant to cl 5. Recital D was amended to read:
(a) a once only fixed amount, payable in instalments in consideration of the issue of the Licence and the operation of the Casino Exclusivity Agreement;
(b) an annual casino duty and weekly casino revenue duty payable in respect of the operation of the casino (the annual duty being a fixed annual amount and the weekly casino revenue duty payable weekly as a percentage of Gross Revenue); and
(c) a community benefit levy payable weekly as a percentage of Gross Revenue.
... the casino duty payable in accordance with section 114 of the Act and clause 5 in respect of the operation of the Temporary Casino and the Permanent Casino in the annual amounts and on the dates specified in Schedule 3.
163 The term "Casino Duty – Base Amount" was defined to mean:
Rental payable under this Lease reflects in part a tax-effective payment of part of the premium for the issue of the Licence to [the Authority] and is determined as a part of the overall financial structuring of the bid.
164 The draft contained other provisions concerning weekly duty and the Community Benefit Levy. It seems that the First Specified Amount Duty was the payment contemplated in Recital D(a), being in consideration of the issue of the casino licence and the exclusivity arrangements. The Casino Duty – Base Amount was the payment contemplated in Recital D(b) and was apparently not to be part of the consideration for the grant of the licence and the exclusivity arrangements. Clause 5 provided that the Treasurer had determined that the Casino Duty – Base Amount be commuted to a present value amount and paid in three instalments in accordance with the 15-30-55 Payment Schedule. At least some of these amendments addressed the problems raised in Arthur Andersen’s letter of 15 March 1994. However there is no evidence that such letter was sent to the Authority. The third draft probably did not reflect or assume the proposed payment of rent. The Authority’s approval of that alternative was notified to Star City at the same time as the draft was forwarded. The final paragraph of the Authority’s letter suggested that further amendment might be necessary in light of the proposed alternative approaches. 165 On 19 April 1994, Dunhill Madden Butler issued a further explanatory memorandum. Concerning the lease of the permanent casino site it said:
The impact of taxation on casino operations in the Atlantic City are apparently half to those applicable to the Australian, and specifically those proposed for the Sydney casino. This therefore reflects the monopoly situation in the Sydney casino.
166 The apparent reference to "the issue of the Licence to [the Authority]" is the result of bad syntax. Clearly, the licence was to be issued to Star City. The payment was to go to the Authority. 167 On 21 April 1994 Arthur Andersen wrote to Star City, offering two bases for valuing the permanent casino site for rental purposes. The first relied upon information concerning a casino operated by Showboat Casino ("Showboat") in Atlantic City. Showboat was a member of the Consortium. Arthur Andersen first identified the annual rental paid pursuant to the lease of the land upon which the Atlantic City casino was situated. This showed rental varying from $US6.02 million in 1987 to $US8.03 million in 1993. Arthur Andersen understood the landlord’s assessment of the value of the land at the commencement of the lease to have been $US60 million, although rent was not payable until the completion of the casino in 1987. Thus it was suggested that the ratio of rent to land value was about one to ten. That casino had gross revenue in the calendar years 1992, 1993 and 1994 of $US238.7 million, $US290.1 million and $US305 million respectively. The annual rental for 2003 was $8.03 million, about 3% of revenue. Star City predicted that in 1998-1999, the Sydney casino would derive $719 million in gross gaming revenue, worth $563 million in 1994, using 5% as a discounting rate. Using the 3% relationship between rent and revenue produced an annual rental of $16.9 million. From this, assuming a general market ground rental yield of 9-10% in the Australian market, the value of the land would be between $170 million and $190 million, adopting a 5% discount rate, ie to bring the figure back to 1994 value. Using a 3% discount rate the figure would be $185 million to $210 million. The writer observed:
However, we stress that our analysis has been based on information provided to us and that no independent research has been conducted. The above analysis is intended as an informative outline and should not be construed as a formal valuation.
168 I do not fully understand this statement. However the last sentence suggests that the identified rental for the permanent casino site reflected the benefit of the exclusivity arrangements. 169 The alternative basis for valuation involved comparisons with other sites in the Darling Harbour area. In particular the writer focussed upon the Novotel Hotel over which there was a 99 year lease with a ground rental of $100,000 per annum plus 8% of room revenue. The writer understood that room revenue represented 75% of total revenue. Thus it was assumed that the ratio of ground rental to total revenue was 6% plus $100,000 per annum. The writer then identified the fees generally charged pursuant to hotel management agreements as being about 3% of gross revenue whilst a casino operator’s charge was said to be 1% of gross revenue "plus incentive". The projected revenue for the Sydney casino in 1998-1999 was $719.16 million for the casino and $209.43 million for non-gaming revenue. Using a discount rate of 5%, those amounts had 1994 values of $563.5 million for casino revenue and $164 million for non-gaming revenue. These figures were said to show an annual ground rental of $21.11 million and an estimated valuation of between $210 million and $235 million (using a 5% discount rate) or between $230 million and $250 million (using a 3% discount rate). They were said to be "indicative assessments based upon the limited information to hand", a "broad guide ... not to be construed as a formal valuation". The letter concluded as follows:
1. Payment within 21 days of the issue of the licence $256 million
170 As can be seen, Arthur Andersen’s "indicative assessments" varied substantially from the Valuer General’s 1993 valuation. The difference in approach is obvious. The Valuer General commenced with the value of the land and added an amount to recognize its potential for development as a casino. In other words, the valuation represented the price which a buyer would have to pay for the land as a potential casino site, but without the licence or the exclusivity arrangements. Arthur Andersen’s assessment was based upon the anticipated revenue to be derived from a casino operation on the site, assuming both a licence and the exclusivity arrangements. 171 According to Mr Snape, a "development director" advising the Authority, at some time prior to the submission of final bids, it orally advised the two remaining bidders that the maximum payment by way of rental which would be taken into account in assessing the financial offers was $125 million as at 1 July 1994. Any further amount would be disregarded. It is not clear to me how this figure could be reconciled with the requirement contained in the letter to Mr Vella dated 8 April 1994 that any such proposed payment should not "grossly exceed" the Valuer General’s valuation of $80 million. Mr McTigue, the valuer who prepared Arthur Andersen’s indicative assessment, said that he was not "directed to any particular number or value for the assessment". 172 The solicitors’ memorandum of 19 April 1994 was considered at a meeting of the Holdings board, held on 22 April 1994. At that meeting the final offer was approved. It was made on the same day. It is implicit in the minutes that the board expected Star City, as a wholly owned subsidiary, to give effect to its decision. 173 On 22 April 1994 Star City made its "final bid submission". Attached were documents headed "Conforming Financial Offer 1" and "Conforming Financial Offer 2". Conforming Financial Offer 1 was as follows:
within 21 days of the issue of the licence $120 million2. Prepayment of the Rental for the Permanent Casino Site
Total cash offer $376 million
NPV July 1994 $365 million
3. Lease rental payment on Temporary Casino
Total Rental Payment $10.6 million
4. Value to NSW Government of Residual Building
attached) $45.2 millionWorks on Temporary Casino site (refer WT letter
1. Payment within 21 Days of the issue of the licence $43.65 million 2. Payment before the commencement of the operations of the Temporary Casino but no later than 31 July 1995 $87.3 million 3. Payment before the commencement of the operations of the Permanent Casino but no later than 31 December 1997 $160.05 million 4. Prepayment of the rental for the first 12 years of the permanent casino licence within 21 days of the issue of the Licence $120 million Note: Above dates have been calculated on the assumption of the granting of the Licence by 28 October 1994. Total Cash Offer $411.01 million NPV July 1994 $365 million Other financial benefits to NSW Government 5. Lease rental Payments on Temporary Casino Total Rental Payment $10.6 million 6. Value of NSW Government of Residual Building works on Temporary Casino Site (refer WT letter attached) $45.2 million
174 Conforming Financial Offer 2 was as follows:
175 Attached to the offer was a further advice from Arthur Andersen dated 22 April 1994. It identified the "First Specified Amount Duty for Offer 1" being $256 million and, for Offer 2, $291 million. It advised that these amounts were payable by way of premium for the grant of the casino licence and therefore would be of a capital nature and not deductible for tax purposes. Arthur Andersen noted that there was provision for pre-payment of the rent for the permanent casino site. They considered that if no election were made, and the payments were made periodically, the amounts would be deductible. If the Authority elected to take the money in advance, it would nonetheless be "strongly arguable" that the payments were on account of rent and therefore deductible. 176 The Commissioner submits that in these bids Star City had effectively substituted its offer of pre-paid rent for the proposed Casino Duty – Base Amount in the draft Duty Agreement. It is convenient to set out the subsequent history of cls 4 and 5 of the Duty Agreement. A further draft was attached to the "Compliance Deed" executed by the Authority, Star City and others on 22 April 1994. In that draft, the term "First Specified Amount Duty" was replaced by the term "Specified Payment Amount". However the terms had the same meaning. Finally, prior to the ultimate execution of the Duty Agreement, at Star City’s request, cl 4.2 was amended to provide for payment of the whole Specified Payment Amount 21 days after the Licence Issue Date. Clause 5 (concerning the Casino Duty – Base Amount) was deleted as were all other references to such duty. 177 In view of the Commissioner’s submission concerning the substitution of a rental payment for a duty payment, it may also be relevant to consider the development of the terms of the lease documentation concerning rent. As far as I can see the earliest version of the lease documentation in evidence is attached to the Compliance Deed dated 22 April 1994. As I have said, there were to be two leases of the permanent casino site, the Construction Lease and the Permanent Lease. Pursuant to Schedule 1 to the Construction Lease, the lessor could elect to receive the rental for the first 12 years under both leases in one payment or three separate payments, all such payments to be made not less than one month prior to the grant of the casino licence. In such event, no further rental was payable for that period. I should add that some information concerning a proposed agreement for lease and lease had been provided in the Brief. I will refer to that information at a later stage. 178 Against the above background the Commissioner particularly relies upon three documents as evidencing the true purpose of the second payment, said to be for rent. They are: • the explanatory memorandum dated 19 April 1994, produced by Star City’s solicitors prior to Star City’s final offer; • a letter written by those solicitors to the New South Wales Office of State Revenue on 27 April 1994, five days after the offer; and • a letter from Star City to the Treasurer of New South Wales dated 13 December 1994. 179 The relevant passages are set out in the judgment of Goldberg J. I have already referred to the memorandum dated 19 April 1994. In the letter of 27 April 1994 it was said that Star City "is proposing to pay portion of the licence premium as consideration for the grant of the licence and portion as rent pursuant to the ‘Permanent Site Leases’ referred to below." It was also said, apparently concerning the possibility of prepayment of a lump sum by way of rent, that "commercially, payment is intended to be a portion of the licence premium to be paid to the Authority". The solicitors referred to cls 2.6 and 2.7 of the Permanent Lease, suggesting that "the commuted lump sum is refundable in circumstances of the early termination of the lease". Of course, pursuant to cl 1 pre-paid rent was only repayable if the parties so agreed. In the letter of 13 December 1994 it was said that "the rental prepaid under the terms of the Permanent Site Construction Lease only reflects the value of the Permanent Casino site if a casino licence is issued and, as such, forms part of the premium paid by [Star City] to obtain the licence ..." Mr Johnston, a former partner at Dunhill Madden Butler, said that the letter of 13 December 1994 was written on counsel’s advice for a reason unconnected with the present proceedings. However he did not suggest that any aspect of the letter was untrue. 180 As to the admissibility of these three documents, the first two were contemporaneous, or virtually contemporaneous, with Star City’s final bid. The third was written in December, but apparently in anticipation of the execution of the relevant documentation. Each was written on behalf of Star City. Each reveals Star City’s views as to the purpose of the second payment. Such views may not be conclusive existence of actual purpose but they must be some evidence of it. In my view each is admissible for present purposes. On the same basis I consider that the minutes of the Holdings board meeting held on 22 April 1994 are also admissible. This was the meeting at which the board considered the solicitors’ memorandum of 19 April 1994 and effectively authorized the final offer. 181 At [102] her Honour disposed of these very clear statements as to Star City’s understanding of the purpose of the second payment. Firstly, her Honour adopted observations which she had made at [61]-[63] concerning the memorandum of 19 April 1994. At that point her Honour was discussing a contractual construction point and the extent to which the "factual matrix" could be used in that exercise. As Goldberg J has pointed out, such considerations were not relevant to the process of determining the purpose for which the second payment had been made. Secondly, her Honour considered that all three documents were only part of the factual matrix, and that it was not open to the parties to "pick and choose" the matters upon which they relied. With all respect, it is entirely appropriate for a party to point to any aspect of the evidence which, it considers, may support its position. The other party may then identify other evidence which undermines that position.
OTHER EVIDENCE
182 Much of the above summary emerges from the evidence of Mr Vella, the evidence of Mr Johnston and the annexure to the primary judge’s reasons. Further evidence came from Mr Snape. He understood that the Authority always expected that any lease would be for fair market rental. The Authority certainly did not wish to receive more than fair market rent, but the evidence does not suggest any desire to maximize the rent to be received. Mr Snape conceded in cross-examination that bids were accepted, notwithstanding the fact that no rental was offered. No doubt the Authority appreciated the potential tax benefit to a bidder in characterizing a payment as rent and expected some such payment. Mr Vella had told Mr Snape that Star City considered that the value of the permanent casino site was considerably greater than $80 million. I have already referred to Mr Snape’s evidence concerning the upper limit for rent of $125 million. His evidence does not disclose how that sum was fixed. 183 Mr McTigue was largely responsible for the preparation of Arthur Andersen’s indicative assessment to which I have referred. In his affidavit he gave a little more detail concerning the process which he followed in preparing the assessment. He was not asked to provide a formal valuation. Had he been asked to do so, he would have scrutinized the cash flows to decide whether or not they were appropriate. As far as I can see he was not cross-examined.
APPEAL AGAINST FINDINGS OF FACT
184 I should say something about two specific factual "findings" which the Commissioner challenges on appeal. At [104] her Honour concluded that, "from the outset, not only was the need for a lease recognised, but the [Authority] stipulated that rent was a matter of negotiation to be determined on a ‘fair’ market rent." At [110] her Honour said: "As it happens, however, both the amount to be paid as rent and the terms on which rental would be paid were points of critical centrality in the negotiations between Star City and [the Authority] and matters about which [the Authority] (not Star City) had the ultimate decision". Again at [112] her Honour observed "But there are two considerations that remained consistent: the Casino would operate on leased land owned by the State and rent would be paid for use of those Premises." 185 These observations appear to be comments rather than findings of fact. In any event, I do not entirely agree with them. No doubt it was always expected that the terms of occupation of the permanent casino site would be agreed and recorded. However it does not follow, and the evidence does not demonstrate, that the Authority considered the amount of rental to be of "critical centrality" to the process. The Authority had said that the lease would provide for the payment of fair market rental and probably expected as much, given the potential tax advantage to the successful bidder of such an arrangement. However the requirement that any rental be a fair market rental was clearly a statement about the maximum rent to be paid, and not the minimum. The Authority was apparently willing to contemplate nominal rental for the permanent casino site. Star City was short listed on the basis of its amended first offer which contemplated only nominal rental. As I have said, there is no evidence that the Authority asked Star City to offer rent, either by amending its first bid or by making such an offer in its final bid. Further, as her Honour noted, the only bid in competition with Star City’s final bid did not involve the payment of substantial rent. The Authority seems to have considered the advantages and disadvantages of that bid as compared to Star City’s bid. There was no suggestion that the absence of an offer of rent necessarily disqualified it from consideration. 186 The Invitation Document and the Brief contemplated the payment of fair market rental either by periodic payments or up front payment. Addendum No 36 changed that position by requiring that it have the option to demand payment of any proposed periodic payments (including rental) according to the 15-30-55 Payment Schedule pursuant to which the whole amount would be payable on or before commencement of casino operations on the permanent casino site. It was also made clear that any risk as to tax deductibility would rest with the successful bidder. (See Part F3:1.1.4.) 187 Star City’s reasons for seeking Arthur Andersen’s advice in mid March 1994 are not known. The letter of 15 March 1994 was written on the day before the Authority published Addendum No 36 to the Brief. The letter seems to have been written in the context of the proposal in the second draft of the Duty Agreement that there be two up front payments. Star City’s first bid had offered two such payments, but only nominal rental for the permanent casino site. The issue of Addendum No 36 and Star City’s ultimate decision to offer rental may have been related. At the time the proposed application of the 15-30-55 Payment Schedule to rent may have been seen from either of two points of view. If, prior to the publication of Addendum No 36, a bidder had proposed to offer periodic rent, the possibility that the Authority might demand payment according to that Payment Schedule may have been a disincentive to such an offer because of the additional early commitment of capital and because of the possible adverse tax effect. On the other hand, if a bidder had not intended to offer rent, publication of Addendum No 36 may have encouraged it to do so in the hope that the Authority’s demand for advance payment might justify a claim to tax deductibility, the position which Star City has, in fact, adopted. It is not necessary that I speculate further about this matter. 188 The Commissioner also challenges the "finding" at [110] that the amount of the prepayment was fixed as the result of "hard bargaining" between Star City and the Authority. I do not understand the expression "hard bargaining" to mean anything more than bargaining bona fide and at arm’s length. As far as I can see the only bargaining done by the Authority with respect to rent was to stipulate that it be fixed at not more than fair market rental and, eventually, at not more than $125 million. However, as I have observed, the Authority seems to have at least contemplated the possibility that there would be no identifiable amount, or only a nominal amount, payable as rent. In my view there was no bargaining concerning the amount of rent. I accept that there was "hard bargaining" as to the amount of the overall bid. The documents suggest that a matter of great concern to the Authority was the amount of any up front payment. Star City and its advisers were conscious of the need to maximize such payment, but also of the possible loss of the tax advantage usually associated with the payment of rental for commercial premises. Of course, rental may be paid in advance and claimed progressively, as Star City has sought to do in this case. But there may be a question as to whether such a payment is really for quiet possession of the premises.
VALUATION EVIDENCE
189 I turn to the evidence as to value of the permanent casino site. We were told that at first instance, the Commissioner did not run a valuation case. However neither the Valuer General’s valuation nor Arthur Andersen’s indicative assessment may be simply overlooked. Presumably, the Valuer General’s valuation reflected an analysis of comparable sales or some other form of local knowledge concerning land values, with allowances for the increase in value with time and for the prospect that the site could be used as a casino, assuming that a licence was obtained. Arthur Andersen’s indicative assessment was based upon anticipated future revenue from the conduct of a casino on the site, with the benefit of the licence and the exclusivity arrangements. This question of the relationship between the valuation of the site on the one hand, and the licence and exclusivity arrangements on the other, had been foreshadowed by Question 12 in Addendum No 17 to the Brief. I have previously discussed that document.
DID STAR CITY INCUR THE OUTGOINGS?
190 I have previously set out the arrangements between Properties and Star City as to the occupation of the permanent casino site. Those arrangements led the Commissioner to conclude that Star City had not incurred the relevant outgoings. For the reasons given by the primary judge and by Goldberg J, I consider that conclusion to have been incorrect. It is not necessary that I say any more about it.
PURPOSE OF THE SECOND PAYMENT
191 Clearly enough, the Authority was offering a package comprising a 99 year lease of the permanent casino site, a casino licence and the exclusivity arrangements. It was anxious to maximize the up front and non-refundable financial benefit to be derived from "sale" of the package as opposed to the benefit of periodic payments over the term of the casino’s operation. The Authority’s concern inevitably influenced the structure of Star City’s bid. I infer that the Authority was not much concerned about the way in which bidders described the components of their bids, provided that there was no undue inflation of any rent component. The concern that the Second Specified Amount Duty be seen to be a duty probably reflected a concern that a bid at least recognize the provisions concerning casino duty and other payments prescribed by the Casino Control Act. Star City’s primary aim was to win the bidding contest. However, at least from March, 1994, it was also concerned with the tax advantage to be derived from making payments in the form of rent. Exploitation of that advantage might have enhanced Star City’s capacity to offer a winning bid. However the position would have been further complicated by the interest incurred or foregone in connection with the second payment. There is no evidence suggesting that Star City’s capacity to finance a winning bid depended upon the potential tax benefit. 192 It may be superficially unattractive to treat the payment of what is said to be fair market rental as not having been paid for the purpose of acquiring the right to quiet possession of the premises in question. However, in this case, that rental was only "fair" if the lessee also held the licence and the benefit of the exclusivity arrangements. That is because the rental was calculated on the basis of anticipated casino revenue to be derived with the benefit of those features. Star City’s bid was, in part, designed to acquire the licence and the benefit of the exclusivity arrangements, in effect a covenant by the State to pay damages suffered as the result of any future issue of a second casino licence within the 12 year period. Payment of greatly increased rental over the exclusivity period suggests that the increase was attributable to the acquisition of the benefit of such covenant. If that were not the case, then the consideration for acquisition of the exclusivity arrangements must have been included in some other aspect of the Star City bid. That would mean that Star City was offering to pay an increased rental in circumstances in which the increase had been brought about by its own expenditure under some other heading. Commercially, this seems most unlikely. The method of assessment of rent used by Arthur Andersen also suggests that the increased rental reflected the value of the licence and/or the exclusivity arrangements. 193 It is by no means uncommon for one party’s needs or preferences concerning a proposed transaction to affect the tax position of another party. The most obvious example is the choice by an owner of land to sell or lease it to a person who requires its use. The latter may seek to persuade the former to change his or her mind, perhaps by making one alternative more or less attractive. In the end, it is the owner’s decision. In the present case, the Authority chose a model for the transaction which included an element which was typical of a sale (substantial up front payments) and an element which was typical of a lease (a fixed term), thereby creating potential problems for Star City. 194 I see no sensible basis for apportioning the two up front payments amongst the licence, the exclusivity arrangements and the lease. The bidding process, with the emphasis on up front and non-refundable payments, strongly suggested that (excluding the offer of rental for the balance of the term) Star City made its bid, including the offer of the second payment, in order to acquire the overall package, and that the Authority accepted it on that basis. The three documents specifically relied upon by the Commissioner refer to a premium for the licence, but it seems probable that the term was used to include the exclusivity arrangements. The reference in the explanatory memorandum of 19 April 1994 to the rental being "a part of the overall financial structuring of the bid" suggests as much. The history of the bidding process suggests that the amount of rental was never of great moment to the Authority, provided that it did not exceed fair market rental. Star City seems not to have considered it to be a necessary element of the proposed transaction, at least in the earlier stages. In its first bid it did not offer rent for the permanent casino site. The Authority did not treat this as a problem or ask for such an offer. When it emerged as an issue, it was raised by Star City. At that time its significance was the tax deductibility normally associated with the rental of commercial premises, a benefit which would arguably not have been available if the same amount were paid as the Second Specified Amount Duty. 195 For present purposes the difficulty for Star City lies in: • the apparent connection between the rental, the exclusivity arrangements and the second payment; • the absence of any apparent desire on the part of the Authority to insist upon substantial rental; • the provision that the second payment be non-refundable; • the fact that the Authority accepted and considered bids which did not offer substantial amounts by way of rental; and • Arthur Andersen’s advice and the related correspondence with the Authority, suggesting that payment of rent was seen as an alternative to payment of the Second Specified Amount Duty and its replacement, the Casino Duty – Base Amount.
196 However one looks at it, it is impossible to avoid the conclusion that the up front payment of rent was offered, paid and received as part of the wider bid made for the purpose of winning the bidding contest for the package, including the award of the licence and the benefit of the exclusivity arrangements. For the reasons given by the Full Court in Jupiters Ltd v Commissioner of Taxation (2002) 118 FCR 163 at [31]-[32], any payment for those arrangements was of capital or of a capital nature. For similar reasons, payment for the licence should also be so characterized. Star City has not suggested that the matter should be disposed of upon the basis of any apportionment of the sum of $120 million as between rent and other aspects of the transaction. The whole of the payment was of capital or of a capital nature.
Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may - (a) ...
197 Section 177F(1)(b) relevantly provides:
(b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income – determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination....
198 The Commissioner has disallowed the deductions derived from the second payment. 199 The term "scheme" is defined in s 177A of the 1936 Act. The expression "the obtaining by a taxpayer of a tax benefit in connection with a scheme" is defined in s 177C. Schemes to which the Pt IVA applies are identified in s 177D. In s 177A(1) the term "scheme" is defined to mean:
(1) ...
(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b) any scheme, plan, proposal, action, course of action or course of conduct....
...
(3) The reference in the definition of "scheme" in subsection (1) to a scheme, plan, proposal, action, course of action or course of conduct shall be read as including a reference to a unilateral scheme, plan, proposal, action, course of action or course of conduct, as the case may be.
(4) A reference in this Part to the carrying out of a scheme by a person shall be read as including a reference to the carrying out of a scheme by a person together with another person or other persons.
(5) A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.
Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to: (a) ...
200 Section 177C(1) relevantly provides:
(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
...
and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:...
(c) ...
(d) in a case to which paragraph (b) applies – the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph.
This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that date), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia or partly outside Australia, where -
201 Section 177D provides:
(a) a taxpayer (in this section referred to as the "relevant taxpayer") has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
(b) having regard to -
(i) the manner in which the scheme was entered into or carried out;(ii) the form and substance of the scheme;
(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).
The schemes
202 For present purposes the Commissioner identifies two schemes, the "wide scheme" and the "narrow scheme". The wide scheme involved the following steps:
1. the receipt by the Star City Consortium in March and April 1994 of taxation advice from Arthur Andersen concerning:
(a) the deductibility of the Second Specified Amount Duty then provided for under the draft Casino Duty and Community Levy Agreement; and(b) the possibility of instead making that payment by way of rent for the permanent casino site;
2. the removal from the draft Casino Duty and Community Levy Agreement of reference to the payment of the Second Specified Amount Duty and a Casino Duty – Base Amount;
3. the insertion in the draft Construction Lease and draft [Permanent Lease] of provision for an up front payment by [Properties] of $120 million in lieu of "rent" for the first 12 years;
4. the execution by [Properties] and by the [Authority] of:
(i) the Construction Lease on 14 December 1994; and
(ii) the [Permanent Lease] in 1997, which included provision for an up front payment by [Properties] of $120 million in lieu of "rent" for the first 12 years;
5. the execution by [Properties] and Star City of the Occupational Licence Agreement on 14 December 1994;
6. the making of the prepayment to the [Authority] on 15 December 1994.
The Commissioner is under no obligation to show a series of steps to prove a scheme. However, if (as here) he elects to rely upon multiple actions, there must be a connection between those actions because otherwise they do not constitute "a scheme, plan or course of action": Commissioner of Taxation (Cth) v Peabody (1994) 181 CLR 359 at 382-384 and Hart [Federal Commissioner of Taxation v Hart (2004) 217 CLR 216] at [43] and [55].
203 The narrow scheme identified by the Commissioner comprised steps 1, 3, 4 and 5 above. 204 It seems that Star City was incorporated prior to the first bid which was made in its (then) name. Thus it is reasonable to infer that subsequent conduct by the Consortium in connection with the bid was performed on its behalf. In those circumstances, steps 1, 2 and 3 of the wider scheme were the actions of Star City. Steps 2 and 3 were also the actions of the Authority. Step 4 was taken by Properties and by the Authority. Step 5 was taken by Properties and Star City. Step 6 was taken by, or on behalf of, Star City. The payment was received by the Authority. 205 It may be difficult to fit these elements, taken together, into para (a) of the definition of "scheme" in s 177A(1). The various terms used in that paragraph may arguably assume a common purpose or other meeting of minds in a multilateral transaction. However the expressions used in para (b) are to different effect. Sections 177A(3) and 177A(4) demonstrate that such conduct may be unilateral or multilateral. Whilst a scheme, plan or proposal may involve some integrated purpose, an action, course of action or course of conduct need not. It is not necessary that all participants participate in all elements of the scheme. Both the wide and the narrow schemes involved actions by Star City, the Authority and Properties. Other persons may also have been involved - Arthur Andersen in giving advice and other members of the Consortium. That is of no consequence. 206 No point was taken concerning the distinctions between the wide and narrow schemes. The exclusion of step 2 from the narrow scheme may have reflected a perception that on one view, it was not a necessary step in obtaining the tax benefit. Similarly, it may have been thought that the assumption of the obligation to pay, rather than its discharge, was the significant aspect, so that step 6 could be excluded. 207 At first instance counsel for Star City conceded that both schemes were capable of being schemes for the purposes of Pt IVA. I take that to be a concession that the requirements of subs 177A(1) were met. I agree with Goldberg J that the primary judge ought to have acted upon such concession. I suspect, however, that the apparent failure so to do merely reflected her Honour’s conclusion that the Pt IVA case should fail for other reasons. In those circumstances the primary judge took an appropriate opportunity to demonstrate her disagreement with the concession made by Star City. In any event, I do not share her Honour’s concerns in this regard. Although I propose to proceed upon the basis that the concession was properly made, I shall state my reasons for rejecting those concerns. 208 As the primary judge observed, the definition of the term "scheme" is very broad. It includes both unilateral and multilateral conduct. The terms "action", "course of action" and "course of conduct" suggest that Parliament intended to include virtually any action or collection of actions in the definition of the word "scheme". At [126] her Honour observed that:
The reference to circumstances being "robbed of all practical meaning" appears to have been misunderstood in the Full Court in the present matters as a criterion which must be applied in deciding whether there is a scheme to which Part IVA applies. That is not right. First, it is far from clear what legal test is intended by saying that a scheme must "stand on its own feet". It is not clear how the metaphor is to be translated into legal principle. Secondly, as the Full Court pointed out in the present matters, the words "robbed of all practical meaning", which were adopted in Peabody, were taken from Inland Revenue Commissioners v Brebner. There they were used in a very different context and with a clearly intended meaning ... What Lord Pearce said would be "robbed of all practical meaning", if one part of an arrangement were to be isolated from other parts, was the subsection, not the arrangement. Thirdly, and most importantly, there is no basis to be found in the words used in Part IVA for the introduction of some criterion additional to those identified in the Act itself. There is no reference to a scheme having some commercial or other coherence. Far from the Part requiring reference only to the purpose of those who carry out all of whatever is identified as the scheme, s 177D(b) specifically refers to it being concluded "that the person, or one of the persons, who entered into or carried out ... any part of the scheme" did so for the purpose of enabling the relevant taxpayer (alone or with others) to obtain a tax benefit in connection with the scheme ...
209 This statement seems to imply that the Court need not consider the operation of ss 177C, 177D and 177F unless there is a demonstrable connection between or amongst the various steps. In other words the requirement for such connection will not be satisfied by the conclusion that a relevant taxpayer derived a tax benefit from the various steps, which benefit would not otherwise have been derived (as contemplated in s 177C), or that a relevant person may have intended that such taxpayer derive that benefit from those steps or any of them (as contemplated in s 177D). The primary judge apparently considered that the steps of a scheme must be bound together by some other "connection". Her rejection of the schemes identified by the Commissioner suggests that shared subject matter is also insufficient. 210 The primary judge’s reference to Federal Commissioner of Taxation v Hart (2004) 217 CLR 216 is to the reasons of Gummow and Hayne JJ in that case. It seems unlikely that their Honours meant to imply that s 177A requires that there be a "connection" between or amongst the elements of a scheme independent of any such connection emerging from the operation of s 177C or s 177D. At [47] their Honours referred to the passage in Commissioner of Taxation (Cth) v Peabody (1994) 181 CLR 359 to which her Honour referred and observed:
211 I take the expression "commercial or other coherence" to be virtually synonymous with the word "connection" used by the primary judge. See also the reasons of Callinan J at [89]-[90]. 212 In Hart at [6] Gleeson CJ and McHugh J observed that identification of the tax benefit and of the scheme may be inter-related. This will often be the case. A claim for a deduction will frequently attract the Commissioner’s attention. Sections 177C and 177F assume a deduction which is allowable, absent a determination by the Commissioner under the latter section. The steps of any scheme will emerge from a consideration of the circumstances which led to such deductibility. Those circumstances may or may not satisfy the requirements of s 177A. 213 I do not agree with the primary judge that a connection linking the steps of an alleged scheme must be shown before those steps can be so characterized for the purposes of s 177A. In any event I see no difficulty in "connecting" the various steps in the present schemes. The Commissioner has identified the steps by which, as he alleges, Star City converted a payment which would probably have been of capital or a capital nature into an allowable deduction. The scheme, as alleged, had three parts. The first was its genesis in the advice received from Arthur Andersen. The second comprised the amendments to the proposed draft documentation. The third was its consummation in the execution of the various documents which created an obligation to pay rent (which obligation Star City was obliged to meet pursuant to the Occupational Licence Agreement) and the second payment. As the primary judge observed, other evidence may detract from the capacity of a particular series of steps to be characterized as a scheme, but that is not the present case. 214 In concluding that there was no connection binding together the steps in the postulated schemes, the primary judge seems to have relied heavily upon three matters which she described as "objective facts and matters". They were: • that there was always to be a lease of the permanent casino site; • that from the outset, the Authority had retained the right to require payment of the rent in one or more instalments; and • that the State of New South Wales was at all times attempting to maximize its commercial outcome and, to that end, adopting an increasingly demanding stance about the terms on which the transaction was to be concluded.
215 For present purposes it may be accepted that the first and third propositions are correct. Whilst it may be said that from the outset, the Authority "retained the right" to require payment of rent in one or more instalments, in the sense that it could have demanded that such payment or payments be a condition of any bid, potential bidders may or may not have been willing to bid on that basis. Her Honour identified five documents said to demonstrate the Authority’s retention of a "right" to obtain a lump sum payment of rent. The first was the Invitation Document, particularly at para 3.6 which is set out at [10] above. The second was the Brief at para 5.3 in Section F1:5 and Part G. Paragraph 3.6 of the Invitation Document and para 5.3.2 of the Brief contemplated either annual rental payments or "an up-front capitalised lease payment" but indicated no preference. Part G of the Brief contained outlines of the proposed documentation of the transaction. Section G3 dealt with an "agreement for lease", apparently an earlier description of the Construction Lease. Section G4 dealt with the Permanent Lease. Paragraph 1.18 of Section G3 and para 1.3 of Section G4 provided that under both documents rent would be payable in advance, and that such rent was non-refundable if the lease were terminated other than by mutual agreement. Her Honour seems to have understood these passages as contemplating payment of rent in a lump sum in advance. I do not agree. The references to payment of rent in advance referred, in my view, to provisions of the kind usually found in leases requiring payment of periodic rental in advance of the period to which it relates, rather than to any requirement that rent for the whole term be paid in advance. Since the Brief itself provided for either periodic payment of rent or an up front payment, it seems most unlikely that it was intended further to limit the options available to bidders by contrary statements in the description of the proposed documentation. 216 Her Honour also referred to the draft Permanent Lease attached to the Construction Lease and to the Permanent Lease as executed. Both provided for payment of the rental in one lump sum. However, as far as can be seen from the evidence, those provisions first appeared at or about the time of Star City’s final bid, by which time it was clear that it proposed to offer such a payment. None of these documents detracts from the proposition that at least in the earlier stages, the possibility of periodic payment of rental was in contemplation. Similarly, they do not detract from the proposition that the Authority had at least contemplated the possibility that it would receive only nominal rental. I am unable to conclude that the Authority, from the outset, retained a right to demand that there be rent or that it be paid in advance. As far as I can see, the first suggestion that it would insist on payment in advance was in Addendum No 36 dated 16 March 1994 where the Authority required that it have an option to demand payment of all periodic payments on the 15-30-55 Payment Schedule. The second draft of the Duty Agreement dated 24 February 1994 may have been a precursor to that approach, but it was not clearly so. 217 I do not consider that these matters detract in any way from the capacity of the steps identified by the Commissioner to constitute a scheme. In any event I proceed on the basis of the concession made by counsel for Star City.
A tax benefit
218 Section 177C provides that, for the purposes of Pt IVA, a taxpayer will obtain a tax benefit in connection with a scheme if: • a deduction is allowable to the taxpayer in relation to a year of income; and • the whole or part of that deduction would not have been allowable (or might reasonably be expected not to have been allowable) if the scheme had not been entered into.
As noted earlier, the Commissioner’s reliance upon and characterisation of these events is inaccurate. As the summary of the Bid Process (the ‘surrounding circumstances’ or ‘background’) records, the Star City Consortium did have a choice – continue to make its bid by offering the Specified Payment Amount of $256m and rent for the leases or to amend its bid to include the Specified Payment Amount of $256m, the Casino Duty – Base Amount and nominal rent. The Star City Consortium chose not to amend its bid. But that is not the end of the analysis for the purposes of identifying the tax benefit for the purposes of s 177C. The question posed by s 177C is what might reasonably be expected to have happened if the scheme had not been entered into or carried out?
219 The relevant deductions are those claimed pursuant to s 82KZM in the relevant tax years. Section 177C contemplates a deduction which will be allowable in the absence of a determination pursuant to s 177F. It is therefore necessary to assume that my conclusion as to the nature of the second payment is wrong, and to proceed upon the basis that it was, in reality, the payment of rent in advance. In other words, I assume that it was incurred for the purpose of securing quiet enjoyment of the permanent casino site for use in gaining or producing assessable income, or in conducting a business for that purpose. The next question is whether the deductions would not have been allowable, or might reasonably be expected not to have been allowable, had the scheme not been entered into or carried out. Such an inquiry necessarily involves an inquiry as to events which may have occurred had there been no scheme. To the extent that there is any absence of evidence as to such events, the Commissioner relies upon the provisions of s 14ZZO(b)(i) of the Administration Act, placing the burden of proof upon Star City. 220 The Commissioner submitted at first instance that absent the scheme, Star City would have paid the Specified Payment Amount, the Casino Duty – Base Amount and nominal rent for the permanent casino site. The primary judge concluded that this "alternative postulate" was not "reasonable". To some extent this conclusion appears to have been based upon the "objective facts and matters" identified above at [105]. The Commissioner contended that once the Authority had indicated (on 8 April 1994) that it would only accept the first alternative identified by Arthur Andersen in its letters of 6 and 7 April 1994 (advance payment of rent), Star City could only proceed in that way or pay the Casino Duty – Base Amount as contemplated by the third draft of the Duty Agreement. Given that final bids were due on 22 April, there were certainly only limited opportunities to develop new options and obtain the Authority’s views. The Commissioner, in effect, argued that in response to the second draft of the Duty Agreement providing for the First Specified Amount Duty and the Second Specified Amount Duty (to be paid in one non-refundable lump sum), Star City sought advice from Arthur Andersen with respect to the deductibility of such amounts. The Commissioner submitted that the advice raised "... apparently for the first time and in the context of tax structuring, the possibility of omitting the Second Specified Amount Duty and replacing it with a form of commuted ‘rental payment’ ". 221 Her Honour considered that this "contention" was "incomplete and, for that reason, inaccurate". It was said to be incomplete because it omitted the "objective facts and matters" to which her Honour had previously referred. The possibility of a commuted rental payment had certainly been contemplated from the beginning of the bidding process. However the Commissioner was addressing the substitution of such a payment for the Second Specified Amount Duty contemplated in the second draft of the Duty Agreement. It seems likely that Star City and the Authority understood that the requirement for the First and Second Specified Amount Duty payments reflected, or at least was consistent with, the structure proposed in Star City’s first bid. As far as I can see the Commissioner was correct in submitting that replacement of the Second Specified Amount Duty by a lump sum payment of rent was first raised in Arthur Andersen’s letter of 15 March. That is not to say that the possibility of paying rent in advance had not been previously mentioned. 222 Following Arthur Andersen’s formulation of the nine alternatives and the Authority’s indication that it would accept only the first of them, Star City chose to offer prepayment of rent rather than payment of the Casino Duty – Base Amount and executed the Compliance Deed to which the third draft of the Duty Agreement was attached. I infer that in so doing, Star City acted on Arthur Andersen’s advice and the Authority’s intimation. 223 The Commissioner also relied upon a subsequent letter dated 3 May 1994 from Star City to the Authority requesting amendments to the Duty Deed, in particular the deletion of references to the Casino Duty – Base Amount. The letter asserted, in relation to the Permanent Lease, that the lump sum payment would discharge the obligation to pay rent under the lease, save for the payments of $250,000 per year. It is possible that the writer incorrectly considered that the rent of $250,000 was payable during the 12 year term as well as thereafter. On 6 October 1994 the Compliance Deed was amended to remove reference to the Casino Duty – Base Amount and to include provision for payment of substantial rent. The need to deal with these matters certainly arose out of the substitution of the second payment for the Casino Duty – Base Amount which had, in turn, replaced the Second Specified Amount Duty. In addition, the Commissioner relied upon the Authority’s analysis of the competing bids and the fact that the only competing bid had provided for payment of the Casino Duty – Base Amount and had not provided for the payment of substantial rent. As I have observed, the analysis does not suggest that absence of rental was treated as disqualifying the competing bid from further consideration. 224 At [144] her Honour observed:
The "only" alternative relied upon by the Commissioner is not something which in the words of s 177C "might reasonably be expected to have happened if the scheme had not been entered into or carried out".
225 This passage is a little difficult to understand. It may be that her Honour meant that between 8 and 22 April, Star City formed and adhered to a plan to offer a lump sum payment of rent and persisted in that course after making its final bid on 22 April. The two alternatives mentioned by her Honour seem to have been that which Star City adopted and the alternative postulated by the Commissioner. Her Honour then observed:
The alternative postulate must be reasonable. It must be demonstrated that it was reasonable to expect not only that Star City could have structured the alternative in the manner contended but also that the [Authority] would have accepted that alternative. Only if both conditions are satisfied, might it reasonably be expected that that other arrangement might have happened. In the present case, neither condition is satisfied. The Star City Consortium did not offer it and, no less importantly, the [Authority] did not seek it or choose it. Thus, there was no relevant tax benefit under either scheme.
226 In other words her Honour considered that it was not reasonable to expect that, absent the scheme, Star City would have offered to pay the Specified Payment Amount Duty, the Casino Duty – Base Amount and nominal rent. Her Honour observed that Star City had suggested three alternative methods for payment of the rent, presumably the periodic payment, payment pursuant to the 15-30-55 Payment Schedule and one lump sum payment. Her Honour then observed that the Authority "exercised the right it retained from the outset to elect to receive the payment of rent up front". In my view it elected to exercise the option which Star City conferred upon it in its final bid, an entitlement which the Authority had not indicated that it would require prior to the issue of Addendum No 36. In that document it indicated that it required an option to receive any periodic payment pursuant to the 15-30-55 Payment Schedule. That requirement did not apply exclusively to rent. 227 Her Honour then observed that the Commissioner’s postulate was "... not one of the alternative methods proposed by [Star City]. Moreover it was not an alternative that the [Authority] required." I understand her Honour to have meant that if the Commissioner’s postulate was reasonably to have been expected, it would have been proposed as a possible alternative by either Star City or the Authority and that, therefore, "the objective facts" (that neither did so) do not support the Commissioner’s contention. Her Honour considered that it was "interesting but irrelevant" that the only competing bid had included payment of the Casino Duty – Base Amount and observed at [146]:
228 I accept that the actual proposals made by Star City and the Authority offer some evidence as to alternatives which may have been adopted had Star City not entered into the scheme. However I would have thought that evidence of the content of the other bid would also have been relevant on the same basis. That such evidence may have been relevant does not mean that it conclusively and exhaustively demonstrated all alternatives which might reasonably have been expected. 229 To my mind the alternative postulated by the Commissioner was, in effect, in accordance with the structure suggested in the second and third drafts of the Duty Agreement. Clearly, the Authority required substantial up front payments. At least from the date of the second draft of the Duty Agreement there was provision for two such up front payments by way of duty. The Authority may not have required that there be payment of the Second Specified Amount Duty or the Casino Duty – Base Amount, but it certainly contemplated that possibility. Star City seems not to have considered departing from its proposal to pay nominal rental until the middle of March 1994. As late as 18 March 1994 Star City’s solicitors understood that it intended to offer nominal rental. Her Honour’s observations reflect her view that the Authority always intended to insist upon the payment of fair market rental rather than nominal rental. I disagree with that conclusion. Perhaps not consistently, but particularly between 13 January 1994 and mid-March or early April, 1994, the Authority must have contemplated the possibility that it would receive only nominal rental for the permanent casino site. If it required rent, it surely would have said so expressly. Had it done so, there would be evidence of it, given the onus of proof borne by Star City. Further, the Authority was content to consider the only bid in competition with Star City’s final bid, notwithstanding the fact that it did not include an offer to pay substantial rent. 230 In those circumstances there is much to be said for the Commissioner’s submission that as a matter of probability, after 8 April 1994, the options available to Star City were to offer the Specified Payment Amount and the Casino Duty – Base Amount, with nominal rental for the permanent casino site, or to replace the Casino Duty – Base Amount with a lump sum payment of rent. In assessing whether the Commissioner’s alternative postulate is reasonable one must keep in mind the fact that prior to Star City’s final bid, Arthur Andersen had identified the possibility that an advance payment of rental might not attract the desired deductions. Even in their final letter dated 22 April 1994 (although some of its pages are dated 21 April 1994) Arthur Andersen said only that the deductibility of a lump sum payment pursuant to a s 82KZM was "strongly arguable". Such advice inevitably conveyed the possibility that the argument might fail. Star City made its final bid, accepting that possibility. Whilst such acceptance is not relevant to the question of whether or not the payment was deductible, it is relevant to the identification of the course which Star City may have adopted had it not entered into the scheme. 231 Mr Vella had been anxious to ensure that Star City did not spend too much money on the bidding process until it was "in with a real chance of winning". By April 1994 Star City was committed to winning the bidding process and had no doubt spent substantial amounts of money in seeking to do so. In that context it is understandable that it should have been content to bid, knowing that although the tax deductibility of the up front payment of $120 million was "strongly arguable", it was not guaranteed. Star City was willing to take the risk that, in the event that its bid succeeded, it might not derive the expected tax benefit. It seems probable that had it not adopted the rent alternative, it would simply have made the up front payments in the way contemplated in the third draft of the Duty Agreement. 232 Of course Star City might have sought to improve its prospects of obtaining a tax benefit from any rental payment by deleting or varying one or more of the features of the bid which led to doubts about the true nature of the second payment: up front, lump sum payment, the increased rent which was clearly based upon acquisition of the licence and the exclusivity arrangements and the fact that the rent was non-refundable. Arthur Andersen had stressed that payments for rent should be "genuine rental payments incurred for the quiet possession and enjoyment of the rental property". Without suggesting that Arthur Andersen’s indicative assessment was other than that which it purported to be, I would have expected Star City to have at least considered changing its proposals concerning rent in order to improve its prospects of securing the tax benefit, if to do so were consistent with its desire to win the bidding process. That Star City did not so proceed suggests that it feared that such a course might have compromised the prospects of its bid succeeding. In those circumstances it could not reasonably be expected that Star City would have taken that course. As I have previously observed, Star City has not sought to demonstrate that the anticipated tax benefit was critical to its financial capacity to make a winning bid. 233 I conclude that had the scheme not been entered into or carried out, the amount of $120 million would probably have been offered as the Casino Duty – Base Amount and accepted as such. There was no reason for Star City to act otherwise. It has not been suggested that in those circumstances such payment would have been an allowable deduction. I conclude that it would not have been, or might reasonably be expected not to have been, deductible, either in total or in instalments pursuant to s 82KZM.
Dominant purpose
Objection was also taken to what was said to be the artificiality of the selection of part of the overall transaction as the scheme. This, it was said, was not warranted by Peabody or Spotless. The artificiality was said to result from the fact that the overall transaction was for the clearly commercial purpose of financing the Group’s participation in the takeover bid for BAT. However, as was held in Spotless, a person may enter into or carry out a scheme, within the meaning of Part IVA, for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit where that dominant purpose is consistent with the pursuit of commercial gain in the course of carrying on a business. The fact that the overall transaction was aimed at a profit making does not make it artificial and inappropriate to observe that part of the structure of the transaction is to be explained by reference to a s 177D purpose. Nor is there any inconsistency involved, as was submitted, in looking to the wider transaction in order to understand and explain the scheme, and the eight matters listed in s 177D.
234 My view concerning the operation of s 177C leads to the conclusion that the requirements of s 177D(a) have been satisfied. The remaining question is whether, having regard to the matters identified in s 177D(b), it would be concluded that any person who entered into or carried out the scheme, or any part of the scheme, did so for the dominant purpose of enabling Star City to obtain a tax benefit in connection with it. Conduct by members of the Consortium, Properties and/or Star City will be primarily relevant in this respect. The various criteria identified in s 177D(b) are broadly drawn. They are intended to ensure that any decision as to purpose is made on the basis of objective considerations. See Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (2001) 207 CLR 235 at [95]. 235 The primary judge concluded that any scheme was not accompanied by the requisite dominant purpose, and that to conclude otherwise would be "to ignore the facts that the form and manner of the transaction were in large part constrained by considerations not subject to Star City’s control". This was a reference to the fact that the structure of the transaction was, to a large extent, dictated by the Authority. That fact does not necessarily exclude the operation of s 177D. In Consolidated Press at [96] the High Court said:
236 Where one party, in order to obtain a desired commercial benefit, deals with a second party, it frequently must accede to terms sought by that second party. Agreeing to pay the asking price is an example of this. Such agreement will be, at least in part, for the purpose of acquiring the desired benefit. It does not follow that the dominant purpose of every aspect of the transaction will necessarily be for that purpose. If one party convinces another party to agree to terms which confer a tax benefit on the former, then Pt IVA may be engaged. As Gleeson CJ and McHugh J pointed out in Hart at [15], the relevant question is as to the dominant purpose. In any event, as I have said, I consider that the decision to offer rental in advance was Star City’s. The evidence does not persuade me that the ultimate shape of the transaction, in so far as concerns the purpose of the second payment, was dictated by the Authority. It is more accurate to say that the Authority was willing to accommodate Star City’s proposal that the second payment be described as being for rent. 237 In determining the dominant purpose, relevant conduct is to be assessed by reference to the considerations identified in s 177D(b) and in light of the overall transaction of which the scheme formed part. See Consolidated Press at [96].
The manner in which the scheme was entered into or carried out
238 The correspondence demonstrates that by March 1994, Star City and its advisers were concerned about the tax implications of the proposed transaction. This concern provoked numerous suggestions as to ways in which a tax benefit might be derived, including the up front payment of rent. The second draft of the Duty Agreement was re-drafted by varying the recitals, removing the requirement for payment of the Second Specified Payment Duty and inserting the requirement for payment of the Casino Duty – Base Amount. 239 The circumstances surrounding the valuations of the permanent casino site were also part of the manner in which the scheme was carried into effect. Given the existence of the Valuer General’s valuation it was, as I have previously observed, surprising that Star City should have been willing to act upon Arthur Andersen’s indicative assessment, given that it varied substantially from the earlier valuation, and given Mr Vella’s doubts concerning the capacity of an Australian valuer to value the relevant site. Nonetheless, in what seems to have been a very short period of time, the indicative assessment was accepted at face value as the basis for the final bid, or at least so I infer. I do not mean to detract in any way from the validity of the indicative assessment. However one might have expected at least some attempt to reconcile the two differing approaches to such an important matter. 240 Another relevant matter is the content of the various explanatory memoranda prepared by the solicitors. Clearly, at some stage, Star City instructed its solicitors that nominal rental was to be paid for the permanent casino site. This was reflected in the draft memorandum dated 18 March 1994. The memorandum issued on 21 March 1994 indicated that rent was to be the subject of negotiation but recognized the possibility that it might reflect payment of a premium for the issue of the licence. The memorandum dated 19 April 1994 confirmed that "commercially, payment is intended to be a portion of the licence premium to be paid to the Authority". That appears to have been the basis upon which the board of Holdings acted in deciding to make the final bid. 241 Finally, there is the way in which the proposal for nominal rent became a proposal for substantial rental. It has not been demonstrated that the change in approach was demanded by the Authority. Hence it cannot be said that the change was necessary in order to obtain quiet possession of the permanent casino site. There seem to have been only two possible reasons for it. It may have been caused by a perception that the anticipated tax benefit would allow Star City to offer more than it could otherwise afford and so enhance its prospects of winning. Alternatively, Star City may have decided that it should try to obtain the tax benefit normally associated with the payment of rent for commercial premises, notwithstanding the difficulties posed by the Authority’s insistence upon up front payments. Star City has not sought to establish that the tax benefit was necessary in order to maximize the overall amount which it could offer. That it offered to pay rent in advance, notwithstanding the fact that such deductibility was not certain, suggests that availability of the deduction was not critical to the viability of the bid. In other words the purpose was not to enable the bid to be made. The alternative is that the purpose was to obtain a tax benefit, although success in so doing was not assured.
Form and substance
242 I have previously concluded that whilst the form of the transaction may have been by way of payment of rent, the substance was otherwise. Nonetheless, for present purposes I must assume that the payment was deductible. If the sole purpose had been to obtain the tax benefit, Star City would almost certainly not have offered lump sum rental, nor would it have agreed to its being non-refundable. Taken in isolation these considerations militate against the conclusion that the dominant purpose was to secure the tax benefit. However they must be considered in light of the overall transaction, Star City’s wider purpose and the Authority’s enthusiasm for large, up front payments.
Other considerations
243 As to the time at which the scheme was entered into and the length of the period during which it was carried out, I observe only that had the issue of rent been significant, it is remarkable that it was not addressed in the first offer. The results of the scheme in relation to the operation of the Act and Star City’s financial position are obvious. I need not comment further upon them. Similarly, I need not comment further upon any change in the financial position of Star City or any other person. There is nothing relevant to be said about the connection between Star City and any other person.
Conclusion on the Part IVA case
244 In my view Star City’s election to offer the second payment as rental was based upon its acceptance of the Authority’s desire to maximize the up front benefit to it and to the State. There had always been the option of paying substantial rent. However the evidence suggests that Star City did not decide to do so until April 1994. As far as the evidence goes the decision made no difference to the effective amount of its bid or, therefore, to its prospects of success. Star City’s dominant purpose in entering into the scheme and carrying out its part of it, must have been to acquire the tax benefit. To the extent that it may be relevant, the members of the Consortium and Properties must have had similar dominant purposes. Again, Star City has not argued for any approach based on apportionment of the claimed deductions.
PENALTIES AND TAX SHORTFALL ASSESSMENTS
245 Pursuant to s 226 of the 1936 Act, the Commissioner imposed penalties at the rate of 50% in connection with each relevant year of income prior to that ending 30 June 2000. For subsequent relevant years of income, the Commissioner assessed tax shortfall penalties pursuant to s 284-145 of Pt 4-25 of the Administration Act, again at the rate of 50%. As her Honour resolved the matter in favour of Star City she set aside all such penalties and assessments. However, in the course of so doing, she indicated that the proper penalty rate in each case should have been "at the most" 25%. Her conclusions concerning the appropriate rate appear not to have been included in the perfected orders. In paras 14 and 15 of the amended notice of appeal the Commissioner asserts that the primary judge erred in finding that the relevant legislation did not authorize the imposition of the penalties which he had imposed. However counsel for the Commissioner made no reference to penalties in the course of oral or written submissions. Counsel for Star City raised the matter in oral submissions, pointing out that the matter had not been addressed. Counsel for the Commissioner did not respond. 246 It may be as well, in the circumstances, if the parties have liberty to make further submissions as to orders concerning penalties.
PUBLICATION OF EVIDENCE
The Court may, at any time during or after the hearing of a proceeding in the Court, make such order forbidding or restricting the publication of particular evidence, or the name of a party or witness, as appears to the Court to be necessary in order to prevent prejudice to the administration of justice or the security of the Commonwealth.
247 The Authority filed written submissions seeking an order pursuant to s 50 of the Federal Court Act. That section provides:
248 At the end of the hearing the Court made an interim order restricting publication of a document entitled "NSW Treasury Comments on Casino Bids" dated 2 May 1994. This was done on the motion of counsel for the Commissioner, acting at the request of the Authority. The Authority now asks that such order be made permanent. 249 As I understand the Authority’s submissions, the relevant document was obtained by the Commissioner using his statutory powers. It was tendered as part of the five volumes of documents (Ex 2) to which I have referred. Part of the document is recited in the Annexure to the primary judge’s reasons. I infer that it was received into evidence. It gives information concerning the bids but says little about the bidders. 250 Exercise of the statutory discretion depends upon the proposed order being necessary in order to avoid prejudice to the administration of justice or to the security of the Commonwealth. This document was created more than 14 years ago. I see no reason to fear that its publication will prejudice either matter. 251 I would decline to make the order sought.
ORDERS
252 I agree with the orders proposed by Goldberg J.
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I certify that the preceding one hundred and forty-three (143) numbered
paragraphs are a true copy of the Reasons for Judgment herein
of the Honourable
Justice Dowsett.
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Associate:
Dated: 26 February 2009
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IN THE FEDERAL COURT OF AUSTRALIA
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VICTORIA DISTRICT REGISTRY
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BETWEEN:
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AND:
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DATE:
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PLACE:
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REASONS FOR JUDGMENT
JESSUP J
Payments, even recurrent payments, that are the consideration for acquisition of ownership of a capital asset are usually characterised as an affair of capital. However, rent is not an instalment payment in respect of the purchase of a capital asset: each amount of rent is for the use of a capital asset for a particular defined period and is therefore, and for that reason, on revenue account. (Emphasis in original)
253 I have had the advantage of reading the reasons of Goldberg J in draft. I agree with his Honour’s conclusion that the prepayment of rent by the respondent was an outgoing of a capital nature and, subject to what follows, with his Honour’s reasons for that conclusion. 254 The primary judge’s holding that the prepayment was on revenue account derives considerable support from a number of circumstances. First, since it was a requirement by statute that the casino be constructed on Crown land, the operator was always going to have something less than a freehold interest in the land. A lease was perhaps the most obvious contractual arrangement under which the operator’s right of occupancy of the land might have been contemplated. And a lease was in fact contemplated by the Authority from the outset. Secondly, and conformably with the first point, Star City’s right of occupancy of the land in fact derived from the Construction Lease and the Permanent Lease. It was not suggested that these leases were other than what they purported to be. Looking only at the leases, the primary judge’s view that the character of the advantage sought by the prepayment was the right to occupy the land is a natural one. Thirdly, it was accepted by the Commissioner that the annual rental fixed under the leases of $15 million was a fair market rental for the premises in the circumstances obtaining. 255 The primary judge articulated the conventional approach to the determination of the question whether a single payment was of a capital or of an revenue nature when she said:
Her Honour noted that Star City did not, by the prepayment of rent,
obtain a capital asset: it merely obtained the right to use
the asset of the
State. She said:
However, the nub of the question in the case was whether, from a
practical or business point of view, the prepayment did secure an
enduring asset for Star City, namely, the licence to operate the casino
(and to do so without competition for the
first 12 years). Merely to observe
that the prepayment, because it was rent, did not deliver the premises as such
to Star City
as a capital asset was, in my respectful view, to beg the
question.
With respect to the first point, it is true the Prepayment was a one-off payment which was refundable only in very limited circumstances. But [Properties] took the lease for 99 years and Star City was committed to the operation of the Casino at those Premises for the duration of its licence. Moreover, both cl 2.1(c) of the Construction Lease and cl 2.1(b) of the [Permanent Lease] provided that the Prepayment was refundable if the Parties mutually agreed to terminate the Lease. Thus the refundable nature of the Prepayment (even though limited) was tied to the Lease, not the Licence.
256 Approaching the matter from a practical or business point of view, the substance of the relationship between the Authority and Star City was no conventional landlord and tenant one. Significant commercial advantages which Star City derived from executing the transaction documents included the right, for 99 years, to operate a casino in New South Wales and an effective monopoly to do so for 12 years. As against these considerations, Star City was not entitled to conduct any lawful business on the land: it was required to conduct a casino. It was also obliged to design and construct the casino in the first place. It is clear from a perusal of all the evidence before the primary judge that the commercial reality of the arrangements into which Star City entered in 1994 involved a great deal more than the conventional exchange of rent for a right of occupancy. 257 The primary judge accepted this, of course, but her Honour took the view that the arrangements did involve such an exchange, that Star City’s payments to the Authority would inevitably include, as they did, something in the nature of rent, and that the overall circumstances were not such as to displace the conventional characterisation of that rent as a recurrent expense. It is at this point that I consider, with respect, that her Honour erred. 258 As Goldberg J points out, the prepayment was not refundable without the agreement of the Authority. On this aspect, the primary judge said:
That her Honour should have regarded it as significant that
Star City was committed to the operation of the casino for 99 years
bespeaks a perception, with which I agree, that the first 12 years of rent was
at least to an extent justified by commercial factors
other than the benefit of
occupying the premises for that term.
The explanation for the difference in rate of annual rental offered by Star City Consortium (and accepted by the [Authority]) is no doubt (as the Commissioner accepted) connected with the period of exclusivity of the casino licence ending at the point at which the rate of rental changes ...
259 The other significant consideration relates to the amount of rent which Star City was obliged to pay. The prepayment represented the discounted present value of rental payments of $15 million annually over 12 years. Thereafter, rent was fixed at $250,000 per annum. The case was conducted on the basis that $15 million per annum was a fair market rent. The figure of $250,000 was, it seems, treated as little more than a nominal rent. The disparity between the two figures required explanation. The explanation accepted by her Honour was set out in her judgment as follows:
That is to say, in the fixing of the rentals for the casino premises
there were commercial factors at work which went beyond the conventional
exchange of rent for the right to occupy.
The "surrounding circumstances" or "background" relied on by the Commissioner is irrelevant to the proper characterisation of the Prepayment because the advantage sought by the Prepayment is capable of identification and characterisation by reference to the Leases and the Occupational Licence Agreement and, if necessary, the Transaction Documents as a whole: City Link (Federal Court) at [44]-[45], approved by Citylink (High Court) at [120], [151] and [154].
260 The identification of these other factors was, in my view, central to any exercise which required the characterisation of the advantage sought by the prepayment. This was not a case in which the leases, or even the transaction documents as a whole, gave the complete picture. 261 On the issue of the relevance of evidence outside the Transaction Documents as such to the question of characterisation, the primary judge said:
If by this citation of authority her Honour meant no more than to point
to City Link Melbourne Limited v Commissioner of Taxation [2004] FCAFC 272; (2004) 141
FCR 69 as an instance where the advantage sought by a particular outgoing was
capable of characterisation by reference to the contractual
and other formal
documents involved, the citation does not address, or perhaps begs, the question
whether the present case was also
such an instance. If her Honour meant to
imply that City Link Melbourne Limited v Commissioner of Taxation
[2004] FCAFC 272; (2004) 141 FCR 69 had established a proposition of law which bound her to
conclude in the present case that the advantage sought by the prepayment
is
capable of characterisation by reference to the transactional documents to which
she referred, I take the view, with respect,
that no such proposition was so
established.
While it will often be relevant to ask what the money the subject of a deduction is paid for, in order to conclude whether the outgoing has the character of capital, generally, however, that question will be answered where the amount in question is consideration for obligations which the payee undertakes in favour of the payor, by having regard to the legal agreements entered into. Generally in such a case it will be unnecessary to go outside the legal agreement to determine deductibility. So it would ordinarily be unhelpful to have regard to precontractual negotiations in characterising an outgoing as capital in the same way as such evidence would ordinarily be unhelpful in construing the legal agreement entered into between the parties.
262 In the passage in City Link Melbourne Limited v Commissioner of Taxation [2004] FCAFC 272; (2004) 141 FCR 69, 84 upon which the primary judge relied, the Full Court said:
Here the Full Court was, in my opinion, going no further than to indicate
the approach that would "generally" or "ordinarily" be necessary
or helpful.
What their Honours said allows for the occasion in which it will be necessary to
go outside the agreements in question.
The position may be different if it be asserted that the agreement does not record the true agreement of the parties – whether because it is a sham in the legal sense of that expression or because it does not record the whole of the legal arrangement between the parties. There will be, it may be accepted, some cases where regard may be had to the matrix of facts which form the background to the entering into of a legal agreement to determine the character of an amount payable under that agreement: Reuter v Commissioner of Taxation [1993] FCA 576; (1993) 27 ATR 256 at 262; Commissioner of Taxation v Cooling (1990) 22 FCR 42 at 53 per Hill J. The surrounding circumstances may in such cases, cast light on the nature of the relationship between parties to the agreement or deny as relevant to the character of an outgoing a label which the parties have used to describe it. Merely to call in [sic] an agreement an outgoing "interest," for example, will not make it so. An example of such a case is the decision of the Full Court of this Court in Commissioner of Taxation v Broken Hill Pty Ltd [2000] FCA 1431; (2000) 179 ALR 593 at [36] - [40]. Likewise where parties in an agreement purport to exclude the relationship of employee/employer the surrounding circumstances may reveal that the true relationship is an employment relationship with the income taxation consequences which follow: Australian Mutual Provident Society v Allan (1978) 52 ALJR 407 at 409. Clearly where a particular transaction or agreement is said to be a sham in law there will be a need to consider the surrounding circumstances to determine what the other and real relationship is for which the agreement entered into between the parties is a disguise: Snook v London and West Riding Investments Ltd [1967] 2 QB 786. There is no suggestion in the present case that the agreement entered into between the State of Victoria and Transurban is a sham. Indeed the present does not seem to us to be a case where reference to the surrounding circumstances in which the City Link agreements were entered into assists at all in determining the character of the concession fees. What the concession fees were paid for appears clearly enough from the terms of the Concession Agreement.
263 There may be occasions upon which even a complete understanding of the agreements and other formal legal documents (or non-documentary transactions) will be insufficient for the purposes of characterisation under s 51 or s 8-1, or will present a misleading impression of the advantage sought by way of the outgoing in question. At the simplest end of the spectrum, the outgoing may be for the purchase of an item, evidenced only by the supplier’s invoice and receipt. Without knowing who the buyer is, what is his or her line of business, and what is the use to which the item is to be put, it would not be possible to undertake the task of characterisation. Likewise, while wages are ordinarily a revenue expense, wages paid to employees engaged wholly upon the installation of new capital equipment should not be so regarded. Merely to look at the legal rights and obligations which existed as between the payer and the payee (ie the employer and the employee) would be of no assistance in the task of characterisation. I do not believe that the Full Court in City Link Melbourne Limited v Commissioner of Taxation [2004] FCAFC 272; (2004) 141 FCR 69 was concerned to make the point that surrounding, or background, circumstances, standing outside the transactional documents involved, should always be regarded as irrelevant to the completion of that task. 264 As Goldberg J points out in his reasons in the present case, in City Link Melbourne Limited v Commissioner of Taxation [2004] FCAFC 272; (2004) 141 FCR 69 the Full Court went on to say (at 84-85):
Again, I regard these passages as involving a discussion of some of the
more obvious situations in which it may be either necessary
or desirable to go
outside the transactional documents in a particular case. I do not read them as
laying down exhaustively the
full range of situations in which one might do
so.
Moreover, even if the "surrounding circumstances" or "background" were examined, they do not alter the identification of, or the character of, the advantage sought by the Prepayment. The three documents referred to in [100] above cannot be said to constitute the "whole factual matrix of which the [Leases and the Occupational Licence Agreement] forms part": FCT v Cooling (1990) 22 FCR 42 at 51-53 citing Duke of Westminster’s Case [1936] AC 1. The documents by their nature and content do not form part of the factual matrix. None of the documents was sent by one contracting party to any other contracting party or was executed by the contracting parties. I considered the letter sent by Star City to the NSW Treasurer on 13 December 1994 in pars [61] to [63] above. The issues identified in relation to that document apply equally to the 19 April 1994 and 27 April 1994 letters. Moreover, even if the documents did form part of the factual matrix, they form just that – only part. It is not open to either party to pick and choose from the factual matrix.
265 In particular, I would not accept that the characterisation given to the advantage obtained by an outgoing by the parties involved, or the characterisation which is to be divined by reference only to the agreement between them, is binding on the Commissioner unless that characterisation is a sham or does not record the whole of the legal arrangement between the parties. I have attempted to illustrate situations in which genuine agreements, recording every element of the legal arrangements between the parties involved, provide an incomplete or inaccurate impression apropos the matter of characterisation. Although much more complex than the examples I have given, I consider that the present was an occasion upon which the agreements themselves did not paint the full picture. It was, in my view, an occasion on which the primary judge was obliged to look at the non-contractual evidence upon which the Commissioner placed so much store. Her Honour did so in the alternative but, at least in important respects, she did so in a limited and, I consider with respect, an unsatisfactory way. 266 The three non-contractual documents upon which the Commissioner particularly relied are referred to in the reasons of Goldberg J. The primary judge’s treatment of their influence on the question of characterisation was as follows:
Paragraphs [61]-[63] of her Honour’s reasons, however, dealt with
the question of the identity of the obligee under the leases
(essentially a
matter of construction), not with the characterisation of the prepayment for tax
purposes. On the assumption (admittedly
rejected by her Honour) that the
documents formed part of the factual matrix, her Honour appears not to have
addressed directly the
value (as distinct from the relevance) of these documents
to the question of characterisation.
In relation to these payments, we wish to record that: ... (b) the rental prepaid under the terms of the [Construction Lease] only reflects the value of the Permanent Casino site if a casino licence is issued and, as such, forms part of the premium paid by [Star City] to obtain the licence if the [Authority] determines that it will issue the licence to [Star City]. [Star City] will loan $120,000,000.00 to [Properties] for the purpose of allowing it to prepay the rental under the [Construction Lease] and [Properties] will only be able to repay that loan if the licence is granted.
267 Star City’s letter to the Treasurer of New South Wales on 13 December 1994 contained the following passage:
This letter goes a long way to explaining the apparent oddity that, while
representing a fair market rental, the annual rent for the
first 12 years was so
much in excess of that payable for the balance of the 99 years. The value of
the land by reference to which
the fair market rent was ascertained, it seems,
was "the value of the Permanent Casino site if a casino licence is issued".
When
the process of ascertaining the rent is understood in the context of this
explanation by Star City itself, the discrepancy between
the different
rents does not seem so odd. In that context, Star City described the
initial rent as "part of the premium ...
to obtain the licence". Absent the
licence, it seems, there would be no agreement either on the level of the rent
or on the payment
of it by way of a capitalised prepayment. This justification
of the prepayment by Star City not only seems commercially realistic,
but
provides important assistance on the question of characterisation of which, in
my view, her Honour should have availed herself.
268 The memorandum from the legal advisers to Star City’s parent company dated 19 April 1994 contained an important statement that the rental paid under the Permanent Lease "reflects in part a tax effective payment of part of the premium for the issue of the Licence ..." This memorandum was considered by the board of the parent company before the submission of Star City’s financial offer on 22 April 1994. I cannot, with respect to the primary judge, understand why the statement, together with its consideration by the board, should not be taken at face value as an identification by Star City itself of the advantage which it sought to obtain by agreeing to the rent for which the Permanent Lease provided. It was, of course, not the only element of the surrounding facts and circumstances which bore upon the matter of characterisation, but it did so bear. It is also true that it was a communication wholly internal to Star City and its associated companies, and could not, therefore, have affected the content of Star City’s rights and obligations as against the Authority. But it was, in my opinion, more than merely an expression of opinion as to the legal effect of the Transaction Documents. It was part of the business justification for a very substantial investment. Relevantly, that justification dealt directly with the character of the advantage which Star City sought from the rent which it agreed to pay. 269 The letter from the legal advisers to the New South Wales Office of State Revenue on 27 April 1994 was consistent with their memorandum dated 19 April 1994. What I have said in the previous paragraph applies equally to that letter. 270 Finally, I refer to the primary judge’s comment that it was "not open to either party to pick and choose from the factual matrix ..." As I understand the case conducted before her Honour, however, the Commissioner was engaged in a fairly conventional forensic exercise of drawing attention to parts of the evidence that supported his case that the practical, as distinct from the documentary, characterisation of the prepayment was that it was an affair of capital. He was, in my view, entitled to do so. That evidence ought, with respect, to have been regarded as especially helpful because it consisted of statements made by Star City or its advisers. The Commissioner was not picking and choosing. So far as I can see, in relevant respects his case did not involve the proposition that these, and only these, pieces of evidence could be looked at. Everything which had the potential to assist on the matter of characterisation could be looked at. It was open to Star City to rely upon other parts of the evidence, if any, which tended to suggest that the evidence sought to be relied on by the Commissioner was not what it appeared to be, or had been overtaken by events, or something similar. There was, however, no such other evidence. 271 I agree with the orders proposed by Goldberg J.
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I certify that the preceding nineteen (19) numbered paragraphs are a true
copy of the Reasons for Judgment herein of the Honourable
Justice Jessup.
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Associate:
Dated: 26 February 2009
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Solicitor for the Appellant:
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Australian Government Solicitor
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Counsel for the Respondent:
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G Davies QC and A Broadfoot
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Solicitor for the Respondent:
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Allens Arthur Robinson
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URL: http://www.austlii.edu.au/au/cases/cth/FCAFC/2009/19.html