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Federal Court of Australia |
INCOME TAX - assessable income - firm of solicitors moving to new premises - lease incentive - whether capital or income
Selleck v Commissioner of Taxation [1997] HCA 34; (1997) 97 ATC 4,856 discussed
Wattie v Commissioner of Inland Revenue [1997] NZCA 135; (1997) 18 NZTC 13,297 discusssed
Investment and Merchant Finance Corporation Ltd v Federal Commissioner of Taxation [1971] HCA 35; (1971) 125 CLR 249 referred to
Californian Copper Syndicate Ltd v Harris (1904) 5 TC 159 referred to
Elsey v Federal Commissioner of Taxation [1969] HCA 48; (1960) 121 CLR 99 referred to
Federal Commissioner of Taxation v Myer Emporium Ltd [1987] HCA 18; (1987) 163 CLR 199 distinguished
Federal Commissioner of Taxation v Becker [1952] HCA 77; (1952) 87 CLR 456 at 467 referred to
Edwards (Inspector of Taxes) v Bairstow [1955] UKHL 3; [1956] AC 14 referred to
Commissioner of Taxation v Cooling (1990) 22 FCR 42 distinguished
Lister Blackstone Pty Ltd v Commissioner of Taxation [1976] HCA 46; (1974) 134 CLR 457 discussed
Sun Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337 referred to
British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 referred to
PAUL MONTGOMERY v COMMISSIONER OF TAXATION
NO. VG 176 and 177 of 1997
JUDGES: DAVIES, LOCKHART AND HEEREY JJ
DATE: 6 FEBRUARY 1998
PLACE: MELBOURNE
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| VICTORIA DISTRICT REGISTRY | VG 176 and 177 of 1997 |
|
BETWEEN: | PAUL MONTGOMERY
AppELLANT |
|
AND: | COMMISSIONER OF TAXATION
Respondent |
|
JUDGES: | DAVIES, LOCKHART and HEEREY JJ |
| DATE OF ORDER: | 6 FEBRUARY 1998 |
| WHERE MADE: | MELBOURNE |
THE COURT ORDERS THAT:
1. The appeals be allowed.
2. The orders made by the trial judge are set aside and in lieu thereof it be ordered that:
(a) The objection decisions for the years ended 30 June 1991 and 1992 be set aside.
(b) The objections to the assessments for the years ended 30 June 1991 and 1992 be allowed insofar as they sought the exclusion from the appellant's assessable income of his share in the subject lease incentive payments.
(c) The matter be remitted to the Commissioner of Taxation to amend the assessments accordingly.
(d) The respondent pay the costs of the proceedings before the Court.
3. The cross-appeals be dismissed.
4. The respondent pay the costs of the appeals and of the cross-appeals.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| VICTORIA DISTRICT REGISTRY | VG 176 AND 177 of 1997 |
|
BETWEEN: | PAUL MONTGOMERY
Appellant |
|
AND: | COMMISSIONER OF TAXATION
Respondent |
JUDGES:
davies, lockhart and HEEREY JJ DATE: 6 FEBRUARY 1998 PLACE: MELBOURNE
Lease Premiums on Capital Account
Premiums for the grant and taking of a lease are, generally speaking, on capital account. In a landlords' market, the premium will be paid by tenant to landlord. In the Melbourne CBD in the late 1980s there was a tenants' market for office accommodation, so premiums were often paid by landlords to tenants. But either way the essential capital nature of the payment remains the same. I respectfully adopt what was said by Beaumont J in Selleck v Commissioner of Taxation [1997] HCA 34; (1997) 97 ATC 4,856 at 4,877:
"In my opinion, a lease incentive payment should be treated, in principle, as prima facie on capital account by reason of its character, that is, as a payment made, in the nature of a premium, in consideration of a prospective lessee agreeing to accept the burdens (along with the benefits) of the proposed lease. The payment is an inducement to a prospective tenant to enter into the leasing transaction. As a separate and collateral arrangement, the agreement to pay this premium or incentive stands apart from, and necessarily precedes, the operation of the lease itself. In conveyancing terms, the incentive payment is an incident of the agreement for lease, rather than of the lease instrument itself. Although a payment made to a prospective lessor is perhaps more readily identified as a premium, and thus prima facie on capital account, for present purposes there can be no distinction in principle between a payment to a prospective lessee or to a prospective lessor as an inducement to take, or to grant, respectively a lease. In either case the amount is, I think, paid as a `price' for the grant of the lease; it is a premium in that sense (see Chelsea Investments Pty Limited v Commissioner of Taxation [1966] HCA 15; (1966) 115 CLR 1 per Windeyer J. at 8). It is the `purchase money which the [prospective lessee or prospective lessor] pays for the benefit he gets under the lease' (see King v Cadogan [1915] 3 KB 485 per Warrington LJ. at 493; Nixon v Doney (1961) SR (NSW) 311 at 316)."
See also Wattie v Commissioner of Inland Revenue [1997] NZCA 135; (1997) 18 NZTC 13,297 at 13,308.
A valid comparison can also be made with the hypothetical case of a legal firm which carries on practice in its own freehold building. If the firm sells its building and purchases another, the sum received from the purchaser of the old premises seems like the sum received from the landlord of the new premises in the present case - a sum received on a capital occasion.
Profit or Gain
In my opinion it could not be said that there was here a profit or gain. In order to determine whether there was a profit or gain one must look at the net result of the whole scheme, including outgoings. As was said in Investment and Merchant Finance Corporation Ltd v Federal Commissioner of Taxation [1971] HCA 35; (1971) 125 CLR 249 at 264:
"There is no profit from a scheme to be included in assessable income until such outgoings have been taken into account."
See also Elsey v Federal Commissioner of Taxation [1969] HCA 48; (1960) 121 CLR 99 at 114 and Federal Commissioner of Taxation v Becker [1952] HCA 77; (1951) 87 CLR 456 at 467 where Kitto J said:
"Whether a given amount is to be characterised as a profit within the meaning of the provision is a question of the application of a business conception to the facts of the case."
The learned trial judge said that although the payment to Freehills was "not easily expressed as a profit" it was "rightly described as a gain".
However, most of the cases in this area, implicitly at least, use the term "gain" as synonymous with "profit". This is particularly so in Federal Commissioner of Taxation v Myer Emporium Ltd [1987] HCA 18; (1987) 163 CLR 199 at 209 in a passage quoted in full later in these reasons where the High Court says:
"Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income." (Emphasis added)
Both the Macquarie Dictionary and the Shorter Oxford give as one of the meanings of "gain" the concept "to obtain as a profit". A trader who merely receives a customer's dollar and puts it in the till does not make a "gain" in this sense.
An essential element of the reasoning in Myer was that a profit was made, in the sense that the company laid out a sum and got back a greater sum. The High Court said (at 216):
"By no stretch of the imagination is it possible to describe the transactions, or the assignment standing on its own, as the mere realization of a capital asset. As we have seen, the assignment was not unrelated to and independent of the loan agreement. The two transactions were interdependent in the sense that Myer would not have entered into the loan agreement unless it knew that Citicorp would shortly thereafter take an assignment of the moneys due or to become due for a sum approximating the amount payable in consideration of the assignment. Indeed, from the viewpoint of Myer the two transactions were essential and integral elements in an overall scheme, that scheme being a profit-making scheme.
If the two transactions, namely the loan agreement and the assignment, are considered as separate and independent transactions, Myer's argument that no relevant profit arose from the assignment has compelling force. The consideration payable for the assignment reflected the true value of the chose in action which Myer assigned. But once the two transactions are seen as integral elements in one profit-making scheme, it is apparent that Myer made a relevant profit, that profit being the amount payable on the assignment. As a result of the two transactions Myer, having lent $80,000,000 on 6 March 1981 repayable in accordance with the terms of the loan agreement, had profited by 9 March 1981 to the sum of $45,370,000 paid for the assignment, the principal on the loan being intact. Of course the value of the chose in action, the right to recover the principal sum, was substantially less than the amount of the principal sum because there was no obligation to repay until 30 June 1988. But this circumstance cannot affect the character of the consideration for the assignment. It exists in every case where money is lent for a fixed term."
And also (at 220):
"For an outlay of $80,000,000 in the transaction Myer acquired a debt of $80,000,000 owed by Myer Finance and $45,370,000 in cash from Citicorp. It has made a profit of $45,370,000."
In the present case the change of premises from Freehills' point of view included at least on the debit side:
* obligations in respect of its former premises at BHP House - $6.2 million;
* fitout - $12.9 million; and
* rent at new premises - $8,471,675 per annum.
Counsel for the Commissioner argued as follows:
"Comparisons indicate that the better the quality of the premises, the higher both the rents and the immediate incentives. The firm could have chosen less expensive premises and received a lower incentive; it chose the highest level. In effect it traded a future prestige rent on prestige premises for an immediate surplus (profit or gain) on the incentive payment. That immediate surplus was a profit which the firm set out to get, obtain, and used as partnership profits to share among partners."
In my respectful opinion, the fact that such a strained and artificial construction has to be used to identify a profit or gain supports the opposite conclusion, namely that as a matter of "the application of a business conception to the facts" (Federal Commissioner of Taxation v Becker [1952] HCA 77; (1952) 87 CLR 456 at 467) the payment did not constitute a profit or gain at all. At most the Commissioner's argument might show an economic equivalence - as to which see Myer at 217.
Distinguishing Myer
The present case is to be contrasted with the facts of Myer. I would respectfully adopt the analysis of Myer by Blanchard J delivering the joint judgment of Richardson P, Gault and Henry JJ and himself in Wattie as follows (at 13,306):
"(Myer) involved a scheme designed to enable the taxpayer to receive a lump sum of capital in the place of instalments of interest. A part of Myer's business had been the financing of transactions of Myer group companies. There was a general reconstruction of the group in which a new finance company subsidiary was established. By prior arrangement with an unrelated company, Citicorp, Myer advanced $80 million to the finance subsidiary repayable with interest over a number of years and, three days later, assigned to Citicorp, in exchange for $44.37 million, the right to receive the interest on that loan (but not the principal sum, which continued to be owing to Myer by its subsidiary). An income stream had been sold for a lump sum in a deal arranged before the principal sum was advanced. Not surprisingly, the $45.37 million was held to be assessable in the hands of Myer in the year of payment of Citicorp.
The passage in the joint judgment of the High Court which has provoked much discussion in Australia and is in the present case relied upon by the Commissioner is at pp 209, 210:
Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a "one-off" transaction preclude it from being properly characterized as income: Federal Commissioner of Taxation v Whitfords Beach Pty. Ltd. [1982] HCA 8; (1982) 150 CLR 355 at pp 366-367, 376. The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.
Immediately afterwards the Court referred to the decision in Californian Copper Syndicate Ltd v Harris (Surveyor of Taxes) (1904) 5 TC 159 as making the point. But that is simply the classic example of the well recognised assessability of a profit derived from an adventure in the nature of trade or, as it is put in a passage then quoted from Californian Copper, a `gain made in an operation of business in carrying out a scheme for profit making'. At p 211 the High Court observed that the important proposition is to be derived from Californian Copper Syndicate:
... is that a receipt may constitute income, if it arises from an isolated business operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction.
That seems to be a description of an adventure in the nature of trade, a description well able to be applied to what occurred in Myer itself. A gain from such an adventure deliberately entered into with a view to the profit, though perhaps unprecedented for the taxpayer, will constitute income. It is a profit making scheme. The profit is income in accordance with ordinary concepts."
In Myer, the company had acquired something (the loan with a right to interest) with the attention of profit-making by selling the interest to Citicorp. In the present case there is no equivalent thing which Freehills acquired and then sold so as to make a profit or gain of $29.3 million.
A further feature of the Myer type situation is that something is acquired - albeit in a one-off transaction - not for the purpose of earning income. This was the case in Californian Copper Syndicate itself, where the Syndicate "never intended to work the property with a view to deriving income from mining operations on the property" (163 CLR at 210), and also in Edwards (Inspector of Taxes) v Bairstow [1955] UKHL 3; [1956] AC 14, where the taxpayers
"had no intention of using the machinery and therefore did not buy it to hold as an income-producing asset or to consume it or for the pleasure of enjoyment, and, instead of having any intention of holding the plant they planned to sell it even before they bought it. This they did, making a net profit, as they hoped and expected to do. In (Lord Radcliffe's) opinion, this was `inescapably, a commercial deal in second-hand plant'."
This aspect made the profit "a profit from an adventure in the nature of a trade" (163 CLR at 212).
In the present case the payment in question was inextricably tied up with the acquisition of an income earning asset - the premises on which Freehills would carry on their practice. It was only as a result of market conditions that Freehills was receiving such a premium rather than paying it.
Cooling
The application of the general principles stated in Myer to the specific situation of a professional firm receiving a lump sum as an incentive to enter into a lease has become the subject of controversy in Australasia in recent years. In Commissioner of Taxation v Cooling (1990) 22 FCR 42, a Full Court of this Court held that such a payment was income. In Wattie a five member bench of the New Zealand Court of Appeal held, by a majority of four to one, that the payment was capital. In Selleck, another Full Court of this Court held such a payment was capital and distinguished Cooling. In the present case counsel for the appellant argued that Cooling was wrong, or alternatively that it should be distinguished on one or more of seven different bases.
In Cooling the following passage appears in the judgment of Hill J (at 56):
"Where a taxpayer operates from leased premises, the move form one premises to another and the leasing of the premises occupied are acts of the taxpayer in the course of its business activity just as much as the trading activities that give rise more directly to the taxpayer's assessable income. Once this is accepted, the evidence established that in Queensland in 1985 it was an ordinary incident of leasing premises in a new city building, at least where the premises occupied were of substantial size, to receive incentive payments of the kind in question. Why then should a profit received during the course of business where the making of such a profit was an ordinary incident of part of the business activity of the firm not be seen to be income in ordinary concepts?"
This rather suggests that a lease incentive will always be income (unless a tenants' market prevails there are unlikely to be any lease incentives on offer - and where they are offered it is likely that there will be more than an isolated incident). Therefore Cooling in its own terms argues against distinctions based on detailed analysis of a particular lease incentive situation.
In my respectful opinion, the interests of clarity and predictability - desiderata in all areas of the law and especially in revenue law - require one to grapple with the issue whether Cooling should be followed or not. Putting aside any suggestion of trading in professional premises, or disguised rent incentives, it does not seem logical to draw distinctions, for example as was done in Selleck, between a move to new premises for an existing firm and a move to new premises for a firm which is a result of a merger and in reality a new practice. It is not clear why a lease incentive should be income in the one case but not in the other. Usually an expenditure on capital account does not lose that character because it is not made at the commencement of a business.
Nor does it seem satisfactory to have the issue turn on the degree of compulsion operating on the particular firm to move. It is not clear why a payment should be capital only if a firm is faced with the alternative of being out on the street tomorrow.
A critical passage in the principal judgment in Cooling is the following (at 56):
"For the respondent it was submitted that the partnership business was the performance of professional services and not the receipt of incentive payments. In my view this submission, while in one sense true, disguises the true nature and extent of the firm's business. It is true that the firm's business includes the rendering of professional services but the firm does not cease business when it moves from one set of leased premises to another as the decision of the High Court in Lister Blackstone Pty Ltd v Commissioner of Taxation (Cth) [1976] HCA 46; (1974) 134 CLR 457 at 459 makes clear. That case held that the cost of moving from leased premises to other premises acquired when the first premises became inadequate, to the extent that it was necessary to move stock and plant, was an allowable deduction to a distributor of imported agricultural equipment. The real issue in that case was not whether the expenditure in question was necessarily incurred in carrying on a business, but whether it was capital in nature. It was held that it was not on the facts of the case."
However, Lister Blackstone is distinguishable. As Beamont J pointed out in Selleck (at 4,871) the case was concerned with the relocation of stock in trade, not part of the capital structure of the business. Gibbs J said (at 459):
"The advantage sought by the expenditure incurred in moving the stock to the new business at Revesby was to have the stock conveniently available, so that the business operations of the taxpayer could be carried on in a normal way and without interruption. This was an advantage which enured to the taxpayer in the continuous process of carrying on its business by using the stock for the purpose of making profits, but it was not an advantage of a lasting character because the stock was turned over in the ordinary course of the business and the advantage of moving that particular stock to Revesby lasted only as long as the stock remained unused."
Similarly Jacobs J said (at 462):
"The stock must be looked at separately and when that it is done, it is found that the removal was for the purpose of a more economical utilisation and distribution of that stock."
The premium argument was dealt with in Cooling in these terms (at 57):
"For the respondent it was argued that the amount received was analogous to what was referred to as "key money". It was said that it had been held that a premium paid to a landlord to obtain the key to leased premises was prima facie capital. Reference was made to Regent Oil Co Ltd v Inland Revenue Commissioners [1966] AC 295; and Kosciusko Thredbo Pty Ltd v Commissioner of Taxation (Cth) (1983) 80 FLR 290."
...
However, the reason why the receipt of a premium by a company not carrying on the business of leasing would ordinarily, in the absence of a special legislative regime, be capital, stems, as the Regent Oil case (supra) itself demonstrates, from the nature of the estate or interest of a lessee. The concept of `premium' is normally explained, as by Warrington LJ in King v Earl Cadogan (1915) 3 KB 485 at 492 as being `... a cash payment made to the lessor, and representing or supposed to represent, the capital value of the difference between the actual rent and the best rent that might otherwise be obtained'. A premium is `the consideration for the grant of the lease' as distinct from rent which is a payment for the use of the land itself: cf Frazier v Commissioner of Stamp Duties (NSW) (1985) 17 ATR 64 and cases there cited. Hence it is the capital sum received by the landlord for the grant by him of the leasehold estate to the tenant and prima facie thus received on capital account. By contrast the present incentive payment is not received for the firm parting with an estate in land; the analogy is in my view not sound."
As to this passage, I agree with respect with what was said in Wattie at 13,308:
"Another difficulty we have with the reasoning in Cooling is that we cannot accept that an inducement to take a lease is distinguishable from a receipt of a premium by a lessor simply because in the former case there is no disposition of an estate in land by the recipient of the payment. There is of course an acquisition of a leasehold estate. We do not understand how a distinction can be drawn between acquisition and disposition."
On the issue of purpose, it was said in Cooling (at 56):
"A scheme may be a profit making scheme notwithstanding that neither the sole nor the dominant purpose of entering into it was the making of the profit. In Myer the assignment of the right to interest was an integral part of the total reorganisation entered into by the Myer Group. While the judgment of the High Court in Myer referred to the case as involving the intention or the purpose of making the profit there is no suggestion that the Court dissented from the factual finding of Murphy J that the motivating purpose of the transaction was for Myer to obtain working capital to enable it to diversify. It should however be noted that on the facts of that case the obtaining of working capital was possible only if the profit contemplated by the taxpayer was made."
However, the passages from Myer already quoted make it clear that what the High Court considered the relevant transaction, or scheme, or adventure, was the company making the loan to its subsidiary with the intention of shortly thereafter selling the interest to Citicorp. It was this scheme which revealed the essential purpose of profit-making. For the reasons already discussed, I do not think such an analysis is available in the present case.
Conclusion
In my respectful opinion the appeal should be allowed for the same reasons that persuaded the New Zealand Court of Appeal in Wattie (at 13,308). Freehills' ordinary business did not include the acquisition and disposition of leases. The incentive the firm received was related to the structure of the business, not its operation. Its business cannot sensibly be said to be or include the business of dealing with leaseholds because it is obliged to have rental accommodation. Moreover, the payment in question did not represent a profit or gain. Nor was it an adventure in the nature of a trade.
The appeals should be allowed. I agree with the orders proposed by Davies J.
|
I certify that this and the preceding ten (10) pages are a true copy of the Reasons for Judgment herein of the Honourable Justice
Heerey |
Associate:
Dated: 6 February 1998
|
Counsel for the Appellant | N J Young QC, J W de Wijn and T P Murphy |
| Solicitor for the Appellant: | Freehill, Hollingdale and Page |
| Counsel for the Respondent: | T Slater QC and A Richards |
| Solicitor for the Respondent: | Australian Government Solicitor |
| Date of Hearing: | 30 September and 1 October 1997 |
| Date of Judgment: | 6 February 1998 |
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| VICTORIA DISTRICT REGISTRY | VG 176 & 177 of 1997 |
ON APPEAL from a single judge of the Federal Court of Australia
|
BETWEEN: | PAUL MONTGOMERY
APPELLANT |
|
AND: | COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent |
|
CORAM: | DAVIES, LOCKHART & HEEREY JJ |
| DATE: | 6 FEBRUARY 1998 |
| PLACE: | MELBOURNE |
If the traditional approach to the question of capital and income were adopted, the receipts would be regarded as capital receipts. The sum in substance was a lump sum arising out of a transaction of a capital nature. It did not arise from the ordinary revenue earning activities of the firm. It did not arise from a profit making scheme or venture. It did not arise from the exploitation of an asset owned by the partners. It was not a reward for services. I see no element of the facts which would make the incentive a receipt of a revenue nature. The transaction of obtaining a new lease, in this case a lease for 12 years with an option of another 6 years, was in its essence a capital transaction. See Selleck v Federal Commissioner of Taxation (1997) 97 ATC 4856; Wattie v Commissioner of Inland Revenue (1997) 18 NZTC 13297. If further authority were needed for this, it would be found in the oft-cited remarks of Dixon J in Sun Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337, where his Honour said at 359:
"The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss."
The obtaining of the lease was an activity concerned with the structure of the business. The lease when entered into was "an asset or an advantage for the enduring benefit of a trade", to use the words of Viscount Cave L.C. in British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 at 213. And the incentive, when received, was a once and for all sum arising from this capital transaction. It was not a part of the regular returns of the business. The sum was not a rebate of the rental payable under the lease. It was simply an inducement offered to the prospective lessee to enter into the lease.
So far, I have dealt with the issue in the traditional way. However, concepts undergo change. Traditional views of capital and revenue are these days undergoing change as more sophisticated techniques are being developed for the determination of matters such as profit and income. This development was given recognition in the law in Federal Commissioner of Taxation v The Myer Emporium Ltd [1987] HCA 18; (1987) 163 CLR 199, when the High Court of Australia, constituted by Mason ACJ, Wilson, Brennan, Deane and Dawson JJ, reminded us that a transaction which, if it were looked at on its own and by reference to its formal structure, might be regarded as resulting in a capital receipt, could be regarded as resulting in a revenue profitable gain if it were entered into with the intention or purpose of achieving that profitable gain. Thus, where the Myer Emporium Ltd had sold an income stream, the interest due on a loan which the Myer Emporium had made, it was held that the lump sum was assessable as income because the assignment had been in mind at the time when the loan was made and the lump sum when received was the profit or gain which the Myer Emporium Ltd had planned to receive from the making of its loan. The lump sum was its return or reward for the loan of the moneys. Their Honours emphasis of the profit-making element is significant, for even under traditional rules the receipt would have been regarded as income. The loan itself was not assigned.
I see nothing in the facts of the present case which attracts the approach applied in Myer. The facts do not show that there was any scheme to make a profit or gain. Freehills had to move from their existing premises. They were not given the opportunity of taking a lower rent at a lesser or no incentive. In respect of the premises to which they moved, the rent was fixed, but the lessor was prepared to grant an incentive. The transaction was not a profit making transaction and, having regard to the obligations under the existing lease, the costs of the fitout and of the transfer and the rental obligations under the new lease, Freehills did not make a profit. Cf. Dickenson v Federal Commissioner of Taxation [1958] HCA 62; (1958) 98 CLR 460 at 474; Wattie v Commissioner of Inland Revenue at 13309. In Myer, the sum assessed as income was the reward obtained by the Myer Emporium Ltd from the use of its capital. In the present case, the sum was not a profit and it was not a gain made by Freehills from the provision of services or the exploitation of its assets. The incentive was certainly a gain but it arose from a capital transaction, the undertaking of a new lease, and derived its character from that transaction.
In Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42, the Myer principle was applied to a circumstance, somewhat similar to the present, where a firm of solicitors took a lease of new premises and received a substantial incentive payment. Hill J, with whom Lockhart & Gummow JJ agreed, held that the receipt was of an income nature assessable under s.25(1) of the Income Tax Assessment Act 1936 (Cth). His Honour said at p.56:
"If the transaction can properly be said to have been entered into by the firm in the course of carrying on its business and if it can be said that the arrangement is a profit-making scheme in the sense that those words are used by the High Court in Myer then it will follow that the amount received by the parties will be income and it will matter not that vis a vis the firm, the transaction was extraordinary."
His Honour went on to hold at 57:
"In my view the transaction entered into by the firm was a commercial transaction; it formed part of the business activity of the firm and a not insignificant purpose of it was the obtaining of a commercial profit by way of the incentive payment. This result accords with common sense. The firm had the alternative of paying less rent and therefore obtaining a smaller tax deduction for its outgoings or paying a higher rent, (assuming its lessor (Bengil) passed on the rental holiday), and therefore obtaining a larger tax deduction but receiving an amount in the form of assessable income."
After hearing counsel for both the taxpayer and for the Commissioner, I am persuaded to the view, which both counsel expressed, that Hill J applied the principle enunciated in Myer. It follows that his Honour was satisfied that there was, in the transaction in Cooling, an intention to make a profitable gain which assisted to convert that which might otherwise have been a capital receipt into an income receipt. That intention may have been inferred from the fact that the payment in Cooling went to the partners of the solicitors' firm and not to the lessee, from the fact that the solicitors and the lessee had the option of negotiating for a lesser rent and a lesser incentive and from the fact that the firm had not decided that it was essential or even important to move. The decision was made by the Court on the facts of the case. In the present case, there is no such element which gives rise to the application of the Myer principle.
In my opinion, the incentive received by Freehills was of a capital nature and was not assessable income of the partnership. The appeals should be allowed. The orders made by the trial Judge should be set aside and in lieu thereof it should be ordered that:
i. the objection decisions for the years ended 30 June 1991 and 1992 be set aside.
ii. the objections to the assessments for the years ended 30 June 1991 and 1992 be allowed insofar as they sought the exclusion from the appellant's assessable income of his share in the subject lease incentive payments.
iii. the matter be remitted to the Commissioner of Taxation to amend the assessments accordingly.
iv. the respondent pay the costs of the proceedings before the Court.
The cross-appeals should be dismissed. The respondent should pay the costs of the appeals and of the cross-appeals.
|
I certify that this and the preceding four (4) pages are a true copy of the Reasons for Judgment herein of the Honourable Justice
Davies |
Associate:
Date: 6 February 1998
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| VICTORIAN DISTRICT REGISTRY | VG 176 AND 177 of 1997 |
|
BETWEEN: | PAUL MONTGOMERY
APPELLANT |
|
AND: | COMMISSIONER OF TAXATION
Respondent |
JUDGES:
DAVIES, LOCKHART AND HEEREY JJ DATE: 6 february 1998 PLACE: MELBOURNE
These two appeals from the judgment of a judge of the Court (Jenkinson J), heard together by consent, concern the question whether certain payments received by the appellant in the years of income ended 30 June 1991 and 1992 were correctly included by the Commissioner of Taxation in the appellant's assessable income for those years. During those years the appellant was a member of a firm of solicitors, Messrs Freehill, Hollingdale and Page ("the Firm"). The Firm received monies from the lessor of premises at 101 Collins Street, Melbourne ("the Collins Street premises") as an inducement to enter into an agreement for lease of the premises ("the Inducement Amount"). The appellant's share of those monies ($136,562 and $955,596 received in the 1991 and 1992 years of income respectively) were treated by the Commissioner as assessable income of the appellant.
The learned primary Judge held that the Inducement Amount was assessable income in the hands of the Firm and, therefore, the appellant's share of it was assessable income in his hands. His Honour found that it was assessable income on two bases. Firstly, that "one purpose of the applicant and his partners in entering into the transaction was to secure" the relevant gain and that this therefore brought the case within the principles expounded in Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42 and Federal Commissioner of Taxation v The Myer Emporium Limited [1987] HCA 18; (1987) 163 CLR 199. Second, that the transaction that involved the incentive payment "was one occurring in the course of carrying on [the Firm's] business".
His Honour also found that certain expenses referable to the incentive payment ought to have been included as allowable deductions.
His Honour heard the two appeals (one for each year of income) together. The appellant appealed from his Honour's judgment and the Commissioner cross-appealed from so much of his Honour's judgment that dealt with the deductions issue.
The case turns essentially on its facts; but there is no dispute about them even though the parties' submissions reflect differences of emphasis. It is necessary to recite the relevant facts with some precision and detail. My statement of facts is taken principally from the judgment of the primary Judge; but I have included other facts.
The Firm occupied four floors in BHP House. The leases of floors 28 and 29 were to expire on 28 February 1994, whilst those of floors 31 and 32 were to expire on 31 March 1993. The Firm also occupied premises at Nauru House where its industrial law practice was carried on.
In October 1987 the Firm had expressed to the manager and principal tenant of BHP House, BHP Pty Ltd ("BHP"), its concern about rumours that a refurbishment of the whole building was contemplated by the lessor. BHP's written response was that "a study directed at the refurbishment of BHP House" was being undertaken; that the elevator system, air conditioning, electrical services and toilet and lift lobbies were subjects of the study; that advice about "the direct impact on your refit program" could not be given at the time of writing; but that "landlords must have concern for tenant inconvenience and disruption should relocation be deemed necessary".
In September 1988 the owner of BHP House, the Australian Mutual Provident Society ("AMP"), took over the management of the building and informed the Firm that all levels of the building were to be gutted and cleansed of asbestos. In the same month the Firm constituted a "Premises Committee" of four partners and the Firm's managing director, Robert William Moses (who is not a lawyer), to consider the Firm's future accommodation.
On 10 November 1988 the Premises Committee reported to the Firm's Management Committee that the Firm was faced with a choice:-
"1. Refuse to vacate our BHP leases and accommodate our expansion in another building and move to new premises at the expiration of our lease.
[or]
2. Move to new premises which we would occupy from 1990/1991."
In November 1988 the Firm sought from AMP "specific information" about the asbestos in BHP House and an assurance "that renovation work on other levels will not create airborne asbestos which could flow through the air handling system and endanger our staff and clients".
AMP replied by letter dated 29 November 1988 which included the following:
"Prior to addressing your specific questions on asbestos we would like to put the refurbishment strategy planning into perspective. The decision to upgrade the property was taken because of a need to provide accommodation including services and building finishes equivalent with the buildings of the 90's. That decision having been taken it was a natural consequence that any asbestos would be removed at such an appropriate time. As you can see the catalyst to remove the asbestos was in fact the upgrading works and not the presence of asbestos itself. To answer your questions specifically we advise that expert reports obtained by us state that:
(a) the type of asbestos is chrysotile (white asbestos) and it is a small part of the fire proofing material sprayed onto the structural steelwork.
(b) no demonstrable risk from the fireproofing material exists for building occupants and removal of the material is not warranted on health grounds.
(c) removal will be carried out strictly in accordance with current codes and regulations. The Department for Labour and Industry will be monitoring the levels of airborne asbestos and have the power to suspend work in the unlikely event that such action becomes necessary.
In summary you can therefore be assured that:
1. the asbestos situation existing in the building has not and does not represent a health hazard to building occupants.
2. asbestos removal on other floors will not create airborne asbestos which could flow through the air-handling system.
We hope that this information is sufficiently detailed to enable you to provide a satisfactory report for the partners' meeting but we will be pleased to assist further where we can.
Please contact us should you be interested in further discussing our proposal to cater for your future expansion and relocation in the building."
In a letter to the Firm dated 20 March 1989 AMP: stated its intention to commence the proposed work in September 1989 which it expected to continue for four years; declared that work in the Firm's premises would not start before 1991; and offered to locate within BHP House those tenants who wished to remain while work was undertaken in their leased premises.
A memorandum dated 29 March 1989 from a group of members and advisers of the Firm called the "Facilities Planning Group" to the management committee included the following:
"7. Partners will note that MP's ["MP" is Managed Projects Pty Ltd, a property consultant employed by the Firm] findings in relation to 565 Bourke Street support their initial view that the purchase option is not one which is practical or financially attractive to the firm. In addition to the financial and other considerations set out in Attachments B and C, MP has also raised one other difficulty with the purchase option. This relates to the increasing problems landlords of major buildings are having with refurbishing requirements, both in terms of frequency and cost. We are informed that the current average refurbishment cycle is ten years. Specifically, for a building to remain competitive and retain its value, total refurbishment is required on average every ten years during its life. We are also informed that this cycle is contracting. . .
10. Although MP makes mention in its reports of the favourable terms currently being offered to tenants and there are various reports in the press of an expected oversupply of office space over the next few years, we are of the view that the firm needs to make a decision as to its premises plans through the 1990's and beyond as quickly as possible. We say this because there are in fact few buildings which are either presently under construction or planned for the early 1990's which are big enough to accommodate a firm of our size, and adequately provide for future growth. Perhaps because of the forecast oversupply in the next few years, the leasing programmes for all major sites in the western end of the CBD, either under way or planned, are currently well under way. They are all currently attempting to attract major leasings and therefore the inducements are attractive. Once the major precommitment phase has passed we do not believe the inducements will be as attractive nor will we have the same premises options available to us as we currently have.
11. We are therefore of the view that the firm's premises position is one which requires a decision as to its future needs to be made as a matter of urgency."
The primary Judge found that on 5 April 1989 the partners had authorized the management committee to negotiate with AMP and the developers of new buildings.
In June 1989 work that was carried out in a ceiling of one of the Firm's floors in BHP House by electrical contractors engaged by AMP brought down dust considered to contain asbestos, and caused loud noise. The Firm protested strongly to AMP about the disturbance of its members and staff and about the danger of harm from the asbestos.
Evidence was given by the appellant and another member of the Firm, Mr Denis Davies, that they and other members of the Firm were very concerned about the risk to health posed by the presence of asbestos in BHP House while the proposed refurbishment, of which the removal of the asbestos was an essential procedure, was in progress. Mr Moses gave evidence that, having had experience of the health hazard which the presence of asbestos created, he strove to make the members of the Firm aware of the danger to health which would be involved during the refurbishment.
It was common ground that the intention of the members of the Firm was relevant to the determination of the character of the incentive payments received by the Firm (whether income or capital) and that the relevant time was 9 August 1989, when the meeting of members of the Firm resolved to accept the offer to take a lease of the Collins Street premises and to receive the incentive payment.
In the documents prepared in anticipation of that meeting, and in the documents prepared for the meeting itself, there is no reference to asbestos or to a danger to health during the proposed refurbishment of BHP House. There is reference to "inconvenience" and to "disruption" if the Firm were practising in BHP House during the refurbishment. The appellant and Messieurs Davies and Moses gave evidence, which the primary Judge accepted, that the partners' policy was to minimise reference to asbestos in documents written by them, so that in any future litigation against the Firm based on damage caused by asbestos in the Firm's premises, the number of discoverable documents containing such a reference would be small.
The primary Judge accepted the evidence of the appellant and Mr Davies that, on 9 August 1989, they were worried that asbestos in BHP House might cause physical harm to persons in the Firm's premises and that the danger would be increased while the asbestos was being removed. His Honour said that he was prepared to find that a number of other members of the Firm had the same concerns on that day; but he was not persuaded that on that day any other partner shared the attitude which Mr Davies expressed in evidence in these terms:
"unless AMP could satisfy ourselves that the proposed refurbishment had a plan whereby the removal of the asbestos could be undertaken with complete safety to the members of our firm, that is the partners and all staff, then we had no option in terms of staying in that building, we couldn't stay on."
Nor could his Honour accept as an accurate recollection of the appellant's state of mind on 9 August 1989 the last sentence of this passage in an affidavit sworn by him on 11 April 1995:
"27. I was aware of concern about the dangers of long term exposure to asbestos. I knew that it could lead to very serious lung disease such as mesothelioma and other forms of cancer. I also knew that the symptoms may not show themselves for 20-30 years. I had no intention of exposing members of staff, myself or my partners to any risk of death or injury in this horrible way. I reached the view that remaining in BHP House was simply no longer an option."
His Honour found that the Firm had been hampered in its consideration of its future accommodation by AMP's failure until 2 August 1989 to place before the Firm any concrete proposal. In June 1989 AMP had responded to the Firm's protest about the presence of asbestos in office spaces with a "bland parroting" of what had been communicated in November 1988. If the attitude of the members of the Firm had been that expressed by the appellant or Mr Davies, they would, his Honour found, have again sought - as they had in 1985 - expert advice for themselves about the asbestos. His Honour said that the evidence demonstrated that some of the partners were inclined to stay in BHP House if the lessor was able and willing to minimize the disruption of the Firm's practice, and to obviate the danger from asbestos, which was threatened by the refurbishment.
His Honour found that the Firm could not force AMP to present a proposal concerning the Firm's future accommodation in BHP House; but that the Firm could, and, if Mr Davies' or the appellant's attitude had been widely shared, no doubt would, have sought expert advice before 9 August 1989 about whether, and at what cost, the danger from asbestos during refurbishment could be obviated. There was no evidence that the Firm did take that course.
The Firm's Management Committee presented to the partners' meeting on 9 August 1989 a document which posed for decision the question whether the offer of a lease of the Collins Street premises should be accepted. The offer had been declared to be available for acceptance only until 11 August 1989. The document stated that five buildings in the centre of Melbourne had been considered. One had been discarded because insufficient space in adjacent floors had been available, and another because the offered incentive payment of about $8 million was considered inadequate. The other three buildings were BHP House, the Collins Street premises and a proposed building called Grand Central at the corner of Bourke and William Streets. In the concluding summation, which recommended acceptance of the Collins Street premises, the premises in BHP House and Grand Central building were dismissed in these terms:
"(b) There is a need to ensure that by the time our BHP lease expires we have in place adequate quality space to meet our anticipated expansion needs not just at that time but through the 1990's. On the basis of current projections, the 101 offer would satisfy that requirement.
(c) The 101 offer is good and the only hard offer on the table at present.
(d) Too much uncertainty surrounds the other offers. As good as the Grand Central offer and the likely quality of the building are, there are increasing doubts as to if and when that project will proceed. As to BHP, we have no idea how prepared AMP will be to improve their offer and, given the speed at which AMP has moved so far, we may not reach a final position for some time. Furthermore, the proposed refurbishment works have the potential to be very disruptive to our practice.
(e) Consequently, a rejection of the 101 offer would run the risk of us not have [sic] another opportunity to secure a position in a landmark prestige building by the end of the BHP lease."
Under the heading "Financial Evaluation" the observation was made:
"A decision on the 101 offeror must include an evaluation the offer itself (that is, is it generous or otherwise or is it no more than we should expect) as well as a comparison with other offers on the table. As to the first point, the Committee is of the view that, by and large, the offer really reflects no more than the firm's importance as a potential tenant to any owner or developer. As to the second issue, there is really nothing to separate the 101 and Grand Central offers."
Under that heading the AMP proposal was discussed in these terms:
"We have only just received a proposal from AMP for remaining in BHP House. A copy of AMP's letter comprises Appendix 3 and Appendix 5 contains (to the extent that it is currently possible) a comparison of that proposal with the 101 Collins Street and Grand Central positions. Clearly the proposal suffers in financial terms with the other two but it must be stressed that this is probably AMP's starting position. The time pressures, and the August 11 deadline in particular, prevent us from making any proper evaluations of the BHP House option from a financial viewpoint."
The document analysed also "non-financial considerations". It was observed with respect to BHP House:
"Advantages
(a) The obvious non-financial advantage in staying in BHP House is that we would not have to leave the building. We have some doubts as to how real this advantage might be as, apart from the actual cost of relocation, it could almost be as disruptive to move from one floor to another as it would be to move from one building to another.
(b) Location. One of the most prominent buildings and sites in the city.
Disadvantages
(a) We would be in the building during the entire period of the refurbishment although, as we have said, it is difficult to assess the extent of any inconvenience which might result.
(b) It is difficult to assess, at least at this stage, the quality of the end product. Although AMP are apparently spending something in the order of $100 million and wish to upgrade the building to a quality level comparable with other landmark buildings either proposed or under construction, the extent to which the interior of the building, and the services, can be transformed must be open to question. However, at this stage we have not sighted any design brief or even outline specifications."
In the concluding summation the recommendation was made thus:
"(a) On the basis of the financial analysis, given our anticipated rate of personnel and client growth and an appropriate use of the incentive package, we are of the view that a move to 101 on the terms offered can and should be made by the firm.
...
(f) We consider the advantages of a move to 101 outweigh the disadvantages."
Unlike Cooling the lessor would not in any way reduce the specified rent. In Cooling the firm of solicitors had the option of receiving the incentive payment or enjoying an initial period of occupancy rent free.
On 9 August 1989 the partners of the Firm resolved to accept the offer of a lease of the Collins Street premises. The resolution was expressed to be conditional on the Firm's inability to procure an extension beyond 11 August 1989 of the time limited by the offeror for acceptance of the offer. Having failed to procure any extension, the members of the Firm accepted the offer and on about 14 August 1989 caused a company, Plurimus Holdings Pty Limited ("Plurimus"), to execute, as their nominee, an agreement for a lease to that company of a number of floors in the Collins Street premises and another agreement, of the same date, for payment to Plurimus of the Inducement Amount.
This agreement for lease specified six floors of leased space numbered 42 to 47. The rental for the lowest floor, numbered 42, was at the rate of $660 per square metre per annum. The rate increased by $5 per square metre in respect of each higher floor.
By the other agreement it was provided:
"2.1 As an inducement for the lessee to enter into the agreement for lease, the lessor agrees to pay to the lessee the inducement amount."
The expression "inducement amount" was defined to mean:
"The total amount payable by the lessor to the lessee pursuant to this agreement."
It was provided that on the latter occurrence of two specified dates, the "Commencement Payment" should be paid to the lessee. Those dates were the date of completion of the Collins Street premises and the date that marked the end of the 12 weeks during which the lessee was required to perform fitting-out work (called the Lessee's Work). The Commencement Payment was defined to mean, in effect, $15,890,000 (called the "Specified Amount") less any amounts from time to time drawn down between the date of the agreement and the date of commencement of the lease (the day after the date for making the Commencement Payment). Compound interest was also provided. Before the date of commencement of the lease the lessee might draw down so much of the Inducement Amount as was proved to be required to defray "Authorized Expenses", which latter expression was defined to mean the following categories of expense:
(a) the Lessor's costs with respect to the Agreement for Lease payable pursuant to Clause 4.2 of the Agreement for Lease;
(b) stamp duty on the Agreement for Lease and Lease;
(c) up to $3,000,000 in respect of expenses properly incurred with relation to the early termination of the Lessee's lease from Australian Mutual Provident Society of premises in BHP House, 140 William Street, Melbourne;
(d) reasonable expenses with regard to the design and documentation of the Lessee's Works; and
(e) reasonable consultants' and contractors' fees with respect to the Lessee's Works or relating to the Agreement for Lease.
By deed dated 14 August 1989 between the lessor, the lessee (called "the Nominee" in the deed) and most of the members of the Firm (called "the Principals" in the deed) the Principals covenanted "to meet all obligations of the Nominee pursuant to the Transactions Documents". The recitals to the deed stated:
"The Principals are some of the partners of the Melbourne firm of Freehill, Hollingdale & Page practising from its offices at 140 William Street and 80 Collins Street, Melbourne (`the Partnership').
The Principals have requested the Nominee to enter into certain documents comprising an Agreement for Lease, a Lease and Car Parking Licence and certain other documents with the lessor relating to space in the tower building being constructed at 101 Collins Street, Melbourne (`the Transaction Documents' which expression shall include all documents or agreements contemplated pursuant to the Transaction Documents including (without limitation) any variation or renewal of the said Lease, any notice under any other Transaction document or any other agreement in connection with the Transaction Documents) as nominee for the Principals."
The deed contained an acknowledgment by the Principals that:
"they are liable pursuant to the Transaction Documents to the same extent as if they had executed the Transaction Documents in their own names in lieu of the Nominee."
In the deed there are warranties and representations by the Principals about the Nominee's authorization by the Principals to enter into the Transaction Documents and about the binding effect on the Principals of the Transaction Documents. Clause 7 of the deed provided:
"7.1 Subject to the provisions of Clause 7.2, any liability of a Principal shall be released upon written notification being given to the Lessor of the retirement or resignation of that Principal from the partnership, but no such release shall release any other Principals.
7.2 No less than twenty (20) Principals shall remain liable hereunder at all times.
7.3 The Principals shall procure any new member of the Partnership to acknowledge in a form acceptable to the Lessor that he or she is bound by this Deed as a Principal as if he had executed it on the date hereof."
The appellant was one of the Principals who executed the deed and he remains a member of the Firm.
The Firm later agreed to take a lease of two additional floors in the Collins Street premises numbered 48 and 49. By an agreement dated 25 July 1990, it was recited that the lessor and lessee had "agreed as an inducement for the Lessee to include levels 48 and 49, to vary the terms" of the agreement dated 14 August 1989 "concerning the inducement". The agreement of 25 July 1990 varied the earlier agreement by substituting $21,490,000 for $15,980,000, as the Specified Amount. By a deed, also dated 25 July 1990, recording the agreement to take the two additional floors, it was provided that in specified circumstances the floor numbered 50 should be substituted for the floor numbered 42 as being a subject of the lease to Plurimus, and that if that substitution occurred, as later it did, the Specified Amount should be, and should be treated as if in the earlier agreement it had been, $21,770,000.
In consequence of the operation of the provision in the earlier agreement for compounding of the Specified Amount, the Inducement Amount payable to the lessee became $29,351,530. The amount was paid, as to $5,000 during the year ended 30 June 1990, as to $2,994,784 during the following year, and as to the balance of $26,351,746 during the year ended 30 June 1992.
His Honour found that, as the partners had foreseen in August 1989, the move to the Collins Street premises in July 1991 occasioned the Firm very substantial expense. Although the cost of fitting out the Firm's new premises (estimated in August 1989 at $11 million) was financed by way of lease, the actual expense of moving and the high rental commitment resulted in a low profit in the early years of the Firm's tenancy in the Collins Street premises. The amended partnership agreement between the members of the Firm, dated 12 December 1990, made provision for "topping up" ordinary income in 1991/92 and future years to offset, by recourse to the incentive payment, the effect on partners' incomes of the move in the first years of the tenancy at the Collins Street premises. The amended partnership agreement also made provision for any partner who was required to pay tax in respect of a part of the incentive payment, namely, that the Firm would reimburse any tax paid.
Certain expenses were incurred by the Firm in the course of moving premises. The Firm claims those expenses as deductions if it is found that the Inducement Amount is assessable income. The only evidence of those expenses is in paragraphs 11 and 12 of the appellant's affidavit sworn 3 October 1996. Those paragraphs read:
"11. The firm incurred expenditure in relation to the
negotiations leading up to the receipt of the payments and
the move from BHP House to 101 Collins Street which has
not been claimed as a deduction. In the year of income
ended 30 June 1991:
(a) Managed Projects - lease negotiations
and fit-out consultancy $392,000
(b) WT Partnership - cost management and
verification services 55,520
(c) Idee - interior design consulting 5,100
(d) 101 Collins Street - architectural services 15,569
(e) 101 Collins Street - engineering services 23,991
Total $492,180
12. In the year of income ended 30 June 1992:
(a) Managed projects - lease negotiations $77,860
(b) WR Partnership - cost management and
verification services 5,040
(c) Idee - interior design consulting 12,540
(d) J Wilson Removals - moving furniture etc 8,119
(e) Woollahra Art Removals - moving
paintings 1,154
(f) IBM - moving IBM equipment 11,277
(g) Nauru House - final clean 312
(h) Nauru House - reinstatement costs 19,723
Total $136,025"
His Honour found that, whilst it may be true that the disruption attendant on a lessor's refurbishment was a circumstance influencing lessees to move away from a building, it was a less common circumstance than a number of others having a similar influence, such as the need for more space, or for a more convenient location, or for a higher or lower class of business premises. His Honour found that the refurbishment was not a circumstance which the evidence showed compelled the Firm to resolve to move away from BHP House. His Honour found that:
"before and after the firm became aware of the lessor's intention to refurbish BHP House its management committee was contemplating as possibilities a purchase of part of a prestigious building, a lease of part of such a building and expansion of its occupancy within BHP House."
His Honour was satisfied that, in August 1989, the members of the Firm were resolved not to take for their immediate benefit a share each of the incentive payment, but intended that the moneys received should be retained as working capital of the Firm. His Honour concluded that in those circumstances:
"it may be said that the members of the firm had no choice but to take the money which an entity such as their firm would inevitably be offered to commit the prestige of the firm's name as tenants of an expensive building under construction in the centre of Melbourne."
His Honour found that:
"the amount of the sum to be offered they might seek to influence by negotiation. But the offer of some large amount was an occurrence independent of any action of theirs. While the incentive payment offered them was important, if not essential, to the financial viability of so expensive a lease for the firm, they had not the alternative means of lessening the burden of the rent, by seeking to persuade the owners to accept a lower rent. And, it might be said, in those circumstances there was not disclosed a "purpose of ... obtaining ... a commercial profit by way of incentive payment". According to the submission of Mr Archibald the reasoning in Cooling's Case ordains that a receipt is assessable only if a transaction which generates the receipt "can properly be said to have been entered into by the firm in the course of carrying on its business and ... the arrangement is a profit making scheme in the sense that those words are used by the High Court in Myer". ... In this case, in Mr Archibald's submission, not only did the circumstances concerning the proposed refurbishment of BHP House place the firm in the extraordinary situation of a tenant, of recently refurbished premises held under a lease which was to run for more than another four years, compelled, or at least strongly motivated, to move, but also the terms of the available transactions being offered under which a move might be made afforded no occasion for the formation by the firm of a profit making purpose."
The primary Judge then made the following findings:
* the receipt of the incentive payment by the Firm was consideration for the Firm's public commitment in August 1989 to take the lease of the premises in 101 Collins Street;
* whilst it is not easily expressed as a profit, the receipt was rightly described as a gain, and one purpose of the appellant and his partners in entering into the transaction was to secure that gain and this brought the case within the operation of the principles expounded in Cooling;
* the decision which was required by the members of the Firm on 9 August 1989 occurred in the course of carrying on its business.
These finding were followed by the following important passage in his Honour's judgment:
"As one of the small number of large leading firms in legal practice in Melbourne the firm had to keep under review the adequacy of its accommodation to house, comfortably and efficiently, its numerous work force, and to project to its clients and those who might decide to become clients a conception of the firm which would attract the class of client which suited the firm's practice. Such a firm may by good fortune or good planning be able to stay in the same premises for a substantial period, but there remains always a likelihood that such a firm will as part of its conduct of its business have to decide whether or not to move. During the years when a move from BHP House was under consideration incentive payments of the kind which was involved in the move to 101 Collins Street were common in respect of large new buildings in the centre of Melbourne, they being the buildings most likely to suit the requirements of the large leading firms of solicitors. I find that the applicant and his partners did not think themselves devoid of choice on 9 August 1989 between staying in BHP House and leaving it. On the contrary, they were, as I find, set upon making a choice between the alternatives placed before them in the papers prepared for the meeting. And one substantial purpose of their making the decision to choose 101 Collins Street was to obtain the incentive payment which that choice could secure. To each of them who remained a partner in 1990, 1991 and 1992 the payment was in my opinion a gain which he had sought and obtained, notwithstanding his participation in the resolution that no part of the payment would be distributed to a partner. The resolution for commitment of the incentive payment to the firm's working capital was in law a direction under the partnership agreement to apply each partner's share of the payment in a particular way. When the payments were received in 1990, 1991 and 1992 they were received in my opinion as income, and therefore as assessable income for the purposes of Division 5 of Part III of the Income Tax Assessment Act 1936 [`the Act']."
His Honour dealt with the contention of the appellant that, if the incentive payments were assessable income of the partnership, certain expenses should be included in the deductions allowable in the calculations of the "net income" of the partnership for the purposes of Division 5 of Part III of the Act. His Honour found with respect to the items claimed by the appellant as his share of the appropriate allowable deductions, that certain of those expenses were allowable deductions; others were incurred on capital account and therefore were not deductible; and that in respect of others, since the evidence was unclear as to which category would appropriately identify them, his Honour was of the view that the matter of the objection be remitted to the Commissioner to determine the question of deductibility of those items.
In the result his Honour allowed the appeals of the appellant; ordered that the objection decisions be set aside; and that the matter of the objections be remitted to the Commissioner to be considered and decided according to law. His Honour declared that the sums of $136,562 and $955,596 specified in the appellant's notice of objection were assessable income of the appellant.
His Honour requested the parties to file written submissions concerning costs of the appeal before him. After later taking into account those submissions, his Honour ordered on 12 May 1997 as follows:
1. That the Commissioner's costs of the appeals be taxed.
2. The appellant's costs of the issues and questions in the appeals concerning certain of the expenditure be taxed.
3. That the appellant pay to the Commissioner for his costs of the appeals the amount by which the amount of the Commissioner's taxed costs exceeded one-quarter of the amount of the appellant's taxed costs of the issues and questions.
The two appeals to the Full Court were heard together.
* The decision made by the Firm to move from the four floors it occupied in BHP House to the Collins Street premises was forced upon it by AMP's intention to gut and cleanse the floors of asbestos and refurbish the building. The circumstances which gave rise to the need for the Firm to consider the move were extraordinary and emanated from the decision of the AMP in September 1988 that all floors in BHP House be gutted and cleansed of asbestos.
* It was not an ordinary incident of the Firm's business to receive lease incentives. The Firm had never previously received such incentives.
* Cooling is not authority for the proposition that every inducement payment received as an incident of moving premises is a profit made in the ordinary course of the taxpayer's business which is of an income nature. There must be a profit making purpose.
* The Firm's only purpose in entering into the lease for the Collins Street premises was to obtain suitable premises from which it could conduct its legal practice at the lowest overall cost achievable. The occasion giving rise to the inducement to payment was clearly a capital occasion.
* The partners of the Firm had no intention of deriving the inducement payment to enable a cash distribution to be made to them. The payment was seen by the partners as reducing the very significant additional costs incurred by the Firm as a result of its decision to move to the Collins Street premises rather than to relocate within BHP House. It was not seen as an opportunity to make a profit or gain.
* The proper application of the principles in Myer requires the Court to assess the overall transaction and not merely the receipt of the inducement payment.
* Looking at the whole of the relevant facts, there was no profit nor was there a gain to the Firm.
* Cooling was wrongly decided by the Full Court of this Court.
* In any case, the circumstances of this case stand in stark contrast to those in Cooling.
* If, contrary to the submissions of the appellant, the occasion for the move to the Collins Street premises was a revenue occasion, the expenses incurred by the Firm connected with the negotiation of the agreement to lease the Collins Street premises were also on revenue account, and so are properly deductible as revenue outgoings.
The argument of counsel for the Commissioner may be summarized as follows:-
* The reasoning of the primary Judge is correct and should be adopted by the Full Court.
* The receipt of the incentive payment by the Firm and therefore the appellant was on revenue account and his Honour correctly so found.
* The Firm intended to make a gain from entering into the incentive agreement.
* There was a scheme or transaction entered into by the Firm which yielded a profit or gain.
* The Firm was not compelled to take the incentive payment by either a perception of an unacceptable asbestos risk or the disruption to the practice resulting from remaining in BHP House.
* It was an ordinary incident of the conduct of the Firm's legal practice to move into the new Collins Street premises.
* It was an ordinary incident of leasing premises in the Melbourne Central Business District in 1989 for a lessee to receive an incentive payment.
In my opinion the case raises no new questions of principle. The relevant principles were expounded by the High Court in Myer and by the Full Court of this Court in Cooling. The case turns essentially on its facts. The findings of fact by the primary Judge were not in contest, although we were referred by counsel for both parties to facts additional to those found by his Honour and from which inferences were said to be capable of being drawn which might affect the ultimate conclusion of fact to be made by the Court.
The circumstances in which an appellate court will interfere with findings of fact by the primary Judge are well established. The following oft cited passage from the judgment of Gibbs ACJ, Jacobs and Murphy JJ in Warren v Coombes [1979] HCA 9; (1979) 142 CLR 531 at 551 makes the point clearly:
"Shortly expressed, the established principles are, we think, that in general an appellate court is in as good a position as the trial judge to decide on the proper inference to be drawn from facts which are undisputed or which, having been disputed, are established by the findings of the trial judge. In deciding what is the proper inference to be drawn, the appellate court will give respect and weight to the conclusion of the trial judge, but, once having reached its own conclusion, will not shrink from giving effect to it. These principles, we venture to think, are not only sound in law, but beneficial in their operation."
Before an appellate court will interfere with findings of fact by the primary Judge a court must be satisfied that the primary Judge's judgment is erroneous. It may be so satisfied if it concludes that the primary Judge failed to draw inferences that should have been drawn by the facts established by the evidence or drew the wrong inferences therefrom. But if at the end of the day all that is established is that the primary Judge chose between competing inferences, even if the appellate court may not have been disposed to reach the same conclusions as the primary Judge, the appellate court will not interfere; see also Minister for Immigration, Local Government and Ethnic Affairs v Hamsher [1992] FCA 184; (1992) 35 FCR 359 per Beaumont and Lee JJ at 368-9; Edwards v Noble [1971] HCA 54; (1971) 125 CLR 296 per Barwick CJ at 304 per Menzies J at 308-9 and Walsh J at 318-9; News Limited v Australian Rugby Football League Limited [1996] FCA 1256; (1996) 64 FCR 410 at 423-4. See also s 27 of the Federal Court of Australia Act 1976 .
The incentive payment to the Firm is assessable as income under ordinary concepts if any of the following questions are answered in the affirmative. These questions are derived from Myer and Cooling, which in turn are derived from California Copper Syndicate v Harris (1904) 5 TC 159:-
1. Was the incentive payment a profit or gain made by the Firm from a transaction which formed part of the ordinary course of its business: Myer at 209. See also Westfield Limited v Federal Commissioner of Taxation (1991) 28 FCR 333 at 342.
2. Was the incentive payment a profit or gain made from a transaction that was not in itself part of the ordinary course of the taxpayer's business; but which was an ordinary incident of the business activity of the Firm: Westfield at 342-3. See also Colonial Mutual Life Assurance Limited v Federal Commissioner of Taxation [1946] HCA 60; (1946) 73 CLR 604 and more recently, CMI Services Pty Limited v Federal Commissioner of Taxation (1990) 94 ALR 153.
3. If any profit or gain was made by the Firm from an extraordinary transaction; was the profit or gain so made acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit: Myer at 210-213 and Westfield at 344.
Earlier I set out the facts at some length, but it will be necessary in the course of my reasons, at the risk of repetition, to repeat some of them.
At relevant times there was an over supply of office space in the Melbourne CBD and the market for it was very competitive. It was usual for owners of city buildings to offer incentives to prospective tenants. The primary Judge accepted that the Firm was not able to negotiate a lower rent because owners of buildings in the CBD maintained rent levels and, notwithstanding the over supply of office space, reductions in rents did not follow.
As mentioned earlier, the leases of two of the floors by the Firm in BHP House were to expire on 31 March 1993 and the leases of the other two floors on 28 February 1994.
Freehills had been a tenant of BHP House since 1977 and in the period 1987-8 had totally refurbished the leased premises at a cost of about $3.8m. The refurbishment caused serious disruption to the Firm's practice. When the refurbishment had been completed the Firm intended to remain in BHP House.
When the Firm learned in September 1988 that BHP House was to be gutted and cleansed of asbestos, followed by a major refurbishment, the Firm took the steps previously mentioned including the establishment of a "Premises Committee" which, when reporting to the Firm's Management Committee on 10 November 1988, stated that there were two alternatives: first to refuse to vacate BHP House and move to new premises at the expiration of the lease or secondly, to move to new premises to be occupied from 1990-91.
The programme which AMP intended to pursue of gutting and refurbishing BHP House necessarily meant that the Firm would have been compelled to vacate the premises either totally or floor by floor as the refurbishment proceeded. It was made clear by AMP, by letter of 20 March 1989, that the works were to commence in September 1989 and to proceed for over four years. It was plain that the Firm would have to vacate the floors occupied by them. The appellant's case was put on a number of bases; but at its highest that the gutting and refurbishing compelled the Firm to vacate BHP House. This submission was not accepted by the primary Judge who found that "the disruption attendant on a lessor's refurbishment ... was not a circumstance which the evidence showed to have compelled the Firm to resolve to move away from BHP House" and that, both before and after the Firm became aware of the lessor's intention to refurbish BHP House, its Management Committee was considering the possibility of purchasing part of a prestigious building or a lease of such a building or the expansion of its occupancy within BHP House. His Honour found that the appellant and his partners did not think themselves devoid of choice between staying in BHP House and leaving it; but they embarked upon a course of choosing between the alternatives placed before them in the papers prepared for the meeting of 9 August 1989.
Nevertheless, it was clear that the Firm was most concerned about the effect that the proposed four year refurbishment programme at BHP House would have upon its practice, staff and clients.
The Firm looked at various options. But by 9 August 1989 only three of the options remained. Those three options were relocating on renovated floors of BHP House, accepting the offer which had then been made in respect of the Collins Street premises or accepting the offer made in respect of Grand Central, which was a Lend Lease project planned for the corner of Bourke and William Streets, Melbourne which was then in the preliminary planning stage.
In my view, in practice it was not feasible for the Firm to remain on the floors which it occupied in BHP House. The Firm was seriously concerned about the inconvenience and the risk of asbestos if it stayed at BHP House. It seems to me to be an inevitable conclusion from the facts that the decision to move from the four floors in BHP House was in practical terms essential to the Firm. The circumstances which required the Firm to look at options for alternative premises (whether within BHP House or elsewhere) were extraordinary and directly flowed from the statement by AMP in September 1988 that all floors in BHP House were to be gutted and cleansed of asbestos.
The Firm had no practical alternative, when confronted with the gutting and cleansing from asbestos of BHP House including its own premises of four floors, but to move out of those four floors even on a temporary basis while other floors were reconditioned. By staying at BHP House the Firm would experience all the problems that would be consequent upon refurbishment of a major city office block, including the attendant disruption to its practice and nuisance to clients and staff.
After weighing all the relevant considerations, one factor being, of course, the offer of the inducement payment, the Firm chose to move to the Collins Street premises.
If any profit or gain was made by the Firm in relation to the move to the Collins Street premises it was not made in the ordinary course of carrying on its practice. Of course, if firms of solicitors occupy rented premises they cannot be assured of permanent occupancy. Obviously it must be expected by a firm of solicitors that it may have to move premises from time to time consistent with the lessor's requirements, the expansion or retraction of the solicitors' practice, the rental charged and matters of this kind. But this was not a move to premises made in the ordinary course of carrying on the practice of a firm of solicitors.
Nor can it be said, in my view, to be correct that, if a profit or gain was made, that was itself an ordinary incident of the practice of the Firm.
The real question is whether the third principle mentioned earlier applies, namely, whether, assuming there was a profit or gain in the relevant sense, the transaction which constituted the move from BHP House to the Collins Street premises was made in the course of a business operation or commercial transaction for the purpose of profit-making.
For the third principle to apply it is essential that a transaction for the purpose of profit-making be identified; there must be a profit making scheme. On the facts of this case the only possible transaction or scheme could be the entry by the Firm into the agreement of 14 August 1989 for the payment of the Inducement Amount and the agreement for lease of the same date. The Inducement Amount was payable "As an inducement for the Lessee to enter into the Agreement for Lease" (clause 2.1).
Under the Agreement for Lease, also of 14 August 1989, the lessee (Plurimus) agreed to lease floors 42 to 47 in the Collins Street premises for twelve years with an option for a further six years at an annual rental of $6,184,610. This was later increased to $8,471,675 for levels 43-50. The rental was substantially higher than the rental payable for the premises in BHP House of approximately $3m. Also, under the Agreement for Lease the lessee agreed to fit out the whole of the leased floors at a cost of $12.9m. The commitments which were entered into by the lessee were very substantial in monetary terms and were for a long term.
In my opinion, the evidence establishes that the Firm's purpose in entering into the lease of the 101 Collins Street premises was to secure prestigious premises in which the Firm could conduct its practice as solicitors at the lowest possible cost. The evidence is not consistent, in my opinion, with a finding that the making of a profit or gain was a significant element in entering into the transaction.
Certainly the Firm intended to obtain the incentive payment; but the Firm was primarily concerned to secure "a position for the Firm in a landmark prestige building" with as little inconvenience and disruption to its practice, clients, members and staff as possible. Naturally the Firm wished the inducement payment to be as large as possible, but it does not follow that the acquisition of an incentive payment was the object of the transaction. The purpose or object of entering into the transaction to lease the Collins Street premises and to receive the inducement payment was to secure premises for the long term future of the Firm, not to obtain a payment by way of inducement to be received as a profit or gain by the members of the Firm.
It is easy to say that, because a lessee receives a substantial sum of money as an inducement to occupy office premises when there is an oversupply of such premises, the receipt is necessarily of a revenue nature. But the whole of the relevant facts and circumstances must be examined; and when one does so in this case it seems to me that the correct conclusion to draw is that the occasion giving rise to the inducement payment was a capital occasion: Selleck v Federal Commissioner of Taxation 97 ATC 4856 per Lockhart J at 4859 and Beaumont J at 4875-4878.
In this case the relevant transaction plainly was not one that formed part of the ordinary course of the Firm's business (thus it did not fall within the first principle) and was not an ordinary incident of the Firm's business (thus not falling within the second principle). Nor, in my opinion, was there a purpose by the Firm of profit-making by agreeing to enter the lease.
The primary Judge's judgment was given on 8 April 1997, before the judgment of the Full Court of this Court in Selleck was given on 20 August 1997. The Court stressed in Selleck, thus reflecting what was said by the High Court in Myer and by a Full Court of this Court in Cooling, that whether a gain is assessable depends on the circumstances of the case (per Lockhart J at 4859).
The facts of Cooling were different. In Cooling the firm of solicitors had not decided that it was essential or even important to move premises. There were no extraneous factors such as a merger or refurbishment of the building which brought about the need to move. In Cooling the promised receipt by the partners individually of the incentive payment was a not insignificant purpose in the firm's decision to move to the AMP premises. In Cooling the decision to leave the firm's old premises and take up a lease with the AMP was influenced by the incentive payment to a not insignificant degree: see Selleck per Lockhart J at 4859.
There is a question as to whether the intention or purpose of making a profit or gain need be the sole or dominant purpose of entering into the transaction or whether it is sufficient if there is a significant purpose. The debate stems from the use of the phrase in Myer by the High Court: "with the intention or purpose of making a profit or gain" and has led to the argument whether the word "the" is intended to denote the sole or dominant or a significant purpose. It does not matter in this case because, in my opinion, the evidence does not establish that it was a significant purpose of the Firm in entering into the relevant transactions that it make a profit or gain.
In all the circumstances, in my opinion the Firm's need to move from BHP House to the Collins Street premises was a capital occasion. The Firm did not have any relevant purpose of profit making when the lease was entered into for the leasing of the Collins Street premises and to receive the inducement amount.
I would allow the appeals with costs. I agree with the orders proposed by Davies J.
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I certify that this and the preceding twenty-five (25) pages are a true copy of the Reasons for Judgment herein of the Honourable
Justice Lockhart |
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Dated:
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