BP Australia Ltd. v Federal Commissioner of Taxation
(1964) 110 CLR 38737 ALJR 365
(Judgment by: Kitto J)
Between: BP Australia Ltd
And: Federal Commissioner of Taxation
Judges:
Taylor J
Dixon CJ
McTiernan J
Kitto JWindeyer J
Owen J
Subject References:
Income Tax
Judgment date: 25 February 1964
Melbourne
Judgment by:
Kitto J
This appeal relates to an amended assessment of the tax payable by the appellant under the provisions of the Income Tax and Social Services Contribution Assessment Act 1936-1952 in respect of income derived in the year ended 30th June 1952. In that year the appellant, in the course of carrying on a business which included supplying motor spirit to operators of service stations in Australia, incurred outgoings in the form of payments to the operators of certain service stations in consideration of their entering into restrictive agreements. It is common ground that these outgoings are allowable deductions under s. 51 (1) of the Act unless they are of a capital nature. Whether they are of a capital nature is the question to be decided. (at p411)
The relevant facts have been stated by Taylor J. in his reasons for judgment, and I need not repeat them. The choice to be made is between describing the outgoings as expenditure "upon establishing, replacing and enlarging the profit-yielding subject", "the profit-making machine" (see John Fairfax & Sons Pty. Ltd. v. Federal Commissioner of Taxation (1959) 101 CLR 30 , at p 41 ) and describing them as expenditure which, though unusual, was for a purpose falling within the conduct of the trade. A conclusion that they were expenditure of the former description may be supported by arguments along two lines. The ideas on which they depend are not, I think, fundamentally different, and they were not always kept separate in the argument of the appeal; but it is perhaps useful to treat them separately for completeness of discussion. (at p411)
One line of argument is that the purpose of each payment was to obtain freedom from competition in respect of a particular service station; that such a payment, if made to a potential competitor, is ordinarily a capital charge as being the price of an advantage in the nature of a capital asset added to the profit-earning structure of the payer's business: see Sun Newspapers Case (1938) 61 CLR 337 ; Broken Hill Theatres Pty. Ltd. v. Federal Commissioner of Taxation (1952) 85 CLR 423 ; that the payment should be held to have the same character when made to a customer, because it achieves the same end; and that therefore the present case is simply one of a large number of capital outgoings. The other line of argument is that the payments considered as a whole were simply the cost to the appellant of equipping itself with a new market in place of one which had been or was being destroyed by the action of competitors in inducing a number of service station operators to refuse to do further business with the appellant; and that the payments were made not as part of the cost of effecting sales but in order to create a totally new situation within the framework of which future sales might be made - a framework of service stations selling only motor spirit supplied by the appellant or its allies. This latter argument does not ignore the limit of time in each restrictive agreement, but treats it as not affecting the character of the payments, for the reason that once a service station had ranged itself with an oil company it would be likely to remain with that company more or less permanently. The trade of the service stations, formerly divided horizontally among the oil companies, was split vertically during the months that followed August 1951, and (so the argument goes) what the appellant did by making the payments in question was to secure for itself, as a pre-requisite to its continuing to sell motor spirit to service stations, a share of the trade as thus newly divided. The payments, that is to say, bought customers; and the analogy of a purchase of goodwill should suffice to show that the expenditure was of a capital nature. (at p412)
The case for the respondent was elaborately developed, but in essence it seems to me to amount to no more than this. I think, with all respect to those who see the matter differently, that it misinterprets the facts of the case. (at p412)
In the first place, while it is true that for each payment made to an operator the appellant obtained an immunity from competition for a period in respect of that operator's service station, the transaction differed in an important respect from one in which a trader takes from a potential competitor an agreement in restraint of trade. The effect of a binding promise not to compete is to create for the promisee a more favourable situation in which to carry on his business for the future; it makes an improvement in the conditions in which he may proceed to carry on his profit-making activities. In other words, the elimination of the competitor is anterior to, and not part of, the trading in which the benefit of it will be felt; and accordingly, in the ordinary case at least, the cost of it is a cost of adding a protective element to the structure of the promisee's business. Forming no part of his trading expenses, but being, in effect, the purchase price of a capital asset, it is a capital charge. But a promise by a service station operator not to deal with oil companies other than the appellant or its allies was only the negative side of the substantial positive advantage which it was the purpose and practical effect of the agreement to produce, namely the advantage of a practical certainty that the whole of the custom of the service station, for motor spirit, would be given to the appellant or its allies for the agreed period; and what the appellant really paid its money for was that positive advantage. The purpose was not to create a situation in which to set about selling motor spirit; it was to secure the particular sales which would be necessary for the satisfaction of the service station's requirements of the period. The payment of the money was analogous to expenditure in sending a commercial traveller on his rounds to secure orders; it was part and parcel of the business of effecting sales. I do not say that a payment by a trader to his customer in order to obtain sales to the customer cannot in any circumstances be a capital outlay. Generalization in this field is dangerous, and one must bear in mind such cases as United Steel Companies Ltd. v. Cullington (1939) 23 Tax Cas 71 . But it is, I think, safe to say that a payment made by a trader to a customer for the purpose of securing orders for a quantity of goods is prima facie part of the cost of selling the goods. (at p413)
The second way of putting the respondent's case requires rather fuller discussion. There began in August 1951, it is true, a radical change in the organization of the wholesale trade in motor spirit, and the making of the payments in question formed a part of the appellant's endeavours to cope with the resulting threat to its trade. But I do not find in the evidence any justification for regarding the payments as final in character, having the practical result of providing for the appellant's business a new basis of operation. The occasion for making payments of the kind was not over when the appellant had secured for itself the allegiance of service stations sufficient in number and size of business to ensure that its future sales figures would equal or exceed those of the past. The change that occurred was a change to a system in the working of which the need would have to be continuously faced of obtaining, by means of cash payments or other inducements, periodical monopolies (or near monopolies) of the orders of individual service stations. The initial need was to get as many service stations as possible to accept the appellant, or the appellant and its allies, instead of any of its rivals, as their sole source of supply for the time being. It was an urgent need, for the day was over when an oil company could expect to go on sharing with others the orders of individual service stations. The appellant had to face the fact that thenceforth every service station from which it could not manage to exclude its competitors was a station from which it would be itself excluded. But since permanent exclusion of competitors was out of the question save by buying the station outright, the payments to which this appeal relates were made for monopoly rights for limited periods only. The periods varied from three to fifteen years, and the amounts paid varied very greatly. The appellant naturally paid an operator as little as he would accept for as lengthy a monopoly as he would give. Of course a stage would be reached when the initial emergency would be over, when substantially the whole of the service stations would have declared themselves for this oil company or for that; but the error that seems to me to underlie the respondent's argument is in thinking that when that point had been reached the wholesale trade in motor spirit would for practical purposes have been finally carved up among the oil companies, and that the appellant would have secured a portion for itself at the cost of such expenditure as that which we have now to characterize. What in truth happened in August 1951 was that an era began in which continuing competition among oil companies for blocks of orders, each block consisting of the whole of the orders from a service station in a period, would be a permanent feature of the trade. (at p414)
The point may perhaps be elaborated a little more. The first year or so was naturally the period of most spectacular and expensive competition for exclusive agreements with service stations, for the whole of the service stations of Australia, thousands of them, were all prizes to be scrambled for. Once they had taken up their alignments with oil companies by means of agreements for set periods, the maintenance of each oil company's relative position in the "solo" system might well be expected to involve less feverish activity; for as a service station's agreement expired, there would probably be a tendency for the operator to renew his allegiance with the oil company with which he had been dealing, and, unless another oil company had a special reason for intervening notwithstanding the share of the consumers' market enjoyed by neighbouring stations that were already tied to it, one might expect that any financial inducement that might be necessary to bring about a renewal of the old agreement would be on a smaller scale than had been required in 1951-1952. But the quantum of inducement required is beside the point. What matters is that the change in the organization of the wholesale trade in motor spirit from the old system of multiple pump service stations to the new "solo" system meant inevitably that every oil company, if it wanted to sell motor spirit to service stations in the future, had to accept the necessity of spending money, not at the beginning once and for all, but at the beginning and from time to time, to ensure that it would receive from as many service stations as possible the whole of their orders for limited periods. Whenever a station's agreement giving one oil company a monopoly of its orders for a period came to an end, whether by effluxion of time or any other cause, and whenever a new service station was built otherwise than by one of the oil companies, some oil company would have to incur expenditure, be it much or little, as the cost of securing for itself, for a period ahead, the whole of that station's orders. A constant course of effort and expenditure in securing the exclusive right to supply the whole requirements of individual resellers for agreed periods was thus of the very essence of the "solo" system. Expenditure by an oil company to get its quota of stations during the months in which the market was in the throes of arranging itself initially, however great the amount may havebeen, was simply a part of the expenditure to which that company's participation in the new system committed it as a regular feature of its selling activities. (at p415)
How then should the advantage be described for which the appellant made the expenditure we have here to characterize? In the view I take of the case, the advantage was not the acquisition of a new market, not a new framework within which to carry on trade for the future, not an extension of the appellant's selling organization to include a regiment of resellers. It was not such an exclusion of competition as adds to goodwill a negative right and thus increases the value of goodwill. It consisted simply of the practical assurance of receiving bundles of orders for motor spirit, the circumstances being such that for the foreseeable future it would be only by getting similar bundles of orders that such a trade as the appellant's could be carried on. That that was really what the money was paid for appears very clearly from the evidence as to the part which "gallonage" played in the matter. "Gallonage" is an expression used in the evidence to refer to the quantity of motor spirit a particular service station was currently selling, or might be expected to sell, every month. It was the standard of measurement of the size of a station's business in motor spirit, and consequently it was always a factor in the appellant's assessment of the amount which it should agree to pay in order to induce an operator to enter into an agreement. Of course it was not the only factor in the fixing of the amount. Obviously the period for which a monopoly was being obtained would always be another; and the evidence makes it clear that both the degree of competition offered by other oil companies for a particular service station and the ease or difficulty of bargaining with the operator influenced the figure. But always the ultimate question for the appellant was whether, bearing in mind the probable amount of the trade which would result from obtaining an agreement with the operator, it was worth while to pay a particular sum as the price of the agreement. The fact that the quantity of spirit likely to be ordered every month in pursuance of the agreement was a guiding though not governing consideration in the fixing of the amount to be paid throws, therefore, a clear light upon the nature of the payment, from the appellant's point of view, as that of a cost of obtaining orders for the spirit to be supplied during the term. I say from the appellant's point of view, because if the payments be looked at from the recipients' point of view they wear a different aspect. What the operator did for the money he received was to give up a portion of his trade freedom. To do so was no part of his trade, and the amount he received, at least in a case where the facts were similar to those of Dickenson's Case (1958) 98 CLR 460 , could not properly be regarded as received on revenue account. But it seems to me that it would be an odd piece of accounting that would work out the appellant's profit from supplying motor spirit to service stations without bringing in, as an item of marketing cost, every sum spent to make sure of securing orders in the new way in which the trade was going about the securing of orders, namely by inducing individual resellers to put themselves in the position of having to give the whole of their orders for a period to a single oil company. (at p416)
The matters to be considered in deciding the capital or income nature of expenditure incurred to secure an advantage for a business are stated by Dixon J. in the Sun Newspapers Case (1938) 61 CLR 337 , at p 363 , and I shall not restate them. The conclusion to which consideration of these matters brings me is that the outgoings in question here were not of a capital nature, but were of the nature of trading expenses to be allowed for in the ascertainment of the profits from the carrying on of the appellant's business. (at p416)
I am therefore of opinion that the appeal should be allowed and the assessment of tax remitted to the Commissioner for further amendment. (at p416)