BP Refinery (Kwinana) Ltd v Federal Commissioner of Taxation
[1961] ALR 52(1960) 8 AITR 113
(1960) 12 ATD 204
(Judgment by: Kitto, J)
BP Refinery (Kwinana) Ltd
v Federal Commissioner of Taxation
Judge:
Kitto, J
Judgment date: 7 October 1960
Melbourne
Judgment by:
Kitto, J
The following written judgment was delivered:
This appeal relates to the method of calculation, under the provisions of the Income Tax and Social Services Contribution Assessment Act 1936-1955, of the taxable income of the appellant derived in the year ended 30 June 1955. The only question to be determined concerns an amount of £849,253 which the appellant contends is an allowable deduction in respect of depreciation of plant owned by it during the year and used for the purpose of producing assessable income. The appellant's income is derived from the business of an oil refinery which it carries on at Kwinana in Western Australia, and the plant referred to is plant of the refinery. The relevant provisions of the Act are contained in ss. 54, 55 and 56. The Commissioner does not deny that within the meaning of these provisions the units of property in question are "plant", or that in the circumstances of the case the Act entitles the appellant to an allowable deduction for their depreciation.
The Commissioner has determined, under s. 55 (1), percentage rates of annual depreciation for classes of plant into which the several units of the appellant's plant respectively fall, and the appellant has elected, pursuant to s. 56(1) (b), to have as the relevant allowable deduction the percentage so fixed of the "cost" of each of those units. It is in the ascertainment of "cost" that the point of difference between the appellant and the Commissioner has arisen.
The question at issue is whether the appellant is right in treating as a component in the "cost" of each unit of plant a proportion of what I may call the net cost of certain temporary buildings, including a construction camp, which were erected for purposes incidental to the construction of the refinery. The amounts in question are shown in schedule 13 to the appellant's return of income, headed "Construction camp and temporary buildings allocated over refinery plant - Calculation of depreciation for tax purposes". This schedule lists the units of plant which admittedly are depreciable for tax purposes, with the addition of three items for which depreciation is not claimed, viz. roads and paved areas, oxygen storage, and (permanent) refinery buildings. The first money column, headed "Original cost", attributes to these units respectively amounts which total £207,187. These amounts, I am satisfied, were the original cost of the temporary buildings referred to. The second money column is headed "Adjustment", and it distributes over the respective units amounts which total £24,186. The nature of these adjustments I shall indicate later. The third money column shows under the heading "Amended original cost" the several remainders after subtracting the amounts in the second column from the corresponding amounts in the first, the total remainder being £183,001. The next three columns produce as a decimal figure the proportion of the relevant year of income during which each unit of property mentioned was owned by the appellant after having been taken over from the contractor who installed it. The seventh column gives the relevant percentage rates of depreciation as fixed by the Commissioner. The eighth column, headed "Depreciation 1954-1955", contains the amounts which result from applying the percentage rates so fixed, over the respective decimal parts of the year, to the respective amounts of "Amended original cost" of the depreciable items (that is all the items except the roads and paved areas, the oxygen storage and the permanent refinery buildings), the total being £6104. This total figure is the amount which, being included by the appellant in its calculation of the cost of the depreciable plant, has been disallowed by the Deputy Commissioner.
It may be, as the appellant's counsel has suggested, that the Deputy Commissioner originally disallowed the £6104 under the mistaken impression that it was claimed as depreciation in respect of the temporary buildings themselves. It never was so claimed, though possibly the form of the schedules to the appellant's return of income could have made clearer than they did what the nature of the item really was. The claim is that the amount forms part of the allowable depreciation of the plant. Whether the claim is justified depends upon whether the "Amended original cost" figures totaling £183,001 are properly to he described as forming part of the "cost" of the plant to the appellant, within the meaning of s. 56. And upon that, the onus of proof lies of course on the appellant.
In order to discharge the onus the appellant has proved the transactions by which it came to acquire the plant and the amounts which it paid under those transactions, and has called as a witness its chief accountant. So far as the transactions are concerned, there is no need to do more than to mention their salient features. The refinery was established by the appellant pursuant to an agreement made in 1952 between the then Premier of the State of Western Australia and the appellant's parent company, which received legislative approval by the Act No. 1 of 1952 of that State. The site selected was in undeveloped country, ill-served by public transport, and at such a distance from centres of population that the housing of the considerable labour force required for the construction presented a substantial problem. At the time there was a serious shortage of houses, even in the centres; and it was necessary to provide for an influx of workers from other parts of Australia and from abroad. As one measure towards coping with the difficulty, the appellant took from the Crown a lease of land close to the site for the purpose of establishing a construction camp; and it made the site available for this purpose to the construction company to which the contract for the refinery was let.
That company was Kellog International Corporation, called in the construction contract KIC. The contract covered the whole construction of the refinery, including the furnishing by KIC of the labour and supervision necessary; and the contract price consisted of a fixed fee plus an amount equal to all expenditures reasonably incurred by KIC in carrying out the work. The expenditures referred to were to include a series of items specifically described, among them being the cost to KIC of providing, maintaining, operating and removing all temporary buildings. In the event, KIC constructed a number of temporary buildings, including not only the construction camp contemplated in the appellant's lease from the Crown but also certain temporary offices, tool rooms, workhouses, sheds and other erections. The cost was the £207,187 which schedule 13 to the appellant's income tax return was to show as the total of the "Original cost" column. All these buildings, which may be found itemized in exhibit D, were used solely for purposes incidental to the construction of the refinery. In particular, the construction camp was used throughout the period of the construction, and used exclusively, for the accommodation of single men engaged in the construction work. When the construction had been completed, most of the temporary buildings, including the construction camp, were demolished, and such of the materials as were saleable were sold. The rest were handed over by KIC to the appellant, some having general utility for the appellant's organization and the others having only a residual value as providing storage for surplus equipment. The sale of materials produced £8195. In exhibit D the components of this amount appear. To them are added in that exhibit the estimated salvage values (I accept them as correct) of the temporary buildings which the appellant took over as useful for storage, and the full original cost of the temporary buildings which the appellant took over as possessing general utility. The total is the £24,186 which schedule 13 shows in its second money column as the total of the amounts appearing under the heading "Adjustment". At the foot of the exhibit is the subtraction resulting in the £183,001 which appears in the third money column of schedule 13 as the total of the "Amended original cost" of the temporary buildings. It does not clearly appear from the evidence whether the estimated salvage values of the buildings taken over for storage and the amounts of original cost of the other temporary buildings taken over were treated by the appellant and KIC as diminishing the amount payable to KIC under the construction contract in respect of its expenditure of £207,187 for the erection of the temporary buildings; but, however that may be, the appellant concedes that only the balance, £183,001, should be regarded as having been paid by it to KIC under this heading. I have accordingly called this balance the net cost of the temporary buildings. I am satisfied that this amount was so paid by the appellant to KIC, and accordingly formed part of the cost of the refinery to the appellant.
If the whole of the refinery had been plant, it would have followed from the foregoing that the whole £183,001 ought to be treated as part of the cost of that plant for the purpose of ascertaining, in accordance with ss. 54, 55 and 56, the amount which was an allowable deduction to the appellant for depreciation. But admittedly not the whole of the refinery was plant, and not the whole of the plant was plant to the construction of which the erection of the temporary buildings was incidental. Accordingly the company drew a distinction in the main depreciation schedule to its income tax return, a schedule headed "Calculation of depreciation for tax purposes". This schedule itemizes, first, the units of plant, under the heading "Refinery plant"; then the other units of equipment, under the heading "Refinery equipment"; and after these the refinery buildings and the senior staff houses. Schedule 13, to which I have referred, being directed to the allocation of appropriate proportions of the net cost of the temporary buildings amongst the items of property to the construction of which the erection of the temporary buildings was incidental, lists those of the items mentioned in the main depreciation schedule which were depreciable plant excluding those which were outside KIC's contract, viz. service plant, motor vehicles and training equipment, and adds, without giving details, the three remaining headings, "Roads and paved areas", "Oxygen storage" and "Refinery buildings". The latter description in fact covers all such other items in the main depreciation schedule as were constructed by KIC. In making up the total of £6104 depreciation claimed for the relevant year of income, schedule 13 attributes to "Roads and paved areas" £3697 of the amended original cost of the temporary buildings; to "Oxygen storage" it attributes £183; and to "Refinery buildings" it attributes £6460 of that cost. Accordingly, of the £183,001 which is the amended original cost of temporary buildings, only the remaining £172,661 relates to units of property, being plant, in respect of which the claim is made that £6104 is an allowable deduction for depreciation.
That the claim is justified in principle seems to me to be clear. The total sum paid by the appellant to KIC necessarily included the amount of the net cost to KIC of the temporary buildings. That amount formed part of KIC's total net expenditure on construction, as did every other item of its indirect cost, or on-cost as it is often called; and when reimbursed to KIC by the appellant it formed part of the total cost to the appellant of the finished refinery. The cost to the appellant of every individual item of property in the refinery, or at least of some individual items, must therefore be considered to have included some portion of the appellant's reimbursement to KIC of the net cost of the temporary buildings. But a submission is made on behalf of the Commissioner that, while this may be correct as a matter of theory, in practice it cannot be applied on the evidence before the Court, and that to the extent to which it cannot be applied on the evidence the appellant fails to establish an allowable deduction. The point which is made is that there is no proof that the distribution in schedule 13 of KIC's net cost of the temporary buildings over the items comprising the whole refinery attributes to each item no more than its true share of that cost.
The method by which the distribution has been made has been explained in the witness-box by Mr. Butchart, the appellant's chief accountant. The method is to ascertain the direct cost of construction of each item - and that, I am satisfied, has been accurately done - and to spread the indirect costs, and in particular the indirect cost now in question, in the proportions which the direct costs are found to bear to one another. This is, of course, a well-known method of apportioning on-costs over items of production, but it is by no means the only method. The apportionment may be based upon labour costs only; or on some particular category of labour costs only; or on the number of man-hours spent on the whole or some part of the work of construction or production. There is a variety of courses amongst which a choice may be made by one who is seeking the most satisfactory practical answer to a problem which, after all, does not admit of a mathematically demonstrable solution. The problem of selecting the appropriate method of dealing with on-costs in a process of costing is a problem of business judgment, rather than one of mere mathematics. I say "in a process of costing" because, in my opinion, the word "cost" in s. 56(1)(b) bears the meaning which it has in the business life of the community. It seems to me impossible to suppose that the depreciation provisions of the Act are intended to apply only to those simple cases in which the ascertainment of cost is a purely arithmetical process. I interpret it as embracing the whole sum which, according to accepted accountancy practice as applied to the circumstances of the case, ought to be considered as having been laid out by the taxpayer in order to acquire the subject-matter as plant, that is to say installed and ready for his use as plant for the purpose of producing assessable income. Accordingly, where a taxpayer spreads an item of indirect cost over the several parts of a construction which has included both plant and other things, and does so in proportion to the direct cost of each, it is, in my opinion, irrelevant to criticize his method, as counsel for the Commissioner criticized the appellant's method in the present case, as "a statistical approach which is acknowledged not to be accurate with reference to any particular item of plant". Accuracy in such a matter is often unattainable. But that is not to say that "cost", in the relevant sense, cannot be determined; or that an apportionment of indirect costs is necessarily wrong because it involves some degree of arbitrariness. The only admissible criticism, in my opinion, is that the method of apportionment employed is not justified in the particular case by sound accountancy principles. Whether that criticism, when it is offered, should be upheld must depend upon a consideration of the facts, with the assistance of any expert opinion that may be available.
It has been submitted for the Commissioner that in the present case an apportionment according to the proportions of direct costs cannot be right. In particular, it is said that the cost of the construction camp was not a general overhead cost, but was an indirect labour cost, and that it should have been apportioned in the same ratio as direct labour costs. And as the direct labour costs have not been proved, it is contended that the appellant has not established what the assessment ought to have been, and that for that reason the appeal fails. The question is one upon which expert opinion is apt to be peculiarly valuable. To subdivide indirect costs so as to relate them as closely as possible to specialized categories of direct costs has everything to commend it in the abstract, but how far the process should be controlled by practical considerations in particular cases is a question which a non-expert in accountancy must approach with diffidence, The process might conceivably be carried in the present case to the length of insisting that the cost of the construction camp should be apportioned, not even by reference to direct labour costs generally, but by reference to direct labour costs of the work on which the particular men were engaged who were accommodated in the camp, or perhaps by reference to the man-hours worked by those men while they were so accommodated. But it cannot be in accordance with the intention of s. 56 that one should chase the rainbow of absolute accuracy beyond the point at which the practical accountant would stop. In my opinion, it is at that point that the requirement of the word "cost" is satisfied, so that the question in each case is: what is the figure reached by a proper application of the recognized principles of costing to the particular circumstances?
The only expert assistance I have in the present case has been given by Mr. Butchart, who is a qualified accountant of considerable experience. He is, of course, employed by the appellant, and in defending the method of apportionment which is reflected in the appellant's return he is defending his own work. But I was impressed by his evidence, and no doubt of its correctness was raised in my mind by his cross-examination. He considered that to apportion the amount representing the cost of the temporary buildings in the manner adopted in the preparation of the return accords with usual accounting practice. I do not find it difficult to accept this statement. To adopt any other mode of apportionment, even if it seems more scientific may be to sacrifice practical considerations to purely theoretical, to an extent which sound principles of cost accounting would not sanction. On the part of the Commissioner, no evidence was adduced. In all the circumstances, I accept Mr. Butchart's evidence. It satisfies me that in determining the cost of the refinery plant to the appellant it is correct, according to recognized accountancy practice, to spread over the items of plant and the rest of the refinery, in the manner appearing from schedule 13, so much of the amount paid by the appellant to KIC for the construction of the refinery as was the net amount of KIC's expenditure on erecting the temporary buildings. I therefore find that within the meaning of s. 56 (1) (b) the cost to the appellant of each unit of plant in respect of which a deduction for depreciation is claimed included the amount shown against that item in the column headed "Depreciation 1954-1955" in schedule 13.
I allow the appeal and remit the assessment to the Commissioner to be amended by treating as an allowable deduction the sum of £6104 referred to in the alteration sheet which accompanied the notice of assessment order dated 26 May 1959.
Appeal allowed.