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PONTIFEX JEWELLERS (WHOLESALE) PTY LIMITED v FC of T; SILROX PTY LIMITED v FC of T

Judges:
Burchett J

Court:
Federal Court

MEDIA NEUTRAL CITATION: [2000] FCA 1384

Judgment date: 29 September 2000

Burchett J

Each of these two matters raises the question whether, in the jewellery trade, a particular method of discounting the wholesale price of aged stock yielded, in the circumstances of certain sales, and would yield in similar circumstances, a price falling within s 16 and Table 1 Part A item AD1b of the Sales Tax Assessment Act 1992 (Cth), there being no dispute that it would do so unless s 94 produced a different conclusion. As each case did raise this issue, though in slightly different circumstances, they were heard together and, by consent, I made an order that the evidence in each, so far as relevant, be evidence in the other.

2. There was an earlier hearing in these matters (reported as
Pontifex Jewellers (Wholesale) Pty Ltd v FC of T 99 ATC 5324), when I dismissed a motion by the respondent for summary dismissal of each application. Of course, as I then made clear (at 5329), the issue at that time was ``not what ultimate conclusion I should draw; it [was] whether the Commissioner [had] shown that the applicants' cases `must fail', so that they `should not be permitted to go to trial in the ordinary way'...'' What I am required to do now is consider the correct ultimate conclusion. In doing so, however, I am able to draw on the interpretation I then gave to s 94, since both counsel accepted at the hearing that the section should be so understood. It is convenient to set out the section at the outset:

``(1) This section applies to a taxpayer if:

  • (a) the taxpayer (or an associate) has been a party to a non-arm's length transaction; and
  • (b) if the transaction had instead been an arm's length transaction, it would have been the case (or could reasonably be expected to have been the case) that:
    • (i) the liability of the taxpayer to tax on the non-arm's length transaction, or any other transaction, would have been increased; or
    • (ii) the entitlement of the taxpayer to a credit in connection with the non- arm's length transaction, or any other transaction, would have been reduced.

(2) The liability or credit is taken always to have been the amount that it would have been (or could reasonably be expected to have been) if it had been based on an arm's length transaction instead of on the non- arm's length transaction.''

3. Without referring again at length to the authorities which I discussed in my earlier decision, in summary, I held that the section involved the following important propositions:

  • (1) In accordance with the conclusion reached at 5328, the section ``does not refer to the relationship between the parties to a transaction, but the manner of their dealing, although any relationship will obviously be important for the inferences it may raise.'' In so holding, I adopted the reasoning of Lee J in
    Granby Pty Ltd v FC of T 95 ATC 4240 at 4243, and of Hill J in
    The Trustee for the Estate of the Late AW Furse No. 5 Will Trust v FC of T 91 ATC 4007 at 4014-4015 and in
    Copperart Pty Ltd v FC of T 93 ATC 4779 at 4798-4799.
  • (2) In accordance with the conclusion reached at 5329, the expressions ``it would have been the case (or could reasonably be expected to have been the case)'' and ``it would have been (or could reasonably be expected to have been)'' were used in the section in a sense which I explained as follows:
    • ``Since the hypothetical event is ultimately unknowable, I think the draftsman inserted the words `or could reasonably be expected to have been the case' as explanatory of the concept intended to be conveyed by the expression `would have been the case'.

      ATC 4644

      That is why the words are in brackets - there would have been no reason for brackets had they expressed a true alternative. [I referred to The New Shorter Oxford English Dictionary.] Were the parenthetical words in s 94 to be construed as really expressing an alternative, they would swallow up the primary statement, for if something `would have been the case', of course it `could reasonably be expected' to have been so....
    • It follows that the section poses hypothetically the question, what would have been the case, as a question to be answered in accordance with what could reasonably be expected. It does not pose two alternative questions.''

4. Each of the applicants is a wholesale company set up to purchase stock (watches, jewellery, clocks etc) which is then on-sold at wholesale to an associated retailer or retailers. In each case, the goods are delivered to a retailer upon consignment, so that the sale by wholesale only occurs immediately before a retail sale. In the case of Pontifex Jewellers (Wholesale) Pty Limited (which I shall call ``Pontifex''), there is only one retail shop (``the Pontifex retailer''), which is at Sylvania, a Sydney suburb. The directors of the retailer are the same persons who are directors of Pontifex, Mr and Mrs Pontifex. In the case of Silrox Pty Limited (``Silrox''), the executive director, Mr Whitaker, is also a director of Whitmarsh Pty Limited which operates four retail shops in the area of Raymond Terrace and Tuggerah, and has given a franchise to another company, controlled by Mr Whitaker's son and his wife, to operate a retail jeweller's shop.

5. Common to both applicants is the problem of what to do about aged stock. The difficulty occurs in a relatively small proportion of the transactions into which they enter. Sometimes an item of jewellery or a watch, to the cost of which the same mark-up has been applied as to other items, simply fails to sell for a period in excess of a year, and even up to three years or longer. At any given time, the evidence is that, of the stock held on consignment by the Pontifex retailer, approximately 20% would be aged stock of this kind. Of course, as the other stock is turned over much faster, the proportion of transactions involving aged stock would be considerably less than 20%. In the case of Silrox, there was no evidence of the percentage involved, but Mr Whitaker was not challenged on his statement in cross-examination that ``we have a very minimum amount of aged stock and a very maximum amount of what we would call regular or good selling stock''. Although the aged stock is a relatively small proportion of the stock handled by the businesses, it represents a burden on their resources, since capital is buried in it unproductively for substantial periods, like the buried talent in the well known parable (Matthew 25: 14-30).

6. Accordingly, it was plainly in the best commercial interests of Pontifex and Silrox to achieve a disposal of the aged stock, so as to release capital for the purchase of hopefully better selling items. If the wholesaler simply withdrew this stock from consignment to the retailer, in order to sell it by auction or in some other way at a low enough price to secure a prompt sale, it is difficult to imagine a basis on which the Commissioner of Taxation could attack the appropriateness of the sale as a true measure of sales tax payable. However, that is not what was done, and the question is whether what was done attracts the operation of s 94.

7. Each of the applicants used computer software, in keeping track of its stock and for business purposes related thereto, which had been purchased from a supplier referred to as Advanced Retail Management Systems. This software enabled automatic discounts to be applied, on a predetermined basis, in respect of aged stock falling into various categories. The percentages involved in these discounts were ascertained by the application of advice given by Mr Terence Mitchell. Mr Mitchell is a valuer of jewellery and precious stones, who carries on business under the name ``The Valuation Centre of Australia''. He has been engaged in the jewellery trade for 36 years, and was licensed as a valuer in 1982. But Mr Mitchell was not guided by the accepted techniques of valuation in attempting to solve the applicants' problem. That would plainly have been impracticable, having regard to the number of items involved and the expense that would have been incurred. It was not suggested that wholesale jewellers dealing in items of this kind would follow any such course. What Mr Mitchell did was to identify from documents the date of purchase of each item, and its category, and to apply a discount based on the category and on the length of time the item had

ATC 4645

remained unsold. He expressed the view that ``[i]f an item of jewellery has not sold within 18 months [he was] of the opinion that it can then be classed as an item which is difficult to sell at the price at which it is offered for sale''. He considered that watches are currently being manufactured and sold as fashion accessories with frequent changes of style and model ``to accommodate change in fashion and style'', so that ``a watch can become outdated very quickly''. He considered ``that a 30% discount to the wholesale value of a watch should be made if it has not sold between 12 and 18 months'', and that ``a 60% discount to the wholesale value of a watch should be made if it has not sold between 18 and 36 months''. After 36 months, he thought it conservative to discount by 80%, as ``in many cases a watch in this category simply cannot be sold by wholesale''. As regards jewellery, he considered that a ``substantial discount should be made to the wholesale value of jewellery if an item of jewellery has not sold for 18 months [ as] it is likely that its style is not acceptable to customers having regard to the price at which it has been offered for sale''. He advised the applicants ``the discounts which [he] consider[ed] would have to be applied to the wholesale value of jewellery which has not sold within 18 months to 36 months of being offered for sale''. After 36 months, he considered the jewellery should be discounted further, to an estimate of what could be obtained for the components if it were broken down for remodelling.

8. Mr Mitchell expressed the opinion that in the case of stock which has not sold for more than 18 months of being offered for sale, in the alternative to the provision of a discount on the wholesale price to the retailer holding it on consignment, it could be offered to another retail jeweller, or for sale at an auction, or it could be remodelled. In his experience, he said, ``it is extremely rare in Australia for a retail jeweller to buy stock which could not be sold by another retail jeweller for more than 18 months''. He thought a sale in that way would require ``a substantially greater discount'' than he suggested to the applicants. Sale by auction would also yield substantially less. Remodelling would not involve a sale of the item in question, but of different items. There was no evidence called by the Commissioner which appeared to me to cast any doubt on Mr Mitchell's evidence that these alternative courses would not provide higher wholesale returns, but in reality much lower returns.

9. The starting point of Mr Mitchell's assessment is, of course, the original price paid by the applicants, as experienced jewellers, to independent manufacturers or distributors. He said he regarded that as ``a very good indication'' of the fair value at that time. But if a particular item had not sold after being offered for sale over the periods to which reference has been made, his evidence indicated that a reappraisal was required, and that the percentage reductions he recommended to the applicants were appropriate. As he said, there ``must be something - a reason for it not selling''.

10. Plainly, Mr Mitchell's approach involves the application of a broad brush. But, assuming each transaction fell within s 94(1)(a), could it reasonably be expected within the meaning of paragraph (b) that a non-arm's length transaction, or some other transaction, would have increased the liability for tax? Mr Mitchell's evidence, supported by Mrs Pontifex and Mr Whitaker, is that the alternatives open to an arm's length wholesaler would not have yielded any higher prices. Both Mrs Pontifex and Mr Whitaker were experienced in the jewellery trade, as wholesalers and as retailers. They impressed me as capable people, and no significant attack was mounted on their credit in cross-examination. No attack at all was mounted on the genuineness and efficiency of their attempts to sell the stock in their retail shops. Mrs Pontifex gave evidence of past experience of ``purchas[ing] old stock at a discount from other jewellery wholesalers''. She asserted: ``My experience in the jewellery business allows me to say that [Pontifex] could not sell old stock to any retail jeweller other than [the Pontifex retailer] for a price greater than the adjusted wholesale price recorded in the books of [Pontifex].'' Mr Mitchell himself has extremely impressive credentials. He has been in the jewellery industry since 1964, at first overseas and, since 1980, in Australia. He has had experience as the manager of a retail jewellery store and as the manager of a manufacturing jewellery factory with over 100 jewellers for both local and export products. He came to Australia to open a precious stone trading business for Bonas & Co., the second largest diamond broker and one of only five

ATC 4646

major brokers to De Beers. He has operated his business under the name The Valuation Centre of Australia since 1984, in which he employs ten registered valuers and services over 150 Australian retail stores. He also supplies management advice to major retail groups dealing in jewellery, both in Australia and in Hong Kong. His personal professional qualifications include a fellowship of the Gemmological Association of Great Britain, and he is a past president of the Rhodesian Valuers Council and of the Australian Jewellery Valuers Council. While counsel for the Commissioner attacked his approach of applying his expertise to broad categories of jewellery, rather than examining each piece individually, she made no attempt to analyse his categories, and the various percentage discounts (ranging from no change to 92%) he applied to them, so as to suggest that the categories were inappropriate or the distinctions between the different percentages for those categories were insupportable. Accepting as I do that it would not have been sensible for the applicants to have incurred the cost of separate appraisal of all these items, I am left with the evidence of Mr Mitchell, Mrs Pontifex and Mr Whitaker that the discounts were appropriate, the prices ascertained in this way being at least as high as could have been obtained by any of the alternative methods of disposing of long unsold stock. Mrs Pontifex and Mr Whitaker had, of course, seen the individual items. Mrs Pontifex's evidence was that the prices ascertained by Mr Mitchell's discounts were ``conservative'', and Mr Whitaker's evidence was the same.

11. No evidence was led for the Commissioner of Taxation from anyone with significant expertise in either the wholesale or the retail jewellery trade. The Commissioner called Mr Alford, who has been ``a valuer specializing in jewellery, antique and fine art valuation for the past 30 years.'' He is qualified and experienced as a valuer and auctioneer, and is a fellow of the Gemmological Association of Australia. But his affidavit does not claim experience in retailing or wholesaling jewellery or watches. It does indicate that Mr Alford equates the ``wholesale value'' with ``the cost of materials and labour'', a view which is, of course, inconsistent with the Commissioner's own rulings. This is not a mere slip, as he explains it in a little detail. It indicates how far he is from practical familiarity with wholesaling. His expertise is plainly as a valuer. In cross-examination, he said he had also had experience as a retail jeweller, but that was 27 years ago, and he is now 51.

12. Each of the items with which I am concerned is one of thousands of items of stock, and one of a smaller, but still numerous, collection of aged stock. In the case of Pontifex, which sells to one retail shop, there are about 800 items of aged stock, and there must be several thousands in the case of Silrox, which sells to four plus the franchisee. Some broad approach or rule of thumb seems appropriate to ensure that stock of this kind does not continue unproductively to tie up the capital of the enterprise. Apart from Mr Mitchell's approach, the only solutions suggested in the evidence would have produced no larger return, and probably significantly less. Counsel for the Commissioner herself suggested, at one stage, that an arm's length commercial wholesaler would not continue to leave goods on consignment which were not selling. She criticised the applicants in argument for ``not taking any steps as you might expect an arm's length party to take for a return of the goods after a particular period of time''. But there was simply no evidence on which I would conclude that an arm's length wholesaler would have succeeded in selling the aged stock of which the applicants gave evidence (that is to say, jewellery which had not sold after being offered for sale for 18 months or 3 years or more and watches which had similarly not sold after 12 months) in any manner that could be expected to have yielded a higher return. Counsel argued such stock might simply have always been unattractive, so that its purchase by the wholesaler in the first place might have been a poor decision; but this contention does not seem to me to improve the Commissioner's case at all. If the original price paid for the stock was too high because it was really not a desirable item, that would plainly be a good commercial justification for discounting its price after it had remained on consignment unsold for a significant period. The Commissioner's written submission asserted Mr Alford's evidence was to the effect ``the age of jewellery plays little part in its value''. There are two answers to this. Even if age in itself is not a factor, it may reveal that the price fixed at the time of consignment must have been too high since this

ATC 4647

item failed to sell over a long period while other items did sell. And I accept the evidence for the applicants that age does also have an effect in itself, insofar as fashion and taste change over time; an item which missed the tide of its vogue may drift till it sinks from notice in a stagnant shallow.

13. Counsel for the Commissioner also urged upon me that I should regard each transaction as ``a non-arm's length transaction'' because both Mrs Pontifex and Mr Whitaker gave evidence that the wholesale price was fixed on the basis of a mark-up of 6% on the price paid by Pontifex or Silrox to the manufacturer or distributor from whom the goods were acquired. Counsel put the proposition that, since the sales tax would be 32%, such a mark-up would inevitably involve Pontifex and Silrox in operating at a substantial loss. There were many difficulties about this submission. In the first place, nothing of the sort was suggested in cross-examination to either Mr Whitaker or Mrs Pontifex. If it was to be said that the wholesale businesses were not bona fide, common fairness demanded that the point be put to them. In the next place, what they were saying, it seemed to me, as they said it, - and in the context of the opening of the cases by their counsel as cases in which they had adopted what the Commissioner called ``a safe harbour'' as their general mode of doing business - was not intended to indicate that the wholesale companies bore the sales tax, but rather, as the scheme of the ``safe harbour'' plainly contemplates, that the sales tax would be borne by the retail company. Streamlined Sales Tax Bulletin No 10: JEWELLERY, which is the source of the safe harbour in question, is to be found in the CCH Australian Sales Tax Guide at 85,161. At 85,166, two examples are given of sales of diamond rings to retailers ``for $200 before tax'' (emphasis added), and in one case $200 is described as ``the price for which the goods were sold'', and in the other case the same sum is described as ``the price for which you could reasonably have been expected to sell the goods by wholesale''. So Mrs Pontifex's and Mr Whitaker's use of language, far from revealing an absurdity or a disinterest in the viability of the applicants, coincided precisely with the Commssioner's own usage in the Streamlined Sales Tax Bulletin. When the bulletin comes to the plus 6% price, it speaks as follows (at 85,169):

``Some retail jewellers interpose a wholesale entity between themselves and their normal arm's length suppliers in order to defer the time at which tax is payable and for other reasons. The wholesale entity then sells the goods exclusively to the non-arm's length retail jeweller.

...

The Tax Office has previously approved an acceptable taxable value that may be applied to non-arm's length dealings between wholesale and retail jewellers. This taxable value that applies where goods are purchased from an Australian manufacturer or a wholesaler, whether a wholesaler of locally produced or imported goods, is:

  • • purchase price of the goods increased by 6%.''

It is perfectly plain that what is envisaged is the retailer paying the sales tax, as is, of course, permissible subject to s 125; otherwise, the use of the safe harbour would always involve the wholesaler in operating at a substantial loss.

14. Although Mr Whitaker was not called upon to answer the suggestion that Silrox was bearing the sales tax, so that each transaction was loss making, he was asked a question which led him to do some mental arithmetic on a transaction in the witness box. Thus, by chance, the transcript does include figures that clearly show the sales tax added to the wholesale price before the calculation of the retail margin. Counsel asked no question about that. Accordingly, I am quite satisfied the safe harbour was utilised by Silrox in the intended manner, with the retailer bearing the sales tax. There is no reason to conclude otherwise in the case of Pontifex.

15. In my opinion, even assuming the transactions in question here fell within s 94(1)(a), as to which it is unnecessary to reach a conclusion, the evidence is clear that they did not fall within s 94(1)(b). If the actual transactions were not at arm's length, it cannot be said that if they had instead been arm's length transactions, it could reasonably be expected to have been the case that the liability of the taxpayer would have been increased, as specified in s 94(1)(b)(i). It could reasonably be expected that any wholesaler, dealing at arm's length, would have determined to turn unsold stock on consignment to account (as, indeed, the Commissioner urged when arguing that, by

ATC 4648

leaving the stock on consignment as long as they did, the applicants did not behave as wholesalers dealing at arm's length would have done); and, on the evidence, that would have resulted in some transaction yielding no greater liability to sales tax. An arm's length wholesaler who was satisfied of the probity and ability of the retailer (which were not questionable in these cases) could reasonably be expected to have entered into transactions with the retailer at the same prices.

16. Some propositions were put in the Commissioner's Outline of Submissions which were not pursued either in evidence or in oral argument. I do not think it is necessary to say something about all of these. In particular, an argument that the dates of Mr Mitchell's advices somehow invalidated their subsequent use by the applicants was not supported at the hearing. Much time was, however, taken up in a minute examination of the selling techniques of the retailers in the conduct of discount sales. Unsurprisingly, Mrs Pontifex and Mr Whitaker did not conduct sales in precisely the same manner. But I do not think the retail selling methods employed have much to do with the wholesale transactions, and I shall not encumber these reasons with descriptions of them. I accept the evidence of both Mrs Pontifex and Mr Whitaker. They did not conceal the fact that, on occasion, old stock did sell at the full original retail price, but this was not usual, and a recognition of it did not, and does not, seem to me to affect the conclusions I have reached. In general, I am satisfied the retail sales could only be effected at very substantial reductions.

17. In the amended application by Pontifex, declarations are sought in respect of six particular assessable dealings, and a general declaration is sought in relation to dealings with respect to which the same principles of the sales tax law would apply. The specific declarations relate to the following:

  • (1) A sale by Pontifex on 23 October 1996 of a yellow gold and diamond ring purchased on 18 November 1993 (that is approximately 2 years and 11 months previously), the sale price being $204-34;
  • (2) A sale by Pontifex on 25 October 1996 of a diamond ring purchased on 14 September 1992 (that is approximately 4 years and 1 month previously), the sale price being $212-12;
  • (3) A sale by Pontifex on 24 October 1996 of a GTS Seiko watch purchased on 10 December 1993 (that is approximately 2 years and 10 months previously), the sale price being $30-30;
  • (4) A sale by Pontifex on 16 October 1996 of a Pulsar watch purchased on 23 March 1994 (that is approximately 2 years and 7 months previously), the sale price being $28-92;
  • (5) A sale by Pontifex on 3 October 1996 of a gold pendant containing an opal purchased on 8 September 1994 (that is approximately 2 years and 1 month previously), the sale price being $133-00;
  • (6) A sale by Pontifex on 23 October 1996 of gold earrings purchased on 21 October 1994 (that is approximately 2 years previously), the sale price being $78-97.

18. I am prepared to make declarations, in respect of each of these dealings, that the sale price was the taxable value for sales tax purposes. I am also prepared to make a general declaration to the effect that while the Sales Tax Assessment Act 1992 remained in force in relevantly the same terms, sales of jewellery and watches at prices determined in the same manner and in similar circumstances by Pontifex to the Pontifex retailer were and are assessable dealings in which the taxable value is the wholesale price so determined. However, I shall leave until the bringing in of short minutes the precise terms of all declarations in these matters.

19. In the case of Silrox, I am asked to make specific declarations in respect of the following assessable dealings:

  • (1) A sale by Silrox on 10 March 1995 of a diamond ring purchased on 21 May 1990 (that is approximately 4 years and 10 months previously), the sale price being $80-44;
  • (2) A sale by Silrox on 23 March 1995 of a pendant with chain purchased on 13 August 1993 (that is approximately 19 months previously), the sale price being $94-24;
  • (3) (I note that evidence which was to be tendered in relation to the third transaction appears to have been mislaid. I am unclear as to whether the applicant, Silrox, is pressing its application in this respect, and shall defer further consideration of this item until the bringing in of short minutes.)

    ATC 4649

  • (4) A sale by Silrox on 14 March 1995 of a Seiko watch purchased on 23 September 1993 (that is approximately 18 months previously), the sale price being $40-46;
  • (5) A sale by Silrox on 4 July 1997 of a GTS Diver's Aqualand Citizen watch purchased on 31 August 1995 (that is approximately 22 months previously), the sale price being $142-81;
  • (6) A sale by Silrox on 5 July 1997 of a citrine diamond ring purchased on 31 July 1992 (that is approximately 4 years and 11 months previously), the sale price being $44-16;
  • (7) A sale by Silrox on 2 July 1997 of a garnet enhancer purchased on 19 July 1995 (that is almost 2 years previously), the sale price being $174-27;
  • (8) A sale by Silrox on 5 July 1997 of a necklet chain purchased on 7 December 1994 (that is approximately 2 years and 7 months previously), the sale price being $207-66;
  • (9) A sale by Silrox on 2 July 1997 of a silver bracelet purchased on 10 March 1995 (that is approximately 2 years and 4 months previously), the sale price being $84-68.

20. Silrox seeks a general declaration in respect of its other sales in similar circumstances, at prices similarly calculated, to Whitmarsh Pty Ltd, its associated retail company. I am prepared to make specific declarations in the case of Silrox also, and a general declaration, in terms similar to those I have already indicated in respect of Pontifex.

21. I direct the applicants to bring in, on a date to be fixed, short minutes of orders appropriate to be made to reflect these reasons. The respondent must pay the applicants' costs.

THE COURT ORDERS THAT:

The applicant bring in on a date to be fixed, short minutes of orders appropriate to be made to reflect the reasons of the Court.


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