Federal Commissioner of Taxation v. Cliffs International Inc.
Judges: Bowen CJFranki J
Brennan J
Court:
Federal Court (Full Court)
Franki J.: This is an appeal by the Commissioner of Taxation from a judgment of a single Judge of the Supreme Court of Western Australia. The major question involved in the appeal is whether certain payments by the respondent, Cliffs International Inc. (Cliffs), referred to as royalties in the notice of assessment issued by the Commissioner and calculated in relation to the weight of iron ore mined and transported were allowable deductions under the provisions of sec. 51 of the Income Tax Assessment Act 1936 (the Act) for the years ending 31 December 1973 and 31 December 1974. The amount involved in this question is $837,137 in the year ended 31 December 1973 and $1,176,640 in the year ended 31 December 1974.
On 5 March 1962 the Under Secretary for Mines for the State of Western Australia wrote to a company, Basic Materials Co. Pty. Ltd. (Basic), advising that subject to certain conditions, certain temporary mining reserves under the Mining Act 1904 of Western Australia had been approved for a period of two years from 1 April 1962 to 31 March 1964. It was common ground before the learned trial Judge that occupancy rights to the temporary reserves were granted to Basic by that letter. The learned trial Judge held that the rights of occupancy gave Basic the exclusive right to prospect for iron ore and the further right, when it was shown to the satisfaction of the Minister, that iron ore had been discovered on the reserves in payable quantities, to negotiate with him on behalf of the State of Western Australia for a mining tenement to be granted under the Mining Act to mine the iron ore. He also pointed out that the right of occupancy did not give Basic any right to any iron ore discovered upon the reserves. The only way Basic could become the owner of the iron ore, or obtain the right to mine it, was if, after successful negotiations with the Minister pursuant to the applicable conditions, it was issued with a mining tenement or tenements under the Mining Act. These findings were not disputed before us. At the relevant time Basic's shareholding was owned as to 50.1% by Howe Sound Company, whose name was subsequently changed to Howmet Corporation (Howmet), and as to 49.9% by Garrick Agnew Pty. Ltd. (Agnew Co.).
In July 1962 The Cleveland-Cliffs Iron Co., a corporation incorporated in Ohio, United States of America (Cleveland-Cliffs) was approached by Howmet in an endeavour to interest it in the temporary reserves. Cliffs is a corporation incorporated in Cleveland, United States of America and registered as a foreign company in Western Australia and it is a wholly owned subsidiary of Cleveland-Cliffs.
The only witness called before the learned trial Judge was Mr. Dohnal, the then managing director of Cliffs. In the latter part of 1962 Mr. Dohnal occupied the position of controller with Cleveland-Cliffs and he gave some oral evidence concerning the matters hereinafter referred to. The learned trial Judge
ATC 4577
said that Mr. Dohnal had given his evidence very fairly. On 27 November 1962, Cliffs entered into an agreement with Howmet, Agnew Co. and Mr. & Mrs. Agnew, who between them, held all the shares in Agnew Co. This agreement is of the utmost importance in the determination of this appeal. The central feature of this agreement was the grant to Cliffs in cl. four of an option to purchase from Howmet and the Agnew Co., ``their entire right, title and interest in all of Basic's capital stocks and shares, for the purchase price set forth below...'' The agreement, in cl. five, provided that the purchase price referred to in cl. four should consist of an ``Initial Payment'' of two hundred thousand dollars ($200,000) plus ``Deferred Payments'' equal to 15 ¢ (U.S.) per ton of iron ore. Iron ore for the purpose of calculating the payment of 15 ¢ per ton was defined as meaning ``... iron bearing material mined and transported from the Reserves by or with the consent of Basic or its successor in interest...'' The agreement further provided that the option could be exercised by written notice from Cliffs to Howmet and Agnew Co. on or before 30 December 1963 and that the purchase should be ``consummated'' at a specified address and at a date specified in the notice exercising the option (called the closing date) being not less than 20 days but not more than 30 days from the notice exercising the option and the method of ``consummation'' was to be the making of the Initial Payment by Cliffs to Howmet and Agnew Co. against delivery to Cliffs of appropriate certificates and assignments.Clause one of the agreement provided that certain representations by Howmet, Agnew Co. and Mr. & Mrs. Agnew to Cliffs, including, that Howmet and Agnew Co. owned the entire equity interest in Basic and that Basic ``holds the exclusive rights to occupy and use for the purpose of prospecting for iron ore the temporary reserves numbered 2400H-2417H...'' No representation in this clause extended beyond the closing date.
By cl. two, Cliffs undertook, whether the option was exercised or not, at no expense to Howmet or Agnew Co. to perform certain tasks, but only during the term of the option. These tasks could broadly be described as those of investigating the extent and quality of the reserves and the feasibility of mining and selling ore from the reserves. By cl. three Howmet, Agnew Co. and Mr. & Mrs. Agnew, agreed, so long as they were stockholders of Basic, to cause Basic to do and perform its obligations in respect of the prospecting rights and all parties agreed ``to assist Cliffs to secure for Basic, iron ore development and mining rights in the said reserves on such terms and conditions as shall be appropriate for the full development thereof and satisfactory to Cliffs''. Although the provisions of cl. three were to be effective throughout the option period, and thereafter if Cliffs exercised the option, upon the ``consummation'' of the purchase neither Howmet, Agnew Co. nor Mr. & Mrs. Agnew would have any power to control any activity of Basic.
Clause six permitted Cliffs to designate another corporation registered in Australia, or in the United States of America, to make the purchase provided for in cl. four and that if this was done the new corporation should be substituted for Cliffs in the agreement. Clause seven provided that Howmet, Agnew Co. and Mr. & Mrs. Agnew should be free from any costs or expenses in carrying out their obligations under the agreement other than the obligations contained in cl. one and the obligation ``to deliver at the Closing all the issued and outstanding stock of Basic to Cliffs''.
It is to be noted that Basic was not a party to this agreement and that after the ``consummation'' the vendors held no interest in any property, or rights of any description, which related to or concerned any reservations or rights in relation to mining on the relevant temporary reserves. The only rights they retained were the rights to be paid the ``deferred payments'' and the only obligation that existed after the closing date was that in cl. three.
Clause nine provided that the agreement constituted the entire agreement among the parties and that it would be governed by and construed in accordance with the laws of the State of New York, United States of America. The learned trial Judge noted that upon payment of the initial payment Cleveland-Cliffs was in a position to transfer the shares owned by Howmet and Agnew Co. to itself or to a designated transferee, and thus acquired complete control of Basic, and through Basic, the rights of occupancy. He also pointed out that the agreement did not place any obligation on Cliffs to mine iron ore, or cause it to be mined, should it exercise the option and hence, the agreement by itself, did not
ATC 4578
assure to Howmet or Agnew Co. any deferred payment. The evidence Mr. Dohnal gave was accepted by the learned trial Judge as indicating that the figure of $200,000 appeared to have been arrived at as a recompense for expenditure incurred by Howmet and Agnew Co. in connection with the work they had done in evaluating the deposit for which they wished to be reimbursed, and it also included what was called a finder's fee. The figure of 15 ¢ per ton appeared to have been arrived at after a series of discussions and it was a negotiated amount. The major issue, as I have said, concerns the question of whether or not Cliffs could deduct the amount of the deferred payments under the provisions of sec. 51 of the Act.It had been agreed by the parties before the learned trial Judge that the issues upon this question were: Was this expenditure (a) incurred in gaining or producing Cliffs assessable income; (b) necessarily incurred in carrying on a business for the purpose of gaining or producing Cliffs assessable income; (c) an outgoing of capital or of a capital nature?
On the same date as the option agreement Cleveland-Cliffs entered into an agreement with Agnew Co. which provided that in the event of Cleveland-Cliffs exercising its option, it would thereafter, with all convenient speed, form a company or companies (the operating company) to mine, exploit and develop the reserves and to sell the ore obtained therefrom, and that Agnew Co. or any company nominated by it should have the right to purchase, and Cleveland-Cliffs undertook that the operating company would offer, upon certain terms and conditions, to Agnew Co. 7 ½ % of the capital then or at any time or times thereafter to be subscribed in the operating company. It is to be noted that this agreement did not require Cleveland-Cliffs to conduct any mining.
The option was exercised in December 1963. Prior to completion Cleveland-Cliffs designated Cliffs to make the purchase on its behalf and a company, Mt. Enid Iron Ore Pty. Ltd. (Mt. Enid), resolved to accept an offer to purchase from Agnew Co. its shares in Basic and this purchase proceeded to completion.
On 17 January 1964, the option was completed and all shares in Basic were transferred to Cliffs and Mr. Dohnal on behalf of Cleveland-Cliffs.
On 18 March 1964, the shareholders of Basic met and resolved that the company acknowledged that the rights of occupancy were held in trust for Cliffs.
On 18 November 1964, the State of Western Australia passed an Act of Parliament called the Iron Ore (Cleveland-Cliffs) Agreement Act No. 91 of 1964 and the effect of this Act was, inter alia, to provide for the continuing exploration by Basic of the temporary reserves with a view to mining the reserves and during the continuance of the exploration, its rights of occupancy were confirmed up to 31 December 1965 and thereafter until application for a mineral lease or the termination of the agreement or the abandonment thereof.
On 21 October 1965 it was resolved at an extraordinary general meeting of the shareholders of Basic that it be wound up voluntarily and that the liquidator be authorised to divide all or such parts of the assets of the company as he saw fit amongst the members of the company in specie. At that time the only assets of the company were the rights of occupancy which it had already declared it held in trust for Cliffs and its interest in the Agreement with the State of Western Australia.
On 19 November 1965 by agreement between the State of Western Australia, Cliffs and Basic, Cliffs undertook as from that date to be bound by the terms of the agreement with the State, of 18 November 1964, and Basic was released by the State from any further performance of its obligations under that agreement.
On 7 December 1965 Basic assigned to Cliffs all of its interests in that agreement and its right of occupancy and from that time onward Basic ceased to play any part.
I do not consider it necessary to trace the subsequent events in detail but the Iron Ore (Cleveland-Cliffs) Agreement Act 1964 was amended by Acts No. 35 of 1970 and 68 of 1973.
Ultimately mining proceeded on the reserves and it was carried on by a joint venture which paid a royalty to Cliffs.
I pass now to consider the main question in issue of whether the so called ``deferred payments'' are allowable deductions under sec. 51(1).
ATC 4579
It is convenient to commence by considering the questions posed by
Fullagar
J., in
Colonial Mutual Life Assurance Society Ltd.
v.
F.C. of T.
(1953) 89 C.L.R. 428
at p. 454
. The two questions were:
-
- (1) What is the money really paid for? and,
- (2) Is what it is really paid for, in truth and in substance, a capital asset?
The correct approach to a consideration of these questions has been formulated by the Privy Council first in
Commr. of I.R.
v.
Europa Oil (N.Z.) Ltd.
,
(1971) A.C. 760
(Europa No. 1)
and in
Europa Oil (N.Z.) Ltd.
v.
Commr. of I.R.
76 ATC 6001
;
(1976) 1 W.L.R. 464
(Europa No. 2)
. The majority judgment in
Europa No. 1
at p. 771 referred to
I.R. Commrs.
v.
Duke of Westminster
(1936) A.C. 1
and reiterated that in a matter of taxation it is necessary to consider and respect the legal form of a transaction. At p. 772 it was noted that the Crown was not bound by the taxpayer's statement of account, or by the heading under which the expenditure is placed, but is entitled to ascertain for what the expenditure was in reality incurred. In
Europa No. 2,
the majority explained the use of the expression ``for what the expenditure was in reality incurred'' used in
Europa No. 1
and at ATC p. 6006; W.L.R. p. 472 said:
-
``Taken in isolation this might be though to suggest that the court was entitled to look behind the legal character of a payment made pursuant to the provisions of a contract and to take into account economic benefits which would in fact accrue to the taxpayer otherwise than as a matter of contractual right. Any such suggestion had, however, already been emphatically repudiated in a preceding paragraph in which I.R. Commrs. v. Duke of Westminster (1936) A.C. 1 had been referred to as authority; and the repudiation was repeated in the same paragraph as that in which the passage which their Lordships have just cited appears. Its concluding sentence is: `Taxation by end result, or by economic equivalence is not what the section achieves.' Read in this context it becomes clear that the reference to `reality' was directed only to the legal character of the payment and not to its economic consequences. All that was meant was that the court was not bound by the description, such as `price of goods', attached to it in the taxpayer's own accounts or in a particular contract, if upon an analysis of the contractual arrangements taken as a whole under which the payment was made it appeared that its true legal character did not accord with that description.''
Earlier in the judgment the following appeared: -
``... that it is not the economic results sought to be obtained by making the expenditure that is determinative of whether the expenditure is deductible or not; it is the legal rights enforceable by the taxpayer that he acquires in return for making it.''
In considering whether or not the payments referred to in the option agreement as ``deferred payments'' are deductible under sec. 51, I consider the critical question is whether or not they are outgoings of a capital nature, because if they are, it matters not whether they are incurred in gaining or producing assessable income or are necessarily incurred in the carrying on of a business for the purpose of gaining or producing such an income. That in the agreement they are called ``deferred payments'' is not conclusive if in reality they are something else (see
Europa No. 2
at ATC p. 6006; W.L.R. p. 472,
M.N.R.
v.
Spooner
(1933) A.C. 684
at p. 688
and
Ralli Estates Ltd.
v.
Commr. of I.T.
(1961) 1 W.L.R. 329
at p. 334)
. In whatever way these payments are examined I consider that whether they be called ``deferred payments'' or royalties or given any other name they are still payments made as part of the purchase price of the shares.
In many cases the courts have had to look at the question of whether payments spread over a period of time were allowable deductions under sec. 51 or similar sections, and usually the most important matter to be considered has been whether the payments were made for the acquisition of a capital asset.
This test has been expressed in several ways. In
Poole and Dight
v.
F.C. of T.
70 ATC 4047
;
(1970) 122 C.L.R. 427
Walsh
J. at p. 436 said: ``But in my opinion the basic question for decision is whether or not the true character of the payments is that they are made as the consideration for the acquisition of a capital asset.'' In
Sun Newspapers Ltd., and Associated Newspapers Ltd.
v.
F.C. of T.
(1938) 61 C.L.R. 337
Latham
C.J. said at p. 354:
ATC 4580
``The most authoritative decision upon the question is
British Insulated and Helsby Cables Ltd. v. Atherton (1926) A.C. 205 at pp. 213, 214 , where Viscount Cave said: `But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital'.''
The words in this passage, ``an asset or an advantage for the enduring benefit of a trade'' were also mentioned by
Dixon
J., at p. 361 and referred to as ``... a phrase which by constant use had almost become a formula.'' This passage has been cited as a test in many cases, for example,
Hallstroms Pty. Ltd.
v.
F.C. of T.
(1946) 72 C.L.R. 634
at pp. 641, 643 and 653-654
;
Associated Portland Cement Manufacturers Ltd.
v.
I.R. Commrs.
(1946) 1 All E.R. 68
at pp. 71 and 74
;
W. Nevill
&
Co. Ltd.
v.
F.C. of T.
(1937)) 56 C.L.R. 290
at p. 299
;
Strick
v.
Regent Oil Co. Ltd.
(1966) A.C. 295
at pp. 319, 320, 328, 343 and 344
. In
John Fairfax
&
Sons Pty. Ltd.
v.
F.C. of T.
(1959) 101 C.L.R. 30
at p. 36
, after citing the abovementioned passage
Dixon
C.J., said:
-
``That is an affirmative proposition. But it is hardly necessary to say that it is a logical fallacy to turn it around and say that an expenditure cannot be attributable to capital unless it is made once and for all and is made with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. Nor did Viscount Cave L.C. mean to say that no expenditure falling outside this proposition could be of a capital nature.''
I am satisfied that if one applies the test whether or not the relative payments were made ``... with a view to bringing into existence an asset or advantage for the enduring benefit of a trade'' it is clear that they were and I consider that they were of a capital nature. They were part of a transaction which was a sale and purchase of shares and they are part of the purchase price. I consider that it is not to the point to say that this makes the purchase price uncertain or to attempt to advance any distinction between consideration and price.
I pass next to consider whether any different conclusion flows from the fact that no payments would be made if no mining eventuated, or that the payments are on an annual basis and for an uncertain period, dependent, firstly on the amount of iron ore mined and transported, secondly on the life of the mine, and thirdly on the period of the relevant mining leases.
In M.N.R. v. Spooner (1933) A.C. 684 the Privy Council was considering a case where the respondent sold all her right, title and interest in land which she owned in freehold to a company in consideration of a sum in cash, shares in the company, and an agreement to deliver to her 10% (described as a royalty) of oil produced from the land, on which the company covenanted to carry out drilling and, if oil was found, pumping operations. It was held that receipt by the respondent of the amount described as a royalty, which was in fact discharged, by agreement, by the receipt by her of 10% of the gross proceeds of the oil produced, was of a capital nature. At p. 688 their Lordships said: -
``The transaction was one of sale and purchase. It may have taken the form which it did because of the uncertainty whether oil would be found by the purchaser or not; as the value of the land depended on this contingency the price, not unnaturally, was made to depend in part on the event.''
I have referred to this case because, notwithstanding the manner in which the consideration was payable, the transaction was held to be one of sale and purchase.
In
Colonial Mutual Life Assurance Society Limited v. F.C. of T.
(1953) 89 C.L.R. 428, a vendor agreed to transfer to the appellant a piece of land adjoining land owned by the appellant in consideration of a promise by the appellant to pay to the vendor, for a period of 50 years an amount equal to 90 per cent of all rents, as and when received, from lessees or tenants of three shops and a basement in a new building to be erected on both blocks of land. It was held that the annual payments were an outgoing of a capital nature and not deductible under sec. 51(1) of the Act and this was so, notwithstanding that the court in another case ((1949) A.L.R. 438) held that the same annual payment was taxable in the hands of the recipient.
Williams
A.C.J. at p. 445 said that it was impossible to distinguish the facts from those in
Delage
v.
Nugget Polish Co. Ltd.
(1905) 92 T.L.R. 454
and
Tata Hydro Electric Agencies Ltd., Bombay
v.
I.R. Commr. Bombay Presidency and Aden
(1937) A.C. 685
.
ATC 4581
Without dealing with the facts of this latter case, it involved annual payments and, at p. 695, Lord MacMillian who delivered the judgment of their Lordships, said, in considering a section of the Indian Income Tax Act which allowed a deduction of certain expenditure ``not being in the nature of capital expenditure'':``In short, the obligation to make these payments was undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business.'' Returning to the judgment of Williams A.C.J. in Colonial Mutual Life Assurance Society v. F.C. of T., his Honour concluded (at p. 448) by saying: -``The present case seems to be one in which it is proper to apply the test laid down by Lord Clyde in
Robert Addie & Sons Collieries Ltd. v. I.R. Commrs. (1924) S.C. 231 : Are the sums in question part of the trader's working expenses, are they expenditure laid out as part of the process of profit-earning; or, on the other hand, are they capital outlays, are they expenditure necessary for the acquisition of property or of rights of a permanent character the possession of which is a condition of carrying on the trade at all? The acquisition of land is an acquisition of property of the most permanent character and the acquisition of the Just Brothers' land was a condition of erecting the new building and carrying on there the business of letting shops and offices and other space.''
Fullagar J., at p. 454 said that it was incontestable that the monies were paid in order to secure a capital asset. At p. 459 his Honour said: -
``Here we have a transaction of a purely business nature, in which it may be safely assumed that two parties, bargaining on equal terms, had full regard to the value of the land and the probable value of the consideration. According to the documents the periodical payments are the price for which the land is being bought, and no reason can be suggested for not giving to the documents their full literal effect.... The transaction might perhaps have taken a form under which parts of the total payments to be made were, or could be, treated as interest on deferred payments of a price. But it did not take any such form. As matters stand, the total of the payments is simply the total price of the land.''
I am satisfied that the ``deferred payments'' in issue, are payments made for the purchase of a capital asset namely, the shares in Basic and are not allowable deductions under sec. 51(1). The shares were undoubtedly an asset for the enduring benefit of the appellant, indeed it was only through that acquisition that the appellant acquired the opportunity to mine.
In my opinion even if the word royalties had been used instead of the expression ``deferred payments'' I would still have considered that such payments were not allowable deductions under sec. 51.
A further question arose in respect of the financial year ended 31 December 1973 with regard to what were called Exchange Losses of $39,610 and unrecouped losses of $176,120. However it was agreed before the learned trial Judge that both these amounts were deductible if the ``deferred payments'' were deductible. Before us the appeals also proceeded on that basis.
The only other question for our consideration is whether an amount of $16,638 in respect of legal expenses incurred in obtaining advice concerning the taxation position in relation to the deferred payment to Howmet was an allowable deduction for the year ended 31 December 1974.
These expenses arose because, after Cliffs advised the Commissioner that it was making the deferred payments to Howmet, the Commissioner wrote requiring Cliffs to retain an amount in respect of income tax pursuant to the provisions of sec. 255 and 256 of the Act. Howmet objected to this and demanded payment of the full amount of deferred payments.
I consider that the payments were necessarily incurred in carrying on business for the purpose of gaining or producing assessable income. Although they were related to the liability to deduct tax from payments made by Cliffs which are outgoings of capital or of a capital nature so far as Cliffs were concerned, I do not consider that it can be said that the legal expenses themselves were outgoings of capital or of a capital nature.
I would allow the appeal and set aside the orders of the Supreme Court. In lieu thereof I
ATC 4582
would order that the assessments appealed from should be remitted to the Commissioner to be amended and that the respondent pay to the Appellant Commissioner his costs of the appeal and of the proceedings before the Supreme Court, other than the costs of the issue relating to legal expenses in both Courts.ORDER:
1. Appeal allowed.
2. Orders of the Supreme Court set aside. In lieu thereof order that the assessments be remitted to the Commissioner to be amended.
3. Respondent to pay to the Appellant his costs of the appeal and of the proceedings before the Supreme Court, other than the costs of the issue relating to the legal expenses in both Courts.
This information is provided by CCH Australia Limited Link opens in new window. View the disclaimer and notice of copyright.