F.C. of T. v. South Australian Battery Makers Pty. Ltd.

Members: Gibbs ACJ
Stephen J

Jacobs J
Murphy J
Aickin J

Tribunal:
Full High Court

Decision date: Judgment handed down 10 August 1978.

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Jacobs J.: The question whether payments are made on revenue or capital account is often difficult to answer and it seems to me that the question as it arises in the present case is more than ordinarily difficult. The facts, though complex in their detail, may be stated in fairly general terms. Chloride Group Ltd. (``Chloride'') was a United Kingdom company whose business included battery making. It had an Australian subsidiary, Associated Battery Makers of Australia Pty. Ltd. (``ABMAL'') which made batteries in New South Wales. It was desired by ABMAL to extend manufacturing operations to another State, preferably South Australia. Negotiations were commenced with the South Australia Housing Trust (``the Trust'') with particular reference to a ten-acre site for a factory at Elizabeth. The Trust proposed two alternative forms of lease in a letter of 5th August 1963 as follows:

``(1) A straight lease which would carry as an annual rental the sum equivalent to six per cent of the total capital cost and for a term of ten years. This lease would carry with it an option for renewal for a further period of ten years. In addition the lease would grant the Company an option to purchase which, if exercised within the first three years, would be at cost; and if exercised beyond the third year, would be at a sum to be determined from a valuation.

(2) A form of lease which carries with it some substantial advantages for purchase. This lease has as the annual

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rental, a sum equivalent to ten per cent of the capital cost, and read in conjunction with it would be a special option to purchase which confers on the grantor, [sic `grantee'] the advantages of the annual amortised amounts. The copies of the model documents for Agreement for Lease, Memorandum of Lease and Option to Purchase and Memorandum of Encumbrance illustrate the method of leasing the property under these forms of agreement and the option to purchase shows how a company to be named by the holding company may exercise the option at any time during the term of the lease. The schedule attached to this option agreement shows the sums outstanding at the commencement of each year for completion of the purchase.''

The model documents do not require extensive reference but it is to be noted that cl. 1 of the model Option to Purchase which dealt with conditions for exercise of the option required that ``at the time of the exercise thereof the grantee is to the satisfaction of the Trust a land-holding company for the lessee company as a trading company or otherwise directly associated with the lessee company.'' It may here be interposed that later, when the agreement for lease was made with ABMAL, a form of option to purchase in favour of ABMAL was annexed to the documents proffered by the Trust. Clause 1(a) stated that the option was granted to ABMAL. Sub-clauses 1(b) and (c) were as follows:

``(b) When exercising this option the grantee may in the notice exercising the same nominate any (or any other) associated company to pay the price and take a transfer of the said land on completion of the purchase thereof in lieu of the grantee.

(c) `Associated Company' for the purposes of this paragraph 1 means a limited company incorporated or registered in South Australia under the Companies Act 1962 and which is to the satisfaction of the Trust a land-holding company for or is otherwise directly associated with the grantee.''

ABMAL received authority from its parent company to proceed and negotiate with the Trust for the acquisition of the land and the construction of a factory building. It elected for the second form of leasing arrangement proposed by the Trust (10th September 1963). ABMAL informed the Trust: ``the equipping and operating of the proposed Elizabeth satellite will be financed by a plough-back of local profits.'' (1st October 1963). The lessee company was to be ABMAL but it was envisaged that another company would take the Option to Purchase (12th November 1963).

ABMAL and the Trust executed an agreement for lease in May 1964. On 18th June 1964 ABMAL requested that its interest in the proposed lease be assigned to the taxpayer, the respondent (`` SABM ''). The Trust gave its agreement to the assignment on 3rd July 1964. Then on 31st July 1964 ABMAL nominated a company named Property Options Pty. Limited, which had been incorporated in South Australia, as the associated company to hold the option to purchase.

Building proceeded. By December 1965 the final cost of the factory premises had been fixed at £ 89,150 with a rent of £ 8915 per annum representing one-tenth thereof. ABMAL were notified accordingly. This rent under the proposed lease was payable from 1st January 1966 in place of the provisional rent which had been payable from 1st July 1964 to that date. In the letter of notification the Trust also set out the table of prices for inclusion in the option to purchase as the respective purchase prices at the end of each year of the lease. ABMAL was informed that preparation of the lease in favour of SABM and of the option to purchase in favour of Property Options Pty. Limited would now proceed.

At this stage the Trust raised what it saw as a problem. It is best to quote from their letter to ABMAL of 11th February 1966:

``However, a problem has arisen concerning the granting of the option to purchase to Property Options Pty. Limited in lieu of Associated Battery Makers of Australia Pty. Ltd. which is the company described as 'the grantee' in the identified copy of the form of option to purchase.

On the advice of the Trust's solicitors this letter is being written to seek clarification.

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ATC 4423

At this point, I would mention the assignment of the lease to South Australian Battery Makers Pty. Limited means that this company is eligible to exercise the option to purchase should it so wish as it now comes within the ambit of clause 1(a)(b) and (c) of the proposed option document.

However, a search at the company's office with regard to Property Options Pty. Limited indicated that this company seems totally unconnected with your company or your South Australian company. Its paid up capital is £ 2/-/- consisting of the two subscribers' shares of £ 1/-/- each, the subscribers being two members of a local firm of accountants and the two directors named in the list of directors filed in the company's office are two members of a local firm of solicitors.

Based on this information alone, Property Options Pty. Limited does not meet the requirements of clause 1(c) of the form of option to purchase, a fact of which the Trust was not aware prior to the search at the company's office.

The grant of an option to purchase to a company other than ABMAL, the lessee company or 'an associated company' within the meaning of the aforesaid clause 1(c) is inconsistent with the Trust's original conception under which an option to a lessee company was to be an incentive to such a company to take a lease. In addition, an option to purchase at an annual reducing price is a valuable asset especially to a company which has not paid any of the rent.''

The Trust required an assurance that SABM and Property Options Pty. Limited were or were to be associated ``and in what manner and within what period''. ABMAL replied through their accountants on 23rd February 1966 who discussed the taxation aspects and then explained that the shares in Property Options Pty. Limited were held in trust for Edro Industrial Finance Company Limited, a wholly owned subsidiary of Chloride.

This information apparently did not satisfy the Trust. Discussions continued and eventually the subject was taken up between the solicitors for the Trust and those for ABMAL. On 25th August 1966 the latter's solicitors wrote to the Trust's solicitors recounting the relationship of ABMAL with Property Options Pty. Limited and continuing:

``At some stage a draft lease and memorandum of option were initialled by the parties, which were a variation of the drafts originally submitted. The memorandum of option so initialled provides that the option is granted to the lessee company (including any associated company to which the lease may be transferred with the consent of the Trust) and provides also in clause 1(b) that the grantee (lessee) may in the notice exercising the option nominate any associated company to pay the price and take a transfer. In this document 'associated company' is defined as a company which is to the satisfaction of the Trust a land holding company for, or is otherwise directly associated with the grantee.

Under this document the grantee (lessee) is stated to be Associated Batteries, but it was subsequently arranged that in fact the lessee should be South Australian Battery Makers Pty. Limited, which is a subsidiary.

The Trust has indicated that Property Options Pty. Limited does not meet the requirements of clause 1(c) above referred to, although this company was formed for the sole purpose of serving as a land holding company in connection with this transaction, and all the companies concerned are members of a group which either directly or indirectly are wholly owned by Chloride Electrical Storage Co. Limited.

The Trust's definition of 'associated company' in the relevant document requires either:

• (1) That the company exercising the option shall be a land holding company for the grantee
  • or, alternatively -
• (2) Is otherwise directly associated.

It appears to us that Property Options Pty. Limited complies with both of these requirements.''

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The Trust's solicitors replied on 31st August 1966 requesting further proofs which were given in the form of the declarations of trust in respect of the shares in Property Options Pty. Limited. The Option to Purchase was granted to the latter company on 25th October 1966.

The Commissioner has claimed that the payments by SABM under the lease ought to be apportioned partly to revenue account and partly to capital account. He did not succeed in this claim on the taxpayer's appeal to the Supreme Court of New South Wales. There the objection was allowed and the whole of the payments under the lease were held to be deductible. The Commissioner has appealed to this court.

Periodical outgoings reserved to a lessor under a lease (1) may be incurred by a lessee (either wholly or partly) in gaining or producing assessable income or may (either wholly or partly) be necessarily incurred in carying on a business for the purpose of gaining or producing assessable income; (2) may be wholly or partly outgoings of capital or of a capital nature. In the case of (1) above the question whether they are wholly or partly so incurred falls to be determined according to the true legal nature and consequences of the transaction or transactions of which they form part. The description given by the parties to the outgoing is not conclusive but on the other hand the legal nature is not altered by the existence of extrinsic economic consequences or benefits even though those consequences and benefits may be intended or expected.

Thus in the case of trading stock the cost thereof can only be the price in fact paid unless one goes behind the transaction, and that is what one cannot do without alleging that the form of the transaction is a sham. The price may not be that which is described as such in the documentation but it must nevertheless be the price - that which is in fact paid as consideration for the stock. The contractual quid pro quo is the governing consideration. It appears to me that this was the approach of the majority of their Lordships both in
Europa (No. 1) 70 ATC 6012 ; (1971) A.C. 760 and in
Europa (No. 2) ATC 6001; (1976) 1 W.L.R. 464 . The price paid for the recurrent purchase of trading stock is essentially an outgoing on revenue account and the question which arises is whether it is incurred for the purpose of producing or in the production of the assessable income. (I use this language broadly in order to comprehend whatever variations there may be between the language of different statutes.) In Europa (No. 1) the Privy Council examined the real legal nature of the transactions and concluded that the outgoings were not wholly, but only partly, incurred in payment for the trading stock and were therefore partly incurred in the production of the assessable income gained from trading in that stock and partly for the dividend benefit which was not assessable income. In Europa (No. 2) an examination of the real legal nature of the transactions, which were after Europa (No. 1) carried on under different arrangements, led to a contrary conclusion. The dividend benefit never went to the taxpayer at all under the later contractual arrangements.

However, when one moves from the kind of question which arose in those cases to the question which arises when one is considering whether a payment of a kind which may be made on revenue account or on capital account is in fact made on the one or the other account the question to be determined is significantly different. An outgoing may be incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business for the purpose of so doing even though it is wholly of a capital nature. Neither the particular form nor the legal nature of the transaction in which the outgoing occurs can of itself determine whether that outgoing is on capital account or revenue account or partly on one and partly on the other. It is necessary to go beyond the contractual form and the legal nature of the transaction and to consider on the basis of business reality and consequent accounting practice the nature of the advantage or benefit sought to be obtained. That this is so is well established. And it is to be noted that it is not the nature of the advantage or benefit actually obtained but the nature of the advantage or benefit sought to be obtained - the object of the expenditure - which is the subject of the inquiry. See per Dixon J. in
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634 , at pp. 647-648 . I shall refrain from elaborating upon this last distinction because it has been

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fully discussed by Gibbs J. in his reasons and I agree with his conclusion that it is the nature of the advantage sought which is the critical matter for examination.

Once it is found that the outgoing has been incurred in gaining or producing the assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, then in considering whether the outgoing is of capital or of a capital nature, the relevant advantage or benefit sought and the nature of which falls to be examined will be the advantage or benefit - directly or indirectly - to the person who claims to have expended the money on revenue account. But the advantage or benefit need not be of a proprietary nature, an asset vested in the taxpayer at law or in equity. To transfer the requirement of a legal, as distinct from an economic, consequence from the subject matter of the Europa cases to the subject matter of the present inquiry is fallacious. It would run contrary to the statement of Dixon J. in Hallstroms' case which was approved by the Privy Council in
B.P. Australia Ltd. v. F.C. of T. (1965) 112 C.L.R. 386 , at p. 397 . The subjects were considered by Lord Wilberforce, dissenting, in Europa (No. 2), 76 ATC at p. 6013; (1976) 1 W.L.R. at p. 480 to be ``different but analogous'' and he quoted the words of Dixon J. in Hallstroms' case. The majority in that case do not draw the distinction but they must have been conscious of it when attention was thus expressly directed to it by Lord Wilberforce and in the light of the precedent cases. The implicit view of the majority in their emphasis on the legal and not business character of the payments is that the two subjects not only were different but also were not analogous.

The decision of Walsh J. in Poole and Dight v. of T. 70 ATC 4047; (1970) 122 C.L.R. 427 is an example of how the distinction operates. The annual rent payable to the Crown for agricultural land could be set off by the leaseholder against the purchase price for obtaining a title in fee simple. This rent was paid by the partnership which carried on business on the lands. Two of the partners were the leaseholders and the other two partners were not. It was held that, though in the case of the former the rent was of a capital nature which on the facts was not required to be apportioned between capital and income, in the case of the latter the rent was wholly deductible as an outgoing. The reason why in the case of the latter the rent was wholly deductible was because there would be no benefit to the partnership if a fee simple were acquired. See 70 ATC at p. 4056; (1970) 122 C.L.R. at p. 443. Walsh J. does say ``...the payment made by the partnership was not related in any way to the acquisition... of a capital asset,'' but he cannot be taken by those words to be asserting that the relevant inquiry was whether a proprietary or legal asset was to be acquired. On the facts there was nothing to suggest that any benefit, legal or commercial, was sought from the conversion of the leasehold to a freehold by that taxpayer partner who had no interest in the leasehold.

I propose to frame what I regard as the relevant inquiry in the instant case by adapting the language of Dixon J. in the Sun Newspapers' case (1938) 61 C.L.R. 337, at p. 363 to the circumstances of the present case. The character of the advantage sought by SABM was use and enjoyment of the factory premises. The question is whether the periodic outlay under the lease was to cover that use and enjoyment for periods commensurate with the payments or was in part by way of provision or payment so as to secure future use or enjoyment beyond those periods. In other words did SABM by the payments seek to secure to itself the advantage of a use and enjoyment of the factory premises at a future time beyond the time when there was an obligation to pay rent to the Trust? I have already explained this use of the word ``secure'' does not mean only ``secure as a legal right.''

I here observe that the burden lay upon the taxpayer on the appeal of proving that the assessment was excessive (sec. 190(b)) and therefore it had to establish the negative of the question which I have posed. It was content to rely upon the legal proposition that it had no legal right to use and enjoy the factory premises after the expiry of the lease and produced no evidence that by the payment of a rent which would secure transfer of the fee simple without further cost it did not thereby seek the advantage that it would be able to use and enjoy the premises free of the obligation to pay a rack

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or other rent thereafter. If it fails in this approach, as in my opinion it does, it has failed to produce evidence which will satisfy the burden of proof which lay upon it. But it seems to me that the Commissioner does not have to rely wholly on sec. 190(b). Such evidence as there is tends strongly to support the conclusion that a relevant advantage was sought by SABM in respect of the time after expiry of the lease. The Trust was not prepared to grant an unconditional Option to Purchase. It required that any company granted the Option or nominated to exercise the Option should be a land-holding company for the lessee or otherwise directly associated with the lessee. The reason is obvious. The concern of the Trust was to encourage industrial development in South Australia and to ensure that the factory premises continued to be used for the industrial development which it had encouraged. There is nothing to indicate that it was interested in a mere financial association of companies. It wanted a direct association which would encourage the proposed lessee to take up the lease and to continue to use the factory premises for its manufacturing business after the expiry of the lease. Naturally it was not concerned, provided that it did its best to ensure that the industry was continued by the lessee, whether the former lessee paid rent to the associated company. But that is not to the point on the present inquiry. Further, there is no reason to think that, unless it suited the companies for bookkeeping purposes, the taxpayer would be required by its co-subsidiary to pay a rack rent for premises in respect of which it had already paid the value in fee simple.

The Trust was assured by the solicitors for SABM and ABMAL that Property Options Pty. Limited was formed for the sole purpose of serving as a land-holding company for SABM and was a company directly associated with SABM . The Trust accepted those assurances on the proof that the two companies were co-subsidiaries within a single group of companies. The taxpayer would need to produce strong evidence that the statement by the solicitors was wrong, but it produced no evidence on the matter at all. That being so, it has not discharged the burden which lay upon it.

In my opinion the appeals should be allowed with costs. The parties agree that in this event there should be an order remitting the matters to the Supreme Court and I would so order.