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Cliffs International Inc. v. Federal Commissioner of Taxation.

Judges:
Barwick CJ
Gibbs J
Stephen J
Jacobs J
Murphy J

Court:
High Court of Australia

Judgment date: Judgment handed down 13 March 1979.

Barwick C.J.: The appellant, Cliff's International Inc., appeals against an order of the Federal Court of Australia allowing an appeal to that Court by the respondent Commissioner from an order of the Supreme Court of Western Australia ( Brinsden J.) ordering the respondent to amend his assessments of the appellant's income tax for the financial years 1973 and 1974 by excluding from the amount assessed as taxable income certain specific amounts totalling for the year 1973 $1,052,867 and for the year 1974 $1,193,278. The order of the Federal Court, except as to an item of $16,638 paid as legal costs, upheld the respondent's assessments.

The principal dispute between the parties is as to the relevant nature of payments made by the appellant to two companies, Howmet Corporation (``Howmet'') (formerly called Howe Sound) and Mt. Enid Iron Co. Pty. Ltd. (``Mt. Enid'').

I find it unnecessary, and indeed unprofitable, to recite in detail the development of the contractual relationship between the appellant and the companies to which the payments were made. I confine my narrative to what I consider to be the essential facts which may briefly be stated, though particular terms of the relevant agreement must be set out in full.

As at November 1962, Howmet and Garrick Agnew Pty. Ltd. (``Agnew Co.'') were the two major shareholders in the capital of Basic Materials Co. Pty. Ltd. (Basic). Howmet owned 50.1% of the shares and Agnew Co. 49.9%. As at that date Basic had been allotted under the Mining Act, 1904 as amended (W.A.), Temporary Reserves for a period of two years from 1st April 1962. The Reserves were subject to stated conditions and covered Crown lands ``within a total area of 246 square miles as shown'' on a specified plan. By the approval of the Reserves, Basic had a right to occupy the described lands for the sole purpose of prospecting for iron ore. Amongst the stated conditions upon which the right of occupancy had been granted were the conditions:

  • (1) that the occupant should ``forthwith'' commence operations prospecting for iron ore and should continue them to the satisfaction of the Minister for Mines;
  • (2) that no transfer of the authority to occupy would take place without the antecedent approval of the Minister;
  • (3) that the occupant would periodically and at the expiry of the occupancy report its operations and their result, including details of the manner of exploration, geological and geophysical work and the results of assays of material extracted;
  • (4) that when it is shown to the satisfaction of the Minister for Mines that iron ore has been discovered on the Reserve in payable quantities, the Minister, after negotiation with the occupant regarding the mining, treatment, processing and marketing of the ore (including conditions as to royalties, quantities, volume, rate, location and methods), will (subject to the provisions of any contract which the Minister may require the occupant to make with the State Government) offer to grant to the occupant, for the mining of iron ore, mining tenements under the Mining Act, 1904 and the regulations thereunder (as amended from time to time) on such conditions as the Minister determines and on acceptance will (subject to the Act and regulations) make

    ATC 4062

    such accordingly. If the occupant rejects or within a reasonable time (not exceeding 90 days) fails to accept the offer, the Minister may make any similar grants on the same or less favourable conditions to any other or others, but will not, for a period of at least two years after the original offer is made, grant to any other or others for the mining of iron ore from the Reserve any similar mining tenements on more favourable conditions without first giving to the occupant the prior right and opportunity to accept such a grant on those more favourable conditions.

Apparently prior to that date some moneys had been spent by one or both of the said companies or by their respective predecessors either in obtaining the approval of the Temporary Reserves or in performing their conditions.

On 27th November 1962, Howmet and Agnew Co., by an agreement in writing (the option agreement), granted to Cleveland-Cliffs Iron Co. an option to purchase the whole of the shares held by them in Basic. By the terms of this agreement, the optionee was assured that at the date of the exercise of the option, Basic would have no liabilities and would be possessed of the rights given by the approval of the Temporary Reserves. In 1963 Cleveland-Cliffs Iron Co. exercised a right to do so under the option agreement and nominated the appellant as its substitute in the agreement whereupon the appellant became a party to the option agreement as if it had been so originally. I therefore so treat the appellant in this recital.

As certain terms of the grant of this option have been central to the discussion of this appeal, I shall set them out in full:

``4. Cliffs is hereby granted the option to purchase from Howe and Agnew Company their entire right, title and interest in all of Basic's capital stock and shares, for the Purchase Price set forth below, payable to them in proportion to their participations above set forth, such option to be exercised by written notice by Cliffs to them on or before December the thirty first One thousand nine hundred and sixty three. Such purchase by Cliffs shall be consummated at the offices of Messrs. Parker & Parker, 21 Howard Street, Perth, Western Australia, at a date specified in Cliffs' notice of exercise of the option, not less than twenty nor more than thirty days from the date of such notice (herein called the `Closing') by making of the Initial Payment by Cliffs to Howe and Agnew Company against delivery to Cliffs of appropriate certificates and assignments.

5. The Purchase Price referred to in Article 4 shall consist of an Initial Payment of TWO HUNDRED THOUSAND DOLLARS $200,000 (U.S.), payable in good New York or Cleveland, Ohio funds by certified or official bank check at the Closing of the purchase hereinabove referred to, plus Deferred Payments equal to 15c (US) per ton of Iron Ore payable as in this Article 5 set forth. Such 15c per ton payments (hereinafter sometimes called `Deferred Payments') shall be computed and paid as follows:

  • (a) `Iron Ore' shall mean iron bearing material mined and transported from the Reserves by or with the consent of Basic or its successor in interest, whether or not such iron ore shall have been dried, roasted, burned, sintered, crushed, ground, concentrated, pelletized, agglomerated or otherwise beneficiated or processed or prepared prior to sale or consumption, but iron bearing material of low grade may be sold for construction purposes without any liability to pay any Deferred Payments with respect thereto.
  • (b) A `ton' shall be a gross ton of 2,240 pounds avoirdupois weight in the form and at the time transported from the Reserve. Reports as to the weight of any such Iron Ore made by any common carrier trucker, railroad or vessel operator shall be conclusive for all purposes hereof. In the absence of such reports, reports thereof by Basic or its successor in interest shall, unless fraud is involved, be conclusive on each party hereto unless challenged in writing within thirty days after receipt of such report by such party.
  • (c) Within ninety days after June thirtieth and December thirty first of each year Cliffs shall make or cause to be made to Howe and Agnew Company a report of the tons of Iron Ore mined and transported from the Reserves during the semi-annual period then ended, together with payment by check drawn on good

    ATC 4063

    United States funds of their respective participations in the Deferred Payments with respect thereto. Subject to the provisions of paragraph (b) of this Article, in the event Howe or Agnew Company does not object in writing to the computation of such amount within ninety days after receipt of such report, such report shall be binding and conclusive upon the parties, unless fraud is involved.
  • (d) For purposes of this Article 5, iron bearing material mined from the Reserve shall be considered as still located at the Reserve so long as it is located at any plant in Australia for the purpose of drying, roasting, burning, sintering, crushing, grinding, concentrating, pelletizing, agglomerating or otherwise beneficiating or processing or preparing prior to its sale or consumption.

The initial Payment will be in the form of check payable jointly to Agnew Company and Howe, and the Deferred Payments will be paid in cash or by check in the proportion of 50.1% to Howe and 49.9% to Agnew Company.''

For its part, the appellant, whether or not it exercised the option, undertook during the currency of the option to investigate the extent and quality of the iron ore in the Reserves and the feasibility of mining and selling iron ore derived therefrom. The appellant performed this obligation.

On 17th January 1964, the appellant exercised the option to purchase the shares and paid the sum of $200,000 as required by cl. 5. The shareholdings of Howmet and Mt. Enid in Basic were thereupon duly transferred to it, Agnew Co. having sold its shareholding to Mt. Enid just prior to the option's exercise.

On 18 November 1964, Basic and the State of Western Australia entered into an agreement by which Basic undertook within four years of the commencement date to expend $70,000,000 in the installation of various facilities for mining iron ore, its transport by rail to a plant for pelletising and for ultimate shipment. On its part, the State undertook to grant Basic or its approved assignee a mineral lease for mining iron ore for a term of 21 years successively renewable for like terms. The agreement fixed rental and royalties payments to be made by Basic to the State.

The appellant's investigation of the Reserves led it to believe that they contained insufficient iron ore to sustain an economic development. Accordingly, the appellant gained access to iron ore in another area, the Deep Dale deposits which were controlled by the Dampier Mining Co. Ltd.

The appellant, after Basic had made the agreement with the State, organised a consortium of companies to mine the iron ore contained in the areas of the Temporary Reserves and the Deep Dale deposits. This consortium entered into an agreement with the State of Western Australia which is scheduled to the Iron Ore (Cleveland-Cliffs) Agreement Act Amendment Act, 1973 (W.A.) The consortium proceeded to mine, transport and sell iron ore derived from the said areas.

The appellant, which did not itself at any stage conduct mining operations with a view to the transport and sale of iron ore, became entitled under the arrangements it made for the formation and operation of the consortium, to receive from the consortium a royalty of 30c per ton of ore mined, transported and sold by the consortium.

The appellant's business thus involved it in the receipt of the royalties from the consortium which, though I do not think it matters, accrued on a slightly different basis to that applicable to the computation of the payments to Howmet and Mt. Enid under the option Agreement. As the operations of the consortium involved the mining and transport of iron ore from the area of the Temporary Reserves and thus attracted the obligation under the option agreement to make the ``deferred payments'', the appellant paid to Howmet and Mt. Enid from time to time sums equal to 15c per ton of iron ore mined and transported by the consortium.

The Commissioner maintains, and the Federal Court has held, that those recurrent payments to Howmet and Mt. Enid of 15c per ton of iron ore mined and transported were outgoings of a capital nature under the exception described in sec. 51(1) of the Income Tax Assessment Act 1936 as amended. It is said that they constituted part of the purchase price of a capital asset sold to the appellant by Howmet and Agnew Co. In support of this contention, the language of clauses 4 and 5, which I have quoted, is relied upon and, in particular, the use of the description ``deferred payments'' in relation to the recurrent sums. Reliance is placed by the Commissioner upon

ATC 4064

the decision of this court in
Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1953) 89 C.L.R. 428 .

The taxpayer submits that the payments were outgoings necessarily incurred in the gaining of its income from the mining of iron ore by the consortium and, though the promise to make them was part of the consideration for the agreement to transfer the shares, they do not thereby become capital payments but are analogous to the payment of rent agreed to be paid on the grant of a lease at a premium or to royalties agreed to be paid on the grant for a money sum of a licence to use a patent.

The issue to be settled is thus the nature of the payments when made by the appellant. This is not to be resolved by any attempt to apply to these payments or to what was purchased by the exercise of the option some description judicially used in a decided case in relation to the facts and circumstances of that case as a means of explaining the reasoning used in arriving at the conclusions of fact in that case. I might therefore say at the outset that, in my opinion, there is little profit in the citation of such descriptions.

The proper conclusion in each case in this particular area of the law is peculiarly dependent upon the particular facts and circumstances of that case.

But there are several generalisations emerging from the decided cases which, in my opinion, have universal validity in relation to a decision whether a payment made in performance of a promise given as part of the consideration for the acquisition of a capital asset is itself of a capital or of a revenue nature. These generalisations are to be found in the reasons for the judgment of this Court in
Egerton-Warburton & Ors. v. D.F.C. of T. (1934) 51 C.L.R. 568 at pp. 572-3 . I have no need to repeat or extract them here: or to repeat the citations which are there made. It is sufficient to say that from the statements in that case and the decisions to which reference is there made, it clearly and, in my opinion, correctly appears that the fact that payments are made or received in performance of a promise given as part of the consideration for the acquisition of a capital asset does not necessarily mean that the payments are themselves of a capital nature.

In the next place, the relevant quality of these payments is to be determined, in my opinion, in relation to the gaining of the income against which they are sought to be deducted. What quality they may have in the hands of the recipient will not determine their quality as disbursements by the appellant, though, for my part, that quality is not of necessity irrelevant.

Then, the description given such payments by the parties cannot decide their quality. What was meant, in my opinion, in
Europa Oil (N.Z.) Ltd. (No. 2) v. Commr. of I.R. (N.Z.) 76 ATC 6001 ; (1976) 1 W.L.R. 464 , was that in deciding taxability, and the same is true of deductibility, the nomenclature applied by the party or parties cannot foreclose the examination of what in truth the receipts or payments relevantly are.

But I ought at once to point out that the description ``deferred payments'' is quite obviously inapt. Clause 5 itself created no present debt for the amounts to be paid. It did not merely provide a manner of discharge in the future of a debt presently incurred. From any point of view, no conclusion could be founded upon or, in my opinion, could be aided by the description ``deferred payments'' applied by the parties to the sums which might thereafter become due pursuant to the appellant's promise in cl. 5. I say ``might become due'' because none of the payments might ever be due. The appellant did not undertake to mine iron ore. Indeed, there was then no certainty that the appellant would ever have or control the right to do so. It was only in the eventuality that iron ore was drawn from the Temporary Reserves by or at the instance of the appellant that cl. 5 would be activated so as to result in an obligation to make the stipulated payments.

There can be little doubt that from the time that it made the arrangements with the consortium under which the two areas, which included the Temporary Reserves, should be mined and the appellant paid the agreed royalty on iron ore mined, transported and sold, the appellant was engaged in a commercial venture or business of which those royalties formed at least part of the income. The Commissioner has rightly acted on that footing and has treated the royalties paid by the consortium as part of the appellant's assessable income. A direct consequence of the availability of that income, i.e. of the mining and transport of iron ore by the consortium, was a liability to make the payments sought to be deducted. They were, to my mind, undoubtedly outgoings incurred in gaining the assessable income. Indeed, as I understand the respondent's counsel, that conclusion was not challenged. Then, does the fact that the appellant was under promise to

ATC 4065

Howmet and Agnew Co. (later Mt. Enid) to make such payments require the conclusion that, though such an outgoing, they were of a capital nature?

It is proper to point out, and to do so with emphasis, that by making the recurrent payments the appellant acquired nothing which it did not already have. The question is not of what relevant quality was the thing or right acquired by the payments: for nothing at all was thus acquired. It is, of course, true that, if it mined or procured the mining of iron ore from the area of the Temporary Reserves, the appellant was contractually bound to make the payment. It is also true that its promise to make the payments in the events which occurred formed part of the consideration given for the acquisition of the shares. But they were acquired without making the payments in question. The recurrent payments were not made for the shares though it might properly be said that they were payable as a consequence of the purchase of the shares.

Whilst there is a sense in which the promise to pay an amount rated to the tonnage of iron ore extracted from the Temporary Reserves in events then contingent and uncertain could be regarded as part of the cost to the appellant of the shares, I cannot think that the payments when made, having become payable because of supervening events can properly be regarded as part of the purchase money for the shares in Basic. As I have indicated, the fact that the promise to make the payments formed part of the consideration for the transfer of the shares does not mean that, when made, they were paid for the shares.

This is not a case where there need be any discussion of the nature of the asset acquired by the exercise of the option.

Some discussion took place in argument, and evidently also before the primary judge and the Federal Court, as to the identity of the asset which was acquired by the exercise of the option. This, to my mind, is not of significance in the resolution of the question in the case. However the subject matter of the purchase is identified or described, the purchase was of a capital asset. But I should point out that the subject matter of the purchase, in my opinion, was the shares in Basic. It is, of course, clear that the motive for this acquisition was to obtain control of Basic and by the use of that control to obtain access to the rights of occupancy and exploration of the area in the Temporary Reserves together with the possibility of the grant of a mining lease, i.e. the right to remove and dispose of the iron ore in that area. For my part, I do not think the purpose in acquiring the shares can be used to convert the subject matter of the purchase into something which plainly it was not. I do not think it correct to treat the rights of occupancy as the subject matter of the purchase and transfer. Thus no question arises in this case, in my opinion, as to the relevant quality of what was the subject matter of the purchase and transfer. As I have said, on any view, the subject matter was undoubtedly of a capital nature.

The matter may be approached in another, though perhaps not so dissimilar a way. The vendors for the transfer of their shares took a cash price and stipulated for a share of the proceeds of mining iron ore, if that eventuated. For its part, the appellant by agreeing to make the recurrent payments was prepared to admit the vendors of the shares to participation in the result of the mining of the iron ore. They were made, and necessarily made, by the appellant as disbursements in its business. They were none the less so by reason of the fact that the appellant had agreed to make them: nor does the fact that the agreement to make them formed part of the consideration for the purchase of the shares made them payments of a capital nature. It does not seem to me to matter greatly what description is applied to such recurrent payments by the appellant. That they were in the nature of royalties I have no doubt. But, however described, I would find it difficult to accept that the receipt of such a share, particularly by recurrent payments, measured in relation to the produce of the mining, was a capital receipt in the hands of the vendor. But, of course, though relevant, that conclusion does not necessarily determine the first question.

If an analogue is felt to be of assistance, an analogy may be found in the grant of a licence to use a patent upon payment of a cash price and a continuing royalty on what might be produced by employment of the patent. The promise to pay the royalties is, in my opinion, in such a case part of the consideration for the grant of the licence but neither the receipt nor the payment of the royalty is for that reason a capital receipt or payment. The reasoning in Egerton-Warburton & Ors. v. D.F.C. of T., especially at pp. 572-3 of the report strongly suggests the conclusions at which I have arrived. The payments were, in my opinion, disbursements by the appellant in the course of its business and were not of a capital nature.

ATC 4066

In this connection, I should say that I do not find the facts in Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1953) 89 C.L.R. 428, analogous to those of the present matter, or so closely to resemble them as to make what the Court said and decided in that case definitive of this. Being of that view, I have no need to explore those reasons or to express a concluded view as to their acceptability. Suffice it to say that that case, as Williams A.C.J. indicated at p. 441 of the report, depended upon its own facts and is, in my opinion, clearly distinguishable from this. Whether it was rightly decided upon its own facts is not a matter I have presently to consider.

My conclusion is that, whilst the promise to make them in the events which occurred formed part of the consideration for the transfer of the shares of Howmet and Agnew Co. in Basic, the payments themselves when made were outgoings incurred in gaining the appellant's assessable income consisting of royalties paid by the consortium and that they were not of a capital nature.

It would follow that the amount of legal costs in dispute were deductible. But I should add that I agree with the reasons of the Federal Court for concluding that, apart from the question of the deductibility of the deferred payments, the amount of the legal costs was deductible.

I would allow the appeal and restore the order of the Supreme Court of Western Australia.


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