Cliffs International Inc. v. Federal Commissioner of Taxation.
Members: Barwick CJGibbs J
Stephen J
Jacobs J
Murphy J
Tribunal:
High Court of Australia
Stephen J.: This case concerns the problem of distinguishing between outgoings of capital and of income, a problem inherent in a system of taxation which selects a taxpayer's income as the subject matter upon which tax is to be levied.
That the distinction may in some cases be no easy one to draw is demonstrated by the history of this case. The Commissioner having treated the taxpayer's outgoings as on capital account, Brinsden J. regarded them as of an income nature, while the members of the Full Court of the Federal Court of Australia took the view that they were affairs of capital: nor has the expression of divergent views now ceased with the appeal to this Court.
The outgoings in question are payments which were made by the taxpayer in consequence of the exercise of an option to purchase all the issued capital in a company, Basic Materials Co. Pty. Ltd. They are described in the agreement which conferred that option as deferred payments forming part of the purchase price payable as a result of the exercise of that option.
I have had the advantage of reading the reasons for judgment prepared by the Chief Justice, in which appear a distillation of the complex facts of this case, which are recounted in their full detail in the judgments at first instance and in the Federal Court, reported in 77 ATC 4216 and (1977) 16 A.L.R. 681 respectively. This has made it unnecessary for me to undertake any further recitation, as distinct from analysis, of the facts.
It must be from these facts, and by the light which they cast, that the character of these payments is to be determined. In my view their character is that of outgoings of capital.
An analysis of the facts may conveniently begin with the terms of the agreement under which these payments were made. By art. 4 of that agreement an option is granted to purchase all of the issued capital in Basic for ``the Purchase Price set forth below''. Then art. 5 describes in detail that purchase price. It consists of two parts, an ``Initial Payment'' of $200,000 ``plus Deferred Payments equal to 15c (U.S.) per ton of Iron Ore payable as in this Article 5 set forth''. There follow details concerning those payments. The deferred payments were, then, part of the agreed consideration to be paid.
From the terms of art. 4 and 5 of the agreement there emerges the subject matter of the debate in this appeal. On the one hand may be seen the acquisition of an asset having all the apparent characteristics of a capital asset and in determining the character of an outgoing which consists of the purchase price of an asset the fact that what is bought, what the expenditure brings in, is a capital asset must be of high significance. On the other hand, as art. 5 reveals, that part of the purchase price which is in dispute is payable by periodic half-yearly payments which are of indefinite duration and are unlimited in total amount, being dependent for their quantum upon the quantity of iron ore mined and removed from certain mining tenements; it resembles a royalty payment, is a recurring sum whose fluctuating quantum will reflect the variable outturn of iron ore in the future, and is therefore intimately associated with those day-to-day mining operations which the agreement contemplates as occurring in the future. These features are said to give to these periodical payments the character of outgoings on revenue account.
Of course, to regard what was acquired as merely shares in Basic is to concentrate upon form to the exclusion of substance. As
Dixon
J. pointed out in
Hallstroms Pty. Ltd.
v.
F.C. of T.
(1946) 72 C.L.R. 634
at p. 648
, in a passage subsequently much cited both in this Court and by their Lordships:
``What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.''
To look only at the acquisition of shares is to ignore that which was the real advantage which, from a practical and business point of view, was acquired by the exercise of the option. The basis of calculation of the deferred payments, as well as much else in the agreement and in the evidence as a whole, makes it clear that although it was the issued capital of Basic that was the express subject matter of the option, what gave it its value and made it a desirable asset was the bundle of rights, both existing and prospective, which Basic enjoyed, or was in a position to enter into the enjoyment of, if iron ore deposits in the Temporary Reserves proved to be commercially significant. It was the benefit of those rights which was the advantage to be gained by any exercise of the option.
In the judgment of Bowen C.J. in the Federal Court - 77 ATC 4216; 16 A.L.R. 681 at p. 694 - appears a description of the bundle of rights which the taxpayer acquired or, more
ATC 4070
accurately, ``was placed in a position to gain access to''. It consisted, immediately, of an exclusive right to use the Reserves for the purpose of prospecting for iron ore, this being a right of quite limited duration but which might be renewed by the Minister. Should iron ore in payable quantities be discovered in the Reserves, the Minister was then to offer to grant mining tenements, upon such conditions as he determined, to enable ore bodies to be worked, the grant being subject to entry into any such contract with the State of Western Australia as the Minister might require. As Bowen C.J. observed, this bundle of rights was of significant value involving ``a speculative potential of long-term advantage, dependent upon any necessary extension or renewal of the right of occupancy, the discovery of iron ore in payable quantities and the preparedness of the Minister to require a reasonable contract and to make the offer of a grant of mining tenements on reasonable conditions''.The advantage which exercise of the option would secure to the taxpayer was, then, in part of a speculative and prospective nature, the immediate advantage being in some respects restricted to the attaining of an advantageous position from which the better to gain additional rights. This reflected, of course, the quality of what it was which Basic itself possessed and which, in consequence, the vendors of its issued capital could offer. However, the use to which the taxpayer might put the advantage which it acquired is not in doubt: it could seek to derive income either by itself undertaking exploratory and developmental work, followed by mining and resultant exploitation of orebodies within the Reserves, or by permitting others to do so. It acquired the nucleus of a profit-yielding subject from which to derive income in the future. Much of course remained to be done, both by way of exploration and development in the field and by way of negotiation and the obtaining and renewal of appropriate mining tenements. But the exercise of the option provided the taxpayer with the opportunity of doing all this and, if all went well, of thereby acquiring, and being able to confer upon others, title to iron ore which might be mined from orebodies in the Temporary Reserves. In that sense it was the very foundation of what might be, and has in fact proved to be, a great mining enterprise that was being acquired, as much a capital asset as were the shares which constituted the express subject matter of the option.
That the asset or advantage acquired, however regarded, was an affair of capital must point most strongly towards the deferred payments being themselves outgoings of a capital nature. By promised payment the taxpayer secured to itself rights, in part existing, in large partly only prospective and in a sense speculative but from the exercise of which, directly or at one remove, it might look forward to the deriving of income in the future. Their promised payment formed a part of the consideration in return for which those rights were secured and they were aptly enough described in the agreement as a part of the ``Purchase Price''. Moreover that ``Purchase Price'' was paid or promised once and for all in return for one bundle of rights. Once those rights were acquired by the taxpayer there remained nothing more for the vendors to give it, the transaction between them was complete save that the taxpayer's promise to make the ``Deferred Payments'' remained to be performed. Those future payments were not to be paid in return for advantages to be granted in the future but, rather, in consideration of a single event occurring in the past, namely the transfer of the vendors' shareholding in Basic. The linking of the quantum of the future payments with matters contemporaneous with the making of those payments was but the outcome of the particular method adopted for the determination of their quantum.
The important distinction between such a case and instances of leases of land or the licensing of patents is that in those cases rent or royalties are paid for the right to occupy or use the property or rights of another. But here the vendors, upon exercise of the option, retained nothing and the taxpayer thereafter made no use of anything to which the vendors retained any claim.
The nature of the rights which were being acquired explains the form of the consideration payable in return: that the Deferred Payments were to be periodical in nature, might be payable for an indefinite future period and were linked to the quantities of ore mined and removed from the Temporary Reserves did but reflect the wholly uncertain value, as at date of acquisition, of that which was to be acquired by exercise of the option. Only from the outcome of future events could a measure be had of the true value of that with which the vendors had parted. As appears from that portion of the evidence of a Mr Dohnal, set out in full in the judgment of my brother Jacobs, this circumstance proved to be critical in arriving at agreement concerning the form of consideration payable should the option be exercised. That that value was, at the date of
ATC 4071
grant of the option, entirely uncertain was not only because there was uncertainty whether iron ore in large commercial quantities was to be found in the Reserves: there was also no certainty as to the terms and conditions upon which such orebodies as might be discovered would be allowed to be exploited: all this would have to await the outcome of negotiations with the State of Western Australia. These cumulative uncertainties precluded the placing of any certain value upon the advantages to be derived from exercise of the option. However, by relating the consideration payable as a result of its exercise to the quantities of ore in fact mined and removed from the Reserves it became possible to establish a price formula which would accurately reflect the ultimate value of the advantages gained from exercise of the option.It may be that money paid by a purchaser as part of the purchase price of a capital asset which he buys will not, for that reason alone, necessarily always bear the character of an outgoing of capital. But at least where, as here, whatever indicia of a revenue nature which the agreed purchase price may possess can be seen to be due only to factors such as the impossibility of placing a value, at the date of grant of the option, upon what is bought, the capital nature of what is bought will be most cogent evidence of the capital nature of the outgoing. To such a case I would apply what was said by
Fullagar
J. in
Colonial Mutual Life Assurance Society Ltd.
v.
F.C. of T.
(1953) 89 C.L.R. 428
at p. 454
, where, speaking of payments made as the price of acquiring an asset, his Honour said:
``It does not matter how they are calculated, or how they are payable, or when they are payable, or whether they may for a period cease to be payable. If they are paid as parts of the purchase price of an asset forming part of the fixed capital of the company, they are outgoings of capital or of a capital nature.''
In
Cooper
v.
F.C. of T.
(1957) 97 C.L.R. 397
Kitto J., at p. 404, made the same point when he said that ``in ordinary cases of the purchase of a capital asset'' the necessary conclusion which followed was that:
``the consideration paid, whether in one sum or in several and whether at one time or over a period, is an outgoing of a capital nature.''
That the purchase price payable on the acquisition of a capital asset should, for that reason alone, be regarded as at least very strong evidence that the outgoing itself possesses the character of an outgoing of capital is scarcely remarkable since there can be little else capable of so reliably reflecting the character of the particular outgoing. A bare payment of money is itself devoid of any character, either as on revenue or on capital account. It is only from surrounding circumstances that it acquires its character and a most powerful circumstance must be that it forms the purchase price for a capital asset, so that by its outlay an advantage for the enduring benefit of the payer's trade is acquired, the profit-yielding subject being thereby created or enhanced.
That this is so is shown by many cases, of which it is enough to cite those of the highest authority and of relatively recent date. In
Ralli Estates Ltd.
v.
Commr. of Income Tax
(1961) 1 W.L.R. 329
Lord
Denning,
speaking for their Lordships, said of a price paid ``in order to acquire a capital asset'', of which he instanced freehold land or a long lease, that it was incurred not ``in the production of income, but in the production of capital. It is not deductible as revenue expenditure, no matter whether the price or premium is paid by a lump sum or by instalments. And this is true even when the lease is of a wasting asset...''. In
Commr. of Taxes
v.
Nchanga Consolidated Copper Mines Ltd.
(1964) A.C. 948
Viscount Radcliffe,
at p. 960 described as ``as illuminating a line of distinction as the law by itself is likely to achieve'' that ``demarcation between the cost of creating, acquiring or enlarging the permanent (which does not mean perpetual) structure of which the income is to be the produce of fruit and the cost of earning that income itself...''. In
B.P. Australia Ltd.
v.
F.C. of T.
(1966) A.C. 224
Lord
Pearce
applied the classic tests enunciated by
Dixon
J. in
Sun Newspapers Ltd. v. F.C. of T.
(1938) 61 C.L.R. 337, the first of which his Lordship described, at p. 265, as involving ``the character of the advantage sought, and in this both its lasting qualities and the fact of recurrence may play their parts. Under this head one might also take account of the nature of the need or occasion which calls for the expenditure
-
Dixon
J. in
Hallstroms' case
''. In
Strick
v.
Regent Oil Co. Ltd.
(1966) A.C. 295
Lord
Reid
said, at p. 317, ``If the asset which is acquired is in its intrinsic nature a capital asset, then any sum paid to aquire it must surely be capital outlay. And I do not see how it could matter that the payment was made by sums paid annually''. Lord
Morris,
at pp. 332-333, emphasized the importance of ``the nature of that for which payment has been made'' and said ``If the nature of what is acquired makes it a capital asset the payment
ATC 4072
for it will be a capital payment''. The present significance of the two most recent decisions of their Lordships to which I will refer,Commr. of I.R. v. Europa Oil (N.Z.) Ltd. 70 ATC 6012 ; (1971) A.C. 760 and
Europa Oil (N.Z.) Ltd. (No.2) v. Commr. of I.R. 76 ATC 6001 ; (1976) 1 W.L.R. 464 is succinctly expressed in a passage from the judgment of Gibbs J. in F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412; (1978) 21 A.L.R. 59 at pp. 67-68. His Honour there said of these two decisions that they ``both proceeded on the basis that it is the advantage which the taxpayer seeks and gains from the outgoing that has to be considered in deciding whether the outgoing is of a revenue or of a capital nature''.
The importance which these recent authorities have placed upon the character of the asset of which the outgoing in question is the purchase price had earlier been emphasized by all that was said by Dixon J. in his celebrated judgment in the Sun Newspapers case, a judgment which, in the B.P. Australia case, at p. 261, Lord Pearce, speaking for their Lordships, described as providing ``A valuable guide to the traveller in these regions''. In Sun Newspapers his Honour spoke of outgoings on capital and on revenue account being respectively matched with, on the one hand, the profit-yielding subject and, on the other, the process of operating that subject so as to derive profits therefrom - at pp. 359-360. His Honour contrasted ``the instrument for earning profits and... the continuous process of its use or employment for that purpose'' - at p. 360. He distinguished between recurrent outlays and those made ``once for all'' and drew attention to the importance of the asset or advantage acquired: if expenditure was incurred to procure an asset or advantage of a lasting character, for ``the enduring benefit of a trade'' that would be on capital account - at p. 361. Recurrence, endurance and continuity were all matters of degree. Recurrence involved the meeting of a continuous demand to be answered out of the returns of a trade, and both it and an advantage's lasting character were but considerations and not determining factors - at p. 362. Then at p. 363 his Honour pointed out, very appositely to the present case, that whether or not payments are recurrent constitutes no sure test, the important question being the true character of the consideration which they represent.
There then follows in his Honour's judgment this celebrated passage, which I quote in full:
``There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.''
Of these three matters the first and second are exclusively concerned with the character of what is received in return for the outgoing. Where, as here, the outgoing in question is the purchase price of an asset the position is relatively straightforward and when what is purchased is that which is intended as the nucleus of the taxpayer's profit-yielding subject the character of the outgoing seems to me to be indicated plainly enough. I have already described the character of the advantage sought in the present case as being unmistakably that of capital. The manner in which that advantage was to be enjoyed likewise bears all the hallmarks of capital, it was to be the nucleus around which might develop a great mining venture by means of which the taxpayer or its nominees might exploit those deposits of iron ore thought to lie in the Temporary Reserves and to which the vendors alone had exclusive, albeit imperfect, rights.
It is true that, if one looks at the substance and not merely at the form of the advantage which the taxpayer acquired, thus looking beyond the formal acquisition of shares, it was not, of course, perpetual in character; but neither was it by any means evanescent. It was of such a substantial duration as suitably to match the needs of the occasion. The activities of any extractive industry are necessarily of a wasting character and, as extractive industry goes, the advantage acquired gave promise, if all went well, as it in fact has done, of substantial duration. In light of what was said by Dixon J. in Sun Newspapers at pp. 362-3 upon this question of the lasting character of an advantage, it is clear that the present case sufficiently satisfies that criterion. In Strick v. Regent Oil Co. Ltd. Lord Wilberforce considered at length this criterion of lasting quality. His Lordship considered, at p. 353, a number of cases, including mining cases, in which advantages of relatively short duration had nevertheless been treated as capital assets, payment for them being, accordingly, outgoings of capital. He concluded that:
``The principle seems to emerge that if, on a
ATC 4073
consideration of the nature of the asset in the context of the trade in question, it is seen to be appropriate to classify it as fixed rather than as circulating capital, the brevity of its life is an irrelevant circumstance.''
So far as concerns the criterion of recurrence, here represented by the indeterminate future periodicity of the deferred payments, what art. 5 of the agreement provided for was a consideration consisting of a purchase price promised once and for all, performance of that promise consisting in part of a lump sum payment and in part by payment at half-yearly intervals thereafter. What would dictate the extent of that performance would be the gradually revealed worth of the advantage which the exercise of the option procured for the taxpayer, a worth which could only be measured by the future yield of iron ore. That future yield would, as time passed, come to reflect, ever more perfectly, the value of the advantage. This was, then, no case of continuing expenditure to meet a continuous demand in the sense referred to by
Rowlatt
J. in
Ounsworth
v.
Vickers Ltd.
(1915) 3 K.B. 267
at p. 273
, the purpose of the expenditure was not such as to bring it within that ``class of things which in the aggregate form the constant demand'' to be met out of the returns of the trade. The relevance of recurrence is for the light it casts upon the advantage obtained; it provides no test and is no more than ``a consideration the weight of which depends upon the nature of the expenditure''
-
per
Dixon
J. in
Sun Newspapers
at p. 362. Where the expenditure is in the nature of a purchase price for a capital asset its recurrent nature is of little significance, as is shown by the judgments in
Colonial Mutual Life Assurance Society Ltd. v. F.C. of T.
(1953) 89 C.L.R. 428. In that case, especially in the judgment of
Fullagar
J., with whose judgment
Kitto
and
Taylor
JJ. agreed, whatever view to the contrary might have been thought to have arisen from the earlier case of
Egerton-Warburton
v.
D.F.C. of T.
(1934) 51 C.L.R. 568
was laid at rest, the latter decision being explained, at p. 459, as confined to its very special facts, the transaction with which it was concerned not being an ordinary business transaction but ``in substance a family settlement'' involving no true price at all. The other two members of the Court,
Williams
A.C.J., at p. 447, and
Webb
J. at p. 449, expressed like views as did
Kitto
J. in the later decision of
Cooper v. F.C. of T.,
at p. 403, and see also
A.J.C. Investment
v.
F.C. of T.
77 ATC 4201
per
Jenkinson
J. at p. 4208.
The means adopted to obtain the advantage, the third of the matters referred to by Dixon J., was here by outright purchase, by the making, in his Honour's words, of ``a final provision or payment so as to secure future use or enjoyment'' and not by any periodical outlay ``to cover its use or enjoyment for periods commensurate with the payment''. To say this is not to ignore the periodical nature of the ``Deferred Payments'' but, rather, to recognize that their periodicity is for purposes of quantification and casts no light either upon what they are paid for or upon their own character. In directing attention, by means of this third consideration, not, as in the first two matters, exclusively to the character of the asset acquired but instead to the mode of payment made, his Honour was ensuring that account would be taken of cases such as he had earlier described, again at p. 363 when he had spoken of ``the fact that rights and advantages of the same duration and nature may be the subject of recurrent payments which are referable to capital expenditure or income expenditure according to the true character of the consideration given, that is, whether on the one hand it is a capitalized sum payable by deferred instalments or on the other hire or rent accruing de die in diem, or at other intervals, for the use of the thing:''. In the present case there was, as already mentioned, no question of the Deferred Payments being by way of ``hire or rent... for the use of the thing''. They were, rather, in the nature of a purchase sum ``payable by deferred instalments'', and payable in that manner because the character of what was acquired made it incapable of ready valuation in any other way.
Thus an application of the considerations which emerge from the judgment of Dixon J. in Sun Newspapers and which have consistently been applied in modern cases of the highest authority points, in my view, quite clearly to these Deferred Payments being in the nature of outgoings of capital. Indeed one passage from his Honour's judgment, at p. 361, is, I think, particularly applicable to these payments: his Honour there said:
``In the attempt, by no means successful, to find some test or standard by the application of which expenditure or outgoings may be referred to capital account or to revenue account the courts have relied to some extent upon the difference between an outlay which is recurrent, repeated or continual and that which is final or made `once for all', and to a still greater extent upon a distinction to be discovered in the nature of the asset or advantage obtained by the outlay. If what is
ATC 4074
commonly understood as a fixed capital asset is acquired the question answers itself. But the distinction goes further. The result or purpose of the expenditure may be to bring into existence or procure some asset or advantage of a lasting character which will enure for the benefit of the organization or system or `profit-earning subject'. It will thus be distinguished from the expenditure which should be recouped by circulating capital or by working capital.''
The Deferred Payments being promised as consideration for the acquisition of Basic's issued capital, which in turn conferred upon the taxpayer advantages for the enduring benefit of its proposed trade, advantages which would form the nucleus of a great mining enterprise, the question ``answers itself'', the payments are outgoings of capital.
The conclusion at which I have arrived has, of course, involved me in placing particular weight upon the fact that the Deferred Payments formed a part of the consideration for the acquisition by the taxpayer of capital assets. I have endeavoured to show why it is that I regard the authorities as requiring me to do so and why, authorities apart, I would regard the character of the advantage gained by an outlay of money as providing the surest guide to the character of that outlay. That in this case the advantage gained, if not viewed as confined simply to the issued capital of Basic, was only of a relatively enduring nature I have taken to be of little weight in the circumstances, again both because of what I regard as the state of authority and because of the very nature of the extractive industry in which the taxpayer sought to establish itself by its exercise of the option. I have regarded as of considerable weight the fact that the transaction here in question was an outright purchase, the deferred payments being both in form and, in my view, in substance no more than the price payable for the advantage gained once and for all by exercise of the option. That the deferred payments depend for their quantum and, indeed, for their very existence, upon the actual extraction of iron ore from the Reserves I regard as a quite neutral fact, to be accounted for by the quite uncertain value of the advantage which was being acquired and not otherwise casting much light upon the character of the outgoings.
In my view the conclusion to which each of the members of the Full Court of Federal Court of Australia came was correct. I would accordingly dismiss this appeal.
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