E.A. Marr & Sons (Sales) Limited v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
The taxpayer, formerly called E.A. Marr Industries Limited, appeals against assessments to income tax in respect of the years ended 30th June 1975, 1976 and 1977. The appeals do not pose challenges to the amounts assessed as income or allowed as losses or outgoings for the years in question. All the appeals turn on the single question whether certain payments made during the year ended 30th June 1972 constitute losses and outgoings within the meaning of the Act and therefore could be brought forward to reduce the taxpayer's assessable income in subsequent years. It is now agreed that the amount in question expended in the manner claimed in the year ended 30th June 1972 was $396,289.
All the three appeals were by consent held together. I must say that the appeals were marked by a paucity of evidence and it has been necessary to leave a great deal to inferences and deductions. This seemed to me to be a wholly unnecessary burden to thrust on the Court. No explanation has been provided for the absence of those whose evidence might have been expected to throw light on the matters in dispute.
It is necessary to describe in a little detail both the taxpayer's position in a group of companies, its activities and the nature of the expenditures in question before the submissions of the parties can be evaluated. The taxpayer was incorporated in 1948. In 1960 McDonald Industries Limited a publicly listed company, acquired almost all of the issued shares of the taxpayer, and subsequently the outstanding issued shares were also acquired by the same company. In 1960 the taxpayer had a number of wholly or almost wholly-owned subsidiaries: E.A. Marr & Sons Pty. Limited; E.A. Marr Contracting Pty. Limited; Sovereign Industries Pty. Limited; Basco Gate & Fence Pty. Limited; Emar Engineering Services Pty. Limited; Charles J. Duncan Pty. Limited; and Marr Manufacturing Pty. Limited.
In 1964 the taxpayer executed a deed of equitable mortgage over its assets and undertaking in favour of the Commercial Banking Company of Sydney Limited. On 18th March 1971 the bank exercised its powers under the charge and appointed Messrs. Hamilton and Ferrier as receivers
ATC 4656and managers of the taxpayer. On 27th September 1971 a winding up order was made against the taxpayer and Messrs. Hamilton and Ferrier were appointed liquidators. On 30th October 1972 the liquidation was perpetually stayed and on 11th December 1972 Messrs. Hamilton and Ferrier retired as receivers and managers. At the same time as the bank appointed Messrs. Hamilton and Ferrier as receivers and managers of the taxpayer, they were also appointed in the same capacity to all the subsidiary companies of the taxpayer. Similarly, all the subsidiaries, other than E.A. Marr & Sons Pty. Limited were put into liquidation in 1972 or 1973 and were wound up.
From about 1968 the companies in the McDonald Industries Group were organised into a construction group, a mining group and a machinery and plant group. The taxpayer and all its subsidiaries were in the machinery and plant group.
It is important that I set out para. 7 of the affidavit of Mr. Devane, who at all relevant times was the group accountant for the relevant group of companies within the McDonald Industries Group. In that paragraph he sets out the activities of the taxpayer until the date of appointment of the receivers. He says:
``Since prior to 1968 and at least up until 18th March 1971 the taxpayer's principal activities were: -
- (i) holding shares in its subsidiary companies;
- (ii) owning and making available for use by its subsidiaries most of the land and buildings used by its subsidiaries in their respective trading operations;
- (iii) providing management and administration services for its subsidiaries, including undertaking management, accounting and some of the day-to-day accounting for its subsidiaries and making available to its subsidiaries technical staff from within the Marr Group of companies or from outside the Marr Group of companies;
- (iv) hiring and thereafter owning plant and equipment, most of which was hired out by the taxpayer to Frances Creek Mining Corporation Pty. Limited, a company which owned and operated an iron ore mine at Frances Creek in the Northern Territory;
- (v) acquiring by way of lease, plant and equipment from finance companies, which the taxpayer made available to its subsidiaries and other companies for use in their respective operations and activities or for sub-hiring or under-leasing by those subsidiaries or other companies.''
Both in oral evidence and in his affidavit Mr. Devane described the work done by officers of the taxpayer in determining whether plant and equipment should be acquired for members of the group, either by purchase or lease. Upon a request for a particular item of plant being made by an officer, the request was evaluated by the plant manager and a recommendation made. A discounted cash flow for the different possible methods of acquisition (that is, possible lease, hire purchase, or outright purchase) was worked out, and a report made to the financial controller of the group as a whole. After he considered the matter the proposal was submitted to the board of the taxpayer for adoption.
In the result, a substantial number of items of plant was acquired prior to the date of employment of the receivers by the taxpayer, either by outright purchase or by lease. Mr. Devane said in para. 9 of his affidavit:
``Most plant taken on lease for use by a corporate member of the Marr Group of companies was taken on lease by and in the name of the taxpayer because, so it appeared to me, the leasing companies wanted the security of the lessee which to their knowledge owned substantial assets and in particular real estate, and also it was administratively convenient and saved book-keeping costs to have one company in the group alone as the lessee of most of the plant leased by the group.''
Having regard to how leased plant was actually dealt with, I am rather surprised at the statement made by Mr. Devane, but he was not cross-examined on it.
In the course of 1970 the taxpayer entered into lease agreements with a number of finance companies in respect of the items of
ATC 4657equipment, payment in respect of which constitutes the loss or outgoing claimed. The lease agreements were not uniform in their verbiage, and in particular, only some of them called for the payment of the total rent for the period of the lease, whilst others provided merely for a monthly payment of rental. As is usual in the case of those that called for payment of the total rent, an opportunity was afforded to the lessee to pay by monthly instalments, with a provision for making the whole of the amount due and payable upon the occurrence of default in any one payment.
It was what happened after the execution of the lease agreement that founded the argument in the present appeals. As Mr. Devane explained in his affidavit, the first payment of rent to the lessor, and sometimes also the second, was customarily recovered the amount of the rent payment or payments by invoicing the subsidiary which actually had the use of the plant and equipment. In all instances except one, the subsidiary was Emar Engineering Services Pty. Limited. That company either used the plant itself in its own business operations or hired it out at a profit. The one exception was an item of a coping lathe, which was leased too late in the corporate history of the group to be made use in the manner contemplated, and was apparently never used.
Not only did Emar Engineering Services Pty. Limited refund to the taxpayer the rental payment or payments it made, but it continued, until default, to make the payments due under the lease agreements. These were made direct to the finance company by means of banker's orders. Mr. Devane said that this method was followed ``In order to save paperwork and book entries and the resulting expense''. (Paragraph 12(a) of the affidavit.) This statement again was not cross-examined on.
In the result, in the period prior to the appointment of receivers in the taxpayer's return there was no deduction claimed in respect of rental payments incurred in respect of the plant and equipment in question, nor yet was any income shown from the use of the machines. It was left entirely to Emar and the hirer from it, usually Surveys & Mining Pty. Limited, to utilise the plant and equipment in such way as was appropriate.
It is appropriate that I mention that although the equipment actually owned by the taxpayer was hired to subsidiaries and others within the overall group for substantial sums of money, the actual receipt was designed to merely equal the depreciation available to the taxpayer. The matter was adverted to in the cross-examination of Mr. Devane where senior counsel for the Commissioner asked:
``Q. Then there was some review at the end of the year and some rebate paid? A. The rebate wasn't paid to Frances Creek Iron Mining. There was a review of the accounts and the favourite way of doing it was reducing the account called Mine Plant Management by journal entry and crediting various subsidiaries for rebate of plant hire and things like that.
Q. And in fact for the year ended 30th June 1970 the figure shown for Mine Plant Management of $16,000-odd changes sides precisely with the depreciation figure claimed for that year, does it not, in respect of plant? A. I would need to look at it, but it was something - a very similar figure.''
The same situation obtained in respect of the year ended 30th June 1971.
Mr. Devane told senior counsel for the taxpayer that it was hoped that a profit would be derived from the operations of Emar in the form of dividends. However, as Mr. Devane rightly pointed out that was a question of policy for the directors, and even with respect to the review of hiring fees, he disclaimed any participation, saying that he was merely ``the manager'' (p. 17).
After the appointment of the receivers, in respect of some of the items of plant and equipment in question hiring fees were charged, in some cases to subsidiaries, in some cases to third parties. Exhibit Q sets out the amounts thus realised. However, nothing was sought to be made in the argument of the fact that after the appointment of the receivers, income was derived from some of the leased equipment, and accordingly it is unnecessary to refer to this point further.
At the time of the appointment of the receivers there were defaults in respect of
ATC 4658some if not all of the rental agreements, and it was necessary for the receivers to determine what to do about the continuing liability under the leases. It was agreed between the lessor companies and the receivers that the latter should sell the items in question. In answer to some questions put to him by me, the following information was supplied by Mr. Ferrier, one of the receivers (p. 6):
``Q. But am I right in thinking that none of the lease agreements made any provision for the sale by the lessee? That was just an agreement you made with the leasing company in each case? A. That's correct, your Honour.
Q. But call it the deal, it was that you would pay over to them the full amount of the proceeds of sale? A. Yes.
Q. Was there then some arrangement struck as to what deductions or appropriations should be made from that? A. There would not have been a deal at the contemporaneous point. They would have lodged the proof of debt in the winding up and that proof of debt I think would be claimed in a manner similar to that schedule, because the actual amount claimed is that net deficiency figure, which does represent the difference between the sale proceeds, the arrears of payment and the future payments, plus residual values. In some cases there was a notional rebate of future interest.''
In other words, there was worked out the entitlement of the lessor in respect of arrears of rental, future rentals, with perhaps some rebate in some cases, and the residual value which was payable under the agreements. Credit was taken for the proceeds of sale paid to the finance company and the balance was then the deficiency in respect of which proofs of debt were lodged by the lessors, payment made by the receivers, which constitute the amount here in question.
In this setting, then, it was contended by the taxpayer that it was entitled to deduct the amounts in question from its assessable income for the year ended 30th June 1972 by reason of the provisions of sec. 51 of the Income Tax Assessment Act and carry forward the losses thus arising in subsequent years of income. It was contended that the amounts in question were losses and outgoings necessarily incurred in carrying on business for the purpose of gaining or producing assessable income, and therefore allowable deductions.
The Commissioner contested the taxpayer's claim in each particular ingredient. It was firstly submitted that there was no relevant business carried on. In my view, there is no substance in that submission. It must be recognised that there may be transactions carried on by a taxpayer otherwise engaged in business, which fall outside the income producing business. However, that will be relatively rare. An example has been given by Menzies J. in
Investment and Merchant Finance Corporation Limited v. F.C. of T. 71 ATC 4140; (1971) 125 C.L.R. 249. His Honour instanced a company which buys and sells land and which might buy a building to occupy as its principal office. The purchase price so paid, his Honour said, would be an outgoing of a capital nature. However, in my opinion it is inappropriate to exclude the rental of the plant and equipment here in question merely by reason of the way it was dealt with. It is true that the taxpayer merely lent its name, as the lessee, in order to procure the plant and equipment and pass it on for use by other members of the group. However, this was done in a context where the taxpayer was the vehicle for the acquisition and distribution of plant and equipment within the group. It is for this reason that I though the statement in para. 9 of Mr. Devane's affidavit, to which I have already adverted, a matter of importance. It is inappropriate in my view to seek to exclude from the activity of provision of plant for members of the group the provision of the leased machinery, whilst acknowledging, as the respondent must, that the taxpayer was carrying on the business of making available to members of the group and others machinery which was the subject of an outright purchase.
It was next submitted on behalf of the respondent that even if the activity in question constituted the carrying on of a business, that business was not carried on for the purpose of gaining or producing assessable income. This argument founds on
ATC 4659the facts that no income was in fact derived, no fee was charged for procuring the lease, the plant and equipment was not utilised by the taxpayer, and it was quite obvious that money derived from the use of the plant was going to go to that member of the group which would incur the least liability for tax by reason of the receipt of money. It was in this context that the way that the hiring charges or mine management fees for equipment owned by the taxpayer was dealt with was emphasised by counsel for the respondent.
Counsel also emphasised - and rightly so - that no one was called by the taxpayer to give evidence as to the dividend policy of the board of directors and, payment of dividends being a matter of policy, Mr. Devane's evidence on this point could not assist the taxpayer.
The matters to which the submissions draw attention carry great weight. Once again, this is an area in which the taxpayer could have done more to adduce evidence. Nonetheless, in my opinion, the transactions in question here were of a trading character and there is a commercial explanation for the taxpayer entering into the transaction which has given rise to the liability and therefore to the loss and outgoings. The purpose of entering into a transaction was to carry on the business of the taxpayer, and the taxpayer being engaged in commerce sufficiently connects the transaction with the statutory purpose.
As an alternative, it was submitted on behalf of the Commissioner that the outgoings here in question arose from the agreement made between Mr. Ferrier and the lessors, enabling the sale of the equipment. In my opinion that submission also should be rejected. The receivers were faced with the situation where there was liability on the part of the taxpayer under the leases in question. All that the receivers have done was to crystallise that liability in a way which yielded the best advantage to the taxpayer. Merely because Mr. Ferrier entered into the agreements with the lessors, the payments he thereafter made did not lose their character as payments made pursuant to the liabilities incurred by the taxpayer under the lease agreements in question.
It was finally submitted on behalf of the Commissioner that the payments here in question were payments of capital. With great deference to counsel that argument has no substance. It was merely an assessment of the amount payable by way of rental under the lease in circumstances of default.
In those circumstances, the appeals will be allowed and the assessments remitted to the Commissioner for re-assessment in accordance with this judgment. The respondent will pay the appellants costs. Exhibits will be retained for twenty-eight days, and if no notice of appeal is lodged within that time they may be dealt with in accordance with the Rules of Court.