Federal Commissioner of Taxation v. Ampol Exploration Limited.

Judges: Lockhart J
Beaumont J

Burchett J

Court:
Full Federal Court

Judgment date: Judgment handed down 27 November 1986.

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Burchett J.

I have had the advantage of reading in draft the judgment of Lockhart J. It is unnecessary for me to duplicate his statement of the facts, but I shall state my own reasons for agreeing with his conclusions.

The difficulty of cases concerned with the question of whether an outgoing is of capital or of a capital nature or whether it is a revenue outgoing is not a difficulty of comprehension of the principle involved, but of its application to the infinite variety of business circumstances. As Dixon J. pointed out in
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634 at p. 646 :

``The truth is that, in excluding as deductions losses and outgoings of capital or of a capital nature, the income tax law took for its purposes a very general conception of accountancy, perhaps of economics, and left the particular application to be worked out, a thing which it thus became the business of the courts of law to do.''

In
Heather v. P.E. Consulting Group Ltd. (1973) 1 Ch. 189 at p. 216 Lord Denning M.R. said of the distinction between revenue and capital expenditure:

``In many cases the answer is easy, but in others it is difficult. The difficulty arises because of the nature of the question. It assumes that all expenditure can be put correctly into one category or the other. But this is simply not possible. Some cases lie on the border between the two, and this border is not a line clearly marked out. It is a blurred and undefined area in which anyone can get lost. Different minds may come to different conclusions with equal propriety. It is like the border between day and night, or between red and orange. Everyone can tell the difference except in the marginal cases, and then everyone is in doubt.''

In the search for the elusive borderline between the business entity, structure or organisation, set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the Courts have been able to offer only the guidance of fairly broad considerations. In the well-known passage in
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 363 Dixon J. said:

``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.''

Each of these three considerations relates to ``the advantage sought''. In the present case, the nature of that advantage is more clearly seen when it is appreciated just what was the relevant business being conducted by the respondent which sought it. The respondent was, at all events so far as concerns that portion of its business which included its activities in China, carrying on business as an oil exploration company. It was not in that respect establishing or extending the production of oil from a proven field. There was no more than the merest possibility that it would ever be doing so.

In Hallstroms Pty. Ltd. v. F.C. of T. (supra, at p. 647) Dixon J. referred to:

``the general consideration that the contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.''

An attempt to apply directly this general statement to the case of an Australian

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ATC 4882

exploration company sharing in the cost of seismic exploration activity in the South China Sea immediately emphasises the necessity to define the means of production or the enterprise the subject of the enquiry. For the dichotomy propounded by Dixon J. assigns the expenditure either to the acquisition of the means of production, or to the use of them; either to establishment or extension of a business organisation, or to carrying it on; either to its implements, or to their employment; either to an enterprise itself, or to the sustained effort of those engaged in it. These concepts are easily applied to (and naturally fit) expenses in connection with the setting up or operation of a factory, but the comparison they require seems less appropriate for a series of exploration activities which may go on for years without the establishment of any productive field at all. Certainly an expense cannot be assigned to capital or revenue account according as it may be successful:
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1958-1959) 101 C.L.R. 30 at p. 49 . But the comparison Dixon J. makes at least assumes it is not such as in itself to be likely to be thrown away; yet most of the activities of an oil exploration company involve expenditure of that kind.

It seems to me the test can only be sensibly applied, in such a case as the present, on the basis that, the enterprise being the exploration company itself, the relevant business organisation, implement, or means of production, is its exploration arm (including all its skilled employees and sophisticated equipment), and not any one project undertaken by that arm. A project is a part of the regular performance and sustained effort being carried on by the enterprise, all the activities of which are directed to the finding and commercial exploitation of undiscovered oil. But once the matter is so regarded, there is no longer any question: the expenditure is a quite ordinary incident of the company's operations.

An oil exploration company does not expend its moneys upon, for example, seismic surveys, with any expectation of obtaining thereby an enduring asset, but upon the basis that if it engages in efforts of that kind often enough, whilst exercising what judgment the nature of the pursuit permits, one of its outlays may eventually yield a rich return. The whole operation is in marked contrast to such a case as the Hallstrom case where the expenditure, though the result might be seen as doubtful, aimed at a particular business expansion (the manufacture of a product free of restraint by a patent). It is only in a sense akin to that intended by the poet when he wrote that a man's reach should exceed his grasp that the respondent reached for an interest in oil in the South China Sea, and only in heaven could the result be predicted. On the other hand, the pursuit of many such projects offered a reasonable prospect of profit from one or some of them, and this was the company's business. From a practical and business point of view, the outlay was calculated to carry that business purpose into effect. Unlike the payment made in the Hallstrom case, the particular expenditure was not so much aimed at changing ``the character and organization of the profit-earning business'' of the company as it was ``an incident in the operations by which (the business) is carried on'' (see the Hallstrom case at p. 648).

To see expenditure of this kind as such an incident is not a novelty peculiar to the present appeal. In the report of the Taxation Review Committee (the Asprey Report) presented 31 January 1975 at pp. 293-294 it is stated:

``The Committee favours the approach that would make all exploration and prospecting expenditure immediately deductible against assessable income derived from any source. The availability of a deduction upon the lines suggested would constitute an acknowledgement that exploration expenditure is a normal operating expense of a mining enterprise and should be treated as such.''

(Emphasis added.)

It hardly needs to be said that a recommendation that a deduction should be specifically allowed is not at all inconsistent with the proposition that in many cases it may already be strictly allowable:
Ashfield Municipal Council v. Joyce (1978) A.C. 122 at p. 137 ; cf.
Corporate Affairs Commission (S.A.) and Anor v. Australian Central Credit Union (1985) 61 A.L.R. 236 at p. 242 .

Authority supports the proposition that the fact that the expenditure obtained for the respondent no tangible asset or advantage of an enduring kind is a consideration against its being on capital account. The true view is that it is not determinative, but it does point in that direction. In John Fairfax & Sons Pty. Ltd. v.

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ATC 4883

F.C. of T. (supra) at pp. 54-55 Menzies J. quoted the familiar observation of Viscount Cave L.C. in
British Insulated and Helsby Cables Limited v. Atherton (1926) A.C. 205 , and added at p. 55 :

``There can be no doubt that when the question is whether a payment is of a capital nature or not it is an important circumstance that it has or has not increased the taxpayer's assets but this has not been accepted as an infallible test...''

In the South African case
Palabora Mining Co. Ltd. v. Secretary for Inland Revenue (1973) 35 S.A.T.C. 159 at p. 173 Ogilvie Thompson C.J., speaking for the Supreme Court of South Africa, said:

``Nor is the circumstance that expenditure has neither created a new asset nor made any addition to an existing asset necessarily conclusive in favour of such expenditure being on revenue account.... Nevertheless, if no asset has been acquired as a result of the expenditure, that is always a relevant factor.''

The absence of the establishment of a tangible asset is a factor which is often in the cases taken into account in connection with the fact that expenditure forms part and parcel of an enterprise's ongoing and recurring activities directed to the earning of its income. In
BP Australia Ltd. v. F.C. of T. (1964) 110 C.L.R. 387 at p. 410 Dixon C.J. said:

``There appears to me to be no specific expenditure in increasing its plant, machinery or any other element in the profit-earning instrument under its control.''

He was speaking of payments by an oil company, to the proprietors of certain service stations, to obtain restrictive agreements limiting them to the sale of its petrol. At p. 415 Kitto J. referred to the expenditure as ``a regular feature of (the company's) selling activities'', and continued:

``How then should the advantage be described for which the appellant made the expenditure we have here to characterize? In the view I take of the case, the advantage was not the acquisition of a new market, not a new framework within which to carry on trade for the future, not an extension of the appellant's selling organization to include a regiment of resellers. It was not such an exclusion of competition as adds to goodwill a negative right and thus increase the value of goodwill. It consisted simply of the practical assurance of receiving bundles of orders for motor spirit, the circumstances being such that for the foreseeable future it would be only by getting similar bundles of orders that such a trade as the appellant's could be carried on.''

In the companion case
Vacuum Oil Co. Pty. Ltd. v. F.C. of T. (1964) 110 C.L.R. 419 at p. 434 Dixon C.J. said:

``It appears to me clearly expenditure incurred in the process of marketing the commodity and to be expenditure which is not made once for all but is likely to be repeated, and not to be sufficiently identified as outside the ordinary conduct of business.''

Kitto J., at p. 435, referred to the payments as ``part of the process of getting the business - of selling the goods... ''.

When the BP case went to the Privy Council the views of Dixon C.J. and Kitto J. prevailed: BP Australia Ltd. v. F.C. of T. (1966) A.C. 224. At p. 266 the advice of the Privy Council, delivered by Lord Pearce, refers to the payments as ``part of the constant demand which must be answered out of the returns of the trade''. At p. 270 he said:

``It is of commercial importance that profits should not be inflated for tax purposes by the artificial withdrawal from the profit and loss account of expenditure directly incurred in earning them unless it is of a truly capital nature.''

The Privy Council applied the well-known passage I have quoted from the judgment of Dixon J. in the Sun Newspapers case (supra) together with the further passage (at p. 362) where Dixon J. said:

``the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely.''

(With this may be compared the conclusion of Cross J. in
Cooper (Inspector of Taxes) v. Rhymney Breweries Ltd. (1965) 1 W.L.R. 1378

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ATC 4884

at p. 1385 .) Reference was also made to what Viscount Radcliffe said in
Commr of Taxes v. Nchanga Consolidated Copper Mines Ltd. (1964) A.C. 948 at p. 960 :

``Again, courts have stressed the importance of observing a 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 or fruit and the cost of earning that income itself or performing the income-earning operations.''

Viscount Radcliffe's statement was relied on in the joint judgment of Kitto, Taylor and Menzies JJ. in
Foley Bros Pty. Ltd. v. F.C. of T. (1965) 13 A.T.D. 562 at p. 563 where they said:

``The true contrast is between altering the framework within which income-producing activities are for the future to be carried on and taking a step as part of those activities within the framework.''

In my view, the relevant business of the respondent was the discovery and exploitation of oil, to which the seismic survey expenses were incidental. Their purpose was not to enlarge the framework within which that activity was carried on; they formed part of the activity. They were within the wide class of things forming the constant demand upon the enterprise of which Dixon J. spoke in the Sun Newspapers case . The advantage sought by the expenditure was the opportunity to pursue in China exploration of the kind normally pursued by the company in and near Australia, with a view to the rewards the exploration might bring, including such a fee as that in respect of which ultimately a minimum was fixed, though sec. 51 does not require that an anticipated reward be of so direct a nature:
F.C. of T. v. Total Holdings (Australia) Pty. Limited 79 ATC 4279 at p. 4286; (1979) 24 A.L.R. 401 at p. 410 . The manner in which that advantage was to be used was simply as part of the constantly recurring investigations of prospectively oil bearing areas which formed the subject matter of the company's principal activity. The means adopted to obtain that advantage may not, perhaps, in this case be thought particularly significant either way; but it was acquired under participation agreements not in point of principle different from agreements commonly entered into in order to facilitate the carrying out of exploration work in pursuit of gain by oil exploration enterprises.

Having regard both to my understanding of how the general distinction the law requires to be made ought to be applied to the particular circumstances of the activity in question, and also to the three considerations formulated by Dixon J. to assist in the application of that general distinction, I have concluded that the expenditure fell within both limbs of sec. 51, and was not of capital or of a capital nature.

The appellant submitted that, if his arguments otherwise failed, sec. 260 struck down, as against him, the provision in the deed of assignment by which, in certain events, the respondent was to earn a fee. I agree with Lockhart J. and Rogers J. (in the Supreme Court) that the transaction is explicable by reference to ordinary business dealing. But in any case, on the view which I take, it could not be said that it had the purpose or effect of altering the incidence of any income tax, or of achieving any of the other things mentioned in the section. The circumstances of this case do not require me to consider the distinction drawn by Lord Templeman in
Commr of I.R. v. Challenge Corporation Ltd. (1986) 8 NZTC 5219 at p. 5225 between tax mitigation and tax avoidance - in my opinion the assignment had no relevant effect upon the deductibility of the expenses in question in this appeal.

It should perhaps be mentioned that, in his argument in the Supreme Court, senior counsel for the Commissioner referred to sec. 23(q) and suggested that the outgoings were not incurred in gaining assessable income, or for the purpose of gaining assessable income, since any Chinese sourced income might not have been exempt from income tax in China. But it was pointed out that there was in fact no applicable Chinese income tax, at all events at any relevant time, and no such contention was raised upon the appeal to this Court.

I agree with the orders proposed by Lockhart J.

THE COURT ORDERS THAT:

1. The appeal be dismissed.

2. The cross-appeal be allowed.

3. The assessment be remitted to the Commissioner for Taxation to be amended by allowing the deduction to Ampol Exploration

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ATC 4885

Limited of $3,475,339.71 as claimed by it in its return of income for the year ended 30 September 1980 and reducing its assessable income accordingly.

4. The Commissioner of Taxation pay the costs of Ampol Exploration Limited of the appeal and cross-appeal to this Court and of the appeal to the Supreme Court of New South Wales.