Case U98
Members:Purvis J
Tribunal:
Administrative Appeals Tribunal
Purvis J. (Presidential Member)
This review concerns the assessability or otherwise of the profit arising on the sale of computer (word processor) machines which had at one time been leased to customers and were then for one reason or another sold to such customer or others. The taxpayer also, as part of its business, sold computer equipment to customers, such equipment not having been previously subject to a lease. The original intent of the taxpayer company in the subject case was to lease the machines with only the possibility that during the currency of the lease the lessee would wish to buy outright and cancel the lease agreement, or alternatively, that during the currency of the lease it would be terminated, or at its termination another would buy the machine.
In the instant matter the lessees in some cases did so decide and purchased the computer equipment. In other cases, for reasons set forth later in these reasons, the taxpayer resolved to realise on its lease agreement and enable the lessee or another to buy out the same or factor the agreement. In each case the end result was manifested in a final disposition of the machine so far as the taxpayer was concerned. A profit to the taxpayer resulted. It is this profit that has been brought to tax, whether as a consequence of outright sale to a customer or finance company or as the consequence of a factoring arrangement.
The relevant years are the year ended 30 June 1977, year ended 30 June 1978, year ended 30 June 1979 and year ended 30 June 1983, or more precisely the substituted accounting periods, that is, the year ended 31 December 1976, year ended 31 December 1977, year ended 31 December 1978 and year ended 24 December 1982.
In the 1977, 1978 and 1982 financial years the company returned a trading profit from its activities. In respect of the year ended 31 December 1976 the company was to carry forward a loss.
The taxpayer was, and still is, the subsidiary of a United States parent company, the latter manufacturing and/or distributing computer hardware and software. The relevant equipment was supplied by the parent company on order from the taxpayer and shipped to Australia accordingly. It was usual for the purchaser from the taxpayer or lessee from the taxpayer of the equipment to have an ongoing relationship with the supplier to it of the goods,
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that is, the taxpayer company. The equipment supplied either by sale or lease was as specified and indeed an order was not placed by the taxpayer with the parent company until and unless a sight inspection had been carried out and the requirements of the customer obtained. The equipment was configured to the express needs of the user, whether the latter was to be a lessee or an immediate purchaser.The decision as to whether the machine was obtained by sale or lease was for the customer not the taxpayer company.
In the event of a lease being entered into the same was by way of a chattel lease without an explicit or express understanding as to purchase. There was not a residual value specified and the lease could continue year by year with the option in the lessee to terminate the same on three months' notice at any time. The form of lease rental agreement, or equipment rental agreement did vary over the years the subject of review, but not to an extent sufficient to derogate from the above general description.
On termination of a period of lease by effluxion of time or notice, the machine on return to the taxpayer company was sold or scrapped, the same depending on its estimated value or possible future use. Some sales at this point in time were made at a loss, some at a profit.
In the subject case in 1978 the parent company was said to be experiencing a liquidity problem. It instructed its Australian subsidiary to raise money. The Australian company factored a measurable proportion of its leased machines to a finance company, thereby giving ownership to such finance company. The sale was made but notice of such sale was not given to the lessee. Payments under the lease agreement continued to be made by the lessee to the taxpayer company and then remitted to the finance company. Also in 1978, and more especially in the other years the subject of review, machines were sold outright to previous lessee users or financiers who entered into lease agreements with end users.
It was said by the taxpayer that the profits arising upon the sale of the leased equipment by way of sale to a lessee or to a finance company were abnormal and not by way of revenue, they arising in some cases as a consequence of the taxpayer and its parent being in need of funding and in other instances from sales of leased equipment falling outside of a factoring arrangement and not being consistent with the ordinary course of business of the taxpayer. It was said that the surplus or profit on sale was not a part of the assessable income of the taxpayer.
The amounts the subject of dispute in the respective years are as follows:
$
Year ended 31 December 1976
(Year of income ended
30 June 1977) 145,723
Year ended 31 December 1977
(Year of income ended
30 June 1978) 120,032
Year ended 31 December 1978
(Year of income ended
30 June 1979) 129,273
Year ended 24 December 1982
(Year of income ended
30 June 1983) 51,752
The sales not manifesting themselves in a factoring arrangement were to end users or other financiers who, for purposes best known to themselves, wanted to acquire ownership of the machines.
The taxpayer company as aforesaid, claims that for each of the respective years the profits so arising as above detailed, were of a capital nature.
The amending legislation of 1984 caused sec. 26(a) to no longer form part of the Income Tax Assessment Act. Section 25A was to serve the same or an expanded purpose.
As the Act read, at relevant times, sec. 26(a) provided:
"The assessable income of a taxpayer shall include -
- (a) profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale, or from the carrying on or carrying out of any profit-making, undertaking or scheme."
The Commissioner contends that the profits the subject of this review, should be brought to tax under sec. 25(1) of the Act, sec. 26(a) of the Act as it then was, or sec. 26AAA.
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The taxpayer's business and treatment of the relevant transactions
The financial controller and management accountant of the taxpayer company gave evidence. He said that in 1976 when he joined the staff of the taxpayer its financial position was not healthy. A loss had been incurred for the 1975 financial year. He experienced difficulty in establishing appropriate records of lease equipment and the terms of any lease.
By 1976 the supply of mainframe computers and computer peripheral equipment was the mainstay of the taxpayer's business but the same was always consequent on a site inspection or survey. At this time, it was said, the company determined to increase its "lease base" in order to provide a regular flow of income sufficient to absorb concurrent costs. A "linear profit" was sought to be achieved.
The equipment provided to the taxpayer company by way of import from its parent company was manufactured in the United States of America or Japan. A warehouse was maintained in a Sydney suburb where there was in stock all items of equipment and computer parts. Some "off-shelf" sales occurred and visual display of hard copy and printers took place. Other equipment to be configured to a site requiring cabling and technical features was not so displayed.
On a client ordering equipment, the same to be by way of lease or sale, the taxpayer company caused an inspection to be conducted. A record known as a "machine feature index" was then compiled and maintained. What was here entailed was modification so as to render a particular piece of equipment suitable to a customer's desired location.
An equipment order form was then filled out and remitted to the parent supplier. An acknowledgement was received. The parent company had then to configure a machine consistent with the order. On completion of the work a serial number was telexed to the taxpayer company.
It was said, on behalf of the taxpayer, that an order would not be placed on the parent until and unless it was known in Australia as to whether the transaction was to be by sale or by lease. On delivery to the taxpayer the machine was recorded on a stock card maintained by it, the information on the latter being used for the purpose of stock checks and financial records. Subsequent entries were passed through the taxpayer company's books of account. A record of the "lease base" was maintained. The accounting documents identified and tendered at the hearing of the review were consistent with the above. A shipping journal ensured that imported goods were noted as inventory for each category of machine.
When a machine was leased the value of the item was transferred from the inventory account to the "lease base", although this entry was at the request of the parent company, not to be perfected unless and until the machine had been installed. The taxpayer was, or should have been aware as to whether the transaction was by way of lease or sale on the occasion of importation.
In the event of a lease, the average term was for a period of two years; it could have been for four years. There was not an express or implied agreement for purchase, nor was there a stipulation as to a residual value. In a form of lease rental agreement tendered in evidence as being typical of those used in the relevant period it was stated as a term and condition of the lease that "the equipment shall at all times remain the property of lessor and lessee hereby acknowledges that no option, promise or representation expressed or implied, written or oral has been made by, or on behalf of lessor to lessee, that the equipment may be purchased from lessor by lessee or any nominee or lessee at any time during the term of this lease or upon or after expiry thereof. Lessee shall have no right title or interest in the equipment except as bailee".
Agreements were referred to as a "lease rental agreement" and "equipment rental agreement".
The taxpayer company did sell computer equipment. The equipment so sold was of the same or a similar description to the equipment that was leased. It would seem that both as to equipment sold and equipment leased, the customer entered into a maintenance agreement with the taxpayer company. The obligation on the part of the taxpayer to maintain the equipment was pursuant to an express written agreement or a term contained in the lease rental agreement to the effect that the taxpayer would maintain the equipment "in accordance with the terms and conditions of its standard
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maintenance agreement in force from time to time".In the case of a lease rental agreement and on its termination, there would usually be an upgrading by the customer in the equipment or the lessee would turn to another supplier. It was more usual, according to the taxpayer, for the customer to upgrade to larger equipment.
In the event of a lease being terminated, either by effluxion of time, or during the currency of a lease, the equipment remained on the taxpayer company's books as "equipment on lease" and remained so described in its books of account whether reinstalled or not. The equipment, it was said, was only written out of the lease base "equipment on lease" account when scrapped or sold. In the event of a piece of equipment being returned, needless to say attempts were made to re-lease or sell the same, otherwise it was scrapped.
The average life of a machine was five years. There were occasions when a customer would request that a lease be terminated during its currency, in which event an "equipment termination agreement" was executed. The billing of the customer would then be stopped and the taxpayer's engineers would disconnect the equipment.
When equipment was leased, especially in the years between 1976 and 1982, it was said by the taxpayer that the company considered that the same would remain so leased during its currency. There was a possibility of a sale "but it was only that". The taxpayer company, especially in the earlier year, did not discourage leasing "it wanted to maintain a profit/cash flow in contradistinction to an irregular profit arising from outright sales". It was said on behalf of the taxpayer that the intention of changing from outright sales to lease was to achieve a "linear base".
In 1978 the United States parent company was seemingly experiencing some liquidity problem and, in aid of righting this situation, requested its subsidiaries and associated companies, including the taxpayer, to liquidate stock and lease agreements. There were instructions issued "to generate cash as quickly as possible". The taxpayer sold lease agreements, that is, factored the lease contracts to a finance company. The price at which the sales were effected was computed by arriving at the present value of the unpaid rental as at the date of sale, that is 20 June 1978. It is not clear from the evidence as to whether a residual value also played a part in the calculation. Title to the equipment passed to the finance company. Notice was not given to the lessee of the sale and the rent due under the lease agreement continued to be received by the taxpayer who remitted the same to the finance company.
It was conceded at the hearing that the above transactions could well have resulted in the equipment being sold at under market value; this, it was said, was the most effective method of liquidating the stock at the time and was "the only way of getting money in".
There were other sales of leased equipment. It was only sales generated by the taxpayer that went to the above-mentioned particular finance company. Sales as generated by customers were treated differently. In some of the latter cases customers or finance companies purchased the machinery, this at the market price at the time. Some "buy back" was at a loss, some at a profit.
It is nevertheless the sales to customer lessees, sales to the particular finance company and sales to other finance companies that are the subject of this review. A distinction is not significantly drawn by the taxpayer or the Commissioner between such forms of sale.
It is fair to say that the majority of sales to lessee customers in 1977, 1978 and 1982 were at or near to the market value of the machinery at the time. Other than sales to the particular finance company, negotiations that took place resulted in a price being arrived at comparable to that obtainable in the market, that is, "what a customer was prepared to pay". If, it was said on behalf of the taxpayer, a customer was not prepared so to pay, then no sale. As to sales to the finance company, the sale price was based on the present value of the lease. As to sales to existing lessees or their financier, the sale price was the market value.
As appears from the income tax returns the subject of the review, and the accounts of the taxpayer company scheduled to such returns, the moneys realised from selling the lease agreements and paid to the United States parent company resulted in a reduction of the indebtedness of the subsidiary to its parent between 1977 and 1978 of nearly $2,000,000. However, between 1978 and 1979 the position
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was reversed and the amount owing to the parent holding company had increased by nearly $3,000,000 over the 1978 figure.It is apparent, however, from the half-yearly accounts that by the end of the relevant financial year the indebtedness of the Australian subsidiary to its holding company was much as it was prior to this alleged forced liquidation of stock and lease agreements. The Australian subsidiary was not in this sense, adversely affected by the remission of the moneys to the United States holding company.
By 1982 it was alleged the rise in interest rates had made leasing other than profitable. The trend by then seemingly was in favour of outright sales of equipment.
Initial accounting treatment of sales and leases
Whether by way of lease or outright sale the transactions were initially recorded in the books of the taxpayer and described as "sales". That is, there was an allocation to total income of the transactions without a dissection or distinction being drawn.
In the case of a sale to a lessee during the currency of a lease the invoice then issued by the taxpayer bore little difference to that of a normal sales invoice. The initial accounting treatment was hardly distinguishable from that applicable to other sales. In due course, appropriate entries were made transferring the equipment from the "equipment on lease account".
The accounting treatment for the transfer to the particular finance company of the benefit of the unexpired portion of a lease might, on the evidence, not have truly reflected the legal effect of such transfer. However, the intention was clearly to divorce the taxpayer from a lease situation and create a vendor/purchaser relationship.
The taxpayer did not internally draw a distinction between invoicing a sale and a lease; the same form was used in relation to all moneys due to the taxpayer. The subsequent accounting entries in the books of the taxpayer drew the distinction.
Analysis of sales of leased equipment
An analysis of the profits made on the sale of equipment that had been previously leased making up the amounts that are the subject of dispute over the years from 1976 to 1978 reveals the following position:
31/12/76 % 31/12/77 % 31/12/78 %
Sold within
12 months 83,070 57.0 14,222 11.8 97,080 75.1
1-2 years 34,881 23.9 72,931 60.8 30,776 23.8
2-3 years 26,172 18.0 10,191 8.5 - -
3-4 years 1,600 1.1 22,688 18.9 214 0.2
4-5 years - - - - 1,203 0.9
Total $145,723 100.0 $120,032 100.0 $129,273 100.0
The above analysis discloses the pattern of sales of leased equipment year by year, the change in the pattern of sales in the 1977 year and noticeable trend away from leasing equipment that began to develop in the 1978 year.
From the schedules annexed to the various returns of income it is apparent that the sales of lease equipment did not take place at least during the 1976, 1977 and 1978 financial years haphazardly. The sales in these years are not spread out over a particular financial year. Thus, in the 1976 financial year the sales took place in four months only, namely:
May 42%
July 8%
September 38%
November 12%
In the 1977 year 89% of the sales took place in December, the remaining 11% taking place in only February, May, September and October. the sales taking place in December were of ten pieces of equipment sold to three different customers.
In the 1978 financial year 86% of sales of leased equipment took place in June. Other sales took place in August, October, November and December. As to the sales that took place in June, 39 pieces of equipment were sold to the finance company with whom special arrangements had that year been made, and another four pieces of equipment were sold to
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another finance company seemingly at the behest of the lessee. Six pieces of equipment only were sold in the other four months.In the 1982 financial year the sales of lease equipment took place as follows:
February 7%
March 24%
June 12%
July 53%
January, August, September
and December 4%
When a sale of leased equipment took place, the transaction itself, as has been mentioned elsewhere in these reasons, appeared, so far as the taxpayer's records are concerned, as a sale with little, if any, differentiation as to its having been previously on lease in contradistinction to its having been initially purchased for sale or sold from stock. The transactions bore little distinguishing features from an invoicing point of view.
Profit making by sale - Profit-making undertaking or scheme - Ordinary course of taxpayer's business
Relevant to the issues raised in this review are matters pertaining to the nature of the taxpayer company, the character of its assets, the nature of the business carried on by it, and the particular sale or realisation the subject of consideration (
Ruhamah Property Co. Ltd. v. F.C. of T. (1928) 41 C.L.R. 148 at p. 154). The real thing that has to be decided here is what were the acts that were done in connection with this business and whether they amount to a trading which would cause the profits that accrued to be profits arising from a trade or business (
J. and R. O'Kane and Co. v. I.R. Commr (1922) 12 T.C. 303 at p. 347). Latham C.J. in
Western Gold Mines N.L. v. F.C. of T. (1937-1938) 59 C.L.R. 729 at p. 732 said:
"A person may buy something for the purpose of keeping it with the object of earning income or deriving other advantages from it; or on the other hand, he may buy something to sell at a profit. When in fact it happens that an opportunity offers for selling at a profit what has been bought, questions arise as to whether the transaction of sale is a change of a form of investment or of whether it is the making of a profit in a commercial transaction. In the former case, the profit is not taxable as income; in the latter case it is. The mere fact that something has been sold at a profit does not make that profit part of the income of the seller..."
The question as aforementioned to be determined in this review is thus, as to whether the sales in question were other than sales carried out in the course of the taxpayer's business as described on its relevant income tax returns, namely "Data Processing Equipment Installation and Distribution" and hence, that the proceeds are other than income according to ordinary concepts and usages of mankind and properly brought to account as such. Was what was done "not merely a realisation or change of investment, but an act done in what is termed the carrying on or carrying out of a business"? (
Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 T.C. 159 at pp. 165-166.)
There is not a definition of "income" in the Income Tax Assessment Act. As Neasey J. said in
F.C. of T. v. Reynolds 81 ATC 4131 at p. 4141:
"The question is whether the receipt is `income' according to ordinary concepts... Whether it is to be characterised as income for the purposes of the Act depends, as the authorities show, upon the character of the receipt and the circumstances in which it came to the hands of the taxpayer. In the case of a taxpayer conducting a business, if the receipt is, as a matter of reality part of the proceeds of the business or a product of or incidental to the conduct of the business, it is usually income..."
Starke J. in
Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1946) 73 C.L.R. 604 at p. 607 said:
"Next it was said, that the Income Tax Assessment Act charges income and not capital, which no doubt is true. And that where the owner of an investment chooses to realize it, and obtain greater price for it than that at which he originally acquired it, the enhanced price is not income for the purposes of the Income Tax Assessment Act. But, that where what is done is not merely a realization or change of investment but an act done in what is truly the carrying on or the carrying out of a business, then the enhanced value so obtained is assessable.
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The test to be applied is whether the amount in dispute is a gain made in an operation of business in carrying out a scheme of profit making..."
In each year the subject profit on sale will then only be income if it arose from the carrying on of a business undertaking. Thus, an identification or characterisation of the business carried on by the taxpayer company is an essential task to be performed. As it was said in
London Australia Investment Co. Ltd. v. F.C. of T. 77 ATC 4398 at p. 4409:
"It may first be stated that the activity of the taxpayer must be identified as a business activity. If otherwise than as part of a business of so doing, a man purchases a particular item of property primarily in order to enjoy it in specie or to enjoy the income from it, but at the same time expecting and intending that he will at some time in the future, if and when an opportune occasion presents itself, sell the item of property at a profit, the profit will not be taxable under the first limb of sec. 26(a). But, if the dominant purpose is that of sale then it will be.
If the acquisition and disposal of property is part of a business of so doing, the position is significantly different. There must still be a purpose of re-sale because re-sale is part of the description of the relevant business and since business has in it the notion of profit making rather than loss making, there must no doubt be a purpose of re-sale at a profit. But, the significant difference is that the purpose of re-sale need not be the sole purpose or the primary or dominant purpose as is the case under the first limb of sec. 26(a). It need only be one of the purposes. And, in this context, the word `purpose' is hardly, if at all, distinguishable from intention or expectation. The dominant or primary purpose may be to obtain income from the items of property acquired but, if there is a purpose, or intention, or expectation of selling at a profit, if and when a suitable occasion arises, then one condition of carrying on a business of buying and selling at a profit, is satisfied. If a man makes a business of acquiring property with a dual purpose of enjoying it or its profits and of re-selling it eventually at a higher price than he paid for it, then not only the income from the property but also the profit on re-sale will be income in the ordinary sense of the term and within the second limb of sec. 26(a)."
It was submitted on behalf of the taxpayer that its business fell under two heads, viz.:
- Sale of electronic media and peripheral equipment and,
- the holding and leasing out of equipment.
It is to the alleged second aspect of the company's business that our attention is drawn. The company derived from such activities a lease income, the same from the use of the computer hardware. That is, by use of the equipment it is alleged the company derived its income. The establishment of the leasing side of the taxpayer's business was in an endeavour, so it was said, and there was not any evidence to the contrary, to even out its monthly cash flow, this after an experience of losses and inadequacies.
The terms and conditions upon which the taxpayer leased its equipment had certain, so it was alleged, significant features, namely:
- - the lease was for a fixed term with a possible holding over;
- - there was not any residual value detailed in the lease rental agreement;
- - a monthly rental was payable;
- - there was an acknowledgement of ownership clause in favour of the taxpayer;
- - there was an obligation on the taxpayer to maintain the equipment in accord with the relevant maintenance agreement.
The lease was on all fours, it was submitted, with a lease of real estate. It was inconsistent with a lease designed in due course to ensure disposal of an asset. The practice was in accord with an intent to acquire an asset for the purpose of leasing it to customers for their use - consistent with the acquisition of a capital asset for a leasing/rental business.
It is consequential on the construction thus sought to be placed upon the transaction by the taxpayer, and of the taxpayer's business, that a disposal of assets is one of capital and does not give rise to an activity of an income or revenue nature. It is contended that the taxpayer is realising property and changing the form of its investment and not thereby engaging in a profit-making scheme.
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The sale was, it is said, of the equipment from which the profit was derived. It was a change in the form of an investment, a disposal of a fixed asset and of a capital nature.
It is material in this context to note that in many cases, at the time of sale, the machines were still subject to a lease and that the same were sold with the benefit of the covenants under the lease. The machines, it was here said, always remained assets for lease and were not converted into assets for sale. It was here suggested that if the taxpayer had terminated the leases, taken possession of the machines, put them in its warehouse and then sold them, that a different situation would arise. In the subject case, it was said, the equipment from the time that it was ordered to when it was sold, was held by the company as on rental and at no time did it physically take possession for sale. I interpose these submissions by observing that there might well have been a notional retaking of possession prior to sale.
The situation then here existing was sought by the taxpayer to be equated to that of the sale of an investment where a surplus arising on realisation would be other than on account of revenue. (See Western Gold Mines N.L. v. F.C. of T. (supra);
Milton Corporation Ltd. v. F.C. of T. 85 ATC 4243.) It was contended that the sale of a machine previously leased was not in the ordinary course of the company's business.
Whilst some evidence was available as to "lease base movements" showing, for the years where information was available, that the proportion of leased equipment sold with "capital gain" was for 1976 and 1977 relatively small, information was not available for 1978, and as to 1982 the movement was more than one-half of the additions to the lease base for that year.
Whilst there was always the possibility of a sale occurring, even where the machine and its installation was specially structured for the client, the dominant purpose of the acquisition however, it was submitted, was for lease and not for sale, the same negating the machines being otherwise classified than as fixed assets. On the evidence, it is apparent that when an order went forth from the taxpayer to its holding company for equipment, the same in due course to be leased, that the order form and the equipment order form contained specifications peculiar to the prospective customer. The acknowledgement received by the taxpayer likewise detailed the particular specifications. However, a like procedure was adopted in the case of an order referable to a prospective sale.
It was further submitted that the equipment that was under lease was so leased on average for the working lives of the machines, even be it that there was a possibility of sale. A comparable situation was sought to be identified in the transactions described and considered in
Cyclone Scaffolding Pty. Ltd. v. F.C. of T. 87 ATC 4021 where at p. 4024 in dealing with a possibility that scaffolding equipment might be sold, the trial Judge said:
"I am satisfied on the evidence (which was not itself in dispute) that, in relation to any individual item of equipment purchased by the taxpayer, it was purchased with no more than the contemplation of a mere possibility that it could be sold in the future if required... The Board found that hiring was the rule and that sales were the exception. In my view, that was still the position in the period from 1975 to 1981. The substantial bulk of the taxpayer's equipment is not in fact sold. The taxpayer's dominant business is hiring scaffolding equipment, not selling it. The availability of that equipment for sale is the same now as it was in 1949 and I agree with the Board's finding that hiring is the rule and sales the exception.
On the Commissioner's argument, these findings would make no difference because, he says, the mere possibility of sale in the future is sufficient. The taxpayer argues that a purchase contemplating the mere possibility of sale one day if required, does not fall within the definition. It is indeed difficult to see why the mere availability of the equipment for a possible sale if required, should be regarded logically as converting a purchase for the substantial purpose of hiring out the equipment into an acquisition of it for the purpose of sale."
In the case of the taxpayer the outright sales and sales on leased equipment over the relevant years were:
$ $
1976 3,350,227 325,710
1977 6,813,145 257,295
1978 11,163,116 578,726
1982 14,063,509 200,356
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A distinction might well be drawn between the Cyclone Scaffolding case and the subject case on this factual basis alone.
The Commissioner contends that it is unreal to divide the taxpayer's business into two arms and to say that a sale of a piece of leased equipment does not result in a taxable profit, yet the profit arising from the sale of other equipment is taxable. The income-earning activities of the taxpayer, it is said, can only be described as indeed they were on the company's tax returns themselves viz., "Data Processing Equipment Installation and Distribution"; to say that part of the profit is taxable, and part is not, is to draw a distinction inconsistent with the facts of the case.
The sales of equipment, whether leased or not, were, according to the Commissioner, the result of activities all directed to the carrying on or carrying out of a profit-making undertaking or scheme and, as to profits arising on sale, were assessable to tax.
The facts emerging from the evidence and relevant submissions so relied upon by the Commissioner were:
- (a) Clause 2(a)(i) of the taxpayer's Memorandum of Association provided that the business that it was incorporated to carry on included:
- "To carry on all and any of the following business namely the manufacture, sale and distribution for use in information systems of any kind of media equipment and any other product."
- (b) Up until 31 December 1976 the business of the company concentrated on the sales of computer equipment.
- (c) That on the evidence the company in order to meet its recurrent costs, resolved to maximise its linear profit-making potential by leasing machines and thence having a regular and predictable income. It was to the cash flow as such, as much as the profitability, be it that both warrant appropriate consideration, that the attention of the company was directed. On sale of leased equipment it was again to the cash flow as much as the profitability that the taxpayer geared its activities. It was always the intention of the taxpayer that the property be turned to profitable advantage in one manner or another; the achieving of a profit by lease or sale was the intent of the taxpayer, as was the maintaining of a cash flow. It should here be noted however, that the taxpayer company contended that this was not a case of property being acquired to turn to account in the best way possible but on the "unchallenged evidence" to produce rental income. The recognition of the possibility of a sale, it was said, was far different from the same being in contemplation (London Australia Investment Co. Ltd. v. F.C. of T. (supra)).
- (d) From the year ended 30 June 1976 the company added to its income-earning activities that of leasing out equipment, not abandoning straight out sales (for which see the figures set forth above) when this form of activity was available to it.
- (e) The financial statements of the company did not draw a distinction between income derived from sales simpliciter and income derived from sales of leased equipment.
- (f) The schedules to the income tax returns of the taxpayer company, describing the profits the subject of this review as capital profits, should be looked at only in an arithmetic sense as illustrating an arbitrary division of profits.
- (g) The accounting steps adopted by the company are indicative of the minimal distinction drawn by the taxpayer itself. The internal recording of the disposal of lease base equipment was identical with the recording of sales in the ordinary course of business. The drawing of a distinction in the schedules to the income tax returns endeavouring to structure a sec. 59(2) situation was after the event.
- (h) The evidence is consistent with a conclusion being drawn to the effect that the business-earning activities of the taxpayer were those of the distribution of its computer equipment on sale or lease. There is no room for drawing the distinction that a sale to an existing lessee or to a financier, with or without the existing lease remaining in place, was on account of capital, yet a sale outright to an end user was on account of revenue. The taxpayer met this contention by alleging that it adopted a businesslike approach to the disposal of its plant. The "mere possibility", so it was
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alleged, of a sale of leased equipment taking place was of no weight. There was no challenge, it was said, to the evidence that this type of dealing was not in accord with the majority of transactions even be it that it occurred over the relevant years.
No express challenge there might have been, but, in my opinion, it was most certainly implied. The schedule of sales set forth above aptly illustrates the position. Sales to lessee customers, whilst being relatively small in number and value, did occur with the regularity displayed in the schedules to the returns and as set forth earlier in these reasons.
- (i) It was said by the taxpayer that sales to lessees in the majority of instances arose at the instigation of the lessee. There has already been set forth earlier in these reasons a schedule of such sales taking place in particular months of a year. So far as the financial controller of the taxpayer was aware, he was unable to identify an instance where, on an approach having been made by the lessee to buy, that the taxpayer declined to sell.
- (j) As to sales to the particular finance company, this was again in the ordinary course of the taxpayer's business, the only difference between this type of sale and that to lessees or their designated finance company was that the taxpayer itself precipitated the sale.
- (k) As to the accounting treatment afforded to both types of sales,
- (i) the form of invoicing was not different in any material respect nor was the business done in a manner distinguishable from the business not in dispute. There was no way of differentiating between sales made to lessees, being existing customers, and sales of equipment to customers simpliciter in the ordinary course of business.
The taxpayer in this regard alleged that nothing turned on the manner in which the invoices were prepared.
- (ii) Whilst the taxpayer was aware and had regard to the nature of the transaction into which it was entering, the format of the sale did not support a submission as to its being "abnormal".
- The taxpayer alleges that it did distinguish between a sale and a lease identifying groups of items held for lease. This allegation is supported by the existence of depreciation schedules, separate ledger accounts, and the "lease base" established to maintain regular profits. But, in any event, the taxpayer says that it is the substance of the transaction not the labels which it puts upon them, which matters. (Cyclone Scaffolding Pty. Ltd. v. F.C. of T. 87 ATC 4021 at p. 4024.)
- (l) There was always the possibility of a lessee seeking to purchase a machine leased to it.
- Indeed, in this respect, the taxpayer conceded that there was room for distinguishing sales to customers from sales to the finance company.
- (m) The mix of "lease base" rentals and sales in the ordinary course was such that it could not be said that one was more dominant than the other. In this regard heed might again be made to the schedule of figures earlier set forth as to sales and the part played by outright sales and sales of leased equipment in the overall structuring of the taxpayer's affairs.
Relevant findings
1. The taxpayer was engaged at all relevant times in the business of data processing equipment installation and distribution.
2. The taxpayer company was involved in acquiring by purchase from its holding company in the United States computer machines, the same to be then sold in Australia and/or leased to customers at, and in accord with, the most favourable terms it could obtain.
3. The terms latterly mentioned were not necessarily constant in respect of a particular piece of equipment.
4. In some cases in the relevant years, equipment was purchased by the taxpayer and leased to customers, this to provide a lease base and a constant cash flow in aid of meeting overhead expenses. At other times in these years equipment was sold outright to customers.
5. Even where there had been a lease to a customer the equipment might be, and in some cases was, sold to the lessee customer or to a
ATC 600
third party on the lease being terminated. A sale of a piece of equipment was always in contemplation by the taxpayer, at least as a possible method of realisation of its interest in the computer equipment. The taxpayer always expected and intended to profit by the realisation by lease or sale of its interest in the computer machine, be it that of owner, simpliciter, or owner/lessor. The sale of the leased equipment was not a mere realisation of an investment and/or fixed asset at a profit, but a step taken, be it the first step, to give effect to a policy stratagem in "the course of a new part of the taxpayer's ordinary business". (Jennings Industries Ltd. v. F.C. of T. 84 ATC 4288 at p. 4294.)
6. The advantage to the taxpayer of the one course of dealing or the other might and did change. The proportion of sales of purchased equipment to equipment on lease has already been illustrated. The emphasis as one might expect, in a commercial enterprise seeking to make profits, changed dependent upon an assessment being then made by the executives of the taxpayer and its parent company as to the form of commercial transaction which would result in the most promising profit position for a particular period. Thus, the emphasis changed from sales to leasing, from leasing to sales to lessees, and from leasing back again to sales.
7. I see no reason, on the evidence, to regard the sales the subject of this review as different in any relevant sense from the other sales of the taxpayer. I consider that they were all directly relevant to the profit-making activities of the taxpayer, all designed to turn to account and profit the equipment acquired by it from its holding company, all an integral part of the taxpayer's business to deal in computer equipment. What was done was not merely a realisation of leased equipment but an act truly done in the carrying on of its business.
8. A dominant consideration is the close relationship of the receipt of money to the business activity carried on by the taxpayer. The receipt of the money, if not a direct consequence, was fairly incidental to the taxpayer's conduct of his business. (F.C. of T. v. Reynolds 81 ATC 4131 at p. 4143.)
9. It cannot be said that at the time of the purchase of the equipment by the taxpayer that there was neither an intention nor an expectation on the part of the taxpayer that the equipment would not be disposed of by way of sale. (Cyclone Scaffolding Pty. Ltd. v. F.C. of T. (supra) at p. 4027.)
Application of sec. 26AAA
Section 26AAA of the Income Tax Assessment Act was raised by the Commissioner in support of the relevant profits being subject to tax. The section renders income from property purchased and sold within 12 months assessable. The Commissioner sought to rely upon the section "in a formal sense".
It seems to me that sec. 26AAA is to be considered in the context of a situation where profits have been realised on the sale of an asset and such profit is not taxable under sec. 25 or 26(a) as it was prior to the 1984 amendments. That is, where a sale takes place of an asset within the 12-month period, then in the event of the profit falling outside of the earlier two sections, it will be brought to tax by reason of sec. 26AAA.
To the extent, however, that reliance was placed on sec. 26AAA, the taxpayer contended:
- - all equipment purchased was used for lease;
- - the taxpayer was entitled to depreciation under sec. 56 of the Income Tax Assessment Act;
- - the provisions of sec. 53, 59 and 62 of the Act, relating as they do to depreciation of property and the disposal thereof, comprise a self-contained code and preclude the operation of the section.
Application of sec. 54-62 of the Income Tax Assessment Act
That part of the Income Tax Assessment Act comprised within sec. 54-62 exhaustively and exclusively, it was submitted, deals with the sale of plant previously held for income-producing purposes. The sections collectively comprise a code, it was suggested on behalf of the taxpayer, covering the acquisition and disposal of plant.
As did the taxpayer in Cyclone Scaffolding Pty. Ltd. v. F.C. of T. (supra), so did the taxpayer company in this review submit, that the "code" identified in the abovementioned sections is the like of other "codes" contained in the Income Tax Assessment Act where, when a set of circumstances falls within its ambit,
ATC 601
then it is to be taxed solely in accord with the provisions of such "code".The "other codes" identified are:
- - Division 6 Pt III, the provisions of which cover "the whole field and... within the scope of its operation it makes exclusive provision for the levying of tax upon income from trust estates..." (
F.C. of T. v. Belford (1952) 88 C.L.R. 589 at p. 607.) - - Section 26(d) which, before its repeal and being referable to lump sum payments on account of allowances etc., by the ordinary meaning given to its words included "all allowances of the kind thereby described whether they are of an income or of a capital nature". (
Reseck v. F.C. of T. 75 ATC 4213 at p. 4216.) - - Division 2 of Pt III Subdiv. D referable to dividends.
I have already mentioned that the taxpayer company here sought to raise an argument similar to that raised on behalf of the taxpayer in Cyclone Scaffolding Pty. Ltd. v. F.C. of T. (supra). At p. 4027 the trial Judge in the course of his reasons for judgment expressed an opinion which, with all respect, is one concurred in by me. His Honour said:
"I should record here that the taxpayer further argued that sec. 25 has no application because sec. 54-62 (dealing with the depreciation of plant) comprise a complete code concerning the tax payable in relation to the disposal of plant upon which depreciation has been allowed. These explicit and specific provisions in the Act are said by the taxpayer to operate to the exclusion of general provisions such as sec. 25 in the same way, for example, as do the provisions of sec. 26(d)...
So far as depreciated plant is concerned, there could be a substantial difference in tax if sec. 25 were to be applied in lieu of sec. 59 because the amount included in the taxpayer's assessable income by virtue of sec. 59 is limited to the amount of depreciation which had previously been allowed as a deduction whereas that which would be included by virtue of sec. 25 would be the full amount of the profit made. The true position is perhaps by no means clear. The limitation imposed by sec. 59 is easily understood in relation to receipts which are properly characterised as being of a capital nature, but not where the receipts are otherwise of an income nature..."
The Commissioner rejects the contention that the provisions of the Act referable to sale of plant previously held for use in producing income should apply in the circumstances of this case. To accept such a proposition, it is put, the Tribunal would be required to ignore the receipts from sales having the character of income. Reference is here specifically made to sec. 59(1) and 59(2).
The clear function of sec. 59(2), it is submitted by the Commissioner, is to write back into assessable income so much of the depreciation previously allowed on property of a taxpayer as has been recouped on sale as a consequence of the sale price exceeding the depreciated value. The subsection speaks of a disposal of property, not, it is submitted, as with the subject taxpayer, where the disposal was of a machine that at all times was available for sale but had prior to the sale been used for the production of income.
It is my view that the provisions of sec. 54-62 of the Act do not preclude the subject profits being brought to tax if they fall within sec. 25 or 26(a).
Section 170 - sufficient disclosure - amendment of assessments
On behalf of the taxpayer it was submitted that the material disclosed in the returns of income for the four relevant years was sufficient disclosure to preclude amendment of the assessment pursuant to sec. 170 of the Income Tax Assessment Act. Section 170, so far as it is relevant, provides:
"(1) The Commissioner may, subject to this section, at any time amend any assessment by making such alterations therein or additions thereto as he thinks necessary, notwithstanding that tax may have been paid in respect of the assessment.
(2) Where a taxpayer has not made, to the Commissioner, a full and true disclosure of all the material facts necessary for his assessment and there has been an avoidance of tax, the Commissioner may -
- (a) where he is of opinion that the avoidance of tax is due to fraud or evasion - at any time; and
ATC 602
- (b) in any other case - within six years from the date upon which the tax became due and payable under the assessment.
amend the assessment by making such alterations therein or additions thereto as he thinks necessary to correct an error in calculation, or a mistake of fact, or to prevent avoidance of tax, as the case may be.
(3) Where a taxpayer has made to the Commissioner a full and true disclosure of all the material facts necessary for his assessment and an assessment is made after that disclosure, no amendment of the assessment increasing the liability of the taxpayer in any particular, shall be made except to correct an error in calculation or a mistake of fact; and that no such amendment shall be made after the expiration of three years from the date upon which the tax became due and payable under that assessment..."
The Commissioner relied upon sec. 170(2) and, in the alternative, 170(3) of the Act.
It seems to me that the relevant principles that should guide the Tribunal in considering this submission were clearly stated by Fullagar J. in
Australasian Jam Co. Pty. Ltd. v. F.C. of T. (1953) 88 C.L.R. 23 at p. 32 where his Honour said:
"It is common ground that the Commissioner had no power to amend the original assessment for any year unless the case fell within the terms of this sub-section [sec. 170(2)] and that the burden rests upon the Commissioner to establish what is necessary to bring the case within the sub-section...
Obviously the first question to be considered is whether the company made in each year, a full and true disclosure of all the material facts necessary for its assessment. I feel compelled to hold that it did not."
In
F.C. of T. v. Westgarth (1949-1950) 81 C.L.R. 396 it was held that almost identical words in sec. 22 of the Estate Duty Assessment Act 1914-1942 "meant disclosure of relevant facts known to the taxpayer, or of relevant beliefs held by him and that it did not involve making the Commissioner aware of facts unknown to the taxpayer". And in
Foster v. F.C. of T (1951) 82 C.L.R. 606 (see especially per Latham C.J. (at p. 614)). It was held that the words did not require the taxpayer to direct the Commissioner's attention to facts of which the Commission was aware. But as Williams J. observed in
Scottish Australian Mining Co. Ltd. v. F.C. of T. (1950) 81 C.L.R. 188 at pp. 197-198, the expression is a very wide one. His Honour said: "it seems to impose on a taxpayer the duty of disclosing every fact which he knows or is capable of knowing, material to a correct assessment". The words "or is capable of knowing", if read quite literally, may be thought to go a little too far, but I would think that even a nearly inadvertent omission of a material fact may be enough to enable the Commissioner to maintain that the full and true disclosure required has not been made. I think further - what is of some importance in the present case - that, if there is a material omission in the taxpayer's return, it is nothing to the point for the taxpayer to say to the Commissioner: "It was obvious on the face of the return that there was something I had not told you: You could have asked me about it, and if you had done so, the information would have been immediately and willingly supplied...".
Having in mind the matters set forth earlier in these reasons and the specific conclusions to which I have come, it is my opinion that there was not, in the subject case, a full and true disclosure of all the material facts necessary for the assessment.
Was there then an avoidance of tax? If the opinion which I have reached as to the taxability of the profits is correct, it is clear that there was. The word "avoidance", unlike the word "evasion", "does not in my opinion involve any notion of active or passive fault on the part of the taxpayer. If the absence of full disclosure has, in fact, resulted in less tax being paid than ought to have been paid, there has been an avoidance of tax within the meaning of 170(2)". (Australasian Jam Co. Pty. Ltd. v. F.C. of T. (supra) at p. 34.)
Even if there had been a full and true disclosure, a mistake of fact was made by the Commissioner within the meaning of sec. 170(3). The conclusion that the Commissioner came to following advertence to the returns of income and schedules was erroneous. (
F.C. of T. v. Slater Holdings Pty. Ltd. 80 ATC 4534 at p. 4536.)
ATC 603
Decision
For the reasons hereinbefore given, on the basis of the findings of fact that I have made and the conclusions that I have earlier set forth, it is my opinion that the profits derived from the sales of the leased equipment as they arose in the years the subject of this review, were properly brought to tax by the Commissioner.
Accordingly I would affirm the assessments for each of the four years the subject of this review and the determination of the Commissioner upon the objections.
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