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G.P. International Pipecoaters Pty. Ltd. v. Federal Commissioner of Taxation

Judges:
Woodward J
Northrop J
French J

Court:
Full Federal Court

Judgment date: Judgment handed down 7 October 1988.

Woodward, Norththrop and French JJ.

The Court has before it, on appeal from the Supreme Court of Western Australia [reported at 87 ATC 4678], three appeals against taxation assessments, relating to two separate years of income and an assessment of undistributed profits; but the same question arises in each appeal. It is whether a sum of $4,675,931, received by the appellant taxpayer under a contract with the State Energy Commission of Western Australia (``SECWA'') is assessable income under sec. 25(1) of the Income Tax Assessment Act 1936 (``the Act''). The sum was received for what were sometimes described as establishment costs, and at other times as mobilisation costs, incurred in erecting a plant for the sole purpose of coating, both externally and internally, the pipes being used to create the 1,500 km long Dampier to Perth natural gas pipeline.

The taxpayer was the successful tenderer for the coating work; the coating work could not be carried out without first constructing a plant at a strategically convenient point along the pipeline's route; and the overall contract between the taxpayer and SECWA provided in substance for the plant to be built by the taxpayer and paid for by SECWA, although it remained the property of the taxpayer.

In its carefully detailed judgment the Supreme Court of Western Australia (Pidgeon J.) has set out the history of the establishment of the taxpayer as a joint venture company for the purposes of the pipeline coating contract, and the somewhat complicated path which was taken in arriving at the final contract between the parties.

However, it is agreed that nothing turns on the identity of the individuals or companies representing the embryonic company which became the taxpayer. All their actions have been affirmed and adopted by the taxpayer and it will be convenient to refer throughout this judgment to the actions of the taxpayer, even though some important events (including the acceptance of tender in December 1981) occurred before the company was incorporated in January 1982.

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Similarly it is agreed that, although the sequence of events leading to the formulation of the final contract may be relevant to the understanding of its provisions, nothing turns on the fact that the contract was only signed in July 1983, very late in the period of performance. There was at all times agreement between the contracting parties as to their respective rights and obligations, and these were finally set out in the written agreement.

Indeed the contract negotiations, and the performance of work under the contract, all seem to have proceeded very smoothly, considering the size of the project.

It is also agreed that the contract reached between the parties represented a convenient commercial way of carrying out the task ahead. Pidgeon J. held that none of the provisions of the contract was entered into with a view to obtaining a tax advantage.

In spite of the openness of the whole transaction, the courts are faced with a difficult problem in determining whether the sum received by the taxpayer for constructing the coating plant was income within the meaning of the Act or, as the taxpayer asserts, a receipt of a capital nature.

In our opinion, the basic facts relevant to this question, as found by Pidgeon J., are as follows:

  • 1. The taxpayer originally tendered for the whole contract (plant and coating) by quoting rates per linear metre for internal and external coating of different sizes of pipe. When multiplied by indicated lengths of pipe, this produced a single estimated price for the whole contract, of the order of $31m. The taxpayer expressed its tender in this way because it felt constrained to do so by the tender documents.
  • 2. Later, in the course of negotiations, the taxpayer persuaded SECWA that a better way to provide for the cost of erecting the plant was to pay an agreed amount at the time of its erection, thus avoiding the necessity for the taxpayer to borrow money, and pay interest on it, to finance the construction. Thus it was agreed, in broad terms, that the plant and the coating would be paid for separately - the plant in three instalments of an agreed sum as it was being constructed, and the coating in a series of progress payments based on agreed rates for each linear metre coated - the rates first tendered being adjusted by removing from them the costs of erecting the plant. The total sum resulting from this revised schedule of rates was essentially the same as the sum originally tendered, after allowing for some minor agreed variations.
  • 3. The figure for the plant was arrived at, on the part of the taxpayer, by estimating what it would cost to install the plant, apart from leased equipment; and the 15% of total cost which was asked for the plant was chosen because it was a convenient way of framing the tender and yielded a figure very close to the actual estimated cost. A separate estimate by SECWA produced a very similar figure, and so $4,675,931 was agreed as the amount to be paid in three equal instalments as the plant was constructed over a period of six or seven months. These instalments were not directly tied to the progress of construction, although payments would no doubt have been deferred if construction had not progressed steadily - as it did. A performance bond was required by SECWA to cover any delays or defects in the construction of the plant. As counsel for the taxpayer put it:
  • ``[The] minutes show, and the evidence confirms, that SECWA took the view that this, in effect, requested a mobilisation cost. And if this was to be considered, SECWA would require the contractors to produce a bank guarantee to cover the situation of the contractors receiving a payment before delivery.''
  • 4. The original estimate allowed for some pieces of equipment to be written off completely after the contract was concluded. However, some of the plant and buildings were estimated to have a residual value of 35% of their cost, and this was allowed for in the original tender when estimating the appropriate price for SECWA to pay for each linear metre of pipe coated. The plant was to remain the property of the taxpayer throughout the contract unless it defaulted, in which case SECWA would acquire rights in the plant.
  • 5. The plant was constructed between December 1981 and June 1982 on land in

    ATC 4826

    Geraldton leased by the taxpayer from the Industrial Development Corporation. Later it obtained title to the land and eventually sold it to the Port of Geraldton Authority. The plant was sold by auction in May 1984 for approximately $500,000.
  • 6. In the taxpayer's books of account, the payments from SECWA for the plant were not entered as they were received, but were apportioned over 16 months, which was expected to be the life of the project. The taxpayer's accountant explained the reason for this in the following passage of his evidence:
  • ``The purpose of that was, as had been decided by the management of GP International, to bring that money to account over the life of the project and as I recall it was in relation to the amortisation of the cost of the building of the plant and equipment for that project.
  • From an accounting point of view what would be the effect of crediting the receipts account, the sales account, with the mobilisation payments over the 16 month period while at the same time amortising the cost of construction over the same period? - At the end of the project the net accounting effect would have been that the two would have approximately balanced each other out.''
  • 7. In the taxpayer's taxation return for the year ended 30 June 1982, the payment for the plant was shown in the balance sheet as a current liability with the following note:
  • ``Mobilisation deposits.
  • The liability relating to mobilisation deposits advanced by the State Energy Commission of Western Australia will be extinguished over the period of a contract between the company and the State Energy Commission of Western Australia. The anticipated completion date of the contract is 1st October 1983.
  • Security for any liability remaining in relation to the mobilisation deposits the Company and its shareholders have entered into a performance bond supported by letters of credit in favour of the State Energy Commission of Western Australia issued by Citibank N.A. and confirmed by the National Bank of Australasia Limited. The Letter of Credit issued by Citibank N.A. is secured by a floating debenture charge over the assets of the Company.''
  • The actual cost incurred to that time in constructing the plant was shown on the balance sheet as ``capital works in progress at cost''.
  • 8. In the taxation return for the following year, depreciation of the plant was claimed at permitted rates and an investment allowance was also claimed. These entitlements have not been disputed by the Commissioner of Taxation.
  • 9. So far as the actual costs of constructing the plant, and their relationship to the contract price, were concerned, Pidgeon J. made the following findings [at ATC p. 4686]:
  • ``at the time the plant was commissioned an amount of $4,381,709.82 had been spent on it. This does not take into account indirect costs relating to supervision in construction of the plant. The plant as constructed was not, adequate and the taxpayer spent a further $970,257.69 cents in upgrading it of which it received an accelerated payment of $550,000 from the principal but it was on account of coated pipes to be delivered and was required to be brought to account as they were delivered. Portion of the sum related to improving the plant to accelerate delivery under the contract. The balance was to improve the plant to meet the existing contract. The taxpayer made no profit in respect of construction of the plant.''

In the light of the findings of fact, the question to be decided is whether the receipt by the appellant of $4,675,931 for the construction of the plant should be treated as income in accordance with the ordinary usages and concepts of mankind, thus making it assessable income within sec. 25(1) of the Act.

The learned trial Judge held, in effect, that there was one contract, in form and in substance, for the execution of work by the taxpayer and ``the work to be executed included constructing the plant and then using that plant to deliver the coated pipe''. The

ATC 4827

payments to be made to the taxpayer were ``as set out in the schedule of rates which included the three instalments of the payment in question''. His Honour went on to say [at ATC p. 4692]:

``If one looked at the contract alone and asked the question what is the price being paid by the principal for the coating of the pipes then the answer would in my view be the total sum set out in the schedule of rates and being a payment in three instalments designated establishment costs together with the respective sums for external coating, internal coating and some miscellaneous items.''

After considering some of the detailed provisions of the contract, his Honour said [at ATC p. 4693]:

``If an outsider looked at the contract objectively then I consider such outsider must come to the conclusion that [the receipt in question] was part of the price being paid by the principal and being received by the contractor. I do not consider this character can change because the amount to be paid was a genuine estimate of the actual costs and the amount received approximated this. I would therefore see it as remuneration under the contract and by reason of that it must be classified as gross income.''

His Honour concluded by saying that he was satisfied that there was no difference between the substance and the form of the actual contract. He dismissed the appeals.

Before this Court, counsel for the appellant made two ``general contentions'' in the following terms:

``Moneys which are received by a taxpayer to defray in whole or in part the cost of a capital asset or improvement to be used for the purpose of generating income from activities undertaken by the taxpayer for the payer may be capital receipts of the taxpayer.

Whether a particular receipt is of that character depends upon the circumstances of payment and receipt. Those circumstances include the terms upon which the moneys are received and the purposes for which they can be deployed.''

There can, in our view, be no quarrel with these propositions.

Counsel then proceeded to make some 20 contentions of fact, of which the following appear to us to be significant:

``4. It was of no concern to the Appellant whether the SECWA rather than itself owned the plant. Its interest was in deriving a profit from performing the contract to coat the pipe utilising the plant constructed for that purpose or alternatively using the existing pipecoating factory owned by one of the joint venturers.

5. It was accepted by the parties that the Appellant would construct the necessary plant on the basis that the cost was to be recouped from SECWA.

7. The Appellant sought no profit and made none from the construction of the plant.

8. The contract remuneration for coating the pipe was provided for in the revised schedule of rates by payment per length of pipe coated which rates reflected the costs of actually coating the pipe and the profit to be derived from that activity, which contained neither a cost component for construction of the plant nor a profit to be derived from that activity.

10. The pipecoating plant was not an end product of the contract but was the means of obtaining the end product namely coated pipe.

11. In as much as the establishment costs could be described as a consideration at all, they were a separate consideration for the construction of the plant being a genuine estimate of the cost of construction i.e. excluding any profit element.

12. It was a requirement of the contract that the establishment costs be used for the purpose of constructing the plant and they were so used.

13. SECWA did not call for accounts regarding the expenditure of the establishment costs as there was no need to do so. Fluor Maunsell as the engineers employed by SECWA had calculated the cost of constructing the plant, were closely supervising the design and construction and generally monitoring expenditure and expected that if the design was adhered to a

ATC 4828

plant costing at least $4.6m would be produced. Under the special conditions of contract the establishment cost instalments were not payable without the prior approval of the engineer acting for SECWA.

14. SECWA in substance caused a plant to be built for itself to its own requirements but for political and policy reasons it did not wish to either own or operate the plant.

17. It was conceded by the Respondent at first instance that the coating plant was a fixed asset in the nature of a capital asset and the expenditure upon it was in the nature of capital expenditure.''

There is a degree of overlap in some of those contentions, but between them they illustrate the thrust of the appellant's case - that the construction of the plant represented a severable part of the contract; it was only a means to an end, that end being the actual pipe-coating process; and the appellant neither intended to derive, nor in fact derived, profit from the construction.

In reply, the respondent relied upon the fact that the plant construction was an integral part of the contract considered as a whole. Counsel pointed out that the taxpayer was an entity created for the sole purpose of carrying out all aspects of the contract. The nature of its business was to build a plant and then use that plant to coat 1,500 km of pipe. All payments were thus received in the ordinary course of the taxpayer's business. There was evidence that ``up front'' mobilisation or establishment payments were not uncommon in the construction industry. The receipts were essentially progress payments in relation to the whole contract.

The respondent also relied on the fact that the payments for the work in question were based on estimates only and there was a distinct possibility of profits being made from the plant construction, either because of savings on the estimates or because of the sale of the plant at the end of the contract. In the first instance the actual cost of construction was some $4.4m rather than the $4.7m estimated. It was fortuitous that required improvements to the plant destroyed any possibility of a profit being made.

In fact counsel for the respondent went further than this and argued, on the basis of evidence not discovered but adduced during the trial, the full significance of which was apparently not appreciated at the time, that there was a profit element for the plant construction built into the contract figures.

This was said to be so because, when the tender was originally prepared, a 15% profit margin was added to all estimates - for both plant and coating - in the course of calculating the rates tendered per linear metre. When the contract was finalised, it allowed for separate ``mobilisation'' payments for the plant, and a figure close to the actual cost of the plant was taken out of the calculation of the rate per linear metre, but the 15% profit on the plant construction was left in the calculations which produced the amended coating rates.

The relevant figures are as follows:

  • (a) estimated cost of plant construction: $4,252,600;
  • (b) estimated residual value at end of contract: $1,115,300;
  • (c) amount sought as mobilisation payment: $4,284,300;
  • (d) amount taken into account in calculating, tender per linear metre (a-b): $3,137,300.

The 15% profit margin was added to the amount shown in (d) above.

Counsel was able to demonstrate to the Court that the total figures quoted in the original tender were carried through to the total figures set out in the contract; thus the profit element, calculated on the estimated plant cost less its residual value, was retained in the contract figures.

This circumstance was confirmed by the evidence of the taxpayer's managing director who, when asked whether, in relation to the construction of buildings and the purchase of plant ``that was something in respect of which there would be an allowance for profit risk and contingencies?'', replied ``Yes''.

Counsel for the taxpayer argued that the 15% allowance on $3,127,300 (the estimated cost of the plant less recoverable value) was more in the nature of a provision for contingencies than an attempt to make a profit on this aspect of the contract. He pointed out the ``rolled-up'' nature of the question assented to by the managing director.

ATC 4829

There seems to be substance in the respondent's argument on this point, but since it was not put directly to witnesses, submitted to the learned trial Judge, or dealt with in his Honour's reasons for judgment, it is difficult for this Court to reach any concluded view on the difference between the two submissions of counsel. We are prepared to assume for present purposes that the allowance referred to was for contingencies.

The respondent also argued that expert evidence of accounting practice is relevant to questions of characterisation (see
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 at pp. 506-507;
Arthur Murray (N.S.W.). Pty. Ltd. v. F.C. of T. (1965) 114 C.L.R. 314 at p. 318). In this case none of the accountants called to give evidence, including those called by the taxpayer, questioned the propriety of the receipts in question being credited to ``sales'' (a revenue item). Counsel for the taxpayer replied that the witnesses were not giving evidence of accounting practice, but merely saying how they dealt, or would have dealt, with a most unusual problem for an accountant to face.

The authority which is most like the present case, and which received close attention both before Pidgeon J. and in this Court, is that of
Boyce v. Whitwick Colliery Co. Ltd. (1934) All E.R. 706; 18 T.C. 655. The case was conveniently summarised by Pidgeon J., and the following paragraphs which describe the case are largely borrowed from his Honour's judgment.

In that case a colliery company needed to dispose of surplus water and an urban district council desired to be supplied with that water. This resulted in an agreement which was to continue for 30 years with an option to renew for a further period of 20 years. The agreement recited the fact that an extension of the council's works for the supply of water was urgently needed and that the council and company were willing to contract on the terms set out. The company covenanted to clean out a shaft and to erect the necessary works to raise and pump the water. The works were to remain the property of the company. The company agreed to supply specified quantities of water in bulk at a specified pressure to the council's water main. The company agreed to maintain the works in good repair to the reasonable satisfaction of the council's engineer.

The council agreed to pay to the company the following amounts each year by half-yearly payments.

  • (a) The sum of two hundred and eighty-five pounds.
  • (b) A sum equal to 1/30th part of the costs of the works.
  • (c) Interest of 5% per annum on any portion of such costs for the time being unpaid.
  • (d) The sum of one penny per thousand gallons of water pumped by the company.

The agreement was to remain in force for 30 years, but there was a proviso that if the company ceased to work its colliery it would permit the council to continue pumping the water, and if that happened there was to be a corresponding reduction in the annual amount to be paid by the council. The council could determine the agreement at any time and for any reason but was required to pay compensation.

The question before the Court of Appeal was whether the amount of the 30 annual instalments to repay, over the initial life of the contract, the capital expenditure to install the plant, was revenue received by the company. There was a corresponding appeal raising the question whether the amount was an allowable deduction by the council.

The Court saw it as a divisible contract, holding that it provided in effect for two distinct matters, namely a supply of water at an agreed price and the construction of the works necessary to provide the supply, upon terms that the council would reimburse the company the costs of those works. It was held that the annual payments equal to one-thirtieth of such cost were not part of the payments for the supply of water, but were repayments of the capital costs of the works and accordingly were capital receipts not assessable to income tax in the hands of the company; and they were capital expenditure on the part of the council and so not admissible as deductions.

Hanworth M.R. said he intended to look at the agreement as a whole. Having done so, he found in it a capital outlay made not really for the purpose of the company but for the purpose of the supply of water. The outlay was on assets the use of which in certain events might pass to the council, and in respect of which there was no undertaking or covenant or

ATC 4830

certainty that the company would continue to use them for the full term of 30 years. His Lordship later said at p. 711 in All E.R.:

``In the present case the company were not, when this agreement was made, trading in selling water. Their main business, as I have pointed out, was the getting of coal, and if they were to sell water it involved them in an immediate capital outlay which they had to make, the reimbursement of which could only take place after a period of years. But there is as a possible event the contemplation that the company may not go on for the full period of years.''

His Lordship then referred to the fact that the agreement did not provide for an inclusive payment for water over a certain time in any event and that it provided for the repayment of one-sixtieth part of the capital. This was referring to a half-yearly payment. His Lordship concluded that the relevant payment was an instalment towards the complete payment of the capital outlay which was made at the instance and under the direction of the council and which enured in certain events to the benefits of the council even at a time when the company ceased to operate.

Slesser L.J. found there was no question of principle in the case at all and said (at p. 712):

``It is a question which must be decided with reference to the substance of the agreement entered into between this company and the council. As I understand the matter, this agreement, though stated in the preamble to be a contract for supply of water, deals with two distinct and different matters, first, the supply of water simpliciter, for which the company are given the right to make charges, those charges, as has been pointed out, being varied on the expiration of thirty years. Then, altogether apart from the agreement as to the supply of water, there is an agreement with regard to the recoupment to the company of the expense to which they have been put in erecting certain waterworks and associated works in order to satisfy the conditions of the contract and the requirements of the council. It is true that by cl. 1 it is provided that the works shall, when completed, remain the sole property of the company; and hence it is argued, among other things, that really the council are buying nothing, and that there is no capital expenditure on their part. But it appears to me that this is in the nature of a joint adventure between two contracting parties. It is true that ultimately the works become the sole property of the company, but during the period dealt with by the contract the council are given many rights over these works and over the business which is there to be carried on and, as my Lord has pointed out, in the event of the company failing to supply the water under the contract the council are themselves given the power to enter on the works and do the pumping.''

Romer L.J. said at p. 714:

``The question which has to be solved appears to me to be one solely as to the proper construction to be placed on the agreement of July 1, 1918. At the time when that agreement was entered into, it is sufficiently plain that the company, though no doubt well equipped both as regards machinery and buildings for the purpose of carrying on a colliery business, was not properly equipped in either respect for the purpose of supplying water to the council. The council were desirous that water should be supplied to them by the company, and they, therefore, must have recognised that if a contract was to be entered into by the company for supplying water to them the company must put themselves into a position, by the provision of adequate machinery and buildings, to do so. If in those circumstances the company had agreed with the council that they would themselves erect the necessary buildings and machinery for the purpose, and the council had agreed that in consideration of their so doing the council would repay to the company by thirty yearly instalments the cost to which the company had been thereby put, I cannot conceive that anyone could contend successfully that the sums so paid by the council to the company were liable to income tax, even though at the end of the thirty years the buildings and plant, which presumably by that time would not be worth very much, should remain the property of the company.''

Thus the Court of Appeal held that the payments it was considering were not income but capital receipts.

ATC 4831

The taxpayer naturally relied on the decision in Boyce's case for the proposition that payments received for a capital purpose are prima facie capital payments, and that they retain this character whether they represent payments for actual disbursements or payments in advance of estimated costs. Nor is it significant, it was submitted, whether the receipts come in a single payment or in instalments.

Counsel for the respondent argued that Boyce's case should be distinguished for one or more of the following reasons:

  • (a) in that case the business in question was merely incidental to the primary business of the taxpayer,
  • (b) the receipts were intended precisely to recoup a disbursement of a capital nature,
  • (c) the taxpayer in Boyce had no intention of making a profit on the cost of construction of the plant - the contrary is strongly arguable in the present case, and
  • (d) the receipts in Boyce were fixed with a capital character, first, because interest was payable on the amount from time to time outstanding and, secondly, by virtue of the long length of time over which they were spread.

In our view there is no substance in the first point but the other three, taken together, are persuasive. The separation, in Boyce, of the receipts directly related to the capital work was clear cut; the work to be performed was of a classically capital nature - major works carried out once only in order to generate income over a long period of years; and the payments were clearly stamped as capital by the additional payments of interest on the unpaid portion. These circumstances make the case, in our view, so different as to be unhelpful to the decision of the present case.

We believe the same can be said, for similar reasons, of the decision of Owen J. in
A.P.A. Fixed Investment Trust Co. Ltd. v. F.C. of T. (1948) 8 A.T.D. 369.

As we have already said, we do not find it an easy task to answer the question before the Court. The case falls, in our view, close to the borderline between capital and income and there seems to be no direct precedent to assist in resolving the issue. However, we have received some general guidance from the often-cited words of Dixon J., as he then was, in
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634 at pp. 646-647, where he said:

``For myself, however, I am not prepared to concede that the distinction between an expenditure on account of revenue and an outgoing of a capital nature is so indefinite and uncertain as to remove the matter from the operation of reason and place it exclusively within that of chance, or that the discrimen is so unascertainable that it must be placed in the category of an unformulated question of fact. 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. The courts have proceeded with the task without, it is true, any very conspicuous attempt at analysis, but rather in the traditional way of stating what positive factor or factors in each given case led to a decision assigning the expenditure to capital or to income as the case might be. It is one thing to say that the presence among the circumstances of a case of a particular factor places the case within a specific legal category. It is another thing to infer that the absence of the same factor from some other case necessarily places that case outside the category and gives it an opposite description. But towards that kind of fallacy human reasoning constantly tends, and the decisions upon matters of capital and income contain much reasoning that is quite human. My own opinions upon the question I have attempted to explain in
Sun Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 C.L.R., at pp. 359-363 and I shall not re-state them. I shall treat the passage to which I refer as incorporated in this judgment. Once more, however, I shall endeavour to apply what I conceive to be the principles that determine whether an outgoing is on account of capital or of revenue. As a prefatory remark it may be useful to recall the general consideration that the contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of

ATC 4832

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.''

In the earlier case of Sun Newspapers (1938) 61 C.L.R. 337, to which his Honour referred, he had said at pp. 359-361:

``The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss. The business structure or entity or organization may assume any of an almost infinite variety of shapes and it may be difficult to comprehend under one description all the forms in which it may be manifested. In a trade or pursuit where little or no plant is required, it may be represented by no more than the intangible elements constituting what is commonly called goodwill, that is, widespread or general reputation, habitual patronage by clients or customers and an organized method of serving their needs. At the other extreme it may consist in a great aggregate of buildings, machinery and plant all assembled and systematized as the material means by which an organized body of men produce and distribute commodities or perform services. But in spite of the entirely different forms, material and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a `profit-yielding subject,' the phrase of Lord Blackburn in
United Collieries Ltd. v. Inland Revenue Commissioners (1930) S.C. 215, at p. 220. As general conceptions it may not be difficult to distinguish between the profit-yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue. The latter can be considered, estimated and determined only in relation to a period or interval of time, the former as at a point of time. For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose. But the practical application of such general notions is another matter. The basal difficulty in applying them lies in the fact that the extent, condition and efficiency of the profit-yielding subject is often as much the product of the course of operations as it is of a clear and definable outlay of work or money by way of establishment, replacement or enlargement. In the case of machinery, plant and other material objects, this is illustrated by the commonplace difficulty of saying what is maintenance and what are renewals to be referred to capital.

...

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 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 of system or `profit-earning subject.' It will thus be distinguished from the expenditure which should be recouped by circulating capital or by working capital.''

It must be remembered that, in both these cases, Dixon J. was concerned to characterise expenditures rather than receipts as being either capital or income. And it cannot be thought that he had a case such as the present in mind when he was preparing these judgments. Nevertheless his Honour's broad approach has been referred to with approval many times and

ATC 4833

it provides a convenient starting point for the decision in the present case.

In our view, the most significant feature of this case is that the taxpayer was brought into existence for the sole purpose of executing a single profitable contract. And the nature of the task was such that, at the end of the contract, any assets of the taxpayer in the shape of buildings, plant or equipment would have little more than salvage value. This was recognised both in the agreement between the parties and in the taxpayer's statements of account and claims for high rates of depreciation, which were allowed by the Commissioner.

In these circumstances it seems to us to be somewhat artificial to distinguish between the early payments received by the taxpayer which were, in effect, to compensate it for its unproductive preparatory work, and the later payments which related directly to the productive pipe-coating process.

We believe that, if a company is brought into existence for the sole purpose of performing one contract for profit, and particularly if the life of the contract is comparatively short - to be measured in months rather than years, then all payments made under the contract are likely to be income rather than capital receipts in the hands of the company. The business of such a company is the performance of the contract, and the receipts are in the ordinary course of that business.

The position could well be otherwise if it were shown that certain establishment costs, designed to put the contractor in a position to perform its contract, were being met directly by the other party to the contract - thus removing any possible profit element from those payments. But that is not the case here. Because the payments for plant construction were based on estimates (which themselves were expressed in round figures and contained a 5% element for ``miscellaneous''), and the total contract price contained an allowance of 15% of the larger part of the estimated sum, for ``contingencies'', we think there is no sufficient reason to treat those payments differently from other payments made under the contract.

Looking at the matter broadly, we think the construction of the pipe-coating plant was simply the first stage of a continuous but strictly finite operation, for which regular payments were made under the one contract. Gearing-up for such a contract must necessarily involve the accumulation of men and materials and the carrying out of preliminary works of one sort or another. In this case the preliminary work was substantial and unusually expensive but, none the less, impermanent.

The taxpayer was remunerated for all its work, at regular intervals, over the period of the contract. The total payments it received added up to the amount contemplated by the contract, with certain agreed variations. The first three payments, which are in question here, were made before SECWA began to receive the end-product of the contract. This was done, in our view, not so that SECWA could pay for the plant as such, but in order to save the taxpayer having to borrow money and pay interest on high establishment costs which it would have had to pass on to SECWA. There was evidence accepted by Pidgeon J. that such ``up-front'' payments to cover establishment or mobilisation costs, are not uncommon in similar construction contracts.

The two chief factors to which the taxpayer can point as supporting a characterisation of the payments as capital are (a) the nature of the activity for which the payments were made, namely the construction of a production plant, and (b) the fact that the payments were allocated to this purpose and represented a genuine estimate of the actual cost of construction. The construction of a production plant would normally be seen as a capital activity - and the taxpayer's expenditure on it was so treated in the present case. However, in this case, we believe the usual clear distinction, referred to by Dixon J. in the passages cited above, between the creation of a profit-yielding subject and the process of operating it, is somewhat blurred - because the subject is to be used once only as part of a total indivisible contract. For this reason, any inference that receipts to be spent on a capital purpose are capital receipts is weakened.

We say that the contract is indivisible because the payments made at the time the plant was being erected were not the only payments which related to the plant - the ``contingencies'' allowance was accommodated elsewhere - and the amounts paid, although genuine estimates, could not have been expected to work out accurately; any loss to the taxpayer had to be absorbed by profits from the

ATC 4834

remainder of the contract, while possible profits from the construction phase could be added.

For the reasons we have given we can see no sufficient reason to treat the payments in question differently from the other moneys received by the taxpayer under its contract. We take some comfort in this finding from the fact that the payments represented a precise portion (15%) of the total anticipated contract sum, from the way in which the payments were treated as ``sales'' in the taxpayer's balance sheet, and from the expert evidence of the accountants who were called - though we do not rely on any of these factors in reaching our conclusion. We also note, finally, that the taxpayer's expenditure on the plant having, through depreciation provisions, been treated as fully deductible from income, there is no injustice to the taxpayer in the conclusion which the learned trial Judge reached.

The appeals should be dismissed with costs.


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