Allied Mills Industries Pty. Ltd. v. Federal Commissioner of TaxationJudges:
Full Federal Court
Bowen C.J., Lockhard and Foster JJ.
The question in this appeal from the judgment of a single Judge of this Court (Gummow J.) [reported at 88 ATC 4852] is whether the
ATC 4367receipt by Allied Mills Industries Pty. Limited, the appellant, of $372,700 during the income year ended 31 August 1977 was of an income or capital nature.
There is no dispute about the facts. They are fully set out in the judgment of the learned trial Judge and it is necessary to refer only to the primary facts.
The appellant is a member of a group of companies known as the Allied Mills Group. From about 1969 the appellant conducted its business within, what the evidence described as, a divisional structure. In 1977 the appellant's business involved nine divisions in New South Wales engaged in the production, manufacture and distribution of food products and by-products and their raw materials. This case is concerned principally with the Groceries and Packaging Division of the appellant, the activities of which included processing and packaging flour, starch, custard powder and ``convenience foods''.
In 1973 the appellant made arrangements with Peek Frean (Australia) Pty. Limited (``Peek Frean Australia'') to distribute, but not manufacture, Peek Frean biscuits. The appellant was attracted to the distribution of Peek Frean biscuits partly because some Peek Frean lines had a strong position in the market and partly because it would enable the appellant to maintain its position as a supplier of ingredients for Peek Frean biscuits to Peek Frean Australia.
The distribution arrangements made between the appellant, Peek Frean Australia and other companies from 1973 to 1977 were not immutable. They varied not infrequently during that period and the form in which they are recorded consists of a blend of formal written agreements and correspondence.
The initial terms of the distribution arrangement emerge from letters of 1973 and 1974 whereby the appellant became the sole selling and distribution agent for Peek Frean biscuit products in Australia, Papua New Guinea and Fiji for the period 1 October 1973 to 30 October 1974 and thereafter until such time as the arrangement was terminated by six months' notice in writing given by either party. The appellant received a fee or commission calculated as a percentage of the invoiced value of the products sold. This fee or commission was to be deducted from payments due in respect of products purchased by the appellant from Peek Frean Australia. If notice of termination of the agreement was given to the appellant it was to be offered a licence to manufacture and sell Vita Weat biscuits for a period of not less than 10 years and for a royalty calculated by reference to net sales value. The appellant was also granted the right of first refusal of a licence to manufacture biscuit lines other than Vita Weat and an option to purchase Peek Frean Australia's processing and baking equipment and packaging plant in aid of the grant of any such licence.
On 12 March 1975 an agreement in writing was made between the appellant, Peek Frean Australia, Associated Biscuits International Limited (which owned the whole of the issued capital of Peek Frean Australia) and Arnotts Limited (``the 1975 agreement''). Recital C stated that six months' notice of termination of the distribution arrangements expiring 31 March 1975, had been given to the appellant pursuant to the 1973 agreement. Recital F stated that, contemporaneously with the execution thereof, Arnotts had entered into an agreement with Associated Biscuits International and Peek Frean Australia for the acquisition by Arnotts of the whole of the issued capital of Peek Frean Australia with a view to one or more of the subsidiaries of Arnotts carrying on under licence from Associated Biscuits International the manufacture for sale of biscuit products under the brand name of Peek Frean.
Under the 1975 agreement the appellant surrendered and gave up any right or entitlement to manufacture and sell in Australia Peek Frean biscuit products with the exception of Vita Weat (cl. 1). Annexure A to the 1975 agreement is a copy of a letter of 8 November 1973. Pursuant to cl. 4 of that letter the appellant was granted certain rights in relation to Vita Weat which included terms that the licence subsist for not less than 10 years and that a particular premium and royalty be paid. The rights of the appellant as to Vita Weat remained on foot subject to the waiver of any obligation of the appellant to pay the premium for the licence and the deferral until 1 January 1977 of any obligation to pay royalties (cl. 2). Arnotts agreed to cause one or more of its subsidiaries to continue to manufacture for sale Peek Frean biscuit products including Vita Weat, distribution thereof to be effected
ATC 4368through the appellant until 31 March 1975. Arnotts agreed to cause the subsidiaries in question to pay to the appellant commission of 12.5% of the sales value of sales effected by the appellant (cl. 3). Clause 4 provided that on and from 1 April 1975 the appellant would continue the distribution for Arnotts' subsidiaries of Peek Frean products other than Vita Weat and would be sole distributor within ``the Territory'' (Australia, Papua New Guinea, Fiji, New Caledonia, New Hebrides, the Solomon Islands and Tahiti) and would receive from Arnotts in respect of its services commission at the rate of 10% of net sales value. The distribution arrangements were to continue until 31 December 1975 and thereafter only upon such terms and conditions as may be agreed between the appellant and Arnotts.
By cl. 6 the parties agreed that, in the event that the appellant did not by 31 March 1975 accept the offer of a licence to manufacture and sell Vita Weat, then Vita Weat would remain the subject of a licence to Arnotts to manufacture and sell it.
The appellant did not take up its rights to manufacture Vita Weat. If the appellant had exercised its rights in respect of Vita Weat it would have thereafter directly competed with Arnotts, and, as the trial Judge observed, this might have adversely affected its position as supplier of raw materials to Arnotts. The manufacturing equipment used by Peek Frean Australia was outdated and it would have required a large capital outlay to replace it, an expenditure which the appellant did not wish to incur.
Correspondence was exchanged between the parties shortly before 31 March 1975, the effect of which was noted by the trial Judge [at ATC p. 4858] as being:
``to alter the scope of the distribution arrangements so as to include all Peek Frean products and `Vita Weat', but for three years with an option for a further three years subject to six months' notice of termination before the end of any current term. Arnotts also gave the taxpayer an option to purchase the right of Arnotts to manufacture and sell `Vita Weat' together with plant for manufacture and packaging, if Arnotts at any time during the three years commencing 1 April 1975 discontinued the manufacture of Peek Frean products.''
In late 1976 or early 1977 Arnotts informed the appellant that, regardless of where the fault lay, the distribution arrangements were not working satisfactorily. Arnotts saw no future for central warehousing of biscuits and it wished to rationalise the Peek Frean product range and take over the distribution thereof itself as soon as possible. Arnotts was a major customer for raw material supplied by the appellant, and, in response to enquiries by the appellant, told it that it would be likely to remain so. The appellant was asked to suggest a reasonable amount of compensation for termination of the arrangements between them and the sum of $400,000 was arrived at.
On 16 February 1977 Arnotts, the appellant and Peek Frean Australia (having by then changed its name to Consolidated Biscuits Pty. Limited) entered into an agreement in writing which is central to this case (``the 1977 agreement''). The recitals are in the following terms:
``A. By an agreement (`the said Agreement') made the 12th day of March, 1975, between ASSOCIATED BISCUITS INTERNATIONAL LIMITED , (`ABIL'), CONSOLIDATED, AMI and ARNOTTS it was agreed that AMI would distribute products therein described as Peek Frean Products and Vita Weat (herein called `the Products') as a sole distributor and as a del credere agent for ARNOTTS or its subsidiaries.
B. AMI has given up or allowed to lapse all its rights referred to in the said Agreement, to take from ABIL a licence to manufacture and sell Vita Weat in Australia and Arnotts has remained and remains licensed by ABIL to manufacture and sell Vita Weat as well as the other products in the Territory as defined in the said Agreement.
C. AMI remains engaged in the sale and distribution of the Products as sole distributor and del credere agent for ARNOTTS or its subsidiaries pursuant to the said Agreement as varied by negotiations between the parties.
D. It has been agreed by and between the parties hereto that the said Agreement and all other agreements and arrangements between AMI on the one hand and ARNOTTS, CONSOLIDATED and all other subsidiaries of ARNOTTS or any of
ATC 4369them on the other hand in respect of the Products will be discontinued upon and subject to the terms and conditions following.''
The reference to ABIL is to Associated Biscuits International.
The 1977 agreement provided that:
- • the sole agency of the appellant for the sale of the products would cease on 28 February 1977 (cl. 1);
- • the appellant would, for the purpose of disposing in an orderly way of stock of the products in its hands on 28 February 1977, continue sale of the products on the then basis of commission payments and for a short time thereafter (cl. 2);
- • during March 1977 the parties would negotiate and arrange for the return by the appellant of stocks of the products held by the appellant at 28 February 1977 to the extent that such stock was not dealt with under cl. 2 (cl. 3).
- • ARNOTTS will as consideration for the termination of the agency pay or cause one of its subsidiaries to pay to AMI on the 21st March 1977, the following sums or amounts -
(a) Compensation for termination of Agreement $372,700 (b) Refund of severance pay payable by AMI to staff retrenched $18,000
- • the Catering Division of Allied Grocery Products, a division of the appellant, would continue to sell the products as a non-exclusive agent of Arnotts or its subsidiaries upon such terms and conditions as may be agreed from time to time (cl. 5);
- • all existing arrangements between the parties would terminate on 28 February 1977 (cl. 8).
It is the characterisation of the payment of the sum of $372,700 mentioned in cl. 4(a) of the 1977 agreement with which this case is concerned.
The trial Judge held that the receipt by the appellant of the $372,700 was of an income nature and dismissed the appeal with costs.
The problem of distinguishing between a receipt of income and a receipt of capital frequently engages the attention of the courts, and, whilst the law reports are replete with cases involving this distinction, in the end each case has been found to turn on its own facts. No criteria emerge of universal application; but the decided cases do provide useful guidance to principles which may be helpful in considering the question. We shall refer to some of them.
In characterising payments made under an agreement, the terms of the agreement must, of course, be examined; but so must the whole of the circumstances surrounding its execution, its operation and the receipt of the money in question:
Federal Coke Co. Pty. Limited v. F.C. of T. 77 ATC 4255; (1977) 34 F.L.R. 375 per Bowen C.J. at ATC p. 4262; F.L.R. p. 385.
If a payment simply constitutes compensation for loss of profits under an agreement made in the course of the taxpayer's business which it would otherwise expect to have made, it is a payment ``to fill a hole in profits'' and would generally be taxable in the taxpayer's hands:
C. of T. (N.S.W.) v. Meeks (1915) 19 C.L.R. 568;
Heavy Minerals Pty. Limited v. F.C. of T. (1966) 115 C.L.R. 512.
Payments received by a taxpayer are not necessarily of an income nature even if loss of profits was used as a measure for calculating the amount of the payments: Californian Oil
Products Limited (In Liquidation) v. F.C. of T. (1934) 52 C.L.R. 28 at pp. 46 and 49;
Van den Berghs v. Clark (1935) A.C. 431 at p. 442.
A profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business may be income if the taxpayer entered into the transaction with the intention or purpose of making a profit or gain from the transaction:
F.C. of T. v. Myer Emporium Limited 87 ATC 4363; (1987) 163 C.L.R. 199.
The following passage from the judgment of Brennan J. in Federal Coke at ATC p. 4273; F.L.R. pp. 401-402 is apt in the present case:
``When a recipient of moneys provides consideration for the payment, the consideration will ordinarily supply the touchstone for ascertaining whether the receipt is on revenue account or not. The character of an asset which is sold for a price, or the character of a cause of action
ATC 4370discharged by a payment will ordinarily determine, unless it be a sham transaction, the character of the receipt of the price or payment. The consideration establishes the matter in respect of which the moneys are received. The character of the receipt may then be determined by the character, in the recipient's hands, of the matter in respect of which the moneys are received. Thus, when moneys are received in consideration of surrendering a benefit to which the recipient is entitled under a contract, it is relevant to enquire whether or not that benefit was a capital asset in his hand. To adapt the words of Lord
MacMillan in Van den Berghs Limited v. Clark (1935) A.C. at p. 443 and of Williams J. in
Bennett v. F.C. of T. (1947) 75 C.L.R. 480 at p. 485, the enquiry is whether the congeries of the rights which the recipient enjoyed under the contract and which for a price he surrendered was a capital asset.''
The enquiry as to the character of the receipt by the appellant of the $372,700 commences with the 1977 agreement itself. In particular, the terms of the agreement are relevant in so far as they disclose the consideration given by the appellant for the payment in question. Where an agreement, as here, provides for the termination of certain pre-existing arrangements it is also important to establish the mutual rights and obligations of the parties before that agreement was entered into. At the time of the 1977 agreement the appellant held contingent rights which entitled it, in certain circumstances, to obtain a licence to manufacture and sell Vita Weat biscuits in Australia. Those rights had been acquired pursuant to the letter of 8 November 1973 mentioned previously and, subject to certain modifications, were confirmed as remaining on foot by cl. 2 of the 1975 agreement. They were, however, never exercised by the appellant.
By correspondence which followed the execution of the 1975 agreement (i.e. between 12 March 1975 and 31 March 1975) Arnotts granted to the appellant an option to purchase the rights of Arnotts to manufacture and sell Vita Weat together with plant for manufacture and packaging if Arnotts at any time during the three years commencing 1 April 1975 discontinued the manufacture of Peek Frean products. These rights, though not exercised by the appellant, were still alive when the 1977 agreement was executed. Recital B to the 1977 agreement states that the appellant had given up or allowed to lapse the rights to take a licence to manufacture and sell Vita Weat in Australia and that Arnotts remained licensed to manufacture and sell the same. The rights given up or lapsed were all those referred to ``in the said Agreement'' which Recital A defined as the 1975 agreement. In our view Recital B refers to the 1973 rights of the appellant, confirmed with some modifications by the 1975 agreement, and not to the rights which Arnotts conferred on the appellant thereafter. At the time that the 1977 agreement was made the appellant therefore held certain contingent rights of manufacture and sale of Vita Weat, along with its rights of sole distributorship.
Clause 4 of the 1977 agreement states that Arnotts would, as consideration for the termination of the agency, pay or cause one of its subsidiaries to pay to the appellant on 21 March 1977 two sums, one of which is the sum of $372,700 as ``Compensation for termination of Agreement''. There is a degree of ambiguity in these words. As mentioned earlier the expression ``the said Agreement'' is defined by Recital A as being the 1975 agreement, yet cl. 4(a) refers to ``Agreement''. More than one interpretation is possible. Was the compensation of $372,700 paid only for termination of the sole distributorship which the appellant held from Arnotts without the inclusion of the contingent rights to manufacture and sell Vita Weat; or for termination of the sole distributorship together with those contingent rights; or, as Recital D appears to envisage, for termination of the 1975 agreement ``and all other agreements and arrangements'' between the relevant parties?
There is an air of artificiality in construing cl. 4 by attempting to sever the sole distribution rights from the contingent manufacturing rights and any other rights which existed as between the appellant and Arnotts or its subsidiaries in 1977. Although the rights of manufacture and distribution are logically distinct, the commercial reality of the situation here is that they were very much part of a package of rights. It was in this sense that the parties themselves dealt with the rights throughout their relationship and in cl. 4 of the 1977 agreement. The contingent rights of manufacture and sale of Vita Weat were treated
ATC 4371by the parties as being subsidiary to the main right of sole distribution. When viewed in this sense, the ``Agreement'' in question, for the termination of which compensation was paid, was the accumulation of rights which had arisen between the appellant and Arnotts or its subsidiaries under the 1975 agreement and thereafter. Those rights were primarily the sole agency of the appellant, but they included the contingent rights to manufacture and sell Vita Weat. The 1977 agreement does not bear a construction that confines the payment of the $372,700 to the sole agency, leaving outstanding and alive the residual contingent rights of manufacture and sale of Vita Weat.
However, it is clear from the 1977 agreement and the circumstances that surrounded its execution that the fundamental element in the payment of the compensation of $372,700 was the termination of the appellant's sole distributorship in which the contingent manufacturing rights with respect to Vita Weat assumed little significance. There is evidence as to the negotiations between Arnotts and the appellant which led to the 1977 agreement; but they appear to have been conducted in general terms without any dissection of the consideration into components and certainly no division as between sole distribution rights and residual manufacturing rights. Indeed, the evidence does not convey the impression that the latter were regarded by either the appellant or Arnotts as being of significance or that the exercise of them by the appellant was likely even if the circumstances should arise in which they became exercisable. Both companies were, however, conscious of the existence of the contingent manufacturing rights and intended that they too should terminate.
The appellant's objective in the negotiations was to secure the maximum payment from Arnotts consistent with its continuing position as supplier of raw materials to Arnotts. The appellant also had in mind that it would be saved costs by no longer being involved in the distribution arrangements, but, on the other hand, it would lose future profits by reason of the termination. The negotiations did not descend into fine details, but were approached on both sides in a broad way as a fair basis for terminating the agreement, each party having in mind a continuing business relationship.
The distribution arrangements between the appellant and Arnotts accounted for a substantial percentage of the turnover of the Grocery Products Division of the appellant. It is not appropriate, however, to view the separate divisions of the appellant as separate entities. The appellant is a large company arranged in a divisional structure and conducted as a single corporate concern. The separate divisions, whilst maintaining some degree of autonomy, are responsible to the same executive management and share common objectives and concerns. Indeed, the very distribution agreement in question was evaluated, not simply with respect to the Grocery Products Division to which it directly applied, but also with respect to the wider impact on the corporate body and in particular on the Flour, Starches and Flavour Division and the Edible Oils Division.
The activities and structures of the appellant as a whole must be considered in determining whether the rights of the appellant which were terminated by the 1977 agreement constituted a structural asset. Normally in order for a contract to be regarded as a capital asset it must be a contract which is of substantial importance to the structure of the business itself. This is a factual matter and inevitably a matter of degree. Here the appellant was not parting with a substantial part of its business of ceasing to carry on business as was the case in Californian Oil Products. Furthermore the appellant was not disposing of part of the fixed framework of its business in the sense required by Van den Berghs v. Clark. The contracts here in themselves yielded profit; they did not simply provide the means of making profit.
Also, the arrangements between the appellant, Peek Frean Australia and its parent and later, Arnotts, fluctuated considerably over the years of their existence in the sense that there was no element of permanence in them; they were varied not infrequently during a period of a few years and primarily with reference to matters concerning the distribution arrangements for the sale of Peek Frean products and Vita Weat biscuits. In no real sense therefore could the payment be considered as a payment for the giving up of a capital asset.
In return for payment of the $372,700 the appellant gave up the right to exploit its sole distributorship of Peek Frean products and Vita Weat and rights ancillary thereto and thus earn profits.
Contracts are made to be performed, not terminated, so in one sense the termination of contracts will be outside the ordinary course of business. Yet it is clear that payments made upon the termination of contracts may be of an income nature. What is important in characterising the payment is not the fact that it is made as compensation for the termination of the contract, which will often be outside the ordinary course of business, but rather the nature of the contract which generated the payment, and the way in which that contract related to the structure and business of the taxpayer. Here the contract in question was one whereby the appellant undertook, for a fee, to provide distribution services for the owners of the Peek Frean biscuit range.
We have taken into account that the appellant did not enter into a large number of distribution arrangements and that of the two arrangements which it entered into with some elements of similarity to the present arrangements, both differed from those lastmentioned arrangements in material respects. Nevertheless, it seems to us that it was part of the appellant's business to provide such distribution services. The contract in question was therefore one made in the ordinary course of the business of the appellant. The payment made upon its termination was essentially designed to compensate the appellant for the loss of the anticipated profits flowing from the contract. They should be regarded on the same footing as the profits themselves would have been: C. of T. (N.S.W.) v. Meeks. In our opinion the receipt by the appellant of $372,700 was of an income nature.
It was argued on behalf of the appellant that the receipt of the $372,700 was of a mixed nature, namely, a component from the termination of the sole distribution rights and a component from the loss of manufacturing rights with respect to Vita Weat, that neither the whole nor any part of the receipt could be attributed solely to the termination of the distribution rights, that there was no warrant for regarding the receipt as income and that the whole receipt should be regarded as capital. Reliance was placed on the decisions of the High Court in
McLaurin v. F.C. of T. (1961) 104 C.L.R. 381 and
Allsop v. F.C. of T. (1965) 113 C.L.R. 341 and on the decision of a Full Court of this Court in
F.C. of T. v. Spedley Securities Limited 88 ATC 4126. The question was also adverted to by the High Court in
H.R. Sinclair & Son Pty. Limited v. F.C. of T. (1966) 114 C.L.R. 537.
In McLaurin, Dixon C.J., Fullagar and Kitto JJ. said in a joint judgment at p. 391:
``It is true that in a proper case a single payment or receipt of a mixed nature may be apportioned amongst the several heads to which it relates and an income or non-income nature attributed to portions of it accordingly... But while it may be appropriate to follow such a course where the payment or receipt is in settlement of distinct claims of which some at least are liquidated... or are otherwise ascertainable by calculation... it cannot be appropriate where the payment or receipt is in respect of a claim or claims for unliquidated damages only and is made or accepted under a compromise which treats it as a single, undissected amount of damages. In such a case the amount must be considered as a whole...''
McLaurin and Allsop were cases of payments of lump sums paid pursuant to releases in settlement of claims for unliquidated damages or claims which included claims for unliquidated damages where the settlement treated the payment as a single undissected amount of damages, one incapable of severance. In neither case was the lump sum capable of apportionment between the causes of action. The receipts by the taxpayers were of moneys derived outside the ordinary trading activities of the businesses and were therefore of a capital nature.
In Spedley this Court approached the matter on the basis that, as the Administrative Appeals Tribunal, from whose decision the appeal was brought to this Court, had found that the receipt was a lump sum which was at least in a substantial part compensation for injury to a capital asset, namely, goodwill, and, as the parties had agreed that this was an item of capital, what was received was not capable of dissection or apportionment.
In the present case there was a single payment of $372,700. Although the sum was paid and received as compensation for termination of the appellant's sole distributorship and its residual contingent manufacturing rights with respect to Vita Weat we do not regard it as a payment of a mixed nature capable of apportionment in the sense in
ATC 4373which McLaurin, Allsop and Spedley speak. The residual manufacturing rights were elements in the sole distributorship of the appellant or ancillary to it. There was a single payment received in compensation for the termination of the arrangements between the appellant and Arnotts which is properly characterised as a payment for the loss of profits caused by the termination.
We would dismiss the appeal with costs.