The Griffin Coal Mining Company Limited v. Federal Commissioner of TaxationJudges:
These are two appeals by The Griffin Coal Mining Company Limited (``Griffin Coal'') under subsec. 189(3) of the Income Tax Assessment Act 1936 (the Act) against decisions of the respondent disallowing Griffin Coal's objections to assessments of tax issued by the respondent for the years of income ending 30 June 1985 and 30 June 1986.
On 25 June 1987 Griffin Coal requested, pursuant to the provisions of sec. 187 of the Act as it then stood, that the respondent's decisions on the objections be referred to the Supreme Court of Western Australia. The matters had not been referred by 1 September 1987 at which time the amendments to the Act effected by the Jurisdiction of Courts (Miscellaneous Amendments) Act 1987 became operative and pursuant to the transitional provisions of that Act a request to forward the decisions to the Supreme Court was treated as a request to refer the decisions to the Federal Court of Australia.
Both appeals raised the same issue namely, whether certain expenditures incurred by Griffin Coal in each of the years of income were allowable deductions from the assessable income of those years pursuant to sec. 51 of the Act. Any other issues raised in the grounds of objection were either compromised between the parties prior to the hearing or were abandoned by Griffin Coal.
The case Griffin Coal consisted of:
- (a) an affidavit sworn by Mr Strmotich, a civil engineer with substantial experience in mining and a director of Griffin Coal for a major part of the relevant period and evidence contained in various documents such as minutes, memoranda, correspondence, summaries, reports, agreements and draft agreements produced as exhibits to that affidavit;
- (b) additional viva voce evidence from Mr Strmotich who was cross-examined at length;
- (c) an affidavit sworn by the secretary of Griffin Coal deposing to the company's methods of accounting for and recording
ATC 4748expenditure and a large number of invoices and expenditure vouchers exhibited thereto.
At the outset of the hearing the Court was advised by counsel for the respondent that the respondent accepted that expenditure had been made in the amounts claimed and that each item of expenditure had been expended on the matters deposed to by the deponents of the two affidavits.
It is now necessary to distil the evidentiary material and set out the relevant facts.
Griffin Coal was incorporated in 1925. Since incorporation it has been engaged in the business of coalmining in coalfields near the township of Collie in the State of Western Australia. At all material times Griffin Coal has been one of two coalminers operating in those coalfields, the other being Western Collieries Limited. In the earlier years of its business Griffin Coal's principal customers were departments and instrumentalities of the State of Western Australia involved in providing services of rail transport and electrical power. Although Griffin Coal made significant sales of coal to private customers in those years, such sales had become a minor part of the business for some years prior to the years of income. In recent years Griffin Coal has supplied almost the whole of its production of coal to the State Energy Commission of Western Australia (``SECWA'').
In March 1979 Griffin Coal entered a long-term contract with SECWA (``the coal sale agreement'') under which Griffin Coal agreed to sell coal to SECWA for a period of 25 years from 1 July 1978. Pursuant to the coal sale agreement the price to be paid for the coal was variable and was to be determined by adding a margin to the actual cost of mining the coal. Accordingly, the agreement sought to control the amount of mining equipment that Griffin Coal might acquire to develop the mine to be used to produce the coal required for the coal sale agreement and acknowledged that Griffin Coal had undertaken substantial financial commitments in respect thereof. In due course the justification or verification of the cost of producing the coal and the need to obtain SECWA's consent before further costs were incurred in acquiring any major mining machinery led to some friction between the parties to the coal sale agreement.
It was a term of the coal sale agreement that Griffin Coal mine and supply the required coal only from the coalmining leases known as the Muja leases. Griffin Coal operated an open cut mine on those leases and SECWA had a major power station adjacent to the mine. The coal sale agreement required the reserves of coal in the Muja leases at any given time to be 105% of the amount of coal still to be supplied under the coal sale agreement. It was a term of the agreement that Griffin Coal not supply more than 100,000 tonnes of coal per year from the coalseam situated on the Muja leases to purchasers other than SECWA unless the consent of SECWA to such sales had been obtained. SECWA's consent was not to be unreasonably withheld if Griffin Coal demonstrated that sales to other customers would not prejudice SECWA's rights under the coal sale agreement and that the price of such sales was no more favourable to the proposed purchasers than the price SECWA was required to pay under the agreement.
The coal sale agreement required Griffin Coal to adhere to a mining plan already prepared by consultant mining engineers to prove the feasibility of Griffin Coal supplying coal from the Muja leases under such a long-term contract. The purpose of that contractual term was to ensure that efficient mining practices were followed by Griffin Coal and thereby to protect the position of SECWA as purchaser at cost.
It was a further requirement of the coal sale agreement that Griffin Coal and SECWA together appoint a consultant mining engineer each five years during the life of the contract to review the company's adherence to the plan and to determine whether the company had mined coal efficiently and at as low a cost as would have been incurred by any prudent coalmine operator. The review would also consider how the actual costs incurred by Griffin Coal compared with projected costs and would determine whether any equipment should be replaced to ensure efficient low-cost production of coal.
Although the amount of coal to be produced under the coal sale agreement required Griffin Coal to undertake substantial borrowings and to execute detailed security documents to protect the interests of lenders, the coal sale agreement took account of Griffin Coal's borrowing obligations by providing for the price paid for
ATC 4749the coal to cover all costs of the mining operation including the cost of servicing the borrowed funds. In that way Griffin Coal was able to put itself forward to prospective lenders with the security of a long-term contract under which borrowing costs were expressly provided for.
The execution of the coal sale agreement was a significant event for Griffin Coal. It became the foundation for a major expansion of Griffin Coal's coalmining operations. It provided a substantial long-term market with a dependable profit and assisted Griffin Coal to secure its hold on the various coalmining leases that had been granted to it by the State and to obtain the grant of further leases.
In November 1979 Griffin Coal entered a formal agreement with the State of Western Australia (``the coal leases agreement'') in respect of its coalmining leases at Collie. The coal leases agreement was ratified by the Collie Coal (Griffin) Agreement Act 1979. The recitals to the coal leases agreement recorded that Griffin Coal desired to expand its activities and increase production; that it had applied for additional coalmining leases and that the State desired to ensure that the coal resource at Collie was developed in the most economic and practicable way and to ensure that the requirements of SECWA and industry in Western Australia would be adequately safeguarded. The recitals referred to the coal sale agreement made earlier that year.
The State agreed to grant the additional coalmining leases applied for by Griffin Coal subject to the proviso that 50% of the reserves of coal contained in some of those leases and in some of the existing leases held by Griffin Coal be reserved to satisfy the needs of SECWA and be made available to SECWA pursuant to mutually acceptable commercial arrangements to be entered into between Griffin Coal and SECWA in the future. The Muja open cut leases were excluded from the proviso because the coal sale agreement apparently provided sufficient security for SECWA's needs. As a consequence of the coal leases agreement, Griffin Coal almost trebled the coalmining leases under its control. The leases granted by the coal leases agreement were for a term of 21 years with a right to renew for a further period of 21 years. Following its entry into the coal leases agreement Griffin Coal held three coalmining areas capable of open cut mining being the coalmining leases known as Muja, Chicken Creek and Ewington. The Chicken Creek leases had reserves of approximately 21 million tonnes capable of extraction by open cut mining of which 50% was reserved for the use of SECWA. The Ewington leases had reserves of approximately 53 million tonnes of open cut coal, none of which was subject to reservation for the requirements of SECWA.
Pursuant to the coal leases agreement, Griffin Coal was obliged to prepare forthwith an overall scheme for the exploration and development of the coal resource contained within the coalmining leases it already held and the leases granted by the coal leases agreement, to ensure that the coal resource was mined in the most economical and practicable way having regard to the need to satisfy the coal requirements of SECWA and industry during the period of the coal leases agreement. The coal leases agreement required Griffin Coal to submit by 1 July 1980 detailed proposals for the exploration and development of that coal resource for the ensuring 15 years including specification of the total tonnage of coal it proposed to mine for each year of the ensuing 15 years. The proposals were to set out the measures to be taken for open cut mining and deep mining.
In addition to the reserves of coal capable of open cut mining referred to above, Griffin Coal held reserves of approximately 220 million tonnes of coal accessible by underground mining. Such mining involved higher costs of production. Griffin Coal had ceased deep mining operations in 1965.
Griffin Coal's proposals were to be approved by the Minister and similar proposals were to be submitted for each 15-year period of the coal leases agreement. The coal leases agreement recognised that Griffin Coal may desire to expand its production over and above the mining operations required to satisfy the coal sale agreement with SECWA, but from the point of view of the State such expansion would have to be conducted in the most efficient manner having regard to the whole of the resource contained in the mining leases.
In addition to the detailed long-term proposals, Griffin Coal was obliged by the coal leases agreement to supply the Minister with five-yearly plans of its proposed mine development for coal production. If Griffin
ATC 4750Coal desired to vary significantly any of its proposed activities, it was required to submit further proposals to the Minister for further approval.
There was no indication in the materials placed before the Court of the proposals submitted to the Minister by Griffin Coal in respect of the development of the whole resource contained in its coalmining leases for the period of 15 years after 1 July 1980.
As at July 1980 the prospect of Griffin Coal obtaining further coal sales and developing its coalmining operations beyond the level required to meet the coal sale agreement was very limited. SECWA, the major purchaser of the coal produced by Griffin Coal, did not appear likely to increase the amount of coal it would purchase from Griffin Coal in the foreseeable future and the coal produced from the Collie coalfields was not of export quality.
Under the coal sale agreement SECWA had agreed that it would either take from Griffin Coal, or pay for, a fixed tonnage of coal per year set at 2.1 million tonnes after the initial stages of the contract. In addition to the coal it had undertaken to take or pay for under the coal sale agreement, SECWA also had other arrangements in place pursuant to which it had agreed to purchase 1.2 million tonnes of coal per annum from Western Collieries Limited. Furthermore, at the time SECWA negotiated the coal sale agreement with Griffin Coal, it had undertaken obligations to take or pay for vast quantities of natural gas to be produced from the North West Shelf natural gas project, a circumstance described by Mr Strmotich as ``the gas bubble''. SECWA was obliged to either take or pay for a quantity of gas equivalent to 7 million tonnes of coal per annum.
Griffin Coal, therefore, was aware that SECWA had undertaken contractual obligations that may impose financial burdens on it and which, in the short-term, would result in a gross oversupply of fuel to be used for the production of energy.
By December 1981 Griffin Coal had fallen short of the deliveries of coal required to be made under the coal sale agreement. Earlier in 1981 Griffin Coal had sought to obtain SECWA's approval to acquire major items of plant to be used in the mining operation. The request had been refused and Griffin Coal had commenced proceedings against SECWA in the Supreme Court of Western Australia seeking enforcement of certain of the terms of the coal sale agreement.
On 21 December 1981 SECWA served a notice of default upon Griffin Coal which required the shortfall to be made up within 14 days and advised that failure to do so may result in the coal sale agreement being terminated. Although the coal supplied under the coal sale agreement was committed to the needs of the Muja power station, Griffin Coal considered that SECWA maytake steps to terminate the agreement if it were able to do so and perhaps seek to renegotiate the agreement in terms more advantageous to SECWA.
The threat of termination of the coal sale agreement was of serious concern to Griffin Coal because it would have attracted the default provisions of the security documents the company had executed. Furthermore, determination of the coal sale agreement would have been a breach of the agreement made with the State of Western Australia permitting that agreement to be determined and the leases granted by the agreement, which included the Ewington leases, would have been forfeited. Griffin Coal would have been left with the Muja and Chicken Creek coalmining leases and no long-term contract for the sale of coal.
That dispute between Griffin Coal and SECWA was resolved in February 1982 when a timetable was settled for the shortfall in deliveries to be made up and it was agreed that an independent consultant be appointed to consider Griffin Coal's application to SECWA for approval to acquire additional plant.
Later in 1982, however, the parties were in dispute again over the construction of other terms of the coal sale agreement and again litigation was commenced between the parties in the Supreme Court of Western Australia. In August 1982 Griffin Coal and SECWA resolved that dispute by a further agreement pursuant to which Griffin Coal was permitted to supply SECWA with coal from the Chicken Creek leases to make up the shortfall in deliveries under the coal sale agreement. The agreement permitted Griffin Coal to use equipment employed at Muja open cut to develop an open cut mine on the Chicken Creek leases as a short-term mine during 1982 and 1983.
In September 1983 the parties were again in dispute and SECWA commenced proceedings against Griffin Coal in the Supreme Court seeking a declaration of an entitlement to terminate the coal sale agreement on the ground of Griffin Coal's default under the agreement. That dispute was not compromised until approximately June 1985.
By 1983 Griffin Coal had already accepted advice provided by Strmotich that it should endeavour to diversify its mining activities to lessen the company's financial dependence upon its relationship with SECWA.
In early 1983 the construction of an aluminium smelter in the south of the State was under discussion between the State of Western Australia and interested parties. At that time Mr Strmotich advised Griffin Coal that such a project may provide a substantial additional market for the sale of coal. The State had established an Aluminium Smelter Task Force to endeavour to form a consortium of parties interested in establishing such a smelter. One party which had expressed an interest in promoting the construction of an aluminium smelter was a Korean company, Kukje-ICC Limited (ICC), a subsidiary of which was the contractor building part of the pipeline delivering natural gas from the North West Shelf gas project to SECWA for reticulation and sale.
In March 1983 executives from Griffin Coal initiated discussions with ICC in respect of the smelter project. Griffin Coal was well aware that the viability of the project may have been wholly dependent upon the cost of the fuel used to generate the energy supplied to the smelter being sufficiently low to allow the large quantities of electricity consumed by the smelter to be supplied at a cost that permitted the smelter to be operated at a profit.
In 1979 Griffin Coal had appointed a related proprietary company, Jacia Pty. Ltd. (Jacia), as manager of Griffin Coal's mining operations. Jacia employed engineers, geologists, geophisicists, construction managers, cost accountants and contract administrators and Griffin Coal relied upon the management services provided by Jacia. In addition, another related proprietary company, Devereaux Holdings Pty. Ltd. (Devereaux), provided additional administrative services for Griffin Coal. Each company was paid fees for its managerial and administrative services.
Jacia and Devereaux became involved on Griffin Coal's behalf in the development of Griffin Coal's contacts with the parties discussing the construction of the aluminium smelter with the State. Mr Strmotich, as assistant managing director of Jacia, and Mr Stowe, a director of Jacia and Devereaux and chairman of directors of Griffin Coal, attended a meeting with representatives of ICC in March 1983 to discuss ICC's proposals for the construction of an aluminium smelter. It was made clear by ICC at that meeting that the smelter was to be commercially viable and competitive in its field. ICC advised Griffin Coal that the energy needs of the proposed smelter would be supplied by a dedicated power plant to be constructed by the operators of the smelter and no contracts would be made with SECWA for the supply of electricity from its State power grid.
By May 1983 Griffin Coal had approached the Aluminium Smelter Task Force advising that Griffin Coal had a strong interest in the project. Griffin Coal advised that it regarded itself as a prospective supplier of coal for the proposed dedicated power station, but recognised that the coal may have to be provided at little or no profit and perhaps at a loss. Apparently it was assumed that development of the coal resource in that way would not be contrary to the terms of the Collie Coal (Griffin) Agreement Act 1979. Griffin Coal indicated that it would be prepared to be such a supplier provided it was given an ``equity interest'' in the smelter project. Griffin Coal advised that it would provide finance for its share of ``the project''.
In August 1983 Griffin Coal was invited by the Aluminium Smelter Task Force to provide its projected prices for the supply of coal between 1990 and 2000, the deliveries being 500,000 tonnes of coal per annum in the first year and 1.7 million tonnes at the end of the 10-year period. Griffin Coal understood that until approximately 1990 the fuel to be used by the proposed power station would be part of SECWA's excess inventory of natural gas to be supplied at a price equivalent to that of coal and at less than its normal cost.
Griffin Coal understood from the Aluminium Smelter Task Force that although the proposed power station would be privately constructed and owned, it was intended that it would be operated by SECWA under an agreement to be
ATC 4752made between the smelter operators and SECWA.
Griffin Coal responded to the Aluminium Smelter Task Force request by stating that it did not believe that coal could be supplied at commercial rates because such rates would make the cost of electricity too high for the smelter to operate profitably. Griffin Coal therefore suggested that it supply coal to the project at an appropriate price and take up a position as one of the parties in the smelter project.
Prior to suggesting its participation as a co-venturer in the project, Griffin Coal had commenced to look at the nature of the world market in aluminium metal and the economics of the process of aluminium smelting. At about the same time Griffin Coal, through Jacia, prepared and submitted to ICC a proposal for the supply of coal to generate electricity for the smelter project which set out the company's capacity to meet the required tonnages from its existing reserves, the quality of the coal and the manner of mining it. The submission presented three alternatives for the supply of coal, either:
- (a) an ``arm's length'' commercial agreement;
- (b) the supply of coal at a fixed negotiated margin on cost to be capitalised and converted into an equity contribution to the smelter project; or
- (c) the payment of a negotiated margin on the cost of coal supplied, with the joint venturers in the smelter project taking an equity holding in the coalmining operation to be developed to supply the needs of the smelter project and Griffin Coal taking an equity holding in the aluminium smelter project.
Throughout the latter part of 1983, Griffin Coal maintained contact with ICC and ICC sought further information from it as to the method Griffin Coal had used to calculate the price at which Griffin Coal would supply coal to the power station to be constructed for the purposes of the smelter. At this stage Reynolds Metals Limited (Reynolds Metals) and Broken Hill Proprietary Limited (BHP) were participating in discussions as prospective developers of the smelter project. Griffin Coal also made known to BHP its interest in taking up a position as a developer of the smelter project.
In February 1984 Griffin Coal supplied a letter of intent to ICC setting out the basis on which it would be prepared to enter a long-term coal supply arrangement with the proprietor of the power station to be constructed as part of the aluminium smelter project. The letter quoted a base price for the supply of coal of $19.22 per tonne. The response from ICC was that the smelter project would need coal to be supplied at a base price of $18 per tonne. Griffin Coal indicated that it would be prepared to offer the delivery of coal at such a price on condition that the company was invited to join the smelter project as the holder of 25% interest therein. By April/May 1984 exchanges between ICC and Griffin Coal gave encouragement to Griffin Coal that a coal supply agreement could be established which would ``provide Griffin with a modest but adequate margin over cost'' and that Griffin Coal would be regarded as an acceptable member of an aluminium smelter consortium.
Griffin Coal, therefore, began to consider the requirements for its participation in the smelter project. It was aware that the development of the aluminium smelter would be carried out by a joint venture project pursuant to which the joint ventures would be responsible for acquiring alumina on their own account for treatment in the smelter and would be responsible for taking and disposing of the aluminium ingots produced as a result of the treatment of the alumina quota. To that end Griffin Coal began discussions with ICC for the purpose of concluding an ``off-take agreement'' pursuant to which ICC would purchase Griffin Coal's aluminium metal for a price to be calculated according to agreed criteria which should guarantee Griffin Coal ``an internal rate of return on equity invested in the smelter'' of not less than 20%. At that time it was anticipated that Griffin Coal would need to expend approximately $300m. to develop a mine on the Ewington leases to supply coal under any coal sale contract it may conclude with the supplier of energy to the smelter and to meet the contribution of funds required from a 25% participant in the joint venture project for the construction of the smelter. It was anticipated that $70m. of the $300m. would be supplied by shareholder subscribed capital and the balance would be obtained from borrowings.
In order to determine what price criteria should be set for the ``metals off-take agreement'', Griffin Coal sought information on how the world aluminium metal market was operated and how prices were set. Part of the advice received by Griffin Coal on the vagaries of the market for aluminium metal was that Griffin Coal should consider becoming involved in the fabrication of that metal because value-added products were less susceptible to variation in price than the raw metal ingots. During May and June of 1984 Griffin Coal was able to establish the outlines of principles for a proposed ``off-take agreement'' with ICC.
By May 1984 Griffin Coal was seeking to be included as a participant in a feasibility study on the costs of construction and operation of the proposed smelter to be carried out by parties interested in the smelter project. As at late May 1984 Griffin Coal had abandoned the pursuit of a long-term contract for the sale of coal at a reasonable ``arm's length'' profit. The long-term sale of coal at a reduced profit was considered to be a possibility provided the smelter could be proved to be feasible. Griffin Coal was, therefore, looking at participation in the operation of a smelter as the means of providing an appropriate return upon any capital it applied to the mining of coal and the construction and operation of the smelter.
At about that time it had also become clear to Griffin Coal that the proposal for a privately owned power station dedicated to the needs of the aluminium smelter would not proceed and that SECWA would be the supplier of power to the smelter. The Aluminium Smelter Task Force, the chairman of which was the chairman of SECWA, was able to advise ICC in May 1984 that there was a ``high level of confidence'' that negotiations would result in contracts being concluded by SECWA for the long-term supply of coal which would allow the suggested power tariff to be charged by SECWA to be calculated on a delivered coal price of $20 per tonne.
In June 1984 Griffin Coal, at the request of SECWA, supplied a proposal for a 17-year contract for the supply of coal commencing in the year 1996, being the year in which SECWA anticipated it would cease to use gas as a fuel source for the power station generating the electricity supply for the smelter. Griffin Coal quoted a base price for the supply of coal of $20 per tonne which apparently provided a small measure of profit. The proposal was made conditional upon Griffin Coal becoming a member of the consortium to be formed to construct the aluminium smelter. Further discussion with SECWA ensued resulting in minor modifications to the proposal.
By early July 1984 SECWA, relying upon Griffin Coal's proposal for the supply of coal, was able to inform the Aluminium Smelter Task Force of the likely tariff it would charge, subject to Cabinet approval, for the supply of power to the operators of the smelter. The Aluminium Smelter Task Force then informed ICC that the actual cost would be determined by competitive offers for the supply of coal to be obtained by SECWA from coal suppliers. It appears that SECWA may have been conducting negotiations with Griffin Coal's coal producing competitor, Western Collieries Limited, to obtain the best available price for the supply of coal.
Although Griffin Coal signalled its enthusiasm for joining the aluminium smelter project as a joint venturer and tied its offer to supply coal at a favourable price to the condition that it be invited to join the joint venturers, no formal invitation to join the venture came from the Aluminium Smelter Task Force. Notwithstanding that, Griffin Coal proceeded to employ consultants to receive advice on the ramifications of any proposed investment in the aluminium smelter joint venture.
Griffin Coal's major expenditure on matters related to its proposed participation in the smelter joint venture project commenced in about July/August 1984. At the beginning of August 1984 a meeting attended by representatives of Griffin Coal, ICC, Reynolds Metals, BHP and the Government of Western Australia was held in Korea. At that meeting BHP decided to withdraw from the venture. ICC, Reynolds Metals and Griffin Coal agreed to form a consortium known as the International Aluminium Consortium of Western Australia (IACWA) to pursue the objective of constructing an aluminium smelter and to conduct a feasibility study to determine the costs of constructing and operating the smelter and to initiate such studies as were necessary to assess the impact of the proposal on the environment.
The announcement of the formation of the consortium marked the realisation of Griffin Coal's objective to be accepted as a participant in the joint venture project. In September 1984, in a circular to shareholders, Mr Stowe, as the chairman of directors, was able to advise shareholders that Griffin Coal had become a participant in a consortium to develop an aluminium smelter and to inform them of the directors' belief that the construction of a smelter would provide an opportunity for Griffin Coal ``to achieve, in the one investment, diversification and the enhancement and protection of its coal interests which comprise(d) its principal asset''.
It was agreed by the consortium members that that part of the feasibility study which related to the costs of the smelter should be completed by 30 November 1984 and that the environmental studies should be completed by 31 January 1985. The costs of the study were to be shared between ICC (50%); Reynolds Metals (25%); and Griffin Coal (25%).
After the formation of IACWA some of the work on the consortium's feasibility study was carried out by personnel employed by Jacia, the cost of such work being charged to Griffin Coal and recharged by Griffin Coal to IACWA. IACWA rendered invoices to Griffin Coal in respect of Griffin Coal's share of the total feasibility study costs incurred by IACWA. Griffin Coal continued to incur expenses in respect of its own assessment of the feasibility of the proposed joint venture including the prospects of obtaining alumina and marketing aluminium metal. In addition to the use of the services of Jacia in that regard, Griffin Coal used the services of various consultants to advise on aspects likely to arise in the operation of an aluminium smelter such as industrial relations, access to finance, environmental questions, terms of proposed legislation and consideration and negotiation of the terms of a comprehensive joint venture agreement for the construction and operation of the smelter. Some of those aspects also involved costs and expenses chargeable to IACWA while other outgoings were solely for the account of Griffin Coal.
Although the consortium had been supplied by SECWA with a proposed power tariff, and had been advised in April 1984 that Cabinet had approved that proposal, IACWA commissioned an evaluation of Griffin Coal's study of the feasibility of the coal supply proposal submitted to SECWA. The costs of that evaluation were charged to consortium members as part of the costs of the feasibility study of the smelter project.
If Griffin Coal had become the holder of a 25% interest in a joint venture operating an aluminium smelter, it would have been required to supply and treat approximately 106,000 tonnes of alumina and dispose of approximately 50,000 tonnes of aluminium metal each year. In addition to acquiring the alumina, it would have been required to provide 22,500 tonnes of petroleum coke per annum for the treatment of its share of the alumina. In assessing its obligations under the proposed joint venture agreement, Griffin Coal received advice on the prospect of discharging its obligation to provide a throughput of alumina for the smelter by entering tolling agreements with alumina producers pursuant to which Griffin Coal would receive income and a return on its investment by charging alumina owners a fee for reducing their alumina to aluminium metal. The tolling fees would be related to the costs of operation of the smelter and the costs of servicing the borrowings incurred for the construction of the smelter. Griffin Coal entered into negotiations with Kobe Alumina Associates (Australia) Pty. Ltd. for the supply of alumina and the negotiation of tolling contracts and incurred expenditure in doing so. By February 1985 draft memoranda of understanding and draft terms of agreement had been prepared as a result of those negotiations.
The IACWA feasibility study on the construction and operation of the smelter had been completed by December 1984. The study indicated that, in appropriate conditions, the operation of the smelter would be viable and that it could be constructed by 1987. In January 1985 the State of Western Australia through the Western Australian Development Corporation, joined the consortium. Its 20% interest in the consortium was obtained by reducing the interests of ICC and Reynolds Metals. In February 1985 ICC was dissolved by decree of the Government of South Korea and it departed from the consortium. The consortium continued, however, and in March 1985 selected contractors were invited to bid for contracts for phases of construction of the smelter.
On 20 June 1985, however, Reynolds Metals gave notice of its withdrawal from the consortium and on 25 June 1985 the Government of the State announced that the aluminium smelter project had been deferred indefinitely.
After the collapse of the project and the consortium in June 1985 Griffin Coal incurred some further expenditure in respect of the smelter project by discharging the fees for the completion of certain environmental studies charged to Griffin Coal's account and fees for other work which may be described as tailing-off expenses in respect of the study of the smelter project undertaken by the consortium on the one hand and by Griffin Coal on its own account on the other.
Between July 1984 and June 1985 Griffin Coal continued to conduct detailed feasibility studies on its proposal for the long-term supply of coal for power generation for the smelter and entered more detailed negotiations with SECWA in respect of the necessary terms of a contract to supply such coal including consideration of a draft contract. Substantial costs were incurred in discharging the fees of Jacia and other consultants in respect of the assessment of Griffin Coal's ability to mine and supply such additional coal and in settling the terms of the proposed contract. At all times the accounting records of Griffin Coal maintained a separation between the costs and expenses incurred in respect of the proposal for a coal supply contract relating to the proposed aluminium smelter and the costs incurred in assessing the feasibility of, and obligations arising under, participation in a joint venture to construct the smelter.
In its income tax return for the year ending 30 June 1985 Griffin Coal claimed the sum of $1,439,930 as an allowable deduction for ``smelter feasibility study costs''. A separate claim for an allowable deduction was made for the sum of $774,025 described as expended upon ``smelter coal supply study; investigation re possibility of sales''.
The respondent assessed Griffin Coal's liability for income tax by disallowing a sum of $1,446,900.16 as a ``deduction claimed in relation to proposed aluminium smelter'' and by increasing the taxable income accordingly. The deduction claimed for expenditure on the study and investigation of the possibility of coal sales to the proposed smelter was allowed in full.
In addition to the deduction claimed for ``smelter feasibility study costs'' of $1,439,930, the respondent disallowed two items of travel expenditure that had been included in ``General Travel and Accommodation Expenses'' as operating expenses of the business of Griffin Coal. The additional sum disallowed, $6,986, comprised two items of travelling expense not specifically included in the category ``Travelling Expenses'' in the overall costs of the smelter feasibility study. Of that sum, $2,010 appears to be an apportioned travel expense which, according to the invoices produced, was in fact allocated as part of the expense of the investigation of possible coal sales and as such would have been part of the expenses accepted by the respondent as an allowable deduction. The remainder of $4,976 appears to be of the same character as the aggregated travel expenses included in the smelter feasibility study costs.
As set out above, the respondent did not contest that the sum of $1,446,900.16 was expended and nor did the respondent deny that each item of expenditure was expended as described by Griffin Coal.
Griffin Coal contended that those outgoings were allowable deductions pursuant to subsec. 51(1) of the Act.
The terms of subsec. 51(1) are as follows:
``All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.''
As to the manner of operation of the two limbs of subsec. 51(1) it is sufficient to recite the comments of Fullagar J. in
John Fairfax and Sons Pty. Ltd. v. F.C. of T. (1958) 101 C.L.R. 30 at p. 40:
``The two categories of s. 51(1) are clearly not mutually exclusive, and it has indeed been said that `in actual working' the
ATC 4756addition of the second category `can add but little to the operation of the leading words `losses or outgoings to the extent to which they are incurred in gaining or producing the assessable income':'
Ronpibon Tin N.L. and Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 C.L.R. 47 at p. 56. But it was not denied that there may be cases which fall outside the first category and within the second. The first is directed to expenditure incurred in the actual course of producing assessable income:
Amalgamated Zinc (De Bavay's) Ltd. v. Federal Commissioner of Taxation (1935) 54 C.L.R. 295 at pp. 303, 309 and
W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation (1937) 56 C.L.R. 290 at p. 305. It is primarily at least, concerned with expenditure voluntarily incurred for the sake of producing income. Its scope is not, of course, confined to cases where the income is derived from carrying on a business. The second may be thought to be concerned rather with cases where, in the carrying on of a business, some abnormal event or situation leads to an expenditure which it is not desired to make, but which is made for the purposes of the business generally and is reasonably regarded as unavoidable.''
F.C. of T. v. Total Holdings (Australia) Pty. Ltd. 79 ATC 4279; (1979) 24 A.L.R. 401.)
Counsel for Griffin Coal submitted that the outgoings qualified as allowable deductions under either limb of subsec. 51(1), but placed greater reliance on the outgoings being deductible under the second limb. The submissions followed two alternative paths and I will deal with them in that way in these reasons.
In the first line of submission it was argued that outgoings expended on involvement in the smelter project were outgoings made for the pursuit of income from the mining and sale of coal or made in the course of conducting the business of mining and selling coal.
In that submission Griffin Coal placed strong reliance upon a decision of the Full Court of the Federal Court in
F.C. of T. v. Ampol Exploration Limited 86 ATC 4859; (1986) 69 A.L.R. 289. However, that case involved particular, if not unique, facts and although the elucidation of the relevant principles set out in that case is of considerable assistance, the application of those principles to the facts of that case can have little relevance to the determination of these appeals. As Lockhart J. stated (at ATC pp. 4860 and 4870; A.L.R. pp. 291 and 304) the case turned upon its own facts and circumstances and provided no warrant for a general proposition that outgoings of companies engaged in petroleum exploration were necessarily deductible under the second limb of subsec. 51(1) if the expenditure was related to that activity.
In F.C. of T. v. Ampol Exploration Ltd. (supra), the principal business of the taxpayer was carrying out the work of exploration for petroleum. The business had been conducted principally in Australia and its offshore waters. The activities were conducted for reward. As a subsidiary of Ampol Petroleum Limited the taxpayer obtained the opportunity to carry out exploration activities in the Peoples Republic of China and the disputed expenses were incurred by the taxpayer carrying out the work of exploration for oil in areas off the coast of China. The exploration activity was carried out without the grant of a lease or tenement and no rights to petroleum would have been created by the discovery of a petroleum field in the course of the exploration activity. Pursuant to the agreement made with the Chinese Government, the exploration activity was a data-gathering exercise after the completion of which the surveyed areas were to be divided and offered for bidding by interested parties. The activities in respect of which the taxpayer incurred expenditure were incapable of producing any interest from which an income-producing asset could arise such as the ownership of an oil or gas resource. The Full Court held that the taxpayer's expenditure was necessarily incurred in carrying on the taxpayer's business of petroleum exploration. In addition the taxpayer had entered a deed of assignment pursuant to which it assigned any rights it may have acquired by its activities, including the right to tender and bid for the right to further explore, develop and exploit any of the surveyed areas and in return the assignee, another subsidiary of Ampol Petroleum Limited, covenanted to pay to the taxpayer certain fees for that assignment. It was held that the expenditure also attracted the operation of the first limb of sec. 51 in that it was incidental and relevant to gaining or producing the taxpayer's assessable income in
ATC 4757the form of the fees provided for in the deed of assignment being remuneration for the taxpayer's activities in exploration off the Chinese coast.
In F.C. of T. v. Ampol both Lockhart and Burchett JJ., in separate judgments, concluded that the expenditure of the taxpayer was of a revenue and not of a capital nature, the reason for the conclusion of Lockhart J. being that the payments in question were in truth part of the outgoings of the taxpayer in the course of carrying on its ordinary business activities and not expenditure incurred for the purpose of creating or enlarging a business structure or profit-yielding or income-producing asset (ATC p. 4872; A.L.R. p. 307). Burchett J. concluded that the expenditure was an ordinary incident of the company's operations which may or may not yield a return and was not directed at changing the character of the profit-earning business of the company (ATC p. 4882; A.L.R. p. 319).
Perusal of the invoices exhibited to the affidavit of the secretary of Griffin Coal and the evidence of Mr Strmotich make it clear that the accounting procedure adopted by Griffin Coal distinguished between expenditure or outgoings incurred in respect of the prospect of developing a contract to sell coal to the operators of the proposed aluminium smelter or the supplier of electrical power to that venture and the expenditure or outgoings incurred in promoting Griffin Coal's objective of becoming a member of a consortium to construct and operate the smelter and in assessing the feasibility of, and likely return on, investment in the joint venture. The elements of the latter expenditure related entirely to the assessment of the smelter project, the entry into a joint venture, the financing of the obligations to be undertaken as a joint venturer, the assessment of the market for the purchase of alumina, the assessment of the market for the sale of aluminium metal, the negotiation of tolling contracts and the consideration of procedures for the minimisation of industrial problems in the construction and operation of the smelter.
By July 1984 Griffin Coal had succeeded in gaining an acceptance in principle by ICC and Reynolds Metals of the proposal that Griffin Coal should be a participant in the proposed consortium to study the feasibility of the construction of an aluminium smelter. At the beginning of August 1984 that approval in principle was converted to the formation of a consortium comprised of the three parties. Griffin Coal's expenditures for the study of the feasibility of the smelter project in the course of the year ending 30 June 1985 were incurred after August 1984 as part of, or in conjunction with, its participation in that consortium.
Although Griffin Coal's preferred option may have been to further develop its coalmining business by extracting coal from a mine to be established on its Ewington leases and to sell that coal at commercial rates to the operators of the proposed smelter, it was very clear by July 1984 that no such sales could be negotiated.
Griffin Coal, therefore, determined that the path to be followed was to accept a modest or minimal return over the cost of extraction of the coal and to endeavour to secure a participating interest in the operation of the smelter and receive a profit on that investment sufficient to provide an appropriate return on its investment in the smelter and on the investment in the additional coalmining operation. If it were accepted as a participant in the smelter joint venture, a step projected to secure a firm profit, Griffin Coal at the same time would secure its competitiveness as a tenderer for the supply of coal to be used in the generation of electricity for the use of the smelter. Its competitor on the coalfields, Western Collieries Limited, would be less able to match Griffin Coal's proposal for coal supply if it had to place greater reliance on the direct receipt of profit from the sale of coal.
Griffin Coal argued that its motivation was to obtain an appropriate profit from the sale of coal and to obtain part of that profit by using the lever of its willingness to enter a contract for the sale of coal on terms favourable to the smelter participants to obtain an interest in the smelter project and access to the profit to be obtained by such participation. The facts show that the activities and objectives of Griffin Coal were not so limited. Firstly, it perceived the leverage it could exert as supplier of the cheapest fuel for power generation as opening up an opportunity for the company to diversify its activities and move beyond the extraction and sale of coal for which there was little or no export market and for which Griffin Coal was dependent upon the goodwill and bargaining strength of a single customer. Secondly, participation in the smelter project itself opened
ATC 4758up possible areas of further diversification for Griffin Coal, or for the group of companies of which it was part, as a fabricator or manufacturer of aluminium products. Thirdly, Griffin Coal could negotiate for such profit as it may have forgone on the sale of coal to be recognised by the smelter participants and have that profit capitalised and treated as part of Griffin Coal's capital contribution to the smelter project.
The securing of an off-take agreement or tolling agreements to fix a rate of return and eliminate risks that may be inherent in attempting to sell aluminium ingots on the world market would be prudent steps to be expected of any operator of a business of aluminium production. It cannot be said that the proposal under consideration by Griffin Coal, and on which outgoings were incurred, was the consideration of some scheme for the receipt of a deferred profit on the sale of coal. The outgoings were incurred for the purpose of assessing and understanding the range of its obligations and liabilities as a joint venturer in the construction and operation of an aluminium smelter. The proposal entailed entirely new activities for the company necessitating an understanding of the business of an aluminium producer and vendor. Although the eventual target of the expenditure on attempts to obtain a contract to supply coal to the smelter operation and on the study of the feasibility of participation in the smelter project may have been the same, namely the return of a profit on whatever investment was required to be committed, part of that target was to be reached by the use of a new arrow in the quiver, namely the operation of an aluminium smelter. Furthermore, any profit forgone on the sale of coal and capitalised as equity in the joint venture project for the production of aluminium could not serve to stamp the profits of the investment in the smelter project joint venture as profits from the existing business activity of extracting and selling coal.
The argument that the pursuit of a contract for the sale of coal was so inextricably mixed with the pursuit of participation in the aluminium smelter joint venture that all outgoings were necessarily incurred by Griffin Coal in carrying on its business for the purpose of gain or, alternatively, incurred in producing assessable income, does not reflect the actual circumstances. There was a clear demarcation between the activities undertaken by Griffin Coal in seeking a further long-term contract for the sale of coal and the activities undertaken by it to assess the feasibility of the construction and operation of an aluminium smelter and of Griffin Coal's participation in that venture.
At the time Griffin Coal undertook the latter expenditure the broad outline of the extent of Griffin Coal's possible commitments to the venture were known and horizons had been set as targets for the construction and completion of the smelter. The project was well advanced. The feasibility studies were not mere assessments of whether a project could be undertaken, they were also groundwork activities for the project involving the preparation of tender documents and draft contracts leading to the distribution of invitations to contractors in February 1985 to bid for project construction contracts. There were no discrete stages. The feasibility studies were flowing into the selection of a site, settlement of environmental questions, negotiation of contracts and firm commitments.
It would not be correct to say that the expenditure incurred in the years ending 30 June 1985 and 30 June 1986 was merely of a preliminary nature made under the umbrella of the conduct of the existing business. By July 1984 Griffin Coal had moved well beyond seeking general information. It was engaged in precise activities directed at assessing the prospects of, and preparing the ground for, acquisition of an asset, namely a right of participation in a joint venture for the construction and operation of an aluminium smelter. It was not to the point that essential contracts for the venture had not been concluded. Understandings had been reached and the activities undertaken on the foundation of those understandings were not mere explorations of feasibility but were also the erection of framework necessary for the commencement of a project to construct and operate an aluminium smelter. All of those activities were clearly directed at bringing about the formation of an asset.
In participating in these activities, Griffin Coal was looking at the reality of a new venture. It had moved well beyond an incident occurring in the course of the business of coal extraction and sale. The expenditure on those activities was incurred with the knowledge that the company may have been a participant in the
ATC 4759smelter project but not the supplier of coal to be used to generate electricity required by the smelter if, in due course, SECWA accepted a more competitive tender for the supply of coal submitted by Western Collieries Limited. Griffin Coal's proposal to SECWA for the supply of coal at a price of $20 per tonne enabled SECWA to obtain the approval of State Cabinet to offer to the consortium to supply power at a nominated tariff, but SECWA intended to seek competitive offers from both suppliers before concluding a contract for the supply of coal. The efforts of Griffin Coal had won for it a place in the consortium, but neither on its part nor on the part of its co-venturers was Griffin Coal's place in the consortium conditional upon it being the supplier of coal to be used for the purpose of generating the electricity to be supplied to the smelter.
It must be concluded that the subject expenditure incurred by Griffin Coal was part of the cost of formation of a new source of income and that the expenditure was not an aggregation of outgoings necessarily incurred in carrying on the existing business for the purpose of producing assessable income from the conduct of that business.
For the second limb of subsec. 51(1) to apply the loss or outgoing must have been necessarily incurred in the carrying on of a business. The outgoings disallowed were not necessarily incurred in carrying on the business of extraction and sale of coal. They were expenses incurred for the purpose of seeking to acquire an asset to be used in an expanded business of Griffin Coal or in a business conducted by another member of the Griffin group of companies but they were not expenses necessarily incurred in carrying on the existing business of Griffin Coal.
However, if somehow the outgoings could be regarded as having been so incurred, they were outgoings of a capital nature in their entirety and as such were not allowable deductions under subsec. 51(1) of the Act.
The following statement by Dixon J. in
Sun Newspapers Limited v. F.C. of T. (1938) 61 C.L.R. 337 at p. 363 is often used as the guide to determine whether an outgoing is a capital sum or made on revenue account:
``There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use of enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.''
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634 at p. 647 Dixon J. elaborated upon that earlier statement of opinion on the principles to be observed in determining whether an outgoing was on account of capital or revenue by referring to:
``the general consideration that the contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.''
In Hallstroms' case Dixon J. was not prepared to concede that the distinction between outgoings of capital and revenue nature was so uncertain as to be a matter of chance (p. 646). As Lord Pearce stated in the judgment of their Lordships in
B.P. Australia Limited v. F.C. of T. (1965) 112 C.L.R. 386 at p. 397, the ultimate answer involves the application of common sense.
``The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations
ATC 4760may produce a situation where the answer turns on questions of emphasis and degree. That answer `depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process' (per Dixon J. in Hallstrom's [sic] Case). As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallize particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken.''
As was stated by the chairman of directors of Griffin Coal in September 1984 in a circular to shareholders, the company was attempting to diversify its operations by seeking to become a joint venturer in the operation of an aluminium smelter. The outlays and the various preliminary matters relating to the assessment of that proposition were all calculated to carry that business purpose into effect. Notwithstanding that in the end the venture did not proceed, the expenditures were designed to secure an acquisition of a means of production and to establish a new element of Griffin Coal's business or, indeed, a new business to be conducted by another member of the Griffin group of companies. The fact that the venture did not proceed did not prevent the expenditure being of a capital nature. (See
Softwood Pulp and Paper Ltd. v. F.C. of T. 76 ATC 4439.)
Unlike the taxpayer in F.C. of T. v. Ampol which was not concerned with enlarging the framework within which its business activities were carried on, Griffin Coal had a very clear purpose of enlarging the structure of business able to produce income and was seeking, in part, to use its right to mine and produce coal as a source of capital for entry into an extended form of business. All of the expenditure disallowed as a deduction concerned outgoings solely related to the evaluation of participation in the proposed new venture and was distinguished from any outgoings directed to ascertain whether Griffin Coal could mine and sell coal to the consortium or SECWA at cost or at a profit. All the expenses and outgoings related to the latter aspect were diligently isolated and made the subject of a separate claim for deduction duly allowed. It would be an erroneous account of the facts to suggest that Griffin Coal's outgoings after July 1984 in respect of investigating the worth and ramifications of participation in the smelter project were concerned with determining if Griffin Coal could sell coal profitably to the operators of the smelter or to SECWA or with some general purpose of expanding the opportunity of sales for the business.
The expenditure was incurred in acquiring and developing an interest as a member of a consortium to construct and operate a smelter. They were expenditures on capital account and the collapse of the project did not alter the nature of the expenditure at the time it was made. The object of the expenditure was to establish a new arm of the business of Griffin Coal and a new source of income and the outgoings were stamped with that character accordingly.
The outgoings were in the nature of establishment expenses designed to create and secure a lasting advantage and accordingly should be regarded as capital in nature. The following comments by Dixon J. in Sun Newspapers Limited v. F.C. of T. (supra) at pp. 359-362 are appropriate:
``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
ATC 4761material 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...
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 or system or `profit-earning subject'. It will thus be distinguished from the expenditure which should be recouped by circulating capital or by working capital.
`An asset or an advantage for the enduring benefit of a trade' is the phrase of Viscount Cave, a phrase which by constant use has become almost a formula. The elastic application which the expression should receive is illustrated from the facts in reference to which it was first used. For it was held to include the `lasting advantage of being in a position throughout its business life to secure and retain the services of a contented and efficient staff', which advantage a taxpayer company obtained by contributing the nucleus of a fund to pension its employees (British Insulated and Helsby Cables Ltd. v. Atherton).''
In the second line of submission it was argued that the outgoings were deductible under subsec. 51(1) in that they were made for the purpose of achieving a position that would create a demand for energy, in particular a demand for energy at its cheapest cost which would require SECWA to retain or expand its contracts with the suppliers of coal and require it to adopt a more conciliatory attitude to Griffin Coal thereby removing the then present threat of termination of the existing long-term contract for the supply of coal to SECWA.
With regard to the first limb of sec. 51(1), for the outgoings to have been incurred in gaining assessable income they must have been incidental or relevant to the gaining of the assessable income or incurred in the actual course of producing assessable income. (See Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295 at pp. 309-310; Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at pp. 56-57; and
Charles Moore and Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344 at p. 351.)
It is unnecessary to examine the limits of the first limb of sec. 51 as to how evident the expectation of income must be.
The assessable income was gained or produced irrespective of the outgoings concerned. At best it could be said that the outgoings had the object of creating a situation that would protect the source of assessable income, the coal sale agreement, or would remove the risk of possible destruction of the existing business by removing the threat of termination of that agreement. Outgoings upon such an object would be capital in nature, but in any case the expenditures in question were too removed from the gaining or producing of the assessable income to be able to be described as either incidental or relevant thereto or incurred in the actual course of production of it. (See
F.C. of T. v. D.P. Smith 81 ATC 4114 at p. 4117; (1981) 147 C.L.R. 578 at p. 586.)
With regard to the second limb of subsec. 51(1), it is not sufficient that outgoings have a temporal connection with the conduct of a business. They must be necessarily incurred in carrying on the business for the purpose of gaining assessable income. Expenditure must be clearly appropriate for the conduct of the business, the exigencies of the business making the expenditure imperative in the conduct of the business. (See
Snowden & Willson Proprietary Limited v. F.C. of T. (1958) 99 C.L.R. 431 per Fullagar J. at p. 444.) ``Necessarily incurred'' means that the expenditure must be dictated by the business ends to which it is directed, those
ATC 4762ends forming part of, or being truly incidental to, the business (per Dixon J. at p. 437).
In so far as aspects such as creating a new source of demand or effecting a reconciliation with SECWA may have been within the contemplation of the board of directors of Griffin Coal at the time outgoings were incurred on investigating and promoting the company's participation in the smelter joint venture project, either event was to be a benefit to accrue from establishing and, hopefully, participating in a new profit-earning structure. It was not the case that the acquisition of an interest in that structure was a mere ancillary to the discharge of an imperative expenditure of the business directed at reducing the ``gas bubble''. The expenditure by Griffin Coal was part of the necessary cost of securing participation in, and assessing the worth of involvement in, a new operation. It was not directed at promoting the construction and operation of an aluminium smelter to which Griffin Coal may or may not sell coal, at little or no profit, merely for the purpose of reducing the ``gas bubble'' and improving its relationships with SECWA thereby securing the existing principal source of assessable income.
Therefore, it could not be said that the disallowed outgoings were necessarily incurred in gaining or producing the assessable income of the business of Griffin Coal.
In any event, if, according to this further submission, the outgoings were capable of being regarded as qualifying under either limb of subsec. 51(1), the expenditure was capital in nature in that it was designed to create a new structure that would alter the nature of the market for SECWA as a supplier of power. It sought an advantage of lasting quality to be achieved by discrete outgoings and investments. Accordingly, the outgoings were incapable of meeting the requirements of allowable deductions under subsec. 51(1).
In the light of the findings set out above, it is unnecessary to consider to what extent the further expenses incurred in the year of income to 30 June 1986 after the cessation of the smelter project and settlement of the dispute between SECWA and Griffin Coal in June 1985 had any connection with the gaining of assessable income by Griffin Coal or were incidental and relevant to the carrying on of its income-producing activity, the business of the company. (See Ronpibon Tin N.L. v. F.C. of T.; Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T.)
It could not be said that after June 1985 any expenditure which related to the assessment of the smelter project was for the purpose of expanding the opportunities for coal sales or for protecting the coal sale agreement against termination and, therefore, it could not be said that the outgoings were incurred in gaining or producing the assessable income. Had it been found that expenditures incurred in the year of income ending 30 June 1985 had been outgoings necessarily incurred in carrying on the business of Griffin Coal not being outgoings of a capital nature, it may have been necessary to assess what part of the expenses incurred in the following year of income was an unavoidable consequence of the prior expenditure and was, therefore, equally necessarily incurred in the course of carrying on the continuing business of Griffin Coal. (See
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057; (1975) 132 C.L.R. 175.)
The appeals, therefore, will be dismissed.