G.P. International Pipecoaters Pty. Ltd. v. Federal Commissioner of TaxationJudges:
Full High Court
Brennan, Dawson, Toohey, Gaudron and McHugh JJ.
The appellant taxpayer was assessed to income tax and to undistributed profits tax for the income year ended 30 June 1983 on the footing that its assessable income included the sum of $3,117,291, described in an adjustment sheet as ``mobilisation deposits''. It was assessed to income tax for the income year ended 30 June 1984 on the footing that its assessable income included the sum of $1,558,639, also described in an adjustment sheet as ``mobilisation deposits''. The sum of these two amounts, $4,675,930, was received by the taxpayer from the State Energy Commission of Western Australia (``SECWA'') under a contract which described that sum as ``establishment costs''. The taxpayer objected to the relevant assessments claiming that the moneys received as establishment costs did not form part of its assessable income. The objections having been disallowed, the taxpayer appealed unsuccessfully to the Supreme Court of Western Australia (Pidgeon J.) and to the Full Court of the Federal Court of Australia [reported at 87 ATC 4678 and 88 ATC 4823]. In its appeal to this Court, the question is whether the amount received by the taxpayer as establishment costs is assessable income falling within sec. 25(1) of the Income Tax Assessment Act 1936 (Cth) (``the Act''). The Commissioner does not rely on sec. 26(a) as that provision stood in the relevant income years.
The contract related to the external and internal coating of pipes to be used to transport natural gas from Dampier to Perth and the south-west area of Western Australia. Tenders had been called by SECWA for the external and internal coating of the pipe required. A joint tender, submitted by Gardner Perrott C.K.K. Pty. Ltd. (``GPCKK'') and Commercial Resins-Indeng Pty. Ltd. (``CRI''), was accepted by SECWA on 9 December 1981. The tender price, based upon the estimated quantities of pipe required, was $31,172,910. The several components of the price were set out in the several schedules of rates to be charged for the respective units of equipment or service. The taxpayer was incorporated by GPCKK and CRI on 15 January 1982 to take an assignment of their interests under the accepted tender and to enter into and to perform the contract which was to embody the agreed terms. The tender price of $31,172,910 was translated into the contract as the contract price for the several categories of work to be done under the schedule of rates set out in Sch. B.
There was a significant difference between the components of the tender price and the components of the contract price. The components of the tender price did not include an item ``establishment costs'', whereas that item was specified as a component of the final contract price. Necessarily, the amounts attributed to certain items in the tender (notably external and internal coating) were reduced in
ATC 4416the contract to allow for the insertion of the item ``establishment costs'' amounting to $4,675,930. There was a further significant difference between the tender and the contract. Whereas the whole of the tender price was subject to an escalation clause, the amounts to be paid as ``establishment costs'' under the contract were fixed: cl. SC12.3.
The explanation of these differences is to be found in the intention of GPCKK and CRI to construct a plant at Geraldton where the pipe-coating required by the contract would be performed. They might have utilised a plant in Holland to do the pipe-coating, but SECWA preferred the establishment of a local plant. It was estimated by GPCKK and CRI that the cost of constructing the local plant would be of the order of $4,252,600 and that the residual value of the plant after the contract had been performed would be of the order of $1,115,300. The estimated depreciation of the plant was taken into the calculation of the tender price. To obtain funds for constructing the plant, GPCKK and CRI provided in their tender for a cashflow of payments of 5% of the total contract value on each of day 1, day 90 and day 180 of the contract period in advance of the commencement of production. Mr Marijs, a director of GPCKK's parent company, explained:
``... SECWA, if it wanted the pipe to be coated in Western Australia by ourselves, would have to provide the plant although we could undertake to supervise and organise its construction. It was agreed that the SECWA would be required to contribute the capital in advance necessary for the construction of the special plant but there were then problems arising from the fact that the tender had to be for a `schedule of rates' contract with all the costs being expressed in terms of the overall rates for coating pipe. We got around this problem by expressing the capital contribution requirement for plant construction in the cashflow schedule of the tender.''
He added that ``it was never intended to make any profit from the construction of the plant''. After the tender was received but before it was accepted, SECWA asked GPCKK and CRI to review the tender in respect of these ``up front'' payments. The tenderers replied on 9 September 1981:
``In our bid, in accordance with the requirements of your Schedule F, we show a projected Cash Flow which allowed for the payment by the Commission of three amounts, each valued at 5% of the contract on Day 1, Day 90 and Day 180 inclusive.
We have been asked to review our bid and advise the Commission of the extra required by us to allow for payment on pipes produced with no `up front' payment. The extra cost to us is computed at $602,000. This would allow the Commission to pay therefore for pipes as they are produced from the Geraldton facility.
... The principle applied on this contract, and which we find to be fairly standard, is that a front end payment is made which effectively allows the contractor to establish on the site and remove from the contract amount, establishment costs. This means the cost of coating is reduced by that fixed establishment amount, and that any variations, either plus or minus, are then handled at a 15% discount. The Commission therefore, could ask the contractor to carry out the treatment of an additional meterage of pipe and have that work treated at a lesser rate than if he does not pay the up front payment.
Additionally escalation would also apply on the same basis. If the 15% up front payment was to be removed from the cost of treatment, then escalation would apply to a lesser amount than the Commission would be liable for if they are paid purely on a treatment basis.''
In the result SECWA opted to make the ``up front'' payments requested by the tenderers and the tender was accepted on that basis. Pidgeon J. found (at p. 4682):
``The reason why this total payment of 15% was requested was to cover the cost of erecting the plant. I am satisfied Mr Perrott arrived at this figure by estimating what it would cost to install the plant other than the leased equipment and that he made the calculation to yield a figure equal to this cost. It was the intention of the tenderer that it would be used for this purpose and it was so used.''
In saying that the payment of 15% (scil. the $4,675,930) was used for the purpose of
ATC 4417installing the plant, his Honour must have meant that the taxpayer, having received that amount into its coffers, then drew it out to pay the cost of erecting the plant. In fact the plant as constructed proved to be inadequate and it was necessary to upgrade it so that the total cost exceeded the amount estimated for the construction of the plant by $1,099,367.40. Pidgeon J. found:
``The taxpayer made no profit in respect of construction of the plant.''
The contract bound SECWA to make the payments provided for in the contract ``[i]n consideration of the agreements on the part of the Contractor in the Contract set forth'' and bound the taxpayer to execute the contract work ``[i]n consideration of the agreements on the part of the Principal in the Contract set forth'': cl. 4 and 3. The scope of the work contained in the contract was expressed to comprise ``application of external and internal coatings... [and the furnishing of] all coating materials, labour, supervision, inspection and plant and equipment as required for performance of the... work'' of pipe-coating: cl. A1.1. The taxpayer's obligation with respect to the construction of the plant was stated in Pt 1 of Sch. C to the contract which provided:
``PIPE COATING PROGRAMME
The Contractor undertakes to construct the coating plant and perform the pipe coating operation in accordance with the following programme.
- (a) Coating Plant Construction Programme
- The Contractor shall construct the coating plant in accordance with the programme titled `Critical Path Plan - Internal and External Coating Plants'.
- (b) Pipe Coating Programme
- (c) Alterations to Programme
The Critical Path Plan specified, inter alia, the time within which various stages of the work in constructing the plant and installing and testing the equipment was to be completed. By Pt 3 of Sch. C to the contract, the taxpayer agreed to establish the production plant at Geraldton in accordance with certain drawings. The special conditions of the contract provided for progress payments to be made on progress certificates to be issued by the engineer certifying the value of work carried out in performance of the contract, the certificates being based upon statements to be submitted periodically by the contractor to the engineer: cl. SC2.6. But claims for establishment costs were subject to a different regime. The contract provided (by cl. SC2.6):
``... subject to Clauses SC19.0 and SC20.0, the Contractor shall be entitled to submit to the Engineer a claim for Establishment costs. The amount shall be paid in three instalments in accordance with Schedule B Item B2.0 on the following basis:Payment Item Date payable after No. Acceptance of Tender Item B2.1 One (1) day after Date of Acceptance of Tender Item B2.2 Ninety (90) days after Date of Acceptance of Tender Item B2.3 One hundred and eighty (180) days after Date of Acceptance of Tender.''
The amount of the establishment costs were specified in Sch. B, item B2.0 as follows:
``--------------------------------------------------------------------- Unit Item Estimate Rate Amount No. Description Unit Quantity $ $ c --------------------------------------------------------------------- B2.0 Establishment costs B2.1 Establishment costs to be paid on Day 1 of the Contract Lump Sum 1,558,645.50
ATC 4418--------------------------------------------------------------------- Unit Item Estimate Rate Amount No. Description Unit Quantity $ $ c --------------------------------------------------------------------- B2.2 Establishment costs to be paid on Day 90 of the Contract Lump Sum 1,558,645.50 B2.3 Establishment costs to be paid on Day 180 of the Contract Lump Sum 1,558,639.00 ------------- SUB TOTAL $4,675,930.00 -------------
- For conditions relating to payments made under Item B2.0
- above. Refer to Clauses SC2.6, SC19.0 and SC20.0.''
The amount to be paid to the taxpayer as establishment costs under item B2.0 corresponds with the 15% of the contract value sought by GPCKK and CRI in their tender and in their letter of 9 September 1981. In accordance with the agreement between the tenderers and SECWA, these three payments were excluded from the operation of the escalation clause: cl. SC12.3.
Of course, by agreeing to make advances before the coating of pipe commenced, SECWA was exposed to a risk of loss of the money to be paid ``up front''. SECWA was given some security by cl. SC19.0 and SC20.0 mentioned in item B2.0. Clause SC19.0 required the taxpayer to lodge with SECWA ``an unconditional and irrevocable (pay on demand) Undertaking to the value of the payment'', the undertaking to be given by an approved bank or insurance company: cl. SC19.1. The undertakings were convertible into cash on demand without the need to provide any reasons at any time prior to the issue of the Final Certificate: cl. SC19.2. They were to be ``released to the Contractor in accordance with Schedule B. Item B2.4.3'' (cl. SC19.5), a curious provision for Sch. B does not contain an item B2.4.3. Clause SC20.0 required the contractor to provide performance and payment bonds by an acceptable surety ``for the purpose of securing the Principals Interest in the case of payment made under Item B2.1 and further ensuring the due, proper and faithful performance of the Contract and of satisfying all the obligations of the Contractor under the Contract'': cl. SC20.1 and SC20.2. By cl. SC20.6(a), bonds lodged for the payments made under items B2.2 and B2.3 were to be released when certain stages of the production had been completed but the undertaking lodged for the payment made under item B2.1 was not to be released until the engineer issued his certificate of practical completion for the whole of the works.
The taxpayer was not bound by contract to meet the cost of constructing the plant out of the moneys received from SECWA as establishment costs. The taxpayer (or its parent companies) was free to choose the manner in which it would finance the construction of the plant, but it was to be put in funds to the extent of $4,675,930. None of the three payments specified in items B2.1, B2.2, and B2.3 necessarily bore any relationship to the value of work which was to be done by the date on which the payment was to be made. Indeed, the first payment was to be made on day 1, perhaps before any work commenced. Although the contract ensured that the taxpayer had sufficient funds to meet the estimated cost of constructing the plant, the establishment costs were not paid in discharge of any obligation to pay for the construction. SECWA's interest in seeing the plant constructed was secured not by a right to withhold payment of any of the establishment costs in the event of delay in construction of the plant but by the unconditional undertakings and performance bonds which the taxpayer was to provide and which were enforceable to recoup the moneys advanced if construction did not proceed according to the Critical Path Plan.
SECWA also had a right to ``terminate the Contract in whole or in part'' by giving the taxpayer 21 days' written notice to that effect: cl. SC10.0. Upon payment of some prescribed sums, SECWA was entitled ``to take possession of all parts of the Work''. Some reliance was placed on this provision as conferring on SECWA a right to take back the plant and it will be necessary to refer again to this clause after the question for determination is identified.
The question in this appeal is the character of the establishment costs as receipts in the hands of the taxpayer. ``Whether or not a particular receipt is income depends upon its quality in the hands of the recipient'':
Scott v. F.C. of T. (1966) 117 C.L.R. 514, per Windeyer J. at p. 526. The relevant question is not the character of the expenditure by SECWA. A receipt may be income in the hands of a payee whether or not it is expenditure of a capital nature by the payer. Nor is the relevant question the nature of the expenditure made by the taxpayer in the construction of the plant. A taxpayer may apply income in the acquisition of a capital asset or, conversely, apply a capital receipt to discharge a liability of a non-capital nature. As Cozens-Hardy M.R. observed in
Hudson's Bay Co. v. Stevens (1909) 5 T.C. 424 at p. 436:
``... if the money is otherwise liable to income tax it cannot escape taxation by reason of its being applied to a capital purpose.''
And thus a receipt may be income although the recipient is bound to apply it for the purpose of discharging a capital liability:
Mersey Docks v. Lucas (1883) 8 App. Cas. 891 at pp. 904, 909-910;
Commrs of I.R. v. Corporation of London (as Conservators of Epping Forest) (1953) 34 T.C. 293 at p. 329; (1953) 1 W.L.R. 652 at p. 670; (1953) 1 All E.R. 1075 at pp. 1089-1090. The Commissioner and the taxpayer both treated the cost of constructing the plant as capital expenditure, but the question is not whether that was an expenditure of capital nor whether the plant was used for the purpose of producing assessable income so that depreciation of the plant was deductible under sec. 54 of the Act. The relevant question is whether the receipt of the establishment costs was income in the taxpayer's hands. It is necessary to keep that question steadily in mind and not to confuse the character of the receipt with the nature of the asset acquired by application of the moneys received.
The appellant's argument was, in substance, that the plant was a capital asset, that the moneys expended in its construction were an expenditure of a capital nature by the taxpayer and that, as those moneys were received for the purpose of expenditure on the construction of the plant, their receipt was a receipt of capital. The first two steps may be accepted but the final step assumes that, when money is received for the purpose of its being expended by the recipient, the character of the receipt is necessarily determined by the character of its proposed expenditure by the recipient. That assumption is erroneous and, even if the establishment costs were received for the purpose of expenditure on the construction of the plant, it does not necessarily follow that their receipt was a receipt of capital. Before turning to the character of the receipt, it is desirable first to consider the means by which the character of expenditure may be determined.
The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid:
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 363;
Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1953) 89 C.L.R. 428 at pp. 445-447, 454;
Cooper v. F.C. of T. (1957) 97 C.L.R. 397 at p. 404 (affirmed on other grounds: 100 C.L.R. 131); and see the differing analyses of what the subject expenditure was for in
Cliffs International Inc. v. F.C. of T. 79 ATC 4059; (1979) 142 C.L.R. 140. In the present case, the taxpayer expended the amount received as establishment costs - and more - in constructing the plant which it used in pipe-coating. That was an expenditure as capital and the plant was depreciable property. It was accepted on both sides that the plant was a capital asset and that expenditure by the taxpayer in its construction was an outgoing of a capital nature, though the plant was a wasting asset: see Cliffs International, per Gibbs J. at ATC pp. 4066-4067; C.L.R. p. 153. But that
ATC 4420circumstance does not necessarily answer the relevant question.
Although the amount received as establishment costs was expended by, and was intended by SECWA to be expended by, the taxpayer to meet the costs of constructing the plant so far as that amount would extend, and although the amount expended on the construction of the plant was a capital expenditure, it does not follow that the taxpayer's receipt of the establishment costs was a receipt of capital. To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.
The importance of ascertaining the scope of a business and a recipient's purpose in engaging in it as a means of determining the character of a receipt appears from a passage in the judgment of this Court in
F.C. of T. v. The Myer Emporium Ltd. 87 ATC 4363 at pp. 4366-4367; (1987) 163 C.L.R. 199 at pp. 209-210:
``Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a `one-off' transaction preclude it from being properly characterized as income (
F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031 at pp. 4036-4037, 4042; (1982) 150 C.L.R. 355 at pp. 366-367, 376).''
What was the scope of the business in which the establishment costs were received and what was the taxpayer's purpose in engaging in it? The taxpayer submits that its business consists in the coating of pipes, not in the construction of the plant. At the time when the tender was submitted, that was the intended scope of the business and the tender was submitted on the footing that the income of the business would be the fees calculated on the length of pipe which was coated. At that time, the taxpayer intended to construct the plant and sought an advance of 15% of the expected total fees to cover the anticipated costs of construction. If the tender documents be treated as defining the taxpayer's business, it is clear that 15% of the estimated total fee, though payable before production commenced, was intended to be received as income. If the cashflow requirement of 15% of the estimated fee payable on the coating of 1,500 km of pipe which was payable before production commenced had been received in the form contemplated in the tender documents, it would have been received as a payment on account of the coating fee. Such a receipt would have been income in the taxpayer's hands, at least as the coating progressed sufficiently to earn the 15%. However, the agreement which came into existence between GPCKK and CRI on the one hand and SECWA on the other was, and was intended by them to be, superseded by a contract entered into by the taxpayer and SECWA, the taxpayer being incorporated in order to enter into and to perform that contract. Recital F to that contract notes that GPCKK and CRI assigned their interest under the
ATC 4421antecedent agreement to the taxpayer on the day of its incorporation but, as the contract is deemed to be effective from the date of acceptance of the tender (cl. 7), the contract superseded the accepted tender. Therefore it is that contract which is critical to the ascertainment of the true scope of the taxpayer's business.
The activity of the taxpayer corresponds with what the contract required. The contract defines both what the taxpayer was bound to do and the consideration for doing it. It bound the taxpayer to construct the plant and to coat the pipe required by SECWA, and conferred on the taxpayer a right to receive the moneys payable thereunder including the establishment costs. The terms of cl. 3 and 4 of the contract show that the entirety of the obligations on one side were to be performed in consideration of the agreement to perform the entirety of the obligations on the other. The establishment costs were received by the taxpayer under the contract as part of the monetary consideration payable for the taxpayer's agreement to perform, or its performance of, the entire contract. It is impossible to treat the business of the taxpayer as limited to the coating of the pipe when the construction of the pipe-coating plant was an integral part of the work which the taxpayer was bound to perform. The establishment costs were not received under a severable part of the contract relating to the construction of the plant. By constructing the plant and coating the pipe the taxpayer performed the obligations in consideration for which it was entitled to be paid the establishment costs and other moneys payable under the contract. It earned the money by doing the work it had contracted to do. The establishment costs were not received in exchange for an item of capital or a right of a capital nature.
Clause SC10.0 does not affect this view. It is doubtful whether, if the contract had been terminated pursuant to cl. SC10.0, and SECWA sought ``to take possession of all parts of the Work'', SECWA would have acquired any title to the plant. The clause appears to be intended to enable SECWA to take possession of such work as it must pay for pursuant to that clause: ``The Contract Value of all parts of the Work completed in accordance with the Contract and all incomplete parts to the extent to which they have progressed... less any payments already made... in respect thereof.'' The clause does not entitle SECWA to take possession of the taxpayer's assets other than ``the Work'' to which a ``Contract Value'' is assigned. The establishment costs are not the ``Contract Value'' of the plant. Nor, if it be material, does the plant fall within the definition of ``the Works'' in cl. 2 of the General Conditions: work ``to be handed over to the Principal''. And if SECWA could acquire no title under SC10.0, the establishment costs could not be thought to be received in exchange for an item of capital. However that may be, there is a more fundamental reason why cl. SC10.0 does not affect the character of the receipt of the establishment costs. If the establishment costs, paid and received in partial performance of the contract, acquire the character of income from the terms of the contract which apply to its performance and define the taxpayer's business, they are not to be classified as capital by reason merely of cl. SC10.0 which applies not to its performance but only to its termination.
Looking at the contract as it was to be performed, it is clear that the cost of constructing the plant was the taxpayer's debt, not SECWA's; and the plant was the taxpayer's asset, not SECWA's. If the establishment costs had been received as the price on sale of the plant which the taxpayer had constructed for its own purposes, the receipt may well have borne the character of capital (
Egerton-Warburton v. D.F.C. of T. (1934) 51 C.L.R. 568 at pp. 572-573) and, on the other hand, if the establishment costs had been received as payment for work done in constructing a plant which was then to be transferred (but not sold) to SECWA, the receipt would have borne the character of income. Of course, the establishment costs were not received on either of those bases. The establishment costs were received under the contract which provided that the taxpayer should construct the plant for its own use and (putting cl. SC10.0 to one side) retain ownership of it. The taxpayer received the establishment costs and owned the plant it constructed. To say that the taxpayer made no profit in constructing the plant is to overlook the fact that the taxpayer's receipt of the establishment costs allowed it to construct the plant it needed to perform its contractual obligation of pipe-coating at a net cost to itself
ATC 4422which was $4,675,930 less than the actual cost of construction. This sum was a gain by the taxpayer, made in and by reason of the ordinary course of the business which it carried on.
Applying ``a business conception to the facts'' (see
F.C. of T. v. Becker (1952) 87 C.L.R. 456 at p. 467) the receipt of the establishment costs must be classified as a receipt of income. The taxpayer was engaged first in the construction of the plant and then in the coating of the pipe: that was the work it did and was bound to do under the contract. It received the establishment costs during the construction period and the appropriate linear rate on the coating and delivery of the pipe. It treated its expenditure on the plant as capital expenditure. It wrote off the plant to its residual value. There was no disposition of a capital asset throughout the entire venture, yet the work which was done - construction and coating - yielded receipts consisting in the establishment costs plus the amounts paid for coating the length of pipe required. If that aggregated sum be treated as the revenue derived from the carrying on of the business, the profit is arrived at by deducting expenditure on revenue account incurred in pipe-coating and the depreciation of the plant. That result accords with business conceptions, but it would distort those conceptions to omit the receipt of $4,675,930 from the calculation of a revenue profit arrived at after deducting depreciation on the plant. To omit the receipt of $4,675,930 from the calculation of the revenue profit would require the receipt to be treated as a capital profit, though it was not received as a gift intended to replenish capital nor in exchange for a capital asset. Once the receipt of $4,675,930 is seen to be a receipt in the ordinary course of carrying on the taxpayer's business, it is unnecessary to consider whether, if the ordinary course of its business did not include the construction of the plant, the receipt should nevertheless be treated as income on the ground that the construction of the plant was intended to be a separate profit-making venture. That question does not arise.
Next, it is necessary to consider the taxpayer's submission that the cases show that a receipt of moneys intended by payer and payee to recoup a recipient's capital expenditure is a receipt of a capital nature. That proposition can be accepted when the amount is received by way of gift or subsidy to replenish or augment the payee's capital, for in such a case the receipt cannot fairly be said to be a product or incident of the payee's income-producing activity: see
Hayes v. F.C. of T. (1956) 96 C.L.R. 47 at pp. 54-56;
The Federal Coke Company Pty. Ltd. v. F.C. of T. 77 ATC 4255; (1977) 7 A.T.R. 519;
Reckitt & Colman Pty. Ltd. v. F.C. of T. 74 ATC 4185; (1974) 4 A.T.R. 501;
The Seaham Harbour Dock Co. v. Crook (H.M. Inspector of Taxes) (1931) 16 T.C. 333. But it cannot be accepted that an intention on the part of a payer and a payee or either of them that a receipt be applied to recoup capital expenditure by the payee determines the character of a receipt when the circumstances show that the payment is received in consideration of the performance of a contract, the performance of which is the business of the recipient or which is performed in the ordinary course of the business of the recipient.
However, the taxpayer takes its stand on two cases in which payments made under a contract to recoup capital expenditure were held to be capital in the hands of the recipient. The first is
Boyce v. Whitwick Colliery Co. Ltd. (1934) 18 T.C. 655; (1934) All E.R. 706; the second is
A.P.A. Fixed Investment Trust Co. Ltd. v. F.C. of T. (1948) 8 A.T.D. 369; (1948) 4 A.I.T.R. 105. In Boyce, a colliery company agreed with the Coalville Urban District Council, a water authority, that the company would install plant and equipment to pump water out of its mine, to filter it and supply it to the council's system. The plant and equipment were specified by the council to meet its needs, and the council entered into a contract with the company to pay each year one-thirtieth of the cost outlaid by the company in installing the plant and equipment together with certain other charges including one penny per thousand gallons of water supplied. In the event of the company ceasing to work their colliery during the currency of the agreement (30 years with an option for a further 20 years), the council was entitled to continue to pump, filter and supply water using the plant and equipment installed for the purpose. (The facts are abbreviated, but they suffice to illustrate the point of the decision.) It was held that the payments of one-thirtieth of the cost outlaid in installing the plant and equipment were of a capital nature and not subject to income tax in the company's hands. Boyce was decided under a provision of the Income Tax
ATC 4423Act 1918 (U.K.) which brought to tax ``profits or gains arising... from any trade'' in the computation of which no sum was deductible in respect of ``... any sum employed or intended to be employed as capital in such trade'' (Sch. D, cl. 1(a)(ii), and r. 3(f) of the Rules applicable to Cases I and II). It was decided as one of two appeals decided consecutively: one by the company seeking to exclude the payments in respect of the cost of plant and equipment from the profits or gains arising from its trade, one by the council seeking to deduct those payments from the profits or gains arising from its water undertaking. Thus in the company's appeal, Lord Hanworth M.R. (at T.C. p. 680; All E.R. p. 711) said:
``I intend to look at the agreement as a whole and I find in the agreement a capital outlay made not really for the purpose of the Colliery Company but for the purpose of this supply of water and upon certain assets, that user of which, in certain events, might pass to the Council and in respect to which there was no undertaking or covenant or certainty that the Colliery Company would continue to use them for the full term of thirty years.''
His Lordship appears to disregard the company's extension of its business to the supplying of water in determining the character of the receipt. And Romer L.J. took the character of the expenditure by the council as determining the character of the receipt by the company. He said (at T.C. p. 685; All E.R. p. 714):
``The Urban District Council were desirous that water should be supplied to them by the Colliery Company and they, therefore, must have recognised that, if a contract was to be entered into by the Colliery Company for supplying water to them, the Colliery Company must put themselves into a position, by the provision of adequate machinery and buildings, to do so. If, in those circumstances, the Colliery Company had agreed with the Urban District Council that they would themselves erect the necessary buildings and machinery for the purpose and the District Council had agreed that, in consideration of their so doing, the Council would repay to the Colliery Company, by thirty yearly instalments, the cost to which the Colliery Company had been thereby put, I cannot conceive that anyone could contend successfully that the sums so paid by the District Council to the Colliery Company were liable to Income Tax, even though, at the end of the thirty years, the buildings and plant, which presumably by that time would not be worth very much, should remain the property of the Colliery Company. A taxpayer can make a capital expenditure upon the land of a third party; it is, none the less, a capital expenditure even if it is upon the land of a third party and not upon his own land.
The question that we have to determine, as it seems to me, is this: is the agreement of the 1st July, 1918, a composite agreement consisting partly of such an agreement as I have just referred to and partly of an agreement by the Colliery Company to supply the water when the capital expenditure had been made, or is it solely an agreement by the Colliery Company to supply the Urban District Council with water?''
When the council's case was decided, the capital character of the repayments which had been determined in the company's case seems to have been the important factor - Romer L.J. said ``it seems to me necessarily to follow'' - in determining that they were of a capital character in the council's trade of water undertakers: see pp. 689-690, 717. Indeed, the Crown had accepted that one appeal must succeed and one must fail (see 18 T.C. at pp. 674-676) according to the character attributed to the payment. Boyce is, in our opinion, open to substantial criticism. In so far as the decision in Boyce treated the character of the company's receipts as determined by the character of the council's expenditure, it cannot be accepted as sound authority - at least for the purposes of the Act. It is difficult to see why the profit or gain arising from the company's trade as a supplier of water should not include the amounts received periodically throughout the original term of the supply agreement merely because they were calculated to compensate the company for its expenditure on the plant and equipment required for the supply of water. If the Court in Boyce declined to treat the receipts there in question as income because they did not arise from the company's trade as the operator of a colliery, the decision failed to recognise the company's trade in
ATC 4424supplying water. The receipts appear to have been received in the ordinary course of the company's business of supplying water. Boyce is not sound in principle and, in our opinion, it should not be followed in this country.
The A.P.A. case arose out of an agreement for lease with an option of purchase. The intending lessor was to buy land and erect a building to be occupied by the intending lessee at a rental of £1,475/10- calculated at 5% on the cost of the land and 10% on the cost of the building. The rental approximated 8% p.a. return on the capital sum to be outlaid on land and building by the lessor. In addition, the lessee was to pay £250 p.a. as a ``sinking fund'' to meet the cost of the building. The price at which the lessee was to be entitled to exercise the option was the cost of the land and building less whatever had been paid into the sinking fund. For each payment of £250 made into the sinking fund, the rent was reduced by £20 p.a., or 8% of £250. Owen J. held that the payments into the sinking fund were not received as assessable income. He regarded those receipts as a recoupment of the capital outlaid, not as rent. The dichotomy may not be complete but the case is distinguishable from the present. There, every payment into the sinking fund reduced the value, pursuant to the option, of the recipient's capital asset; each payment was, so to speak, an instalment of the price contingently payable. Here, there is no sale or contingent sale of a capital asset by the taxpayer; the receipt of the establishment costs did not affect the taxpayer's ownership of or interest in the plant. Neither of the cases on which the taxpayer takes its stand requires this Court to hold that the establishment costs were received not as income but as capital. The establishment costs were not received as the price of a capital asset nor as a payment dissociated from the taxpayer's business; they were received as part of the remuneration earned by the carrying on of its business which consisted in the performance of the contract, that is, in constructing the plant and coating the pipe required. The establishment costs were therefore received as part of the taxpayer's assessable income.
The appeal must be dismissed.