FC of T v GKN KWIKFORM SERVICES PTY LIMITED

Judges:
Davies J
Beaumont J
O'Loughlin J

Court:
Full Federal Court

Judgment date: Judgment handed down 17 April 1991

---

Davies J

These are appeals from a judgment of a single judge of the Court [reported at 90 ATC 4823]. His Honour upheld appeals against assessments of the taxable income of GKN Kwikform Services Pty Limited (``Services'' in respect of the years of income, 1 May 1984 to 30 April 1985, 1 May 1985 to 30 April 1986 and 1 May 1986 to 31 December 1986.

Services was one of a number of companies in the GKN Group. Another company, GKN Kwikform Sales Pty Limited (``Sales''), handled the sale of scaffolding components to purchasers in the building and related industries and sold scaffolding to other companies in the group including Services. The business of Services was to hire out scaffolding equipment to users in the building industry.

The scaffolding held and hired out by Services was undoubtedly plant and was so treated by Services and accepted by the Commissioner. The provisions of s. 54 of the Income Tax Assessment Act 1936 (Cth) (``the Act'') were applied in respect thereof. We are not concerned with the fact that, as it was not practicable to keep track of each individual item of equipment, accounting means were adopted to calculate the depreciation. There is no disagreement between the parties in these appeals as to the basis upon which any figures were calculated or as to the figures themselves. I therefore need not discuss
FC of T v. Cyclone Scaffolding Pty Ltd 87 ATC 5083 ; (1987) 18 F.C.R. 183 in which the majority decision turned on the appropriateness of the accounting system adopted.

The issue in the dispute arises from the fact that there was a regular leakage of scaffolding due to the failure of hirers to return all the

---

ATC 4338

amounts hired. A short-return rendered the hirer liable to pay to Services, in addition to the hiring fee, compensation for the items not returned. Each hiring agreement contained a provision in or to the effect that: -

``on termination of hire the hirer shall forthwith pay to the Company an amount sufficient to cover all losses at the then current list price for such lost items and any other costs and expenses which the Company may incur as the result thereof.''

The amount received by Services under this clause was, in the 1985 year, $837,781.00, being 5.71% of total receipts of Services' business, in the 1986 year it was $1,133,697.00, being 3.26% of total receipts, and in the 1986 year ending December 1986 it was $828,688.00, being 3.25% of total receipts.

The issue does not involve the total of these sums. We are concerned only with the profits that inevitably arose. The current list prices charged for non-returns were Sales' current prices and, as those prices increased from time to time over the subject and prior years, the receipt of the compensation resulted in profits being the excess over the cost of the lost scaffolding. The profit was $442,088.00 in the first year, $749,049.00 in the second year and $586,460.00 in the third year. These profits were the result of an accounting calculation based on FIFO and an average cost. The existence of the profits and their quantification are agreed. The issue in these appeals is whether the profits were assessable revenue, as the Commissioner contends, or capital profits, as is contended on behalf of Services.

Evidence was called that the clause I have mentioned was inserted in the hiring agreements, not with a view to making a profit, but with a view to imposing a stiff penalty which would encourage the return and discourage the non-return of all items of equipment hired. That is a factor to be taken into account; but it is equally true that the inclusion of the clause in the contracts of hire and its implementation in the event of short-returns had the inevitable and known consequence that the compensation received for short-returns would be greater than the cost price to Services of the goods which were hired.

Services did not have to make a profit on short-returns. It could have charged for short-returns the cost price of the goods which were lost. In this event, no part of the compensation received would have been treated as income. But it chose to make a profit, partly for the reason that, by doing so, short-returns were discouraged. For the purposes of income tax, the reason why a businessman wishes to make a profit is irrelevant. What is important under s. 25(1) of the Act is whether the profit derived was a regular and ordinary incident of the carrying on the business undertaking.

The present is a clearer case even than
Memorex Pty Ltd v. FC of T 87 ATC 5034 ; (1987) 77 A.L.R. 299 , in which the judgment went against the taxpayer. In the present case, there is no doubt that what occurred was a regular and ordinary incident of Services' business. In Memorex, it was necessary to examine the facts and to pay regard to what was said in cases such as
Gloucester Railway Carriage & Wagon Co. Ltd v. Inland Revenue Commissioners [1925] A.C. 469 before coming to that conclusion. Once that finding had been made, the Court considered that the profit derived was assessable in accordance with the principle enunciated in
Californian Copper Syndicate Ltd v. Harris (1904) 5 T.C. 159 and the many decisions of the High Court of Australia applying that principle.

As was said by Mason A.C.J., Wilson, Brennan, Deane and Dawson JJ. in
FC of T v. Myer Emporium Ltd 87 ATC 4363 at 4366; (1986-1987) 163 C.L.R. 199 at 209 : -

``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.''

Their Honours went on to emphasise the distinction drawn by the Lord Justice Clerk in Californian Copper Syndicate v. Harris between, on the one hand, an act done in what was truly the carrying on, or carrying out of a business and, on the other, a mere realisation or change of investment.

In Services' case, profit-making resulting from the enforcement of the compensation clause was a regular incident of Services' business of hiring out scaffolding. It was put by counsel for Services that the sums received on

---

ATC 4339

short-returns were of a capital nature for they were compensation for the loss of scaffolding which, in the hands of Services, was a capital asset. Remarks in
The Federal Coke Co. Pty Ltd v. FC of T 77 ATC 4255 at 4273; (1977) 34 F.L.R. 375 at 401-2 , and in G.P. International
Pipecoaters Pty Ltd v. FC of T 90 ATC 4413 at 4419-4420; (1990) 64 A.L.J.R. 392 at 396 were relied upon. But it is not sufficient to show that the cause of the receipts was the non-return of plant. It is necessary to apply the principles I have mentioned, which have been enunciated in so many cases, many of which were mentioned in Memorex. Two recent examples are
R.A.C. Insurance Pty Ltd v. FC of T 90 ATC 4737 and
FC of T v. Employers' Mutual Indemnity Association Ltd 90 ATC 4787 . The High Court recently repeated the principle in G.P. International Pipecoaters Pty Ltd v. FC of T. The Court said at ATC 4422; A.L.J.R. 398: -

``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.''

And so, in the present case, it is crucial that the non-return of scaffolding was a regular, expected and ordinary incident of Services' business and that the profits derived therefrom.

By way of analogy, it is relevant to consider BP Australia Ltd v. FC of T in which a petrol company paid moneys to petroleum retailers in exchange for exclusive ties. At first instance, (1964) 13 A.T.D. 268; (1961-1964) 110 C.L.R. 387, McTiernan, Windeyer and Owen JJ. held that the sums paid were paid to secure capital assets, petroleum sites. However, Dixon C.J. and Kitto J. held that the sums paid were deductible. At A.T.D. 272; C.L.R. 410, Dixon C.J. emphasised that the taxpayer ``was engaged in a continuous process of business expenditure''. The minority view was upheld by the Judicial Committee (1965) 14 A.T.D. 1; (1965) 112 C.L.R. 386. The opinion of their Lordships, delivered by Lord Pearce, emphasised at A.T.D. 8-9; C.L.R. 398-9 that the payments were not made once and for all but were of a recurrent nature made to meet a continuous demand in the trade. Likewise, in
FC of T v. Ampol Exploration Ltd 86 ATC 4859 ; (1986) 13 F.C.R. 545 , Lockhart and Burchett JJ., Beaumont J. dissenting, held that certain expenditure was an allowable deduction under s. 51(1) of the Act and was not of a capital nature. At ATC 4872; F.C.R. 562, Lockhart J. said: -

``The true legal character of the expenditure was that of the ordinary business activity of the taxpayer as a petroleum exploration company... The payments in question were in truth part of the outgoings of the taxpayer in the course of carrying on its ordinary business activities. It was not expenditure incurred for the purpose of creating or enlarging a business structure or profit-yielding or income-producing asset.''

The basal distinction between receipt or outgoing on capital account and the receipt or outgoing on revenue account was enunciated [by] Dixon J. in
Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1938) 5 A.T.D. 87 ; (1938) 61 C.L.R. 337 . At A.T.D. 93-4; C.L.R. 359, his Honour said: -

``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 organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and the returns representing profit or loss.''

This principle accords with the cases I have mentioned above. The profits which Services derived from short-returns were not of a capital nature in this sense. The profits did not go to the business structure or entity but were a part of the regular returns resulting from the manner in which Services operated its business Cf.
Allied Mills Industries Pty Ltd v. FC of T 88 ATC 4852 at 4864; 89 ATC 4365 (Full Ct) at 4371-2; (1989) 20 F.C.R. 288 at 303-4, 311-12 .

I would allow the appeals with costs. I would set aside the orders made by the trial judge and would substitute therefor orders that the applications to the Court be dismissed with costs.

---

ATC 4340