KENNEDY HOLDINGS AND PROPERTY MANAGEMENT PTY LTD v FC of T
Judges:Hill J
Court:
Federal Court
Hill J
The applicant, Kennedy Holdings and Property Management Pty Limited has referred to this Court the decision of the respondent Commissioner of Taxation to disallow the applicant's objection to an assessment of income tax in respect of the year of income ended 30 June 1989. There is no dispute between the parties as to the facts relevant to the disposition of the present case. What is at issue is the proper characterisation of a payment of an amount of $262,500 in the year of income to Mark Foys Pty Limited and, in particular, the question whether the applicant's share of that payment was an allowable deduction pursuant to the provisions of s. 51(1) of the Income Tax Assessment Act 1936 (Cth) as amended (``the Act'').
The applicant is the co-owner as tenant-in- common of a property situated at 9-11 Knox Street, Double Bay. That property was originally wholly owned by the applicant, but in 1988 the applicant transferred half its interest to Andale Nominees Pty Limited which, at all relevant times thereafter, remained a co-owner as tenant-in-common of the property.
In 1978 the applicant, then the sole owner, had leased the property to Mark Foys Pty Ltd (``the lessee'') for a term of six years and seven months, commencing from 1 March 1978 and terminating on 30 September 1984, at a rental fluctuating from year to year as therein set out. That lease contained an option to the lessee to renew for a period of five years subject, inter alia, to due performance of the terms of the lease. On 30 July 1981, that original lease was varied and a further option for a further five- year term, commencing on 1 October 1989, was granted.
In 1984, the lessee exercised the option granted to it by the original lease of 1 March 1978. In the result the lessee was entitled to a lease for a period of five years until 30 September 1989 with a further option for a period of five years from 1 October 1989 subject to the lessee duly observing and performing the covenants of the lease up to the date of expiration of the option.
In July 1988, the applicant and Andale Nominees Pty Limited, as lessors, agreed with the lessee that upon payment of an amount of $262,500 to the lessee that company would vacate the premises on or before 30 September 1988. The letter confirming this agreement, signed both on behalf of the applicants and on behalf of the lessee, acknowledged that, as and from 30 September 1988 the lessee would cease to occupy the premises and that the mutual obligations between the parties under the lease agreement would terminate and be of no further effect.
In an affidavit read in the proceedings, a director of the applicant deposed, without objection, to the fact that the purpose of the payment to the lessee by the applicant, and presumably by Andale Nominees Pty Limited, was to allow the applicant and Andale to gain possession of the property so that a new lease could be granted to a new tenant yielding a higher rental return. Under the lease to Mark Foys Pty Limited, the rent for the period ended 30 September 1989 would have been $137,239. However, a new lease was negotiated by the owners of the property to Australia and New Zealand Banking Group Limited (``ANZ'') for a term of six years, to commence on 1 October 1988 and to terminate on 30 September 1994, together with an option for renewal. That new lease was executed on 19 September 1988. The rent reserved under the new lease was a minimum rent of $420,000 per annum, but subject to review under the terms and conditions of that lease.
In these circumstances the applicant claimed to be entitled to deduct its one-half share of the amount paid to the lessee, as being an amount incurred by it in gaining or producing its assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing that income, not being an outgoing of capital or of a capital nature.
ATC 4920
I should say that an examination of the accounts and tax returns of the applicant disclosed that the only income derived by the applicant in the relevant period, other than the rent from the lessee, were a management fee which it received from the partnership of which it was a member with Andale Nominees Pty Limited for collecting rents and interest or dividends from related companies. In the 1987 year there was also a profit from the sale of certain publicly listed securities.
The applicant submitted that the payment of $262,500 made by the applicant and its co- owner was for the purpose of bringing to an end an uneconomic lease ``which has only one year to run'' so that a more profitable lease could be entered into. For the purpose of this submission the option to take a lease for a further five years was ignored. It was said that the co-owners had spent $262,500 to earn $420,000, in increased rent. In the first year of the new lease, therefore, an amount of approximately $253,463 was derived roughly approximating the amount paid to the tenant under the old lease.
Particular emphasis was placed upon the oft cited observation of Dixon J in
Hallstroms Pty Limited v FC of T (1946) 8 ATD 190 at 196; (1946) 72 CLR 634 at 648 as follows:
``What is an outgoing of capital and what is an outgoing on account of revenue 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.''
Accordingly, it was said that from a ``practical and business point of view'' it was apparent that here was expenditure calculated to bring in additional income by way of rent in a continuous activity of leasing the property and in circumstances where no new asset was derived. Thus it was emphasised that any argument based upon juristic classification and presumably the juristic nature of the leasehold estate should be ignored.
I should say immediately that the observations in Hallstroms are both instructive and important and may often assist in answering a question concerning deductibility under s. 51(1) of the Act: cf
McLennan v FC of T 90 ATC 4047 at 4053; (1989) 21 FCR 80 at 87. They do not, however, provide a test as to the dichotomy between capital and revenue. For that we must look elsewhere. Nor do they counsel a complete disregard of legal rights or interests.
A reference was made by counsel for the applicant to a number of cases, some conflicting, in jurisdictions other than Australia, in which analogous questions had been determined. It was agreed by the parties that the precise question had not arisen for decision directly in Australia.
The starting point for a discussion of the issue in Australia is the well known decision of Sir Owen Dixon in
Sun Newspapers Limited & Associated Newspapers Limited v FC of T (1938) 5 ATD 87 at 93; (1938) 61 CLR 337 at 357 ff, especially at ATD 94-96; CLR 359-363. It will be recalled that in that judgment his Honour pointed out that the basic distinction between outgoings on revenue account on the one hand and outgoings on capital account on the other lay in 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...''
Relevant to the question was whether the purpose or result of the expenditure was to bring into existence or procure some asset or advantage of a lasting character purely for the benefit of the profit earning subject. In saying this his Honour was echoing the famous words of Viscount Cave, ``an asset or an advantage for the enduring benefit of a trade'', in
British Insulated and Helsby Cables Limited v Atherton [1926] AC 205 at 213.
Dixon J, as he then was, said (at ATD 96; CLR 363):
``There are, I think three matters to be considered, (1) the character of the advantage sought, and in this its lasting qualities may play a part, (2) 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 (3) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.''
ATC 4921
It cannot be said on the evidence of the present case that the applicant is, for purposes relevant to s. 51(1), carrying on a business. The applicant and its co-owner own one property which they lease out and from which they derive rental income. The freehold held in co- ownership is, in such circumstances, the income producing entity, structure or organisation for the earning of the rental income of the co- owners. The freehold is the profit-making subject.
As the passage cited from the judgment of Sir Owen Dixon suggests, the first matter to be considered is the character of the advantage sought. Indeed, in
GP International Pipecoaters Pty Limited v FC of T 90 ATC 4413 at 4420; (1990) 170 CLR 124 at 137, the High Court described this as being the ``chief, if not the critical, factor in determining the character of what is paid'': cf
Mount Isa Mines Limited v FC of T 92 ATC 4755.
To put the matter neutrally, the advantage sought by the taxpayer here in making the payment was the bringing to an end of the lease with the lessee. It must be accepted, so far as purpose is relevant, that the Mark Foys lease might be described as uneconomic, or even perhaps as onerous to the lessors, meaning thereby that that lease was not at a market rental. The agreement between the co-owners and the lessee, when acted upon by a change of possession, operated to put to an end the tenancy and to bring about the result that the applicant and its co-owner were the owners of the whole estate in the property in fee simple:
Phene v Popplewell (1862) 12 CB(NS) 334 and cf
Oastler v Henderson (1877) 2 QBD 575.
By the payment, the applicant secured a permanent advantage, namely the surrender of the lease with its attendant option. It could not be said that that advantage was ephemeral merely because immediately thereafter the applicant and its co-owner were able to enter into a new lease, albeit for a more advantageous rent.
It may be that it is correct to say that no asset is acquired by virtue of the payment, in the sense that because the surrender of the lease occurred by operation of law, there is not a conveyance of the leasehold estate to the owner of the freehold, having the consequence that the lesser estate merges in the greater. But it is not the law of Australia that it is essential for a payment to be of a capital character that there be the acquisition by the payer of some asset. In this context, the decision of Lawrence J in
Southern (HM Inspector of Taxes) v Borax Consolidated Limited [1941] 1 KB 111, to the extent to which it requires the contrary conclusion, was incorrectly decided: cf
Broken Hill Theatres Pty Limited v FC of T (1952) 9 ATD 306; (1951-1952) 85 CLR 423 and
John Fairfax & Sons Pty Limited v FC of T (1959) 11 ATD 510 at 516; (1959) 101 CLR 30 at 41 per Fullagar J, with whose judgment Kitto and Taylor JJ agreed. Of course, if a capital asset is acquired by virtue of an outgoing, that fact will generally lead to the conclusion that the outlay is of capital or of a capital nature.
The second and third of the matters referred to by Dixon J in Sun Newspapers similarly support the view that the expenditure was of a capital nature. The payment was a once and for all payment, it was not paid by way of a periodical reward or outlay to cover use and occupation for some period commensurate with the payment, nor could it appropriately be said to have been recurrent in the sense in which that expression is used in the cases. The present is not a case of a company whose business consisted of granting leases and obtaining surrenders of them as part of the normal ebb and flow of the business, in which event a different view of the matter might be taken.
Counsel for the applicant submitted that I should bear steadily in mind that a lease was properly to be characterised as an item of personal property. I was referred to what was said by Deane J in
Progressive Mailing House Pty Limited v Tabali Pty Limited (1985) 157 CLR 17 at 51:
``A lease for a term of years ordinarily possesses a duality of character which can give rise to conceptual difficulties. It is both an executory contract and an executed demise. Its origins lie in contract rather than in real property in that the lessee's remedies were originally restricted to a personal action against the lessor on his covenant to give enjoyment of the land...''
This is, of course, true, although it is hardly an adequate description of a lease today to suggest that the benefits of a lessee depend solely upon contract and not upon the underlying estate in land which is demised. Nothing in Tabali suggests to the contrary. Indeed, immediately after the passage quoted by counsel for the applicant, Deane J points out
ATC 4922
that in time it had become accepted that a lessee had a right to ``possession'' which was an interest in the land that the lessee was entitled to protect against third parties.Nothing in the cases decided elsewhere persuades me that the outgoing in the present case was on revenue account.
In Canada, the Tax Appeal Board in
Meyer Shuchat v Minister of National Revenue (1961) 61 DTC 119 held that a payment by a lessor to a lessee to cancel a lease was deductible as an expense incurred for the purpose of earning income under the provisions of s. 12(1)(a) of the Income Tax Act RSC 1952. In so holding, the board reversed its earlier decision to the contrary in
Dyment Ltd v Minister of National Revenue (1957) 57 DTC 492, having regard to subsequent decisions of the Exchequer Court of Canada in
Halifax Overseas Freighters Limited v Minister of National Revenue (1959) 59 DTC 1013;
Falaise Steamship Co Limited v Minister of National Revenue (1959) 59 DTC 1016 and
Bedford Overseas Freighters Limited v Minister of National Revenue (1959) 59 DTC 1008. These last three cases concerned payments by steamship owners to rid themselves of insufficiently remunerative contracts of affreightment in order to obtain more profitable terms, an issue which, to my mind, is distinguishable from that here involved.
I was referred, as well, to a decision of the Transvaal Special Court in Income Tax Case No 1267
(1977) 39 SATC 146. It was held that the payment to the lessee in that case was not of a capital nature because it did not create a new asset, nor was there any addition to an existing asset, nor was there any long term advantage gained, the benefit being on the facts of that case short-lived. By way of contrast, however, the United States Courts, to the level of the United States Court of Appeals, have held that a payment by a landlord to a tenant for bringing a lease to an end is not a business expense but an outlay of capital to be amortised over the term of the unexpired term of the old lease:
Miller v Commissioner of Internal Revenue (1928) 10 BTA 383;
Borland v Commissioner of Internal Revenue (1933) 27 BTA 538 and
Handlery Hotels Inc v US (1981) 82-1 USTC 9106.
There is no direct authority in the United Kingdom, although some assistance may be drawn from the decision of the House of Lords in
Tucker (Inspector of Taxes) v Granada Motorway Services Ltd [1979] 2 All ER 801. In that case the landlord accepted payment of a lump sum in consideration of tobacco duty being thenceforth excluded in computing the gross profits, a factor in the rental calculation. It was held that the amount paid was of a capital nature and not deductible. This was so, notwithstanding that the amount was paid to enable the lessee to earn more profits. The payment produced a modification of the lease making it less disadvantageous and thus the case was analogous to the payment made to modify the conditions of a burdensome mining lease in
Mallett v Staveley Coal and Iron Co Ltd[1928] 2 KB 405.
I do not receive much assistance, however, from the recent decision of the House of Lords in
Lawson (Inspector of Taxes) v Johnson Matthey plc [1992] 2 All ER 647. The facts of that case are remote from the present. Counsel for the applicant relied upon what was said by Lord Keith of Kinkel (at 649):
``A number of decided cases make it clear that a payment made to get rid of an obstacle to successful trading is a revenue and not a capital payment.''
For this proposition his Lordship cited
Mitchell (Inspector of Taxes) v BW Noble Ltd [1927] 1 KB 719;
Anglo-Persian Oil Co Ltd v Dale (Inspector of Taxes) [1932] 1 KB 124 and
IRC v Carron Co (1967) SC (HL) 47. In each of these cases the taxpayer was carrying on a business. In the first, the payment was made to a director to avoid the publicity that might otherwise have arisen had that director been dismissed for misconduct. In the second, the payment was made to terminate a disadvantageous agency contract which was held to be a revenue asset. In the third, the payments were the expense of obtaining a new charter to facilitate the administration and management of the company. In that sense the payment removed an obstacle to profitable trading. In none of them can there be said to be, as in the present case, an advantage accruing to a capital asset of the taxpayer.
Even if it were right to say that the present applicant carries on a business, the association of the payment with the capital asset of the taxpayer (the property available for lease) makes the present case closer to the facts involved in
Strick v Regent Oil Co Ltd [1966] AC 295 than to
BP Australia Ltd v FC of T [1966] AC 224. The distinction between these two cases lay largely in the fact that the method
ATC 4923
involved in providing for the trade tie in Regent Oil resulted in the creation of an interest in property; that involved in BP Australia did not.A surrender, at least if by deed, would operate to convey the leasehold estate to the holder of the reversion. An agreement to surrender would operate as an agreement to convey: cf
Clyne v Commissioner of Stamp Duties [1967] 1 NSWR 415. Payment for a surrender by deed would thus involve payment for the acquisition of an interest in land. Although an agreement to surrender by operation of law might not in law amount to an agreement to acquire an interest in land, it could not be thought that a different result would flow depending upon whether the agreement was to surrender by deed or to carry out a surrender by operation of law. In each case the substance of the transaction would be the freeing, by way of merger or otherwise, of the freehold from the leasehold estate, thereby leaving the freehold unencumbered. Whether or not the agreement, coupled with the payment of money, created in the applicant an equitable interest in the lease, an issue which it is unnecessary to decide, there was nevertheless an improvement effected to a capital asset of the taxpayer and the payment for that was on capital account.
It follows that the application should be dismissed and that the applicant should pay the respondent's costs of it.
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