METAL MANUFACTURES LTD v FC of TJudges:
MEDIA NEUTRAL CITATION:
 FCA 1712
1. The applicant, Metal Manufactures Limited (``the Taxpayer''), is, and has for many years been, engaged in the manufacture of energy cables and tubes and pipes, in the business of facilitating the transmission of electronic communications and in the merchandising of electrical, electronic and lighting products.
2. In 1987, the Taxpayer owned land at Port Kembla, New South Wales. In addition, a wholly owned subsidiary of the Taxpayer, Austral Bronze Metal Manufactures Pty Ltd (``Austral Bronze'') was the owner of a parcel of land adjoining the land owned by the Taxpayer. On the land owned by the Taxpayer and Austral Bronze, there were erected factory premises occupied by the Taxpayer. Various items of heavy plant and equipment were contained within the factory premises. Specifically, there were manufacturing lines used by the Taxpayer in its manufacturing operations (``the Plant and Equipment''), which might be shortly described as follows:
- • No. 3 Tube Shell Extrusion Line;
- • Marshall Richards 84 inch diameter Horizontal Bull Block;
- • Marshall Richards Motorised Vertical Continuous Pay Off Block;
- • Wean Vaughn Rotubloc Motorised Continuous Pay Off Block;
- • Continuous Rod Manufacturing Line (sometimes referred to as Kembla Continuous Rod, or ``KCR'' Line);
- • Two Vaughn High Speed Tandem Wire Drawing Plants;
- • Properzi Aluminium Rod and Wire Continuous Manufacturing Line.
3. Each of the above lines itself comprised several discrete and separate components, although each component within a line was linked in a way that I shall describe below. Most of the components within each line were securely fixed to the floor of the factory premises in which they were situated. I shall describe below the manner of fixing.
4. In April 1988, the Taxpayer entered into arrangements with the State Bank of New South Wales (``the Bank'') whereby the Taxpayer purported to sell the Plant and Equipment to the Bank and the Bank purported to lease the Plant and Equipment back to the Taxpayer, in consideration of the payment by the Taxpayer to the Bank of regular half-yearly amounts of Rent. The Taxpayer's income tax returns were compiled using a substituted accounting period ending 31 December in the year preceding 30 June of the relevant tax year. In respect of the years of income ended 31 December 1988 to 31 December 1995 inclusive (in lieu of 30 June 1989 to 30 June 1996), the Taxpayer claimed the amount of the regular payments of Rent made in these years under section 51(1) of the Income Tax Assessment Act 1936 (``the Act'') as an allowable deduction against its assessable income for those years of income.
5. The respondent, the Commissioner of Taxation (``the Commissioner''), issued amended assessments disallowing the payments as deductions on several alternative bases. The Commissioner also concluded that, insofar as the payments constituted allowable deductions, the Taxpayer had obtained, or would but for the operation of section 177F of the Act, obtain, a tax benefit in connection with a scheme to which Part IVA of the Act applies.
ATC 5232Accordingly, the Commissioner determined under section 177F of the Act that the payments were not allowable as deductions.
6. The Taxpayer objected against the amended assessments in respect of each year and contended that the assessments should be reduced by the allowance of the deductions claimed. The Commissioner made appealable objection decisions by disallowing the objections. The Taxpayer has now appealed to the Court pursuant to section 175A of the Act and section 14ZZ of the Taxation Administration Act 1953 against those appealable objection decisions and asks for each decision to be set aside.
7. There are presently eleven separate proceedings before me. There are two proceedings in respect of each of the years ended 30 June 1989, 30 June 1993 and 30 June 1994. The others relate to the years ended 30 June 1990, 1991, 1992, 1995 and 1996. The question of deductibility of the regular payments is raised in respect of each of the years ended 30 June 1989 to 30 June 1996 inclusive. In relation to the other three years, the deductibility of other expenses is also raised. The outcome of the appeals in relation to the other expenses will be determined by the outcome of the appeals in relation to the deductibility of the regular payments of Rent. Precisely the same issues as to deductibility of those payments arise in relation to each of the years in question.
The sale and leaseback arrangements
8. The arrangements between the Taxpayer and the Bank (``the Arrangements'') were evidenced by several documents (``the Instruments''), being:
- • Credit Purchase Agreement, dated 19 April 1988, between the Taxpayer as ``Vendor'' and the Bank as ``Purchaser'',
- • Invoice, bearing the date 12 April 1988, addressed by the Taxpayer to the Bank,
- • Lease, dated 19 April 1988, between the Bank as ``Lessor'' and the Taxpayer as ``Lessee'',
- • Landlords' Waiver, dated 19 April 1988, between Austral Bronze and the Taxpayer as ``Landlord'', the Taxpayer as ``Lessee'', Permanent Registry Limited (``Permanent'') as ``Mortgagee'' and the Bank as ``Bank''.
I shall describe each of them.
The Credit Purchase Agreement
9. The recitals to the Credit Purchase Agreement were as follows:
``A. The Vendor has acquired the items of equipment (the `Goods') more particularly described in Column 1 of Schedule 2 (each of which items is referred to as a `scheduled item').
B. The Purchaser has agreed to purchase the Goods from the Vendor, and the Vendor has agreed to sell the Goods to the Purchaser on the terms and conditions hereinafter referred to.
C. The Purchaser has agreed to lease back the Goods to the Vendor and to this end after such purchase will enter into a Lease to be made between the Purchaser as Lessor and the Vendor as Lessee (the `Lease').''
10. Recital ``A'' describes the subject matter of the Credit Purchase Agreement by reference to Schedule 2, which is in the following form:
``SCHEDULE 2 Column 1 Column 2 Description of Goods Location of all Goods Cost of Goods $ SEE ANNEXURE A PORT KEMBLA SEE ANNEXURE A'' NEW SOUTH WALES
11. Schedule 2 refers to ``Annexure A''. The annexure to the Credit Purchase Agreement was an extract from a valuation dated 17 March 1988 conducted by Mason Gray Strange Valuations VIC Ltd (``the Mason Gray Strange Valuation''), to which I shall refer below. The annexure consisted of that part of the Mason
ATC 5233Gray Strange Valuation that comprised a detailed inventory of the Plant and Equipment.
12. The operative provision of the Credit Purchase Agreement was Part 2, which relevantly provided as follows:
``2.1. On a date to be agreed upon in writing (the `Delivery Date'), the Vendor as beneficial owner shall sell and the Purchaser shall purchase all the Vendor's right, title and interest to each scheduled item... in the following manner:-
- 2.1.1. the Vendor shall deliver each scheduled item to the Purchaser by the delivery... prior to the Delivery Date to the Purchaser of:-
- 126.96.36.199. an invoice from the Vendor to the Purchaser (which invoice shall give full particulars of the scheduled item including its cost as well as stating the serial or other appropriate identification number for such item, where applicable);
- 188.8.131.52. a certificate by the Vendor to the Purchaser that the sale price of the Goods will be the value shown against each scheduled item in Column 2 of Schedule 2 and stating that the Vendor is the unencumbered owner of each scheduled item...
- 184.108.40.206. such other documents evidencing the Vendor's title to the Goods held by the Vendor;
- 2.1.2. as from the Delivery Date the Vendor acknowledges that the Vendor holds the Goods as bailee for the Purchaser;
- 2.1.3. property in each scheduled item shall thereupon pass to the Purchaser upon and by virtue of delivery of such scheduled item being made in accordance with sub-clause 2.1.1 hereof and not by virtue of this Agreement; and
- 2.1.4. each certificate delivered to the Purchaser pursuant to sub-clause 220.127.116.11 shall constitute a warranty that at the date of delivery of the certificate, the facts stated therein are true and correct in all respects.
2.2. The Purchaser shall pay to the Vendor... the purchase price of the Goods (being the aggregate of the purchase prices specified in Column 2 of Schedule 2 corresponding to each scheduled item) by instalments as set out in Schedule 1.''
13. Schedule 1 to the Credit Purchase Agreement is in the following form:
``SCHEDULE 1 Amount of Instalment Payment Date $48,000,000.00 the Delivery Date. $1,000,000.00 the date being 6 months and 1 day from the date of this Agreement. $1,000,000.00 the date being 6 months and 7 days from the date of this Agreement.''
14. The Credit Purchase Agreement also contained the following clause:
``4.3 The Vendor also warrants and represents to and agrees with the Purchaser as follows:-
- 4.3.6. the Vendor warrants that the Goods, notwithstanding its construction, manner of fixture to the land upon which the Goods are or shall be installed is and shall always be severable from the Premises and therefore will not either at law or equity form part of the Premises in the nature of a fixture and that title in and to the Goods and each and every part thereof shall at all times be and remain in the Purchaser;
- 4.3.7. the Vendor acknowledges that while it remains the registered proprietor or lessee of the land the subject of the Premises that the Goods may, until otherwise agreed in writing, remain on the Premises and while the Goods remain upon the Premises will place upon and
ATC 5234maintain upon the Premises a plaque identifying the Goods and the rights of the Purchaser in and to the Goods...''
15. The Credit Purchase Agreement incorporates, by reference, definitions of words, phrases and expressions defined in the Lease. The expression ``the Premises'' does not appear to be defined either in the Credit Purchase Agreement or in the Lease. However, as will appear, the expression is defined in the Landlords' Waiver.
16. Clause 18.104.22.168 of the Credit Purchase Agreement required delivery of an invoice from the Taxpayer to the Bank. The Taxpayer issued an invoice to the Bank. The invoice bears the date ``12 April 1988''. A word processing code suggests that the document was brought into existence on 31 March 1988. That was the only invoice delivered in relation to the Arrangements. It is clear that the document was prepared in advance of completion of the Arrangements. While the discrepancy in the date is curious, I do not consider that there is any reason for concluding that the Invoice was not delivered by the Taxpayer to the Bank at completion of the Arrangements.
17. The pivotal provision of the Lease is clause 2.1 as follows:
``2.1. The Lessor hereby leases to the Lessee and the Lessee hereby takes on lease the Goods at the Rent and for the Term and subject to the covenants and conditions contained in this Lease.''
The following expressions are defined in the Lease:
``Goods: the property and each item thereof described in Item 3 of the Schedule together with anything added or attached thereto and replacement parts which are required by law or which are required to make an item complete and functional...
Rent: the rent as set out in Item 5 of the Schedule.''
Item 3 of the Schedule is in the following terms:
see Annexure B
LOCATION OF GOODS:-
Port Kembla, New South Wales''
Annexure B to the Lease is also a copy of the inventory contained in the Mason Gray Strange Valuation.
18. Other relevant provisions of the Lease are in the following terms:
``3.1. In consideration of the granting of the Lease the Lessee hereby covenants and agrees to pay to the Lessor the Rent by way of rent for the Term at the times and by way of rental instalments as specified...
4.2. The Lessor has acquired or will acquire (as the case may be) the Goods for the sole purpose of leasing and nothing herein contained shall confer on the Lessee and the Lessee warrants that the Lessee has not and will not have (apart from these presents) any right or property or interest in the Goods other than as bailee only.
4.9. The Lessee acknowledges that:-
- 4.9.1. the Goods shall at all times be and remain personal property;
5.1. The Lessee represents, warrants and confirms to the Lessor that:-
- 5.1.4. it will not have or acquire any property or interest whatsoever in the Goods and the Lessee will indemnify the Lessor against any loss it may suffer by reason of it transpiring that the Lessor has had any such property or interest.
10.1. The Lessor and Lessee hereby agree and declare that occurrence of any one or more of the following events (hereinafter referred to as a `Repudiation Event') shall be deemed to be a breach of an essential and/or fundamental term by the Lessee and shall constitute a repudiation by the Lessee of this Lease thereby entitling the Lessor (at its option) to sue for damages and or repossess the Goods in Accordance with this Lease.
10.3. Upon the occurrence of a Repudiation Event the Lessor and Lessee hereby agree that, in addition to any other right or remedy herein provided or available at law, the
ATC 5235Lessor may at any time (unless in the meantime the full amount payable under this Lease hereof has been paid) retake possession of the Goods after giving three (3) Business Days' notice to the Lessee.
11.1. If, upon the Goods being received into the Lessor's possession consequent upon the expiration of the Term or any extension of this Lease, the Goods shall be disposed of by the Lessor at public auction or by private treaty to or through traders dealing in goods of a similar description for the best price the Lessor can reasonably obtain at the time and if the proceeds of such disposal... are less than the residual value stated in Item 6 of the Schedule, the Lessee covenants to pay to the Lessor upon demand the amount of such deficiency by way of indemnity for the capital loss so sustained...
12.1. Subject to the conditions hereinafter mentioned the Lessee shall be entitled to renew this Lease... for two (2) further terms of five (5) years each, the first to commence upon the Expiry Date provided that the term of any renewed lease shall not extend beyond the effective life of the Goods (as reasonably determined by an independent expert agreed upon by the parties and failing agreement nominated by the Lessor in good faith)...
13.5. No option to purchase the Goods is hereby conferred or implied on the Lessee and there is no option or agreement whether express or implied in the Lessee's favour for the sale of the Goods to him on expiry of the Lease or at any other time.
13.15. That all the terms and conditions in relation to and incidental to this Lease are contained herein and that this Lease supersedes and rescinds any other agreement term condition or representation made on the part of the Lessor relating to this Lease and/ or the purchase of the Goods unless such agreement term condition or representation is expressly incorporated herein.''
19. The schedule to the Lease specifies that the Term is five years from 30 March 1988, the latter date being defined as the ``Commencement Date''. Item 5 in the Schedule specifies that the Rent is to be half- yearly instalments of $5,265,784.65 payable in advance. In addition, the Taxpayer was to make an initial payment of stamp duty of $10,000. Item 6 specifies that the residual value of the Goods at the end of the Term was $18,750,000.
The Landlords' Waiver
20. The Landlords' Waiver defines the term ``Premises'' in terms of title references. They are references to land owned by the Taxpayer and Austral Bronze on which the Goods were situated as at 19 April 1988. The Landlords' Waiver relevantly provides as follows:
``2. In consideration of the Lessor agreeing to lease to the Lessee the Goods (herein referred to as the `Lease') which are installed or are to be installed in the Premises which are or are to be occupied pursuant to an agreement between the Landlord and the Lessee (hereinafter called the `Occupancy'), the Landlord and the Mortgagee hereby agrees with the Lessor:-
- 2.1. to the Occupancy;
- 2.2. that the Landlord and the Mortgagee has no right, title or interest to or in the Goods nor shall the Landlord and the Mortgagee acquire any right, title or interest to or in the Goods by virtue of the Occupancy;
- 2.3. that notwithstanding that the Goods may be wholly or partly fixed or annexed to the Premises no part of the Goods shall be treated as a fixture;
- 2.4. after the occurrence of a Repudiation Event (as that expression is defined in the Lease) under the Lease, the Lessor its agents, employees and servants shall have full right and licence to enter the Premises, for the purpose of repossessing the Goods and removing them from the Premises at any reasonable hour during the term of such Occupancy...
- 2.5. that the Goods are and shall at all times remain the property of the Lessor...
- 2.6. as between the Landlord, the Mortgagee and the Lessor, the exercise of the right and licence to enter the Premises... shall be conclusive evidence of default by the Lessee under the Lease...''
Completion and Amendments
21. The first instalment of the purchase price payable as a result of the Arrangements, being the sum of $48,000,000, was received by the Taxpayer on 19 April 1988. That sum of money was applied by the Taxpayer as to $27,000,000 in repaying short term loans. $5,265,784.65 was applied in payment of the first of the regular payments under the Lease. $5,000,000 was invested in the short term money market. The balance was applied in paying dividends that were then payable by the Taxpayer.
22. On 19 April 1993, a further agreement (``the First Amendment'') was entered into between the Bank and the Taxpayer, which recited the option to renew contained in Part 12 of the Lease. The First Amendment purported to amend the Lease by deleting the schedule and inserting a new schedule. Items 4, 5 and 6 were relevantly different. The Term of the Lease was changed to 10 years ending 18 April 1998. Curiously, the Commencement Date was stated to be 19 April 1993 and the Termination Date 18 April 1998. In lieu of a reference to half-yearly instalments of $5,265,784.65, the new schedule required payments of $1,667,990.17 on 19 April and 19 October in each of the years 1993, 1994, 1995, 1996 and 1997. The residual value was stated to be $7,031,250.
23. Another agreement (``the Second Amendment'') was entered into on 20 April 1998. The Second Amendment recited the Lease and the First Amendment. It also purported to amend the Lease with effect from 20 April 1998. The Term of the Lease was amended to 5 years commencing on 20 April 1998 and terminating on 19 April 2003. A new schedule of instalments was inserted. It required payments on 20 April and 20 October in each of the years 1998, 1999, 2000, 2001 and 2002. The payments varied slightly from instalment to instalment. The instalment on 20 April 1998 was $599,117.79 and the instalment payable on 20 October 2002 was $597,267.11. The new residual value was $2,636,718.75.
24. In its income tax returns for the relevant years, the Taxpayer claimed as a deduction from its assessable income the whole of the regular payments made under the Lease and the First Amendment. That claim was made under section 51(1) of the Act. Section 51(1) is in the following terms:
``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.''
25. In the assessments which are the subject of the appeals to this Court, the Commissioner, in addition to disallowing the payments as allowable deductions under section 51(1), relied on determinations made under Part IVA of the Act. Part IVA is concerned with ``schemes to reduce income tax''. The relevant provisions of Part IVA are in the following terms:
``177A(1) In this Part, unless the contrary intention appears:
- (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
- (b) any scheme, plan, proposal, action, course of action or course of conduct;
177A(5) A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.
177C(1) ... a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to-
- (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of
ATC 5237income if the scheme had not been entered into or carried out;
and, for the purposes of this Part, the amount of the tax benefit shall be taken to be-
- (d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph.
177D This Part applies to any scheme... where-
- (a) a taxpayer (in this section referred to as the `relevant taxpayer' ) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
- (b) having regard to-
- (i) the manner in which the scheme was entered into or carried out;
- (ii) the form and substance of the scheme;
- (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
- (iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
- (v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
- (vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
- (vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and
- (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme...
177F(1) Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may-
- (b) in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income - determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination.
177F(3) Where the Commissioner has made a determination under subsection (1) in respect of a taxpayer in relation to a scheme to which this Part applies, the Commissioner may, in relation to any taxpayer (in this subsection referred to as the `relevant taxpayer' )-
- (b) if, in the opinion of the Commissioner-
- (i) an amount would have been allowed or would be allowable to the relevant taxpayer as a deduction in relation to a year of income if the scheme had not been entered into or carried out, being an amount that was not allowed or would not, but for this subsection, be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income; and
- (ii) it is fair and reasonable that that amount or a part of that amount should be allowable as a deduction to the relevant taxpayer in relation to that year of income,
determine that that amount or that part, as the case may be, should have been allowed or shall be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income;
and the Commissioner shall take such action as he considers necessary to give effect to any such determination.''
The Commissioner's contentions
26. The Commissioner's first contention is that, because the Plant and Equipment consisted of fixtures, the Credit Purchase Agreement was ineffective to vest any title in the Bank. Therefore, the Lease was ineffective to confer any right in respect of the Plant and Equipment on the Taxpayer. Accordingly, the payments in question made by the Taxpayer to the Bank cannot be characterised as payments made under a lease for the purpose of securing the right to use property owned by the Bank as lessor.
27. Rather, having regard to a series of factors identified by the Commissioner, the payments should be characterised as the making of a loan by the Bank to the Taxpayer of $50,000,000 and the repayment of that loan together with interest by regular instalments during the period of 5 years and by a balloon payment at the termination of that period. The regular payments were said to comprise partly repayment of principal and partly payment of interest. Therefore, the payments were said to be deductible only to the extent that they represented interest.
28. Alternatively, irrespective of whether the Plant and Equipment were fixtures or chattels, if the Lease is to be treated as securing to the Taxpayer the right to continue to use the Plant and Equipment free of any contractual entitlement on the part of the Bank to interfere with that use, a collateral advantage secured to the Taxpayer was the right, upon payment of the amount of the residual value, to unfettered dominion, possession and control and ownership of the Plant and Equipment after the expiration of the Term of the Lease or any renewal thereof.
29. As a practical matter, it was expected that, upon payment of the residual value, the Bank would no longer assert any rights in relation to the Plant and Equipment. Thus, the Arrangements secured for the Taxpayer the right to regain unfettered dominion, possession, control and ownership upon payment of the residual value. The residual value was substantially less than the value that the Plant and Equipment would have at the expiration of the Term of the Lease. Thus, by payment of the residual value, the Taxpayer would reacquire the rights that it had conferred on the Bank by the Credit Purchase Agreement, or would secure the extinguishment of those rights. To the extent that the periodical payments under the Lease were consideration for the opportunity to acquire or to extinguish the Bank's rights, they were of a capital nature. Accordingly, they were not deductible under section 51(1) of the Act. If that analysis is correct, the result is the same, in the sense that the periodical payments were deductible only to the extent of the interest element.
30. The Commissioner also maintains that there was a scheme to obtain a tax benefit in the form of a deduction for the regular payments to be made by the Taxpayer under the Lease. If the Commissioner's determination under Part IVA stands, no part of the payments would be deductible. It may be that the Commissioner, in the exercise of his discretion, would make certain allowances. For example, it may be appropriate for the Commissioner to make an allowance against assessable income of the notional amounts of interest paid by the Taxpayer in the years in question. However, that is not a question which arises at this stage in these proceedings, because the Commissioner has not yet exercised his discretion in that regard under section 177F(3).
31. It may also be appropriate, if the Commissioner's determination under Part IVA were upheld, to defer the consideration of penalties until after the exercise of that discretion by the Commissioner. The question of penalties has already been deferred until after decision of the question of whether the payments in question are deductible. It may be appropriate that the question of penalty, if it ensues, should be deferred not only until a decision has been made in these proceedings but until, if necessary, the Commissioner has
ATC 5239exercised his discretion under section 177F(3) in relation to any such allowance.
Background to the arrangements
32. As at 31 December 1987, the board of directors of the Taxpayer included the following individuals:
- • Mr Friedrich Heinrichs, Managing Director;
- • Mr Benjamin Revett Cant, Non-Executive Director;
- • Mr Glen Bruce Dudley, Executive Director;
- • Mr John Allan Allen, Executive Director - Finance.
The other directors were as follows:
- • Sir David Ziedler, Chairman;
- • Mr R.A. Biggam, Deputy Chairman;
- • Mr G. Billard, Non-Executive Director;
- • Mr J.J. Craig, Non-Executive Director;
- • Mr L.A. Farran, Non-Executive Director;
- • Sir Eric Neal, Non-Executive Director;
- • Mr H.W. Revell, Non-Executive Director; and
- • Mr D.C. Vernon, Non-Executive Director.
Mr Peter Matthew Ryan was the Corporate Secretary of the Taxpayer.
33. In March 1987, Mr J.B. Anderson was the Corporate Taxation Manager of the Taxpayer. On 5 March 1987, Mr Anderson sent to Mr Allen a memorandum in which he reported a meeting that Mr Anderson had had with Macquarie Bank Limited (``Macquarie Bank'') for the purpose of ``discussing suitable ways in which the Group might improve its taxation position''. The memorandum contained the following:
``One tax effective fund-raising proposal suggested was for MM to dispose of the whole or part of its plant and equipment and lease it back under a finance lease.
The benefits of the transaction are that it:
- (i) reduces after-tax financing costs;
- (ii) increases reported profits;
- (iii) improves cash flows;
- (iv) improves the balance sheet.
The MB proposal is applicable where a company holds depreciable assets and their current market value is substantially greater than their historical cost. Market value would be determined by an independent valuer.''
34. Under the heading ``Profit and Loss'' the following appeared:
``The profit and loss is also enhanced because the company obtains a tax deduction for the whole of the lease payment including that part which is effectively a repayment of principal, i.e. (a contribution to the repurchase of the plant and equipment).''
35. The memorandum also contained a comparison of the effect on profit and loss of a straight borrowing and a sale and leaseback transaction over a six year period. A summary of the advantage of a lease transaction over borrowing indicated that there was an advantage for the lease transaction to the extent of 3.5% in the effective pre-tax borrowing rate in respect of a transaction that generated $10,000,000 in cash.
36. On 24 July 1987, Mr Anderson wrote to Macquarie Bank referring to ``your innovative proposal to raise funds'', under the heading ``Sale and Lease-back of Plant''. Mr Anderson forwarded under cover of his letter an appendix setting out those items of plant which he believed ``fit the criteria for your proposal''. Mr Anderson asked for calculations that would show the annual effective after tax cost of the funds. The plant described in the appendix was as follows:
- • KCR plant;
- • high-speed tandem wire drawing machines;
- • Properzi alum rod plant;
- • No. 3 tube shell extruder;
- • Shumag tube line.
The last was never part of the Arrangements.
37. On 9 September 1987, Mr Anderson sent a further memorandum to Mr Allen concerning ``sale and leaseback of plant'', in which he referred to his earlier memorandum of 5 March 1987. The memorandum relevantly said as follows:
``As requested I have now obtained details of the plant items at Port Kembla which would be suitable for sale and leaseback under Macquarie Bank's proposal.
Subsequent to the proposal by Macquarie Bank the State Bank of NSW and Capel
ATC 5240Court approached me about quoting on the transaction. The data supplied by Port Kembla was consequently forwarded to each of the three banks requesting a submission on the effect of the transaction in comparison with conventional borrowing...
Capel Court's proposal suggested that we adopt a residual value of 10% of the value of the plant leased which is clearly outside the Tax Commissioner's guidelines. Capel Court's attitude was that we could get away with 10% residual but they are unable to offer any legal opinion nor did they think it was necessary to obtain one.
The State Bank provided a very comprehensive submission using a 37.5% residual value demonstrating that, assuming that the sale of the plant yielded $55 million with a $5 million up front fee to the State Bank, the company would save $7.8 million over five years compared to a conventional loan of $50 million. This represents an after tax interest rate of 5.68% per annum for the lease compared with 8.38% per annum after tax for a conventional loan.
Given the significant savings in cost of borrowing there is clearly an arbitrage available to the company by merely investing funds raised in the money market.
There is a great deal of work to be done before a formal proposal could be submitted to BICC and MM Board. I strongly recommend that we investigate this proposal fully. Perhaps we should discuss how it should be progressed.''
38. On 30 September 1987, Mr Allen wrote to Macquarie Bank saying, relevantly, the following:
``I refer to your letter of 21 August 1987 to John Anderson regarding our intention to pursue the implementation of sale and leaseback of certain plant owned by this company.
I am pleased to grant Macquarie Bank Limited a mandate to commence to implement this proposal subject to approval by this company's Board of Directors.
It is understood that the bank's fee on satisfactory completion of the sale and leaseback would be a flat fee of 0.5% of the sale price of the plant plus an additional fee based on the bank's ability to effect additional savings measured against a minimum saving yet to be agreed. It is understood that the additional fee would be one quarter of the savings over this yardstick.
I understand that you intend to seek tenders from parties who you believe will be interested in purchasing the company's plant and leasing it back. However, until a formal valuation of the plant has been carried out and the company has decided on the amount of the funds it wishes to raise, you will be unable to seek formal tenders. It is therefore suggested that you approach interested parties, including the State Bank of NSW, with whom we have had some discussion, to obtain indicative quotes using a principal sum of $50 million.''
39. In 1987, Mr R.H. Hocking was a licensed estate agent and licensed auctioneer and valuer with C.J. Ham & Murray Pty Ltd of Melbourne. In early November 1987, Mr Hocking received a letter dated 3 November 1987 from Macquarie Bank, foreshadowing a valuation of plant and equipment on a going concern basis. The letter indicated that the Plant and Equipment would be subject to a sale and leaseback financing arrangement. The letter indicated that the vendor of the Plant and Equipment considered its market value was approximately $50,000,000.
40. A schedule of the Plant and Equipment in question was attached to the letter from Macquarie Bank. The schedule listed the items shown in the schedule attached to Mr Anderson's letter to Macquarie Bank of July 1987. The schedule indicated that the total original cost of the items was $11,000,000 and that their replacement value was $66,200,000. Mr Hocking was subsequently told by Mr Stephen Cook of Macquarie Bank that approval for carrying out the proposed valuation had been deferred to the next meeting of the Taxpayer's Board in February 1988.
41. At the meeting of the directors of the Taxpayer held on 23 November 1987, consideration was given to a memorandum submitted to the Board by Mr Allen. The memorandum was headed ``SALE AND
ATC 5241LEASEBACK FINANCING PROPOSAL'' and was in the following terms:
``The underlying value of many items of plant at Port Kembla provide MM with an opportunity to raise a significant amount of funds at very low cost. This opportunity has been considered and discussed with a number of independent financial institutions.
Macquarie Bank Limited has now submitted a financing proposal (executive summary attached) which would have the following effects on the group:
- 1. Increased reported profit after tax
- 2. Improved balance sheet
- 3. Lower after-tax finance costs
- 4. Reduced income tax payable and improved cash flow
- 5. Reduced effective rate of tax on pre- tax profits
The transaction involves the sale and leaseback of major items of plant located at Port Kembla, the market value attributable to each item of plant to be determined by independent valuers. An informal valuation estimates the nominated plant to be worth about $50 million. Formal valuations will be obtained if this proposal is approved.
The lessor has agreed to purchase each item of plant for its market value and to leaseback the plant to MM. The optimum term of the lease is five years. For taxation reasons the residual value would be fixed at 40% of the principal sum. As is customary with all finance leases, there can be no option for the lessee to acquire the plant at the termination of the lease. Such an option would result in the lease being treated as a hire purchase agreement for taxation purposes and negate the purpose.
THUS MM'S SECURITY FOR RETAINING THE PLANT ON TERMINATION OF THE LEASE IS DEPENDENT UPON THE BUSINESS REPUTATION OF THE LESSOR AND THE RESTRICTED SALEABILITY OF THE RATHER SPECIAL PURPOSE PLANT.
The sale of the nominated plant is expected to generate cash of about $50 million, the exact amount being dependent upon the independent valuations. The sale would give a rise [sic] to profit on sale of $48 million.
Accounting Standard AAS17 on leases requires that profit on sale of assets which are leased-back under a finance lease be amortised in the profit and loss account over the period of the lease. The unamortised profit on sale is included with shareholders funds. The plant leased-back must be capitalised and the lease liability recorded as debt.
The inclusion of the unamortised profit on sale with shareholders funds means equity increases by $48 million while debt increases by $50 million being the lease liability. With a conventional borrowing of $50 million, debt would increase by that amount with no increase in equity. The effect on net gearing of this proposal is therefore an increase from 2.6% to 15.7% compared with 18.0% for a conventional borrowing.
Capitalisation of the leased plant requires a charge to be made to the profit and loss for both notional interest payable under the lease and amortisation of the leased plant. These higher costs are offset by the amortisation of the deferred income. The net effect on operating profit before tax under this proposal is a cost of $24.5 million compared with $24 million for a conventional borrowing. As the amortised deferred income is substantially not subject to income tax, the income tax benefit is significantly higher than with a conventional borrowing.
Consequently, the net effect on operating profit after tax under this proposal is a benefit of $5 million compared with a cost of $13 million for a conventional borrowing.
It is important that the consideration paid by the Bank for the plant is an arm's length price; the independent valuation will establish the market value of the plant. Further the lease must contain a realistic residual value; 40% of the principal is conservative and well within the Tax Commissioner's published guidelines.
The tax deduction available for the whole of the lease payments amounting to approximately $10 million p.a. will reduce the tax payable by MM by approximately $5
ATC 5242million each year. The reduction in tax payable will reduce MM's franking account by 51/49ths of that amount. The reduction in tax payable compared with a conventional borrowing is only 2.5 million. On current estimates MM would still be able to fully frank its dividends provided dividends from ASC and CMA are maximised. It should be borne in mind that investment of the funds raised will generate income upon which tax will be payable which will in turn increase MM's franking account.
This proposal does not take account of income generated by the funds raised.
Greenwoods & Freehills have advised that payments under the lease will be fully deductible against the income of MM. Advice has also been received that the consideration paid for the plant on termination of the lease, i.e. the residual value, will be depreciable for taxation purposes.
They [sic] are a number of companies which have entered into sale and leaseback of assets and adopted the same accounting treatment proposed by MM. These companies include Linter Group Ltd, Pioneer Concrete Services Ltd and Monier Ltd.
The fees payable to Macquarie Bank Limited for arranging the finance are a flat fee of $250,000 plus an incentive fee based on savings made by the lessor over savings contained in a proposal submitted directly by the lessor. This maximum fee payable to Macquarie Bank is limited to a total of 1% of funds raised.
The proposal provides a most effective method of raising funds at a cost significantly less than other methods currently available and is submitted for the Board's consideration.
IT IS IMPORTANT, HOWEVER THAT DIRECTORS NOTE MM'S SECURITY FOR RETAINING THE PLANT ON TERMINATION OF THE LEASE IS DEPENDENT UPON THE BUSINESS REPUTATION OF THE LESSOR AND THE RESTRICTED SALEABILITY OF THE RATHER SPECIAL PURPOSE PLANT.''
42. Some attention was focussed on the two paragraphs in upper case contained in the memorandum. In particular, attention was addressed to the proposition that the Taxpayer's ``security for retaining the plant on termination'' was dependent on the ``business reputation'' of the Lessor and the restricted saleability of the plant.
43. Annexed to the memorandum was a schedule that was in the following form:
``INNOVATIVE FINANCING PROPOSAL EXECUTIVE SUMMARY Principal: $50 million Lessor: State Bank of New South Wales or Citibank Arranger: Macquarie Bank Limited ------------------------------------------------------------- PROPOSAL CONVENTIONAL BORROWING After tax effective interest rate: 2% 8% Increase on gearing: 13.1% 15.4% Increase in net tangible assets $48.0m 0* Reduction in operating profit before tax: $24.5m $24.0m Reduction/(Increase) in operating profit after tax: ($5.0m) $13.0m Reduction in dividend franking account: $5.0m $2.5m Savings after tax over conventional borrowing over term discounted at 10% p.a.: $10.0m -- * An increase in net tangible assets could be achieved by revaluing the relevant plant. The revaluation increment would never be reflected in profits.''
44. The minutes of the meeting of the directors of the Taxpayer held on 23 November 1987 record that, after discussing the proposal set out in Mr Allen's memorandum, the Board resolved to defer a decision pending the receipt of further information. During the course of the meeting, two matters occupied discussion. The two matters were:
- • concern that the Taxpayer could lose the use of the Plant and Equipment at the expiration of the lease term in 5 years' time;
- • the desire of those at the meeting to obtain information about whether other companies were entering into such arrangements.
45. On 22 December 1987, Macquarie Bank sent two letters to Mr Anderson. In the first letter, there were set out the names of several major companies which, as a matter of public knowledge, have entered into transactions for the lease of major items of property. The property was briefly described. The letter went on to say as follows:
``In each situation questions would have arisen as to the ability of the lessee company to acquire ownership of the property upon termination of the leasing arrangements. In each case, it must be concluded that the lessee was satisfied with the arrangement. In many instances the plant in question has been critical to the company's operation.''
46. The other letter contained comments on the probable terms of a lease as follows:
``• The lease will include a stated residual value.
As you know, the stated residual value should represent a bona fide estimate of the fair market value of the plant at the time of expiration of the lease. The taxation office has indicated in rulings that residual values on relatively short term leases should not have an unreal or nominal value. The tax office rulings go so far as to indicate minimum residual values classified according to tax depreciation rates on a prime cost basis. The plant in question is subject to a prime cost depreciation rate for tax purposes of 10%. The proposed residual of 40% in five years time is higher than the minimum residual value as provided in tax office rulings and should therefore be acceptable to the taxation office.
• The lease will not contain a right or option on behalf of Metal Manufactures to purchase the equipment. Otherwise, the transaction will be treated as a hire purchase agreement for income tax purposes.
• Under the terms of the lease Metal Manufactures will be granted a right to renew the lease on termination of the original period. We would like to discuss the terms of this second lease (period and rental).
• The lease will provide for the equipment to be auctioned at the end of the period of the primary lease, unless Metal Manufactures exercises its option to renew the lease. Metal Manufactures will be appointed as exclusive selling agent of the equipment for the purpose of this auction.''
47. Macquarie Bank subsequently received a letter dated 11 January 1988 from the Bank confirming that approval had been given ``to acquire certain nominated assets from [the Taxpayer] for $50 million and lease those assets
ATC 5244back to [the Taxpayer]''. The letter set out a summary of the terms and conditions of the proposed ``facility''. The relevant conditions were as follows:
``Amount: $50 million. Lessee: Metal Manufactures Limited. Term: Five years. Equipment: To be agreed. Lease Payments: Semi-annually in advance (equal amounts). Residual: $20 million (40%). Security: To the Bank's legal requirements and to include satisfactory sale and lease documentation incorporating various conditions precedent, representations, warranties and events of default common to this type of transaction. Pricing: Establishment fee: 0.4% ($200,000) of the Amount of the Facility. Interest Rate: To be the Bank's cost of funds plus a margin of 0.65% p.a. (includes Counter Party Risk Margin for swap). An all-up fixed interest rate for the term of the lease will be quoted to the Lessee. All legal fees, stamp duties and reasonable out-of- pocket expenses to be to the account of the Lessee.''
48. The letter enclosed draft documentation and went on to say:
``We assume that the equipment is capable of movement and will not be regarded as fixtures. Please advise the location of the relevant equipment and the owner of the land where the equipment is located.''
49. At a meeting of the directors of the Taxpayer held on 22 February 1988, the Board considered a further memorandum from Mr Allen entitled ``Resubmission of Sale and Leaseback Financing Proposal''. The memorandum repeated material that had been contained in the memorandum considered by the Board at its meeting in November 1987. The memorandum also said:
Directors will recall that the proposal involves the sale and five year leaseback of major items of plant located at Port Kembla, the market value attributable to each item to be determined by independent valuation. A preliminary valuation estimates the plant identified to be worth about $50 million.
The re-submitted lease agreement proposes that MM be granted a right to renew on termination of the original period on terms which are very satisfactory from MM's point of view. If MM fails to exercise its option to renew, the plant would be auctioned. The agreement appoints MM as exclusive selling agent of the plant for the purpose of this auction. MM may if it wishes bid at this auction.
Greenwoods & Freehills have advised that payments under the lease will be fully deductible. Advice has also been received that the consideration paid for the plant on termination of the lease, i.e. the residual value, will be depreciable for taxation purposes. For taxation reasons the residual value is to be fixed at 40% of the principal sum. As is customary with all finance leases, there can be no option for the lessee to acquire the plant at the termination of the
ATC 5245lease. Such an option would result in the lease being treated as a hire purchase agreement for taxation purposes and negate the purpose.
The proposal provides a most effective method of raising funds at a cost significantly less than other methods currently available and is recommended.''
50. Mr Allen's second memorandum also contained an executive summary as follows:
``Principal: $50 million Lessor: State Bank of New South Wales Arranger: Macquarie Bank Limited ---------------------------------------------------------------- PROPOSAL CONVENTIONAL BORROWING After tax effective interest rate 2% 8% Decrease on gearing 8% No change* Increase in net tangible assets $48.0m No change** Reduction in operating profit before tax over estimated life of plant $22.6m $22.2m Increase (decrease) in operating profit after tax over estimated life of plant $12.0m ($11.3m) Reduction in dividend franking account per annum*** $5.0m $2.5m Savings after tax over conventional borrowing over term discounted at 10% p.a. $10.0m -- * Assumes new debt would substitute for existing debt. ** An increase in net tangible assets could be achieved by revaluing the relevant plant, however the revaluation increment would never be reflected in profits. *** The reduction in dividend franking account is not material. On current forecasts MM dividend will be capable of being franked for some time.''
51. The minutes of the meeting of Directors held on 22 February 1988 record the following:
``SALE AND LEASEBACK FINANCING PROPOSAL
The Board considered the Sale and Leaseback Financing Proposal set out in Appendix IV to the Agenda [Mr Allen's memorandum]. Considerable discussion took place concerning the desirability of the proposal and its place in the company's overall financial planning.
The Executive Director, Finance, commented that longer term financing strategies were, by necessity, part of the companys overall strategic planning which was currently being revised.
Following further discussion, the Board resolved to approve the proposal involving
ATC 5246the sale and five year leaseback of certain major items of plant located at Port Kembla as detailed in the Appendix to the Agenda. Messrs F. Heinrichs, J.A. Allen and G.B. Dudley were authorised to complete all necessary documentation on behalf of the Board.''
52. On 23 February 1988, Mr Hocking received a further telephone call from Mr Cook who told him that the valuation of the Plant and Equipment was approved at the Board meeting the previous day and that it would need to be completed by mid March. Mr Cook said that the valuation was to be of the moveable components of plant on a going concern basis and was not to include footings.
53. Mr Hocking decided that, in order to complete the proposed valuation by the time specified, he needed some assistance. In consequence, he contacted Mr Noel Mason, the Managing Director of Mason Gray Strange and arranged that Mason Gray Strange would assist with the valuation. Mr Mason then met Mr Cook in Melbourne and also had some contact with an officer of the Taxpayer. Mr Mason was informed that the proposed valuation was required for financing reasons.
54. Mr Mason and Mr Hocking travelled to the Taxpayer's factory premises at Port Kembla in early March 1988. The Taxpayer's asset register and depreciation schedules, including an inventory of spares and tools, were made available for their inspection. Mr Mason and Mr Graham Roberts of Mason Gray Strange inspected the large items of plant. Mr Hocking and Mr Chris Mason, also of Mason Gray Strange, inspected the tools and spares held by the Taxpayer in connection with the relevant plant.
55. The plant initially examined was as follows:
- • Continuous Rod Manufacturing Line;
- • Two Vaughn High Speed Tandems;
- • Properzi Line;
- • Marshall Richards Horizontal Bull Block.
Mr Mason had been informed that the Taxpayer was looking for assets having a value of $50,000,000. Having inspected the plant just referred to, Mr Mason said more plant would be needed to reach that figure. The Taxpayer then nominated additional plant for inclusion in the valuation, which included the Tube Extrusion Line and two Pay Off Blocks.
56. After the site inspection, enquiries were made to ascertain the current selling price of the items of Plant and Equipment. That was necessary because, according to Mr Mason, a valuation on a ``going concern'' basis is arrived at by taking into consideration the depreciated replacement value of the items concerned. After such calculations were carried out, Messrs Hocking, Noel Mason, Christopher Mason and Graham Roberts met at the offices of Mason Gray Strange in Melbourne where they conducted a final review of the valuation. Once the terms and content of the valuation had been settled, it was agreed that the valuation would be issued by Mason Gray Strange.
57. Mr Mason did not consider that the valuation of $50,000,000 reflected realisable value. Rather, the value adopted was based on the cost of the installed equipment, being the discounted replacement cost, installation cost, spares and a separate figure for tooling. The evaluation approximated about two-thirds of the replacement cost, calculated as half of the replacement cost plus a component for spares. Most of the equipment involved was regarded by Mr Mason as ``off the shelf'' and was supplied from overseas. No separate valuation was made for each component of plant.
58. Mr Mason said that he was instructed not to include any excavation work, pits or drainage areas because those could be construed as fixtures and not plant. He said that where building stopped and plant started was a matter of discussion between the Taxpayer and Mason Gray Strange and was recorded in his report.
59. Mr Mason considered that the plant that he valued was between 15 and 30 years old. He considered that that type of plant could, basically, last indefinitely, except for parts that needed replacing. Its useful life would remain much the same unless there were radical changes in method. As at the time of the valuation, there had been additional items added including computerisation, multiple operation functions and more efficient gauging. The computer equipment and other items that had been added were included in the valuation.
60. Mr Hocking and Mr Mason both said that a going concern basis produced a considerably higher value than break up for removal basis. On that basis, Mr Mason said that the plant could be worth as low as $15,000,000, since much of the cost is in installation and fabrication costs.
61. During March 1988, Macquarie Bank received the Mason Gray Strange Valuation. The valuation was sent under cover of a letter dated 17 March 1988 from Mr Mason and was addressed to Mr Cook of Macquarie Bank. It was described as ``VALUATION OF MOVABLE ALLOY TUBE, BAR AND WIRE MANUFACTURING PLANT AT METAL MANUFACTURES LIMITED, GLOUCESTER BOULEVARD, PORT KEMBLA, NSW''. After referring to inspection of the items, the covering letter said:
``The various lines inspected by us have been continuously maintained and upgraded in line with technology advances, and are therefore high production and efficient entities.''
62. After referring to spare parts and tooling, Mr Mason went on to say:
``Each line has therefore been valued by us as a complete operating entity as installed and operating on site and as inspected by us.
No allowance has been made for building installations, concrete floors, under floor excavations, overhead cranes, concrete support structures and pit-works.
Where services i.e. compressed air installations, transformers, electrical control and distribution boards, water cooling and reticulating equipment exist solely for the line being valued, those services have been listed in our inventory and form part of our valuation of each line.
Where services are common to the line being valued by us and to other areas of the plant, they have been excluded from our valuation, except for any support systems and feeder work pertaining specifically to the line being assessed.
Using the foregoing criteria, it is our opinion that the total value of the whole of the items as listed in detail in the enclosed inventory where and now installed and placed as an Active Going Concern is $50,755,000.''
63. There was then attached a detailed inventory describing each manufacturing line separately and assigning a separate value to each manufacturing line as follows:
- • No. 3 Tube Shell Extrusion Line: $11,860,000;
- • Marshall Richards 84 inch diameter horizontal bull block: $4,210,000;
- • Continuous Pay Off Block (No. 1): $2,055,000;
- • Continuous Pay Off Block (No. 2): $1,370,000;
- • Kembla Continuous Rod Line: $18,640,000;
- • Vaughn High Speed Tandems: $2,870,000;
- • Properzi Line: $9,750,000.
The Taxpayer's security for retaining use of the plant and equipment
64. It is clear that, in considering Mr Allen's proposal, the directors of the Taxpayer were concerned that the effect of the proposed arrangements could be that the Taxpayer would cease to have the right to unfettered use of the Plant and Equipment upon the expiry of the term of the Lease. Their concern was assuaged by three factors:
- • other reputable organisations had entered into such arrangements without apparent detriment;
- • the nature of the Plant and Equipment is such that it is unlikely that any other party would be interested in buying it;
- • the business reputation of the Bank.
65. The latter appears to be acceptance that the Bank would ``do the right thing'' by the Taxpayer and would accept an offer made by the Taxpayer at the expiration of the Term of the Lease to buy the Plant and Equipment for the amount of the residual value. Whereas, in theory, the Bank would have been free to do what it liked with the Plant and Equipment at the expiration of the Term, the understanding that the directors had was that the Bank would accept such an offer if made on behalf of the Taxpayer. The directors obtained further comfort by the inclusion in the Lease of successive options that secured to the Taxpayer the right to exclusive use of the Plant and Equipment for a period of fifteen years, whatever happened.
66. The Taxpayer is a subsidiary of BICC Plc, an English company (``BICC''). On 25 March 1988, Mr Allen sent a memorandum to Mr P. Hooley, of BICC. The memorandum was in response to a facsimile communication not in evidence and was headed ``Sale and Leaseback''. The first section appears to be a response to an enquiry concerning the effect of an Australian Accounting Standard. Mr Allen's
ATC 5248memorandum was relevantly in the following terms:
``AAS 17 (paragraphs 36 and 37) requires that assets subject to a finance lease be capitalised and the corresponding liability taken up. The leased asset must be amortised over its effective useful life by making an appropriate charge to operating profit and crediting a provision for amortisation. You will note that in accordance with paragraphs 39 and 40 MM has more than reasonable assurance that it regains ownership at the end of the lease.''
67. Mr Allen said that, when making that statement, he had in mind the reputation of the Lessor, to which he had referred in his November 1987 memorandum to the Board. He said that if the Lessor was not a reputable person, there would be a concern that the property could be sold to somebody else. He said that his main concern at that time was that it would be sold to the other tube maker in Australia ``who are no great friends of us''. He said that the Taxpayer was relying on the Bank's reputation as a government authority and that they would not be ``underhanded... in the way that they disposed of the plant''.
68. When asked whether he had formed the view that the Taxpayer had more than a reasonable assurance that it would regain ownership at the end of the lease, Mr Allen's response was that if the Taxpayer wanted to be in the tube business at the end of the five years, it would have been in their interest to buy back the Plant and Equipment. However, he said that at that stage, he did not know whether in fact the Taxpayer would want to be in the tube business at the end of five years.
69. Subsequently, Mr Allen received a facsimile transmission dated 13 April 1988 from Mr R.F. Morgan, the Finance Manager of BICC. After referring to a ``quick note yesterday'', which is not in evidence, Mr Morgan went on to say:
``I think it will be helpful if I go into a little more detail about the renewal option, which to us is the most important single point. Incidentally, it is in this connection very important that the State Bank should not be able to assign the lease without your consent. If it could, an unfriendly successor might seek to exploit any difficulties over the renewal, to your disadvantage.
Our problem in this connection is that while we understand that it is established custom and practice to allow lessees to purchase back their plant, such customs and practice have an unfortunate habit of changing over the years. For instance, our own Revenue authorities have never had much sympathy with the leasing concept, because they feel, quite rightly, that it allows one company to enjoy the benefits of another's taxable capacity. There have been a number of cases in recent years which have severely embarrassed a number of big players in the leasing industry.''
70. On 15 April 1988, Mr Allen responded to Mr Morgan's two facsimiles. In responding to the facsimile of 12 April 1988, which is not in evidence, Mr Allen said:
``Clause 12 dealing with the renewal options was inserted at MM's request. The Bank did not want this clause included. It is important to note that the Bank has effectively provided MM a borrowing facility which may be extended at MM's option for a further 10 years at only 1% p.a. over the Bank's cost of funds. Fifteen year borrowing on this basis is generally not available to corporations in Australia. In MM's view the conditions imposed by the Bank are reasonable.
The fact remains that State Bank still prefer [ sic] that MM purchase the plant at the end of the lease as they realise that the plant would be virtually unsaleable to another corporation given the cost and difficulty of removal from the site at Port Kembla.
A secondary period with peppercorn rent is unacceptable to the Commissioner of Taxation.''
71. In responding to the facsimile of 13 April 1988, Mr Allen said the following:
``MM has fought to the limit to achieve the many concessions in the documents, including notice periods, insurance and the 1% margin over cost of the funds for the removal [sic, scilicet renewal] options. In both MM's view and that of its legal advisers, the provisions in case of default are not especially harsh. The State Bank has absolutely no security or covenants for this financing, the Bank is relying solely on the credit worthiness of MM.''
Mr Allen agreed in cross-examination that he believed that the Bank had no security in terms of the payment of the Rent but that he was not looking at the security over the Plant and Equipment itself which was expressly covered in the Lease.
72. When asked what he meant by referring to ``the business reputation of the Lessor'' in his memorandum of November 1987, Mr Allen said that he imagined that there would always have been a concern that, at the end of the Lease, the Plant and Equipment would become the property of the Lessor who was free to do with it ``what he will''. He said that the Taxpayer would be looking at the Lessor's reputation to conduct an auction or a sale in a reputable manner.
73. Mr Allen was asked, in cross- examination, whether, in fact, he was referring to the likelihood that the Lessor would act in accordance with the usual practice and allow the Plant and Equipment to be purchased by the Taxpayer at its residual value. Mr Allen's response was that he ``wouldn't have thought 5 years down the track, frankly in that''. He said that business reputation would have meant that, had the Plant and Equipment been sold on the open market, it would have been a fair sale and not ``an undercover sale to somebody who may be an MM competitor''.
74. Mr Allen was being invited to recall his state of mind at a time more than eleven years earlier. I consider that his attempts to recall his state of mind in that regard are not convincing. The passage about which he was being asked follows on a statement in his memorandum that there could be no option for the lessee to acquire the plant at the termination of the lease, since such an option would result in the lease being treated as a hire purchase agreement. The memorandum then went on to set out the passage in upper case set out in paragraph 41 above.
75. It is clear that, in doing so, Mr Allen was intending to provide to the directors some degree of comfort that, by entering into the Arrangements, with no option to repurchase the Plant and Equipment, the Taxpayer would have some security for retaining the Plant and Equipment at the expiration of the Term of the Lease. First, there was the business reputation of the Lessor. Implicit in that statement is that the Lessor would not act in a way which could be regarded as improper. In the context of the comment, that must mean that, if the Taxpayer wished to repurchase the Plant and Equipment, the Bank would permit it to do so. Such a construction of the November 1987 memorandum is corroborated by Mr Allen's memorandum to Mr Hooley concerning the operation of AAS 17.
76. Added to the likelihood that the Bank would not act ``improperly'' was the pragmatic fact that there would only be a very restricted market for the Plant and Equipment. That is to say, the easiest course for the Bank to adopt would be to sell the Plant and Equipment to the Taxpayer for the residual value, on the assumption that the Bank had no interest in deriving a windfall profit from the transaction, by selling it for more than the residual value.
77. Mr Cant regarded it as important in 1987 and 1988 that the Taxpayer retain the continuing use of the Plant and Equipment after the five year Term of the Lease which was then being proposed. It did not occur to him that the Taxpayer might not need the Plant and Equipment at the end of the Term and he certainly considered that the Taxpayer needed to have continued use of the Plant and Equipment. He also considered that it was important that, as the Taxpayer was paying substantial lease payments to the Bank over a five year term, it would be able to reacquire the Plant and Equipment at a reasonable figure. He was satisfied that the Plant and Equipment was of a sufficiently special purpose nature that the probability was that there would be no great other demand for it and that therefore the Taxpayer would stand a very good chance of acquiring it at the end of the Lease. He thought that because of its restricted saleability, the Taxpayer would be the only company that would want to buy the Plant and Equipment at the end of the Term. Mr Cant thought it was likely that the Taxpayer would be the purchaser at the end of the Term. He said that the reference to the ``business reputation'' of the Lessor was understood by him as being that the Lessor ``would be a man of integrity''.
78. Mr Dudley said that, when he considered the proposal at the November 1987 meeting of directors, he was concerned that the Taxpayer would have no security over the use of the assets at the end of five years. He was told that there was no guarantee over the ownership of an asset or the right to use the asset at the end of
ATC 5250the five year period and that there could not be an option to purchase.
79. Further, Mr Dudley said that he did not regard it as inevitable that the Taxpayer would acquire the Plant and Equipment at the residual value at the end of the Term. He said that there were discussions about various types of new technology that might replace parts of the Plant and Equipment. He said that his view was that, if the Taxpayer decided to go down the path of ``cast and rolled technology'', the Taxpayer would not have renewed the Lease, notwithstanding that he was aware that if there was any deficiency when the Plant and Equipment was sold elsewhere, the Taxpayer would have an obligation to make up that deficiency. Mr Dudley referred to the fact that a piece of equipment might be made redundant technically overnight.
80. Mr Ryan said that at the November meeting, there was discussion about whether or not the Taxpayer would be entitled to retain the use of the Plant and Equipment beyond the Term and that that was one of the major concerns. When asked about discussion concerning the reference in Mr Allen's memorandum to there being no option for the Lessee to acquire at the end of the lease, Mr Ryan said:
``It all related to security, whether the company would be entitled to retain the use of the plant beyond the 5 year term of the lease. It was being proposed as a sale and leaseback and I think Mr Allen was simply making the point there that everything needed to be done to ensure that it could be properly regarded as a lease.''
However, Mr Ryan could not recall any specific discussion about the question of the Taxpayer's security for retaining the Plant and Equipment on termination of the Lease.
81. The directors of the Taxpayer were clearly mindful of the proposition that the proposed arrangement with the Bank entailed that the Taxpayer would be divested of ownership of the Plant and Equipment. They were also mindful that there would be no legal guarantee that the Taxpayer would be entitled to reacquire the Plant and Equipment at the end of the Term of the Lease. Nevertheless, they were prepared to accept the risk that the proposal involved for Taxpayer. As a practical matter, the risk was regarded as minimal or theoretical.
The Taxpayer's need for finance
82. At a meeting of the directors of the Taxpayer held on 16 September 1986, the directors considered a paper prepared by Mr Cant. The paper was entitled ``Towards a Strategy for Metal Manufactures Limited''. In the paper, Mr Cant set out what he referred to as ``some financial parameters''. Mr Cant expressed the view that future acquisitions by the Taxpayer should be financed either from the issue of further equity capital or from borrowing facilities not required or likely to be required for the existing businesses. He raised the question of principle as to whether it is better to acquire new activities from additional equity capital rather than from loans or cash. While accepting that there was no absolute answer to that question, Mr Cant expressed the view that:
``... as a general rule it is probably sound to maintain that it is on balance wiser to use at least a substantial proportion of new equity to make larger acquisitions.''
83. Another matter touched on by Mr Cant in his paper was the question of ``debt-equity ratio''. The paper contained the following observation:
``The extent to which prospective lenders will be prepared to accept going concern valuations of fixed assets rather than market values will be an important consideration here. It should be noted that the increasing availability of leverage of borrowing facilities secured on the assets of the activity to be acquired does offer a more open ended borrowing potential which may in certain circumstances be more appropriate than committing the value of existing assets to borrowings to acquire new ones.''
It was that proposition which led to the question of principle referred to above.
84. At the Board meeting on 16 September 1986, it was agreed that a draft growth plan should be prepared for consideration by the Board which was to incorporate details of the recommended financial parameters referred to by Mr Cant. It is not clear whether the strategy suggested by Mr Cant was ever adopted by the Taxpayer. However, Mr Cant, in his evidence, relied on that background as supporting his approach to the proposals for the sale and leaseback of the Plant and Equipment when they came before the Board.
85. At a meeting of the directors of the Taxpayer held on 21 September 1987, there was discussion concerning possible acquisition of the interests of minority shareholders. The minutes record the following:
``The Managing Director added that MML was adversely affected by the existence of minorities in CMA and ASC which prevented a rationalisation of operations and the consequent achievement of considerable cost savings. He advised that whilst MM's minority partner in ASC, STC Australia, had not previously been prepared to sell its interest to MM at other than an unacceptably high price, the position may now be changing and STC Australia's new parent, Alcatel of France, may be willing to part with the holding at a more realistic price.''
The references to CMA and ASC are references to Cable Makers Australia Pty Ltd and Austral Standard Cables Pty Limited.
86. Mr Allen said that up until that time, while it had been a hope to acquire the minority interests, that report was the first suggestion that there was a real opportunity to do so. That may have some bearing on one of the issues which arises in the proceedings. The prospects of acquiring minority shareholdings in subsidiaries would require an expenditure of funds by the Taxpayer. The prospect of such expenditure could be a justification for raising funds by means of sale of plant and equipment and the lease back of such plant and equipment.
87. Mr Allen said in evidence that he regarded the Taxpayer's situation at the end of 1987 as entirely unsatisfactory and not in accordance with prudent business practice. He considered that at that time, the Taxpayer had a need to raise longer term funds to correct balance sheet ratios. He said that the Taxpayer could not have pursued the acquisition policy that it pursued in 1987 and continue to borrow on a short term basis.
88. Mr Cant said that in 1987 and 1988 he was of the opinion that an outstanding weakness of manufacturing companies in Britain and Australia was the relative lack of medium to long term low interest bearing loan capital. By that he meant loan capital from 5 to 20 years at a rate of interest of between 3 and 7 per cent. Mr Cant, in 1987, was aware of a plan having been developed by the Taxpayer to buy out minority shareholder interests in two subsidiaries of the Taxpayer, Austral Standard Cables Pty Ltd and Associated British Cables Ltd. He considered that the Taxpayer needed additional finance for both the initial purchase and the capital expenditure required to achieve the rationalisation of the structure of the cable businesses of those companies that was intended. He said that his decision to approve the sale and leaseback proposal was made against a background of a desire to see medium term finance in place generally and, especially, in light of the needs for finance that I have just mentioned.
89. Mr Allen also said that the only reason he considered and ultimately decided that the Taxpayer should enter into the sale and leaseback transaction was to raise long term funds for the Taxpayer. He regarded the taxation advantages that were referred to in the documents as only relevant in so far as they influenced his decision to raise the funds by way of the sale and leaseback, rather than by way of a conventional borrowing or some other method.
90. Mr Dudley, when he joined the Board of the Taxpayer in July 1987, had a number of plans for the Taxpayer. He believed that it was highly desirable that it acquire the minority interests in the subsidiaries that operated cable businesses. He also believed that it was necessary to invest further capital to upgrade those businesses. In order to proceed with the acquisitions and the upgrading, he considered that it was necessary for the Taxpayer to acquire significant additional finance. He was also concerned, as the end of 1987 approached, that the Taxpayer had high levels of short term debt. It was in that context that he evaluated the sale and leaseback proposal that was put to the Board by Mr Allen. He considered that the proposal represented a cost efficient form of financing that would assist in addressing the Taxpayer's immediate and longer term finance needs and the need to restructure the Taxpayer's debt.
91. Because of illness, Mr Heinrichs was not available for cross-examination. I admitted his affidavit but on the basis that the weight to be given to his evidence would be assessed after cross-examination of other witnesses.
92. Mr Heinrichs said that, at the time of the meeting of 23 November 1987, he was aware that the acquisition of shares in Austral Standard Cables Pty Ltd would need to be completed on or before 31 December 1987. He
ATC 5252considered that it would be desirable that the funds be raised in a way that would not lead to an increase in the Taxpayer's short term borrowings as at 31 December 1987. He considered that the sale and leaseback proposal that was put to the directors at the November meeting would assist in achieving that object. He agreed to defer the decision concerning the proposal for the following reasons:
- • concern that the Taxpayer could lose the use of the plant at the expiration of the lease term in 5 years;
- • the desire of those at the meeting to obtain information about whether other companies were entering into such arrangements.
93. The meetings of directors held in 1987 and 1988 were attended by Mr Ryan as Corporate Secretary. In that position, he considered that the sale and leaseback proposal was a cost effective means of providing medium term funding to the Taxpayer in what he considered to be its expansionary phase, in particular, to assist with the funding of the purchase of the remaining 40% of the share capital of Austral Standard Cables Pty Ltd.
94. The same theme was taken up at the meeting of the Executive Committee held on 2 February 1988. Under the heading ``Operating Performance - Financial'', Mr Allen is reported as commenting that the Taxpayer's net debt had increased significantly at the end of 1987 as a result of the substantial borrowings arranged to fund the purchase of STC's minority interest in Austral Standard Cables Pty Ltd.
95. At the meeting of directors held on 22 February 1988, the directors resolved that the consolidated accounts and accounts of the Taxpayer for the year ended 31 December 1987, together with the Directors' Report and Statement by Directors, be adopted and that they be signed by the Chairman and Managing Director on behalf of the Board. The Directors' Report is dated 25 February 1988.
96. The Directors' Report contains the following under the heading ``State of Affairs'':
``On 31 December 1987 the company acquired from Standard Telephones & Cables Pty Ltd the minority 40% shareholding in Austral Standard Cables Pty Ltd for a consideration of $70 million. The acquisition was effected using available finance facilities with a consequent increase in current borrowing. The directors recognise the need to review the group's funding profile during 1988.''
97. The minutes of the meeting of directors held on 22 February 1988 also include the following under the heading ``FINANCE'':
``(a) Net funding
- ... the Executive Director, Finance, advised that the high level of short term debt reflected the borrowing arranged to fund the acquisition of the minority interest in ASC. Discussion took place concerning the relative merits of the methods of finance available to the Company and the desirability of preparing a financial plan.''
That reflects the comment contained in the Directors' Report in the 1987 Annual Report of the Taxpayer to which I have referred above. It is also consistent with the comment recorded in relation to the proposed sale and leaseback transaction that longer term financing strategies were part of the Taxpayer's overall strategic planning.
98. The question of increase in the Taxpayer's short term debt was taken up again at a meeting of the Executive Committee of the Taxpayer held on 1 March 1988. Mr Dudley was the chairman of the meeting and the meeting was also attended by Mr Allen. The following comment appears in the minutes of that meeting:
``Mr Allen stated that with the significant increase in the level of Group short term debt at the end of 1987 an overall MM Finance Plan was being developed. He commented that as matters stood, there was little scope to increase debt to fund further acquisitions and alternative means of raising finance were being investigated. He added that if a share issue or placement was to be considered, there was a need to ensure that the market price of the Company's shares remained at a reasonable level or was increased.''
99. The balance sheet contained in the Taxpayer's 1987 Annual Report showed an increase in the following assets:
Asset 1986 1987 Receivables $52,995,000 $87,564,000 Inventories $28,384,000 $85,670,000 Investments $69,971,000 $226,099,000
The increase in investments resulted from the purchase by the Taxpayer of shares in Balfour Beatty Pty Ltd, Gooder Ltd and Associated British Cables Ltd on 27 July 1987 for $86,000,000 and the purchase of shares in Austral Standard Cables Pty Ltd on 31 December 1987 for $70,000,000. $92,000,000 of that increase in assets was financed by the issue of 35,850,000 additional fully paid shares in the capital of the Taxpayer. The balance of the increase in assets was financed almost entirely out of short term debt. The balance sheet shows the following increase in current liabilities:
Liability 1986 1987 Creditors 12,050,000 68,286,000 Borrowing 34,402,000 149,338,000
That demonstrates an increase in the total of current liabilities, comprising creditors and borrowings, of in excess of $170,000,000.
100. A meeting of the directors of the Taxpayer was held on 18 April 1988. The minutes record the following under the heading ``Finance'':
The Executive Director, Finance stated that that the improvement in MM's gearing during the first quarter was due to the Group's strong cash flow.
He added that the finalisation of the sale and leaseback proposal approved at the last Board meeting would have the effect of decreasing short term debt and increasing long term debt at end 1998 [sic] by some $42 million.''
101. Under the heading ``MM Financial Planning'', reference was made to a discussion paper prepared by Mr Allen. That discussion paper included the following:
Discussion took place at the February Board [ sic] concerning the company's borrowing profile and the desirability of preparing a financial plan. This paper sets out the 1988 forecast financial position of the Metal Manufactures Ltd Group,... the likely level of debt over the next five years and details of possible actions that could be implemented to provide an appropriate capital structure for MM.
The adverse gearing ratios noted in [the appendix to the discussion paper] will be normalised fairly quickly during 1988 as MM's strong cash flow reduces gross borrowing to around $76 million. Year end 1988 gearing in Australian Rating terms is forecast at a very comfortable 22%. The sale of certain non-core business interests, together with the proposed sale and leaseback, which replaces $50 million of short term borrowing with five year debt, have also assisted in improving the profile.''
The minutes record that the Board noted the contents of the discussion paper and agreed that it provided a base from which to develop a financial plan for the Taxpayer.
102. The minutes of the meeting of the directors held on 25 July 1988 included the following:
The Executive director, Finance, referred Directors to Page 9 of Appendix I. He stated that the sale and leaseback of certain plant at Port Kembla had reduced the level of short term borrowings and increased long term borrowings, thereby creating a more favourable borrowing profile as well as
ATC 5254lowering the Company's overall effective tax rate. He added that the reduction in the corporate tax rate to 39% had the effect of reducing the tax savings resulting from the sale and leaseback from $20 million to $17 million over the term of the lease.''
The document referred to in the minutes was a schedule of indebtedness of the Taxpayer showing significant reductions in borrowings forecast for December 1988 when compared with December 1987.
103. The facts that I have recited indicate that the proposed sale and leaseback transaction was perceived by the directors of the Taxpayer as being part of the financial structure of the Taxpayer. It is clear that there had been a significant increase in short term debt during 1987 as a consequence of the acquisitions of minority shareholdings. It is true that the possibility of a sale and leaseback transaction was mooted early in 1987 before the acquisitions became a likelihood. Nevertheless, the mandate to Macquarie Bank of 30 September 1987 was not given until after the meeting of directors of 21 September 1987, when the Board was informed that the position concerning the possible sale of the outstanding interest in Austral Standard Cables Pty Ltd might be becoming a possibility.
104. It is clear enough that the first reference to the possibility of a sale and leaseback transaction was in Mr Anderson's memorandum to Mr Allen of 5 March 1987. Mr Anderson referred to his discussion of ``suitable ways in which the group might improve its taxation position''. However, it would be possible for a taxpayer to have a desire to raise funds but to do so in a manner that would involve the most favourable tax treatment available to the taxpayer. It is clear that the Taxpayer had a need for medium to long term funds in order to discharge the short term borrowings that had been undertaken in order to fund the acquisitions of minority interests and increases in receivables and inventories during the 1987 year. While consideration of a sale and leaseback transaction progressed during the first part of 1987 before there was a consideration at Board level of the need to arrange medium to long term finance, that could be taken as prudent planning. A prudent industrialist may well examine tax effective means of raising finance before the need for finance actually arises.
105. Mr Anderson's memorandum of 9 September 1987 contains a suggestion that the sale and leaseback transaction would constitute an end in itself and that the Taxpayer would benefit by investing in the money market the funds raised by the transaction. Mr Anderson did not give evidence and there was no explanation offered on behalf of the Taxpayer for failing to call him.
106. However, the ultimate decision was made by the directors. Certainly, evidence was called from only a small number of the directors without explanation as to why evidence was not called from the others. The affidavits read by the directors who gave evidence were in fact prepared in 1993. They were apparently prompted by an audit conducted by the Australian Taxation Office. The assessments in issue were not issued until some time after that time and the proceedings were not commenced until 1997.
107. Nevertheless, the contemporaneous materials in evidence support a conclusion that, by the time the Arrangements were approved at Board level, the directors were mindful of the need to replace short term debt with medium to long term finance. In any event, an objective assessment of the financial position of the Taxpayer indicated that replacement of short term debt with medium to long term finance of at least $50,000,000 would be a sensible step for the Taxpayer to take in the first half of 1988.
The Plant and Equipment
108. In order to consider the Commissioner's contention that the Plant and Equipment were fixtures, it is necessary to describe the Plant and Equipment in some detail. In particular, it is necessary to explain the manner and degree of affixation of the Plant and Equipment to the factory premises owned by the Taxpayer and Austral Bronze. I shall describe each manufacturing line separately.
The Taxpayer's Tube Division
109. The Taxpayer's copper tube factory is situated on the southern edge of the Taxpayer's Port Kembla site. The factory is housed in a single building which has access to roads on the eastern and northern sides of the building. The factory produces a wide range of copper tubes in both coils and straight lengths. The copper tubes are manufactured using a number of items of plant, including, but not limited to, some of
ATC 5255the plant referred to in the Inventory in the Mason Gray Strange valuation.
110. The Tube Division plant includes:
- • Shell Extrusion Line;
- • Marshall Richards 84 inch diameter Horizontal Bull Block;
- • Marshall Richards motorised vertical Continuous Pay Off Block;
- • Wean Vaughn Rotubloc motorised Continuous Pay Off Block.
111. Tube is produced from billets of copper, commencing with the process carried out by the Shell Extrusion Line. The Extrusion Line converts the billets into thick walled tubes or shells. The Extrusion Line pierces a cylindrical hole down the centre of the billets and then extrudes them through a die to produce shells of varying diameters and lengths. Some shells are passed through a tube reducing line which is not dealt with by the Mason Gray Strange Valuation. That process reduces the wall thickness and the diameter of the shells.
112. After the Extrusion Line, the shells are then transported by a system of conveyer chains or overhead cranes to various other places. One of those places is the Horizontal Bull Block where the shells are further drawn. After that process, the shells are drawn through one of the Continuous Pay Off Blocks. In each case, the diameter and wall thickness of the tube is reduced. The Continuous Pay Off Blocks produce either finished product or product for further processing in the factory. The remaining processing of the shells depends on the proposed use of the finished product.
No. 3 Tube Shell Extrusion Line
113. The main components of the Extrusion Line are as follows:
- (a) Furnace:
- The non-ferrous metal billets are fed into a heating furnace by a loading system that includes a handler for the billets, various conveyers and a saw, which cuts up the billet to various lengths. The billets are heated in the furnace, which is supported by, among other things, an exhaust system and fans to prevent overheating.
- (b) Induction heater:
- From the furnace, the billets, which are then red hot, are transferred to induction heaters, which generate heat by ``soaking'' the billets in an electric field. The induction heater completes the heating process and stabilises the heat level.
- (c) Hydraulic press/mandrel/die/container:
- The red hot billet then goes into the main extrusion process. A circular hole is made down the centre of the billet by a mandrel which is forced through the billet by the piercing ram. The billet is then pushed by the main ram through a die, from which it emerges as a thick walled shell.
114. The extruder, and in particular the rams, are operated by a substantial hydraulics system which is located under the floor of the factory. Some two cubic metres of oil and approximately 10 pumps are involved. The remainder of the Extrusion Line treats the extruded shell and prepares it for further processing, which includes cooling and washing equipment, and conveyor equipment. The Extrusion Line is supported by extensive services including water cooling towers and two switchrooms.
115. The Extrusion Line is located on the northern side of the factory. The three column hydraulic extrusion press has a 1,700 tonne main ram capacity and a 400 tonne piercing ram capacity. The various components of the line are bolted onto large concrete foundations on the floor. A layer of grouting sits on top of the concrete footing. Metal packing is placed between the footings and the plant and any resulting spaces are filled by surrounding the base of the plant with a concrete grouting. The grouting plays no role in locating or affixing the plant.
116. The alignment of the Extrusion Line components, including the mandrel, ram, container and die, is crucial and is achieved with the assistance of a laser to an accuracy of 1/3 of a millimetre. If these items go out of alignment, then the line produces unacceptable levels of eccentricity in the extruded shells. If the units were not secured by being bolted to the footings, the forces concerned would cause vibrations and could pull the mounted barrels out of position. That would result in damage either to the product or to the units which would be rendered inoperable.
117. All the main elements of the line could be removed by being unbolted and by being
ATC 5256freed from the grouting where required. The major elements would have to be partially dismantled. It would then be necessary to establish a jacking frame and rollers to move the larger components, such as the main ram support, platforms and base, in reach of a mobile crane which could then be used to lift them onto appropriate transport.
118. The items could be positioned onto the jacking frame using the existing overhead cranes connected in tandem. The mobile crane could be given the necessary access through either the eastern access door or the northern wall of the factory. The wall is a steel framed structure clad in corrugated iron. It would take a team of eight men one day to remove the wall and the same time to restore it.
119. In the removal process, all of the components of the Extrusion Line would be retained except for some small and relatively inexpensive parts such as pipe work and cabling, which would be scrapped. For example, some pipe work is embedded in concrete and would be destroyed in the removal process. Alternatively, it would be configured to suit its present location but may be useless for a different location.
120. The cost of removing the Extrusion Line from its present location and placing it on floats for transportation to another location would be $288,455. The removal process would take approximately two months. The cost of installation of the machinery at a new site would be approximately $1,200,000, excluding a building and footings.
Horizontal Bull Block
121. The Horizontal Bull Block is located in that part of the factory building referred to as the No. 2 Tube Factory. Its function is to reduce the diameter and wall thickness of the product in order to produce intermediate product, which is suitable for further processing in one of the Continuous Pay Off Blocks. Tube can be passed through the Bull Block a number of times to be reduced, with the number of times depending on the size and wall thickness of the final product required.
122. In addition to the Bull Block itself, there are tube preparation and conveyance systems where the tube is prepared and then fed into the Bull Block. In the Bull Block, the tube is drawn through a die block to reduce its diameter and wall thickness. Once it has been drawn, it is coiled. A hydraulic hook lift puts the coil on to the overhead coil conveyor, either to go through the Bull Block again or to be taken to another line for further processing.
123. The components of the Bull Block also rest on concrete footings and are bolted down and grouted. The Bull Block can be broken down into components and unbolted from the footings. There is a crane in the No. 2 Tube Factory with the capacity to move all of the components. The cost of removing the Bull Block from its present location and placing it on floats for transportation to another location would be $98,414. The removal could be carried out in less than a day. The total cost of removing and relocating the Bull Block would be $1,050,000, excluding the building and footings.
Continuous Pay Off Blocks
124. There are two Continuous Pay Off Blocks which are located in the No. 3 Tube Factory. They are similar machines but manufactured by different manufacturers. The input into the Continuous Pay Off Blocks are coils of tubes that have been through the Horizontal Bull Block. The Continuous Pay Off Blocks draw the tube to finished sizes as well as tube for finishing elsewhere.
125. The Marshall Richards Continuous Pay Off Block and the Wean Vaughn Continuous Pay Off Block draw the tube to reduce the diameter and wall thicknesses required. Each has motorised pay off and take up stations from which the coils of tube from the Horizontal Bull Block are fed into the die. Both Pay Off Blocks have various conveyor systems for transferring the coils.
126. The major components of the two Continuous Pay Off Blocks rest on concrete footings and are bolted down and grouted. The process for removing the Continuous Pay Off Blocks is similar to that for removing the Horizontal Bull Block. The components of the Continuous Pay Off Blocks would be able to be removed using the overhead crane presently installed in the No. 3 Tube Factory. The cost of removing each of the Continuous Pay Off Blocks from their present location and placing them on floats for transportation to another location would be $118,391 for one and $117,264 for the other. The total cost of removing and relocating the Continuous Pay Off Blocks would be $800,000 each, excluding the building and footings.
Continuous Rod Manufacturing Line (KCR Line)
127. The continuous copper rod manufacturing line, also known as the ``Kembla Continuous Rod Line'' or the ``KCR Line'', is located immediately south of the Wire Factory and is housed in its own building. A roadway runs along the northern side of the building.
128. The KCR Line produces copper rod of four different diameters from sheets of copper or copper cathode. The copper rod is either sold as a commodity or further processed by the Taxpayer by, for example, being reduced to wire in a Tandem Drawing Machine.
129. The main components of the KCR Line are as follows:
- (a) Melting Furnace:
- The copper cathode is melted in a refractory brick lined steel-shelled furnace. The melting furnace was not included in the inventory attached to the Mason Gray Strange Valuation.
- (b) Holding Furnace:
- The molten copper from the melting furnace flows, via a refractory lined launder, into a gas fired 15 tonne barrel holding furnace with hydraulic revolving action.
- (c) Casting Wheel, with Casting Wheel Pump:
- The molten copper travels from the Holding Furnace via a refractory lined launder to a Continuous Casting Wheel. The molten copper is contained in the profile of the casting wheel by a metal band and is converted to solid copper through a water quenching process. It emerges from the Casting Wheel as a strip or ribbon. The Casting Wheel is a bolt-on/bolt-off component that is removed from the line every three to four weeks.
- (d) Trimming Plant:
- The strip or ribbon is guided to the Trimming Plant or Bar Preparation Unit, which shaves the edges to remove things from the metal which remain after it emerges from the Casting Wheel.
- (e) Roughing Mill:
- From the Trimming Plant, the copper ribbon undergoes the first stage of the reducing process in the Morgan Continuous Roughing Mill Preparation Station. The Mill is divided into two stands and is fitted with alternating horizontal and vertical roll drives, which commence the process of reforming the ribbon into rod.
- (f) Finishing Mill:
- The Morgan Ten Station Horizontal and Vertical Plane Roll Forming Line (or the Finishing Mill) is also fitted with alternating horizontal and vertical roll drives. The rolls convert the ribbon from the rough form which emerges from the Roughing Mill into copper rod.
- (g) Cropping Shears:
- The rotary cropping and sizing heads and two waste cropping shears are situated at two points in the KCR Line. They enable the metal ribbon to be cut into short lengths without stopping the operation of the melting furnace. They are situated after the Casting Wheel and before the Roughing Mill and after the Morgan Two Stand Mill and before the Morgan Ten Stand Mill.
- (h) Water Descaling Pickle Plant:
- After emerging from the Finishing Mill, the red hot copper rod passes through pipe work containing a recirculating pickle solution which both cools the rod to nearly ambient temperature and precludes contact with the air, thus avoiding oxidation of the rod.
- (i) Coiling Station:
- The rod is collected in packs by a Morgan motorised coiling station.
- (j) Post Crane Gantries and Hoists:
- Gantries and hoists are situated on an elevated steel structure supported on steel columns. The overhead crane has a maximum lifting capacity of 10,000 kilograms. These run almost the total length of the factory. They run on columns that support the building itself.
- (k) Electrical Reticulation:
- This comprises an operation process control cabinet, switch room transformers and various other equipment and cabling.
130. The whole process of the line is integrated. Without any one of the components, the line could not function. The components are
ATC 5258connected by electrical, hydraulic, water and pneumatic service lines which are used to move the product along the lines. All of those lines are exposed.
131. All the major components of the KCR Line stand on concrete footings to which they are bolted. The bolts are set into the concrete footings. Typically, metal packing is placed between the footings and the plant and any resulting spaces are filled by surrounding the base of the plant with a concrete grouting which plays no role in locating or affixing the plant.
132. The items of plant are bolted down in order to:
- • locate them;
- • ensure they are correctly aligned and level in relation to adjacent equipment in the production line;
- • ensure that they do not move while in operation.
All of the major components have substantial moving parts that would cause those components to shift were the components not firmly bolted. Minor shifts would compromise the proper operation of the plant and detrimentally affect product quality. More substantial shifts could have serious consequences due to the risk of molten metal being spilled or the uncontrolled outfall of red hot metal.
133. In order to relocate the KCR Line, other than the melting furnace, it would be necessary to check the holding capacity of the building columns which support the present overhead crane. A second crane could be installed. That would allow removal of all the major components and the line and should minimise the need to break major items into their component parts. That would result in savings in the cost of removal.
134. The present building columns are sufficiently strong to support the second 10,000 kilogram capacity crane. If the columns were found not to be strong enough to support two cranes, it would be necessary to hire a suitable mobile crane or further dismantle the major components. It would be preferable to dismantle the components to permit the use of the smaller crane. The area is fairly cramped and access would be difficult.
135. Once appropriate cranes were obtained and put in place, all the major items would be freed for removal by being disconnected from their associated services and by being unbolted from their respective footings. It may be necessary to break up some of the grouting where the grouting had adhered to or flowed over relevant base components. A jack pick would be used.
136. To relocate the Holding Furnace, it would first have to be stripped down. It is routinely stripped down every five to six years as part of regular maintenance. The refractory would need to be broken up to allow the Holding Furnace to be stripped down. The Holding Furnace consists of two principal components, being the rotatable barrel of the furnace proper, weighing approximately 5 tonnes, and a steel supporting base. Once the furnace proper has been lifted away, the base can be unbolted and removed from the concrete foundations.
137. It would be possible to salvage services to the Holding Furnace such as cabling and pipelines. In practice, however, that would be unlikely because it would be more efficient to use new pipeline and cabling, particularly if a different configuration of pipelines was required at the new location.
138. The Continuous Casting Wheel is a bolt- on/bolt-off component and is easy to remove. It is routinely removed for maintenance. Removal involves unbolting the casting wheel from the metal support structure and drive train and lifting it away. The drive train is removed by disconnecting its components and lifting them away. That part of the assembly which is annexed to the concrete footing simply has to be unbolted.
139. Each of the Roughing Mill and Finishing Mill is a single unit. Some breaking up into smaller components would be necessary to make the mills light enough to be removed using the cranes contemplated. However, they would not have to be completely stripped down. The Roughing Mill weighs approximately 15 tonnes and the Finishing Mill weighs approximately 20 tonnes. Both are bolted to their concrete footings. To free them for removal, all that would be required would be to disconnect the relevant services and to unbolt them from their footings. The launders, belt and control room facilities would be easy to remove using the crane facilities briefly described above.
140. The removal of the KCR Line, as described above, would not result in any
ATC 5259damage to the fabric of the factory building. Some damage might result to ancillary steel platforms that presently provide access to the plant and to the concrete footings.
141. The cost of removing the KCR Line from its present location and placing it on freight for transportation to another location would be $307,751. The overall cost of reinstallation of the KCR Line at another line would be in the order of $4,000,000. The single most costly aspect of the reinstallation would be the construction of the necessary building and footings. The cost of the building and footings would be $2,375,000 and the cost of reinstallation of the plant itself would be $1,625,000.
Vaughn High Speed Tandem Wire Drawing Plants
142. In 1988, there were two Wire Drawing Plants at Port Kembla. Both have since been removed. Mr R.J. Rankin, as part of his duties as Senior Projects Engineer of the Taxpayer, was responsible for the relocation of a Vaughn High Speed Tandem Wire Drawing Plant with associated machinery and services from the Taxpayer's Port Kembla works to the premises of the Taxpayer at 1 Heathcote Road, Liverpool, NSW (``the Liverpool Vaughn Tandem Plant''). He also assisted in an advisory role with the relocation of a Vaughn High Speed Tandem Wire Drawing Plant with associated machinery and services from the Port Kembla site to the Taxpayer's telecommunications location at Clayton, Victoria (``the Clayton Vaughn Tandem Plant'').
143. The Liverpool Vaughn Tandem Plant is a stand-alone unit which draws copper rod to a range of intermediate wire sizes. At the time immediately before its relocation to the Liverpool site, the main components of the Tandem Plant were:
- (a) Vaughn high speed tandem Model 11DMT drawing machine.
- (b) Vaughn 400 kva annealing unit which anneals the wire after it has been drawn. This is not used for all products.
- (c) Niehoff motorised spool winding plant, which spools the wire after it has been drawn and, if required, annealed.
- (d) Vaughn VSB36 inch down coiler which coils the wire into 2 tonne baskets for reprocessing.
The product passes either to the spool winding plant or the down coiler, but not to both.
144. The Liverpool Vaughn Tandem Plant also comprised services which supported the above items. The main components of the services were:
- (a) Heat Exchanger PL cooling tower;
- (b) Mild Steel 8,000 litre tank and 2 split case centrifugal pumps, cock valves and fittings;
- (c) one steel full slewing post cranes with hoist;
- (d) pneumatic strapping plant and fittings.
- (e) electric panel;
- (f) assorted pipework and cabling.
Without the services, the items of plant would simply not operate.
145. Each main component listed above was bolted to concrete footings on the floor of the KCR building at the Port Kembla site. Typically, there was metal packing between the footing and the base of the units of plant which had been placed there to level them. Any resulting gaps between the base of the plant items and the footing were filled with a concrete grouting which surrounded the base. The grouting played no part in affixing the plant to the footings. The plant was bolted to the footings:
- • to prevent the plant from shifting while it was in operation and to prevent components of the plant from shifting relative to other components;
- • to facilitate the attachment of services to the plant through cables and pipes.
If the various components of the plant were able to move during operation, product quality could be impacted adversely. If the movements were sufficiently large, the wire could break.
146. The services were affixed as follows:
- (a) the heat exchanger cooling tower and pumps sat on a platform that ``bridged'' the road between the KCR building and the Wire mill;
- (b) the lubricant tank and pumps sat on concrete footings in the cellar of the KCR building directly beneath the main components of the plant;
- (c) the crane sat in concrete footings on the floor of the KCR building;
- (d) the electrical drive and control equipment was housed in the cellar of the KCR building directly beneath the main components of the plant;
- (e) electrical services and pipework were attached to the equipment either via duct work in the concrete floor or overhead by being suspended from the structure of the building.
147. The Liverpool Vaughn Tandem Plant was removed from the Port Kembla site to the Liverpool site in early 1992. The removal commenced on about 10 January 1992 and was completed on about 15 January 1992. The removal was effected with equipment either already on site at Port Kembla or supplied by the contractors who carried out the work.
148. The only disturbances to the structure of the factory as a result of the removal process were as follows:
- (a) The drilling of the concrete floorings in which the units were embedded meant that there were recesses in the factory floor and the floor of the cellar. Those recesses were filled with concrete.
- (b) The removal of some pipe work and cabling involved drilling concrete in which the pipe work or cabling was embedded, in order to get rid of the grouting. Those areas were subsequently levelled.
149. Some items, which were components of the Liverpool Tandem Plant when it was located in Port Kembla were either not removed to Liverpool or were not reinstalled. They included:
- (a) the annealing unit;
- (b) monochrome monitor;
- (c) heat exchanger;
- (d) Mild Steel vat and centrifugal pumps;
- (e) pneumatic strapping plant and fittings.
150. The cost of removal and reinstallation at Liverpool, excluding new capital expenditure, was $522,768.59. The total expenditure, including capital expenditure on new items, was $1,140,996.80.
151. The Clayton Vaughn Tandem Plant is very similar to the Liverpool Vaughn Tandem Plant. Immediately before its relocation to the Clayton site, the main components of the Clayton Vaughn Tandem Plant were:
- (a) Vaughn high speed tandem Model 10DSTX drawing machine with cone drive reduction geared electric motor and switches;
- (b) Vaughn 400 kva annealing unit;
- (c) Vaughn VSB 36 inch down coiler.
152. The Clayton Vaughn Tandem Plant also comprised services which supported those items. The main components were:
- (a) Heat Exchanger PL cooling tower;
- (b) Mild Steel 8,000 litre vat and 2 split case centrifugal pumps, cock valves and fittings;
- (c) one steel full slewing post cranes with hoist;
- (d) pneumatic strapping plant and fittings;
- (e) electric panel;
- (f) assorted pipework and cabling.
153. Prior to removal, the components of the Clayton Vaughn Tandem Plant were affixed in the KCR building at the Port Kembla site in the same way as the Liverpool Vaughn Tandem Plant.
154. Some items which were components of the Vaughn Clayton Tandem Plant when located in Port Kembla were not removed to the Clayton site as follows:
- (a) annealing unit;
- (b) heat exchanger, vat and centrifugal pumps;
- (c) banding unit.
155. The total cost of the removal from Port Kembla and reinstallation at the Clayton site, excluding new capital expenditure, was approximately $489,500. Total expenditure, including capital expenditure on new items, was $696,000.
156. The Properzi No. 7 Line is an aluminium rod manufacturing line located in the Aluminium Remelt Factory. The Properzi Line is a stand-alone plant which produces aluminium rod from aluminium ingots. It is similar in its general design and operation to the KCR Line. The building in which the Properzi Line is housed is bounded on the southern side by a road. There are wide areas of empty floor space on the southern and eastern side of the Properzi Line allowing easy access to it.
157. The major components of the Properzi Line are as follows:
- (a) Melting furnace
- Aluminium ingots are fed into a gas fired pig melting furnace with semi automatic carriage load station, where they are melted.
- (b) Holding furnaces
- The molten aluminium is then fed into one of two Major Melt gas-fired additive mixing tilt furnaces.
- (c) Continuous casting wheel
- From the holding furnaces, the aluminium passes through a refractory lined launder to a Properzi 55 inch casting wheel, where it is cooled from liquid to solid ribbon.
- (d) Waste cropping shear station
- After exiting the casting wheel, the aluminium ribbon passes through a waste cropping shear station. This can be used to cut the ribbon into short lengths.
- (e) 15 head roll forming line
- This is equivalent to the mills in the KCR Line, and converts the aluminium into rod form.
- (f) OTT dual spool product coiling station
- The aluminium rod is then coiled at an OTT dual spool product coiling station, from which it is removed for storage prior to sale or further processing.
158. The major service supporting the Properzi Line is a cooling system, comprising:
- • Muller timber external cooling tower;
- • Centrifugal motorised circulation pump and pipe work; and
- • Underground coolant storage tank facility.
159. All the major components of the Properzi Line stand on concrete footings. Except for the Melting Furnace, they are bolted to the footings and surrounded with grouting in the same way and for the same reasons as indicated above in relation to the KCR Line. The Melting Furnace is not attached to the concrete footings but sits on support beams, which are fixed to the concrete footings. Movement of the furnace is constrained by adjusting the stops at the end of the support beams and by the weight of the furnace.
160. The process involved in removing the Properzi Line would be similar to that outlined above for the KCR Line. However, removal of the Properzi Line would be easier because of its smaller size, compared with the KCR Line. All major components would be freed by being unbolted and, if necessary, by breaking up sections of grouting.
161. The Major Melt Melting Furnace would have to be stripped down and unbolted into its component parts before being lifted by crane and transported. The stripping down process would include breaking up the refractory lining of the furnace. The breaking up and removal of residual aluminium and old refractory material would take approximately eight days with crews working 24 hours a day.
162. Removal of the remaining major components of the Properzi Line would be similar to the process outlined above for the KCR Line. The most efficient way of gaining access to the major components of the Properzi Line would be to lift them out using hydraulic cranes of a type readily available. It would be necessary to remove part of the building which houses the line to allow suitable access to the crane. The building is a steel framed structure clad with a mixture of corrugated iron and compressed asbestos sheeting. It would take a team of five men approximately two days to remove the cladding and steel structure concerned. Rebuilding would take the same period.
163. The cost of removing the Properzi Line from its present location and placing it on floats for transportation to another location would be $297,682. The cost of reinstallation of the Properzi Line at another site would be in the order of $2,200,000, excluding the cost of a building and footings.
Fixtures or chattels
164. A fixture is tangible personal property or a chattel that has been attached to land with the intention that it remain attached permanently or indefinitely such that it becomes part of the realty -
Australian Provincial Assurance Co. Ltd v Coroneo  38 SR (NSW) 700. It loses its character as a chattel. All parts of the Plant and Equipment constituted chattels prior to affixation to the Taxpayer's or Austral Bronze's land. The question of whether the Plant and Equipment constituted fixtures or chattels as at 19 April 1988 is to be determined by reference to the objective circumstances and not by reference to the subject intention of those who affixed them.
165. Various considerations may be taken into account in determining the purpose of annexation. The considerations include the following:
- • whether removal would destroy the attached property;
- • whether the cost of removal would exceed the value of the attached property;
- • whether removal would occasion significant damage to the land or buildings to which the property is attached;
- • whether the attachment was for the better enjoyment of the property or for the better enjoyment of the land and buildings to which it was attached;
- • the nature of the property itself;
- • the contemplated use of the property;
- • period of time for which the property was to be in position;
- • function to be served by the annexation of the property.
No one of the above factors, of itself, will be conclusive.
166. Personal property or chattels that are attached to land otherwise than by resting on their own weight are prima facie fixtures and part of the land. The onus of establishing to the contrary is on the person who asserts to the contrary -
Holland v Hodgson (1872) LR 7 CP 328. In the present case, it is clear that such an onus rests on the Taxpayer. All of the Plant and Equipment in question was securely attached to land otherwise than by resting on its own weight.
167. The question of whether property constitutes a chattel or a fixture must be determined at the time of affixing. Of course, if additional attachment occurs or the nature of the attachment changes, the status of property may change. However, mere effluxion of time is not relevant because the question must be capable of answer as at the time of attachment. Otherwise questions would arise as to when a piece of personal property ceased to be a chattel and became a fixture. The change in status occurs with some physical manifestation in relation to the personal property in question.
168. The intention with which the Plant and Equipment were attached to the land is to be imputed objectively from the degree of affixation exhibited in relation to each item, and also from the extent of integration or incorporation of each item into the manufacturing line of which it forms part. If the intention was that the object of affixing was for the Plant and Equipment to become part of the realty itself, then it is a fixture. All other questions and considerations are relevant only in so far as they help resolve that question. The intention is to be determined objectively from the circumstances ``patent for all to see'', not from any subjective intention -
Hobson v Gorringe  1 Ch 182 at 193.
169. An important test for ascertaining that relevant intention is to inquire whether the object and purpose of the affixation was for the better enjoyment of the chattel itself, or for the better enjoyment of the freehold -
Reid v Smith (1905) 3 CLR 656.
170. Thus, the two objective circumstances which are said to be relevant to determining the intention with which the object was fixed to the land are:
- • the degree of annexation and
- • the object of the annexation.
Degree of annexation
171. Although there are several different manufacturing lines that were the subject of the Arrangements, each of which itself consisted of various items, little distinction was made between them in the course of argument. The common method of attachment was that items were bolted into concrete footings, and the gaps between the footings and the items were filled with concrete grouting. The grouting did not serve any purpose other than as a filler.
172. In the present case, although the Taxpayer was able to demonstrate that the Plant and Equipment could, as a practical matter, be removed, such removal would:
- • cause not inconsiderable damage to the floor of the factory premises,
- • necessitate dismantling part of the buildings (including cutting cross-supports in the walls) to enable access to various items,
- • involve some necessary scrapping of components of the services relating to the manufacturing lines; and
- • take considerable time, in some cases several months, to complete.
173. Further, the Plant and Equipment was incorporated to a high degree with other items within the Taxpayer's factories. For example,
ATC 5263the KCR Line was dependent upon and attached to the Melting Furnace, which was not itself the subject of the Arrangements. The Properzi Line was supported by various services which were essential to its operation. Those services would be destroyed to a significant extent by removal of the Properzi Line.
174. These considerations lead to a conclusion that there was an extremely significant degree of attachment of the Plant and Equipment to the land. Such a high degree of attachment weighs heavily in the balance towards a conclusion that the intention, objectively ascertained, in placing the Plant and Equipment on the land was that they were intended to become part of the land.
Object of annexation
175. The purpose for which the Plant and Equipment were annexed to the land, objectively ascertained, must be determined by reference to a number of the factors outlined above. The Plant and Equipment are extremely heavy items for the manufacture of tubes and pipes in the conduct of heavy industry. Whilst the Plant and Equipment may need to be replaced from time to time, in line with technological changes, there was no suggestion that the items in question were of a type inherently likely to become redundant within a fixed period of time. That situation may be contrasted with a situation where it is foreseeable that the presence of plant on a mining site would be limited because the mining site, by its nature, operates only for a limited period of time - see
Eon Metals NL v Commr of State Taxation (WA) 91 ATC 4841.
176. In the present case, it is clear that properly maintained items of the kind in question could last indefinitely, although they could become redundant overnight by a major technological advance. Those considerations do not lead to any conclusion other than that the Plant and Equipment were installed with the intention that they would remain in place permanently or indefinitely, rather than for a purpose that had a particular, or in some way limited, life span.
177. Certainly, it was necessary that the Plant and Equipment be attached to the land in a manner that would steady it, ensuring quality of the ultimate product, and for safety reasons. In that sense, the items were affixed for the better enjoyment of the items themselves, rather than for the better enjoyment of the land. However, there can be circumstances in which chattels may become affixed for the better enjoyment of land used for a particular use. Thus, a milk processing plant might constitute a fixture because it was annexed to the land for the better enjoyment or use of the land
as a dairy processing plant
National Dairies WA Ltd v Commr of State Revenue  WASCA 152. Similarly, items of machinery in a factory plant may be fixtures because they were annexed for the better use and enjoyment of the land as a furniture factory - see
Re Starline Furniture Pty Ltd (1982) 1 ACLC 312; (1982) 6 ACLR 312.
178. Parts of the Plant and Equipment were installed on land belonging to a third party, namely Austral Bronze. That might suggest an intention that the items were not to become part of the land. However, Austral Bronze is a wholly owned subsidiary of the Taxpayer. In any event, the relationship between the Taxpayer and Austral Bronze appears to be that of tenant at will and landlord. Thus, while the items may be removable as tenant's fixtures they would nevertheless be fixtures.
179. The law of fixtures may operate harshly. The doctrine of tenant's fixtures ameliorates that harshness in certain circumstances. Thus, a tenant is given the right, upon the expiration of the tenancy, to sever items from the land that have been installed during the currency of the tenancy. The right stems not from any consideration that the tenant must not have intended that the items remain permanently on land belonging to the landlord, and therefore, the items must continue to be chattels. Rather, the principle recognises that, despite the fact that the tenant did not intend the item to become affixed to the land , the item did in law become a fixture. The fact that the Plant and Equipment was installed, in part, on land belonging to a third party does not assist in a determination of the objective intention with which the items were placed on the land.
180. The evidence on the question of the practicality and viability of removing the Plant and Equipment demonstrates that it would be possible to remove the Plant and Equipment. The Tandem Wire Drawing Plants had, in fact, been removed to other locations. However, the removal was a time-consuming and difficult task. This tends to support the conclusion that the objective intention in affixing the Plant and
ATC 5264Equipment on the land was that they remain there, and form part of the land.
181. The land on which the Plant and Equipment was installed has been modified to adapt to the better use of the Plant and Equipment by the construction of footings and pitworks. The Plant and Equipment is more than merely bolted down in a way that could be easily reversed. Any removal will require jack- hammering concrete footings and grouting, dismantling part of the surrounding building (including cutting through cross-beams in the factory wall) and perhaps cutting through bolts which had seized up. Although strictly capable of removal, the degree of complexity, difficulty and the time involved indicates that the intention, objectively ascertained, was that the Plant and Equipment was to remain permanently or indefinitely. The degree of integration of the items with other aspects of the factory (furnaces and supporting services, for example) also indicates that the intention objectively ascertained was that it was to remain indefinitely.
182. The degree of annexation of the Plant and Equipment is a very significant factor. It is difficult to see how items, the removal of which may require months to complete, considerable modifications to the buildings surrounding them (at least for the duration of the removal works) and digging up part of the underlying floor space, can still be said not to exhibit an objective intention that they were to become part of the land.
183. Weighing up all the relevant factors, the circumstances surrounding the attachment of the Plant and Equipment to the land show that the Plant and Equipment were intended to become part of the land to which they were attached. They were fixtures as at 19 April 1988.
The effect of the arrangements
184. The Commissioner contends that, because the Plant and Equipment were fixtures, the Instruments were ineffective to achieve their stated objects. He says that the payments are therefore not lease payments or payments for hire because they were not for the use of chattels in the ordinary sense in which true lease or hire payments are for the use of chattels. Nor could the payments be characterised as being for the use of the land which the Taxpayer already owned, apart from the parcel owned by Austral Bronze.
185. It is clear that the parties intended by the Credit Purchase Agreement that the Bank would have rights in respect of the Plant and Equipment. Specifically, there can be no doubt that the Bank acquired contractual rights in respect of the Plant and Equipment. Whether or not the Credit Purchase Agreement also secured to the Bank some proprietary right in relation to the Plant and Equipment, the Bank clearly had enforceable rights against the Taxpayer in respect of them. Those rights, if enforced, would have interfered with the Taxpayer's right to unfettered use of the Plant and Equipment.
186. Further, whether or not the Plant and Equipment constituted fixtures or chattels, the payments made pursuant to the Lease by the Taxpayer to the Bank secured that unfettered right of use during the Term of the Lease. The same position applied in relation to any extension of the Term under the First Amendment or the Second Amendment.
187. Even if the Plant and Equipment are fixtures, there can be no doubt that, as between the Taxpayer and the Bank, the Bank is entitled to require the Taxpayer to vest legal ownership of the Plant and Equipment in the Bank. The promise for further assurance in clause 4.3.3 of the Credit Purchase Agreement would require the Taxpayer to do all such acts as may be required by the Bank for further and more perfectly assuring the Plant and Equipment to the Bank. Under clause 4.3.6, the Taxpayer warranted that the Plant and Equipment was severable from the Premises and would not either at law or equity form part of the Premises in the nature of a fixture. The Taxpayer also warranted that title in and to the Plant and Equipment would at all times be and remain in the Bank. Under clause 4.3.7, the Bank was to have the right:
``... to break open any gate, door or fastening and detach the Goods from any part of the Premises to which they may have become affixed.''
188. In addition, under the Landlords' Waiver, each of the Taxpayer and Austral Bronze agreed that they had no right, title or interest to or in the Plant and Equipment and that they would not acquire any right any such right, title or interest. They agreed that no part of the Plant and Equipment would be treated as a fixture. They also agreed that the Bank would have full right and licence to enter the Premises for the purpose of repossessing the Plant and
ATC 5265Equipment and removing them from the Premises at any reasonable hour. They acknowledged that the Plant and Equipment was, and was at all times to remain, the property of the Bank. The Taxpayer and Austral Bronze had apparently granted a mortgage over their respective parcels of land to Permanent. Permanent also entered into the same arrangements with the Bank.
189. If the Plant and Equipment are fixtures, any interest of the Bank could not be a legal interest since, as a matter of law, the Plant and Equipment would form part of the land to which they were attached. It is beyond question that the Taxpayer was intending to vest legal ownership in the Bank. It agreed to do everything that was necessary to do so. If it has not achieved that stated object, it remained subject to a continuing obligation to do so. A court of equity would treat as having been done that which ought to have been done. I consider that the Credit Purchase Agreement was effective to vest in the Bank an interest in the nature of property which should be characterised as equitable.
190. That means, of course, that if a bona fide purchaser for value acquired the legal estate in the two parcels of land without knowledge of the Bank's interest, that interest may be defeated. On the other hand, if a third party acquired an equitable interest in the parcels of land, questions would arise as to priority between competing equitable interests. Such questions have arisen in the past and courts both in the United Kingdom and in this country have consistently held that a party in the position of the Bank acquires an equitable interest - see:
Hobson v Gorringe  1 Ch 182;
Re Samuel Allen & Sons Ltd  1 Ch 575;
Re Morrison Jones & Taylor Ltd  1 Ch 50;
Kay's Leasing Corporation Pty Ltd v CSR Provident Fund Nominees Pty Ltd  VR 429; and
Sanwa Australia Leasing Ltd v National Westminster Finance Australia (1988) 4 BPR 9514.
191. By the Lease, the Bank conferred on the Taxpayer the right to exclusive use of the Plant and Equipment. That is the effect of 2.1, whereby the Bank ``hereby leases'' to the Taxpayer and the Taxpayer ``hereby takes on lease'' the Plant and Equipment at the Rent, for the Term. That language, of course, is the language of a demise of land for a term whereas, conceptually, the Lease is a contract of hire of chattels for use by the Taxpayer. The language of the Lease generally is inapt, having regard to the nature of the Plant and Equipment.
192. The language of the Lease has apparently been adapted from a precedent that was not concerned with assets that had been sold to the lessor by the lessee. For example, the Lease also contains the following provisions:
``4.1. The Lessor shall not be liable in damages nor shall this Lease be in any way affected by any delay in or refusal of delivery save and except a delay in or a refusal of delivery caused by the wilful and unreasonable refusal of the Lessor to purchase or pay for the Goods and/or permit them to be delivered...
4.3. As soon as practicable after delivery thereof the Lessee shall install, erect or set up the Goods at the address set forth in Item 3 of the Schedule. The cost of delivering, unpacking, assembling, installing, erecting or setting up of the Goods at the said address and the cost of putting such Goods in order shall be borne by the Lessee.
4.9. The Lessee acknowledges that:
- 4.9.3. The Lessee shall not affix the Goods to any real or personal property other than the premises or personally on the premises where they are now situated... unless the Lessor is reasonably satisfied that such affixing... will be subject to the rights of the Lessor under this Lease in respect of the Goods and the Lessee shall procure from the landlord... an acknowledgment in writing addressed to the Lessor... acknowledging that the legal and equitable title of the Goods are in the Lessor and that the Goods are not and shall not be a fixture notwithstanding that they or any part thereof may be affixed to the land...
- 4.9.4. The operation of this Lease shall be conditional upon any landlord... of any premises (other than the Lessee) to which the Goods are affixed executing the aforesaid acknowledgment.
5.1. The Lessee represents, warrants and confirms to the Lessor that:
- 5.1.2. The Lessee has thoroughly examined the Goods and/or the specifications thereto before this Lease was made and is satisfied as to their compliance with the description in the Schedule and also as to the Goods [sic] condition, quality and fitness for the Lessee's purpose...
6.2. The Lessee will, at the Lessee's own expense,...
- 6.2.1. Install and keep the Goods in a proper, secure and suitable premises in such a manner and with all facilities as specified or recommended by the manufacturer or the Lessor and protect them from the weather...''
193. Those provisions are clearly appropriate only for a hiring arrangement under which chattels are actually delivered by the lessor to the lessee. They are not provisions which are appropriate for an arrangement, such as that under consideration, where the subject matter is securely affixed to land occupied by the proposed lessee and has been for many years.
194. On one view of the Lease,
, it has the effect of conferring on the Bank the right, on default in the payment of the regular instalments of Rent, to enter the Taxpayer's premises and dismantle and remove the Plant and Equipment. However, the fact that the Lease may be capable of having that effect cannot mean that the advantage that the Taxpayer sought by assuming the obligation under the Lease, that it did not previously have, to pay the rental instalments, was to protect itself from what might happen if it failed to pay those instalments. The Taxpayer, so it might be said, cannot sensibly be regarded as having assumed a new obligation to pay rental instalments in order to obtain the advantage of protecting itself against detriment capable of arising if it were to fail to pay one or more of the instalments - see
Eastern Nitrogen Ltd v FC of T 99 ATC 5163;  FCA 1536 at paragraph 45.
195. The consideration for which a tenant's payment of rent is promised and made under a lease of land is governed entirely by the agreement. The Lease shows that the Taxpayer undertook to pay the regular instalments of Rent in return for the ``leasing'', that is, possession of the Plant and Equipment, during the Term of the Lease. It did not undertake to pay the rental instalments for freedom from disruption of that possession by the Bank. It might be said that the Taxpayer never needed to pay the instalments to acquire possession of the Plant and Equipment because it never lost that right - Eastern Nitrogen Ltd at paragraph 46.
196. However, such an analysis ignores the effect of the Credit Purchase Agreement, which confers on the Bank an equitable interest with respect to the Plant and Equipment. A question may arise as to whether that equitable interest was an interest in the whole of the land or only in that part of the land which consisted of the Plant and Equipment. The correct analysis does not matter. It is clear, however, that the Bank did acquire a proprietary interest pursuant to the Credit Purchase Agreement. It is that interest that would give the Bank the right to enter upon and sever the Plant and Equipment from the land, but for the rights conferred on the Taxpayer by the Lease.
197. The concepts which appear to underlie the Arrangements are transfer of ownership of chattels by a seller to a buyer and then the hire by the buyer to the seller of the same chattels in consideration of a hiring fee. However, ownership was not intended to be conveyed by the Credit Purchase Agreement, no doubt because of stamp duty considerations. Rather, ownership, or legal title, was intended to be conveyed by delivery. That is clear from the language of clause 2.1.3, which provides that property is to pass by virtue of delivery being made in accordance with clause 2.1.1, and not by virtue of the Credit Purchase Agreement itself. Delivery is sufficient to convey legal ownership of chattels under the general law, although, of course, it is not sufficient to convey any legal interest in land.
198. On the other hand, it was the common intention of the parties that, while title would pass to the Bank, physical custody of the Plant and Equipment would not change. That is to say, it was intended that the Taxpayer would at all times retain dominion, possession and control over the Plant and Equipment, while ownership would pass by a constructive delivery.
199. Common law concepts arising from bailment are steeped in Roman Law jurisprudence - see
Coggs v Bernard (1703) 92 ER 107. Concepts of constructive delivery were recognised in Roman jurisprudence. The
ATC 5267relevant concept is generally referred to as constitutum possessorium or ``possessory agreement'', although that expression itself is not a classical one. While there is some considerable controversy as to whether or not there could, in Roman Law, be transfer of ownership by mere agreement, there is no doubt that Roman jurisprudence recognised a transfer of ownership by one party to another by mere agreement where the transferring party was to retain custody of the subject matter in a different capacity following the transfer of ownership. The classic example was where the seller of an object retains custody as hirer from the buyer. It is a sensible arrangement to avoid what would otherwise by a pointless handing over and taking back - see D 41.2.18.pr and the discussion in William W. Gordon, Studies in the Transfer of Property by Traditio (University of Aberdeen, 1970) Chapter 1, at pp 13-35; W.W. Buckland, A Text Book of Roman Law (3rd ed. 1966) at p 227; Barry Nicholas, An Introduction to Roman Law (3rd ed. Clarendon Press, Oxford 1988) at p 119, and Ernest Metzger, A Companion to Justinian's Institutes (Cornell University Press, 1998) at p 54.
200. Under the common law, there are several ways in which there may be a change of possession without any change of the actual custody. Such a change of possession is sometimes spoken of as constructive delivery or delivery by attornment. An obvious instance is where a seller in possession assents to hold, on account of the buyer, a thing sold. When he or she begins so to hold it, that has the same effect as a physical delivery to the buyer or his agent and is an actual receipt by the buyer. That is so, whether the seller's custody is in the character of a bailee for reward or of a borrower - Pollock & Wright, Possession in the Common Law (1888, reprinted 1990) at p 72 and N.E. Palmer, Bailment (2nd ed 1991) Chapter 20.
201. If the Plant and Equipment are fixtures, of course, the constitutum possessorium contemplated by the Credit Purchase Agreement was ineffective to pass legal ownership. However, for the reasons I have indicated, I consider that the Instruments were effective to create an equitable interest in the nature of property in the Bank, which was sufficient to support the ``leasing'' by the Bank of the Plant and Equipment to the Taxpayer and the ``taking on lease'' of the Plant and Equipment by the Taxpayer.
Loan of $50,000,000
202. The Commissioner contended that the Arrangements constituted a ``package deal'' involving all the elements of a loan and that there was, in substance, an advance of the sum of $50,000,000 by way of loan by the Bank to the Taxpayer. The ``loan'' was unsecured because the Plant and Equipment were never intended to form the security for a loan. The loan was for a period of five years and was to bear interest at the rate of 13.35% per annum. The principal was to be repaid over the five year term by semi annual payments and a balloon payment equal to the residual value at the end of the term.
203. A series of factors was advanced on behalf of the Commissioner in support of that analysis. However, the Commissioner did not advance any submission that the Instruments should be regarded as a sham. Indeed, such a contention could not have been supported. Whatever deficiencies may be observed in relation to the documentation, it was the clear intention of both the Taxpayer and the Bank that the Instruments would be effective according to their terms.
204. The factors relied on by the Commissioner as supporting a conclusion that the Arrangements should be characterised as a loan and the payments under the Lease as part repayments of principal may be dealt with as follows:
(i) The plant was absolutely fundamental to the Taxpayer's business operations.
205. That is true but it is irrelevant to the characterisation of the Arrangements. Even if the Plant and Equipment are clearly chattels, they are nonetheless fundamental to the Taxpayer's business.
(ii) The Taxpayer never parted with, nor did it expect to part with dominion, possession or control over the plant and equipment. Nor did the State Bank ever expect, except in the case of default, to take dominion, possession or control over them.
206. Again those facts are undisputable. However, they are irrelevant to the characterisation of the payments. Assuming the Plant and Equipment were clearly chattels, the intention was that, subject to default, dominion, possession and control of the Plant and
ATC 5268Equipment would always remain with the Taxpayer, apart from the question of its destiny at the expiration of the term of the Lease. I have already referred to the notion of constructive delivery or constitutum possessorium.
(iii) Ownership of the Plant and Equipment did not in fact pass to the Bank.
207. For the reasons I have indicated above, even if the Plant and Equipment are fixtures, the Bank acquired an equitable interest.
(iv) The Taxpayer at all times regarded the arrangement as a ``financing proposal'' with a mandate being given to Macquarie Bank to raise a ``principal sum of'' $50,000,000.
208. The Commissioner advances no contention that, in ordinary circumstances, a sale and lease back arrangement ought not to be treated as giving rise to lease payments which are fully deductible. Such an arrangement is clearly a financing arrangement. It is not surprising, therefore, that the Taxpayer treated the Arrangements as a method of raising funds. That is clearly what they were. The question, however, is whether they were in substance a loan rather than a sale and lease back.
(v) The transaction was presented to the Board of the Taxpayer as a means of raising finance comparable, but for its tax advantages, to a conventional loan.
209. This appears to be the same factor as in the previous paragraph. The Arrangements clearly constituted a financing arrangement. It is not surprising that it would be compared with a loan or any other financing arrangement.
(vi) No real care was displayed by the Taxpayer in identifying the Plant and Equipment which was supposed to have passed to the Bank under the Credit Purchase Agreement.
210. There is a degree of carelessness in the identification of the Plant and Equipment which was intended to be sold by the Taxpayer to the Bank. The inadequacies of the Invoice in that regard are referred to below. The description of the ``Goods'' in the Credit Purchase Agreement consists solely of the inventory attached to the Mason Gray Strange Valuation. Mr Mason said that, in reaching a value, no allowance was made for ``building installations, concrete floors, underfloor excavations, overhead cranes, concrete support structures and pit works''. So much appears in the Mason Gray Strange Valuation. However, reference to such items appears in the inventory.
211. Mr Mason said that to the extent that such items are referred to the inventory, that was done ``solely for the purpose of better identifying the associated items of plant being valued''. That, of course, may have been a perfectly proper approach for Mr Mason in the preparation of his valuation. However, the undiscriminating adoption of his inventory as the description of the Plant and Equipment leaves unclear just what was intended to be the subject of the sale. Indeed, Mr Mason made a mistake in the description in the inventory. The description of the Properzi Line, at page 16 of the inventory is in the following terms:
``Major Melt 60,000lb Gas Fired Pig Melting Furnace with Semi Automatic Carriage Load Station, Hydraulic Pushoff (No. 5) to 2 Major Melt 20,000lb Gas fired Additive Mixing Tilt Furnaces (Nos. 4 & 2) to Degassing Nitrogen Crucible, Refractory lined Launder to Properzi 55[inch ] dia. Continuous Casting Wheel 8-16mm capacity, Water Spray Belt Cooling, 200gpm Centrifugal Pump, 3.1kw DRive [ sic] Motor,
Extrusion Handling Equipment comprising Transducer Speed Controller, Descale Spray, Waste Cropping Shear Station, Preliminary Cooling, 15 head Roll Forming Line with Suds Coolant System, 150HP Main Drive System, 400 gpm Coolant Pump & Reservoir, Cropping Shear, O.T.T. Dual Spool Product Coiling Station with Traversing Feed, Automatic Changeover, 60HP Motor Generator Set, 3 phase Electricals,
The whole plant with Fume Extraction Equipment, 60HP Stack Blower, Ductwork, Sub-floor Pitworks & Fittings .
Cooling System comprising: Muller Timber External Cooling Tower, 20,000 litre System Volume, 30 litres per second Recirculation rate, Centrifugal Motorised Circulation Pump & Pipework to service points.''
Mr Mason said that the ``&'' in the expression ``Sub-floor Pitworks & Fittings'' (shown emphasised above) should be omitted.
ATC 5269The pit works were not intended to be included in the valuation, only the fittings located in the sub-floor pit works.
212. Nevertheless, it appears clear that the parties were intent on taking whatever steps were considered necessary to give effect to the Instruments according to their terms. This factor does not make the Arrangements a loan.
(vii) There was not displayed any real concern to comply with the conditions of the transaction documents as to:
- • delivery of the Plant and Equipment to the Bank;
- • identification of the Plant and Equipment as the Bank's property by the affixation of appropriate plaques;
- • notification to the Bank in the case of scrapping or removal of items of Plant and Equipment.
213. Under clause 22.214.171.124 of the Credit Purchase Agreement, the prepared invoice was to give full particulars of each scheduled item, including its cost, as well as stating the serial or other appropriate identification number for such item, where applicable. Clearly, the Invoice does not satisfy that requirement.
214. The Credit Purchase Agreement required delivery of a certificate as to the sale price of the Plant and Equipment and such other documents evidencing the Taxpayer's title to the Plant and Equipment held by the Taxpayer. There was no evidence as to whether any such documents were ever delivered to the Bank.
215. The Credit Purchase Agreement also required the Taxpayer to place and maintain on ``the Premises'' a plaque identifying the Plant and Equipment and the rights of the Bank in relation to the Plant and Equipment. Mr Allen said that little plates were attached to the items of the Plant and Equipment ``much to the aggravation of the engineers''.
216. Mr R.G.H. Whale is the Engineering Manager in the Taxpayer's Kembla Products Division. Mr Whale gave evidence describing in detail certain of the Plant and Equipment and in particular the manner of its affixation. Mr Whale said that he is not aware of any plaques on items of equipment to which he referred. He does not believe that he would have overlooked any such plaques.
217. Mr R.J. Rankin is a Site Services Engineer at the Taxpayer's Cables Division. Mr Rankin gave evidence in detail concerning other parts of the Plant and Equipment, being the Vaughn Tandem Wire Drawing Plants that was moved to Liverpool. He could not recall that any of the items that made up that Wire Drawing Plant bore plaques or any indication that they were owned by the Bank. He said that there was no indication at all and, if they had been there, he would have seen them. There was no evidence concerning plaques on the Wire Drawing Plant that was moved to Clayton.
218. The evidence of Messrs Whale and Rankin is clearly more reliable than that of Mr Allen concerning the existence of plaques on the Plant and Equipment. In that regard, it may be significant that the requirement of the Credit Purchase Agreement is not that plaques be placed on the Plant and Equipment but that a plaque be placed upon and be maintained ``upon the Premises''.
219. Parts of the Plant and Equipment have been replaced since 1988 without reference to the Bank. Further, the removal of the Vaughn High Speed Tandem Wire Drawing Plants to Liverpool and Clayton appears to have taken place without any consultation with the Bank. Those circumstances are not consistent with a conscious awareness on the part of the Taxpayer of the ownership of the Plant and Equipment being vested in the Bank.
220. Even if all of these matters are established, it is irrelevant to the characterisation of the payments. If the Instruments were intended to be effective according to their terms, failings on the part of the parties to give effect to the express requirements of the Instruments might give rise to some criticism of the advisers and consultants involved. However, in the absence of any allegation of sham, it is difficult to see how these matters could lead to a conclusion that the payments should be characterised as an advance by way of loan and repayment of principal and interest by instalments.
(viii) From the point of view of Mr Allen, the Bank was lending without security and on the basis of ``the financial standing'' of the Taxpayer.
221. The point of view of Mr Allen is not to the point. As I have indicated, it is clear that the Arrangements constituted a financing transaction. No doubt a financier, irrespective of the method of financing adopted, would take into account many considerations in deciding whether to make a loan. A fundamental
ATC 5270consideration would be the financial standing of a borrower. Clearly, the Bank did not enter into the Arrangements with the intention or the expectation that it would be required to repossess the Plant and Equipment in order to ensure that the payments provided for in the Lease would be made by the Taxpayer. No prudent financier would lend solely on the basis of security without having regard to the capacity of the borrower to pay. This factor is equivocal.
(ix) The sale and lease back agreement represented a package so integrated that in a practical sense, the $50,000,000 was received by the Taxpayer not for the sale of the Plant and Equipment but in return for the covenants to make the payments under the lease.
222. In any sale and leaseback arrangement, the two transactions must represent a package. As I have said, the Commissioner advanced no contention that, in ordinary circumstances, a sale and leaseback arrangement ought not to be treated as giving rise to lease payments which are fully deductible. The fact that the Credit Purchase Agreement and the Lease were interdependent cannot lead to the conclusion that the Arrangements should be characterised as an advance by way of loan and repayment of principal and interest by instalments.
(x) In practical terms, there was a virtual certainty that the Taxpayer would pay the ultimate residual value to the Bank, whether under the original term or pursuant to the option to renew.
223. There is little doubt that the evidence leads to the conclusion that it was likely that the Taxpayer would reacquire the Plant and Equipment by paying the ultimate residual value to the Bank. Mr Allen and Mr Cant said as much. Mr Dudley, on the other hand, denied the inevitability. His response was that, at the time of the Arrangements, the question did not arise in his mind because he wanted the flexibility to make a decision, at five year intervals, whether the Plant and Equipment was required as part of the future operation of the Taxpayer's business.
224. This question is dealt with in more detail below. I am prepared to conclude that there was a firm expectation on the part of the directors of the Taxpayer that the Taxpayer would be able to reacquire the Plant and Equipment for the residual value if it wished to. It was a matter of considerable concern to the Board that they have some security in that regard. Indeed, the concern led to the deferment of the proposal from the November 1987 meeting to the February 1988 meeting.
225. Nevertheless, the Commissioner accepts that under the Instruments, no legal right to acquire the Plant and Equipment was conferred. There was a risk to the Taxpayer, albeit a risk that the directors of the Taxpayer were prepared to take, having regard to the business reputation of the Bank, coupled with the fact that the risk was deferred for a period of 15 years, after the options to renew were taken into account. I do not consider that the fact that there was a virtual certainty, in all the circumstances, that the Taxpayer would reacquire the Plant and Equipment, bears on the character of the payments.
(xi) The residual value was higher than the Plant and Equipment would have realised to the Bank on a break up basis.
226. The Commissioner contends that such a discrepancy shows that the Bank had no real interest in acquiring the ownership rights attached to the Plant and Equipment but was treating the Arrangements as a loan backed by the financial standing of the Taxpayer, rather than secured by its ownership of the Plant and Equipment. This seems to be much the same as factor (viii) above in that the Bank was not relying primarily on the security of its ownership of the Plant and Equipment but on the financial standing of the Taxpayer.
227. The matters referred to in relation to factor (xiii) below suggest that the value of the Plant and Equipment to the Taxpayer would be higher than the original value. Further, it is clear that the sale price of $50,000,000 was higher than the amount that would have been realised on a break up sale of the Plant and Equipment at the time of entering into the Lease. Nevertheless, it is not self evident that the Bank never had any real interest in acquiring ownership of the Plant and Equipment. Even if a financier relies primarily on the financial standing of a borrower, it does not follow that any other security available to the financier in connection with the transaction is to be completely ignored.
228. Clearly, the Bank must have made a judgment that the Taxpayer had the capacity to meet its obligations under the Lease. The Bank may well have decided that the risk of the
ATC 5271Taxpayer not being in a position to do so would be met by the price that would be realised upon a break up sale of the Plant and Equipment. As I have already said, the Bank should not be assumed to have entered into the Arrangements on the basis that the only prospect of repayment of the amount paid for the Plant and Equipment would be upon default by the Taxpayer.
(xii) The Taxpayer, in its accounting treatment of the transaction, charged its profit and loss account only with an amount equivalent to the ``interest'' element in the regular lease payments.
229. That undisputed fact does not advance the matter. There is no necessary symmetry between the quantum of an outgoing of a taxpayer that is deductible under section 51(1) and the quantum of its expenses shown in its profit and loss account. While, in an ideal world, that would not be so, it is clearly not the position - see
Steele v DFC of T 99 ATC 4242 at 4249 (paragraph 30). This factor is equivocal.
(xiii) The residual value was set at an amount which bore no relationship to the likely value of the Plant and Equipment to the Taxpayer at the expiration of the term of the Lease.
230. The Commissioner contended that the value of the Plant and Equipment was unlikely to have diminished over the five year Term. There was no formal evidence as to the value of the Plant and Equipment at the end of the Term of the Lease. However, on 8 December 1995, the Commissioner's solicitors wrote to J.C. Singleton Pty Ltd, industrial and commercial valuers, requesting a valuation of the Plant and Equipment as at 19 April 1988 and 19 April 1993. No signed valuation was produced. However, a draft valuation bearing the date 30 April 1996 was provided to the Commissioner's solicitors. That draft valuation, after describing the Plant and Equipment and the valuation basis, indicated that the ``existing use'' value of the Plant and Equipment as at 19 April 1988 was $22,088,000 and as at 19 April 1983 was $18,215,000. ``Existing use'' value was described as the value of the assets to the Taxpayer as a continuing business. The valuation on that basis assumed that the Plant and Equipment are or are capable of being utilised as assets of a profitable undertaking.
231. The draft valuation also indicated that the ``market value'' of the Plant and Equipment as at 19 April 1988 was $7,100,000 and as at 19 April 1993 was $5,800,000. The ``market value'' basis was described as the best price at which an interest in the Plant and Equipment might reasonably be expected to be sold by public auction as at the relevant date. That evidence, of course, does not support the contention that the residual value bore no relationship to the likely value of the Plant and Equipment at the conclusion of the Term of the Lease.
232. The Commissioner relied on the evidence of Mr Allen that plant of the kind in question does not depreciate in the same way as, for example, a motor car does. Mr Allen said that if such plant is fully maintained ``it will be as useful as the day it was put in''. Mr Allen agreed that it was certainly possible, subject to questions of obsolescence, that the value of the Plant and Equipment to the Taxpayer at the end of Term of the Lease could have been much higher than 37.5% of the sale price, being the proportion that the residual value bore to the sale price.
233. Mr Mason said that the replacement cost of plant such as the Plant and Equipment tends to be greater than its original cost, if it is well maintained. Mr Mason considered that the Plant and Equipment would not have been worth a great deal less at the expiration of the Term of the Lease than it was at the beginning of the Term, provided that the Plant and Equipment continued to be maintained at the same level.
234. Mr R.H. McCulloch gave evidence on behalf of the Taxpayer. Mr McCulloch considered that, with appropriate maintenance, the Plant and Equipment could continue to operate at its present efficiency almost indefinitely or for between 15 to 30 years. That view was formed on the basis of an inspection at the Port Kembla site and the Liverpool site and on the basis of a consideration of the Mason Gray Strange Valuation. The remaining effective life means the period of time that the item in question could be expected to be used for income producing purposes assuming that it is kept in good order. An estimate of that period would depend upon the number of factors including:
- • the level of technology reflected in the machinery and the expectation as to advancements in technology;
- • the present and anticipated level of maintenance required on the machinery;
- • the state of the market for the product of the machinery, and expectations as to the state of that market;
- • the business plans of the machinery's operator, including whether the operator intends to wind down production with the machine.
Estimates, of course, may prove to be inaccurate where, for example, they are based on expectations as to the state of the market or advancements in technology which do not eventuate.
235. Those conclusions are supported by the evidence of Messrs Whale and Rankin who, nevertheless, acknowledged that estimates of effective remaining life are highly subjective and that views may differ.
236. Messrs Whale, Rankin and McCulloch each gave different estimates of the remaining effective life of the different items of Plant and Equipment. Of necessity, an estimate of the effective remaining life of an item of plant and equipment is based on the circumstances prevailing at the time when the estimate is given. Those circumstances include matters such as technology and economic considerations and the likely developments in the business of the operator as I have indicated above. It does not follow that, because an estimate of one period is given at a particular time that, five years after that time, if another estimate is made of life expectancy, the period of the estimate would be the same less than the intervening period. Circumstances could well change in the meantime.
237. At the time of the transactions, Mr Dudley was conscious of the possible impact of technology and other matters that might bear on the usefulness of the Plant and Equipment at the expiration of the Term of the Lease. Further, since that time, the Taxpayer has from time to time actively considered the possibility of replacing the Plant and Equipment with more advanced equipment. Plant and equipment of the nature of that in question can be made technologically redundant overnight.
238. Be all that as it may, I consider that, as at 19 April 1988, there was every reason to conclude that, at the expiration of the proposed Term of the Lease of five years, the value of the Plant and Equipment would not be significantly less than its value as at 19 April 1988. The Plant and Equipment had been in place for some considerable time, subject to replacement of parts from time to time. Further, the concern expressed by the members of the Board of the Taxpayer indicate a judgment on their part that it was more likely than not that the Taxpayer would want to retain the Plant and Equipment after the expiration of the Term of the Lease.
239. Clearly, it is irrelevant to compare a valuation of the Plant and Equipment on a going concern basis at one time with a valuation on the break up basis at another time. Overall, I consider that the evidence leads to the conclusion that, irrespective of the basis of the valuation, as at 19 April 1988, the Plant and Equipment could reasonably be expected to have much the same value in five years' time as it then had.
240. However, I do not consider that that conclusion assists in the Commissioner's contention that the payments in question should be characterised as repayment of a loan, together with payment of interest, by instalments, once it is accepted that the Lease was effective as a grant by the Bank to the Taxpayer of the right to use the Plant and Equipment, free of any entitlement on the part of the Bank to sever and remove it.
(xiv) The Mason Gray Strange Valuation was made on a going concern basis. That basis could only have arrived at the value of the plant to the Taxpayer with no consideration or regard being paid to the value that the Plant and Equipment might have had to the Bank on default. Thus, the Bank should be regarded as indifferent as to the basis of the valuation and should not be regarded as dealing with the Taxpayer at arm's length in that regard.
241. There is no issue but that the Mason Gray Strange Valuation was made on a going concern basis, being the value of the Plant and Equipment to the Taxpayer. Nor is there any issue as to the proposition that, on default, the value of the Plant and Equipment to the Bank was much less. As I have said above, that indicates that the Bank must have relied, in its decision to enter into the Arrangements, not only on the security that it would have by reason of its rights in respect of the Plant and Equipment, but also on the financial capacity of the Taxpayer to meet its obligations under the Lease. Any discrepancy between going concern value and break up value would only be of
ATC 5273significance to the Bank in the event of default by the Taxpayer.
242. Nevertheless, the fact that the Bank was prepared to enter into the Arrangements in the expectation that the Taxpayer would be prepared to meet its obligations under the Lease and would be capable of doing so, has no bearing on the question of whether the payments made pursuant to the Lease should be characterised as being other than payments for the right to use the Plant and Equipment free of any claim by the Bank.
243. It follows from what I have said that there is no basis for concluding that the payments in question should be characterised otherwise than as payments made pursuant to the obligations imposed by the Lease in order to secure to the Taxpayer the right to use the Plant and Equipment free of any risk that the Bank might exercise such rights as it may have to the Plant and Equipment as owner, whether legal or equitable. There is no basis for concluding that the Arrangements should be treated as constituting a loan and the regular payments characterised as repayment of principal and payment of interest under such a loan.
244. The Commissioner contended, in the alternative, that, whether or not the Plant and Equipment were fixtures, some portion of the regular payments made by the Taxpayer secured a collateral advantage of a capital nature for the Taxpayer and therefore represented outgoings of a capital nature because:
- • the residual value was so low in comparison to the price at which the Plant and Equipment was sold; and
- • the Taxpayer was unlikely not to have reacquired the Plant and Equipment at the residual value.
The collateral advantage to the Taxpayer over the five year Term of the Lease, so the Commissioner contended, was the difference between the sum of $50,000,000 paid to the Taxpayer by the Bank and the sum of $18,750,000, being the residual value. It was said that the Plant and Equipment was unlikely to have decreased in value and that the Taxpayer could be expected to have reacquired it from the Bank at the expiration of the Term of the Lease. The matters relied on by the Commissioner for those contentions are those referred to in (xiii) (paragraph 230 and following) and (x) (paragraph 223 and following).
245. The foundation of the Commissioner's contention is the discrepancy between the residual value and the sale price in circumstances where there was every reason to expect that the value of the Plant and Equipment would not deteriorate significantly during the term of the Lease, coupled with the high likelihood that, at the end of the Term, the Plant and Equipment would be reacquired by the Taxpayer.
246. In effect, the Commissioner contended that each payment, purportedly made as rent, comprised two separate parts. One part was attributable to the right of possession under the Lease and was therefore of a revenue nature. The other part, however, was said to be attributable to the acquisition of the collateral advantage of being able to reacquire the Plant and Equipment for the residual value, being a value considerably less than its value to the Taxpayer.
247. There can be no doubt that the payments made by the Taxpayer under the Lease were outgoings incurred in gaining or producing assessable income or alternatively were necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income. It is not for the Court or the Commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent -
Ronpibon Tin NL v FC of T; Tongkah Compound NL v FC of T (1949) 8 ATD 431 at 437; (1949) 78 CLR 47 at 60.
248. The following three matters are to be considered in determining whether an outgoing is made on revenue or on capital account (see
Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T (1938) 5 ATD 87 at 96; (1938) 61 CLR 337 at 363):
- • the character of the advantage sought by the outgoing;
- • the manner in which the advantage is to be used, relied upon or enjoyed by the Taxpayer;
- • the means adopted to obtain the advantage, such as by recurring payments.
In some cases, the problem will be to determine the character of the advantage sought, once it has been identified. In other
ATC 5274cases, the problem will be to decide what was the advantage sought by the taxpayer by making the payments. If the only advantage sought was the right to possession under a lease and what was called ``rent'' really answered that description, clearly the outgoings would be entirely of a revenue nature. If on the other hand, one advantage sought by the outgoings was the acquisition of a capital asset, the fact that the payments were called ``rent'' and were made periodically, would not necessarily prevent them from being in part outgoings of a capital nature -
FC of T v South Australian Battery Makers Pty Ltd 78 ATC 4412 at 4417; (1978) 140 CLR 645 at 655.
249. It is clear that by making the regular payments, the Taxpayer did not acquire any interest in the Plant and Equipment, except that of a lessee or hirer. The only binding arrangement between the Taxpayer and the Bank was that embodied in the Lease, under which the Taxpayer had the rights and interests of hirer or lessee and nothing more. There was no option to purchase.
250. Even if there were a binding and enforceable option granted to a related company, not being a subsidiary, that would not be sufficient to alter the character of the payments. Even where the payments were made not only with the knowledge but also with the purpose that part might be treated as part of the price of a capital asset which a related company would probably acquire, that would not be sufficient to make the payments outgoings of a capital nature so far as the payer is concerned - South Australian Battery Makers Pty Ltd (at ATC 4417-4418; CLR 656). A fortiori, where there is no legally enforceable right arising either in the Taxpayer or anyone else, the payments cannot be attributable to a collateral advantage that would render the payments outgoings of a capital nature.
251. Where what is sought to be obtained by an outgoing is not legally enforceable rights but a practical, though intangible, business advantage, that advantage must be analysed in order to see whether the expenditure was made with a view to bringing into existence an enduring advantage for the benefit of a business. However, practical business considerations are not to be used to the exclusion of an analysis of legal rights - South Australian Battery Makers Pty Ltd (at ATC 4421; CLR 662).
252. The only advantage that the Taxpayer sought and obtained by each of the regular payments was the right to continue unfettered and uninterrupted use of the Plant and Equipment. While, as a practical matter, it may be concluded that the Plant and Equipment would not be sold to anyone other than the Taxpayer at the expiration of the Term, that was a consequence of the nature of the Plant and Equipment. It was not something secured by the payments themselves.
253. The Plant and Equipment has not yet been the subject of any purported re- acquisition. Nevertheless, while the Taxpayer has not actually reacquired the Plant and Equipment and has no legal right to do so, if the Commissioner's contention is correct, it is probable that the Taxpayer will reacquire the Plant and Equipment for $2,636,718.75 after 19 April 2003.
254. If the Lease contained an option for the Taxpayer to buy the Plant and Equipment for the amount of the residual value at the expiration of the Term of the Lease, the Arrangements could be characterised as a hire purchase agreement. In that case, the Taxpayer would have been entitled to a deduction for no more than that part of the regular payments that is attributable to interest. That part of the payments that exceeds the amount attributable to interest would be treated as part payment of the repurchase price. It would not matter whether the final payment, at the expiration of the Term, was a nominal sum or a sum that was substantial in relation to the original cost. All payments would, in such a case, need to be apportioned between principal and interest.
255. It does not matter how confident the Taxpayer may be that, at the expiration of the Term or any of the extended Terms, it will be able to reacquire the Plant and Equipment from the Bank. It has no entitlement to do so. The Bank would be entitled to sell the Plant and Equipment to whomsoever it chooses. There may be some duty imposed on the Bank to take reasonable steps to obtain the best available price. Such a duty might arise from the existence of the provision whereby the Taxpayer must indemnify the Bank in respect of any shortfall of the proceeds of sale below the residual value. However, even if the sale proceeds far exceed the residual value, there is no reason why, as a matter of contract as
ATC 5275between the Bank and the Taxpayer, the excess should not be retained by the Bank.
256. There was evidence of the existence of a convention or practice whereby financiers under finance leases normally afford to the lessee the opportunity of buying leased property for the residual value at the expiration of the lease. That was probably the origin of the reference in Mr Allen's memorandum of November 1987 to the ``business reputation'' of the Bank. It may well be that it would be regarded as sharp practice for a financier not to afford to a lessee the opportunity of buying leased property for the residual value where the market value of the property is significantly in excess of the residual value.
257. Be that as it may, however, it is common ground that there was no legal entitlement conferred on the Taxpayer to acquire the Plant and Equipment. I do not consider that the regular payments to be made under the Lease should be characterised as being attributable to the acquisition by the Taxpayer of the advantage of being able to repurchase the Plant and the Equipment at the expiration of the Term of the Lease for the amount of the residual value.
258. The question under Part IVA is whether, having regard to the matters referred to in section 177D(b), it would be concluded that the dominant purpose of any of the persons who entered into or carried out the relevant scheme was to ensure that the Taxpayer would be allowed a deduction in relation to a relevant year of income, where the whole or part of that deduction would not have been allowable, had the scheme not been entered into and carried out. It was common ground that, if the relevant dominant purpose was made out, the other requirements for the application of Part IVA were also satisfied in the present case.
259. The term ``dominant'' indicates a purpose that is the ruling, prevailing, or most influential purpose. If a taxpayer takes steps that maximise its after tax return,
and does so in a manner indicating the presence of the ``dominant'' purpose to obtain a ``tax benefit''
, then the criteria that are to be met before the Commissioner might make determinations under section 177F would be satisfied. In other words, those criteria would be met if the dominant purpose was to achieve a result whereby there was deducted from assessable income an amount that might reasonably be expected not to have been deductible if the scheme was not entered into or carried out -
FC of T v Spotless Services Limited & Anor 96 ATC 5201 at 5206; (1996) 186 CLR 404 at 416. A person may enter into or carry out a scheme, within the meaning of Part IVA, for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit where the dominant purpose is consistent with the pursuit of commercial gain in the ordinary course of carrying on a business - Spotless Services Ltd at ATC 5206; CLR 415.
260. Thus a taxpayer may have a particular objective or requirement that is to be met or pursued by a particular transaction. The shape of such a transaction need not necessarily take one form. It is only to be expected that the adoption of one form over another may be influenced by revenue considerations. However, the fact that a particular course of action may bear the character of a rational commercial decision does not determine the answer to the question of whether a person entered into or carried out a scheme for the dominant purpose of enabling a taxpayer to obtain a tax benefit - Spotless Services Ltd at ATC 5206; CLR 416. Nor, in my opinion, does the fact that a taxpayer chooses one of two or more alternative courses of action, being the one that produces a tax benefit, determine the answer to that question.
261. Part IVA will be satisfied if it was the obtaining of the tax benefit that directed the relevant persons in taking steps they otherwise would not have taken by entering into the scheme - Spotless Services Ltd at ATC 5210; CLR 423. However, more is required than that a taxpayer has merely arranged its business or investments in a way that derives a tax benefit. The scheme must be examined in the light of the eight matters set out in section 177D(b). Further, that examination must give rise to the objective conclusion that some person entered into or carried out the scheme or part of the scheme for the sole or dominant purpose of enabling the Taxpayer to obtain a tax benefit in connection with the scheme. Such a conclusion will seldom, if ever, be drawn if no more appears than that a change of business or investment has produced a tax benefit for a taxpayer - Spotless Services Ltd at ATC 5212; CLR 425. Nor should such a conclusion be drawn if no more appears than that a taxpayer
ATC 5276adopted one of two or more alternative courses of action, being the alternative that produces a tax benefit.
262. The Commissioner contended that the relevant scheme was constituted by the Arrangements, together with the steps described above that led to the Arrangements. The steps that led to the Arrangements consisted of the memorandum from Mr Anderson, the communications with Macquarie Bank, the communications with the valuers, Mr Allen's memoranda to the directors of the Taxpayer and Mr Allen's communications with BICC. While those steps may constitute a course of conduct, I do not consider that they can be properly regarded as part of a ``scheme'' within the meaning of that term as defined in section 177A(1). Rather, they were steps that led to a scheme consisting of the Arrangements. While a scheme might consist of a plan, a proposal, an action or a course of conduct, it must be possible, under section 177C(1)(b), to postulate that a deduction was allowable that would not have been allowable if the scheme had not been entered into or carried out. The preliminary steps had nothing to do with the Taxpayer being entitled to an allowable deduction. The allowable deduction became available, if at all, by reason of the Arrangements.
263. The persons who are said by the Commissioner to have entered into or carried out the relevant scheme are:
- • The Taxpayer, Messrs Anderson and Allen and the members of the Board at the time of the decision to enter into the Arrangements and at the time the amending agreements were entered into.
- • BICC.
- • Mr R.F. Morgan.
- • Austral Bronze and members of its Board.
- • Macquarie Bank and Messrs Calden and Cook of Macquarie Bank.
- • The Bank.
- • Mason Gray Strange Valuations VIC Ltd and Messrs J.N. Mason, G.A. Roberts, C.N. Hocking and R.H. Hocking.
- • C.J. Ham & Murray Pty Ltd.
264. The only persons among those named above who could be said to have entered into or carried out the Arrangements are the Taxpayer and Austral Bronze and their respective directors, and the Bank. While Mr Anderson was responsible for the communication of the original proposal to Mr Allen, he did not carry out the Arrangements. Nor did Macquarie Bank or anyone connected with Macquarie Bank carry out the Arrangements. The valuers were incidentally involved but they could not be said to have carried out the Arrangements or any relevant steps that would be said to be part of a scheme. BICC and Mr Morgan did not carry out any steps that could be said to be part of a scheme.
265. The Commissioner identified several matters, which he said pointed towards the relevant purpose, although he did not necessarily categorise any of those matters in terms of section 177D(b). The matters that the Commissioner says point towards the relevant purpose are as follows:
- • purporting to enter into a sale and chattel lease in circumstances where the Plant and Equipment consisted of fixtures;
- • purporting to enter into an arm's length sale of the Plant and Equipment on the basis of evaluation prepared on a going concern basis where that basis was inappropriate as an indication of the value of the plant to the Bank as purchaser;
- • selecting Plant and Equipment for the purposes of the transaction with a low original cost relative to its current value on a going concern basis;
- • entering into the Arrangements, intending that dominion over and possession and control of the Plant and Equipment would remain with the Taxpayer at all times;
- • setting a residual value that was unrealistic and disproportionate to the price at which the Plant and Equipment was sold;
- • entering into the Arrangements in circumstances where the parties indicated that the Plant and Equipment would be reacquired at the residual value.
266. I shall deal with each separately:
267. Notwithstanding that the Plant and Equipment were fixtures, the Bank acquired an equitable interest in them sufficient to support the Lease. While the Plant and Equipment were fixtures, the parties clearly evinced an intention to treat the Plant and Equipment as chattels. On the other hand, while the effect of the Credit Purchase Agreement was to vest in the Bank an
ATC 5277interest in the Plant and Equipment which was in the nature of property, the nature of the Plant and Equipment made them inherently unsuitable for a transaction such as that comprised in the Arrangements.
268. Whether or not the parties to the Arrangements believed that the Plant and Equipment comprised chattels separate from the land and did not constitute fixtures, is not relevant. While the Instruments contemplated severance in some circumstances, there was clearly never any intention to effect any severance at the time of the Arrangements. The intention of both parties, as gleaned from the Instruments, was that the Plant and Equipment would remain in situ quite unaffected by the Arrangements.
269. In addition, the fact that the residual value was fixed without any reference to the expected value of the Plant and Equipment at the expiration of the Term, having regard to the sale price, indicates that, from the Bank's viewpoint, the primary ``security'' of the Bank was the financial standing of the Taxpayer. Those considerations suggest that it was not of great importance to the Bank whether the Plant and Equipment were chattels or fixtures. In that regard, the Bank's letter to Macquarie of 11 January 1988 is of some significance. At that stage, it appears the Bank had given no consideration to the intended subject matter of the proposed arrangements.
Going concern valuation
270. The adoption of a going concern basis for valuation of the Plant and Equipment is consistent with a desire on the part of the Taxpayer to raise as much money as possible by the Arrangements. The sum of $50,000,000 was contemplated as the amount to be raised. Clearly, the Bank was prepared to rely on the financial standing of the Taxpayer, in addition to any interest in the Plant and Equipment, for assurance that it would obtain a return from the transaction. However, there is nothing to suggest that the Bank was concerned at the time of entering into the Arrangements to ascertain the value of the Plant and Equipment as security.
271. One could imagine circumstances where a financier, desiring some security, might say that it required either a mortgage of specific chattels, such as plant and equipment, or alternatively, that it required security in the form of ownership of chattels in respect of which it would grant a lease. In either case, the financier would be expected to require a valuation of the chattels indicating the sum that would be realised if the financier were compelled to enforce its ``security''. That would be a valuation on a break up sale, not as part of a going concern. The going concern basis upon which the Mason Gray Strange Valuation was carried out was, on the face of it, irrelevant to the Bank.
Low original cost
272. If the Taxpayer sold assets in respect of which a deduction had been allowed for depreciation and the sale price exceeded the written down value of the assets sold, the Taxpayer would be liable for a balancing charge, in effect rendering the excess assessable income to the extent of the depreciation allowed. However, the excess over the cost price to the Taxpayer would not be the subject of any balancing charge and would be free of tax, other than capital gains tax, depending upon when the assets were acquired.
273. The Commissioner contends that the effect of the Arrangements is that the Taxpayer will have the benefit of the deduction in respect of payments to the Bank which, as to part, are in substance repayments of principal borrowed. Unless the proceeds of sale are free of such a balancing charge, such intended benefit would not be derived.
274. I do not accept that low original cost and high current value was a selection criterion for the assets to be the subject of the Arrangements. Mr Allen considered it relevant but rejected it as a selection criterion. He said that the only criterion was to get plant with a value to an ongoing business of around $60,000,000. Mr Cant made it clear that he did not consider that to be a selection criterion. I am not satisfied that Mr Dudley regarded it as a relevant criterion. In any event, the subjective state of mind of the directors is not relevant for the purposes of Part IVA.
275. In fact, as appears from the Mason Gray Strange Valuation, the Plant and Equipment had a value as at 19 April 1988 much greater than the cost to the Taxpayer. However, that of itself is equivocal. If the Taxpayer had arranged to borrow on the security of a mortgage or charge of the Plant and Equipment, assuming that were possible, the Taxpayer would have chosen assets with as high a value as possible in order to maximise the funds to be raised. Whether or
ATC 5278not the asset had a low cost relative to its current value would not matter.
276. If there had been evidence that other assets owned by the Taxpayer could have raised a sum of around $50,000,000, being assets that did not have a low original cost compared to its then current value, that may have indicated that the Plant and Equipment was chosen for its advantageous position in relation to any balancing charge. Mr Allen said that the Plant and Equipment was chosen because it was the only plant and equipment that was 100% owned by the Taxpayer. However, the Taxpayer's 1987 Annual Report records that the Taxpayer owned plant and equipment with an original cost totalling around $77,000,000. The Plant and Equipment represented only about $10,000,000 of that total. When asked to explain the figure in the Annual Report, Mr Allen said:
``It could have been a lot of rats and mice. It doesn't take much to build up.''
That rather indicates that Mr Allen's initial response that the Taxpayer did not wholly own any other plant and equipment was not accurate. Nevertheless, there was no evidence one way or the other as to whether the other plant and equipment had a high current value compared with its original cost. Accordingly, I consider that the fact that the Plant and Equipment had a high current value compared to its original cost is equivocal.
No change in control
277. The fact that dominion over and possession and control of the Plant and Equipment would remain with the Taxpayer is quite equivocal. That would be the position with any sale and leaseback financing arrangement. I have referred above to the concept of constitutum possessorium or constructive delivery.
278. The residual value under the Lease was unrealistic in the sense that there is reason to conclude that the value of the Plant and Equipment at the expiration of the Term of the Lease was greater than the residual value. If properly maintained, the Plant and Equipment may well not have deteriorated in value. However, that is equivocal in the absence of any right or entitlement on the part of the Taxpayer to reacquire the Plant and Equipment. The purpose of the residual value, from the point of view of the financier, is simply to fix the amount that will be ``owed'' to the financier at the expiration of the period of the lease. If the financier treats the transaction as purely one of financing, the ultimate destination of the subject matter of the lease will be of no concern to the financier so long as, at that expiration, he receives at least the amount of the residual value. It would be of no consequence to the financier whether the lessee or some third party bought the subject matter, so long as the proceeds were not less than the residual value.
279. Notwithstanding that it might be regarded as sharp practice by a financier who sought to retain any windfall that might arise upon sale of the subject matter of the lease at the expiration of the period of the lease, that is the legal position that prevails in relation to such an arrangement. As I have said, that is the risk that a lessee must take. The same risk would arise irrespective of whether the arrangement is a sale and leaseback or a purchase of the subject matter by the lessor from a third party in the first instance.
280. It was, of course, necessary that the Plant and Equipment be properly maintained in order for it not to deteriorate in value. That was a matter within the control of the Taxpayer. On the other hand, the Taxpayer could well have taken the view that the cost of maintenance would be outweighed by the risk that it would not ultimately be entitled to reacquire the Plant and Equipment.
281. The same considerations arise in relation to the proposition that the residual value was disproportionate to the price at which the Plant and Equipment was sold. That proposition assumes an expectation that the value of the Plant and Equipment would not deteriorate during the Term of the Lease. The relevant tax benefit is said to be the deductibility of the regular payments under the Lease. It is not asserted that the so-called collateral advantage of being able to reacquire the Plant and Equipment for the residual value was a tax benefit. It clearly was not.
282. The Taxpayer had some ``security'' that it would be able to reacquire the Plant and Equipment for the residual value. That security was afforded both by the ``business reputation'' of the Bank and the nature of the Plant and Equipment itself. The time, effort and cost that would be involved in removal of the Plant and
ATC 5279Equipment could be a huge disincentive for the Bank to sell the Plant and Equipment to anyone other than the Taxpayer at the end of the Term depending upon its value at the expiration of the Term. That of itself was a significant circumstance in ensuring that there would ultimately be no adverse consequences to the Taxpayer from disposing of its ownership of the Plant and Equipment.
283. Of necessity, any taxpayer who enters into a finance lease transaction must make a judgment in weighing the benefits of a finance lease against the disadvantages. So long as a distinction is made for tax purposes between a hire purchase arrangement, under which the ``borrower'' has a right to acquire the subject matter of the arrangement, and a lease, under which all payments are deductible but there is no security for acquiring goods at the end of the term, such a judgment will always have to be made. It is clear enough that, as a practical matter, there may have been little risk that the Plant and Equipment would not be available to the Taxpayer at the end of the term of the Lease if it were required. However, there was no legally enforceable right to reacquire the Plant and Equipment.
284. Clearly, if the likelihood of the Taxpayer being able to reacquire the Plant and Equipment at the expiration of the term were translated into a legal right, the residual value may well be a significant factor pointing to a dominant purpose of obtaining the relevant tax benefit. In such a case, of course, there would be no tax benefit in any event. Once it is accepted that the Taxpayer had no right or entitlement to reacquire the Plant and Equipment, this matter becomes equivocal.
285. I consider that the matters that the Commissioner says point towards the relevant purpose are equivocal, once it is accepted that:
- • in ordinary circumstances, a sale and lease back arrangement ought not to be treated as giving rise to lease payments that are not fully deductible;
- • the Instruments were intended to have effect according to their terms;
- • there is nothing untoward in an arrangement whereby a seller retains custody of the subject of a sale in the capacity of hirer: it would clearly be inconvenient to require a physical delivery by a seller to a buyer and a subsequent re- delivery by new owner to hirer;
- • there was no legal right or entitlement on the part of the Taxpayer to reacquire the Plant and Equipment, whatever the probabilities might have been.
286. The primary focus in determining whether a tax benefit ought to be disallowed under Pt IVA is on the ``dominant purpose'', objectively ascertained. In that respect, it is necessary to have regard to each of the matters referred to in section 177D(b). Those matters will not all necessarily point to the same purpose. Some of the matters might point in one direction and others point in another direction. Section 177D requires an evaluation of all of them, alone or in combination. The conclusion to which the section refers requires a balancing exercise. I shall deal separately with each of the paragraphs of section 177D(b):
287. (i) Manner of carrying out. The scheme was entered into and carried out in a manner that would be expected, having regard to the amount involved. The Instruments were prepared with the assistance of legal advisers and were entered into with a degree of formality. Having regard to the amount of money involved, that is not surprising. However, there was a degree of carelessness involved in the performance of the Arrangements. That is to say, there is some ambiguity in the description of the Plant and Equipment (see paragraphs 210-211 above). The requirement of the Instruments that a plaque be placed on the Plant and Equipment appears to have been ignored (see paragraphs 215-218). Parts of the Plant and Equipment were replaced or moved without any prior consent of the Bank (see paragraph 219). There was no evidence of complaint by the Bank in respect of those matters.
288. Those considerations tend to suggest that the Taxpayer treated the Plant and Equipment as though it was still the unencumbered beneficial owner. The absence of complaint from the Bank suggests that the Bank did not regard the Plant and Equipment as its primary security for ensuring that it would be paid the moneys provided for under the Lease.
289. (ii) Form and Substance. The form of the Instruments was not unusual for a commercial financing arrangement of the nature of the Arrangements. However, the nature of
ATC 5280the Plant and Equipment was unsuitable for the Arrangements. The Arrangements were therefore somewhat artificial. Further, as I have indicated above, the form of the Lease was hardly apt for the Arrangements. The inaptness of the language of the Lease emphasises the artificiality of the Arrangements.
290. The artificiality, and the apparent disinterest of the Bank in the value of the Plant and Equipment to the Bank in the event of default, tend to suggest that the form of the Arrangements may have been regarded as more important than the substance of the rights and obligations that the parties recognised. Nevertheless, the Arrangements were not a sham. The Instruments were intended to have effect according to their terms. Those matters are therefore not decisive as to the dominant purpose of the persons who entered into and carried out the Arrangements.
291. (iii) Time. The Arrangements were entered into at a time when the Taxpayer had a need for medium to long term finance. The length of period during which the scheme was carried out is unexceptional, having regard to the nature of the Arrangements. That is to say, there has no suggestion that a five year term was out of the ordinary. Nor is there any basis for concluding that the timing of the Arrangements was dictated by anything other than a desire for longer term finance.
292. The idea of a sale of plant to a financier and its lease back originated in the approach from Macquarie Bank in March 1987. That approach related to ways in which the Taxpayer ``might improve its taxation position''. There is a clearly discernible line from that approach to the ultimate consummation of the Arrangements, although it was more than 12 months before the Arrangements were entered into. Further, the decision to grant a mandate to Macquarie Bank was made after a meeting of directors at which the prospect of acquiring minority interests had become a real prospect.
293. In relation to the time at which the Arrangements were entered into, a very significant factor was the Taxpayer's requirement for longer term finance. There was no urgency in the steps taken by the Taxpayer to enter into the Arrangements. The time at which the Arrangements were entered into is indicative, if anything, of a purpose of raising finance. The Taxpayer, more likely than not, would have raised finance, in one way or another, at about the time that the Arrangements were entered into.
294. (iv) Result. The executive summary attached to Mr Allen's proposals of November and February compared the ``sale and leaseback financing proposal'' with ``conventional borrowing''. However, there was never any concrete proposal advanced for conventional borrowing. The Board was not invited to chose between one of two options. Rather, the directors were being invited to consider the proposal because ``the underlying value of many items of plant'' provided the Taxpayer with an opportunity to raise a significant amount of funds ``at very low cost''. The very low cost was a function of full deductibility for the regular payments of Rent. The executive summary shows that the reduction in operating profit before tax under the proposal and under conventional borrowing would be much the same. On the other hand, there is a significant difference between the operating profit after tax under the proposal and the operating profit after tax under conventional borrowing.
295. The result that would be achieved by the Arrangements in relation to the operation of the Act is that the Taxpayer will have a deduction for payments that would not be deductible in whole, if the Taxpayer had an enforceable option to reacquire the Plant and Equipment. The Taxpayer would not have been entitled to a deduction of the same amount if it had simply borrowed $50,000,000 from the Bank at a rate of interest equivalent to that adopted by the Bank in calculating the regular payments under the Lease. If further financing arrangements had been entered into, the Taxpayer would have had a deduction for interest payments on its short term borrowings. Its position in that regard would have been similar to its position under a conventional loan.
296. (v) Change in financial position. The financial position of the Taxpayer changed as a result of the arrangements. It ceased to be the unencumbered beneficial owner of the Plant and Equipment. It received $50,000,000 as proceeds of sale and undertook a commitment to make regular payments for five years and to indemnify the Bank in respect of any shortfall under the residual value of any proceeds of sale of the Plant and Equipment at the expiration of the Term of the Lease. That is the position that one would expect to result from any sale and leaseback arrangement.
297. The Taxpayer had a genuine need to raise medium to long term finance in order to reduce its short-term borrowings. Accordingly, the financial position of the Taxpayer was improved by the Arrangements. That improvement could have been achieved equally well by a conventional loan, without the disadvantage of disposing of ownership.
298. (vi) Other persons. There has been no change in the financial position of any other person who has had any connection with the Taxpayer.
299. (vii) Consequence for Taxpayer. The consequence for the Taxpayer, of the Arrangements having been entered into and carried out, is that the Taxpayer gave to the Bank a proprietary interest in the Plant and Equipment such that, if the Taxpayer defaulted in making the regular payments under the Lease, the Bank would be entitled to require severance of the items of Plant and Equipment from the land of the Taxpayer and Austral Bronze. That is the normal consequence that would follow any sale and leaseback transaction.
300. The critical factor in this regard is that, while there may have been an expectation on the part of the Taxpayer that it would be able to reacquire the Plant and Equipment if it desired to do so, it had no right to do so. In that regard, the Arrangements were not different from any sale and leaseback arrangements entered into in the ordinary circumstances. The consequence of the Arrangements for the Taxpayer is not conclusive of a dominant purpose of obtaining a tax benefit, although it may tend to point towards that as the purpose for entering into the Arrangements rather than other financing arrangements.
301. (viii) Connection with other persons. There is no relevant change in the financial position of any person connected with the Taxpayer and, accordingly, the question of the nature of any such connection does not arise.
302. The Arrangements comprising as they did, the Credit Purchase Agreement and the Lease, were effective to raise $50,000,000 by way of medium term finance capable of replacing part of the short term liabilities that the Taxpayer had incurred during 1987. Clearly, finance could also have been obtained by a conventional loan. The form of finance adopted by the Taxpayer was apparently unprecedented so far as the Taxpayer was concerned. The benefit derived by the Taxpayer from having the whole of the regular payments under the Lease deductible made the sale and lease back attractive.
303. Some of the factors referred to in section 177D(b) point in the direction of a purpose of ensuring a tax benefit. At one level, it would be concluded that the dominant purpose of the Taxpayer, and the Bank for adopting the sale and lease back form of financing was to ensure that the Taxpayer would obtain the relevant tax benefit. That is to say, the sale and lease back form of financing, as distinct from any other form of financing, was chosen because of the tax benefit that would ensue. However, I do not consider that is the relevant level at which to assess purpose.
304. At another level, it would be concluded that the purpose of the relevant persons for the Taxpayer entering into the Arrangements was to ensure that the Taxpayer had access to medium to long term finance to replace its short term borrowings. The Commissioner accepts that, in ordinary circumstances, a sale and lease back arrangement ought not to be treated as giving rise to lease payments that are not fully deductible. Notwithstanding the artificiality of the Arrangements, the Instruments were intended to be effective according to their terms. The Arrangements would not have been entered into if there had been no increase in current liabilities of the Taxpayer during 1987.
305. As I have said above, the Taxpayer had a significant short-term debt prior to entry into the Arrangements. The position of the Taxpayer in relation to short term debt had been exacerbated by the acquisition of the minority shareholdings in Balfour Beatty Pty Ltd, Gooder Ltd, Associated British Cables Ltd and Austral Standard Cables Ltd. The level of the Taxpayer's short term debt was undesirable. That points towards a conclusion that the purpose of entry into a financing arrangement shortly after the acquisition was to raise medium term finance.
306. The way in which the new funds were applied does not detract from that conclusion. $43,000,000 of the initial $48,000,000 realised under the Arrangements was used to discharge short-term liabilities. $5,000,000 was invested in the short-term money market. That is consistent with having the funds available to discharge other liabilities that were falling due. Thus, the funds realised were substantially used
ATC 5282to discharge existing short-term debt. I am satisfied that, in the light of the objective circumstances surrounding entry into the Arrangements, the Taxpayer would have entered into a medium term financial arrangement of one kind or another if the Arrangements had not been available.
307. I consider, after balancing all of the matters in section 177D(b), that it would not be concluded that any of the Taxpayer, Austral Bronze, the directors of the Taxpayer and Austral Bronze or the Bank entered into or carried out the Arrangements, for the sole or dominant purpose of enabling the Taxpayer to obtain a tax benefit within the meaning of Part IVA of the Act. Accordingly, the Commissioner was not justified in making a determination under section 177F(1)(b).
308. It follows then that the appeals should be allowed and the assessments should be set aside. Ordinarily, the Commissioner would pay the Taxpayer's costs of the proceedings. However, the Taxpayer was unsuccessful on the issue of whether the Plant and Equipment were fixtures. That issue required considerable evidence. I shall stand the proceedings over to a time convenient for the parties to bring in short minutes to reflect the conclusions that I have reached and to permit the parties to make submissions, if they wish, on the question of costs.
THE COURT DIRECTS THAT:
1. The parties bring in short minutes to reflect the conclusions reached in the reasons for judgment of 8 December 1999.