Federal Commissioner of Taxation v. Ampol Exploration Limited.

Lockhart J

Beaumont J
Burchett J

Full Federal Court

Judgment date: Judgment handed down 27 November 1986.

Lockhart J.

The question in this appeal from the Supreme Court of New South Wales (Rogers J.) [reported at 85 ATC 4760] is whether certain expenditure incurred by Ampol Exploration Limited (``the taxpayer'') is deductible under sec. 51 of the Income Tax Assessment Act 1936 (``the Act''). The expenditure of $3,475,340 was incurred during the taxpayer's year of income ended 30 September 1980 in relation to the exploration for oil in certain areas off the coast of China. The Commissioner of Taxation disallowed the claim for deduction. An appeal was brought to the Supreme Court which allowed it in part, namely, as to $1,491,024 being the amount of expenditure incurred after 3 April 1980, a date the significance of which will appear later. The Supreme Court disallowed the taxpayer's appeal as to the balance of the deduction claimed. The Commissioner appealed to this Court from the Supreme Court's judgment allowing the deduction as to $1,491,024 and the taxpayer cross-appealed against the judgment disallowing the deduction as to $1,984,316.

The three issues before this Court (as they were in the Supreme Court) are, first, whether the expenditure claimed as a deduction falls within either of the two limbs of subsec. 51(1) of the Act; second, assuming it does, whether the expenditure is nevertheless of a capital nature; and, third, whether sec. 260 of the Act operates to deny the deduction to the taxpayer.

As this case turns, like others in this particular area of law, upon its own facts and circumstances it is necessary to refer to the facts in some detail.

The taxpayer was a subsidiary of Ampol Limited (previously known as Ampol Petroleum Limited and to which I shall refer as ``Ampol'') until some time during the year ended 30 September 1980. On 9 October 1980 Ampol held 49.17 per cent of the issued stock units of the taxpayer and has continued to hold about the same percentage since then. Ampol carries on the business of refining, marketing and distributing petroleum products throughout Australia.

The taxpayer has been engaged for many years in the business of exploration for petroleum in Australia both on land and in offshore waters. It is the exploration arm of the Ampol group. On 30 September 1980 the taxpayer held 11 petroleum exploration permit interests in Western Australia (seven on-shore and four off-shore), four in the Northern Territory, one in Queensland where it also had one farm-in arrangement, and another farm-in arrangement in New South Wales. In each case these interests were held in conjunction with other parties and the actual work of exploration or production was done by operators appointed by the parties. For example, for many years up to and including the 1980 year of income the taxpayer held a one-seventh undivided interest in the production of oil and gas from the Barrow Island and Dongara fields in Western Australia, the operator being West Australian Petroleum Pty. Limited.

The taxpayer has sometimes conducted exploration activities itself and not through an operator. For example, the taxpayer held an authority to prospect for petroleum in the Galilee Basin of Queensland and it was appointed operator to conduct the exploration on behalf of itself and the other parties involved in the project under an agreement effective from 1 February 1984. The taxpayer is entitled to a fee for its work as operator under that agreement. It is the policy of the Board of Directors of the taxpayer that it should become an operator in other permit areas when suitable opportunities arise.

Until 1979 the exploration activities of the taxpayer were principally confined to Australia.

ATC 4861

When opportunities arose for exploration in areas outside Australia a separate company was formed for that purpose.

A.E. Harris is and has been since 1970 the managing director of the taxpayer and since 1977 its chief executive officer. He is and has been since 1959 a director of Ampol and since 1970 its managing director. He gave evidence by affidavit and viva voce before the Supreme Court which was accepted. Over some years before 1979 Mr Harris had been interested in fostering relations between the People's Republic of China and the Ampol group with a view to establishing trade relationships between them. In 1973, for example, on behalf of Ampol he initiated discussions with petroleum officials of China concerning the possibility of acquiring Chinese crude oil. Early in 1979 he was aware that the Chinese were entering into agreements with operators to permit exploration for petroleum in China's sovereign waters, but he had not expected that Ampol would necessarily be invited to join in that activity. There had been no prior communication between Ampol and the Chinese on this matter. In July 1979 Ampol was invited to participate in the exploration in these areas by the National Oil and Gas Exploration and Development Corporation, an agency of the People's Republic of China. As the petroleum exploration activities of the Ampol group were undertaken by the taxpayer, which at the time the invitation was received was a subsidiary of Ampol, Mr Harris formed the view that it would be appropriate for the taxpayer to enter into the relevant agreements rather than Ampol. The taxpayer therefore entered into two agreements for a geophysical survey in July 1979, four in August 1979, and one in September 1979.

During the 1979 year of income, pursuant to those agreements, the taxpayer became involved in a program of seismic investigation of petroleum prospects in areas of the South China and Yellow Seas. The taxpayer is a participant with other international petroleum exploration companies in each area. For each area one of the participants is the operator. The taxpayer is not an operator in any of these areas. The operator and other participants share the exploration costs in the proportions agreed between themselves. Ultimately the taxpayer became a participant in relation to seven separate areas. The participation agreements, of which there are seven, provide for the participants to contribute to the cost of the work as called upon by the operator. The work consists of seismic surveys. Interpretation of the seismic information is carried out separately by each company.

Although basically in the same terms, the agreements differ a little from each other in addition to the fact that the parties thereto differ and the fact that the agreements deal with different areas of the South China Sea. It was common ground that nothing turns on the differences between the agreements for present purposes. The participation agreement which was treated before us as a fair sample of them all is dated 25 July 1979. It is between Phillips Petroleum International Corporation Asia as ``operator'', a number of international oil companies described as ``original participants'' and other parties approved by ``the Chinese side''. The latter were divided into ``early participants'', that is, companies which became parties to another agreement called the survey agreement within a defined period and ``late participants'' being companies that became parties still later. The recital states that the survey agreement was to provide the terms and conditions under which companies other than the original participants could participate in the geophysical survey to be carried out. The participation agreement allocated the costs and expenses incurred pursuant to the survey agreement between all the parties.

The survey agreement is between the Chinese side, the operator and the original participants. It is attached to and made part of the participation agreement. The survey agreement provides the terms and conditions under which other companies may participate in the geophysical survey. The survey agreement provides for the operator to conduct a geophysical survey over a portion of the designated area for the purpose of evaluating the hydrocarbon potential of the area ``so that it may be offered by the Chinese side for the next phase of exploration and development on a competitive bid basis which will not involve transfer of ownership of oil and gas resources''. The operator is required to conduct the geophysical survey and to organise, carry out and supervise the work and to pay all costs incurred in conducting the work (cl. 2). The operator shall use the most advanced equipment and technology to carry out the survey and to

ATC 4862

complete the acquisition, processing and interpretation of the data so as to evaluate the prospectiveness of the survey area (cl. 3). The survey is to include 13,000 km of seismic lines (cl. 4). The operator shall use its best endeavours to accomplish the survey including the interpretation of the data within 12 months after commencement of acquisition of the data, force majeure excepted (cl. 5). In order to be qualified for joining the competitive bidding at the exploration and development phase, early and late participants are required to acquire the data obtained by the operator on a ``shared cost'' principle. Late participants are not only to share in the original costs but to pay a premium. These costs and premiums are non-refundable whether the bidding is or is not successful (cl. 7). The operator is required to turn over to the Chinese side not only the raw field data but also the processed data and interpretations. The operator shall not divulge the interpretations and the analyses of the prospectiveness of the hydrocarbon potential of the survey area without the consent of the Chinese side. The raw field data and the processed data obtained by the operator shall not be transferred or sold to other foreign companies, except to participants, until after the completion of the first round of bidding, an expression to which I shall return later. All participants are required to hand over their respective interpretations to the Chinese side within eight months after receiving the last lot of processed data from the operator and to keep all the data and interpretations confidential and are not allowed to transfer or to sell such data without the consent of the Chinese side. The Chinese side agrees not to divulge the interpretations provided by the operator or any participant without the consent of such operator or participant (cl. 8). The operator shall be responsible for the management of all the data obtained in the survey within the period starting from the date of execution of the agreement until the date of the first round of bidding. After the first round of bidding has been completed the Chinese side will have the sole ownership of and management of all the data, it being understood that the Chinese side will not divulge the interpretations of the operator or other participants. The operator shall not be entitled to sell the data or copies of it and shall keep all the relevant data and interpretations confidential (cl. 9). Pursuant to cl. 10, the survey area is to be divided into blocks and offered for bidding. The first round is to open within 12 months of receipt of all the data by the Chinese. The offer is to be made ``under terms which will provide, in the event of commercial discovery'' for recovery of investments and costs, a reasonable return on capital and a reward commensurate with the risk undertaken and success achieved. Such recovery is not to include the costs of the geophysical survey (cl. 10). During the course of the survey the Chinese side is entitled to participate in all phases of work including the acquisition, processing and interpretation of data (cl. 12). The operator will pay to the Chinese side 3.5% of the total costs of the survey as a service charge (cl. 14).

The learned trial Judge said at p. 4762:

``It will be perceived that the entitlements flowing to participants under the agreements to actually get to the point of exploiting any deposit of hydrocarbons suggested to exist by the survey data are limited in the extreme. At its highest, an agreement entitles a participant to the survey data and to participate in the eventual competitive bidding. On the other hand, without the data, no one would wish to bid even if otherwise able to do so. Thus, although the prospect of eventual reward in the sense of participation in drilling for oil was contingent, there was no chance of doing so without first participating in the survey. To emphasise the obvious, the survey data and the interpretations by the various participants would create a pool of information which would allow both the Chinese and the participants to determine whether the area was a possible prospect at all and, if so, what portion should first be explored. As a matter of commercial reality, no participant could contemplate making a bid without possession of all the data even if the agreement did not preclude it from doing so. It would have been nothing short of gambling to bid without the data. It was for this reason that, in my view, participation in the survey was an integral and essential part of the exploration activity.''

Notwithstanding that it was the taxpayer which was chosen by Ampol to participate in the Chinese enterprise, Mr Harris was of the opinion that Ampol should be compensated by the taxpayer for ``referring the invitation to participate in the seismic activities'' to the

ATC 4863

taxpayer so that the Ampol shareholders, who were not the same as the taxpayer's shareholders, would also benefit. He had discussions with other members of the boards of Ampol and the taxpayer to whom he conveyed his views.

The precise nature of the compensating interests which Ampol should receive had not been determined by 30 September 1979 and was unresolved by the end of November that year. The question was discussed at meetings of directors of Ampol and of the taxpayer on more than one occasion. At the meeting of the board of the taxpayer held on 24 October 1979, at which Mr Harris was present, it was resolved:

``RESOLVED in recognition of Ampol Petroleum Limited having secured for the Company the exploration opportunity in the People's Republic of China, to offer that Company a 10% interest at no cost (equal to about $250,000 of expenditure) in the seismic surveys being conducted in the area off the coast of China and it was FURTHER RESOLVED to offer Ampol after the completion of such seismic surveys:

  • (a) The right to participate to the extent of a 10% undivided interest in any consequent entitlement to bid for blocks to be offered within these areas and,
  • (b) the right to participate to the extent of a 10% undivided interest in any future exploration, development and production of such areas.''

A letter of 18 October 1979 written by Mr Harris to the board of the taxpayer was tabled. In the letter Mr Harris said that he believed that the Chinese officials would regard the taxpayer and Ampol as being pretty much as ``one''. He noted in the letter that:

``a number of multi-national oil companies who are participating in the seismic work are using wholly-owned exploration subsidiaries.''

He also said in the letter:

``The point should be made that the real advantage of being a seismic survey participant is the understanding that the Chinese Government will limit to such participants the right to bid for exploration permits.''

At a meeting of the board of directors of Ampol held the same day it was resolved to accept the offer of the taxpayer and to instruct the general secretary to prepare an appropriate agreement for consideration by both companies.

The matter came before the Board of the taxpayer again on 28 November 1979. Mr Harris was present and the minutes record that a draft letter of offer to Ampol consistent with the board's resolution of 24 October 1979 was tabled by the secretary. The letter was sent by the taxpayer to Ampol on 28 November 1979 and Ampol replied by letter of the same date. By that letter the taxpayer formally offered to Ampol:

  • (a) the right to participate in bids made by the taxpayer for the right to explore and develop areas that may be offered for this purpose by the Chinese side;
  • (b) the right to participate in exploration and development of areas in respect of which successful bids for such purposes are made by the taxpayer; and
  • (c) an entitlement to 10% of any petroleum produced from such areas in respect of which the taxpayer receives an entitlement from the Chinese side and/or an entitlement to 10% of the proceeds of sale of any such petroleum.

The letter stated that in consideration of the participation rights and production entitlement offered to Ampol it would be required to underwrite 10% of the amount of all money bid by the taxpayer for the right to explore and develop areas offered by the Chinese side and to underwrite and contribute to 10% of all the costs and liabilities incurred by the taxpayer in the submission of bids, the undertaking of exploration and development programs and the production of petroleum from oil fields discovered within the areas. In its reply Ampol accepted the taxpayer's offer.

At that time the precise way in which Ampol would be given an interest in the relevant exploration had still not been decided.

There were several reasons for the delay in coming to a final decision as to the form which the agreement between the taxpayer and Ampol would take including:

  • (a) the absence of any legislation in China governing the rights and obligations of

    ATC 4864

    companies participating in the seismic studies and any future drilling activities;
  • (b) the fact that this was the first occasion that the taxpayer had been involved in a project outside Australia of such magnitude;
  • (c) the difficulties of contracting with a number of foreign companies residing in many different countries and with the relevant Chinese authorities were of a kind not previously encountered by the taxpayer;
  • (d) the few available senior executives involved in the project were also required to spend substantial portions of their time on other Ampol projects and projects of the taxpayer; and
  • (e) the concerns of Mr Harris regarding the viability and geological worth of the venture which he conveyed to other members of the board of the taxpayer.

There are various ways in which petroleum exploration companies may conduct and enjoy the benefits of exploration activities, the most usual alternatives being those described by Mr Harris as:

  • (a) a working or operating interest;
  • (b) a royalty interest;
  • (c) an overriding royalty;
  • (d) a net profits interest;
  • (e) a production payment;
  • (f) a carried interest; or
  • (g) sale of the petroleum interest if a commercial field is discovered.

These alternatives are described fully by Mr Harris in his evidence and there is no necessity for me to elaborate.

According to Mr Harris the situation facing the participating companies, including the taxpayer, in the China venture was unique in that none of the more usual methods of conducting exploration activities could be readily adopted. He gave as the reason for this that ``in contradistinction to what one would expect to be the case in relation to Australia, the companies carrying out the seismic activities had no petroleum lease or other petroleum interests and, therefore, no interest out of which an interest'' of the kind to which I referred earlier (e.g. a royalty interest or a carried interest) could be created.

Mr Harris said that the other unique circumstance was that the ``entitlement'' of the parties to the participation agreements was:

``... no more than the possibility of being given the right to bid for an area in which further seismic and exploration drilling could be undertaken. If the parties were not invited to bid they were to be reimbursed for the costs incurred. This meant that there had to be, in effect, a new method worked out to cater for the exigencies thus presented. This was another reason for the delay in determining the manner in which the Ampol group should participate in the activities.''

Mr Harris's reference to the reimbursement ``for the costs incurred'' appears to be to the obligation of the Chinese side under at least some of the survey agreements involving the taxpayer. The survey agreement dated 11 July 1979 for example provides that:

``If the Chinese Side does not offer for competitive bidding at least one-third (1/3) of the Survey Area within three years after the date of this Agreement, then the Chinese Side shall reimburse to the participants all of the costs of conducting the survey including data acquisition, processing and interpretation plus five per cent (5%) annual interest.''

Mr Harris gave evidence that he formed the view that the most appropriate course would be for Ampol to be rewarded by having:

``a 10% interest in any commercial field which might eventuate from the work and that this might best be achieved by Ampol enjoying its interest through a jointly owned company with Ampolex [the taxpayer], in which it would have a 10% interest. I considered that Ampolex [the taxpayer] should bear the burden of costs in the event that the exploration should turn out to be unsuccessful and that Ampol's interest during the seismic and subsequent exploration and drilling phases should be akin to a carried interest...''

He said that, after detailed consideration of the commercial, legal and accountancy aspects involved in a major project of this kind he formed the view that an incorporated joint venture was appropriate for a variety of reasons including the following:

ATC 4865

``(a) Firstly, it satisfied the need to compensate Ampol in a manner that was commercially realistic given the legal uncertainties of offshore exploration and development, especially in China.

(b) Secondly, it accorded with the policy previously employed by the Ampolex group when exploring outside Australia of using a subsidiary for that purpose. That is to say, in the early 1970's a subsidiary of Ampolex namely Ampol Exploration (Tonga) Pty. Limited was incorporated for the purpose of participating in a petroleum exploration venture within the Kingdom of Tonga. Furthermore, during the late 1960's and early 1970's, Ampol Exploration (Q'land) Pty. Limited... a subsidiary of Ampolex had arranged to participate in permits which it expected would be granted in areas off the coast of Queensland and in the Gulf of Papua.

(c) Thirdly, that if at any future time it was thought desirable to seek separate funding through say a stock exchange listing in relation to the further exploration and if discovered, the development of any commercially producible reservoir of hydrocarbons in waters offshore China, then the fact that the participating interests were already held by a subsidiary rather than Ampolex itself would facilitate implementation of any such proposal.

(d)(i) Fourthly, if a commercially producible reservoir was discovered and developed then it is most likely there would be a substantial debt burden carried by the participants until the project reached the production stage. By isolating Ampolex's involvement into a subsidiary there would be a better opportunity of limiting the liability of Ampolex, in that the security given to lenders over the development period would be restricted to the assets of the subsidiary itself. In the event this limitation plan eventuated, the seeking of other finance to fund exploration and development activities inside Australia would not be impeded by arrangements covering the China project.

(ii) The need for this approach has been vindicated as, since 1979, Ampolex has participated in many exploration programmes in its Australian permits, two of which contain the `Jackson' and `Jabiru' fields and there could well be a requirement for external funding by Ampolex in the future for these or other yet to be discovered fields. That is, Ampolex is now in a position of freely deciding whether funds borrowed for those projects should be secured on its existing assets. If the debt burden on the subsidiary became too large then administrative difficulties would be reduced in the event of need for a public listing of the company by having transferred the participation interests to that subsidiary at an early stage.

(e)(i) Fifthly, the use of a subsidiary as the appropriate vehicle was also recognised as potentially providing better scope for more efficient administrative procedures in relation to offshore projects...

(ii)... it was thought possible that additional highly technically qualified staff would be required at the development stage and that a reasonable manner of making it plain to them, the requirements and results of their work and the importance of it to the Ampolex group as a whole, was for separate accounting statements. Furthermore, it was considered relevant that because any China project would likely be substantial, requiring a very high level of cost management that this could be achieved through the use of a separate company. This is because the existence of separate companies presents a greater need for precision in allocating common costs than would be the case if the allocation was between divisions of the one company.

(iii) It is also relevant that to assist in properly managing any external funding of the project on a continuing basis that the availability of a separate set of audited accounts covering the costs could assist relationships with the lenders...''

Mr Harris said that in the period prior to 31 December 1979 he had come to the conclusion that the objectives of Ampol being rewarded by a 10 per cent interest in any subsequent commercial field which might eventuate from the work might best be achieved by the taxpayer assigning its rights, though not its obligations, under the various participation agreements to a jointly owned company to be owned 90 per cent by the taxpayer and 10 per

ATC 4866

cent by Ampol such that the assignee would be entitled to all the benefits of the exploration should it be successful and that the taxpayer should in that event receive a fee of an agreed amount; or, in the event of failure to agree upon an amount, a fee equal to costs plus a profit margin of 15 per cent. Although Mr Harris was cross-examined to suggest that the idea of a fee payable to the taxpayer did not arise until long after he formed the view that Ampol should receive a 10 per cent interest, he did not agree with the suggestion.

Mr Harris's evidence was that during this period (i.e. before 31 December 1979) he discussed these matters with the members of the boards of both Ampol and the taxpayer. He conveyed to them the views which he had formed and they agreed with them. On 27 February 1980 the board of the taxpayer resolved to adopt Mr Harris's recommendations and to approve the execution of a deed of assignment between the taxpayer, as assignor and a company to be formed and to be known as Ampol Exploration (China) Pty. Limited as assignee. That company was not formed. Instead a company, Ampol Exploration (Q'land) Pty. Limited (``Ampolex Queensland'') was selected as assignee. It had been formed some years before to engage in exploration activities off the coast of Queensland and in the Gulf of Papua but had ceased to carry on business. Further allotments of shares were made by it resulting in Ampol holding 10 per cent of its issued share capital. Formal effect was not given to the decision of the board of the taxpayer approving the execution until 3 April 1980 when the deed of assignment of that date was executed. Mr Harris said the delay was due to the fact that the board of the taxpayer:

``... does not customarily, and did not on this occasion, meet in January, and also because of other pressing matters and particularly, because it was decided to assign to an existing subsidiary of Ampolex, i.e. Ampolex Queensland, and to allot shares therein to Ampol rather than to form a new joint company as had been originally proposed and resolved upon by the Board of Ampolex at its meeting held on 27 February 1980.''

The taxpayer and Ampolex Queensland thus entered into a deed of assignment which provided that, subject to the taxpayer obtaining all necessary consents and approvals that may be required under the various participation agreements and to the extent permissible thereunder, the taxpayer assigned to Ampolex Queensland the whole of its rights, including the right to tender and bid for the right to further explore, develop and exploit any one or more of the areas in question: cl. 1. The taxpayer covenanted to use its best endeavours as and when required by Ampolex Queensland to procure all necessary consents and approvals required to give effect to the assignment provided that if they could not be procured or if the rights could not, for whatever reason, be assigned then the taxpayer would hold the rights in trust for Ampolex Queensland for its benefit absolutely: cl. 2. The taxpayer covenanted to continue to meet all of its obligations and liabilities under the agreements: cl. 3. In consideration of the assignment Ampolex Queensland covenanted to pay to the taxpayer fees calculated in accordance with the formula provided in the deed. The fee was to be an amount to be agreed in writing or failing agreement the amount expended by the taxpayer in respect of the area in question plus 15 per cent: cl. 4. The fee was payable within 12 months of notification that the area had been defined and tested to circumscribe a sub-surface hydrocarbon accumulation such that continuous production in commercial quantities was reasonably assured: cl. 5.

Mr Harris said that since entering into the deed of assignment the taxpayer carried out all the obligations required of it thereunder. He said that during the course of the seismic investigation of the relevant areas the operators provided the taxpayer with seismic data regularly and that as the data was received it was referred to a consultant in Australia which had been engaged by the taxpayer to interpret it. Following the interpretation of the data by the consultants, the board of directors of the taxpayer resolved on 27 July 1982 to establish a committee of the board to consider alternative proposals for bidding. Subsequently, applications to bid for blocks were lodged by the taxpayer as a member of a consortium of companies which had agreed to become associated with each other. On 17 August 1982 ``bid proposals'' were lodged with China National Offshore Oil Corporation, a corporation established under the laws of the People's Republic of China. After protracted

ATC 4867

negotiations, agreements were finally executed in 1983 by the taxpayer and other companies forming the respective consortia to explore and develop the areas allotted to them. The board of Ampolex Queensland was informed of these developments.

Counsel for the Commissioner contended that the expenditure the subject of the claim for deduction is not deductible under either limb of subsec. 51(1) and is expenditure of a private or capital nature. First, it was said to be expenditure made merely to obtain seismic data and a right to bid competitively with others for an unspecified right to explore and develop undefined mining land. The rights obtained under the participation agreements were, at their highest, rights entitling a participant to the survey data and to participate in the eventual competitive bidding. The Commissioner accepted before the trial Judge and before us that there was a sound commercial reason for an assignment, though he disputed that the deed of assignment was explicable on sound commercial grounds. Counsel relied on what he asserted was the extraordinary nature of the deed of assignment and the nature of the fee payable thereunder. Second, it was said that the expenditure was antecedent to the commencement of the business of oil production and it preceded the commencement of a business to be operated by another company or entity. It was submitted that the execution of the deed of assignment did not change the previously fixed character of the outgoings which the taxpayer had already assumed and that there was in fact no change to the existing obligations of the taxpayer. All that the assignment did was to transfer to Ampol Queensland such possibility of future benefits as might exist in return for partial recoupment of the prior and future expenditure by the taxpayer which it was committed to make plus a 15 per cent profit on such expenditure as may be recouped, if any. I should say at this point that in my view the participants under the participation agreements including the taxpayer were under no legal liability to make payments to the operators unless and until the operators incurred the relevant expenses and sought reimbursement.

It was submitted before the trial Judge by the Commissioner that the deed of assignment was ineffective to achieve an assignment or the creation of a trust of the taxpayer's rights under the participation agreements but this submission was not pursued before us.

As to sec. 260, counsel for the Commissioner submitted that it did not matter if there were sound commercial reasons for the assignment. He submitted that the provision in the deed of assignment for the payment of the recoupment together with the additional 15 per cent bears on its face the intention of avoiding tax. Reliance was placed upon the decision of the High Court in
F.C. of T. v. Gulland 85 ATC 4765, (1985) 60 A.L.J.R. 150 especially per Gibbs C.J. at ATC pp. 4773-4774; A.L.J.R. p. 154 and Dawson J. at ATC pp. 4796-4797; A.L.J.R. p. 171 with whose reasons for judgment on this question Wilson and Brennan JJ. agreed. Counsel for the Commissioner argued that sec. 260 annihilated the deed of assignment and that the antecedent situation which existed was one in which the taxpayer had an ongoing contractual obligation to make payments from time to time which were not deductible without the aid of the assignment. The only purpose of the recoupment provision for payment of the additional 15 per cent was to create a tax deduction.

Counsel for the taxpayer argued that the taxpayer's principal activity was exploration for petroleum, that the taxpayer engaged in this activity for reward, that it undertook the exploration activities of the Ampol group and accordingly it was considered the appropriate member of the group to enter into the participation agreements. Participation involved no more than the possibility of a right to bid to undertake further seismic and exploration work. It did not involve a transfer of oil or gas resources, the property in which remained with the Chinese Government. The taxpayer did not obtain an income-producing asset to exploit. Under the deed of assignment the taxpayer sold the benefits under the participation agreements to Ampolex Queensland in consideration of a covenant by the latter to pay a fee in the event of a commercial find in an area, by which time the taxpayer's obligation of exploration would have ceased. It was submitted that the outgoings were both incidental and relevant to the taxpayer's exploration activity generally and that as such they were incurred in gaining or producing its assessable income or the assessable income it expected to produce and that accordingly the whole of the outgoings totalling $3,475,340 were deductible.

ATC 4868

Counsel for the taxpayer also submitted that the taxpayer's exploration activity was not confined to Australia, but that if the Chinese exploration activities were to be separated and said not yet to have produced assessable income, then the outgoings were necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income and fell within the second limb of subsec. 51(1). They were recurrent and in the nature of operating expenses of the exploration business. The taxpayer obtained no property or income rights by entering into the participation agreements. At most, its participation did no more than enable it to bid; it was a mere expectation or possibility. After December 1979, or at the latest 3 April 1980, the outgoings were incurred to produce a fee and generate income from Ampolex Queensland.

As to sec. 260, counsel for the taxpayer submitted that the case was governed by the principles laid down by the Privy Council in
Newton v. F.C. of T. (1958) A.C. 450 which, as counsel for the taxpayer expressed it, was rehabilitated by the High Court in Gulland's case (supra). It was submitted that the trial Judge correctly found that there was proper commercial reason for the deed of assignment and that it was not impressed with the stamp of tax avoidance. There was ample evidence to explain the deed of assignment as an ordinary business or commercial transaction. There was nothing to suggest a contrived scheme which could only be explained on the basis of tax avoidance.

There is an initial question to be considered in relation to the taxpayer's argument that the relevant expenditure is deductible under the first limb of subsec. 51(1) on the basis that it represents outgoings incurred in gaining or producing its assessable income derived from its activities generally of which the Chinese enterprise and the assignment of its rights to Ampolex Queensland form only a part. This question arises from the language of the taxpayer's notice of objection.

The trial Judge noted in the opening paragraph of his reasons for judgment that the expenditure was described in the taxpayer's income tax return for the relevant year as: ``... expenditure amounting to $3,475,340 in exploring in permit areas offshore China for the purpose of producing assessable income in the nature of a fee from ...'' Ampol Queensland (the emphasis was that of the trial Judge). In its notice of objection to the Commissioner's assessment the taxpayer claimed that the expenditure of $3,475,340 should be allowed upon certain grounds, the first of which reads, so far as relevant:

``1. The taxpayer is entitled under Section 51(1) of the Income Tax Assessment Act 1936 (hereinafter `the Act') to a deduction for the sum of $3,475,340 being losses or outgoings incurred by the taxpayer in gaining or producing the assessable income in the nature of fees from Ampol Exploration (Q'land) Pty. Limited under the terms of an Agreement... whereby the taxpayer assigned to Ampol Exploration (Q'land) Pty. Limited all of its rights, entitlements, interests and benefits under various petroleum participation agreements relating to exploration in the Northern and Southern Areas of the Yellow Sea;...''

Upon the appeal to the Supreme Court the taxpayer was limited to the grounds stated in its notice of objection: sec. 190 of the Act.

The provisions of sec. 190 cannot be waived by the Commissioner:
H.R. Lancey shipping Co. Pty. Ltd. v. F.C. of T. (1951) 9 A.T.D. 267;
Mooloy v. F.C. of Land Tax (1938) 59 C.L.R. 608 p. 610.

However, grounds of objection should not be interpreted narrowly or technically. Any doubt as to whether a particular matter falls within the grounds stated in the objection should be resolved in favour of the taxpayer:
New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 C.L.R. 179 per Dixon J. at p. 204;
D. v. C. of T. (Qld) (1940) 6 A.T.D. 25 per Mansfield J. at p. 41.

The specification by the taxpayer of the assessable income to which the expenditure is said to be related as being ``in the nature of fees'' from Ampolex Queensland under the deed of assignment at first glance appears to lend support to the view that the taxpayer is confined to income answering that description for the purposes of the first limb of subsec. 51(1) and cannot put a case based on the wider notion of its ``assessable income'' from its activities as a whole.

It would have been sufficient for the taxpayer to have described the sum of $3,475,340 as outgoings received in gaining or producing the

ATC 4869

assessable income. By adding ``in the nature of fees from Ampol Exploration (Queensland) Pty. Limited under the terms of an Agreement...'' the taxpayer, in my opinion, merely gave them greater particularity. The object of the statutory confinement of the taxpayer to the grounds stated in its objection (sec. 190(a)) is to ensure that the Commissioner knows the respects in which the taxpayer challenges the assessment. In this case he would know this without the further particularisation. In my opinion the additional words do not inhibit the taxpayer from putting its argument in relation to the first limb of subsec. 51(1) on this wider plane.

If the words in question do operate to prohibit the wider case being put by the taxpayer then the words ``in the nature of'' etc. are sufficiently wide to encompass not merely fees under the deed of assignment itself but a right to income broadly of the kind described in the deed.

The second ground of objection states, so far as relevant:

``2. Alternatively, and without prejudice to ground 1 above, the taxpayer is entitled to a deduction for the said sum of $3,475,340 under the second limb of Section 51(1) of the Act. That is, the said sum of $3,475,340 being losses or outgoings was necessarily incurred by the taxpayer in carrying on a business for the purpose of gaining or producing the assessable income. The said sum of $3,475,340 was not capital, nor was it of a capital, private or domestic nature and it was not incurred in relation to the gaining or production of exempt income;...''

The language of this second ground of objection, notwithstanding the phrases ``the said sum'' and perhaps ``the assessable income'' are not limited by the language of the first ground of objection. The wider case for the taxpayer is open to it with respect to the second limb of subsec. 51(1) even if the language of the first ground was to be interpreted narrowly. Similarly with respect to the other grounds of objection. Although certain later statements in the notice of objection, a lengthy document, may at first glance tend to support the narrower construction of the grounds of objection, they are really an elaboration of them, are essentially argumentative, are not part of the grounds themselves and do not confine them.

Section 51 has attracted much judicial comment. In
F.C. of T. v. Total Holdings (Australia) Pty. Limited 79 ATC 4279; (1979) 24 A.L.R. 401 I discussed at some length the principles governing the construction and application of the section and, except for a few matters, need not repeat what I said there. It is sufficient for present purposes to say that the two limbs of subsec. 51(1) are not mutually exclusive so that some cases may be within both limbs. However, some cases may fall only within one limb. The words ``the assessable income'' and ``such income'' refer to assessable income generally of the taxpayer and not to the assessable income of a particular period. Expenditure falls within the first limb if it is incurred in the course of gaining or producing the assessable income in the sense that it is incidental and relevant to that end. The phrases ``incidental and relevant'' in this context refer, not to the frequency, expectedness or likelihood of their occurrence but to their nature or character. The outgoings must be connected with the operations which gain or produce the assessable income.

As to the second limb, there must be a nexus between the expenditure and the carrying on of the relevant business. The word ``necessarily'' means in this context ``clearly appropriate'' or ``adapted for''. In order to be deductible, a loss which flows from carrying on a business need not necessarily be incurred in a year when the taxpayer is actually carrying on that business.

I turn first to the taxpayer's case based on the second limb of subsec. 51(1). The principal business of the taxpayer is and has been for many years exploration for petroleum principally on mainland Australia and in its offshore waters. The facts stated earlier establish this. Sometimes the taxpayer has itself conducted the exploration activities, and at other times, perhaps generally, appointed an operator to conduct them on its behalf or on behalf of itself and others where it is a member of a petroleum exploration syndicate. The taxpayer has over the years been involved in negotiating exploration agreements and other agreements relating to interests in petroleum exploration areas. The alternative methods available to exploration companies for conducting exploration activities and enjoying the fruits of them are numerous and varied. The mechanism for conducting the exploration activities with which this case is concerned is

ATC 4870

certainly unusual (Mr Harris described the situation confronting the international exploration companies as unique) in that the companies engaged in the activities have no petroleum lease or other petroleum interest and therefore no interest from which an income-producing asset could arise. Participation involved no more than the possibility of being granted by the Chinese Government the right to bid to undertake further seismic and exploration work.

However, the role of the taxpayer in the Chinese venture was perceived by those who control its affairs as a commercially sound method of carrying on its exploration business and as part of its ordinary business activities. They were seeking a profit opportunity. The managing director of both Ampol and the taxpayer decided that, although the offer to participate was extended by the Chinese Government to Ampol, the taxpayer was the appropriate member of the group to enter into the participation agreements since it is the exploration arm of the group. The expenditure could not lead to the establishment of an income-producing asset. Nor could it lead to ownership of oil or gas resources.

The circumstances which brought the deed of assignment into existence and the provisions of the deed itself are relevant matters for the purpose of characterising the true nature of the expenditure for the purposes of the second limb of subsec. 51(1). Mr Harris explained those circumstances. Ampol and the taxpayer agreed that Ampol should be compensated by the taxpayer for the latter's obtaining from the former the right to participate in the seismic activities since the shareholders of Ampol were not the same as those of the taxpayer. More than one formula was considered to achieve this object, resulting eventually in the deed of 3 April 1980. It was not until 22 February 1980 however that consideration was given to the concept of a company to be incorporated and owned as to 90% by the taxpayer and 10% by Ampol and a fee payable by it to the taxpayer. The trial Judge rightly concluded that the formula for which the deed provides ``did not crystallize in any concluded and legally binding form until the date of execution of the Deed''. But it was clear at all material times that Ampol would have a share of some kind in any benefits resulting from the Chinese Government's offer to participate and that otherwise any benefits would accrue to the taxpayer. The method for accomplishing these objectives remained to be determined.

Under the deed, the benefits to the taxpayer, if it eventually participates in some commercial enterprise for the working of petroleum deposits, are to be recoupment of its expenditure in respect of the relevant areas plus 15 per cent and whatever benefits accrue from holding 90 per cent of the shares in the assignee, Ampolex Queensland. This was the formula finally arrived at to give effect to the broad understanding between both Ampol and the taxpayer. I have the firm impression, however, that the deed was conceived for the additional purpose of adding strength to the taxpayer's argument that the relevant expenditure was not capital in nature.

In my opinion the whole of the expenditure totalling $3,475,340 was necessarily incurred in the carrying on of the taxpayer's business of petroleum exploration and is deductible under the second limb of subsec. 51(1). This finding is based on the particular facts and circumstances of this case including the unusual nature of the enterprise established by the Chinese Government and the international petroleum exploration companies to conduct the exploration activities off the Chinese coast. It provides no warrant for a more general proposition that outgoings of companies engaged in petroleum exploration are necessarily deductible under the second limb of subsec. 51(1) if the expenditure is related to that activity. This is a question of fact in each case. Exploration or prospecting activities (e.g. geological, geophysical or geochemical surveys and appraisal digging) are the kind of activities in which a prospecting company engages if petroleum is to be found. It is, as the title of the activity suggests, of an exploratory nature. Petroleum may or may not be found; but unless expenses of this kind are incurred it will not be found. Once a proven field has been established other expenses, for example, development drilling or activities in the course of working or establishing a petroleum field will be incurred and they savour more of a capital nature since the work is done to bring into being a proven capital asset which will be the source of income-producing activity.

Division 10AA of the Act authorises special deductions in respect of certain expenditure incurred in carrying on ``prescribed petroleum

ATC 4871

operations'' or on exploration or prospecting in Australia for the purpose of obtaining or discovering petroleum. It is not necessary that such expenditure be capital expenditure to qualify for the deduction. It may be that some expenditure on exploration or prospecting may also be deductible under subsec. 51(1). Where both provisions could apply subsec. 82(1) would apply so that the deduction would be allowable under the section which is in the Commissioner's opinion more appropriate. Division 10AA does not, of course, apply to this case as the expenditure was incurred whilst engaging in exploration activity outside Australia; but I mention it because the presence of the Division does not support the view that outgoings incurred by a petroleum exploration company are necessarily and inherently of a capital nature and not deductible unless allowed by a special provision of the Act such as Div. 10AA. The presence of Div. 10AA also perhaps explains why counsel were unable to discover any case touching directly on the question of the deductibility under subsec. 51(1) of exploration expenses of petroleum exploration companies.

There is no warrant for dividing the expenditure in this case into amounts which preceded the deed of assignment and those which followed it. The taxpayer's business activities must be viewed as a whole including the particular circumstances of the taxpayer's involvement in the exploration undertaking off the Chinese coast. It is artificial to treat the deed of assignment as the line of demarcation between deductible and non-deductible expenditure. The characterisation of the expenditure, and therefore of the outgoing which it represents, is to be discerned from the business activities of the taxpayer generally and its role as the prospecting arm of the Ampol group in the Chinese project in particular. The understanding between the boards of Ampol and the taxpayer, informal though it was until April 1980 (though plain enough in February of that year), that a benefit, in the form at least of some payment to the taxpayer in the nature of reward or profit, would accrue to it, requires that the question of deductibility should be approached in a practical fashion. The whole of the relevant expenditure was incurred in the course of the carrying on of the taxpayer's business of petroleum exploration.

I am also satisfied that the total expenditure of $3,475,340 attracts the operation of the first limb of subsec. 51(1). The trial Judge took the view that the taxpayer's case was ``structured'' on the basis that the only deductible outgoings could be those incurred in exploring for petroleum for the purpose of producing assessable income, namely, the fee payable under the deed of assignment. His Honour rejected the argument that it is permissible for the outgoings incurred before the execution of the deed to be deductible under the subsection on the ground, advanced by the taxpayer, that it was at all relevant times the intention of the taxpayer and Ampol that a fee or something akin to a fee would be the taxpayer's reward for its role in the prospecting activities.

In my opinion the expenditure incurred before the deed was both incidental and relevant to gaining or producing the taxpayer's assessable income in the form of a fee, using that word in the broad sense of a payment or remuneration for the taxpayer's role in the exploration enterprise off the Chinese coast. The deduction is not denied because the particular form of payment was not finally determined in a legally binding form until 3 April 1980. It was at all relevant times the intent of Ampol and the taxpayer that a just reward of a business character would be paid to the taxpayer. Only the particular method to be selected to achieve this objective remained to be determined. I referred earlier to Mr Harris's evidence on this aspect of the case and need not repeat it.

Viewed from a practical and business point of view the deed of assignment was the method finally selected to express the object of both Ampol and the taxpayer; first, to enable Ampol to derive a fair share of any benefits which might be produced in the future from the oil production enterprise, if one emerged at all, and, second, to ensure recoupment of the taxpayer's costs if the oil fields were found to be commercially feasible together with a payment geared to a percentage of those costs, and the major share in the benefits of any such enterprise. The total expenditure was thus connected with the gaining of the payment from Ampolex Queensland.

Even if the taxpayer is restricted to the narrow interpretation of its first ground of objection it would nevertheless succeed on the first limb of subsec. 51(1).

ATC 4872

I turn to the more difficult question whether, notwithstanding that the expenditure falls within each of the two limbs of subsec. 51(1), it is nevertheless of a capital nature. The meaning of ``capital'' in the context of sec. 51 has been the subject of a wealth of decisions including of course the oft cited passages from the well known judgment of Dixon J. in
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-363 and the passages from his Honour's judgment when Chief Justice of the High Court in
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1958-1959) 101 C.L.R. 30 at pp. 34-35. See also
Cliffs International Inc. v. F.C. of T. 79 ATC 4059; (1978-1979) 142 C.L.R. 140.

In my opinion the expenditure is essentially of a revenue, not of a capital nature. It was not suggested by the Commissioner that the expenditure was of a private nature. I reach this conclusion whether the test is to examine the ``true legal character'' of the expenditure or to ascertain what it was ``calculated to effect from a practical and business point of view'': Cliffs International Inc. v. F.C. of T. (supra) per Gibbs J. at ATC p. 4066; C.L.R. p. 152 where his Honour acknowledged the sources of those phrases as the authorities cited in
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at pp. 4418-4419; (1978) 140 C.L.R. 645 at pp. 658-659. The true legal character of the expenditure was that of the ordinary business activity of the taxpayer as a petroleum exploration company. From a practical and business point of view the taxpayer sought to adopt one of a number of possible methods in which it engaged for the purpose of its exploration business to obtain, if all went well, the possibility of a right to bid to undertake further seismic and exploration work. The expenditure could not lead to the establishment of an income-producing asset for it to exploit and it was recurrent and in the nature of operating expenses of the taxpayer's prospecting and exploration business. Recurrence is, however, merely one matter to consider. In the Sun Newspapers case (supra) Dixon J. said at p. 362 that recurrence ``is not a test, it is no more than a consideration the weight of which depends upon the nature of the expenditure'' and he said at p. 363:

``There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.''

The payments in question were in truth part of the outgoings of the taxpayer in the course of carrying on its ordinary business activities. It was not expenditure incurred for the purpose of creating or enlarging a business structure or profit-yielding or income-producing asset.

There is no presumption that prospecting or exploration expenses are of a capital nature. It is a question of fact in each case. Ordinarily the purchase by a taxpayer of a right to mine is expenditure of a capital nature and would not be deductible in the absence of special statutory provision. Preliminary expenses incurred in the establishment of a mine also would ordinarily be in the nature of capital expenditure. In general, expenses incurred with a view to setting up a business or extending a business are not allowable deductions. Where expenses are incurred in establishing, developing, extending or rejuvenating a mine, they will generally be of a capital nature since they are incurred for the purpose of bringing a capital asset into existence or enhancing it.

An examination of the authorities establishes that there is no presumption that prospecting or exploration costs are prima facie of a capital nature. I see no purpose in referring to all the cases, to which we were referred, bearing on the subject but will mention some of them.
Coltness Iron Co. v. Black (1881) 6 A.C. 315 was a case where the taxpayers had carried on business as coal and iron masters for a number of years and had opened up several mineral fields, sinking new pits from time to time as the old ones became exhausted. The taxpayers sought to deduct from their gross annual receipts derived from their business sums expended by them in sinking the new pits. It was held by the House of Lords that the taxpayers were not entitled to the deduction sought. In
Alianza Co. Ltd. v. Bell (1904) 2 K.B. 666 the taxpayers owned land in Chile containing deposits of a substance called caliche from which they extracted by a

ATC 4873

manufacturing process nitrates and iodine. The taxpayers claimed to be entitled for the purpose of computing the balance of their annual profits and gains to deduct a yearly sum to meet the exhaustion of the nitrate grounds. It was held by Channell J. that the taxpayers were not entitled to the deduction.

Bonner v. Basset Mines Ltd. (1912) 6 T.C. 146 a company which carried on a large tin mine claimed to be entitled to a deduction of the cost of deepening a main shaft, the bodies of ore accessible from the original level having been practically worked out. It was held that the deduction could not be allowed.

Kauri Timber Co. Ltd. v. Commr of Taxes (1913) A.C. 771 the taxpayer carried on a business in New Zealand of cutting, milling and selling timber and for the purpose of its business it had acquired upon its incorporation and from time to time thereafter rights over freehold and leasehold bushlands bearing natural timber in some cases by purchasing the land and in other cases by purchasing the timber thereon with the right to remove it within a stated period. It was held by the Privy Council that under the Land and Income Assessment Act 1908 (N.Z.) the taxpayer was not entitled to make any deduction for income tax purposes from the gross proceeds of its business of the value of the standing timber which it had cut. The Privy Council held that there could be no question that the cost of acquisition of the taxpayer's possession of an interest in land and of timber rights thereon was just as plainly a capital cost as if the land with the timber on it had been bought outright and just as plainly it was not a proper accounting debit item as against revenue.

Hughes v. British Burmah Petroleum Co. Ltd. (1932) 17 T.C. 286 the taxpayer had carried on the business of oil producing and refining for some years and bought oil from an Indian oil company. Finlay J. said at p. 295 that it had been very well settled since the decision of the House of Lords in the Coltness case that the prime cost of buying a mine or buying a seam of coal is capital expenditure and cannot in any form be deducted.

Knight v. Calder Grove Estates (1954) 35 T.C. 447 the taxpayers carried on in partnership the business of open cast coal mining and purchased the freehold in ten acres of land for £2,000. The conveyance included covenants under which they undertook after getting the coal to reinstate the land and the vendor undertook to repurchase the land for £500 after the completion of mining operations. Upjohn J. held that the expenditure and the receipts were capital and rejected the view that the expenditure should be regarded as the expense of getting and winning the coal. His Lordship noted that it was not suggested that the purchase of the land was circulating capital or stock in trade or anything of that sort but was the purchase of land for the adventure. Hence on ordinary principles the transaction must be regarded as a capital expenditure ``just as when you buy land and put a factory on it, or buy land and sink a shaft''.

H.J. Rorke Ltd. v. I.R. Commrs (1960) 1 W.L.R. 1132 the taxpayers carried on the business of open cast coal mining and entered into an agreement with a land owner whereby certain land was let to the taxpayer for one year on payment of a royalty for every ton of coal won from the land. The taxpayers covenanted to restore the surface of the land on completion of the mining operations and other matters. The taxpayers were held not to be buying circulating capital when making the payments in question (i.e. coal) but to be acquiring rights which enabled them to obtain it and the whole of the payments were of a capital nature.

I.R. Commrs v. Carron Co. (1967) 45 T.C. 18 was a case of a taxpayer incorporated in 1773 carrying on business as an ironfounder. It was decided to revise the company's charter to remove what were regarded as archaic conditions. The company petitioned for a supplementary charter but the proceedings were suspended pending the outcome of an action by a shareholder claiming that the procedure adopted in deciding to petition was invalid. The taxpayer won the shareholder's action before the Lord Ordinary and in the First Division of the Court of Session but was advised that its prospects of success in the House of Lords were dubious. The taxpayer settled the action on terms requiring payment of moneys to dissenting shareholders. A supplementary charter was later granted substantially in the form proposed by the taxpayer. Its affairs were then reorganised and its commercial performance improved. The taxpayer claimed to deduct the cost of obtaining the charter and defending the action and the amounts paid to

ATC 4874

the two dissenting shareholders in respect of their shares and expenses in the action. One of the contentions for the Crown was that the sums in question were incurred on capital account. It was held that the expenditure was essentially of a revenue character in that it enabled the management and conduct of the taxpayers' business to be carried on more efficiently.

Softwood Pulp and Paper Ltd. v. F.C. of T. 76 ATC 4439 the taxpayer was incorporated for the purpose of establishing a new paper production industry in South Australia. The venture did not proceed. The taxpayer claimed the expenses incurred by it as a deduction pursuant to subsec. 51(1). The expenses related to overseas and local travel expenses, legal and accounting expenses, the testing of raw material, professional fees for the conduct of feasibility studies by expert consultants and acquisition of some raw materials. It was held by Menhennitt J. that the activities undertaken by the taxpayer were entirely preliminary and directed to deciding whether or not an undertaking would be established to produce assessable income and that the expenses were not incurred in the actual production of assessable income. Menhennitt J. held also that as the taxpayer had not decided whether or not the business should be proceeded with at the time the expenditure was incurred it could not be held to have been incurred in carrying on a business. Hence his Honour found that the expenditure fell within neither limb of subsec. 51(1). He went on to say that even if the expenditure did fall within either of the limbs, it would nevertheless be of a capital nature and he held at p. 4454 that the expenses all fell within the concept of establishing or creating the profit-yielding subject.

I could go on by multiplying the reference to other cases, but there is no useful purpose in doing so. I have said sufficient to confirm first, the danger of seeking to extract principles of general application in this branch of the law from the authorities where the facts are very different from the case under review and, second, the correctness of the frequently repeated statement in the cases (including those to which I have referred) that whether expenditure in respect of which a deduction is sought is capital or not must be a question of fact in each case.

Division 10AA of the Act does not support any presumption that prospecting and exploration expenses are intrinsically of a capital kind. The section does not proceed on the hypothesis that the expenditure to which it is directed and to which it specifically refers (for example, geological, geophysical and geochemical surveys, exploration drilling and appraisal drilling and which are included in the expression ``exploration or prospecting'') is intrinsically of a capital nature. What the section does is simply to ensure that expenditure which answers the description of expenditure incurred in exploration or prospecting in Australia for the purpose of discovering petroleum is, whatever otherwise might be its character, an allowable deduction.

In my opinion the expenditure is of a revenue nature and is an allowable deduction to the taxpayer.

I reiterate that whether the expenditure is of a revenue nature turns upon the particular facts of this case. If it be said that the facility for deduction may be open to abuse or that opportunity would be provided for wasteful expenditure by taxpayers not really directed to the discovery of petroleum the answer surely must be that before a taxpayer can be entitled to the deduction he must in fact carry on a business to which the losses or outgoings are related and in which they are necessarily incurred or, whether carrying on a business or not, the losses or outgoings must be incurred in gaining or producing the relevant assessable income.

I shall deal briefly with sec. 260. The trial Judge found that ``there is proper commercial reason for the Deed and it is not impressed with the stamp of tax avoidance''. No ground has been shown to warrant this Court's interference with that finding. It is plain to my mind from the evidence, as it was to his Honour, that the deed is explicable by reference to ordinary business dealing notwithstanding that it bears the dual stamp of a business character and the intention to strengthen the argument that the relevant expenditure was not capital in nature. The rebirth of sec. 260 in Gulland's case (supra) and the redemption of Newton's case (supra) and
Peate v. F.C. of T. (1966) 116 C.L.R. 38 does not avail the Commissioner in this case.

The appeal should be dismissed and the cross-appeal allowed. The Commissioner must

ATC 4875

pay the costs of this appeal and cross-appeal and of the appeal to the Supreme Court.

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