Cliffs International Inc. v. Federal Commissioner of Taxation.

Judges: Barwick CJ
Gibbs J
Stephen J

Jacobs J
Murphy J

Court:
High Court of Australia

Judgment date: Judgment handed down 13 March 1979.

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Jacobs J.: The facts are fully set out in the reasons for judgment of the members of the Full Court of the Federal Court of Australia from whose judgment in favour of the Commissioner of Taxation this appeal is brought. See
F.C. of T. v. Cliffs International Inc. 77 ATC 4217 ; (1977) 16 A.L.R. 681 . It is therefore only necessary shortly to recount the facts. In the income years ended 31st December 1973 and 31st December 1974 the taxpayer's gross income included royalties payable to it by a joint venture of four participants (``the Participants'') who were mining iron ore in the vicinity of Robe River. Their right to mine sprang from an assignment by the taxpayer to them of mineral rights to the area. The taxpayer had become possessed of the mineral rights pursuant to the course of events which it is necessary to examine for the purposes of this appeal. At this stage it may be shortly stated that out of that course of events there arose an obligation on the taxpayer to pay to two companies, Howmet Corporation (``Howmet'') and Garrick Agnew Pty. Ltd. (``Agnew Co.''), the sum of 15c (U.S.) per ton of iron ore mined from the area. The taxpayer claimed to deduct the amount of these payments from its gross income pursuant to sec. 51(1) of the Income Tax Assessment Act 1936 (Cth.). The Commissioner disallowed the deductions. The taxpayer appealed to the Supreme Court of Western Australia ( Brinsden J.) where its appeal was allowed and it was held entitled to the deductions. Then an appeal to the Federal Court of Australia by the Commissioner was allowed and from that decision the taxpayer now appeals.

The history of events commences in 1962 when the State of Western Australia granted rights of occupancy pursuant to the State's Mining Act to certain Reserves covering an area of 246 square miles to a company named Basic Materials Co. Pty. Ltd. (``Basic'') for a period of two years from 1st April 1962 to 31st March 1964. The purpose was in order to enable Basic to prospect for iron ore. If ore was discovered in payable quantities Basic was to be granted mining tenements under the Act so that it could mine the ore on the Reserves.

In 1962 the shares in Basic were held by the two companies Howmet and the Agnew Co. In July 1962 Howmet approached the Cleveland-Cliffs Iron Co. (``Cleveland-Cliffs''), a U.S. company, seeking to interest it in the development of the iron ore deposits on the Reserves. There were problems associated with the geological nature of the deposits and the U.S. company was expert in the technology

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ATC 4075

necessary to deal with those problems. Negotiations commenced for an agreement between the various parties, and an agreement was made on 27th November 1962. The agreement recited that Basic held the exclusive right to occupy and use the Reserves for the purpose of prospecting for iron ore. Cleveland-Cliffs undertook at its own expense to prove tonnages and quality of ore on the Reserves, to report and to take other steps. It was granted an option to purchase from Howmet and Agnew Co. the whole of their respective shareholdings in Basic. On exercise of the option Cleveland-Cliffs was to nominate a day twenty to thirty days later on which it would make what was described as the Initial Payment. The obligation to make this payment after exercise of the option was dependent upon, inter alia, Basic having full right power and authority subject to the provisions of Australian law to transfer all of the Reserves or other mining rights.

The amount of payment was provided for in art. 5 of the agreement, the opening paragraph of which was as follows:

``5. The Purchase Price referred to in Article 4 shall consist of an Initial Payment of TWO HUNDRED THOUSAND DOLLARS $200,000 (U.S.), payable in good New York or Cleveland, Ohio funds by certified or official bank check at the Closing of the purchase hereinabove referred to, plus Deferred Payments equal to 15c (U.S.) per ton of Iron Ore payable as in this Article 5 set forth. Such 15c per ton payments (hereinafter sometimes called `Deferred Payments') shall be computed and paid as follows:''

and there then followed details of the method of computation. Article 6 gave power to Cleveland-Cliffs to designate a company to make the purchase. It is noteworthy that the agreement did not oblige Cleveland-Cliffs to mine ore on the reserves should it exercise the option. A request during negotiations that there should be such a provision was refused. So also was a request that there be a condition that the shares should be transferred back if the option was exercised but the project did not proceed.

The figure of 15c (U.S.) per ton was reached after a series of discussions and negotiations as to comparable figures in the United States for royalties. Cleveland-Cliffs insisted on a figure per ton as the method of payment. Brinsden J. heard and accepted the evidence of Mr. Dohnal, part of which he summarised as follows:

``There were various plans put forward based on percentage of profits that might be obtainable but none of those propositions interested Cleveland Cliffs because of the risks involved and because of the fact that it could not at the stage negotiations were being pursued, properly assess those risks, as very little was known of the extent of the deposits and their true value. As to the actual term used in the agreement, namely `deferred payments' that was not a term brought into the discussions until a very advanced date and was brought in then only at the suggestion of Howmet for purposes of its own. So far as Cleveland Cliffs was concerned, the 15 cents per ton payment had always been regarded by it as a royalty and it continued so to regard it whatever term Howmet wished it to be expressed by in the agreement. During the discussions, it was suggested to Cleveland Cliffs that if it exercised the option it should be obliged to mine the deposits but the company declined to agree.''

It may be noted that, on the same day as the option agreement was made, Cleveland-Cliffs made an agreement with the Agnew Co. that if the option were exercised it would form an operating company or companies to mine exploit and develop the Reserves and the Agnew Co. or its nominees was to have the right to purchase up to seven and a half per cent of the shares to a limit of $2,500,000 (U.S.).

Notice of exercise of the option was given and the purchase was consummated on 17th January 1964. By then Cleveland-Cliffs had designated the taxpayer as the company to consummate the purchase. The shares in Basic were transferred to the taxpayer with the exception of one share transferred to Mr. Dohnal on behalf of Cleveland-Cliffs. On 18th March 1964 these shareholders of Basic resolved that the rights of occupancy to the Reserves were held in trust for the taxpayer.

On 18th November 1964 an agreement was made between the State of Western Australia and Basic. This was approved by the Iron Ore (Cleveland-Cliffs) Agreement Act 1964 in which it is set forth as a schedule. It provided for certain work to be done by Basic during a period described as Phase 1 and for continuation of the rights of occupancy during this period. This was to lead up to the commencement date whereupon Phase 2 was to commence. The State undertook then to grant a mineral lease for iron ore in a form set forth as a schedule to the agreement for a term of

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ATC 4076

twenty-one years from the commencement date, with rights to successive renewals of twenty-one years. Basic undertook that it would, within four years after the commencement date, (or extended period approved by the Minister) at a total cost of $70,000,000, instal various facilities to enable it to mine, to transport by rail to the plant site, pelletise and transport to Basic's wharf and to commence shipments therefrom in commercial quantities at an annual rate of not less than one million tons of iron ore pellets and also, within a further period of five years, to increase the capacity of the plant to a minimum of three million tons of iron ore pellets per annum.

Basic undertook to pay to the State of Western Australia rental and royalties. The royalties were to be on all iron ore (or on iron ore pellets produced from iron ore) from the mineral lease shipped and sold. Basic was given the right at any time to assign or dispose of to an associated company as of right, and to any other company or person with the consent in writing of the Minister, the whole or any part of the rights of Basic under the agreement and its obligations thereunder.

On 21st October 1965 Basic was voluntarily wound up and a liquidator was appointed. On 19th November 1965 an agreement was made between the taxpayer and Basic (now in liquidation) and the State of Western Australia whereby all the rights under the agreement of 18th November 1964 were to be assigned to the taxpayer who novated the agreement with the State. On 7th December 1965 the assignment was made.

In 1970 the agreement was made by the taxpayer with the Participants for assignment to them of its rights under the November 1964 agreement, as earlier stated. The Participants have mined the iron ore deposits and have paid rent and royalties to the State of Western Australia and to the taxpayer, who in turn has made the payments of 15c (U.S.) per ton to those entitled thereto under the Option agreement. The question, then, is whether the latter payments can be deducted from the income represented by the rent and royalties received from the Participants, or whether they were payments of a capital nature and therefore not deductible under sec. 51(1) of the Income Tax Assessment Act 1936 (Cth.).

The primary submission on behalf of the Commissioner is a simple one. The obligation to make the recurrent payments arose out of the contract; that contract was one for the purchase of shares; the shares were a capital asset; therefore the payments were part of the purchase price of a capital asset and are for that reason outgoings on capital account. If that submission is correct then that is an end of the matter. However, though the question whether recurrent payments are made on capital account or revenue account can sometimes be answered by considering only the terms of the original contract under which the payments were agreed to be made, this is not always, perhaps not frequently, so. To the question for what purpose is the expenditure made, the answer in the case of a pre-existing obligation could always be that the expenditure was made for the purpose of performing that obligation. The answer is but a conclusion of law. But that leaves no room for the ``practical and business point of view'' to which Dixon J. referred in Hallstroms' case (1946) 72 C.L.R. 634, at p. 648, nor does it enable a solution of the problem to be found, not in any rigid test or description but from many aspects of the whole set of circumstances, to use the phrases appearing in the B.P. case, (1966) A.C. 224, at p. 264. In order to solve the problem in a practical way it is necessary to look at the payments at the time each is made and to ask - what is that payment calculated to effect? Is it merely payment for the capital asset, the shares, already wholly acquired, and which are to be paid for over a period? Or is the purpose of the payment from the practical and business point of view to pay for the current mining operations?

If the option agreement is examined in the light of all the surrounding circumstances it cannot be regarded except in legal form as simply an agreement granting an option to purchase the shares in basic. The whole course of the negotiations with the parent company of the taxpayer, the recitals in the agreement itself, and the subsequent course of events show clearly that the purchase of the shares was no more than the medium whereby the exploration rights and the contingent mining rights on the Reserves were transferred to Cleveland-Cliffs. The shares should in my opinion be regarded as having the same qualities as the assets to which they gave entitlement.

The second argument presented on behalf of the Commissioner is that even if the payments be not regarded merely as payments for the shares and in this way payments for a capital asset, payment for subsisting exploration and contingent mining rights extending over a considerable period is inevitably a payment for a capital asset because the rights are presently subsisting and are of an enduring nature. This

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ATC 4077

submission is based on the view that inevitably payment for an existing right of a substantial kind is an outgoing on capital account provided that the acquired right can be regarded as part of the profit making structure. Thus, it is submitted, in the case of a leasehold, where there is a sub-lease for a consideration in the form of recurrent payments, those payments are on revenue account but it is submitted that when there is an assignment for a consideration in the form of identical recurrent payments, those payments are on capital account. And the same is said of mining leases and other interests.

In my opinion this distinction cannot be maintained so absolutely. It would mean that recurrent payments under a grant for the term less a day would be on revenue account but like payments under a grant of the term (perhaps even in the form of a sublease for the term plus a day. See Foa on Landlord and Tenant (8th ed.), at p. 416) would be on capital account. Such a result would ill accord with their Lordships' statement in the B.P. case at pp. 264-265 of how the problem should be approached and with the statement of Dixon J. in Hallstroms' case which they there quote and to which I have already referred. It gives weight to part only of the oft-quoted statement of Viscount Cave L.C. in
British Insulated and Helsby Cables v. Atherton (1926) A.C. 205 . He said, at pp. 213-214, ``But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.'' If it were correct that the enduring nature of the asset right or advantage were the crucial factor, the reference to ``once and for all'' payments would be of no account. Rather, the enduring nature of the asset or advantage is but one factor to consider. As Dixon J. said in
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 , 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.''

I have not been able to discover a case where payments have been held to be outgoings of a capital nature when all the following features are present:

• (a) the asset right or advantage was of a depreciating character and of limited life;
• (b) the obligation to make the payments in question continues throughout the life of the asset right or advantage or the entitlement of the taxpayer to the asset right or advantage;
• (c) the amount of the payments is recurrent; and
• (d) the amount of the payments is not fixed but is dependent on the use made of or profits derived from the asset right or advantage.

In
Colonial Mutual Life Assurance Society Limited v. F.C. of T. (1953) 89 C.L.R. 428 features (c) and (d) were present but not features (a) and (b); for the asset in question was freehold property and the obligation to pay was to last for fifty years. In that case two earlier authorities were particularly relied on. The first was
Delage v. Nugget Polish Co. Ltd. (1905) 92 L.T. 682 . There again features (c) and (d) were to be found but there was no proof of features (a) and (b). What was acquired was the exclusive right of manufacturing articles by a secret process and of selling them. The grant of the right was perpetual but the payments, though dependent on the value of sales, was for a period of forty years. There was no evidence that the right would have a valuable life of only that limited period.

The second case relied on was
Tata Hydro-Electric Agencies, Ltd., Bombay v. Commissioner of Income Tax, Bombay Presidency and Aden (1937) A.C. 685 . Here features (b), (c) and (d) were present but not (a). The acquisition was of a managing agency of indefinite duration. The payments agreed to be made to third parties were regarded as payments made in fulfilment of the terms of purchase of the managing agency, a liability taken into account when the purchasers agreed to take over that agency. The view was not taken that the asset purchased was a business which was subject to an obligation to make the payments to the third parties. Therefore the case was treated as one of purchase of an enduring asset for a price which included the obligation to make recurrent payments of indefinite duration. As such they were payments in the nature of capital payments.

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In
Ralli Estates Ltd. v. Commr. of Income Tax (1961) 1 W.L.R. 329 feature (d) was not present. The maximum amount of the payment was fixed once and for all, even though it was reducible in certain circumstances. Nor was feature (b) present. The amount of the payments was not payable throughout the 99 years' right of occupancy of the sisal estates, but only until the agreed amount was paid.

Where the acquisition is of a depreciating right or advantage of limited duration the manner of remuneration of the transferor is inevitably a factor which largely determines whether that remuneration is deductible as a revenue outgoing. The best known example is the lease for a term of years where the consideration is a premium and a rental. The premium is a capital outgoing, the rental a revenue outgoing. This can be explained upon the basis that the premium is the price of the initial grant and that the rental is the recurrent price of use and occupation. That is true but it does not gainsay the fact that the obligation to pay both premium and rental springs from the one agreement. It shows that out of one agreement may spring obligations to make payments some of which are capital outgoings and some of which are revenue outgoings.

Each case depends on its own facts and circumstances but it may be stated that when the consideration for a depreciating asset right or advantage of limited life is a series of regular recurrent payments related to the life of the asset right or advantage then it is very likely that the recurrent payments will be found to be outgoings on revenue account. Particularly is this so when the amount of the payments is related to the use made of the asset right or advantage.

When a lump sum is outlayed at the outset it can properly be regarded as the cost of acquisition of the rights under the agreement then made. When there are recurrent payments it may not appear that this is so from a practical or business point of view. Thus in the Colonial Mutual case the recurrent payments could hardly be regarded otherwise than as part of the cost of acquisition of the freehold. It was no more than a method adopted in payment for that freehold. To say that the payments were for rights of use and occupation would make no difference because those rights were rights springing from the ownership of the freehold.

In the present case the question can be asked of a particular payment - was it calculated to effect a discharge of the obligation to pay for the shares (or the shares together with the existing rights over the Reserves) or was it calculated to effect payment for the exercise of the right to mine the ore in respect of which the payment is made? The fact that the parties to the option agreement described the payments as ``deferred payments'' is entitled to some weight but in the light of Mr. Dohnal's evidence of the course of negotiations it cannot be regarded as a factor of great consequence. The fact that there was an absolute transfer of the shares is also entitled to some weight but, for reasons I have stated, this factor cannot in the circumstances be regarded as of great weight. The preponderating factors are that the payments were in respect of a depreciating asset, that they were recurrent over the life of the asset if the asset was used throughout its life and that the amount of the payments were proportioned to the use made of the asset. These factors in my opinion clearly outweigh the other factors which might support a contrary view.

I am therefore of the opinion that the payments in question were outgoings on revenue account and were deductible under sec. 51(1). I would allow the appeal with costs.