Cooling v. Federal Commissioner of Taxation
Judges:Spender J
Court:
Federal Court
Spender J.
This is an appeal against the Commissioner of Taxation's disallowance of an objection by the applicant taxpayer, Mr Cooling, in respect of a payment received by Mr Cooling during the year ended 30 June 1986.
The question on the appeal is whether the sum of $21,060, paid to the taxpayer by the Australian Mutual Provident Society, is exigible.
It should be said that the income tax return for year ended 30 June 1986 made full disclosure of the payment, and I was informed from the bar table and accept that income tax has been paid in respect of that sum. There is nothing in the evidence to suggest, nor does the Commissioner contend, that the taxpayer has made anything other than a full and proper disclosure of matters relating to the receipt by him of the payment.
In the relevant tax year Mr Cooling was a partner in the firm of solicitors, Kinsey Bennett & Gill. There were six partners, the senior partner being Mr Graham Donald Macdonald. One of the partners as at 29 November 1985, Mr Bernard Haiduk, left the firm on 31 December 1985.
A company, Bengil Services Pty. Ltd. (``Bengil Services''), was established by the firm with the prior approval of the Commissioner of Taxation to provide superannuation to its director employees, based on salaries earned by such employees for work of an administrative nature. The amounts of the salaries have been approved by the Commissioner of Taxation. The income of Bengil Services is from the provision of services to the partnership. This again, according to Mr Macdonald, has the approval of the Commissioner. One of those services is the provision of office accommodation.
Kinsey Bennett & Gill is a long established firm of solicitors in Queensland, having been founded by Mr Bennett and Mr Gill in 1939. At that time the firm occupied a building in Edward Street, Brisbane. Mr Macdonald joined the firm in approximately 1951 as a partner, having first been an articled clerk in the firm in 1947. Both of the founding partners served in the armed forces during the war and in 1946 the firm moved to 356 Queen Street, Brisbane and, by 1949, had moved to premises in the Primary Building on the corner of Creek and Adelaide Streets, Brisbane. During the time the firm was at those premises, there were a number of expansions and on occasions the firm changed floors within the building. The firm moved to 127 Creek Street in about 1974.
Bengil Services became a lessee of the Australian Mutual Provident Society in respect of the eighth floor of the A.M.P. Building at 12
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Creek Street, known as Comalco House. That lease commenced on 1 February 1986 and Kinsey Bennett & Gill has since that time practised from those premises.Over the 50 years of the firm's existence its composition has changed. It has practised from various premises, as described above, but has never owned its own building. It was no part and has never been part of the professional activities of Messrs Kinsey Bennett & Gill to receive inducement payments nor was the firm involved in anything of the nature of trade in respect of the receipt by the partners of their respective payments.
Mr Cooling, on 16 December 1985, received a payment of $21,060 from the Australian Mutual Provident Society, being his share of the $162,000 paid by the Society to him and his partners in Kinsey Bennett & Gill. In a disclosure statement to Mr Cooling's income tax return he describes the payment as:
``... being made to me as an incentive to procure Bengil Services Pty. Ltd. to accept a ten year lease from the Australian Mutual Provident Society of premises at 12 Creek Street and to guarantee the performance by Bengil Services Pty. Ltd. of its obligations under such lease. The above payment was made on the execution of the lease by Bengil Services Pty. Ltd. and guaranteed by me and my other partners. I consider such payment not taxable.''
As a matter of history, part of the ``incentive'' was used as bridging finance to cover the cost of outfitting the new premises and moving to them but, by 21 April 1986, the funds had been repaid out of the sale of items acquired from Westpac and leased back.
It was submitted on the Commissioner's behalf that the use made by the taxpayer of the amount received by him after its receipt was irrelevant, and that there was no obligation on his part to use it in the way it was used. I accept this submission.
The income tax adjustment sheet, after the ``Taxable income as returned'' amount was stated, read:
``add incentive payment assessed as income $21,060.00''
to reach the adjusted taxable income.
The adjustment sheet indicates that the Commissioner has assessed Mr Cooling on the entirety of his share of $162,000. There has been no attempt at apportionment, either on the basis that part of the payment is a disguised rent-free advantage or subsidy, or on any other basis.
The contention by the Commissioner is that the $21,060 forms part of the taxpayer's assessable income for the income tax year ending 30 June 1986. The Commissioner's primary contention is that the sum received by the taxpayer was income according to ordinary concepts under sec. 25(1). Alternatively, the Commissioner says that the sum is within sec. 26(e). In the further alternative, the Commissioner relies on the provisions of sec. 160M(6) and (7), found in Pt IIIA ``Capital Gains and Capital Losses''. No other provisions of the Income Tax Assessment Act 1936 are relied on by the Commissioner to support the amended assessment.
In or about April 1985, Messrs Kinsey Bennett & Gill received a written proposal prepared by Richard Ellis Ray White, the real estate agent for the A.M.P., for the firm to relocate from its premises at 127 Creek Street to Comalco Place, constructed by the A.M.P. at 12 Creek Street, Brisbane. The proposal contained a provision that a cash payment of $150,000 would be made payable to Kinsey Bennett & Gill at the lease commencement. The area proposed to be leased was 1006 sq. metres for a 10-year term at a rental of $202 per sq. metre with rent reviews two-yearly to fair market value. The proposal indicated:
``It is not A.M.P's intention to encourage Government multi-floor tenancies in this building.''
It then referred to prospective tenants to date as including solicitors, accountants, insurance companies, banks and other prominent commercial organisations.
The building, also referred to as the ``Blue Tower'', was completed in July 1984 and, at the time it was being let, there was a substantial over-supply of office space in Brisbane. It is accepted by the Commissioner that the property market at that time was such that tenants moving to new buildings had on occasions been able to require such incentives from their prospective landlords. It was contended on the Commissioner's behalf that this circumstance supported the view that the receipt of such an
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incentive represents a profit derived from the move to new premises.Mr Brian Bubbers, the manager of Property Investments in Queensland of the A.M.P., said, and I accept, that it was a common practice where there was an over-supply of office space for building owners to offer incentives to persuade proposed tenants to enter into lease arrangements. Inducement payments were, and are, a feature of the market for the rental of commercial premises. The practice applied in the present case. He says that the negotiations were protracted and were on a fully commercial arm's length basis: if the A.M.P. did not offer competitive concessions as it did, the tenants could have gone to any of several other buildings. He referred in particular to the Riverside Centre, Santos House and the C.M.L. Building. He said that the type of incentives offered to tenants varied but commonly included rent-free periods and lump sum cash payments. He said that cash payments are normally offered as incentives to sign leases where the whole of the floor is being let and also where the lease is for a significant term, such as 10 years. He said that the payment of $162,000 by the A.M.P. to members of Messrs Kinsey Bennett & Gill had nothing to do with payment for services provided by Mr Cooling or his firm. He said that it was, and still is, A.M.P.'s standard requirement in respect of leases by proprietary companies for the obligations of the tenant under the lease to be guaranteed by the directors of the tenant company.
The making of inducement payments is not limited to the private sector of the rental market. The Department of Administrative Services, through the Australian Property Group, sought tenders for the Department of Community and Health's lease of office space. The terms on which the Australian Property Group was prepared to enter into an agreement of lease required a minimum rent-free and licence-free period from the commencement of the lease of 12 months, and a clause of the proposed tender required the tenderer to set out the amount which the tenderer ``shall pay towards the cost of the Fit-out''. The clause provided:
``The amount which the tenderer shall pay shall be not less than $1,000,000.00 (one million dollars)''
It is not difficult to accept that such payments are attractive to a tenant because the receipt of that payment tempers the consequences of a decision to move, which decision entails removal costs, costs of new fit-out and ongoing rent in the old premises. In the instant case, the costs of new fit-out were budgeted at a sum of $205,000.
As early as January 1984 there had been some negotiations between Richard Ellis Ray White and the A.M.P. as to Kinsey Bennett & Gill being a prospective tenant. Further correspondence between those parties a year later acknowledged that the firm had a current lease expiring on 28 February 1986 at a rental of $150 a square metre and noted that ``Graham Macdonald will obviously be very aware of the incentives received by other legal and accounting practices''. Mr Macdonald had acted on behalf of the A.M.P. in respect of leases between the A.M.P. and other tenants of the Blue Tower. At that time either level 6 or level 24 was being considered, at rentals of $215 and $245 a square metre respectively, to commence on 1 May 1985 for a minimum of six years. It was proposed that concessions of either six months rent free as well as a takeover of the existing lease, or a cash payment of $110,000 for level 6 or $120,000 for level 24 be made. Because of the improbability of releasing the space at 127 Creek Street, it was said:
``For this reason and because of Graham Macdonald's knowledge, the cash concession which equates to ten months of rent may be preferable.''
A handwritten notation on the letter from the manager, Project Leasing, of Richard Ellis Ray White to A.M.P., reads:
``Rental 127 Ck. - 5 months
+ r.f. - 5 months
or cash
Total 10 months (as per Mobil)''
Mr Barry Paul, the managing director of Kern Corporation Ltd., a developer of a number of large office buildings in Queensland and elsewhere in Australia including the John Oxley Centre in Coronation Drive, Brisbane and the Grosvenor Place development in Sydney, gave evidence that, by paying an inducement to a tenant, the developer of landlord obtained advantages which varied during the course of the project. At the
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beginning of the leasing period, the attraction of a high calibre tenant to a number of floors permits the opportunity to advertise that tenant and attract other tenants to the building. He said that after a certain percentage of the building had been leased, which varied according to the market conditions, the extent of inducements would be eliminated or reduced significantly in comparison to those offered at the earlier period of leasing. He said that a high profile legal firm was regarded as a ``high calibre tenant'' and that Government Departments are not sought because ``a government tenancy is not regarded as a prime tenant''.Kinsey Bennett & Gill was a reluctant and late prospective tenant of the Blue Tower. After the proposal of April 1985 there were further discussions and a written proposal of 26 August was sent by Richard Ellis Ray White to Mr Macdonald. This proposal spoke of a lease to commence no later than 1 January 1986 and offered by way of concessions either:
``(i) $150,000.00 cash.
(ii) No rental payable on an area of 400m.2 for twelve months from lease commencement, or until such area is occupied by your firm or sub-leased, whichever is sooner.''
or
``(i) $200,000.00 cash.
(ii) A.M.P. will take over your lease commitment [at 127 Creek Street] (to 28.2.86).''
The firm replied on 11 October. That letter indicated:
``This firm (or an entity to be nominated by us) is desirous of leasing the eighth floor of 12 Creek Street on the basis outlined in correspondence subject to the following: -''
and there is then set out a number of matters.
This is the first mention in the negotiations of a tenant other than Messrs Kinsey Bennett & Gill. The letter also said:
``Assuming that the Society would require guarantees from the partners, we would wish to discuss some basis upon which retiring partners could be released from their guarantee obligations.''
Richard Ellis responded by letter of 14 October 1985 with a varied proposal which adjusted the cash payment to $162,000, which is a pro rata adjustment on the $150,000 originally offered as the area proposed to be let had increased from 600 sq. metres to 650 sq. metres. On 6 November 1985, Messrs Kinsey Bennett & Gill wrote to Richard Ellis Ray White. The letter said in part:
``We confirm our telephonic advice that we wish to take up the offer of a lease on the 8th floor of the Blue Tower on the terms basically as outlined in the correspondence.''
The letter said, however, that among the issues which needed to be resolved was the method of payment of the cash incentive.
On 29 November 1985, a Mr Tyson, the manager of the Commercial Leasing Division of Richard Ellis Ray White, wrote to the senior partner, Messrs Kinsey Bennett & Gill at 127 Creek Street. The letter in fact had been drafted by Mr Macdonald. It said in part:
``We confirm that the Society is prepared to pay to Graham Donald Macdonald, James Francis Fitzgerald, Arnold Douglas Bennett, Michael Gerald Maxwell Walton, Cameron Richard Cooling and Ian Fergus Galton (in such proportions as you nominate) the sum of $162,000 as an incentive to sign the guarantees and to procure Bengil Services Pty Ltd to accept the lease.
The above payment will be made on the execution of the lease and guarantees.''
Notwithstanding the terms of that letter of 29 November 1985 which had been drafted by Mr Macdonald, nor the terms of the disclosure statement of Mr Cooling in his taxation return, the reality of the situation, in my opinion, is that the payment was made so that Messrs Kinsey Bennett & Gill would move to the Blue Tower and was made independently of the entity which formally took over the lease. In one sense, of course, it was paid for the giving of guarantees and the procuring of Bengil Services to take up the lease, in that the A.M.P. would not hand over the money until the relevant lease and guarantee documents had been executed. I am satisfied that the payment equally would have been made had the lease been taken up by the partners of Messrs Kinsey Bennett & Gill.
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Mr Robin Q.C., senior counsel for the Commissioner, asked Mr Cooling:
``Is the description of the payment... in that letter one that you are happy with?''
His answer was:
``I do not have any real problem with it; I mean, the fact was it was an inducement for us to shift, and to take a lease.''
Having been shown his disclosure statement, and it being said that that was very close to the description in the letter of 29 November, he was asked:
``You do not see the payment as anything else?''
He answered, ``no''.
Mr Macdonald was asked by Mr Robin Q.C.:
``Do you regard the payment as anything other than the description which is attributed to it there?''
[being a reference to the draft letter of 29 November 1985]
To which Mr Macdonald said:
``I think I would, because the whole sense of negotiations were that the partners of Kinsey Bennett and Gill were going to take a lease. The fact that we broached that we would have Bengil Services as a service company actually to take the lease to comply with the commissioner's guidelines initially, sort of, arose only in the latter part of the proceedings. It was Kinsey Bennett and Gill that was going to take a lease, and it was Kinsey Bennett & Gill partners were going to get some money. It was as simple as that, and then the agent came along and asked me to give a letter saying how you wanted the money paid, and this is what ended up.''
He was then asked:
``None of the partners has accounted to Bengil Services Pty Ltd for his share of the incentive, has he?''
He was then asked:
``No, it was not considered anything to do with Bengil Services.''
That the landlord saw the taking of the tenancy by Messrs Kinsey Bennett & Gill as valuable appears from an article in the Australian Property News of 5 December 1985. Under a headline reading ``Solicitors occupy full floor in central Brisbane'', the article stated:
``Kinsey Bennett & Gill have leased one full floor of modern office space in central Brisbane at a net rental of $203,212 annually.
The letting is in `Comalco Place' at 12 Creek Street.
It comprises the whole of the eighth floor - an area of 1006 sq. m. and rental is $202 a sq. m.''
The article indicated that ``This letting makes Comalco Place 80 per cent occupied'', and continued:
``There are five full floors still available - levels three, 11, 12, 13 and 17. Asking rentals range from $195 to $220 for a full office floor.''
I turn now to the bases on which the Commissioner contends that the $21,060 received by Mr Cooling forms part of his assessable income for the income tax year ending 30 June 1986. There are three distinct provisions of the Income Tax Assessment Act relied upon: sec. 25(1), 26(e) and sec. 160M(6) and (7).
Section 25(1) provides:
``The assessable income of a taxpayer shall include -
- (a) where the taxpayer is a resident -
- the gross income derived directly or indirectly from all sources whether in or out of Australia; and
- ...
which is not exempt income, an amount to which section 26AC or 26AD applies or an eligible termination payment within the meaning of Subdivision AA.''
The primary contention of the Commissioner is that the sum in question is income according to ordinary concepts under sec. 25(1). Alternatively, it was submitted that it is a receipt within sec. 26(e), which provides that the assessable income of a taxpayer shall include:
``the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses
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and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him...''
If either sec. 25(1) or 26(e) applies to the sum in question, no occasion arises for the application of Pt IIIA. If neither sec. 25(1) nor 26(e) applies, counsel on behalf of the Commissioner submitted, then sec. 160ZO(1) brings in as part of assessable income the ``net capital gain made by a taxpayer in the year of income'', sec. 160Z(1) providing the mode of calculation of the capital gain. Section 160ZA(4) protects the taxpayer against having to bring a gain in as assessable income twice by reducing the capital gain to the extent that any amount is included in his assessable income under a provision of the Act outside Pt IIIA. This is an acknowledgment, it was submitted, that capital gains may be ``income'' under other provisions.
Section 25(1)
In
F.C. of T. v. The Myer Emporium Ltd. 87 ATC 4363; (1986-1987) 163 C.L.R. 199, the respondent (``Myer'') lent $80m to an associated company for a period greater than seven years at 12.5% annual interest. Myer, three days after making the loan, assigned to an unassociated financier, Citicorp (Canberra) Pty. Ltd., the moneys due or to become due as the interest payments pursuant to the loan agreement and interest thereon. The consideration for the assignment was $45.37m, which was paid immediately. The consideration was calculated as the value as at the date of assignment of the right to interest over the period of the loan. The High Court (Mason A.C.J., Wilson, Brennan, Deane and Dawson JJ.) delivered a joint judgment holding that the consideration for the assignment formed part of the assignor's assessable income as income under sec. 25(1) and also as profit arising from the carrying on or carrying out of a profit-making undertaking or scheme under sec. 26(a). It had been submitted for the taxpayer that: (1) a gain made as a result of a business deal or a venture in the nature of trade is not income unless it is made in the ordinary course of carrying on a business and (2) that the realisation of a capital asset is capital not income, the amount received by Myer representing the receipt of a capital asset.
In response to this, the Court said at ATC pp. 4366-4367; C.L.R. pp. 209-210:
``Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a `one-off' transaction preclude it from being properly characterised as income (
F.C. of T. v. Whitfords Beach Pty. Ltd. 82 ATC 4031 at pp. 4036-4037, 4042; (1982) 150 C.L.R. 353 at pp. 366-367, 376). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.''
The Court, having referred to
Californian Copper Syndicate v. Harris (1904) 5 T.C. 159 and
Ducker v. Rees Roturbo Development Syndicate (1928) A.C. 132, said at ATC p. 4367; C.L.R. p. 211:
``The important proposition to be derived from Californian Copper and Ducker is that a receipt may constitute income, if it arises from an isolated business operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so
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long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction.''
The Court identified three notions which were said to have deterred courts ``so far from accepting the simple proposition that the existence of an intention or purpose of making a profit or gain is enough in itself to stamp the receipt with the character of income''. The notions were: (a) that realisation of an asset was capital, not income; (b) the apprehension that windfall gains and gains from games of chance would constitute income unless the concepts of income, apart from income from personal exertion and investments, was confined to profits and gains arising from business transactions; and (c) that a gain generated by recurrent transactions is income, whereas a gain generated by an isolated transaction is capital.
The Court noted at ATC p. 4370; C.L.R. p. 215 that:
``The periodicity, regularity and recurrence of a receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind. Likewise, the need to distinguish capital and income for trust purposes and other purposes has focused attention on the difference between the right to receive future income and the receipt of that income, a difference which has given rise to the analogical difference between the fruit and the tree (see
Shepherd v. F.C. of T. (1965) 113 C.L.R. 385 at p. 396).''
The Court, having referred to some criticisms of the ``ordinary usage meaning'' and ``flow'' concept of income, continued:
``For present purposes it is sufficient for us to say, without necessarily agreeing with these criticisms, that, valuable though these considerations may be in categorising receipts as income or capital in conventional situations, their significance is diminished when the receipt in question is generated in the course of carrying on a business, especially if it should transpire that the receipt is generated as a profit component of a profit-making scheme. If the profit be made in the course of carrying on a business that in itself is a fact of telling significance. It does not detract from its significance that the particular transaction is unusual or extraordinary, judged by reference to the transaction in which the taxpayer usually engages, if it be entered into in the course of carrying on the taxpayer's business. And, if it appears that there is a specific profit-making scheme, it is pointless to say that it is unusual or extraordinary in the sense discussed. Of course it may be that a transaction is extraordinary, judged by reference to the course of carrying on the profit-making business, in which event the extraordinary character of the transaction may reveal that any gain resulting from it is capital, not income.''
In Myer, the receipt was a lump sum for the assignment of future entitlement to interest. Had the interest been received under the loan agreement, the payments would clearly have been income, according to ordinary concepts, as receipts for the use of the principal moneys. The lump sum received by Myer was in the nature of a surrogate for the future income flow.
It was not suggested in this case that the payment received by Mr Cooling was a payment to compensate for abnormally high rentals to be charged in respect of the premises to be leased. The evidence suggests that the rentals to be paid pursuant to the lease were at proper commercial rates.
It was submitted on behalf of the Commissioner that Myer indicates the High Court's adoption of the approach in
Lambe v. I.R. Commrs (1934) 1 K.B. 178 at p. 183; (1933) All E.R. 417 at p. 420, that income is ``what in one form or another goes into a man's pocket''.
To like effect is the observation by Starke J. in
Resch v. F.C. of T. (1941-1942) 66 C.L.R. 198 at p. 213:
``Income is as large a word as can be used to denote a person's receipts
(Re Huggins) Ex parte Huggins (1882) 51 L.J. Ch. 935 at p. 938); it signifies that which comes in. An `Act to impose a tax upon incomes' is not less general in scope; it must be liberally construed, and include everything which by reasonable understanding might fairly be regarded as income... Parliament possesses power, without infringing the provisions of sec. 55 of the Constitution, to bring to charge in an income-tax Act all profits and gains accruing to a taxpayer, without
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distinguishing whether the profit or gain should be regarded as a receipt on capital or on income or revenue account.''
Rich J. at p. 210 said:
``It is maintained that the Act does not confine itself to one subject of income but extends to another subject of taxation, namely, capital profits. The subject is profits or gain, and the distinction between gains of an income nature and gains of a capital nature is neither instituted nor maintained by the Assessment Act.''
In my opinion, Myer is not authority for the view that every receipt of a business is ``income''. If it were, no sensible distinction between income and capital could be maintained.
In
F.C. of T. v. Spedley Securities Limited 88 ATC 4126, a merchant bank had agreed with Santos Limited to secure a sum by way of loan for a mining enterprise about to be carried out by Santos. A lump sum payment of $200,000 was paid to the taxpayer under a deed of discharge of the agreement. The lump sum payment was assessed to tax in the income tax year of receipt. It was submitted on the Commissioner's behalf that, on the authority of Myer's case, the amount in question was assessable because it was received in the course of business operations which were intended to produce a profit.
The Full Court of the Federal Court (Fox, Fisher and Sheppard JJ.) held that this would be contrary to authority, to the Act and to the basic concepts concerning the distinction between capital and income. Having referred to Myer, the Court said at p. 4130:
``The decision in that case was given jointly by five Judges, doubtless with some recognition that the Court was reversing cumulative decisions of the Supreme Court of Victoria, and this Court on a question of whether a receipt was, on the application of the Income Tax Assessment Act 1936 (the Act) sec. 25(1), one of capital or income. The case is strong authority for what it decides, but it may only have taken a different view of the facts than had the lower courts. The use made of the decision in this case on behalf of the Commissioner is to say that the amount in question was received in the course of business operations, the operations, taken broadly, being intended to produce a profit. The phrase `in the course of' involves a temporal connection. If the proposition were correct, it would mean that any receipt by a business would necessarily be of an income nature, and this would be contrary to authority, to the Act itself and to basic concepts concerning the distinction between capital and income. In Myer what was received related solely to income by way of interest on a loan made by the taxpayer, the amount received being for a transfer of the right to receive the interest in the future. The High Court did not base its decision on Myer being, in a broader sense, a profit-making company. The purpose of profit making must exist in relation to the particular operation.''
In
F.C. of T. v. Reynolds 81 ATC 4131, a taxpayer who carried on business as a log haulier had a truck on lease and, before the lease expired, he decided to replace the truck with a larger vehicle. He was given approval by the lessor to sell the old truck on the understanding that he was to act as agent for the lessor and to account to the lessor for the sale proceeds. The truck sold for a price in excess of the payout figure. The case before Neasey J., proceeded on a statement of agreed facts which included the fact that the taxpayer was permitted to retain the surplus over the payout figure and had assumed that this would be the situation. It was also agreed that:
``Where a lessee is granted approval to sell a leased vehicle on behalf of Esanda Ltd., it is normal practice to allow any excess to be retained by the lessee.''
Neasey J. said, at pp. 4141-4142:
``There is no definition of `income' in the Act. The question is whether the receipt is `income' according to ordinary concepts - per Jordan C.J. in
Scott v. C. of T. (N.S.W.) (1935) 35 S.R. (N.S.W.) 215 at p. 220; and sec.
F.C. of T. v. Harris 79 ATC 4383 at pp. 4387-4388; (1979) 37 F.L.R. 325 at p. 332. Whether it is to be characterised as income for the purposes of the Act depends, as the authorities show, upon the character of the receipt and the circumstances in which it came to the hands of the taxpayer. In the case of a taxpayer conducting a business, if the receipt is as a matter of
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reality part of the proceeds of the business or a product of or incidental to the conduct of the business, it is usually income.''
His Honour inferred that the receipt of the surplus money was ``fairly incidental to the respondent's [taxpayer's] conduct of his business'' and was assessable as income pursuant to sec. 25(1).
In my opinion, the receipt in this case cannot properly be characterised as being fairly incidental to Mr Cooling's occupation as a solicitor. No doubt there is a connection, but the receipt of an incentive payment, a one-off receipt, cannot be described as fairly incidental to his practice as a solicitor. I do not regard Myer as requiring a receipt to be classified as income under sec. 25(1), if there is any connection between the receipt and the carrying on of a business.
There is nothing periodic, regular or recurrent about the receipt in question in this case.
It was submitted on behalf of the taxpayer that the payment was a capital payment. On the analogy between the fruit and the tree, the payment was said to be capital because it attracted the tree to the landlord from which the landlord thereafter derived fruit. It was also submitted that the payment could be characterised as a reverse key money payment, the authorities dealing with a key money payment supporting the conclusion that the receipt in question was a capital payment.
Mr Gzell Q.C., senior counsel for the applicant, submitted that the payment of key money, being a premium paid to the landlord to gain the key to leased premises, is prima facie capital, relying on
Strick v. Regent Oil Co. Ltd. (1966) A.C. 295; and that the receipt of key money is prima facie capital relying on
Kosciusko Thredbo Pty. Ltd. v. F.C. of T. 84 ATC 4043 and Case V150,
88 ATC 948.
The position in Australia under Div. 4 of Pt III of the Act used to be that the receipt of a premium was assessable under sec. 84 of the Act and the payment of a premium for income-producing premises was deductible over the life of the lease under sec. 88(1) of the Act. As the result of the Ligertwood Committee report, Act No. 110 of 1964 effectively repealed Div. 4 by the introduction of sec. 83AA(1), providing that it did not apply to leases granted after 22 October 1964, and by introducing sec. 26AB. Subsequent to that time there was no deduction for the payment of key money and no specific provision bringing key money to account as income, save for sec. 26AB, which provided that the receipt of a premium for non-income-earning property is assessable.
Senior counsel for the Commissioner submitted that there was no difference in principle between receipt by Mr Cooling and that of a taxpayer who facilitated a transaction between two other persons.
In
A.L. Hamblin Equipment Pty. Ltd. v. F.C. of T. 74 ATC 4001; (1974) 130 C.L.R. 159 (affirmed on appeal at 74 ATC 4310; (1974) 131 C.L.R. 570), Stephen J. at first instance dealt with a credit of $5,000 received by a taxpayer in connection with the taxpayer bringing about an order of new plant from another company from a supplier. His Honour said at ATC p. 4010; C.L.R. p. 172:
``This benefit must, I think, properly be regarded as an incident of the present taxpayer's business as an earth-moving contractor, involving it, as it does, in the replacement from time to time of worn-out plant... It is a trade receipt of an income nature being part of the proceeds of the business carried on by the taxpayer received as an incident of carrying on that business:
Squatting Investment Co. Ltd. v. F.C. of T. (1953) 86 C.L.R. 570 at p. 620 per Fullagar J. and at p. 628 and pp. 634-638 per Kitto J. and, on appeal in (1954) 88 C.L.R. 413 at p. 432;
H.R. Sinclair & Son Pty. Ltd. v. F.C. of T. (1966) 114 C.L.R. 537 at p. 544 per Taylor J. and at p. 547 per Owen J.; Scott v. F.C. of T. (1966) 117 C.L.R. 514 at pp. 526-527 per Windeyer J.''
The payment in this case was said also to be indistinguishable in principle from that in
Austrotel Corporation Pty. Ltd. v. F.C. of T. 76 ATC 4245; (1977) 51 A.L.J.R. 54. In that case a sum was received by the taxpayer for negotiating the grant of an option and agreeing to make bridging finance available so that the option might be exercised. In the joint judgment of Gibbs, Stephen, Mason, Jacobs and Murphy JJ., their Honours said at ATC p. 4248; A.L.J.R. p. 56:
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``The transaction with Artagen was a business transaction, and it resulted in the taxpayer receiving the payment as the consideration for the services which it performed. The payment was income according to ordinary usages and concepts. It was rightly treated by the Commissioner as assessable income under sec. 25 of the Income Tax Assessment Act.''
Reliance was also placed on a number of English authorities establishing the assessability of fees payable to taxpayers who undertake the obligations of a guarantor:
Ryall v. Hoare (1923) 2 K.B. 447; 8 T.C. 521:
Sherwin v. Barnes (1931) 15 T.C. 278 and
Wilson v. Mannooch (1937) 3 All E.R. 120; 21 T.C. 178.
For the Commissioner it was said that the present payment, expressed to be an incentive to procure Bengil Services Pty. Ltd. to enter into a lease with the A.M.P. Society and for the taxpayer's guaranteeing the lessee's obligations, is indistinguishable in principle from the receipts in Hamblin, Austrotel and the English cases. I have already expressed the view that, notwithstanding the description given to the payment by the taxpayer and in the letter drafted by Mr Macdonald, the payment was not in truth made for the rendering of services or for undertaking the obligations of a guarantor. The payment was made to induce Messrs Kinsey Bennett & Gill to move to Comalco Place.
It was further submitted on behalf of the taxpayer that the payment in this case enabled the A.M.P. Society to utilise the goodwill associated with Messrs Kinsey Bennett & Gill and that a payment for the use of goodwill is capital or, alternatively, that a portion of the payment was for the use of the goodwill and the Commissioner cannot apportion an undissected lump sum between income and capital,
McLaurin v. F.C. of T. (1960-1961) 104 C.L.R. 381;
Allsop v. F.C. of T. (1965) 113 C.L.R. 341.
I have no doubt that the payment was made in part to facilitate the leasing of the remaining unlet floors, but in the same way that in my view the payment was not made for the procuring of the execution of a lease by Bengil Services or the execution of guarantees for Bengil's performance, which were ancillary aspects of the payment, I do not think the payment can properly be characterised as payment in whole or in part for the use of the goodwill of Messrs Kinsey Bennett & Gill.
Section 26(e)
In my opinion, the payment by A.M.P. to Mr Cooling was not ``in respect of, or for or in relation directly or indirectly to his employment'' by Bengil Services Pty. Ltd., nor was the payment ``in respect of, or for or in relation directly or indirectly'' to services rendered by him to the A.M.P. Society, namely the procurement of a lease to Bengil Services Pty. Ltd. and the provision of the guarantee.
As
Calvert v. Wainwright (1947) K.B. 526 indicates, it is not necessary for the payment to be made by the employer. In my opinion, however, while Mr Cooling was an employee of Bengil Services, the entire payment paid by the A.M.P. and received by Mr Cooling was not by way of or for any services rendered by him to the A.M.P. Society or to Bengil Services, but by way of Mr Cooling's position as a partner of Messrs Kinsey Bennett & Gill.
The capital gains tax provisions
I turn finally to the nightmare provisions of Pt IIIA of the Act.
Part IIIA applies to disposals after 19 September 1985 of assets acquired after that date: sec. 160L.
By way of an aside, the lack of lucidity in the present state of the Income Tax Assessment Act is lamentable. For example, sec. 160A which defines assets to which ``Part IIIA - Capital Gains and Capital Losses'' applies, is conveniently to be found somewhere between sec. 160AAA and 160ZZU.
Section 160A provides:
``In this Part, unless the contrary intention appears, `asset' means any form of property and includes -
- (a) an option, a debt, a chose in action, any other right, goodwill and any other form of incorporeal property;
- (b) currency of a foreign country; and
- (c) any form of property created or constructed, or otherwise coming to be owned without being acquired,
but does not include a motor vehicle of a kind mentioned in paragraph 82AF(2)(a).''
This definition has been the subject of much comment.
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Mr J.G. Mann, in a paper ``Capital Gains Tax - Central Concepts'' given at the University of Queensland Law School in October 1987, drew attention to four aspects of that definition:
``(a) prima facie, `asset' is `... any form of property...';
(b) a chose in action is specifically included;
(c) something called `... any other right' is also included; and
(d) just in case there is some other form of property not already comprehended by any of those terms, we have included `any form of property created or constructed, or otherwise coming to be owned without being acquired..'''
Of the definition, Mr Mann said:
``The draftsman of Part IIIA has adopted Section 19(1) of the UK. Capital Gains Tax 1979 but felt it was perhaps a little deficient; it needed a little topping up;''
He suggested there was therefore the inclusion of choses in action and the extension of the creation of property to property which was ``constructed''. He caustically commented:
``From the purist's view, all of this is, to say the least, a fruit salad and I suspect that Section 160A may be held in the end to refer not only to property and proprietary rights in the usual understanding of those terms, but other non-proprietary rights as well: frankly, I get that impression in Section 160M(7).''
He says:
``The implication of this definition is that one can, for the purposes of Part IIIA, have property which is neither a chose in action nor any other right nor any other form of incorporeal property and which one has never acquired but which one at the same time owns!''
If the consideration on the disposal exceeds the indexed cost base of the asset, there is a capital gain: sec. 160Z. If the offsetting of capital gains against capital losses results in a positive amount there is a net capital gain: sec. 160ZC. It is the net capital gain which is included in assessable income: sec. 160ZO.
Section 160M defines what constitutes a disposal or acquisition. Section 160M(1) provides:
``Subject to this Part, where a change has occurred in the ownership of an asset, the change shall be deemed, for the purposes of this Part, to have effected a disposal of the asset by the person who owned it immediately before the change and an acquisition of the asset by the person who owned it immediately after the change.''
The notion that a change of ownership of an asset constitutes a disposal by the former owner to the later owner presents no conceptual difficulty.
However, sec. 160M(6) provides:
``A disposal of an asset that did not exist (either by itself or as part of another asset) before the disposal, but is created by the disposal, constitutes a disposal of the asset for the purposes of this Part, but the person who so disposes of the asset shall be deemed not to have paid or given any consideration, or incurred any costs or expenditure... in respect of the asset.''
This extraordinary subsection deals with a disposal of an asset which does not exist before the disposal but which is created by it.
If one transposes into the subsection the concept of a disposal being effected ``where a change has occurred in the ownership of an asset'' (as sec. 160M(1) indicates), the provision reads:
``a change which has occurred in the ownership of an asset that did not exist before the change in the ownership of the asset occurred but which is created by the change in the ownership of the asset constitutes a change in the ownership of the asset.''
As Mr Mann noted, the CCH Australian Federal Tax Reporter [at ¶78-772] commented on sec. 160M(6) in these terms:
``It would seem that if sec. 160M(6) is to be given practical operation, the first three references in the subsection to disposal, i.e. `disposal' in the words `a disposal', `before the disposal' and `created by the disposal', must receive a different meaning from the word disposal where it next appears, i.e. in the clause `constitutes a disposal of the asset
ATC 4743
for the purposes of this Part'. Indeed, the reference in the last-quoted words to a disposal, rather than the disposal, implies that the disposal there referred to is different from the disposal previously referred to in the subsection. What meaning of the word `disposal' should be adopted for the first three references to the word, however, is not readily apparent.''
As others have observed, the section must have been based on a passage in Whiteman and Wheatcroft on Capital Gains Tax, Sweet & Maxwell, London, 1980, 3rd ed. at pp. 134-135, where the learned authors say:
``Where... the asset did not exist (either by itself or as part of another asset) before the disposal but is created by the disposal, it is submitted in the absence of special provisions there is no disposal for capital gains tax. The word disposal must, it is suggested, involve there being some proprietary or beneficial right in the disposer at the time. Hence there will be a distinction between the creation of a contractual right in B's favour, which will not involve a disposal by A, and the creation in favour of B of a right in or over an asset owned by A, which will be a part disposal of that asset.''
Section 160R states that a reference to a disposal of an asset includes a reference to disposal of part of an asset.
In the explanatory memorandum, what appears in relation to sec. 160M(6) is this:
``Sub-section 160M(6) applies to a disposal of an asset that did not exist (either by itself or as part of another asset) before the disposal, but is created by the disposal. The sub-section makes clear that such circumstances constitute a disposal of the asset for the purposes of this Part. Sub-section (6) would apply, for example, to deem there to be a disposal of an asset by a person granting a lease, or giving an option to another person to buy an asset at a future date. The lease or option is an asset created by such a transaction.''
For the Commissioner it was contended that the rights under the agreement to lease and the rights under the guarantee are well recognised contractual rights. It was submitted that they amounted to ``an asset to which Part IIIA had application''. It was submitted that both are created by the act of their disposal. I note that sec. 160M(5)(c) provides that:
``the creation of an asset by or for a person constitutes the acquisition of the asset by the person.''
It is an extraordinary consequence that that subsection can constitute an acquisition of an asset by reference to ``creation'', while sec. 160M(6) refers to a creation by disposal. Section 160M(5)(c) constitutes the acquisition of an asset by creation; sec. 160M(6) constitutes the creation of an asset by its disposal.
If the submission on behalf of the Commissioner is correct, it means that in every situation in which, on the suffering of an obligation, a correlative right springs into existence, there is a capital gain. If a person were to borrow $100,000 from a bank, that person incurs an obligation to repay it. There springs into existence in the bank an asset which did not exist prior to the transaction; that is, the rights of the bank under the loan agreement. On that analysis, sec. 160M(6) would require a borrower to pay tax on the sum borrowed as a capital gain.
The central concept of Pt IIIA is based on there being a disposal of an asset. To interpret sec. 160M(6) as applying whenever contractual obligations are created, ignores this fundamental basis. To make sense of this quite extraordinary provision, it seems to me there must be an asset in existence out of which is created a new asset. Such an approach is consistent with the structure of the legislation requiring an asset to have been acquired after 19 September 1985 and accords with what was said of the operation of the section when the legislation was introduced. It is consistent also with the statements in Whiteman and Wheatcroft, on which the section obviously has been based. Nor does that approach conflict with the part disposal provision in sec. 160R, because that section relates to disposals of part of an asset rather than the carving out of a new interest. The granting of a lease or the giving of an option to buy an asset at a future date, the examples referred to in the explanatory memorandum, do not sit unhappily with this approach. On the other hand, to interpret the section as applying to the creation of any contractual right seems to me fundamentally to ignore the rationale of that part of the Act.
ATC 4744
In the circumstances, it seems to me that the rights created by the guarantee and/or the agreement to lease, are not carved out of any asset held by Mr Cooling and the section has no operation. Even if the section did operate to deem Mr Cooling to have disposed of an asset, that asset was not one acquired by him after 19 September 1985. In no sense can it be said that Mr Cooling acquired the rights obtained by the A.M.P. Society pursuant to the guarantee or to the agreement to lease.
Section 160M(7)
Section 160M(7) provides:
``Without limiting the generality of sub-section (2) but subject to the other provisions of this Part, where -
- (a) an act or transaction has taken place in relation to an asset or an event affecting an asset has occurred; and
- (b) a person has received, or is entitled to receive, an amount of money or other consideration by reason of the act, transaction or event (whether or not any asset was or will be acquired by the person paying the money or giving the other consideration) including, but not limited to, an amount of money or other consideration -
- (i) in the case of an asset being a right - in return for forfeiture or surrender of the right or for refraining from exercising the right; or
- (ii) for use or exploitation of the asset,
the act, transaction or event constitutes a disposal by the person who received, or is entitled to receive, the money or other consideration of an asset created by the disposal and, for the purposes of the application of this Part in relation to that disposal -
- (c) the money or other consideration constitutes the consideration in respect of the disposal;
- ...''
The explanatory memorandum in respect of this subsection said:
``Sub-section 160M(7) also applies, subject to the other provisions of Part IIIA, in situations where there is a disposal of an asset created by the disposal. It will deem a disposal of an asset to have occurred where a taxpayer receives or becomes entitled to receive an amount of money or other consideration for the forfeiture or surrender of a right or for refraining from exercising the right or receives consideration for the use or exploitation of an asset. The sub-section provides that the act, transaction or event which results in the taxpayer receiving the consideration will constitute the disposal by the taxpayer of an asset created by the disposal for the purposes of Part IIIA. Examples of the acts, transactions or events affected by this provision include that of an amateur sportsman who receives a payment on becoming a professional, the receipt of consideration for entering into exclusive trade tie agreements or restrictive covenants, or in connection with the variation, cancellation or breach of business contracts or agency agreements.''
It was submitted on behalf of the Commissioner that what the subsection requires is that the taxpayer receive the consideration ``by reason of'' the act, transaction or event. It was said that the words ``by reason of'' comprehended ``a relevant connection''; see
Wickes v. Firth (1983) 2 W.L.R. 34. It was then submitted that there was a relevant connection between the receipt of $21,060 by the taxpayer who was a partner of the firm and a director and employee of an administration company from that company's landlord, the A.M.P. Society, and the leasing by that company of premises in the landlord's building. There were, according to the submission on behalf of the Commissioner a number of possible operations of the subsection.
I set out below in tabular form what was submitted on the Commissioner's behalf as being the act, transaction or event and what is said to be the corresponding asset:
The multiple alternatives for which the Commissioner contends illustrates the extent of the departure, on this interpretation, from the central concept of that part of the Act, namely the bringing to taxation of the net capital gain on the disposal of an asset occurring after 19 September 1985.
It seems to me, however, that sec. 160M(7) is to apply ``where there is a disposal of an asset created by the disposal'', as the explanatory memorandum states. This in turn means, and as the two particularised instances in sec. 160M(7)(b)(i) and (ii) exemplify, it is necessary that there be an existing asset, in respect of which an act or transaction has taken place, or an event affecting that existing asset has occurred.
The instances proffered by the Commissioner are the creation of new assets. On that approach, the subsection would apply in relation to the creation of contractual rights associated with a borrowing from a bank. I do not think that such an interpretation of the subsection can be right.
For the above reasons, in my opinion the appeal should be allowed. I will hear the parties as to the form of the orders I should make, and on costs.
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