FC of T v GKN KWIKFORM SERVICES PTY LIMITED

Judges: Davies J

Beaumont J
O'Loughlin J

Court:
Full Federal Court

Judgment date: Judgment handed down 17 April 1991

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Beaumont J

The Commissioner of Taxation appeals from orders made by a single judge of the Court allowing appeals by the respondent taxpayer, GKN Kwikform Services Pty Limited (``GKN''), in respect of three assessments by the Commissioner [reported at 90 ATC 4823]. The income periods in question are the years 1 May 1984 to 30 April 1985, 1 May 1985 to 30 April 1986 and the period 1 May 1986 to 31 December 1986. The same issues arise in each appeal.

There was no dispute about the facts, which were found by the primary judge as follows. GKN carried on the business of hiring out scaffolding for use for support purposes inside and outside buildings under construction or renovation. GKN's business is substantial. It has in stock a very large number of the component parts of scaffolding. The ultimate lifespan of the scaffolding is unknown. It is not a practical possibility to keep track of the individual items of scaffolding equipment which GKN hires out to customers. The components are interchangeable and the age of individual components has no bearing upon their suitability for use by customers. The only practical way of keeping a record of the equipment is to treat as ``equivalent'' all items of the same kind, whenever they were manufactured. GKN's fixed asset register makes no distinction in terms of the dates of acquisition of individual items of equipment. Orders for the hire of scaffolding are filled from stock, according to the number of parts ordered but without reference to the age of those parts.

There is regular ``leakage'' or ``short-return'' of items of scaffolding from the amounts ordered by customers for hire for particular jobs. Such short-returns occur in three ways. First (rarely), GKN will make a sale of stock on hire to a customer, at the customer's request. It is the general policy of GKN not to sell its equipment. (GKN Kwikform Sales Pty Ltd, a member of the corporate group of which GKN is a member, carries on the business of selling scaffolding.) Secondly, where comparatively insignificant items of equipment are not returned, GKN will simply disregard the loss and write it off. Thirdly (and this is the subject of the present litigation), where a significant quantity of equipment is not returned at the completion of the hiring, the customer is charged an amount for the loss of the scaffolding calculated in accordance with the provisions of the contract of hire, which are set out below. Most of the leakage falls into this category. Equipment in the first category is referred to as ``sales off hire'', whilst equipment in the third category is referred to as ``chargeable losses''.

The present litigation is concerned with the appropriate treatment, for taxation purposes, of moneys received in the relevant income years in respect of the ``chargeable losses''. In GKN's 1985 financial year the amount of these losses was $837,781.00, being 5.71% of the total receipts of GKN's business. In its 1986 financial year, the amount was $1,133,697.00, being 3.26% of the total business receipts. In the 1986 year (ending December 1986) the amount was $828,688.00, being 3.25% of the total receipts. In the same years, the amounts received for ``sales off hire'' were $451,113.00, $331,850.00 and $417,317.00 respectively. (In fact, the amounts sought to be taxed were the sums of $442,088.00 in the first year, $749,049.00 in the second year and $586,460.00 in the third year, that is, somewhat less than the chargeable losses. We were informed by counsel that the reason for this may be explained by the following example. Assume an amount received under the liquidated damages clause, i.e. a chargeable loss, or notional proceeds of sale of an item of equipment, of $200.00; assume also a cost of acquisition of the item of $100.00; assume further that $80.00 has been allowed as a deduction under the depreciation provisions of the Act, so that the written down value is $20.00. On those assumptions, what has now been assessed is the sum of $100.00 arrived at by deducting the sum of $100.00, being the cost of acquisition, from the notional proceeds of sale of $200.00. In addition, the sum of $80.00, being the amount allowed for depreciation, has independently been assessed under s. 59(2) of the Act.)

Reference has previously been made to the provisions of GKN's hiring agreement which deal with leakage. The terms of the hiring contract which applied in respect of hirings prior to 1985 read as follows: -

``The Hirer shall be responsible for the equipment from the time the Hirer collects it from the Company's depot or from the time the Company delivers it to the Hirer's site (as the case may be) until the time the Hirer

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returns it to the Company's depot or until the time the Company collects it from the Hirer's site (as the case may be). An Inventory of equipment prepared by the Company shall be binding and conclusive between the Company and the Hirer and in the event of any discrepancy in items of equipment being disclosed by such Inventory on termination of hire the Hirer shall forthwith pay to the Company an amount sufficient to cover all losses at the then current list price for such lost items and any other costs and expenses which the Company may incur as a result thereof. The Hirer shall be responsible for repairing and maintaining the equipment in good order and condition having regard to the condition thereof at the date of commencement of hire and excepting only fair wear and tear and shall forthwith pay to the Company an amount sufficient to cover any and all losses costs and expenses the Company may incur as a result of the Hirer failing or omitting so to do.''

The corresponding paragraph in use in hiring contracts after 1985 was as follows: -

``At the termination of the hiring all goods shall be returned to the Company in good condition excepting only fair wear and tear. All goods shall be deemed in good condition unless the Hirer notifies Company to the contrary within 24 hour of delivery of goods. The Hirer shall on demand pay in respect of any goods [damaged] or not so returned the then current selling price for the goods. Until such sum is paid hire charges shall continue to accrue and any and all other costs and expenses incurred by the Company as a result of such shortages or losses. The Hirer's responsibility for the preservation and safekeeping of the goods shall not be determined until the goods are physically handed over to the [Company] by the [Hirer].''

Speaking of this provision, the primary judge said [at 4834]: -

``The receipt of money by the applicant under this provision is not a receipt of hiring moneys; it is a receipt of money intended to compensate him for the loss of the object hired. The consideration provided by the applicant for this receipt is not the provision of the goods on hire. It is, in my opinion, a forbearance from suing for the return of the goods or their value. The goods to which this consideration relates are part of the profit-earning capital of the applicant. They do not lose that character simply because they have been lost or disposed of by the customer. Such regularity of receipt of compensation as is established does not, in my view, operate in this case to confer an income quality in the profits.

I am satisfied that the profits on `chargeable losses', even though made in the course of the applicant's business operations, are earned on capital and not revenue account and are therefore not brought to tax under sec 25(1) of the Act.''

With respect, I have difficulty in accepting this analysis.

The general test in this area was recently stated by the High Court in
G.P. International Pipecoaters Pty Ltd v. FC of T 90 ATC 4413 at 4420; (1989-1990) 170 C.L.R. 124 at 138 , as follows:

``To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.''

It is, and could not be, disputed that the hiring fees themselves constituted income earned by GKN. The present question is whether amounts received from time to time by way of liquidated damages (it was not suggested that any penalty was involved), payable in respect of the failure to return equipment, also amounted to income.

It is true that the amount payable is fixed by reference to GKN's current selling price. But it cannot be said that the reference to current selling price means that the provision

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constitutes an agreement for the sale of the equipment. On the contrary, the provision proceeds upon the footing that the parts have been lost or destroyed, so that a sale is not practicable. In my opinion, the provision in question operates in accordance with its tenor, that is to say, as a liquidated damages clause inserted in the hiring agreement, as a genuine pre-estimate of the damage suffered by GKN from time to time, when its equipment is not returned to it. It follows, in my opinion, that the true character of amounts received by GKN under this type of clause is that of a receipt of an additional fee payable by the customer as part of the total consideration given by the customer for the hire of the goods. If, as I think, GKN received an amount in the nature of an additional hiring fee to compensate it for breach of the customer's obligation to return the equipment, it must follow that the receipt of this amount is income: it has the same revenue character, in essential respects, as the hiring fees themselves.

It is not necessary, in my view, to consider what might have been the position if, instead of a liquidated damages clause, GKN had contracted for the sale of the equipment to the hirer. The provision in question, as a matter of form as well as substance, cannot be described as an agreement for sale, either express or implied. The clause provides for the payment by the hirer of an additional sum or fee in a particular contingency, that is, the loss or destruction of the equipment. In my view, amounts received by GKN from time to time on this account should be treated as in the nature of an extra hiring fee, and thus income. Put differently, the receipt should be treated as analogous to an additional fee payable in respect of the hire of the goods, and thus income. It may be accepted, in this connection, that GKN prefers to recover the equipment rather than to use the liquidated clause. But the question here is to be determined by looking at the true character of the particular receipt, rather than considering the taxpayer's understandable preference that the goods be returned.

Reference was made in argument to the
Memorex Case 87 ATC 5034 ; (1987) 77 A.L.R. 299 and to the
Cyclone Case 87 ATC 5083 ; (1987) 18 F.C.R. 183 . I agree with the primary judge that, for present purposes, both cases can be clearly distinguished on their own rather special facts.

I would allow the appeals with costs; I would set aside the orders made at first instance; in lieu thereof, it should be ordered that the applications be dismissed, with costs.