CBA Investments Limited v Northern Star Limited

Dealings Between the Parties 24 In early February 1996, the appellant drew the respondents' attention to the possibility that the profit component of the termination amount was likely to be taxable. 25 The respondents replied on 21 June 1996 asserting: "The Taxation Indemnity provided for in Part 6 can only be triggered by a notice from the Lessee under Cl 6.1. Provisions in relation to the giving of such notice are contained in Clause 6.3. None of the conditions precedent to the giving of the notice has arisen". 26 The respondents also contended that they were only liable to pay the amount which was originally assumed would be payable on the basis that the termination amount was to be treated as on capital account. 27 The appellant gave consideration as to whether it should apply for a taxation ruling. In a letter to Bain dated 3 July 1996, the appellant commented: "As discussed, we see little value in pursuing [seeking a ruling], besides the unwarranted expense (to Northern Star), it also runs the risk of raising other issues that would otherwise remain unchallenged (not that we are aware of any such issues). In light of these potential 'costs' we see it as entirely Northern Star's decision as to whether a ruling should be sought. In a strictly legal sense, such a ruling is perhaps necessary, from a commercial viewpoint it appears to us to be unnecessary and perhaps even imprudent. Notwithstanding this, should they wish to do so we would be happy to review such a request before its lodgement with the Commissioner." 28 The question of whether a ruling should be sought was raised with the respondent. 29 Debate and correspondence continued throughout the succeeding months without resolution of the issue between the parties, either to whether the amount was to be treated on revenue account or as to whether the appellant should obtain a tax ruling. In the end result, the appellant did not seek a ruling (and as now appears to be recognised by both parties, it was not entitled to do so). 30 By early 1997, the appellant had decided that it would return the receipt of the termination amount as income and advised the respondents accordingly. On 8 May 1997, the respondents informed the appellant that the respondents: "…requires the [appellant] to ensure the termination value is returned in accordance with the "traditional" method of tax accounting adopted … in the past" 31 This was understood by all parties to mean that the respondents were requiring the appellant to treat the termination amount as a receipt of capital. 32 On 12 December 1997 the appellant lodged its income tax return for the year ended 30 June 1997. The return included income for the profit component of the amount paid by the respondents after the expiry of the Sub-Leases. 33 Bain wrote to the respondents on 13 January 1998. They said: "[The appellant's] income tax return has now been lodged with the Tax Office. The effect of lodging the return was to deem the Commissioner of Taxation to have made an assessment of the taxable income and tax payable on that date (refer to section 166A of the Income Tax Assessment Act 1936). That is, the return lodged is deemed to be a notice of assessment under the hand of the Commissioner and served on the company on that day. Accordingly, an amended termination value of $3,075,346.71 has been calculated by [Bain] pursuant to Clause 6.1 of the lease. [Bain], as lessee, hereby makes demand under clause 6.3(b) for payment of $547,758.73 (including $875.01 FID) being the difference between Termination Value paid on 5 July 1996 and the revised Termination Value determined by [Bain]…" 34 The respondents refused to pay the amount claimed. The appellant subsequently brought these proceedings to recover that amount. 35 The trial judge construed the provisions of cl 6.1 and 6.3(a) as follows: "The use of the term 'disallows the relevant claim' in Clause [6.3] of the Head Lease leads me to conclude that the parties intended that some positive step be taken to put before the Commissioner a claim that the payment was of a capital nature. I am satisfied that the structure and wording of Clause 6 evidences an intention that there would be steps taken, within the legislative structure, to defend the assumptions upon which the parties had agreed their relationship would be governed. The Clause envisaged that a claim would be placed before the Commissioner for the relevant amount to be treated as of a capital nature. The Clause also provided for consultation between the [appellant] and the [respondents] as to whether objection should be pursued if the Commissioner did not accept the claim. The discretion as to whether to pursue such an objection was left with the [appellant] after that consultation. If the [appellant] wished to activate its entitlement to have the Termination Value reviewed and amended, [Bain] was required to serve a notice on the [respondents] stating that 'the Commissioner of Taxation has assessed as income' the payment. Once that election was made the review was to be conducted by Bain to provide the [appellant] with the same rate of return as if the event had not occurred. That event was the Commissioner not accepting the payment was of a capital nature. I am not persuaded that the term 'does not accept', in the context of the Head Lease and the taxation legislation in force at the time, can be satisfied by a passive deemed rejection by reason of the furnishing of a return without the option to accept or reject it being raised. The parties' intentions gleaned from the terms of the Head Lease and the surrounding circumstances at the time they entered into the Head Lease were in my view otherwise." 36 Her Honour's finding based on her construction of the head lease was that the appellant was not entitled to decide for itself that the amount was to be treated as revenue and the appellant had to abide by the terms of the lease.

Appellant's Submissions on Appeal 37 The appellant submitted that, as the effect of the deemed assessment provisions was that upon lodgement of the return it was assessed to tax on the profit component of the termination amount, it was deemed to be entitled under cl 6.3 to give the notice referred to in cl 6.1. It followed on this submission that the appellant was not otherwise required to establish that the Commissioner had not accepted that the moneys were received on capital account. Nor was it required in any way to contend to the Commissioner that the amount should be returned on capital account. The appellant relied upon the fact that, on the express words of cl 6.3, the entitlement to give the notice was a deemed entitlement which arose when the assessment was made. The only other requirement under cl 6.3 was that the appellant was required to give evidence of the Commissioner's assessment of income. That could readily be done and was done. 38 The appellant submitted that the correctness of its approach, namely, that it was not required to contend to the Commissioner that the amount was capital, was reinforced by the fact that the appellant was required, at the time of lodging its return to sign the declaration contained within the prescribed form of return: (as to which see s 161 referred to earlier). The declaration was in the following terms: "I declare that the particulars shown in this tax return and the relevant records used to ascertain the taxable/net income, as shown, derived by the company from all sources in and out of Australia during the year of income are true and correct." 39 The terms of the declaration required a taxpayer to characterise receipts and expenses as either capital or revenue based. There was nothing within the terms of the declaration which permitted of any qualification. Accordingly, on this submission, because the appellant had reached a firm view as to the revenue nature of the receipt, it had no alternative but to declare the termination amount as income. 40 The appellant further submitted that the reference in the second part of clause 6.3(a) to disallowance of a claim meant, and as a matter of practice could only mean, the making of the assessment. In expanding on this submission, senior counsel noted that the language of cls 6.1 and 6. 3 was more appropriate, for example, to the claimed deduction of expenses. He further pointed out that in the ordinary course, where, as here, there was no question of capital gains tax involved, an amount was either included in the return as income or there was no reference made to the receipt. To give sense to the provision in the context in which it was required to operate, the "disallowance" was the assessment of the amount in question as income rather than capital. 41 The appellant also submitted that it gained some assistance for its construction of clause 6.3(a) from the second part of clause 6.3. First, there was the reference to the right of the appellant to object "to the disallowance". Given the statutory scheme of the assessment provisions of the Income Tax Assessment Act, that could only refer to an objection to the assessment. 42 Further, in support of its construction of cl 6.3, the appellant drew attention to the last portion of the clause, which protected the appellant's position, except in relation to costs, even where the disallowance was due to some fault or omission of the appellant. It was submitted that fault or omission included where the appellant had, for example, failed to file a return, or even where it had wrongly or mistakenly declared the amount as income rather than capital. 43 In any event, and this was the appellant's fallback position, the appellant submitted that the introductory words of cl 6.1 "if for any reason whatsoever" were words of wide import and wide enough to encompass the consequences which flowed here from the operation of the self assessment provisions. 44 This argument was put in various ways, all of which were directed to demonstrating that the clause operated to the benefit of the appellant. Thus, it was submitted that the reason why the appellant had been assessed to tax was because it had declared the amount in question as income, as it said it was required to do, and the deemed assessment provisions operated on the declared income in the return. That was a "reason" within the opening words. Put another way, it was submitted that the words "the Commissioner does not accept" that the payment was of a capital nature described a state of fact which was satisfied even though the Commissioner had not paid any direct attention to the matter or was not given the opportunity to do so because the appellant had returned the amount as income.

Respondents' Submissions 45 The essential submission of the respondents was that on the proper construction of cl 6.1, some act of the Commissioner in not accepting, or disallowing the amount in question as capital was required before the appellant was entitled to the benefit of the tax indemnity provided for by the clause. On this argument, clause 6.1 was the governing provision. If satisfied, cl 6.3 provided the mechanism whereby the appellant could claim the benefit of the provision. 46 In their written submissions, the respondents argued that the appellant was obliged "in its income tax return or in whatever form was available at the relevant time [to] make the claim that the Termination sum … was of a capital nature". They added that "[b]y necessary implication [the claim] had to be made prior to the Commissioner making the determination…". 47 It was submitted that the existence of such an obligation conformed with the express language of the clause; the implied duty to co-operate as well as the implied obligation of good faith: see Burger King Corporation v Hungry Jack's Pty Limited [2001] NSWCA 187; and also conformed with the commercial circumstances and objects addressed in the document. In addition, it was said that such a requirement conformed with the rule that a party was not to profit by its own wrong: see for example TCN Channel Nine Pty Ltd v Hayden Enterprises Pty Ltd (1989) 16 NSWLR 130. Finally, it was submitted that such an obligation "conformed with what reasonable people in the position of the parties would have intended" - namely to vigorously assert to the Commissioner that the receipt was capital in nature. 48 In his oral submissions, senior counsel for the respondents did not put the matter in quite such categorical terms. Rather, it was submitted that the express provision of cls 6.1 and 6.3, and in particular the words "does not accept" in cl 6.1 and "disallows the relevant claim" in clause 6.3 clearly required some active consideration or step by the Commissioner. It was thereby incumbent upon the appellant to notify the Commissioner that there was an issue as to whether the amount should be treated as income or capital. Section 169A(2) could have been used for that purpose. Alternatively, some note could have been made in the return or a letter sent to the Commissioner so as to disclose that although the appellant considered the amount was properly returnable as income, there was a question between the parties to the arrangement as to whether it was capital. But whatever means was used, and it was submitted not much was required, the respondents contended that the express language of both clauses did not contemplate that the Commissioner's attention was never drawn to the question whether the amount was capital or income. 49 Senior counsel for the respondents also relied on the second part of cl 6.3(a) which refers to the result of the objection process, as indicating that there had to have been some active consideration of the claim. 50 The respondents further submitted that if the appellant's construction was correct, it meant that the appellant could entirely ignore the respondents' interests and act upon its own view of the matter. This submission, which I would reject, can be dealt with shortly. The respondents had asserted in their written submissions and the appellant agreed that the appellant had an obligation to act in good faith: Burger King Corporation v Hungry Jack's Pty Limited. The requirement in cl 6.3, that the appellant consult with the respondents before determining, in its discretion, whether to object, points to the existence of such an obligation, if there was otherwise any doubt about it. The obligation of good faith would require the appellant to raise the matter with the Commissioner in some fashion, if it had any reasonable grounds to believe that the receipt might be income. However, the respondents do not assert that the appellant breached its obligations of good faith. They rely entirely upon the construction of the clause. 51 I should add that I do not consider that it would be necessary for the appellant to establish that it would have been futile to assert or notify the Commissioner that the respondents argued that the amount should be treated as capital.

Conclusion 52 The effect of the respondents' submission was that, accepting that the appellant may have been obliged by the deemed assessment provisions to return the receipt in a particular way, or run the risk of penalties and prosecution, it was also contractually obliged to place some information before the Commissioner claiming that the termination amount might be capital. It was implicit in the respondents' submission that the appellant was obliged to do so notwithstanding the degree of certainty which attended the appellant's view that the amount in question was of a revenue nature. 53 I have a number of difficulties with this approach. In the first place, it is to be remembered that the language of cls 6.1 and 6.3 is not entirely apt for the circumstance it was intended to cover. As senior counsel for the appellant pointed out, the clauses are really drafted in language apposite for claimed deductions. Accordingly, whichever construction is to be preferred, the language requires some adaptation. 54 Secondly, the purpose of the clause was to enable the appellant to maintain the rate of return on the transaction should the circumstance arise that the termination amount was income, not capital. If cl 6.1 is the governing provision, and arguably it is, then the appellant is entitled to the full benefit of the opening words: "If for any reason whatsoever the Commissioner of Taxation does not accept". I have already referred to the arguments in support of the proposition that, given the operation of the deemed assessment provisions, the appellant had satisfied this provision. 55 Thirdly, given the developments in the interpretation of the tax law affecting transactions such as this, the respondents' argument effectively required the appellant to engage in somewhat of a nonsense. In this case the appellant had a genuine and reasonable belief that it was required to return the amount as income. It was required to sign a declaration that the amount was income. Having done so, according to the respondents, it was also required to draw attention to the fact that the respondents contended that it should return the amount as capital. It is relevant, in this regard, in my opinion, that the respondents never asserted, either in the correspondence between the parties, or during the course of the proceedings, that the appellant's belief was not reasonable, nor that the amount was capital. It merely insisted that it was entitled to a process. There might be circumstances where that might be able to be required, where for example, the taxation position was genuinely contentious. In that case however, I am of the opinion that the respondents' rights would derive from the obligation of good faith, not from the express provisions of cls 6.1 and 6.3(a). I am also of the opinion that cl 6 was intended to achieve a substantive outcome and should be so construed. 56 I should add that the appellant provided another response to the respondents' argument. It asked, what would have been the position if the legislation had been amended so that a receipt of this nature was statutorily prescribed as income? Would the appellant, in that circumstance, have been required to draw the Commissioner's attention to the fact that under the lease, it had been contemplated that such an amount would be capital in the hands of the appellant. The answer presumably would be in the negative. Admittedly, the appellant's example involves the notion of futility. But in my opinion, there was no obligation under either cls 6.1 and 6.3(a) or under the parties' implied obligations under the lease agreement to engage in a meaningless exercise. 57 It follows from what I have said that I consider the appellant's construction is to be preferred, although arguably, reference should be made first to cl 6.1, before the mechanisms under cl 6.3 are engaged. However, that approach makes no difference to the outcome and may simply reflect a difference of emphasis rather than any question of construction. 58 The orders I would propose are: (i) Appeal allowed;

(ii) The judgment and orders of Bergin J be set aside;

(iii) In lieu thereof, direct judgment for the appellant in the sum of $547,758.73 together with interest thereon pursuant to s 94 of the Supreme Court Act 1970 (NSW).

(iv) The respondents to pay the appellant's costs of the trial and on appeal, but to have, if qualified, a certificate under the Suitors' Fund Act 1951 (NSW). 59 HODGSON JA: The circumstances giving rise to this appeal are set out in the judgment of Beazley JA. 60 The parties contracted on the explicit assumption that any payment received by CBA Investments on termination of the head lease was of a capital nature. That is made clear by Schedule 1 of the head lease, which relevantly provided as follows: "Where the Termination Value becomes payable or any amount payable under clause 4.1 or 5.2 by the Lessor, the Lessee shall procure that the amount thereof shall be calculated by Bain as at the date on which the Termination Value becomes payable or (if applicable) is paid so as (in either case) to provide the Principal with its agreed rate of return such calculation to be made using the same method and adopting the same assumptions as were used and adopted by Bain in calculating the instalments of rent specified in the Sub-Leases as disclosed in a letter from Bain to Northern Star Limited dated 2 July 1985." 61 This letter of 2nd July 1985 was in the following terms, the most relevant part being the first sentence of the paragraph numbered 6:

"Lease Transaction You have requested that we set out details of how the lessor's rate of return is determined (and, in particular, the assumptions upon which that yield is based).

As a preliminary matter we confirm that the lease documentation will provide for dispute/review provisions under which any party is entitled to apply for arbitration if a rental review is queried. In such circumstances, it is our intention that offer letters to AEFC Limited together with the computer analyses verifying AEFC's return will be lodged with Stephen Jaques Stone James (or Freehills) as "governing documents" to be made available to the actuary appointed as arbitrator under the above provisions. As the analyses are the proprietary information of the lessor, you will appreciate that they cannot be made available at the outset.

We have set out below a description of the underlying assumptions making up the lessor's return.

Lessor' yield Essentially the lessor's yield is the after tax internal rate of return of the cash flows inherent in the transaction, comprising both the net rental cash flows and the tax credits/debits arising over the course of the transaction. The return is analysed on the multiple investment sinking fund basis (the industry norm) using a sinking fund rate of 3.5% per annum after tax.

In calculating this return it is assumed that: 1. The lessor will be entitled to a deduction from assessable income in respect of each year of income of an amount equal to the rate of 4% per annum (prime cost) on the building component of the contract sum (excluding the landscaping and roads) and at the higher rates applicable to the plant components of the contract sum.

The transaction is treated as a lease for tax purposes.

The lessor will receive a deduction for all costs, fees and charges incurred by it in relation to its participation in the transaction. .

The lessor is wholly assessable on rental income as received.

The company tax rate is 46% per annum throughout the transaction.

Any payment received by the lessor on termination or the Site Head Lease to compensate the sub-lessor at the time of termination and/or otherwise indemnifying it for loss of value, is of a capital nature. In this regard, it is assumed that, as an operating lease, there are no residual value clauses under the Sub-Lease to Northern Star Limited and, hence, the lessor's minimum return can be achieved only through receipt of the proceeds on termination of the Head Lease or otherwise through sale of the building.

In all circumstances whether on termination through effluxion of time or early termination, the lessor's same percentage after tax rate of return is maintained, on a monthly basis (whereas its total profit will, of course, decrease in the event of early termination as its investment is not outstanding as long). Hence, Northern Star's position is protected entirely insofar as the lessor cannot effectively receive an amount which takes his rate of return above the objectively verifiable yield built into the original assumptions.

We trust that the above explanation is adequate for your purposes." 62 However, cl.6.1 of the head lease dealt with the possibility that the Commissioner of Taxation "for any reason whatsoever" "does not accept" that the payment is of a capital nature, and provided in that eventuality for an increased payment by the respondents to CBA Investments. The crucial question is whether that provision does or does not depend for its operation upon the Commissioner of Taxation being given the alternative of accepting or not accepting that the payment is of a capital nature. If it does, then it is clear that in fact the Commissioner was not given that alternative; if it does not, then it is clear that the Commissioner did "not accept" that the payment was of a capital nature, the payment having been returned by CBA Investments in its tax return as income. 63 The following factors support the respondents' contention that the provision requires that the Commissioner be given the alternative of accepting or not accepting that the payment is of a capital nature: 1. This is suggested by the words "does not accept" . 2. The clause provides for a re-calculation so as to increase the respondents' liability by reason of a falsification of an assumption upon which the parties explicitly contracted, suggesting that it should not be left entirely to CBA Investments to decide that this common assumption is falsified so that re-calculation should take place. 3. The second paragraph of cl.6.3(a) of the head lease provides what should happen concerning objection and appeal "in the event that the Commissioner of Taxation disallows the relevant claim" . That wording is more apt for a claim for a deduction; but in my opinion it is very plainly referring to a claim that a payment is of a capital nature, and thus supports the view that the non-acceptance referred to in cl.6.1 involves a decision by the Commissioner. 4. The second paragraph of cl.6.3(a) provides for an indemnity by the respondent of CBA Investments of its costs and expenses of objection and appeal, provided that "the initial disallowance was not made by reason of the default or omission of 'Bain or CBA Investments'" . That also supports the view that non-acceptance involves a decision by the Commissioner, and that CBA Investments is required to pose the question for decision fairly and adequately. 64 There are factors supporting the appellant's contrary contention: 1. Court decisions and the Commissioner's rulings since entry into the lease have strongly supported the view that the payment was a payment of an income nature and would be so treated by the Commissioner. 2. A taxpayer is required to sign a declaration to the effect that the particulars in the tax return are true and correct; and so, where a taxpayer honestly and reasonably believes a receipt is income, it has no alternative but to return it as income. 3. By reason of legislative changes that have occurred since entry into the lease, the submission of a tax return showing the receipt as income has the effect that there is ipso facto an assessment by the Commissioner involving the receipt being so treated. 65 It was also submitted for the appellant that the first paragraph of cl.6.3(a) showed that this provision requiring increased payment was triggered in any event when Bain notified the respondents that the Commissioner had assessed the payment as income. That submission must be rejected. In my opinion, the wording of that paragraph is not sufficient to displace the basic requirement that the Commissioner "does not accept" that the payment is of a capital nature: the paragraph in question is directed to the timing of the obligation to pay, not to altering the substantive effect of cl 6.1. 66 The other considerations are quite finely balanced. 67 In my opinion, the second and third factors supporting the appellant's contention are far from conclusive. Although the requirement for a declaration means that a taxpayer must include as income all receipts which it honestly and reasonably believes to be income, this does not prevent it from bringing to the Commissioner of Taxation's attention a contention of another interested party that one such receipt is of a capital nature, and asking for a ruling. As noted by Beazley JA, the private ruling provisions of Pt IVAA of the Income Tax Assessment Act did not apply to this arrangement as the arrangement began to be carried out before 1st July 1992; but the appellant could have raised a question about it under s 169A(2) of the Income Tax Assessment Act. 68 In my opinion, the strongest factor in favour of the appellant is the first one to which I referred. It seems clear that in truth the payment in question was a payment of an income nature, and that, had a question been put to the Commissioner of Taxation, whether under s 169A(2) or otherwise, the Commissioner of Taxation would have answered accordingly. That is, it seems clear that, given the alternatives, the Commissioner of Taxation would not have accepted that the payment was of a capital nature. 69 However, it was not submitted that the appellant was not required to put the question to the Commissioner because this would have been an exercise in futility; and the parties had contracted on the basis that the payment was a payment of a capital nature, with provision for adjustment only if the Commissioner of Taxation "does not accept" that this was the case. On the whole, I think the better view is that the appellant was required to put the alternatives to the Commissioner of Taxation before this condition could be satisfied, as suggested by the four factors I set out earlier supporting the respondents' contention. 70 Accordingly, I am not satisfied that the primary judge was in error, and in my opinion the appeal should be dismissed with costs. 71 ROLFE AJA: I agree with Hodgson JA.

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