Commissioner of Taxation v Metal Manufactures Ltd - [2001] FCA 365 - FCA 2001 case summary — Zoe

CTHFCA

Commissioner of Taxation v Metal Manufactures Ltd

[2001] FCA 365

Federal Court of Australia|2001-04-03|Before: Sundberg J, Emmett J, Brennan J, Aickin JJ, Dixon J, Hill J, Sundberg JJ, Lee J

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At a glance

Source facts

Court

Federal Court of Australia

Decision date

2001-04-03

Before

Sundberg J, Emmett J, Brennan J, Aickin JJ, Dixon J

Source

Original judgment source is linked above.

Judgment (48 paragraphs)

[1]

INTRODUCTION 29 For many years the respondent ("the taxpayer") has manufactured energy cables, tubes and pipes used in the business of facilitating the transmission of electronic communications and in the merchandising of electrical, electronic and lighting products. It occupied factory premises on land at Port Kembla owned by it and on adjacent land owned by its wholly owned subsidiary, Austral Bronze Metal Manufacturers Pty Ltd ("Austral Bronze"). Various items of heavy plant and equipment used by the taxpayer in its manufacturing operations were located in the factory ("the plant"). In April 1988 the taxpayer sold the plant to the State Bank of New South Wales ("the Bank"), and the Bank leased it back to the taxpayer in consideration of payment by the taxpayer of regular half yearly amounts of rent. In respect of its years of income ended 31 December 1988 to 31 December 1995 inclusive the taxpayer claimed the rental payments as allowable deductions under s 51(1) of the Income Tax Assessment Act 1936 ("the Act"). The appellant ("the Commissioner") disallowed the deductions on several alternative bases. He also concluded that insofar as the payments constituted allowable deductions, the taxpayer had obtained, or but for the operation of s 177F of the Act would obtain, a tax benefit in connection with a scheme to which Part IVA of the Act applies, and determined under s 177F that the payments were not allowable as deductions. The taxpayer unsuccessfully objected to the amended assessments issued by the Commissioner, and its appeals to the Court were allowed by Emmett J. His Honour concluded that the rental payments were deductible under s 51(1), and that the Commissioner was not justified in making a determination under s 177F(1)(b). Emmett J set aside the Commissioner's objection decisions and remitted the matters to him for redetermination in accordance with his Honour's reasons for judgment.

[2]

[20]

The memorandum described the characteristics of a sale and lease back, noting that the taxpayer could not have an option to purchase the plant at the termination of the lease since this would cause the lease to be treated as a hire purchase agreement. The consequence of the lease was that the taxpayer's security for retaining the plant on termination would be dependent on the "business reputation" of the lessor and the restricted saleability of the rather special purpose plant. The writer noted the financial advantages of lease back as opposed to conventional borrowing, and the tax advantages of the proposal. He recorded that the taxpayer's lawyers had advised that payments under the lease would be fully deductible. On 22 February 1988, after considering a further memorandum from Mr Allen recommending approval of the proposal put forward by Macquarie, the directors gave their approval. 37 During March 1988 a valuation of the plant that was to be the subject of the arrangements was obtained from Mason Gray Strange Valuations Vic Ltd. On a going concern basis a value of $50,755,000 was attributed to the plant. The valuation was said to exclude building installations, concrete floor, under floor excavations, overhead cranes, concrete support structures and pitworks. 38 After examining memoranda dealing with the directors' consideration of the taxpayer's security for retaining use of the plant at the end of the lease, and considering the evidence given by Mr Allen and other directors, the primary judge concluded that the directors were aware of the risk that the taxpayer would not be able to reacquire the plant, but regarded it as minimal or theoretical. Taxpayer's need for finance 39 After considering memoranda passing between officers of the taxpayer relating to the financing of future acquisitions, the possibility of the taxpayer acquiring the interests of minority shareholders in subsidiaries, and the evidence of certain of the directors as to the relationship between future acquisitions and acquiring funds by the sale and leaseback arrangements, the primary judge said:

[24]

The plant and equipment 40 Before the primary judge the Commissioner contended that the plant consisted of fixtures. This, it was submitted, meant that the Credit Purchase Agreement was ineffective to vest any title in the Bank. Accordingly the lease could not confer on the taxpayer any right in respect of the plant. It followed that the payments made by the taxpayer under the Lease could not be characterised as payments made under a lease for the purpose of securing the right to use property owned by the Bank as lessor. This submission led the primary judge to make a careful examination of each item of plant with a view to deciding whether it was or was not a fixture at the date of the sale and leaseback. His Honour noted that because all items of plant were securely attached to land otherwise than by resting on their own weight, the taxpayer had the onus of establishing that they were not fixtures. His Honour then examined in turn what he called the two objective circumstances relevant to determining the intention with which the object was affixed to land ‑ the degree of annexation and the object of annexation. As to the former, after noting that the common method of attachment was that the items in question were bolted into concrete footings, and the gaps between the footings and the items were filled with concrete grouting, his Honour acknowledged that expert evidence called by the taxpayer had demonstrated that the plant and equipment could, as a practical matter, be removed, although such removal would: · cause not inconsiderable damage to the floor of the factory premises · necessitate dismantling part of the buildings (including cutting cross‑supports in the walls) to enable access to various items · involve some necessary scrapping of components of the services relating to the manufacturing lines · take considerable time, in some cases several months, to complete. 41 The primary judge also noted that the plant was incorporated to a high degree with other items within the factories. On the basis of the foregoing he concluded that there was an "extremely significant degree of attachment" of the plant to the land, and that this weighed heavily in the balance toward a conclusion that the intention, objectively ascertained, in placing the items on the land was that they were intended to become part of the land. 42 His Honour then considered the object of annexation. He noted that the items in question could, if properly maintained, last indefinitely, although they could become redundant overnight by a major technological advance. This, in his view, led to the conclusion that the plant was installed with the intention that it would remain in place indefinitely, rather than for a purpose that had a limited life span. His Honour acknowledged that it was necessary that the plant be attached to the land in a manner that would steady it, ensuring quality of the ultimate product, and for safety reasons, and that this suggested they were affixed for the better enjoyment of the items themselves, rather than for the better enjoyment of the land. However, he appears to have decided that in fact they were affixed for the better enjoyment of the land as a factory. He concluded that as at 19 April 1988 the items were fixtures. Effect of the Arrangements 43 The primary judge rejected the Commissioner's contention that because the plant and equipment were fixtures, the instruments were ineffective to achieve their stated objects. He accepted that the Bank could not acquire a legal interest in the plant since it would form part of the land to which it was attached. Nevertheless he regarded the Credit Purchase Agreement as effective to vest in the Bank an "interest in the nature of property which should be characterised as equitable". This equitable interest was sufficient, in his Honour's view, to support "the 'leasing' by the Bank of the Plant and Equipment to the Taxpayer and the 'taking on lease' of the Plant and Equipment by the Taxpayer." Loan of $50,000,000 44 His Honour then dealt with the Commissioner's submission that the arrangements had all the characteristics of a loan, and that the Bank had in substance lent $50,000,000 to the taxpayer, with the result that payments under the Lease were in part repayments of principal. His Honour examined each of the fourteen matters relied on by the Commissioner to support his submission, and concluded that the submission was not made out. After noting that the Commissioner had, realistically, not attacked the instruments as a sham, his Honour said:

[42]

THE EFFECT OF THE ARRANGEMENTS 56 The primary judge concluded that because the items of plant were fixtures, the Bank could not have a legal interest in them since they formed part of the land to which they were attached. That indeed is the orthodox view. See however Professor Butt's note on Selling land separately from fixtures in (2000) 74 ALJ 130. The primary judge, however, held that the Credit Purchase Agreement was effective to vest in the Bank "an interest in the nature of property which should be characterised as equitable". His Honour referred to cases such as In re Samuel Allen & Sons Ltd [1907] 1 Ch 575 and Kay's Leasing Corporation Pty Ltd v CSR Provident Fund Nominees Pty Ltd [1962] VR 429 in support of the view that a party in the position of the Bank acquires an equitable interest in the plant and equipment. But for the lease, the Bank's proprietary interest would give it the right to enter upon and sever the plant and equipment from the land. That interest was sufficient to support the lease. 57 Before the primary judge the Commissioner argued that because the plant and equipment were fixtures the instruments were ineffective to achieve their stated objects. The contention was not repeated on the appeal, and it was not suggested that his Honour's conclusion that while the Bank acquired no legal interest, it did obtain an equitable interest, was erroneous. In his written submissions the Commissioner asserted that legal title was never transferred, though he accepted the primary's judge's view that the Bank obtained some form of equitable interest. Rather the argument was that, accepting the Bank acquired an equitable interest, the advantage actually obtained by the taxpayer was the same as that which it had sought, namely a capital component being the difference between $50 million paid by the Bank and the residual value of $18.75 million. It was said that this was so whether the Bank's equitable interest in the plant resembled that of a chargee or, as the primary judge thought, was an equitable interest sufficient to support a lease of the plant. It is thus unnecessary to consider the nature of any interest acquired by the Bank under the Credit Purchase Agreement. And since the Commissioner did not advance argument on the point, it is inappropriate that I express any concluded view on the matter. See in addition to the cases cited by the primary judge, Melluish v BMI [No 3] Ltd [1996] AC 454 at 475‑476.

Parties

Applicant/Plaintiff:

Commissioner of Taxation

Respondent/Defendant:

Metal Manufactures Ltd

Legislation Cited (1)

Income Tax Assessment Act 1936(Cth)

Cases Cited (8)

LEE J: 1 I have had the advantage of reading the reasons prepared by Sundberg J, which set out the relevant facts and issues. 2 With regard to the issue relating to fixtures I agree with his Honour, for the reasons he gives, that the learned trial judge (Emmett J) did not err in finding that the items of plant, the subject of the arrangement for sale and lease-back, were fixtures, and that an equitable interest in that property vested in the State Bank of New South Wales ("the Bank") upon purchase. 3 In respect of the deductibility of the outgoings of rent, s 51 of the Income Tax Assessment Act 1936 (Cth) ("the Act") excepts an outgoing from deductibility to the extent to which it is an outgoing of capital, or of a capital nature. Division of the characterisation of an outgoing does not, however, require separation of the facts relevant to each component. All relevant facts must be considered, giving due weight to any transaction relevant to the outgoing that may govern the rights and obligations of the taxpayer in respect thereof. That is not to say that those rights or obligations are considered to the exclusion of other facts (Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation (1980) 49 FLR 183 per Brennan J at 190). However care must be taken not to introduce an hypothetical construct that is considered to the exclusion of the effect of rights or obligations established by a relevant transaction. 4 As was stated by Stephen and Aickin JJ in The Commissioner of Taxation of the Commonwealth of Australia v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 at 662: "We do not read Dixon J's judgment in Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 as intended to convey that practical business considerations are to be used to the exclusion of an analysis of legal rights." 5 Indeed, there will be cases in which the legal rights and obligations which generate the outgoing are sufficient to characterise the nature of it and it will be unnecessary to go beyond them. (Federal Commissioner of Taxation v Broken Hill Proprietary Company Limited (2000) ATC 4659 per Hill J at 4667). 6 In the present case the outgoings made were payments of rent made by the taxpayer to obtain the use of property used in the conduct of its business. The only advantage obtained by the taxpayer was that which it obtained as lessee. Counsel for the Commissioner submitted, however, that a "collateral advantage" was sought by the taxpayer by making payments of rent, namely, the reacquisition of the property upon termination of the lease, and that the taxpayer made payment of the rent with the intention of obtaining the advantage of being able to negotiate with the Bank to repurchase the property at a price equal to the residual value stipulated in the lease. It was submitted that the difference between the residual value, which, it was said, may be expected to be the price of the property on the sale thereof by the Bank on the termination of the lease, and "market value" would be in the order of $31 million and that the outgoings by way of rent should be taken to have sought the advantage of a reduction in the cost of the asset to that extent. 7 If the Bank were to deal with the taxpayer at the termination of the lease, the Bank would do so after deciding that it was in its interests to deal with the taxpayer after considering various factors, including whether the taxpayer had duly performed its obligations under the lease and whether the taxpayer had the means to purchase the property. The contention that the payment of rent was calculated by the taxpayer to maintain good standing with the Bank in order that the Bank would deal with the taxpayer at a later date in respect of the sale of the leased property, fails to describe a circumstance sufficient to ground a conclusion that some part of the payments made by the taxpayer by way of rent were of a capital nature. 8 If it could be said that the taxpayer anticipated that at the termination of the lease it could discuss with the Bank re-acquisition of the property sold to the Bank and leased back to the taxpayer, neither the realisation of that anticipation, nor, for that matter, entry into an arrangement to reacquire the property, could be an advantage secured or effected by a part of each payment of rent. 9 With regard to the contention that the advantage sought was purchase of the property at less than "market value", the learned trial judge noted that in Commissioner of Taxation v Battery Makers, the arrangement under consideration in that case provided expressly that payments made by way of rent by the taxpayer were to be applied by the lessor/vendor in amortisation of the price to be paid for the leased property under an option to purchase granted to a party related to the taxpayer. In that case it was held that no part of the rent was paid by the taxpayer to secure an advantage for the taxpayer. 10 Emmett J noted that in the case before him, even if it could be said that the Bank would deal with, or sell the property to, the taxpayer at less than market value, the taxpayer had no right to call on the Bank to sell the property to it at that price. Furthermore, if in due course, the property were to be purchased from the Bank by an entity other than the taxpayer, albeit an entity related to the taxpayer, any advantage represented by the difference between the purchase price and the market value would fall to the purchaser and not the taxpayer and could not be said to be an advantage in the nature of capital sought by the taxpayer. (see Commissioner of Taxation v Battery Makers per Gibbs J p 660; per Stephen and Aickin JJ p 662) In other words, the learned trial Judge was satisfied that the instant case was even a stage removed from the facts in Commissioner of Taxation v Battery Makers and that it could not be found that any part of the rent paid by the taxpayer sought to effect an advantage of a capital nature. In my opinion, his Honour's analysis was correct and involved no error of law. 11 It is unnecessary, therefore, to consider what principles should have been applied to ascertain what the value of the property would have been upon termination of the lease to determine whether that value exceeded the residual value. 12 When regard is given to the "whole picture" (BP Australia Ltd v The Commissioner of Taxation of the Commonwealth of Australia (1965) 112 CLR 386 per Lord Pearce at 399) the cardinal facts are that the taxpayer made genuine payments of rent pursuant to a Lease under which the taxpayer obtained no interest in the property the subject of the Lease. If the taxpayer defaulted under the Lease it could make no claim for relief against forfeiture in respect of the payments the Commissioner contends were payments in the nature of capital. No part of any outgoing paid by the taxpayer by way of rent is able to be isolated to be shown not to be rent but an outgoing to obtain an interest of a capital nature. It is plain that the whole of the payments were incurred and discharged to obtain the right to use the property for the conduct of the taxpayer's business. 13 I agree with Emmett J that no part of the outgoings made by way of rent were shown to be an outgoing of a capital nature. 14 The final issue is whether Part IVA of the Act applied to the circumstances described. The appeal in this matter was heard in conjunction with the appeal in Eastern Nitrogen Ltd v Commissioner of Taxation [2000] FCA 366. Both matters involved proposals for the borrowing of funds put to the respective taxpayers by Macquarie Bank Ltd. In the instant matter the funds obtained by the taxpayer on sale of the property to the Bank were applied in reduction of short-term debt and to put the finances of the taxpayer on a more stable foundation in the conduct of its business but there is no difference in substance in the respective arrangements under consideration in this case and in Eastern Nitrogen, and the further reasons provided by me, and by Carr J, in Eastern Nitrogen as to why Part IVA of the Act did not apply to the arrangements in that case, apply equally to this matter. 15 For the reasons provided by Emmett J, I agree with his Honour that an objective consideration of relevant facts did not show that the taxpayer, or any other relevant party, entered into the finance arrangements for the dominant purpose of obtaining a tax benefit for the taxpayer. Therefore, Part IVA of the Act did not apply to permit the Commissioner to exercise a discretion under s 177F to determine that any part of the payments made by way of rent were not an allowable deduction from the assessable income of the taxpayer. His Honour considered each of the components of s 177D(b) and applied those provisions to the facts before him. It has not been shown that his Honour erred in any respect in the construction of the provisions of s 177D or in his application of those provisions to the relevant facts. 16 The submissions put by the Commissioner relied on degrees of emphasis and on the weight his Honour may have given some facts if he had been persuaded so to do, and upon a contention that had his Honour so acted, he may have formed another view of the application of Part IVA to the facts of this case. As stated above, no error of law in his Honour's approach to the construction and application of the relevant provisions has been demonstrated. 17 The appeal must be dismissed. I certify that the preceding seventeen (17) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lee.

CARR J: 18 I have had the advantage of reading Sundberg J's draft reasons for judgment in this appeal. I am grateful to his Honour for saving me the task of setting out the factual and procedural background to the matter. 19 I agree, respectfully, with Sundberg J's conclusion (and with the reasons given for that conclusion) that the primary judge did not err in holding that the items of plant were fixtures. 20 I agree with the learned primary judge's conclusion that the Credit Purchase Agreement was effective to vest in the Bank an interest in the nature of property which should be characterised as equitable. I also agree with his Honour's reasons for that conclusion. 21 I agree with the primary judge's characterisation of the rental payments as having been made entirely on revenue account. His Honour's views coincide with the opinion expressed by Drummond J in Eastern Nitrogen Ltd v Commissioner of Taxation [1999] FCA 1536, on the assumption that he (Drummond J) was wrong in his conclusion that the sale and lease-back transaction in that case were legally ineffectual to create the relationship of lessor and lessee with respect to the plant in that matter. 22 I cannot see any relevant factual distinction between the circumstances of this matter and the circumstances in Eastern Nitrogen. I am thus in agreement with both Emmett J in this matter and Drummond J in relation to characterisation of the rent payments. But I disagree, respectfully, with Sundberg J's conclusion that Emmett J was in error in this matter. 23 In my reasons for judgment in the appeal in Eastern Nitrogen I identified further relevant advantages which the appellant in that case obtained by making the rental payments. 24 One of those further advantages was the continuing use of a very substantial amount of money. The same advantage can be seen as obtained by the respondent in this appeal i.e. the continuing use of some $50 million (the comparable figure in Eastern Nitrogen was $71.4 million). 25 For the reasons set out in paras 29 to 47 (both inclusive) of my reasons for judgment in Eastern Nitrogen, I do not think that any portion of the rental payments made by the respondent in this matter should have been disallowed as being outgoings of capital or of a capital nature. 26 In this matter, as in Eastern Nitrogen, the Commissioner relied upon Part IVA of the Income Tax Assessment Act 1936 (Cth) ("the Act"). 27 Again for the reasons which I gave in the Eastern Nitrogen appeal (see paras 48 to 96 both inclusive) I do not consider that Part IVA applies to the scheme identified in this matter. 28 Accordingly I would dismiss this appeal with costs. I certify that the preceding eleven (11) numbered paragraphs are a true copy of the Reasons for Judgment herein of Justice Carr.

(1978) 140 CLR 645

(1980) 49 FLR 183

(1965) 112 CLR 386

(1957) 97 CLR 146

(1946) 72 CLR 634

[2001] FCA 366

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