Commissioner of Taxation v Reef Networks Pty Ltd [2004] FCAFC 275 | Case summary

BEFORE THE PRIMARY JUDGE 6 The subject matter of the proceeding before the primary judge was the "arrangement" identified by the Commissioner in the ruling: see ss 14ZAF, 14ZAA(2) and 14ZAAA of the TAA. The question for his Honour was whether the Commissioner's opinion as to the application of the law in relation to that arrangement was correct: Commissioner of Taxation v McMahon (1997) 79 FCR 127 at 132‑133, 140‑141, 149‑150; Bellinz v Commissioner of Taxation (1998) 84 FCR 154 at 160. Reef had the burden of proving that the ruling should have been made differently: s 14ZZO(b)(iii) of the TAA. 7 The primary judge recorded that it was not in contest that under the arrangement the cable is a unit of plant and a depreciating asset, and that it is used or installed ready for use at all material times. (Reef's Notice of Objection had contested the ruling that the cable is a single unit of plant, but this was not pursued.) The issue for decision was identified by his Honour to be whether, under the arrangement, so much of the cable as comprised the QR fibres would be used for a purpose of gaining or producing assessable income, or in carrying on a business for that purpose, in terms of the definition in s 995‑1 of the 1997 Act. 8 The primary judge referred to cases on s 51(1) of the Income Tax Assessment Act 1936 (the 1936 Act) and s 8‑1(1) of the 1997 Act holding that the fact that an item of expenditure is a necessary prerequisite to the earning of a taxpayer's income does not mean that it is incurred in gaining or producing that income. Outgoings, which though incurred for the purpose of deriving assessable income are not incurred in the course of doing so, are not deductible under the first limb of those sub‑sections: Federal Commissioner of Taxation v Payne (2000) 202 CLR 93 at [9], [13] and [16]. A well‑known illustration of this is found in the travel to work cases. See, for example, Lunney v Commissioner of Taxation (1958) 100 CLR 478 at 498‑499. The position is the same under the second limb. A distinction is drawn between expenditure "in carrying on business" (which is deductible) and expenditure for the purpose of enabling a person to carry on business (which is not of itself): John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1959) 101 CLR 30 at 47‑48, 49. In the case of either limb, the payment must have the character of a working expense. 9 His Honour rejected what he described as a submission by the Commissioner that the principles in [8] are applicable to the depreciation provisions set out in [4] and [5]. He referred to the observations of Hill J in Pettigrew v Federal Commissioner of Taxation (1990) 92 ALR 261 at 279: "In contrast to s 51(1), however, the purpose of which s 54 speaks is the purpose of the use to which the plant or other article is put in the year of income. In so providing, s 54 produces a quite different regime to that applicable in s 51(1). It is clear that in the latter section purpose is not a criterion of deductibility, although as the High Court pointed out in John v FCT (1989) 63 ALJR 166 at 169 it will not necessarily be irrelevant. Given the different concepts invoked by s 54 as compared to s 51(1) it is unnecessary to consider whether what was said in [earlier cases] can fairly be reconciled with the decision of the High Court in John's case." The primary judge said at [16]: "The depreciation provisions are concerned with the amortisation of capital rather than with working outlays, and allow amortisation deductions if the outlays were 'for the purpose of' gaining assessable income, or of carrying on a business to produce assessable income. In neither s 51(1) of the 1936 Act, nor s 8‑1 of the 1997 Act is 'purpose' a criterion of deductibility."

13 As to the first issue, the Commissioner claimed in written submissions that by the grant to QR of the exclusive right to use the QR portion of the cable Reef effectively divested itself of that part of the cable for 30 years. In oral submissions divesting was no longer asserted. Rather it was claimed that Reef's use of that part of the cable was effectively sterilised by the grant. The Commissioner said he did not contend that plant/depreciating assets must be directly productive of assessable income in order to qualify for deductibility. Rather the submission was that because of Reef's divestiture of the QR portion of the cable, or in its later formulation the sterilisation of its use, that part was not used in the process of deriving income from licensing a functional fibre optic cable as was the case with the Optus part of the cable. Whether in its original divestiture or later sterilisation form, the submission takes too narrow a view of Reef's business and of the manner in which it uses the cable. For reasons we expand in [14], that business is not limited to earning assessable income by use of the Optus part of the cable. Put simply, Reef's business was turning its cable to account in order to derive assessable income. Part of that business involved the acquisition of the corridor from QR. 14 The Commissioner's ruling treats "the cable, comprising all twelve optic fibres" as a separate unit of depreciable plant "rather than a particular fibre or cluster of fibres within the cable". The primary judge said it was not in contest that the cable is a unit of plant and a depreciating asset. The subject matter of the depreciation deduction is a single unit of plant or depreciating asset, not a part of the unit or asset. The limitations in ss 42‑170 and 40‑25(2) are directed to the extent to which the unit is not used for income producing purposes (s 42‑170) or the asset is used for some other purpose (s 40‑25(2)). If the cable is used for the purpose of producing assessable income, depreciation is allowable in respect of its cost. It is only if to some extent the cable as a unit is not used for that purpose (s 42‑170) or as an asset is used for some other purpose (s 40‑25(2)) that the deduction is reduced. The amplitude of the notion of use in this context is illustrated by Ryde Municipal Council v Macquarie University (1978) 139 CLR 633 at 638‑639 and Tourapark Pty Ltd v Federal Commissioner of Taxation (1982) 149 CLR 176 at 181. 15 The Commissioner then submitted that the grant to QR of the right to use the QR portion of the cable for a period of 30 years was no more a use of the cable by Reef for the purpose of producing assessable income than was the use of the sea bed by the taxpayer in Goldsworthy Mining Ltd v Commissioner of Taxation (1975) 132 CLR 463 a use of land for the purpose of producing assessable income within s 88(2) of the 1936 Act. It was said that the conclusion of the primary judge set out in [11] cannot stand with the judgment of Barwick CJ in Goldsworthy at 468. 16 In Goldsworthy dredging of a harbour by a mining company in order to facilitate the removal of iron ore by deep‑draught vessels not owned by the company was held not to be a use of land for the purpose of producing assessable income within s 88(2) of the 1936 Act. Section 88(2) provided that a taxpayer who in the year of income was a lessee of land used for the purpose of producing assessable income and had incurred expenditure in making improvements on the land was entitled to a deduction. At first instance Mason J held that the taxpayer's claim to a deduction failed because it could not show that it used the land the subject of its dredging lease for the purpose of producing assessable income. The dredging relied on by the taxpayer could not constitute use of the sea bed for that purpose because, said his Honour, s 88(2) referred to use apart from the mere activities that constitute the making of improvements in which the expenditure sought to be deducted has been incurred. The use of the harbour by the taxpayer's tugs and line launches did not constitute a use of the sea bed as opposed to the water above it. It is clear that his Honour concluded that the taxpayer did not use the sea bed for the purpose of producing assessable income because it did not use it at all. 17 Mason J's decision was affirmed on appeal. Barwick CJ held that the sea bed of the harbour was not used by the taxpayer for the purpose of producing assessable income. His Honour said at 468: "The taxpayer's case cannot I think be put higher than by saying that unless the improvements had been made in the land leased, iron ore carriers could not use the water above the land leased because it would be too shallow, and without carriers coming to the wharf in the harbour at Port Hedland the taxpayer would have no assessable income. These truths, however, do not of themselves warrant the deduction claimed unless what has just been stated does constitute the use of the leased land by the taxpayer to produce assessable income. I do not think it does. Although it may properly be said that the ships used the deepened channel, that use does not 'produce' the taxpayer's assessable income notwithstanding that without it the taxpayer may have no assessable income." This is the passage with which the Commissioner contends the primary judge's reasons (quoted in [11]) are inconsistent. We do not discern any inconsistency. The Chief Justice considered the matters to which he referred insufficient to warrant the deduction. See the emphasised words. We agree with Mr Slater QC that the claimed inconsistency between the primary judge's observations and those of the Chief Justice elevates what the latter treated as insufficient into a disqualification. It does not follow from the fact that the matters to which the Chief Justice referred did not warrant deductibility, that if those matters are present deductibility cannot result. 18 Stephen J held that the taxpayer was not entitled to the deduction because it did not use the leased land "in any sense". It relied on two uses. The first was the passive use of the sea bed for containing within the dredged bed and sides of the channel the depth of water required for the passage of ships carrying its ore. The second was the active use involved in the actual dredging of the sea bed. His Honour said the former did not amount to the use of the stratum originally demised, because it was a mere impediment whose removal was desired and which was incapable of serving any useful purpose. The demised land was to be destroyed to the extent necessary to enable large ships to use the harbour. As to the second use, his Honour agreed with Mason J that the act of dredging, the very thing that went to create an alleged improvement, cannot itself be relied on as user of the land. 19 Gibbs J agreed with the Chief Justice and with Stephen J. 20 It is apparent from the foregoing that Mason J and Stephen J denied the deduction on the ground that the taxpayer did not use the sea bed at all, and for that reason did not use it to produce assessable income. Their Honours did not consider whether, had there been a use of the sea bed, the use would have been for the purpose of producing its assessable income. Gibbs J agreed with Stephen J, but also agreed with Barwick CJ. The Chief Justice began his judgment by saying that he agreed with Mason J that the taxpayer had not shown that it used the land for the purpose of producing its assessable income. It is not clear that his Honour went further and decided not only that the matters relied upon by the taxpayer were not uses of the land, but that even if they were, they were not done for the purpose of producing its assessable income. In a later passage than the one relied on by the Commissioner, his Honour said (at 468‑469): "Finally, I am of the opinion that the fact that the earning by the appellant of its assessable income depends largely, or for that matter entirely, upon the continuing ability of the iron ore carriers to reach the appellant's wharf in the port in order to uplift the iron ore which the appellant has carried from the mine to the wharf, does not warrant the conclusion that the land containing the channel is used by the appellant for the purpose of earning that income. The carriage of the iron ore from mine to wharf for reward provided the appellant's assessable income. The availability of a deep channel from the outer harbour to the wharf and turning basin was essential to the ability of the iron ore carriers to uplift the iron ore from the wharf. But the facilitation of the ore carriers' transport of the ore, which may have ensured the receipt of the appellant's income, was not, in my opinion, a part of the process of producing it, or relevantly incidental thereto." 21 Reef submitted that the Commissioner's reliance on Barwick CJ's observations appears to be directed to a contention that if a dealing with an asset is a precondition to the derivation of assessable income, the asset cannot be used in the carrying on of a business for the purpose of producing that income. We doubt that that is what lies behind the passages quoted at [17] and [20]. For example, a taxpayer who builds factory premises in order to carry on business there is doing something as a precondition to the derivation of assessable income. Nevertheless it is clear that a deduction for depreciation is available in respect of the premises. If, as Reef submits, the distinction maintained in the cases on s 51(1) of the 1936 Act and s 8‑1 of the 1997 Act between expenditure in carrying on business and expenditure for the purpose of enabling a person to carry on business does lie behind Barwick CJ's observations, it is in our view not applicable to deductions for depreciation. We agree with the primary judge when he said that the depreciation provisions are concerned with the amortisation of capital rather than with working outlays, and allow amortisation deductions if the outlays were for the purpose of gaining assessable income or carrying on a business to produce assessable income. As Hill J said in Pettigrew at 279, the depreciation provisions (then s 54 of the 1936 Act) produce a quite different regime from that in s 51(1). Goldsworthy was not a depreciation, but a working outlay case to which the distinction under discussion applies. Accordingly, if Barwick CJ's decision is based on the distinction referred to, the Commissioner can derive no comfort from it. If, as we think is the case, what his Honour said is not based on the distinction referred to, it is no more than a decision on the facts, namely that facilitation of the ore carriers' transport of the ore was not a part of the process of producing the ore or relevantly incidental thereto. On either view of the Chief Justice's observations, they do not assist the Commissioner. 22 As to the second issue identified in [12] (par (b) of the definition in s 995‑1), counsel for the Commissioner disagreed with the primary judge's statement that the Commissioner had submitted that there was no reason why deductions for depreciation should be treated differently from deductions for working outlays under s 51(1). See [8]‑[9]. It was said that what had been submitted was that the words "used in carrying on a business for the purpose of gaining or producing assessable income" require the use to be "in the course of" carrying on that business. It was said that this requires "a direct relationship to exist between the use of the QR portion of the cable … and the carrying out of Reef's business …". There was no such relationship because the QR portion is not being used in the course of carrying on Reef's business, since that business is confined to the operations directed to the derivation of assessable income from the exploitation of the Optus portion of the cable. 23 There are at least two difficulties with this submission. The first is that it misdescribes Reef's business. It is wrong to treat it as confined to the operations directed to the derivation of assessable income from the exploitation of the Optus portion of the cable. Reef's activities that form part of the arrangement are set out in [2]. They were accepted by the parties below as an accurate statement of the key features of the arrangement. They include the corridor licence granted by QR which enables Reef to install the cable beside the Brisbane‑Cairns railway line, and to access the corridor to maintain and operate the network for 30 years, in consideration of which QR obtains the exclusive rights to use the QR fibres. Reef's business just as much includes securing the occupation of the premises from which the business is conducted as it includes deriving income from the Optus portion of the cable. The second is that the distinction drawn by the Commissioner and recorded at [22] is elusive. It is difficult to discern a substantive difference between an assertion that plant/depreciating assets must be directly productive of assessable income and an assertion that there must be a direct relationship between the use of the QR portion of the cable and the carrying on of Reef's business. 24 The Commissioner relied on First Provincial Building Society Ltd v Commissioner of Taxation (1995) 56 FCR 320 for the proposition that the words of par (b) of the definition, which appear in various places in the Assessment Acts, have consistently been construed as requiring, depending on context, "the incurrence, receipt or use to be 'in the course of' carrying on that business". First Provincial concerned s 26(g) of the 1936 Act which includes in the assessable income "any bounty or subsidy received in or in relation to the carrying on of a business". Hill J, with whom Black CJ and Carr J agreed, said at 331‑332: "There are two limbs to the first part of par (g). The first includes in assessable income a bounty or subsidy received by the taxpayer in the carrying on of a business. In that context the word 'in' means 'in the course of' and requires a direct relationship to exist between the bounty, on the one hand, and the carrying on of the taxpayer's business, on the other. … Under either limb, the relationship must be to the 'carrying on' of the business. These words may perhaps be understood in opposition to a relationship with the actual business itself. They would make it clear, for example, that a bounty received, merely in relation to the commencement of a business or the cessation of the business, would not be caught. The expression 'carrying on of the business' looks, in my opinion, to the activities of that business which are directed towards the gaining or producing of assessable income, rather than merely to the business itself." 25 Whatever view one might take as to the relevance of First Provincial to the present case, we are in no doubt that the cable as a whole (including what has been described as the QR portion) is used by Reef in the course of carrying on the business we have identified in [23]. 26 The primary judge derived assistance from the decision in Quarries Ltd v Federal Commissioner of Taxation (1961) 106 CLR 310. There the taxpayer carried on the business of quarrying and crushing stone. Its main source of income was carrying out works for a highway authority at various, frequently remote, places. The taxpayer's equipment included portable sleeping units which were taken from place to place for the use of its employees at the various sites where operations were carried on. The employees were not charged for use of the units. Taylor J held that the units were used for the purpose of producing assessable income within s 54 of the 1936 Act. At 317 his Honour said: "The ultimate question, therefore, is whether the units were used for this purpose [of producing assessable income]. I have already indicated that it would not be unreasonable to regard the entirety of the taxpayer's equipment comprised in the 'train' as a comprehensive unit designed to enable the taxpayer to conduct the major part of its somewhat unusual business. Indeed, I do not see any reason why it should not be regarded as the 'heart and core' of the major part of its enterprise (Commissioner of Inland Revenue v Reid (1950) 31 Tax Cas. 402, at p 417) and, therefore, 'plant or articles' used for the specified purpose. But the majority of the Board of Review considered the units separately and came to the conclusion that they were outside the section because 'they merely provide sleeping accommodation for the company's employees'. From one point of view this may be a strictly accurate statement but it fails to do justice to the taxpayer's case. Its business was of a special character, it could be carried on only if the taxpayer transported its crushing plant and its employees to each selected site and, obviously, it could be carried on only if some accommodation for its employees was provided at each site. The sleeping units were, of course, used by the employees for the purpose which their description implies. But this is beside the point. The critical question is concerned with the purpose for which they were used by the taxpayer. Obviously, without the units, or without tents, it would have been impossible for the taxpayer to carry on its business in the manner which its contractual obligations required. For my part I have no doubt that the correct view is that the units constituted 'plant or articles' within the meaning of the section and that they were used for the purpose specified in the section." 27 We agree with the primary judge that Quarries shows that plant may be used by a taxpayer for the requisite purpose even though it does not itself generate assessable income. It thus supports the view that the fact that QR does not pay for its use of the cable does not mean that Reef's use of the cable in relation to QR is for a purpose other than the derivation of assessable income.

Commissioner of Taxation v Reef Networks Pty Ltd

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