jessup j
253 I have had the advantage of reading the reasons of Goldberg J in draft. I agree with his Honour's conclusion that the prepayment of rent by the respondent was an outgoing of a capital nature and, subject to what follows, with his Honour's reasons for that conclusion.
254 The primary judge's holding that the prepayment was on revenue account derives considerable support from a number of circumstances. First, since it was a requirement by statute that the casino be constructed on Crown land, the operator was always going to have something less than a freehold interest in the land. A lease was perhaps the most obvious contractual arrangement under which the operator's right of occupancy of the land might have been contemplated. And a lease was in fact contemplated by the Authority from the outset. Secondly, and conformably with the first point, Star City's right of occupancy of the land in fact derived from the Construction Lease and the Permanent Lease. It was not suggested that these leases were other than what they purported to be. Looking only at the leases, the primary judge's view that the character of the advantage sought by the prepayment was the right to occupy the land is a natural one. Thirdly, it was accepted by the Commissioner that the annual rental fixed under the leases of $15 million was a fair market rental for the premises in the circumstances obtaining.
255 The primary judge articulated the conventional approach to the determination of the question whether a single payment was of a capital or of an revenue nature when she said:
Payments, even recurrent payments, that are the consideration for acquisition of ownership of a capital asset are usually characterised as an affair of capital. However, rent is not an instalment payment in respect of the purchase of a capital asset: each amount of rent is for the use of a capital asset for a particular defined period and is therefore, and for that reason, on revenue account.
(Emphasis in original)
Her Honour noted that Star City did not, by the prepayment of rent, obtain a capital asset: it merely obtained the right to use the asset of the State. She said:
The fact that the rent was paid by way of a lump sum does not detract from the fact that rent was paid to secure the use of the Premises for the period to which the payment related. … the State retains title to that part of the profit-yielding structure from whichStar Cityderives its income; the Premises were merely made available for use by [Properties] for the duration of the Primary Rental Period. In addition to not receiving title to the Premises at the end of the lease term, [Properties] received no option to purchase (whether at a below-market price or otherwise), and it was not suggested that 99 years constitutes all or a major portion of the life of the Premises.
However, the nub of the question in the case was whether, from a practical or business point of view, the prepayment did secure an enduring asset for Star City, namely, the licence to operate the casino (and to do so without competition for the first 12 years). Merely to observe that the prepayment, because it was rent, did not deliver the premises as such to Star City as a capital asset was, in my respectful view, to beg the question.
256 Approaching the matter from a practical or business point of view, the substance of the relationship between the Authority and Star City was no conventional landlord and tenant one. Significant commercial advantages which Star City derived from executing the transaction documents included the right, for 99 years, to operate a casino in New South Wales and an effective monopoly to do so for 12 years. As against these considerations, Star City was not entitled to conduct any lawful business on the land: it was required to conduct a casino. It was also obliged to design and construct the casino in the first place. It is clear from a perusal of all the evidence before the primary judge that the commercial reality of the arrangements into which Star City entered in 1994 involved a great deal more than the conventional exchange of rent for a right of occupancy.
257 The primary judge accepted this, of course, but her Honour took the view that the arrangements did involve such an exchange, that Star City's payments to the Authority would inevitably include, as they did, something in the nature of rent, and that the overall circumstances were not such as to displace the conventional characterisation of that rent as a recurrent expense. It is at this point that I consider, with respect, that her Honour erred.
258 As Goldberg J points out, the prepayment was not refundable without the agreement of the Authority. On this aspect, the primary judge said:
With respect to the first point, it is true the Prepayment was a one-off payment which was refundable only in very limited circumstances. But [Properties] took the lease for 99 years and Star Citywas committed to the operation of the Casino at those Premises for the duration of its licence. Moreover, both cl 2.1(c) of the Construction Lease and cl 2.1(b) of the [Permanent Lease] provided that the Prepayment was refundable if the Parties mutually agreed to terminate the Lease. Thus the refundable nature of the Prepayment (even though limited) was tied to the Lease, not the Licence.
That her Honour should have regarded it as significant that Star City was committed to the operation of the casino for 99 years bespeaks a perception, with which I agree, that the first 12 years of rent was at least to an extent justified by commercial factors other than the benefit of occupying the premises for that term.
259 The other significant consideration relates to the amount of rent which Star City was obliged to pay. The prepayment represented the discounted present value of rental payments of $15 million annually over 12 years. Thereafter, rent was fixed at $250,000 per annum. The case was conducted on the basis that $15 million per annum was a fair market rent. The figure of $250,000 was, it seems, treated as little more than a nominal rent. The disparity between the two figures required explanation. The explanation accepted by her Honour was set out in her judgment as follows:
The explanation for the difference in rate of annual rental offered byStar City Consortium (and accepted by the [Authority]) is no doubt (as the Commissioner accepted) connected with the period of exclusivity of the casino licence ending at the point at which the rate of rental changes …
That is to say, in the fixing of the rentals for the casino premises there were commercial factors at work which went beyond the conventional exchange of rent for the right to occupy.
260 The identification of these other factors was, in my view, central to any exercise which required the characterisation of the advantage sought by the prepayment. This was not a case in which the leases, or even the transaction documents as a whole, gave the complete picture.
261 On the issue of the relevance of evidence outside the Transaction Documents as such to the question of characterisation, the primary judge said:
The "surrounding circumstances" or "background" relied on by the Commissioner is irrelevant to the proper characterisation of the Prepayment because the advantage sought by the Prepayment is capable of identification and characterisation by reference to the Leases and the Occupational Licence Agreement and, if necessary, the Transaction Documents as a whole: City Link (Federal Court) at [44]‑[45], approved by Citylink (High Court) at [120], [151] and [154].
If by this citation of authority her Honour meant no more than to point to City Link Melbourne Limited v Commissioner of Taxation(2004) 141 FCR 69 as an instance where the advantage sought by a particular outgoing was capable of characterisation by reference to the contractual and other formal documents involved, the citation does not address, or perhaps begs, the question whether the present case was also such an instance. If her Honour meant to imply that City Link Melbourne Limited v Commissioner of Taxation(2004) 141 FCR 69 had established a proposition of law which bound her to conclude in the present case that the advantage sought by the prepayment is capable of characterisation by reference to the transactional documents to which she referred, I take the view, with respect, that no such proposition was so established.
262 In the passage in City Link Melbourne Limited v Commissioner of Taxation(2004) 141 FCR 69, 84 upon which the primary judge relied, the Full Court said:
While it will often be relevant to ask what the money the subject of a deduction is paid for, in order to conclude whether the outgoing has the character of capital, generally, however, that question will be answered where the amount in question is consideration for obligations which the payee undertakes in favour of the payor, by having regard to the legal agreements entered into. Generally in such a case it will be unnecessary to go outside the legal agreement to determine deductibility. So it would ordinarily be unhelpful to have regard to precontractual negotiations in characterising an outgoing as capital in the same way as such evidence would ordinarily be unhelpful in construing the legal agreement entered into between the parties.
Here the Full Court was, in my opinion, going no further than to indicate the approach that would "generally" or "ordinarily" be necessary or helpful. What their Honours said allows for the occasion in which it will be necessary to go outside the agreements in question.
263 There may be occasions upon which even a complete understanding of the agreements and other formal legal documents (or non-documentary transactions) will be insufficient for the purposes of characterisation under s 51 or s 8‑1, or will present a misleading impression of the advantage sought by way of the outgoing in question. At the simplest end of the spectrum, the outgoing may be for the purchase of an item, evidenced only by the supplier's invoice and receipt. Without knowing who the buyer is, what is his or her line of business, and what is the use to which the item is to be put, it would not be possible to undertake the task of characterisation. Likewise, while wages are ordinarily a revenue expense, wages paid to employees engaged wholly upon the installation of new capital equipment should not be so regarded. Merely to look at the legal rights and obligations which existed as between the payer and the payee (ie the employer and the employee) would be of no assistance in the task of characterisation. I do not believe that the Full Court in City Link Melbourne Limited v Commissioner of Taxation (2004) 141 FCR 69 was concerned to make the point that surrounding, or background, circumstances, standing outside the transactional documents involved, should always be regarded as irrelevant to the completion of that task.
264 As Goldberg J points out in his reasons in the present case, in City Link Melbourne Limited v Commissioner of Taxation (2004) 141 FCR 69 the Full Court went on to say (at 84‑85):
The position may be different if it be asserted that the agreement does not record the true agreement of the parties - whether because it is a sham in the legal sense of that expression or because it does not record the whole of the legal arrangement between the parties.
There will be, it may be accepted, some cases where regard may be had to the matrix of facts which form the background to the entering into of a legal agreement to determine the character of an amount payable under that agreement: Reuter v Commissioner of Taxation (1993) 27 ATR 256 at 262; Commissioner of Taxation v Cooling (1990) 22 FCR 42 at 53 per Hill J. The surrounding circumstances may in such cases, cast light on the nature of the relationship between parties to the agreement or deny as relevant to the character of an outgoing a label which the parties have used to describe it. Merely to call in [sic] an agreement an outgoing "interest," for example, will not make it so. An example of such a case is the decision of the Full Court of this Court in Commissioner of Taxation v Broken Hill Pty Ltd (2000) 179 ALR 593 at [36] ‑ [40]. Likewise where parties in an agreement purport to exclude the relationship of employee/employer the surrounding circumstances may reveal that the true relationship is an employment relationship with the income taxation consequences which follow: Australian Mutual Provident Society v Allan (1978) 52 ALJR 407 at 409.
Clearly where a particular transaction or agreement is said to be a sham in law there will be a need to consider the surrounding circumstances to determine what the other and real relationship is for which the agreement entered into between the parties is a disguise: Snook v London and West Riding Investments Ltd [1967] 2 QB 786. There is no suggestion in the present case that the agreement entered into between the State of Victoria and Transurban is a sham. Indeed the present does not seem to us to be a case where reference to the surrounding circumstances in which the City Link agreements were entered into assists at all in determining the character of the concession fees. What the concession fees were paid for appears clearly enough from the terms of the Concession Agreement.
Again, I regard these passages as involving a discussion of some of the more obvious situations in which it may be either necessary or desirable to go outside the transactional documents in a particular case. I do not read them as laying down exhaustively the full range of situations in which one might do so.
265 In particular, I would not accept that the characterisation given to the advantage obtained by an outgoing by the parties involved, or the characterisation which is to be divined by reference only to the agreement between them, is binding on the Commissioner unless that characterisation is a sham or does not record the whole of the legal arrangement between the parties. I have attempted to illustrate situations in which genuine agreements, recording every element of the legal arrangements between the parties involved, provide an incomplete or inaccurate impression apropos the matter of characterisation. Although much more complex than the examples I have given, I consider that the present was an occasion upon which the agreements themselves did not paint the full picture. It was, in my view, an occasion on which the primary judge was obliged to look at the non‑contractual evidence upon which the Commissioner placed so much store. Her Honour did so in the alternative but, at least in important respects, she did so in a limited and, I consider with respect, an unsatisfactory way.
266 The three non-contractual documents upon which the Commissioner particularly relied are referred to in the reasons of Goldberg J. The primary judge's treatment of their influence on the question of characterisation was as follows:
Moreover, even if the "surrounding circumstances" or "background" were examined, they do not alter the identification of, or the character of, the advantage sought by the Prepayment. The three documents referred to in [100] above cannot be said to constitute the "whole factual matrix of which the [Leases and the Occupational Licence Agreement] forms part": FCT v Cooling (1990) 22 FCR 42 at 51-53 citing Duke of Westminster's Case [1936] AC 1. The documents by their nature and content do not form part of the factual matrix. None of the documents was sent by one contracting party to any other contracting party or was executed by the contracting parties. I considered the letter sent byStar Cityto the NSW Treasurer on 13 December 1994 in pars [61] to [63] above. The issues identified in relation to that document apply equally to the 19 April 1994 and 27 April 1994 letters. Moreover, even if the documents did form part of the factual matrix, they form just that - only part. It is not open to either party to pick and choose from the factual matrix.
Paragraphs [61]-[63] of her Honour's reasons, however, dealt with the question of the identity of the obligee under the leases (essentially a matter of construction), not with the characterisation of the prepayment for tax purposes. On the assumption (admittedly rejected by her Honour) that the documents formed part of the factual matrix, her Honour appears not to have addressed directly the value (as distinct from the relevance) of these documents to the question of characterisation.
267 Star City's letter to the Treasurer of New South Wales on 13 December 1994 contained the following passage:
In relation to these payments, we wish to record that:
…
(b) the rental prepaid under the terms of the [Construction Lease] only reflects the value of the Permanent Casino site if a casino licence is issued and, as such, forms part of the premium paid by [Star City] to obtain the licence if the [Authority] determines that it will issue the licence to [Star City]. [Star City] will loan $120,000,000.00 to [Properties] for the purpose of allowing it to prepay the rental under the [Construction Lease] and [Properties] will only be able to repay that loan if the licence is granted.
This letter goes a long way to explaining the apparent oddity that, while representing a fair market rental, the annual rent for the first 12 years was so much in excess of that payable for the balance of the 99 years. The value of the land by reference to which the fair market rent was ascertained, it seems, was "the value of the Permanent Casino site if a casino licence is issued". When the process of ascertaining the rent is understood in the context of this explanation by Star City itself, the discrepancy between the different rents does not seem so odd. In that context, Star City described the initial rent as "part of the premium … to obtain the licence". Absent the licence, it seems, there would be no agreement either on the level of the rent or on the payment of it by way of a capitalised prepayment. This justification of the prepayment by Star City not only seems commercially realistic, but provides important assistance on the question of characterisation of which, in my view, her Honour should have availed herself.
268 The memorandum from the legal advisers to Star City's parent company dated 19 April 1994 contained an important statement that the rental paid under the Permanent Lease "reflects in part a tax effective payment of part of the premium for the issue of the Licence …" This memorandum was considered by the board of the parent company before the submission of Star City's financial offer on 22 April 1994. I cannot, with respect to the primary judge, understand why the statement, together with its consideration by the board, should not be taken at face value as an identification by Star City itself of the advantage which it sought to obtain by agreeing to the rent for which the Permanent Lease provided. It was, of course, not the only element of the surrounding facts and circumstances which bore upon the matter of characterisation, but it did so bear. It is also true that it was a communication wholly internal to Star City and its associated companies, and could not, therefore, have affected the content of Star City's rights and obligations as against the Authority. But it was, in my opinion, more than merely an expression of opinion as to the legal effect of the Transaction Documents. It was part of the business justification for a very substantial investment. Relevantly, that justification dealt directly with the character of the advantage which Star City sought from the rent which it agreed to pay.
269 The letter from the legal advisers to the New South Wales Office of State Revenue on 27 April 1994 was consistent with their memorandum dated 19 April 1994. What I have said in the previous paragraph applies equally to that letter.
270 Finally, I refer to the primary judge's comment that it was "not open to either party to pick and choose from the factual matrix …" As I understand the case conducted before her Honour, however, the Commissioner was engaged in a fairly conventional forensic exercise of drawing attention to parts of the evidence that supported his case that the practical, as distinct from the documentary, characterisation of the prepayment was that it was an affair of capital. He was, in my view, entitled to do so. That evidence ought, with respect, to have been regarded as especially helpful because it consisted of statements made by Star City or its advisers. The Commissioner was not picking and choosing. So far as I can see, in relevant respects his case did not involve the proposition that these, and only these, pieces of evidence could be looked at. Everything which had the potential to assist on the matter of characterisation could be looked at. It was open to Star City to rely upon other parts of the evidence, if any, which tended to suggest that the evidence sought to be relied on by the Commissioner was not what it appeared to be, or had been overtaken by events, or something similar. There was, however, no such other evidence.
271 I agree with the orders proposed by Goldberg J.