Earl of Lonsdale v Attorney-General

2. REVIEW, EVALUATION AND BIDDING COSTS The appellant was a wholly owned subsidiary of Esso Eastern Inc ("Esso Eastern") which in turn was a wholly owned subsidiary of Exxon Corporation ("Exxon"). The appellant was subject to policy directions from Exxon as communicated by Esso Eastern. Since the 1960s the appellant had explored for and produced oil and gas off shore as part of its business in Australia of producing and selling oil and gas. From the early 1970s, the appellant was under direction from Exxon to explore for coal, synfuels (primarily oil shale) and certain other minerals. For each of the years of income ended 31 December 1979 through to 31 December 1984 the appellant claimed a deduction under s 51(1) of the Act for expenditure in investigating the acquisition of interests in potential joint ventures for the exploration and mining of coal, oil shale and certain minerals. The costs and expenditures incurred were general costs which were preliminary to a decision to acquire a particular tenement, or an interest therein, from which mining production can take place. The trial judge, Sundberg J, found (at 467): "The nature of the evaluation varied from case to case. Sometimes there was a simple in-house review of published geological information. In other cases there was a full-scale study requiring on-site work, geological review, mine planning, marketing studies and a full economic appraisal. Outside consultants were often involved in geological studies and mine planning, or where particular problems with respect to infrastructure or the environment were perceived. In most cases the evaluation showed that the prospect was not commercially viable, and for that reason it was not pursued". The parties filed an agreed summary of facts which summarised the activities of the appellant (referred to as "EEPA") as follows: "Coal: EEPA first undertook coal exploration activities during 1973. From 1974 to 1976, EEPA confined its activities to monitoring the Australian coal industry. From 1976, EEPA's corporate objectives included participation in the industry. By the end of 1977, EEPA had acquired an interest in a coal prospect and EEPA made bids for participation in coal prospects from 1978 onwards. Synfuels: from 1973 the taxpayer's activities included testing Victorian brown coal as feed stock for synthetic fuels, and consideration of the acquisition of long term coal conversion resources. By 1979, synfuels were considered to be a commercially viable alternative and EEPA made a bid to participate in the Rundle oil shale project. In the same year, EEPA planned exploration activities. EEPA was the successful bidder for Rundle and undertook exploration and bidding activities in relation to other synfuels prospects. From 1982, EEPA's involvement in synfuels abated. Minerals: From 1973, EEPA conducted a wide ranging and extensive program of exploration for minerals. From 1979, EEPA had interests in a number of minerals prospects in relation to a number of ongoing projects, several of which were at the development stage. Minerals encompassed base metals, gold and uranium." The appellant contended before Sundberg J that in the relevant years of income its business had extended beyond oil and gas and included exploration for coal, oil shale and certain other minerals. Accordingly, so it was said, the appellant was entitled to an allowable deduction under the second limb of s 51(1) on the basis that the costs were outgoings necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Before his Honour, and on appeal, the appellant's case relied on the second limb as the appellant conceded (correctly in our view) that if the expenditure did not fall within the second limb it was unlikely to fall within the first limb. The Commissioner contended that the appellant had not in the relevant years established an exploration business and that the expenditure was incurred in ascertaining the feasibility of potential ventures, in order to decide whether or not to carry on the business of mining coal and oil shale. Accordingly, so it was said, the appellant had never committed itself to the extent of actually producing any of those commodities and therefore had not made the transition from exploring and seeking business opportunities to actually conducting a mining business. His Honour concluded that: · the appellant was in the business of producing and selling oil and gas; · as from 1973, but in particular during the relevant years of income (or some of them in the case of oil shale and minerals) the appellant was actively involved in exploration activities; · the expenditure claimed to be deductible was incurred in the course of the appellant's exploration activities but in the relevant years of income the appellant was not in the business of exploration as it had not engaged in exploration for reward and, in particular, it did not incur the expenditure for the purpose of selling any of the exploration information or otherwise earning fees for its exploration activities; · the appellant had not committed itself to commercial production with the consequence that the element of commitment to the relevant income producing activity in respect of which the expenditure is claimed to have been incurred was missing; · the appellant had not made the transition from exploring and seeking business opportunities to actually conducting a mining business and was therefore not carrying on the business of mining for coal, oil shale and other minerals; · accordingly the review, evaluation and bidding costs in relation to coal, oil shale and other minerals was not expenditure necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. Having arrived at the above conclusions it was unnecessary for his Honour to deal with the Commissioner's alternative submission that the expenditure was of a capital nature. Sundberg J also found against the appellant in respect of a claim pursuant to s 77 of the Act for review, evaluation and bidding costs relating to gold. The appellant did not pursue its appeal concerning the costs relating to gold. The Appellant's Submissions The appellant's principal contentions on the appeal were that his Honour erred in: · finding that the expenditure was preliminary to carrying on a business; · characterising the appellant's business as confined to producing and selling oil and gas; · not finding that the appellant's commitment to extending its business to exploration for coal and oil shale was the first stage of carrying on business as a miner; · placing undue emphasis on the characterisation of the appellant's business rather than asking whether the expenditure was incurred in carrying on a business; · treating "commitment to commercial production" as a principal criterion for the purposes of s 51(1). Counsel for the appellant submitted that the essential question which was required to be answered under the second limb of s 51(1) was whether the relevant expenditure was "necessarily incurred in carrying on a business" and to answer that question it is not necessary to "characterise the business under a particular heading" as his Honour had done. It was contended by its senior counsel that: "The fact that, in a year of income, no discovery was made which met the taxpayer's criteria for development or that the taxpayer had not 'committed to commercial production' in respect of any prospect would not prevent the expenditure being characterised as having been 'incurred in carrying on a business'. The issue is not the category of business; rather, it is the character of the expenditure and its nexus with a business." It was central to the appellant's contentions, before the trial Judge and on appeal, that the business of the appellant included exploration for coal, synfuels and minerals. The appellant acknowledged that, with one exception to which we refer later, it had not made a commitment to commence production of resources other than oil and gas at any particular location or in any particular mining venture during the relevant years. Rather, it contended that it had committed itself to expanding its business to include exploration for resources in addition to oil and gas. The appellant pointed to the detailed and uncontradicted evidence which indicated that its exploration activities related to a large number of different potential mining prospects and had been extensive, recurrent and involve significant numbers of staff engaged full time in relation to exploration activities as well as consultants who were retained from time to time to assist with those activities. Accordingly, it was said that the nature, extent and scope of those activities and the quantum and recurrence of expenditure involved in them including the acquisition of interests in potential mining prospects and ventures were such that the appellant clearly satisfied the test of "carrying on a business" as discussed in Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307 at 311 per Bowen CJ and Franki J and at 318-319 per Fisher J and in Goodman Fielder Wattie Ltd v Commissioner of Taxation (1991) 29 FCR 376 at 385-387 per Hill J. The appellant acknowledged that the questions of whether a business is being carried on and whether a particular activity is part of an existing business are questions of fact. However, it contended that the Court on appeal has jurisdiction to overturn a finding of fact by the trial judge when it is convinced that the wrong conclusion was reached: see Paterson v Paterson (1953) 89 CLR 212 and Warren v Coombes (1979) 142 CLR 531. It was said that that is particularly so in the present case where the primary facts were not in dispute. The appellant appeared to accept that it was not to have its case assessed any differently because it was a taxpayer with an existing business which was undertaking a new range of activities from the situation of a taxpayer commencing a new business or its first business. However, it submitted that the activities it had undertaken were such that it could no longer be said that in the relevant years of income it was merely carrying on the business of producing and selling oil and gas. The appellant claimed that it had taken the first and necessary step in carrying on the business of an energy or resources company, namely incurring expenditure in investigating the acquisition of interests in potential coal, synfuels and minerals projects as part of its extended or new business. It was in that context that it contended that the fact that it had not at the relevant time earned assessable income from its new mining activities, commenced mining production in respect of any particular project or committed itself to commence mining production in respect of any particular location did not have the consequence that it was not carrying on a mining business.

The Commissioner's Submissions On behalf of the Commissioner it was contended that the conclusions of Sundberg J were based on findings of fact which were not open to challenge as there were no grounds on which those findings could be overturned. It was contended that for the taxpayer to succeed in having his Honour's findings of fact overturned it would be necessary to establish that the evidence which was accepted by his Honour was inconsistent with established facts or was glaringly improbable: see Rennie v Commonwealth (1995) 61 FCR 351 at 354-358 and the cases there referred to. The facts found by his Honour were, according to the Commissioner, not only demonstrably open on the evidence but plainly correct. The Commissioner further contended that his Honour correctly applied the law to the facts and, in particular, no error in principle could be demonstrated when his Honour concluded that to render the expenditure deductible, there must be the requisite degree of commitment to the income producing activity in respect of which the expenditure is claimed to have been incurred. The Commissioner submitted that the evidence did not support the view that the appellant had commenced to carry on a business of producing and selling coal, synfuels or other minerals at the time the relevant expenditure was incurred. To the contrary, so it was said, the evidence showed that the appellant had committed itself to no more than a strategy of assessing the feasibility of potential mining ventures as a possible source of income from mining or production of those mineral resources. Accordingly, the appellant had not proceeded to commit itself to the production of coal, oil shale or minerals in respect of any of those potential ventures. Put simply, as was found by the trial Judge, the Commissioner contended that the appellant had not made the transition from merely considering whether to conduct a mining business to actually conducting such a business.

The appeal on findings of fact At the outset it is appropriate to deal with the Commissioner's submission that in essence the trial Judge's findings of fact preclude the contentions which the appellant put on appeal. It was said that the appellant is now attempting to reargue the facts found by the trial Judge and should not be permitted to do so. In our view the facts relevant to this aspect of the case do not depend upon any findings relating to the credibility of witnesses or relating to disputed facts. Rather, this is a case where the primary evidence was not in dispute and the ultimate findings of fact were based essentially on the proper inferences to be drawn from that evidence. In those circumstances this is a case where the appellate court is in as good a position as the trial judge to decide on the proper inferences to be drawn from the evidence. Of course, in deciding what are the proper inferences to be drawn, the appellate court is to give respect and weight to the conclusions of the trial judge, but, once having reached its own conclusion, will not shrink from giving effect to it: see Warren v Coombes (1979) 142 CLR 531, Dawson v Westpac Banking Corporation (1991) 66 ALJR 94 at 99 and Rennie v Commonwealth of Australia (1995) 61 FCR 351 at 354-356 and the cases there referred to. However, even in cases where the primary facts are not in dispute and the trial judge's evaluation of the facts does not depend on an assessment of the credibility of witnesses there is nevertheless a need for appellate caution in reversing the trial judge's evaluation of the facts. As was said recently by Lord Hoffmann (with the agreement of all other members of the House of Lords) in Biogen Inc v Medeva plc [1997] RPC 1 at 45: "The need for appellate caution in reversing the judge's evaluation of the facts is based upon much more solid grounds than professional courtesy. It is because specific findings of fact, even by the most meticulous judge, are inherently an incomplete statement of the impression which was made upon him by the primary evidence. His expressed findings are always surrounded by a penumbra of imprecision as to emphasis, relative weight, minor qualification and nuance (as Renan said, la vérité est dans une nuance), of which time and language do not permit exact expression, but which may play an important part in the judge's overall evaluation." We have approached the issues arising in the present appeal with these considerations in mind.

Carrying on business to gain assessable income The primary question arising on the appeal is whether the expenditure in question was necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. It is only if that question is answered in the affirmative that the issue arises as to whether the expenditure is of capital or of a capital nature. In John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1959) 101 CLR 30 at 49 Menzies J, in a much quoted passage, described the expenditure required for the purposes of the second limb of s 51(1) as being "part of the cost of trading operations". The description was in the context of a consideration of the nexus required by s 51(1) between the expenditure incurred and the taxpayer's business carried on for the purpose of gaining or producing assessable income. Menzies J said: "Disregarding the application of the section to losses and considering the alternative head solely in its application to outgoings, there must, if an outgoing is to fall within its terms, be found (i) that it was necessarily incurred in carrying on a business; and (ii) that the carrying on of the business was for the purpose of gaining assessable income. The element that I think it necessary to emphasise here is that the outlay must have been incurred in the carrying on of a business, that is, it must be part of the cost of trading operations." (Emphasis in original) However to fall within the characterisation described by Menzies J it is not necessary for the business actually to make assessable income - it must simply be conducted for that purpose. Menzies J went on to say in John Fairfax at 49: "It seems to me that the deductibility of an outlay cannot be made to depend upon the success or failure of what the outlay was intended to achieve....the success or failure of what was attempted can make no difference to the character of the expenditure..." In certain cases expenditure claimed to be deductible under the second limb is said by the Commissioner to be preparatory to an activity which might at some time in the future constitute the carrying on of a new or expanded business or the resumption of a previous business. In such cases, as his Honour found in the present case, establishing the proper characterisation of the particular business said to have been carried on is critical to resolving whether there is a sufficient nexus between the expenditure and the taxpayer's business: see Goodman Fielder Wattie (supra) at 386 per Hill J. The Griffin Coal Mining Company Limited v Federal Commissioner of Taxation (1989) 89 ATC 4,745, and on appeal (1990) 90 ATC 4,870, is an example of a case which demonstrates how views can easily differ on whether the requisite transition has occurred. In Griffin, the taxpayer was a coal mining company which claimed as a deduction the costs relating to diversification of its business, including costs of investigating the possibility of coal sales to a proposed aluminium smelter and costs relating to becoming a member of the consortium proposing to establish the smelter. The trial judge, Lee J, stated (at 4,759): "It must be concluded that the subject expenditure incurred by Griffin Coal was part of the cost of formation of a new source of income and that the expenditure was not an aggregation of outgoings necessarily incurred in carrying on the existing business for the purpose of producing assessable income from the conduct of that business. For the second limb of subsec. 51(1) to apply the loss or outgoing must have been necessarily incurred in the carrying on of a business. The outgoings disallowed were not necessarily incurred in carrying on the business of extraction and sale of coal. They were expenses incurred for the purpose of seeking to acquire an asset to be used in an expanded business of Griffin Coal or in a business conducted by another member of the Griffin group of companies but they were not expenses necessarily incurred in carrying on the existing business of Griffin Coal." On appeal, at (1990) 90 ATC 4870 at 4,888-4,889 Wilcox and French JJ held that Lee J's views on the application of s 51(1) to the taxpayer's expenditure were correct. Davies J dissented on the basis that the expenditure was "essentially devoted to the improvement of Griffin's coalmining business" and "was not of a capital nature" (at 4,871-4,872) and that "the expenditure at this early stage was relevant and incidental to Griffin's existing business" (at 4,877). On the issue of characterisation in the present case Sundberg J found that the taxpayer was not in the business of exploration as it "did not engage in exploration for reward". Rather, his Honour was of the view that the relevant exploration activities were "aimed at ascertaining whether it was commercially worthwhile to enter into mining joint ventures". His Honour was said to have erred in referring (at 468-469) to certain evidence given by Dr Kruizenga, Exxon's Vice-President - Corporate Planning from 1980 to 1992 to support that conclusion. The appellant submitted that the evidence referred to was selective and did not accurately reflect the substance of Dr Kruizenga's evidence which, it said, was to the effect that the exploration was a first but necessary step in conducting a mining business. We do not accept the criticism. His Honour's references to aspects of Dr Kruizenga's evidence clearly supported the conclusion at which his Honour arrived. We accept that the nature, scope and extent of exploration activities of the kind engaged in by the appellant might, in some cases, be sufficient to constitute the carrying on of an exploration business. However, that was not the situation in respect of the appellant. It was plainly open to his Honour to conclude that the appellant did not carry on an exploration business. The appellant also pointed to the substantial sums committed by it to exploration activities. However, the substantiality of the amount expended on those activities was merely a reflection of the substantiality of the business proposed to be carried on by the appellant in the event that the exploration activity proved to be successful. As no error has been demonstrated in relation to his Honour's characterisation of the appellant's exploration activities the critical issue relates to whether his Honour erred in his approach to the requirement of the element of commitment as a criterion for deductibility under the second limb of s 51(1). It was on the basis of that approach that his Honour concluded that the appellant had not made the transition from assessing and seeking opportunities to actually carrying on a mining business.

Commitment to the income producing activity Intent of the taxpayer alone in respect of the expenditure is not sufficient to establish deductibility under s 51(1) for outgoings or expenditures that are not themselves productive of income, but are intended to lead in the future to the production of income: see Inglis v Federal Commissioner of Taxation (1979) 40 FLR 191 at 195-196 per Brennan J. In cases where it is necessary to discern between activity constituting the carrying on of a business and activity which is preliminary to the carrying on or recommencement of a business it is the element of commitment that establishes the requisite nexus between the expenditure claimed to be deductible and the business said to be carried on for the purpose of gaining or producing assessable income: see Softwood Pulp and Paper Ltd v Federal Commissioner of Taxation (1976) 76 ATC 4,439 at 4,450 per Menhennitt J; Inglis at 195-196 per Brennan J and at 201 per Davies J; Goodman Fielder Wattie Ltd v Federal Commissioner of Taxation (1991) 29 FCR 376 at 387 per Hill J; Federal Commissioner of Taxation v Brand (1995) 95 ATC 4633 at 4,649 per Tamberlin J. In Steele v Federal Commissioner of Taxation (1997) 73 FCR 330 at 336 Burchett and Ryan JJ referred to these cases for the proposition that a sufficient connection, for the purposes of s 51(1), between an outlay and the prospect of income requires a degree of commitment on the part of the taxpayer to the relevant income producing activity. The existence of the requisite nexus in a particular case is a question of fact and of degree: see Inglis at 195-196 per Brennan J and 205-206 per Davies J. Commitment was considered in relation to s 51(1) by Menhennitt J in Softwood, a case relating to expenses incurred in evaluating whether a paper mill should be established. His Honour, in rejecting the claim, held (at 4,450) that the activities in respect of which the expenses were incurred were "entirely preliminary and directed to deciding whether or not an undertaking would be established to produce assessable income". In reaching this conclusion, his Honour emphasised that "no one was committed, at all, to go on with the project...". The concept of commitment was also referred to in Inglis where the taxpayer claimed deductions under s 51(1) in respect of various outgoings in relation to a pastoral property on the basis of the taxpayer's intention to resume income producing activity at that property at some time in the future. The claim failed, inter alia, on the basis that the taxpayer's business of primary production had ceased despite the taxpayer's intention to resume it. Davies J (with whom St John J agreed) said at 201: "Having considered the evidence, I think that it is an inescapable conclusion that, in the subject years, having regard to the uncertainties and possibilities of the future, the property was not then devoted by Mr. and Mrs. Inglis to the derivation of assessable income. It was then neither used to produce assessable income nor committed by Mr. and Mrs. Inglis to the production of assessable income." The approach in Inglis is consistent with Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 57 where the High Court made it clear that a "hope or expectation" that a taxpayer's mining operations would be resumed and then earn income would not amount to a "present purpose" of gaining income. In Goodman Fielder Wattie at 386-387 Hill J considered the element of commitment in the context of a claim for deductibility for expenditure on research work which, if successful, could result in the development, marketing and sale of certain antibody products derived from the research in the event that the products were shown to be commercially viable. His Honour observed at 386: "Critical to the resolution of the present controversy is the characterisation of the business activity itself which is said to have commenced." After concluding that the appellant had properly conceded that its business was to be characterised as one of manufacturing and selling particular antibody products his Honour was satisfied that the research work carried out involved "activities of a provisional kind only". Hill J concluded that although it was contemplated that, if the research was successful and the commercial feasibility for particular antibody products was established, the products might be produced that was not sufficient to satisfy either limb of s 51(1). His Honour found that the element of commitment to the development of any particular product was absent during the relevant period. In Steele (at 336) Burchett and Ryan JJ concluded that the taxpayer had the requisite "commitment" in respect of the acquisition of certain grazing land for redevelopment as a motel and townhouse complex because: "..she obtained the Council's assent to a change of zoning, employed architects and engineers, entered into joint venture arrangements, and pursued the project with some tenacity until litigation with her collaborator put a complete stop to it. She demonstrated her 'commitment' from the beginning by committing $1,000,000 to the venture plus the time, energy and considerable expense of the subsequent architectural and engineering work, and negotiations with the local Council, sewerage authority and prospective joint venturers and financiers. The matters, of course, raise questions of fact; but it appears to us there is much to be said for the proposition that the Tribunal's own findings of fact, set out in the various reasons in telling detail, suggest it was not open to the Tribunal to find in this case a relevant lack of commitment." In our view it can now be taken to be well established that, in cases such as the present, in determining whether there is a sufficient nexus between expenditure claimed to be deductible under s 51(1) and the prospect of income being earned by a taxpayer's business as a consequence of the expenditure the element of commitment is an important criterion for determining deductibility. The criterion affords a practical and principled basis for ascertaining whether the nexus between the expenditure and the derivation of assessable income is too remote or too tenuous to confer on the expenditure the requisite character under s 51(1): see Inglis at 205-206 and Ronpibon at 57. We are satisfied that no error on the part of his Honour has been demonstrated by the appellant in relation to his Honour's application of the criterion of "commitment" to the facts in the present case. To support its claim for exploration expenditure, the appellant relied on the decision of the majority of the Full Court in Commissioner of Taxation v Ampol Exploration Limited (1986) 13 FCR 545. In Ampol the taxpayer was engaged in exploration for hydrocarbons and claimed a deduction under s 51(1) for expenses incurred in exploration activities off the China coast. The rights gained from the exploration could not lead directly to rights to commercial production but the taxpayer expected that it would be rewarded for or obtain a profit from the exploration or the information it obtained in the course of that exploration. Lockhart and Burchett JJ in separate judgments found that Ampol was engaged in the business of exploration for petroleum for reward with the consequence that the expenditure or exploration off the China coast was an expenditure incurred in carrying on the business of exploration for the purpose of gaining or producing assessable income. As was pointed out by Lockhart J (at 546) the case "like others in this particular area of law" turned upon its own facts and circumstances. His Honour (at 560) concluded that the whole of the expenditure claimed was necessarily incurred in the carrying on of the taxpayer's business of petroleum exploration and was deductible under the second limb of s 51(1). Although his Honour accepted that exploration expenses must be incurred if petroleum is to be found he pointed out that the case provides no warrant for the more general proposition that exploration outgoings of companies engaged in petroleum exploration are necessarily deductible under the second limb of s 51(1). As his Honour said, that will be a question of fact in each case. Burchett J (at 577) arrived at a similar conclusion on the basis that the relevant business of the taxpayer was the discovery and exploration of oil and the expenditure was for the purpose of gaining the opportunity to pursue in China exploration of a kind normally pursued by the taxpayer in and near Australia, with a view to the rewards the exploration might bring. Those factors led his Honour to the conclusion that the expenditure fell within both limbs of s 51(1). Beaumont J formed a different view from that of the majority in relation to the taxpayer's business. His Honour said (at 571): "In short, the taxpayer was not merely an explorer - it was also concerned to develop any find for its own commercial profit. The second phase, that of exploitation of the discovery, is critical for present purposes. The expenditure was made to obtain for the taxpayer information and standing to participate in a potential commercial discovery. This was done with the prospect of the development of that discovery by the taxpayer as a petroleum field. It should be regarded as made on account of capital rather than on revenue account." Accordingly, Beaumont J was of the view that the expenditure was of a capital nature as it was payment of consideration for a capital asset or advantage. The appellant relied upon the majority in Ampol to contend that likewise, in the present case, the exploration expenses incurred by the appellant were a necessary and integral cost of carrying on the business of exploring for profit the minerals that may be discovered. In our view the reliance placed on Ampol by the appellant is misconceived. It was critical to the majority's findings in favour of the taxpayer in Ampol that the taxpayer was engaged for reward in the exploration business. In other words, it was an exploration company which incurred the relevant expenditure with a view to turning to account for profit or reward the benefits it obtained from its exploration activities. That may be contrasted with the position in the present case. His Honour found that the appellant was not an exploration company and that it did not incur the relevant expenditure with a view to turning to account for profit or reward the benefits it obtained from its exploration activities. Rather, his Honour found (at 469) that the activities were: "...of a preliminary nature, aimed at ascertaining whether it was commercially worthwhile to enter into mining joint ventures." One final matter should be briefly mentioned. There was evidence that some kind of commitment was made by the appellant at one mine in 1984. However, we agree with the submission of senior counsel for the Commissioner that the paucity of evidence in respect of that decision was such that the appellant failed to discharge the onus upon it to establish that any part of its claim under s 51(1) for that year of income has been wrongly disallowed. For these reasons the appeal in relation to review, evaluation and bidding costs must fail. 3. DEEP WATER TECHNOLOGY On 1 December 1977 the appellant and Hematite Petroleum Pty Ltd ("Hematite") entered into a joint venture agreement to explore for petroleum in the Exmouth area off the West Australian coast and to exploit any commercially viable reserves discovered. The appellant and Hematite were to share all risks and expenses equally and to jointly own the venture assets and the petroleum obtained. The appellant was designated as operator.

The waters in which the joint venture operations were to be conducted were very deep, of the order of 6,000 feet. Drilling at such depth required highly advanced technology ("the technology"). The appellant had access to thetechnology as an affiliate of its ultimate parent Exxon Corporation Inc (Exxon). Before the appellant entered the joint venture agreement with Hematite, Exxon informed the appellant that Exxon had outlaid approximately US$80m on research for the development of the technology and that the proposed joint venture should pay US$30m for the use of it.

In due coursethe joint venture agreement made provision for the useof thetechnology and for a contribution to be made by Hematite in return for the introduction of that technology to the joint venture by the appellant, as set out infollowing clause: "7.01 EEPA through its affiliates has access to and is entitled to use in ventures in which it is involved, technology capable of being used in drilling in and producing petroleum from deepwater environments such as are found in the area. In recognition that EEPA has agreed to contribute such technology to the joint undertaking: (a)Hematite will bear a proportion of the cost of drilling exploration wells for the joint undertaking equal to its 50% participating interest plus 10% of such proportion (and EEPA's proportion of such costs will be correspondingly reduced) until the total amount paid by Hematite in excess of its 50% participating interest share of such costs equals the sum of US$1.5MM plus the annual increases thereon calculated as provided in cl 7.01(c); (b)EEPA will receive a share of production additional to its 50% participating interest share of production (and Hematite's share of production shall be correspondingly reduced) until the aggregate value of the additional production so received by EEPA equals the sum of US$13.5MM plus the annual increases thereon calculated as provided in cl 7.01(c). At the time the parties first agree on a plan of development, they will in good faith negotiate the amount of additional production to be received by EEPA with the objective of EEPA recovering the sum plus increases as aforesaid within seven (7) years after commencement of production, unless to do so would cause Hematite economic hardship in respect of the joint venture hereby constituted; (c)on each anniversary of the date on which the permit is granted commencing on the first such anniversary the sums referred to in cl 7.01(a) and (b) shall be increased by the product of the average unpaid monthly balances of such sums over each such year and the average over the same year of the maximum bank interest rate for overdrafts with limits of less than $100,000 as published in the Reserve Bank of Australia Statistical Bulletin; ... (f)in lieu of continuing to pay the increased proportion of drilling costs as provided in cl 7.01(a) and in lieu of foregoing a proportion of production as provided in cl 7.01(b), Hematite may at any time elect to pay the whole of or any part of the balance of the amounts referred to and calculated as provided in cl 7.01(a) and (b). Any such payments shall reduce the annual increases under cl 7.01(c) pro rata from the time of payment and annual increases in respect of the outstanding balance (if any) shall abate accordingly; ..." Thus, in broad terms, Hematite agreed to pay a disproportionate amount of the costs of drilling until the amount of costs it had paid exceeded its joint venture share by US$1.5 million and agreed that its share of production be reduced by such proportion as was necessary to enable a distribution of production to be made to the appellant in excess of the appellant's joint venture share up to a value of US$13.5 million. The worth to the appellant of the reduced costs and increased share of production was US$15 million. Of that sum the portion to be "recovered" by the appellant by distribution to the appellant of the increased share of production was to be negotiated between the parties with the intent that it be "recovered" within seven years. Hematite could elect to pay monies directly to the appellant to discharge or reduce the amounts calculated under cl 7.01(a), (b). In about January 1979 Hematite elected to make such a payment. According to the appellant's submissions the payment was the amount calculated under cl 7.01(a) as the increased proportion of costs to be discharged by Hematite. The sum paid was US$1,657,500 which, at that time, converted to A$1,464,934. In its income tax return for the year ended 31 December 1979 the appellant recorded that receipt in its profit and loss statement and described it as "receipt in respect of sale of technology". It brought the amount to account as a capital receipt. The Commissioner treated the sum as assessable income. His Honour held that according to the principles set out in Federal Commissioner of Taxation v The Myer Emporium Ltd (1987) 163 CLR 199 the payment receivedwas income according toordinary concepts for the purpose of s 25(1) of the Act. First, his Honour held (at 472-473) that entering into the joint venture agreement was part of the ordinary course of the appellant's business and as the payment was derived from that agreement it was a gain from a transaction made in the ordinary course of business and, therefore, was stamped with the profit-making purpose of the business. Such a conclusion was open to his Honour on the material before him. His Honour held alternatively (at 473) that even if entry into the joint venture agreement was not a transaction in the ordinary course of carrying on the appellant's business, the appellant had acquired the right to use the technology as part of its business activities and as obtaining the authority to use the technology and the use of the technology were incidental to the appellant's business as an explorer and producer of oil and gas a profit-making purpose could be inferred from the association of the transaction with the appellant'sordinary business. In those reasons we understand his Honour to have held that even if entry into the joint venture agreement was an extraordinary transaction, judged by reference to the ordinary course of the appellant's business, nonetheless it was a transaction entered into for the purpose of making a profit and the sum received was a gain of that character. The profit-making purpose was to be inferred from the application of incidents of the appellant's business and the objects of the agreement. Applying the principles set out in Myer, that was a conclusion open on the facts. As a further alternative, his Honour held (at 473-474) that even though the appellant's primary (but not sole) purpose in making the joint venture agreement was to discover petroleum in the Exmouth area, an ancillary purpose was to turn to profit account the technology made available to it by Exxon. This it did by requiring Hematite to pay more than half of the outgoings and to receive less than half of the production or, at Hematite's option, to pay a sum of money for parity in these respects. Whichever course Hematite took there was a gain to the appellant that would be income according to ordinary concepts. This conclusion may be seen as a re-statement or amplification by his Honour of principles relied upon in the preceding conclusion. In effect his Honour held in the alternative that he was satisfied that the gain obtained by the appellant under the joint venture agreement (for introducing the technology to the joint venture) was a part of a business transaction that had been entered by the appellant for the purpose of gaining profit from the discovery and exploitation of petroleum by use of the technology. It followed that a pecuniary benefit obtained by the appellant for making available the technology under that profit-making transaction would be a gain stamped with the profit-making character of the transaction and would remain so whether the gain was received as a sum of money or by reduced outgoings and increased receipts. When entering the joint venture agreement, the appellant as part of its business possessed know-how which, by means of the joint venture agreement, it turned to account by obtaining consideration from Hematite for use of that technology. Realisation of the profit-making purpose of the transaction depended on the use of the technology. In the circumstances the gain was a receipt realised in a business operation or transaction entered for a profit-making purpose and it bore the character of revenue. Again, that conclusion was open on the facts on application of the principles set out in Myer. In its submissions the appellant contended that his Honour erred in those findings by giving insufficient weight to the evidence of two witnesses. Those were Dr Gardiner, whose affidavit explained the technology and how it had been developed for use in exploration and production by affiliates of Exxon, and Mr Kruizenga whose affidavit described internal company forces and some external economic and political forces affecting the appellant's decision to seek and make the joint venture agreement with Hematite. Further, counsel for the appellant argued that his Honour gave insufficient weight to "the context of the receipt", namely, the joint venture agreement the purpose of which was the exploration of and possible production from the Exmouth area with a suitable Australian joint venture partner. We agree with counsel for the Commissioner that those submissions did no more than contest findings of fact without attempting to display palpable error by his Honour in respect of those findings. In any event, the evidence of Dr Gardiner revealed that the technology was made available by Exxon for use by all of its subsidiaries. This evidence supported his Honour's conclusion that the appellant was turning its technical know-how to account by obtaining payment from Hematite. Mr Kruizenga's evidence did no more than describe the business and political context in which the agreement was entered into. The reference to the "context of the receipt" is not easy to follow. Contrary to the appellant's submissions his Honour's conclusions were based on full consideration of the effect of the "context". The principal submission by the appellant was that the payment received by the appellant from Hematite was a receipt in the nature of capital in that it was a sum received for the "alteration of commercial benefits or entitlements" the appellant held under the joint venture agreement. It was said that the right to such "benefits or entitlements" was a "capital asset" and, therefore, an "alteration" to that asset of a permanent kind, gave the character of capital to a sum received as consideration for that alteration. We, like his Honour, are unable to accept that submission. The rights of the appellant under the agreement were not altered or lost. The appellant received a payment provided for by the joint venture agreement as an amount equivalent to the alternative benefit to be received by the appellant under the clause, namely, by reduction of outgoings and increase in receipts. The payment received may have been an acceleration of the benefit that the appellant may have received otherwise under the joint venture agreement but it was not a payment made independently of the agreement in return for the giving up by the appellant of a "capital advantage". The so called "one-off" nature of the payment did not alter the revenue character of the receipt as stamped by the circumstances described. (See GP International Pipecoaters(1990) 170 CLR 124 at 137; Allied Mills Industries Pty Ltd v Federal Commissioner of Taxation (1989) 20 FCR 288, 300-301). In so far as an alternative submission was made by the appellant that the sum received represented the proceeds of sale of a capital asset, his Honour, correctly in our opinion, dealt with that as follows (at 473-474): "Although the technology payment was described by the taxpayer in its return as a receipt for the sale of technology, that is not an accurate description of the transaction. The taxpayer did not relinquish any part of its business structure. Although it obtained benefits as a result of making the technology available to its joint venturer, it was free to use it for itself in any other project. Indeed the relevant technology had been invented for use in any deep water project, subject only to adaptation for particular sites. There was thus no parting with a capital asset in exchange for the payment. Rather, the taxpayer chose to turn technology available to it to profitable account by sharing it with another in exchange for the payment of money: cf Rolls-Royce Co v Inland Revenue Commissioners [1962] 1 WLR 425 at 427, 429, 433, 438; Allied Mills Industries Pty Ltd v FCT at FCR 301; Case W10 89 ATC 182 at 186." Theevidence showed that the technology was able to be applied anywherein the world. This supports his Honour's conclusion that the appellant did not deprive itself permanently of some part of its capital assets or part of its capital infrastructure. On the contrary it had knowledge which it made available for a price. The same knowledge was available to be used again and again. This part of the appellant's appeal must fail.

4. OPERATORSHIP ASSUMPTION PAYMENT The background facts in relation to this issue were summarised by his Honour: "South Pacific Petroleum NL (SPP) and Central Pacific Minerals NL (CPM) (known as the Rundle Twins) held an authority to prospect in relation to a deposit of oil shale in the Rundle area. In February 1980 the taxpayer submitted a proposal to acquire an interest in the Rundle Oil Shale Project and was selected as the successful bidder. The appellant's bid provided for it to acquire a 25% equity in the resource which could be increased to as much as 50% depending upon the extent of the phase one costs to be incurred by the taxpayer. Increased expenditure by the taxpayer would result in an increase in its equity determined in accordance with what was called the `P' formula. The taxpayer undertook to commence the work program as soon as it was selected and without waiting for the execution of formal documentation. Negotiations continued over a number of months. The taxpayer proposed that it become operator upon the execution of heads of agreement. However, the Twins proposed that the taxpayer become operator only when the joint venture agreement was signed. In June 1980 this impasse was broken by the taxpayer agreeing to make ten annual payments of $25 million each, and an additional payment of $27.5 million called an "operatorship assumption payment". The P formula was to be abandoned and the taxpayer would become operator on signing the heads of agreement. Heads of agreement were executed in July, and pursuant thereto the taxpayer forthwith became operator of the venture. Shortly after, the taxpayer paid the first instalment of the operatorship assumption payment of US$10m (A$9,388,246). The taxpayer thereupon began what was called a Class V estimate of the project - a detailed estimate of probable cost to determine its economic feasibility. In February 1981 the results of the work program and Class V estimate showed that the original cost estimates were too low. The parties agreed to amend the heads of agreement. In substance it was determined that the taxpayer's obligation with respect to the balance of the operatorship assumption payment would be satisfied by payment of a further US$5m (A$4,655,493) three days after the effective date of the joint venture agreement, which was 25 February 1982. The taxpayer claimed a deduction for the two instalments in its 1980 and 1982 years of income in reliance on s 51. The Commissioner disallowed the deductions." (at 474) The parties' contentions to the primary judge in relation to the Commissioner's disallowance of the deductions claimed were summarised by his Honour as follows: "For the Commissioner it was contended that the payment was part of the price paid for the purchase of a participating interest in the joint venture and associated rights accorded it by the heads of agreement. The Commissioner relied particularly on the evidence of Malcolm Lye, who was in charge of the taxpayer's Rundle negotiating team. Mr Lye said that the strategy adopted by the taxpayer was to use a cash payment "to settle the negotiation". He agreed that his American superiors supported the idea of a cash payment which would settle the outstanding issues, chief of which was operatorship (223). He also agreed with the statement in a contemporaneous document that "while payment is stated to be for early operatorship in fact it was much more, it really clinched the deal". He added, however, that "operatorship was the major final issue", and "by settling that it also clinched the deal" (227). He agreed that it was probably the case that the taxpayer would not have had a joint venture or heads of agreement without the payment, that the payment benefited the project for its entire duration and not just its early stages, and that it was really part of the cost of acquisition of what the taxpayer got under the agreement with the Twins (229-230). The taxpayer, on the other hand, relied on cl 10.03 of the heads of agreement. This was as follows: In consideration of SPP/CPM consenting to the assumption of the operatorship of the Project by EEPA prior to the Effective Date and thus in consideration of SPP/CPM agreeing to EEPA being the Operator of the Project during the period between the execution of the Heads of Agreement and the Effective Date, EEPA shall pay an amount (hereafter referred to as the "Operatorship Assumption Payment") .... It was said that in the period preceding the execution of the heads of agreement the taxpayer was in a predicament. It could not get operatorship until the joint venture agreement was signed, and that would not be for quite some time. Yet it had to be operator in order to carry out the Class V estimate. Accordingly, it agreed to pay $27.5 million in order to acquire operatorship so it could carry out the Class V estimate. Clause 10.03 expresses the consideration in that way - the price of the Twins' agreement that the taxpayer become the operator forthwith and not have to wait until the effective date. The clause was not attacked as a sham, and there was no reason why the parties, who were at arm's length, would falsely state the consideration for the payment." (at 475) His Honour concluded that the two instalments in question were outgoings of capital: "On the whole of the evidence, documentary and oral, I have concluded that the payment was made to secure the Twins' agreement to execute heads of agreement, one of the provisions of which was that the taxpayer would become operator upon the execution of the document, and not solely to achieve early operatorship. Although cl 10.03 points to the payment having that limited role, the parties' description of the consideration in exchange for which the payment was made is not conclusive of its character, being only part of the matrix of facts from which the character of the payment is to be determined: Rotherwood Pty Ltd v Federal Commissioner of Taxation (1996) 96 ATC 4203 at 4213. Other contemporaneous documents, and the substance of Mr Lye's evidence, tend against the taxpayer's characterisation. The nature of the advantage sought by the making of an expenditure is the chief, if not the critical, factor in determining the character of what is paid: GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR at 137. In my view the operatorship assumption payment was the consideration for the acquisition of an asset of a lasting character which would enure for the benefit of the taxpayer's organization or system or profit-earning subject; cf per Dixon J in Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 361. The claim to a deduction under s51(1) therefore fails." (at 476-477) On the appeal the appellant contended that his Honour erred in not accepting that: · as the operatorship assumption payment was required to be made pursuant to cl 10.03 of the heads of agreement and not otherwise it was properly to be characterised, in accordance with the clause, as a payment in consideration of the early assumption of operatorship; · the appellant's characterisation was consistent with the substance of the evidence before the Court and, in particular, the evidence of Mr Lye. The difficulty with the first limb of the appellant's submission is that his Honour was not bound by the characterisation given in the contract to the payment in question. The law in that regard, which was applied by his Honour, was stated by the Full Court in Rotherwood Pty Ltd v Commissioner of Taxation (1996) 64 FCR 313 at 324: "Where a sum paid or received is described as the consideration for a contract, the description applied to the sum by the parties to the contract is to be given some weight but it does not follow that the character of the payment as made by the payer, or as received by the payee, is determined by that description: see Cliffs International Inc v Commissioner of Taxation (1979) 142 CLR 140. The description of the payment in the contract may be only part of a matrix of facts from which the character of the payment, as paid or received, is to be determined: see Reuter v Commissioner of Taxation (1993) 93 ATC 5,030 at 5,036; Commissioner of Taxation v Cooling (1990) 22 FCR 42 at 53 per Hill J. That is not to say that the process of characterisation permits documents recording or describing the payment made or received to be disregarded as if the transaction recorded therein were a sham. What is said is that the Court is required to look at the circumstances as a whole and not restrict itself to consideration of the form of a document in which the payment is recorded or the words chosen by the parties to describe the payment: see SP Investments Pty Ltd v Commissioner of Taxation (1993) 41 FCR 282 at 294-295 per Hill J." The difficulty with the second limb of the appellant's submission is that Sundberg J looked "at the circumstances as a whole" including the heads of agreement. His Honour then concluded that, having regard to those circumstances and in particular Mr Lye's evidence and the relevant contemporaneous documents, the operatorship assumption payment was made to secure the Twins' agreement to execute heads of agreement rather than solely to secure early operatorship. It is plain that there was ample evidence before his Honour to support his findings and in our view no error on the part of his Honour has been demonstrated by the appellant. Having rejected the appellant's characterisation of the payments in question and concluded that the payments were made to "secure the Twins' agreement to execute heads of agreement" and not "solely to achieve early operatorship" it followed that the payments were correctly characterised by Sundberg J as payments to acquire a capital asset for the reasons given by his Honour: see The Colonial Mutual Life Assurance Society Limited v The Federal Commissioner of Taxation (1953) 89 CLR 428 at 454 and GP International Pipecoaters Pty Ltd v The Commissioner of Taxation (supra) at 137. Accordingly, the appeal on this ground fails. We would add that the appeal on this ground must fail in any event as it was also dependant upon the Full Court accepting the further contention of the appellant that the payments fell within the second limb of s 51(1). It is clear that: · the joint venture and the relevant payments related to exploration; · despite the large amounts involved in the joint venture it was a commitment to do no more than carry out exploration activities to determine the feasibility of oil shale mining; · any decision whether to make a commitment to produce oil shale was to come at a later stage after the feasibility of oil shale mining was determined. Accordingly, the reasons given by us for rejecting the appellant's appeal against his Honour's conclusions on the non-deductibility of "Review, evaluation and bidding costs" under s 51(1) also lead to the conclusion that the two instalments of the "operatorship assumption payment" do not fall within the second limb of s 51(1) as they were not expenditures necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income.

5. TENEMENT ACQUISITION COSTS In each year except 1979 the appellant claimed deductions for expenditure described as tenement acquisition costs. Tenements were required by the appellant for the purpose of conducting exploration and prospecting activities. Each tenement in relation to which expenses were incurred was abandoned or relinquished during the previous year without any consideration being received. The expenses were for such items as technical and professional services, options, rentals, legal fees, taxes, stamp duties and licence fees. The deductions were claimed under s 122K or alternatively under s 124AM. Section 122K(1), which is in Div 10 provides: "(1) This section applies where deductions have been allowed or are allowable, under this Division or under provisions of a previous law of the Commonwealth relating to the taxation of income derived from mining operations, in respect of expenditure of a capital nature by the taxpayer in respect of property of the taxpayer which, in the year of income, has been disposed of, lost or destroyed, or the use of which by the taxpayer for prescribed purposes or eligible purposes has, in the year of income, been otherwise terminated." Subsections (2) and (3) provided, as they still do, as follows: "(2) Where the aggregate of: (a) the sum of the deductions so allowed or allowable; and (b) the consideration receivable in respect of the disposal, loss or destruction or, in the case of other termination of the use of property, the value of the property at the date of termination of use; exceeds the total expenditure of a capital nature of the taxpayer in respect of that property, so much of the amount of the excess as does not exceed the sum of those deductions shall be included in the assessable income. (3) Where the total expenditure exceeds that aggregate, the excess shall be an allowable deduction." His Honour upheld the appellant's case on this issue and the Commissioner appeals. His Honour held that the expression "expenditure of a capital nature ... in respect of that property" should be accorded its plain meaning and not, as the Commissioner argued, read as though it included the words "allowed or allowable under Division 10." In our opinion, the plain meaning of the statute compels the conclusion which his Honour reached. In s 122K(2)(a) the expression "deductions so allowed or allowable" is referring back to subs 1 which states that the section applies "where deductions have been allowed or are allowable under this Division...". When subs (2) goes on to speak of "the total expenditure of a capital nature ... in respect of that property" clearly a different concept is intended. It is fundamental to Division 10 that some capital expense is allowable (s 122A(1)) and some is not (s 122A(2)). We agree with his Honour that such extrinsic material as was referred to supports the appellant's contention. First, Parliament varied to a relevant extent the recommendation of the committee on taxation (see 144 ALR 478-479). Also the explanatory notes to theamendment to the Bill which introduced the relevant legislation said that the provision "will ensure that the mine owner is allowed deductions totalling the full amount of the difference between the cost price of the asset and the amount received on its sale, loss or destruction" (Emphasis added). The construction placed on the section by his Honour represents a rational view that might be taken, namely that during the course of operations of a tenement only certain capital expenses may be deducted but that when operations cease all may be deducted, or assessable, depending on the net outcome. This result is no more irrational than allowing any deductions for capital expenditure in a statute which imposes a tax on income, or allowing some capital deductions and not others. The appeal by the Commissioner on this issue fails.

SUMMARY OF CONCLUSIONS Exploration and Prospecting Costs The appellant is not entitled to deductions for exploration and prospecting costs incurred in the years of income 1980 to 1984. Review, Evaluation and Bidding Costs The appellant is not entitled to deductions in the years of income 1979 to 1984 in respect of review, evaluation and bidding costs. Deep Water Technology The payment of $1,464,934 received by the appellant pursuant to the joint venture agreement with Hematite was correctly treated as part of the assessable income of the appellant in the 1979 year of income. Operatorship Assumption Payment The appellant is not entitled to deductions for the first instalment of the operatorship assumption payment paid in the 1980 year of income or the second instalment paid in its 1982 year of income. Tenement Acquisition Costs The appellant is entitled to the deductions claimed in respect of tenement acquisition costs in the years of income 1980 to 1984.

Accordingly, the appellant's and the Commissioner's appeals are to be dismissed with costs. I certify that this and the preceding thirty-eight (38) pages are a true copy of the Reasons for Judgment herein of the Honourable Justices Lee, Heerey, and Merkel

Associate: Dated: Counsel for the Appellant: Mr A J Myers QC with Mr J G Santamaria QC

Solicitor for the Appellant: Middletons Moore & Bevins

Counsel for the Respondent: Mr G A A Nettle QC with Mr N Mukhtar

Solicitor for the Respondent: Australian Government Solicitor

Date of Hearing: 23, 24, 25 and 26 March 1998