Federal Coke Co Pty Ltd v Federal Commissioner of Taxation [1977] FCA 3; - FCA 1977 case summary — Zoe

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Federal Coke Co Pty Ltd v Federal Commissioner of Taxation [1977] FCA 3;

[1977] FCA 3

Federal Court of Australia|1977-06-20

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At a glance

Source facts

Court

Federal Court of Australia

Decision date

1977-06-20

Source

Original judgment source is linked above.

Judgment (103 paragraphs)

[1]

Federal Coke Co Pty Ltd v Federal Commissioner of Taxation [1977] FCA 3; (1977) 34 FLR 375 (20 June 1977)

[2]

FEDERAL COKE CO. PTY. LTD. v. FEDERAL COMMISSIONER OF TAXATION (1977) 34 FLR

[3]

Income Tax - Whether receipt income or capital - Agreement between parent company and overseas purchaser varied - Compensation paid to wholly-owned subsidiary that was not party to agreement but had incurred capital loss in consequence of variation - Voluntary receipt - Not related to income-producing activities - Parent company and wholly-owned subsidiary separate entities - Character of receipt in hands of parent company irrelevant - Income Tax Assessment Act 1936-1973, s. 25. The Supreme Court of New South Wales decided that payments received by the taxpayer, the Federal Coke Co. Pty. Ltd. ("Federal") were income receipts and taxable. The payments were made to the taxpayer by Societe Anonyme Le Nickel ("Le Nickel") at the instigation of the taxpayer's parent company, Bellambi Coal Co. Ltd. ("Bellambi"). Bellambi, a coal-producing company, was at all material times the holding company of three coke-producing companies, including the taxpayer. By agreement dated 24th April, 1970, made between Bellambi and Le Nickel, Bellambi agreed to sell to Le Nickel coke produced by its subsidiaries. At the date of the agreement there existed an arrangement between Bellambi and each of its subsidiaries whereby the subsidiary converted into coke such quantities of Bellambi's coal as was required from time to time in return for a service fee.

[31]

13. It seems that the discussions with Le Nickel (Australia) were broken off on 9th December, 1969. On 11th December, 1969, the manager of Bellambi prepared a report for submission to a board meeting held on 19th December, 1969. In his report, which was entitled "Future Operations in Coke Manufacture and Distribution by the Bellambi Coal Co. Ltd.", the general manager reviewed the various alternatives which were open to Bellambi and its subsidiaries. The two principal alternatoves were either to close each of the two coke works then separately owned by the company's subsidiaries, that is Federal and Mt. Pleasant, or to spend $1.12 million at those plants to achieve compliance with the requirements of the Clean Air Act and further to spend $1.13 million on the acquisition of Corrimal Coke Co. Pty. Ltd. and make some modification of its works. In the report, reference was made to the negotiations which had been proceeding with Le Nickel (Australia) and it was noted, "These negotiations have been temporarily suspended". It was noted that coke was on offer to a number of other overseas users and the general manager expressed the opinion that the surplus capacity of the industry could be profitably exported over the next few years. His recommendation was in favour of the second of the alternatives referred to above. At the board meeting on 19th December, 1969, it was resolved that the recommendation by the general manager in his report dated 11th December, 1969, relating to the expenditure of $1.12 million on the coke works operated by Federal and Mt. Pleasant to achieve a compliance with the Clean Air Act and to obtain increased capacity and greater efficiency at the Mt. Pleasant works and the expenditure of $1.13 million on the acquisition and modification of the coke works operated by Corrimal be approved subject to the signing of a memorandum evidencing the willingness of another company, Kembla Coal and Coke Pty. Ltd., to purchase coke for supply for a period of seven years commencing January 1970. (at p380)

[35]

17. In the event and notwithstanding the provisions in the agreement for delivery of 70,000 long tons per annum computed from 1st January, 1971, Le Nickel experienced difficulties and had accepted delivery of only 25,372 tons up to 30th June, 1971. There was a meeting in Sydney on 2nd July, 1971, at which Monsieur Germenot, the managing director of Le Nickel (Australia), requested cancellation of the agreement. On 7th July, 1971, Bellambi sent a telex to the head office of Le Nickel in Paris expressing concern about this request and pointing out that when the agreement was negotiated it was made clear to executives of Le Nickel that Bellambi were purchasing a coke plant for the purposes of fulfilling their obligation to supply the quantity. Capital expenditure on acquisition and subsequent modifications to achieve compliance with the Clean Air Act had been very substantial. It was suggested there should be an exchange of views between the executives of the parties. At a board meeting of Bellambi held on 27th July, 1971, it was resolved that the chairman of the board, Mr. J. B. Massy-Greene, and the general manager, Mr. Ryan, "be authorized to negotiate a settlement with representatives of Societe Anonyme Le Nickel". Meetings were held in Paris on 12th, 13th and 18th October, 1971, the meeting on the last of these days being attended by Mr. Massy-Greene and Mr. Ryan. On this last day a negotiated settlement was reached which was then recorded in minutes of the meeting. These minutes contained various recitals, including one that Le Nickel had informed Bellambi that the prevalent economic recession had affected the demand for nickel and Le Nickel had been obliged to reduce production entailing loss of profit and also other severe financial hardship and this situation had reduced its requirements for coke. It had accordingly asked Bellambi to vary the agreement between them. The minutes also recorded that Bellambi had pointed out that any reduction in the contractual deliveries of coke under the agreement would entail "not only loss of profit to Bellambi but also other severe financial hardship". (at p381)

[42]

"WHEREAS

(A) By an agreement dated 24th April, 1970, (hereinafter called

'the agreement') Bellambi and Le Nickel provided for the sale by

Bellambi to Le Nickel over a period of five years approximately of

coke manufactured by certain subsidiary companies of Bellambi,

including Federal Coke Works Pty. Ltd. (hereinafter called

'Federal').

"(B) Le Nickel has informed Bellambi that, by reason of an

economic recession and a fall in the demand for nickel, the

requirements of Le Nickel for coke have greatly reduced.

"(C) Le Nickel has requested Bellambi to reduce the amount of

the coke produced by subsidiary companies of Bellambi as

referred to in cl. (1) of the agreement and to reduce the quantity of

coke to be sold by Bellambi to Le Nickel under the agreement.

"(D) Bellambi has informed Le Nickel that such reduction as

aforesaid can only be achieved in a practical manner if there is a

discontinuance of all production of coke by Federal and the

closure of Federal's coke works.

"(E) Bellambi has informed Le Nickel that discontinuance of

production at Federal's coke works will involve the closure of

those works and that thereby the value of the land and assets

owned by Federal comprising such coke works will be directly

and immediately reduced by reason, inter alia, of action likely to

be taken by authorities of the State of New South Wales and

certain local government authorities against the coke works in a

non-operating condition which would not be taken against them

while operating and by reason of other detriments to Federal."

Of the operative provisions, it is sufficient to record cl. (1) which

is as follows: "In the circumstances aforesaid Le Nickel hereby

agrees to pay to Federal the sum of one million dollars

($1,000,000) to compensate Federal (and consequently Bellambi)

for such loss in the value of the land and assets of Federal as

aforesaid (and consequently in the value of the assets of

Bellambi) and it is agreed that such sum shall be paid by two

equal instalments of five hundred thousand dollars ($500,000)

each on 31st March, 1972, and 31st December, 1972." (at p383)

[50]

31. The true facts that appear are that Federal was engaged in a coke-producing business, although at the time the first payment was received by it, Federal had ceased to carry on that business. In the negotiation of the round sum of $1 million, which was agreed between Bellambi and Le Nickel, no precise factors were used in the calculation so far as appears from the evidence. It is plain from the order of events and the wording of the minutes of the Paris conference of 18th October, 1971, that what was in the minds of the negotiators was, on the one hand, the effect of the lessening in demand for nickel and the consequent necessity of reducing production and the loss of profit and other financial hardship entailed for Le Nickel making it necessary for that company to secure a reduction in its obligations to take coke from Bellambi, and on the other hand, the loss of profit to Bellambi and other financial hardship which would be suffered by that company if the quantities of coke were to be reduced. "Other financial hardship" referred to may well have involved some assessment of what Bellambi would suffer by reason of consequential loss of profit or capital loss suffered by all or any of its three subsidiaries including Federal. In the latter respect, what appears to have been under consideration was Bellambi's loss and not the loss of any particular subsidiary. When the arrangements between Bellambi and Le Nickel were altered, as appears from the deed of 22nd March, 1972, the decision that the payment should be made to Federal seems to have been made largely for the purpose of avoiding income tax. It is true that between the time of the Paris conference and the amending deed of 22nd March, 1972, a decision had been taken by Bellambi to close down the business of Federal and it had in fact been closed down. It had then become evident that, of the subsidiaries, it was Federal which would suffer loss of profit by loss of the service charge which it would have received from Bellambi for producing the coke from Bellambi's coal. It had also become evident that it was Federal which would suffer capital loss by reason of having to close down its coke works. In the case of Federal, its capital problem was particularly acute because its land, once the existing use terminated, would have value only as land zoned under the Illawarra Planning Scheme Ordinance as open space (public parks and recreation) and its plant and equipment could no longer be sold on a going-concern basis. (at p386)

[54]

35. Counsel for the commissioner further submitted that the payments were to compensate Bellambi for loss of profits and for this reason acquired an income character and that they retained this character and did not lose it when the deed was interposed whereby the arrangement was altered and the payments were made to Federal. Nothing had been done, so it was argued, which would indicate that the character of the payments was altered. It may be possible to envisage a case where, for example, the subject of a gift would be seen to have in its origin the essential character of income and to retain that character in the hands of a donee. The case of a transfer without consideration of a payment of future interest on debentures might be regarded as such a case. But there the essential income character of the receipt, which would lie in its being the product of a capital investment coming forward in a series of periodic payments, would remain unchanged in the hands of the donee. In the present case, the suggested income character of the receipts having regard to the original arrangement, would be partly in the formulation of them as compensation for loss of profits and partly in their being received by Bellambi in the course of its business to "fill the hole in its profits". But under the deed of 22nd March, 1972, they were not received by Bellambi. A consequence of this is that one of the factors, which would have impressed them with the character of income, disappears. One is left only with the method of formulation and the original purpose of Bellambi and Le Nickel. It appears to me that this is insufficient to impress upon the sum an essential and unchangeable character of income. Indeed, it appears to me that the starting point of this argument for the commissioner is wrong. When one is considering the character of an amount received by a taxpayer, the inquiry must start with the question: what is the character of the receipt in the hands of the taxpayer? It appears to me to be wrong to ask: what would have been the character of the amounts had they been received by Bellambi? and then to pose the question: has their character been changed by the fact they were paid to Federal? One must, I think, pose the essential question and start from that question: what is the nature of the receipts in the hands of Federal? (at p388)

[71]

"You will recall that during our meeting in Paris in November,

which was for the purpose of determining certain alterations to

the coke contract which exists between our two companies, it was

agreed that this company would prepare the amending document

and submit it to you for your consideration.

"I regret the delay in not submitting this document to you

earlier. However, upon my return to Sydney from Paris, it was

necessary for me to leave for Japan almost immediately and I

have been there for nearly the whole of the last four weeks.

"I now enclose a copy of the document which is designed to

give effect to the agreement reached between us during our

meeting in Paris. It has been compiled after due discussion with

Mr. Pointon, of Herbert Smith & Co., and with Cooper Brothers,

the company's auditors who are also represented in Paris, and in

its present form I understand that payments made under the

document will be deductible by you for taxation purposes.

"I have sent a copy of this document to Mr. Germenot of your

Sydney office for his information. Our solicitors in Australia,

Allen, Allen & Hemsley, have sent a copy to Mr. Pointon and have

explained to him in detail, the reasons why certain phraseology is

used. Accordingly, if you desire further information on this

matter, may I suggest that initially you contact Mr. Pointon.

"From 27th January to 4th February next year Mr. Mahoney

Q.C. who has been advising this company on the taxation

aspects of moneys received by Bellambi under the agreement, will

be in London and is willing, at Bellambi's expense, to go to Paris

to further explain to you, if you should so require, why the

document is in the form that it is. Mr. Mahoney's function will be

solely to provide an explanation. Arrangements to meet him can

be made through Mr. Pointon, who will attend to all the

necessary details.

"If the document is acceptable to you in the form submitted,

would you please arrange to process it for signature through Mr.

Pointon. If it is not acceptable, I would appreciate receiving your

comments." (at p393)

[84]

19. The learned trial judge went on to hold that the receipt by Federal instead of by Bellambi of the two instalments did not alter their character in the hands of Federal; they were still of an income nature and therefore formed part of the assessable income of Federal for the two years of income concerned. Counsel for the appellant argued that was not so. He contended that the source of the payments to Federal was the deed of 22nd March, 1972, and that receipt by Federal of each instalment was, as stated in the deed, part compensation for the loss in value of its land and assets arising from discontinuance of production at and closure of its works and was therefore of a capital nature. I cannot accept this contention. Although the payments were made pursuant to the deed of 22nd March, 1972, it is an incomplete statement of the position to say that the deed was the source of the payment to Federal. It was Bellambi that gave the consideration and arranged and directed that the payments be made to Federal. The deed, to which Federal is not a party, came into being at the instigation of Bellambi because Bellambi desired to avoid income tax on the two instalments of $500,000 each which it had been informed by Mr. Mahoney it would have been obliged to pay if it had received the two payments from Le Nickel. This is clear from the telex Bellambi sent to Le Nickel on 30th December, 1971. To Bellambi the way out of its taxation difficulty was to persuade Le Nickel to pay the two sums of $500,000 each to Federal instead of Bellambi as it was obliged to do under the settlement of 18th October, 1971, and to make it appear that the two payments were by way of compensation for an alleged loss in value of Federal's land and assets arising from the closure of its works. Bellambi on 23rd December, 1971, sent to Le Nickel a document designed to achieve that end and in the accompanying letter informed Le Nickel that payments by it to Federal would be deductible by it for taxation purposes. Bellambi's persuasion was successful for Le Nickel executed the document on 22nd March, 1972, notwithstanding that there never had been privity of contract between it and Federal and that it was not obliged to pay Federal anything by way of compensation or otherwise. The alleged compensation of $1,000,000 was not based on any valuation of Federal's alleged loss, it was simply the equivalent of what Bellambi was entitled to receive from Le Nickel. Nor was Le Nickel responsible for the closure of Federal. That was the result of a decision made by Bellambi which had it chosen could have kept Federal operative and closed one of its other subsidiaries, i.e. Mt. Pleasant or Corrimal or it could have kept all three subsidiaries active by reducing the output of all or one or two of them. When asked during the hearing before the learned trial judge why it was decided to close the coke works of Federal and not those of Mt. Pleasant or Corrimal, Mr. Ryan, the general manager of Bellambi, replied: "There were numerous reasons, but undoubtedly the major one was the Clean Air Act. Mt. Pleasant was much more advantageously placed than Federal as far as the Clean Air Act was concerned. In the case of Federal there were only seven and a half acres of land and in the case of Mt. Pleasant there were thirty. Federal was zoned open space, Mt. Pleasant was zoned light industrial. In the case of Federal there were buildings on the south and west and tennis courts and playing fields in the north. In the case of Mt. Pleasant there was residential area on the south, but some distance from the coke works, and separated by a line of trees. In addition the Mt. Pleasant works was a much more economic plant to operate than the Federal plant, and historically it had been subject to less industrial trouble than Federal. The reason why Corrimal was not closed was (that) the capacity of Corrimal was 128,000 tons a year, and we were only seeking to achieve a saving of 50,000 tons a year, and if we had done anything at Corrimal we would have had to close half the plant, which would have been a most uneconomic action to take." (at p399)