Federal Commissioner of Taxation v Cooling

The present is not a case where a mere question of fact and degree is involved. It involves the application of the Income Tax Assessment Act 1936 (Cth) ("the Act") to facts not in dispute. It involves a question of construction and the applicant should be entitled to amend the grounds of appeal to enable the issue to be argued: cf Collector of Customs v Agfa-Gevaert Limited (1997) 141 ALR 59. To the extent that the amendment necessitated an adjournment so as to allow the Commissioner to put additional matters to the Court, the applicant must bear the costs of that. But otherwise, there is no prejudice to the Commissioner. Nor can it be said, contrary to the Commissioner's submissions, that the amendment opens up new matters. As will be seen, the issue remains precisely that stated to the Tribunal, namely, whether the applicant made a "gain", the concept of "gain" being inherent in the concept of "income". The applicant complains as well in the amended grounds of appeal that the Tribunal erred in not making findings essential to its decision. The Administrative Appeals Tribunal is under an express obligation, by force of s 43 of the AAT Act, to make findings on material questions of fact and in its reasons for decision to state those findings. If a finding necessary to the determination of an issue is not made by the Tribunal, then the matter must be remitted to the Tribunal so that that finding can be made: cf Collector of Customs v Pozzolanic Enterprises Pty Ltd (1993) 43 FCR 280 at 286. However, as that case points out, in exercising its supervisory jurisdiction this Court should proceed with restraint for it is the Tribunal to which Parliament has entrusted the ultimate factual decision-making process. So, a judge of this Court will bear in mind the caution expressed in Pozzolanic (supra) at 287 and elsewhere, that the reasons for decision of the Tribunal are not to be construed minutely or examined over-zealously in an attempt to find error in law in what may well be merely looseness of expression. To examine, therefore, whether an error of law has been committed and, in particular, findings of fact necessary to an ultimate conclusion have not been made which ought to have been made, it is necessary to endeavour to state the law as I understand it relevant to the present problem. THE RELEVANT LAW Where a taxpayer carries on a business and makes a business profit, that profit will ordinarily be income. The qualification is necessary because a literal interpretation of this general principle must take into account the fact that there is a distinction between profits which are income and profits which are capital. It may literally be true that a taxpayer's sale of a capital asset occurs in the course of a business activity in a temporal sense. But a profit made on the sale of such an asset will not have the character of income because of the relationship which the asset has to the business activity: cf Westfield Limited v Federal Commissioner of Taxation (1991) 28 FCR 333 at 342-3; and Commissioner of Taxation (Cth) v Spedley Securities Limited (1988) 88 ATC 4126 at 4130. Thus, it will be essential to examine with care the nature and extent of the taxpayer's business activities, or, as has been put, to make "a wide survey and an exact scrutiny of the taxpayer's activities": see Western Goldmines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740, cited with approval by Gibbs J in London Australia Investment Co Limited v Commissioner of Taxation (Cth) (1977) 138 CLR 106 at 116. A recent example of the importance of this exact scrutiny is the decision of the High Court in GP International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) (1989-90) 170 CLR 124. In that case the taxpayer contracted to construct a plant and thereafter to coat pipes to be used in a pipeline for the transport of natural gas. The plant was an essential ingredient in the pipecoating process. The taxpayer received a sum of money under the contract, inter alia, for the construction of the plant and the issue for decision was whether this amount was income in the hands of the taxpayer. The Full High Court pointed (at 138) to the importance of ascertaining the scope of the taxpayer's business in determining the character of the receipt in its hands, referring to the well-known passage in Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 at 209-210, in the following terms: "Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit-making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a one-off' transaction preclude it from being properly characterized as income: Federal Commissioner of Taxation v. Whitfords Beach Pty. Ltd [(1982) 150 CLR 355 at 366-367, 376]." On the facts of the case it was held that the scope of the taxpayer's business was not limited to the coating of the pipes but extended to the construction of the plant. That being so it followed inexorably that the payment received was income and not capital. The Court left open whether a different result may have followed had the business been otherwise characterised. GP International Pipecoaters is important too for the statement of principle which it contains (especially at 136-137), applicable to the present case: "The question in this appeal is the character of the establishment costs as receipts in the hands of the taxpayer. Whether or not a particular receipt is income depends upon its quality in the hands of the recipient': Scott v. Federal Commissioner of Taxation [(1966) 117 CLR 514 at 526], per Windeyer J. The relevant question is not the character of the expenditure by S.E.C.W.A. [State Energy Commission of Western Australia] A receipt may be income in the hands of a payee whether or not it is expenditure of a capital nature by the payer. Nor is the relevant question the nature of the expenditure made by the taxpayer in the construction of the plant. A taxpayer may apply income in the acquisition of a capital asset or, conversely, apply a capital receipt to discharge a liability of a non-capital nature. As Cozens-Hardy M.R. observed in Hudson's Bay Co. v. Stevens [(1909) 5 TC 424 at 436]: ' ... if the money is otherwise liable to income tax it cannot escape taxation by reason of its being applied to a capital purpose.' And thus a receipt may be income although the recipient is bound to apply it for the purpose of discharging a capital liability: Mersey Docks v. Lucas [(1883) 8 App Cas 891 at 904, 909-910]; Commissioners of Inland Revenue v. Corporation of London (as Conservators of Epping Forest) [(1953) 34 TC 293 at 329; [1953] 1 WLR 652 at 670; [1953] 1 All ER 1075 at 1089-1090]. The Commissioner and the taxpayer both treated the cost of constructing the plant as capital expenditure, but the question is not whether that was an expenditure of capital nor whether the plant was used for the purpose of producing assessable income so that depreciation of the plant was deductible under s.54 of the Act. The relevant question is whether the receipt of the establishment costs was income in the taxpayer's hands. It is necessary to keep that question steadily in mind and not to confuse the character of the receipt with the nature of the asset acquired by application of the moneys received." So, two questions must initially be asked in a case such as the present. The first is what the payment in question was for. Having answered that question, it is necessary to identify the nature of the taxpayer's business to determine the relationship between what the relevant payment was for on the one hand, and the taxpayer's business on the other. As the cases make clear, in determining what a payment is for regard may be had to the entire matrix of circumstance to elucidate "how and why it came about": Squatting Investment Co Ltd v Federal Commissioner of Taxation (1953) 86 CLR 570 at 627-8; Rotherwood Pty Ltd v Federal Commissioner of Taxation (1996) 96 ATC 4203 at 4213; Reuter v Federal Commissioner of Taxation (1993) 93 ATC 5030 at 5036; and Cooling (supra) at 53. Where a payment is received under a written contract, that contract will generally provide the answer to the question of what the payment was for, albeit that in some cases it would not be determinative: Federal Coke Company Pty Ltd v Federal Commissioner of Taxation (1977) 34 FLR 375 at 403 per Brennan J. In the present case the factual circumstances add nothing to the contractual provisions. The applicant was to receive the $40,000 in consideration of covenanting to cause the lessee's works to be erected and in fact so doing. Having identified what the payment was for, one then turns to see what the applicant's business was. That is clear enough. It was, as the parties agreed in para 1 of the statement of facts, issues and contentions, which paragraph was not in dispute, the carrying on of the business of retailing surfwear. The applicant was not in the business of constructing improvements to shop premises. Although the Tribunal made no finding directly to this effect, the parties' agreement as to the facts permitted no alternative conclusion. It could hardly be said that the applicant was carrying on a business which included shop fitting or making improvements to shop premises. The payment to the applicant thus could not be said to be a payment constituting a profit or gain made by the applicant in the ordinary course of carrying on its business, even assuming it were correct to say that a profit or gain was in fact made by it. If no profit or gain was, in fact, made by the applicant, the applicant would be entitled to succeed whatever the nature of its business. The fact that the so-called profit or gain was not in the ordinary course of business could not be the end of the argument, as the parties agree. As the High Court in Myer made clear, a gain made otherwise than in the ordinary course of carrying on a business may nevertheless give rise to income. But whether it does depends very much on the circumstances of the case. So, as the well-known passage in Myer pointed out (at 209-210): "Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a `one-off' transaction preclude it from being properly characterized as income ...". What the High Court in that passage makes clear is that profit-making is an essential ingredient in the characterisation of an amount as income where the transaction is one not in the ordinary course of business. There is no need to find profit-making as a purpose where the transaction is one in the ordinary course of business because the very conclusion that a business is carried on carries with it the underlying concept of a profit-making purpose: cf Hope v The Council of the City of Bathurst (1980) 144 CLR 1 at 8-9 where Mason J, with whose judgment the other members of the Court agreed, described business as denoting "activities engaged in for the purpose of profit on a continuous and repetitive basis". So, the present case comes down to the question whether, in entering into a transaction designed to achieve that which it did achieve, the applicant had a profit-making purpose from which it received a profit or gain. This can, for present purposes, resolve itself into a single question, namely whether the applicant made a profit or gain in the relevant sense, since if it did there is no dispute that the applicant intended the nature and consequence of its actions. The way in which the Tribunal proceeded to deal with the question whether the applicant derived a profit or gain was to determine whether the non-demountable items were or were not lessor's fixtures. This was not an irrelevant question, although for reasons which I will indicate shortly I do not think it is determinative of the question for decision. It would seem obvious enough that, if the work included under the heading "Lessee's Works" brought about the consequence that the items in question became the property of the landlord, no relevant gain could accrue to the applicant. The Tribunal discussed the law of fixtures without reaching a final conclusion as to all the non-removable items. To the extent that it would be relevant to determine the question which of the items were fixtures, it would be necessary to remit the matter to the Tribunal for decision, unless the circumstances are such that no other conclusion was possible than that the items in question were either fixtures or not, as the case may be. There is little room for dispute as to the principles to be applied in determining whether a particular item is or is not a fixture. The generally accepted view is that the question will depend upon the degree of annexation and the object or purpose of that annexation: Commissioner of Stamps (Western Australia) v L Whiteman Limited (1940) 64 CLR 407 at 411. The two matters are not exclusive of each other. The degree of annexation tells as to the object or purpose of the annexation. When the cases speak of object or purpose, they are not concerned with subjective purpose of some person, although intention will not be irrelevant: Eon Metals NL v Commissioner of State Taxation (WA) (1991) 91 ATC 4841 at 4846; N H Dunn Pty Ltd v L M Ericsson Pty Ltd (1979) (2) BPR 9241 at 9244-9245. The prima facie view, as expressed in cases such as Australian Provincial Assurance Co Ltd v Coroneo (1938) 38 SR(NSW) 700, is that an object merely standing by its own weight on the land will not ordinarily be a fixture. On the other hand, if fixed to any extent prima facie it will be. But that is but a prima facie view as Mahoney JA pointed out in N H Dunn v Ericsson (supra) at 9246. If mere subjective intention were to provide a test, then it might well be said that items which are referred to as "tenants' fixtures" are in strictness not fixtures at all in that the intention is that the lessee have the right to remove them. But Hobson v Gorringe [1897] 1 Ch 182 at 192 provides authority for the proposition that the fact that there is a right of removal or severance does not prevent an item becoming a fixture and, as such, part of the land. When the cases refer to the degree and object of annexation to the land, what is meant is that the fixing of the item to the land, whether by bolts, concrete bases or whatever, is such that removal would be difficult as, for example, where the items could be ruined if sought to be removed: Whiteman (supra) at 411. That case is important in that it drew as a relevant distinction the question whether the affixation was for the better enjoyment of the land, in contrast to the case where the affixation was for the enjoyment of the item itself. That distinction is one later taken up by Mahoney JA in N H Dunn v Ericsson (supra), but subject to the qualification that much may turn upon the actual nature of the asset. In my view, on the evidence in the case, no conclusion is open but that each of the non-demountable items, to which reference has been made, is a fixture. The pebblecrete floor is, of course, the easiest example. To remove it involves rendering it unusable. Likewise, with paint and plumbing. The Tribunal was inclined to the view, and I think rightly, that the degree of annexation of the glass for the shop front, the wooden flooring and the like were such that it would be virtually impossible to hold that they were other than fixtures. In these circumstances it seems to me no point to argue that the Tribunal had made no finding, for to send the matter back to the Tribunal would lead only to the inevitable consequence that the Tribunal would find the items in question to be fixtures. Prima facie, once an item is a fixture it attaches to the land and becomes part of the realty. In other words, it becomes part of the property of the owner of the land. There is a question as to whether that is the case where the item in question is a "tenants' fixture":cf Re Sir Edward Hulse [1905] 1 Ch 406 at 411; Spyer v Phillipa [1931] 2 Ch 183; Registrar of Titles v Charles Spencer (1909) 9 CLR 641; and Commissioner of Main Roads v North Shore Gas Co Ltd (1967) 120 CLR 118. When it is said that an item is a "tenants' fixture", all that is meant is that the tenant has a right to remove the item at the expiration of the term of the lease or a reasonable time thereafter: cf D'Arcy v Burelli Investments Pty Ltd (1987) 8 NSWLR 317. If the item in question were not a fixture, a fortiori it would belong to the tenant and could be removed by the tenant at any time. Thus, the whole concept of tenants' fixtures assumes that the items in question have become fixtures but that the tenant has a right in equity in the land, co-extensive with the right of the tenant to come upon the land after the expiration of the lease and remove the fixture. In North Shore Gas Co Ltd v Commissioner of Stamp Duties (1939-40) 63 CLR 52 at 68, criticised in part in Commissioner of Main Roads v North Shore Gas Co Ltd (supra), Dixon J said of tenants' fixtures: "The primary consequence of so fixing such things in the soil that they are treated as forming part of it is that ownership of the articles follows ownership of the land. Though removable tenants' fixtures may during the term be detached and become chattels belonging to the tenant, yet the better opinion appears to be that unless and until the tenant exercises his right of removal they form part of the realty ... and for this reason, subject to the exercise of the tenant's right to convert them again into chattels, pass with the land." Although I prefer the view expressed by Dixon J, the outcome of the present controversy does not depend upon which view of the nature of tenant's fixtures is correct. The question whether the fixtures here are "tenants' fixtures" is not an easy one. If regard is had only to the lease, then it is clear that the definition of "Demised Premises" would include the non-removable fittings. It is equally true, literally, to say that the items in question would have been installed by the lessee on the premises with the consent and approval of the lessor so as to fall within the provisions of cl 5.05. The argument to the contrary is that, as the items had been paid for, in part, by Burns Philp prior to the lease coming into effect, they should not be regarded as falling within the provisions of cl 5.05. With some hesitation, I think the Tribunal was correct in deciding that the items in question were "tenants' fixtures". The question is whether that is the end of the matter. For the Commissioner it was submitted that the proper construction of cl 10 of the Agreement for Lease was that the applicant was entitled to payment of the $40,000 whether or not a cent was spent on the construction of work referred to as "Lessee's Works". With respect, that is not so. The clear construction of cl 10 in the events that happened was that the applicant contracted to have work carried out which in fact cost $90,000 and in consideration of contracting to have that work performed, became entitled to receive $40,000 as part reimbursement. Had no work been performed the applicant would have been entitled to no amount at all. The amount of $40,000 was payable on the official opening date which was to be not less than fourteen days after the fit-out date, that being the date upon which access was given to the applicant to carry out the works. Next, it was submitted by the Commissioner that the gain to the applicant was to be seen as being the availability to the applicant of the shop premises in their improved state. It was agreed by counsel for the Commissioner that it followed from this submission that all tenants were assessable on work done by landlords to fit-out premises for occupation, since in every such case there would be a gain which, by virtue of the aid of s 21A of the Income Tax Assessment Act 1936 (Cth), would form part of assessable income as a non-cash business benefit. That submission need only to be stated to be dismissed. It is useful to remind ourselves of the legislative history of s 21A. The section was enacted subsequent to the decision of the Full Federal Court in Federal Commissioner of Taxation v Cooke and Sherden (1980) 80 ATC 4140 which held that a free holiday paid for by a manufacturer for the benefit of a retailer was not income because it was not convertible to cash. The principle was stated in the joint judgment of Brennan, Deane and Toohey JJ at 4148 in the following simple proposition: "If a taxpayer receives a benefit which cannot be turned to pecuniary account, he has not received income as that term is understood according to ordinary concepts and usages." A fortiori it may be said that where the taxpayer does not benefit at all there can be no income derived. Section 21A operates only where there is a benefit which is a "non-cash business benefit" defined in s 21A(5) as: " property or services provided ... (a) wholly or partly in respect of a business relationship; or (b) wholly or partly for or in relation directly or indirectly to a business relationship;". Where it applies, the benefit is deemed convertible to cash. The section does not operate to create a benefit where none existed or to make income that which was not, except where the conclusion that the amount is not income depends upon non-convertibility. At the heart of the issue between the parties here lies the evidence of the builder that removal of the items would produce no more than scrap value. He said, and his evidence was uncontradicted, of the wooden floor, that it would be cheaper to leave it where it was and to construct a new floor elsewhere using new materials, rather than to remove the existing floor. He said also it would not be possible to salvage the walls of the storeroom and change rooms for reuse and that removal of pebblecrete or tiles would only be possible after their destruction. The only item of any apparent salvage value would seem to be the wash basin and taps. Thus, the uncontradicted evidence would seem to be that immediately after the work had been performed the applicant had a right worth merely the scrap value of the wash basin and taps to remove what had been constructed, although it did have the right to occupy the premises but only so long as it paid rent for that occupation. The Tribunal did not deal with the matter in the way just discussed. It made no attempt to quantify the profit or gain which the applicant had made. Yet for the conclusion which the Tribunal arrived at to be correct, it necessarily had to follow that the applicant did in fact make a profit or gain. No case to date has raised the issue presently before the Court. In Cooling there was a straight cash incentive. No question arose as to whether there was a gain to the taxpayer, for there was a cash payment. In Selleck v Federal Commissioner of Taxation (1996) 96 ATC 4903, the facts were closer to the present in that the landlord agreed to make the payment to be applied to a particular fit-out which was to remain the property of the tenant. Immediately after the work had been undertaken, however, the tenant sold the items in question and received a payment of $1M being identical to the cash payment made by the lessor. Thus, on any view of the matter, the taxpayer received a profit or gain of $1M. It is not surprising, therefore, that the lessees were held to have derived assessable income in that amount. There is little discussion of the nature of the lessee's gain, although the following comment of Drummond J indicates that the fact that the fixtures were sold was a not irrelevant consideration. His Honour said (at 4914): "... the receipt was a gain to the firm because, but for that receipt, the firm would have had to find the means to pay the entire cost of the fit-out out of its own resources, including its capacity to borrow, and also because it provided the firm with the means to enable the cash distributions to be made to the partners, which the firm would not otherwise have made." The reference to "cash distributions" is a reference to the distributions that were made out of the cash proceeds of sale. The issue of gain did not arise in Rotherwood (supra), a case which depended upon rather unusual facts. In that case the profit or gain consisted of the trustee entering into an arrangement to receive $6M for the surrender of a head lease in circumstances where that head lease was worthless. The lease had no marketable value at the time of surrender (see at 4211). The case was not a mere surrender of a lease for a capital amount which could have involved no gain to the taxpayer. Finally, Montgomery v Federal Commissioner of Taxation (Jenkinson J, 8 April 1997, unreported) again involved the receipt by a taxpayer of a cash amount where the taxpayer was under no obligation to expend the amount at all. I am conscious of the warning emanating from GP International Pipecoaters (supra) that the character of a receipt is not to be determined by reference to outgoings which a taxpayer may be required to make. But that is not the point here. The point here is that the taxpayer covenanted to effect improvements which operated to benefit, one may assume, both the landlord and itself on the basis that it was to be reimbursed to the extent of $40,000. The work which the applicant undertook and for which it was in part reimbursed, produced no direct gain to it other than what appears to be a valueless right at the expiration of the lease to remove a washbasin and taps for scrap. The payment was a part reimbursement of the cost of the work. The payment was not, either in form or in substance, a cash incentive to encourage the applicant to take the lease, although it is clear that without the agreement of Burns Philp to contribute to the fit-out the applicant would not have entered the lease. Although I think it is clear enough on the evidence that there was no substantial gain to the applicant, there is no finding to this effect by the Tribunal. The matter would have to go back to the Tribunal for determination whether there was a gain and, if so, the extent of that gain, unless the parties agreed that the quantum of any gain in the circumstances was nominal, thereby avoiding the necessity for the matter to be remitted to the Tribunal. I would accordingly allow the appeal and set aside the Tribunal's decision. In lieu thereof I would order that the respondent's objection decision be set aside and that it be determined that the applicant's objection be allowed. However, I would stay the operation of these orders for a period of three weeks to permit the parties to determine whether they wish to have the matter remitted to the Tribunal to determine the value of the profit or gain, if any, arising to the applicant by virtue of the work being performed. If the parties are unable to reach an agreement as to the quantum of any profit or gain to the applicant, I would rescind the orders made and remit the matter to the Tribunal for determination of the extent, if any of the gain to the applicant. I certify that this and the preceding twenty-six (26) pages are a true copy of the Reasons for Judgment herein of his Honour Justice Hill Associate: Dated: 26 May 1997 Counsel for the Applicant: R D Marshall

Solicitor for the Applicant: Colin Biggers & Paisley

Solicitor for the Applicant: Australian Government Solicitor