O'Connell v Commissioner of Taxation [2002] FCA 904 | Case summary

Findings and Reasoning 89 The Commissioner's case was put on two general bases: · the amount of $8,009,000 was a receipt from a commercial transaction entered into by PMH with the intention or purpose of making a relevant profit or gain; · the receipt of the $8,009,000 was a profit or gain from a transaction entered into by PMH in the course of carrying on its business and was an ordinary incident, albeit infrequent or extraordinary, of the conduct of PMH's business. It was an integral part, and a not insignificant purpose, of the entry into the agreement for the lease of the premises at the T & G site. 90 Mr O'Connell's case was that the original purpose was to obtain new larger premises with a particular configuration, that the only really suitable premises were to be found at the T & G site and that that purpose did not change because PMH sought to achieve the outcome of the desired premises in a particular way. He submitted that the occasion of seeking and acquiring new leased premises was not converted to a revenue occasion just because PMH wanted to maximise the financial inducement. 91 Mr O'Connell submitted that it was significant that PMH's purpose was to obtain or lease fitted‑out premises and that its negotiations, including the negotiations in relation to the financial inducement, were directed to that objective or purpose. Mr O'Connell said that the decision to move premises was not influenced by the payment offered by Sweetvale Pty Ltd and had its genesis in the need for PMM to look for new premises when it became apparent that 500 Bourke Street would not be able to accommodate the firm adequately in the future. He said that that concern was accentuated by the decision to merge the two firms and the need to move to premises which could hold the entire merged firm and cater for the merged firm's long‑term need. 92 As Mr Spencer said in his affidavit: "There were few foreshadowed buildings that could house the expanded firm and the T&G site offered numerous other advantages including, importantly, locating all the firm over six floors as against as many as 24 floors at other high rise alternatives and achieving naming rights of a landmark building." Mr Spencer said that the merger with Hungerfords effectively ruled out any existing Melbourne CBD building. That view is not borne out by the documentation to which I have referred. 93 In October 1987 PMH was not devoid of choice as to the location of its proposed new premises. It was necessary for new premises to be obtained but as the memoranda in October 1987 demonstrated there were a number of alternatives available. It is apparent from the documentation to which I have referred that Mr O'Connell was giving consideration (not simply nominal) to other buildings. In his memorandum to Mr Spencer dated 12 October 1987 he set out a comparison of "the serious alternatives at this stage" and in his memorandum to partners dated 22 October 1987 he set out a financial comparison of "the serious alternatives at this stage." 94 I am satisfied that the initial motivation for the search by PMH for premises was generated by the need for further space which was seen to be not available in the existing premises at the time. This motivation or need was accentuated by the merger. PMH was outgrowing its available space and the merged firm needed to integrate either the two firms being merged, or at least units of the two firms, under the one roof. I am satisfied that the initial steps which were taken were motivated by the need to obtain new premises. 95 That is not to say that in the course of the progression of the process of looking for, and deciding upon, new premises a motivation or purpose of gaining an incentive or a cash payment did not emerge or manifest itself. The original purpose may have been to obtain new premises, because existing premises were, or were shortly going to become, inadequate for the firm's needs. But it is necessary to address whether a further subsequent significant purpose emerged as the process of deciding upon new premises continued, namely a profit‑making purpose whereby a significant financial gain could be obtained by the use of the bargaining power the merged firm had as a result of its tenancy needs and requirements. 96 Ultimately the relevant decision and purpose to be analysed is that of the merged firm. However, the process of looking for new premises had been commenced by PMM before the merger and the process which was instigated and pursued by PMM informs, in a number of respects, the process which was picked up and continued by the merged firm. 97 I am satisfied that there came a point of time at which PMH, in particular through Mr O'Connell, Mr Spencer and the Local Executive Committee, decided that a financial advantage could be obtained from the proposal to acquire new premises and that objective became a significant purpose of the transaction. 98 It is important to draw a distinction between a consideration by PMM and then PMH of a financial aspect of a l easing proposal which arises in the course of negotiations, and a purpose by PMM and then PMH to obtain or derive a financial or profit advantage or gain from the proposed transaction. A discussion about, or view expressed by PMM or PMH about, a financial inducement or advantage offered by a proposed lessor such as JGL does not automatically translate into a purpose of entering into the leasing transaction to achieve that result. Whether that purpose is to be deduced from the conduct of PMM or PMH depends upon a critical analysis of its conduct, relevant documentation and its negotiations with proposed lessors. Put shortly, one should not confuse a purpose of a transaction with factors that are taken into account in deciding whether to enter into the transaction and, if so, on what terms. 99 There are indications in the documentation and in the evidence of Mr O'Connell and Mr Spencer that by October 1987 PMH was seeking to obtain a substantial financial benefit, advantage, or profit by capitalising on the nature of the firm, the extent of the premises it required and the fact that financial inducements offered to proposed tenants to enter into leases were a feature of the property leasing market in 1987 and 1988. Mr Johns, a property consultant called by the Commissioner, gave evidence as to this latter fact and Mr Aylward, a property consultant called by Mr O'Connell, agreed. Mr Aylward said that by 1986‑1987 the payment of incentives by lessors to lessees of premises was a matter of discussion, and was known in the property marketplace. Mr Spencer recognised this factor in his "Allocation of Cash Inducement" paper where he said: "Having regard to the amount received recently by other lessees the fit out can be seen as a normal occupancy inducement, although the quantum was highly favourable." 100 Mr O'Connell submitted that October 1987 was the point of time at which PMH's purpose should be analysed and determined as at that time PMH was practically, commercially and effectively bound, albeit not legally bound, to proceed with the transaction to lease the premises at the T & G site. Mr O'Connell fixed on this point of time because he contended that at this point of time the purpose of PMH and his purpose was to obtain suitable new premises. I consider that the proper time at which PMH's purpose and the applicant's purpose in entering into the transaction and receiving the inducement amount is at the time the inducement agreement was entered into and the $8,009,000 was received, namely 23 November 1988. Nevertheless the events which occurred up to, around, and after 28 October 1987, are informative of, and relevant in ascertaining, the purposes of PMH and Mr O'Connell in entering into the inducement agreement and receiving the money. 101 Mr O'Connell contended that PMH chose the T & G site and JGL's proposal as it was the only site which was able to provide it with its requirement of what were called "jumbo" floors, that is floors of an area of around 4,000 sq m or 1 acre. However, the documentation does not support the proposition that floors of this size were a critical requirement. Floors of this size were no doubt highly desirable for PMH but they were not a critical requirement. Mr O'Connell's memorandum to PMH's partners on 22 October 1987 set out the parameters established for PMH's long‑term space requirements, such as location, space standard, total area required, quality of the building and whether the firm should always be in the one location. There was no reference in the identified parameters to floor size. Mr O'Connell had asked Mr Spencer and the Local Executive Committee in the memorandum dated 12 October 1987 whether the firm wanted average floors of 1,500 sq m or jumbo floors of 4,000 sq m and he expressed the view that the preferred size of floors was very subjective. 102 Further, in his memorandum to PMH partners of 22 October 1987 Mr O'Connell noted that the factors considered to be of primary importance at the time Colliers were appointed and at the date of the memorandum included "Preferred minimum floor size 1,400 sq m with on‑site parking for at least 150 cars". Later in the memorandum when Mr O'Connell undertook a financial comparison of the projects under consideration, he noted that rental accommodation prima facie would be cheaper "outside the CBD" compared with a prime location such as Collins Street. He explained the basis for the difference by reference to a number of matters which included: · whether we want average floors of 1500 sq. m. or jumbo size of 4,000 sq m. which affects the area over which the firm is located. On 1/7/91 it would be 11 floors or 4 floors. · whether we want jumbo floors, where can we build them, · whether we can sub let jumbo floors more easily in Collins St. against Latrobe St." Mr O'Connell had raised similar questions in his paper to Mr Spencer and the Local Executive Committee on 12 October 1987 when he asked whether PMH wanted average floors of 1,500 sq m or jumbo size of 4,000 sq m. 103 The fact that the availability of jumbo floors in the T & G site was not critical to the decision is demonstrated by the fact that, as the memorandum of 22 October 1987 noted, Mr Carew of Colliers and Mr O'Connell had continued to pursue other alternatives and three serious alternatives were considered. There was also a reference to eight sites or proposals of apparent primary appeal. 104 The opportunity to obtain jumbo floors had an attraction for PMH but the fact that they were not essential and therefore critical to the decision to choose the T & G site highlights the significance given by Mr O'Connell, Mr Spencer, the Local Executive Committee and PMH as at October 1987 to the financial consequences of choosing the T & G site and the JGL proposal. It demonstrates that PMH was looking at a number of options by reference to a number of criteria, a significant criterion being the amount of the incentive available and being offered. It also diminishes the cogency of the submission that PMH had no choice but to move to the T & G site and that by 1987 it was essential from the merged firm's point of view that it have floors which were in excess of 4,000 sq m. Colliers, in its letter of 6 October 1987 to JGL, had stated that "It is essential from Peat's point of view that floor areas be approximately 4,000‑4,500 sq m". But that was PMH's requirement for the T & G site. The memoranda of 12 and 22 October 1987 more accurately reflect what PMH's general criteria and preferences were and what the firm regarded as alternatives in October 1987. Nor is the submission as to the critical significance of the availability of jumbo floors supported by Mr O'Connell who said that the T & G site was considered by the "Working Party to be the most acceptable proposal" for PMH for the reasons he set out. He did not say it was the "only" acceptable proposal. 105 I do not accept that the T & G site was chosen by PMH solely for its physical requirements. I am satisfied that the financial incentive offered played a significant role in the decision‑making process of PMH, particularly having regard to the firm's proposal, carried into effect, to use its reputation and exploit its tenancy requirements to maximise the value of its tenancy and minimise its long‑term rental costs. 106 Mr O'Connell submitted that as at October 1987 PMH's purpose was to obtain fitted‑out new premises and that there could be no other purpose in agreeing to go with the JGL proposal. It was said that in 1987 PMH was negotiating for fitted‑out premises and that as at October 1987 there was no expectation of PMH obtaining a detachable gain or profit; what PMH was after was fit‑out. 107 That submission is not borne out by the slides which were prepared by Mr O'Connell in October 1987 and presented to the PMH partners, and on the basis of which they resolved to enter into the agreement to lease with JGL. Slide 10 is premised on the basis that a cash or monetary incentive will be paid and that there are a number of alternative ways in which the incentive could be applied or used, only one of which was was for fit‑out costs. Further the resolution in slide 12, (par [53] above) is premised on the basis that "the distribution of the incentive between partners is of paramount importance", that is a distribution of money to partners, not a distribution for fit‑out or the cost of fit‑out. 108 At this time, October 1987, PMH may have wanted to cover its fit‑out costs, but the resolution contemplates, or evidences an expectation, that there would be cash available for PMH partners. 109 I am satisfied that as at October 1987 PMH expected that there would be a detachable gain or profit after fit‑out costs were covered and provided for and that the firm was concerned to take steps to maximise the after‑tax benefit of the incentive. The resolution contemplated that a paper would be prepared dealing with the proposed allocation of the incentive and in the events which occurred that paper turned out to be Mr Spencer's "Allocation of Cash Inducement" paper sent to PMH partners on 24 October 1988. 110 Mr O'Connell was reluctant to acknowledge that it was important to consider what was the most financially advantageous offer available to PMH. His memorandum of 12 October 1987 noted that he had asked Mr Carew from Colliers to comment on incentives offered for other major leases yet, in cross‑examination, he initially denied that he wanted to know what the market was offering. The following answers in cross‑examination are illuminating as they demonstrate that the size of the incentive being offered was a relevant consideration in Mr O'Connell's and PMH's decision‑making process: "Yes, you wanted to know what the market was offering, didn't you?---Yes, because I expected all these sorts of questions when I had to address the partners. Yes, you wanted to know what the market was offering, didn't you?---No, as I keep saying to you, the objective was to minimise our long-term rental costs, the economics of the situation were relevant so I had to do all the research. I had to do my job thoroughly. I'll put the question again: you wanted to know what the property market was offering by way of incentives to professional firms to take up tenancies, didn't you?---I did want to know, yes. I needed to be fully informed. Yes?---Yes. You wanted to maximise your firm's return on its size and reputation, didn't you?---No, I wanted to minimise our long‑term rental costs within the objective of the preferred location and quality of the building. That was my objective all the way along. Then if you would go to tab 8 which, as we would read it, is appendix 3. [The letter from Mr Carew of Colliers to Mr O'Connell dated 13 October 1987] I'd like you to look at paragraph 4 on the third page under the heading Incentive. You must have been encouraged by being told by Colliers that this was the biggest incentive they'd ever heard of?---Well, I took that with a grain of salt, actually. I was more interested in getting the right building. So you were indifferent, is that your evidence, to the assertion by your property expert that this was the biggest incentive ever heard of in Melbourne?---Well --- Indifferent, was my question, you didn't care about that. Is that correct?‑‑‑Well, it was nice to know, but I mean, property consultants are making all sorts of outlandish statements all the time. So, you know, I was pleased that we were getting towards achieving our objective. It was important to you, was it not, that in the view of Colliers, as set out at the foot of that page, the JGL offer was financially the most advantageous to you?---Well, it was good to know that because I would then be able to address that issue when I spoke to the partners. Do you have a problem with the word 'important'? I'll ask you my question again: it was important to you, was it not, that Colliers advised that the JGL offer was the most advantageous financially?---It was important, yes." 111 Although Mr O'Connell said in cross‑examination that at that stage (October 1987) distribution to partners was not an issue, I do not accept his evidence in that respect. It is contradicted by the terms of the resolution proposed and passed on 28 October 1987, as recorded in slide 12 which was prepared by Mr O'Connell (par [53] above). 112 Mr O'Connell said that in recommending, and participating in, PMH's decision to enter into the lease of the premises at the T & G site he personally was not influenced by the cash payment of $8,009,000 from Sweetvale Pty Ltd which made no difference to his decision. I do not accept that evidence having regard to the documentary evidence. 113 Although Mr O'Connell was only grudgingly prepared to acknowledge, in cross‑examination, that the distribution of the incentive was important, I am satisfied that slide 12 accurately records the importance and significance of the proposed incentive payment to the PMH partners and the centrality of that payment in their decision‑making process. 114 Mr Spencer was influenced in favour of the JGL proposal by the offer of the cash contribution of $8,000,000. It was one of the matters, but not the only matter, which influenced him in favour of the proposal. I accept Mr Spencer's evidence in this respect. The T & G site met all PMH's requirements. 115 I am satisfied that as at 28 October 1987 the distribution of the incentive payment proposed by JGL was of "paramount importance" to PMH and to Mr O'Connell in particular. 116 I do not accept Mr O'Connell's evidence that by October 1987 he was not aware that if JGL made a cash payment to PMH in consideration for the firm leasing the T & G site, that would give PMH the opportunity to make a cash distribution to partners. The slides prepared by Mr O'Connell contemplated that very situation. Although Mr O'Connell said in cross‑examination that he discounted the value of what was proposed to be paid by JGL, I do not accept that as at October 1987 he did not have an expectation that there would be a cash amount available for distribution to PMH partners. 117 As at 28 October 1987, the proposal from JGL, agreed to in principle by PMH, involved a firm unconditional payment to PMH of $25,000,000 and a further payment of $5,000,000 conditional and dependent upon the profitability of the project by JGL. 118 The slides prepared by Mr O'Connell, shown to the partners in PMH and on which their decision was based to go with the T & G site, demonstrate that they knew money was to be paid and they wanted to organise their affairs to make that payment tax effective. The receipt of money was more than just a factor in the transaction; it was one of the significant purposes of the transaction. It is true that in November 1988 PMH wanted to get JGL "on the hook" and make sure it was committed to the development. That accounted for the discounting of the $12,000,000 to $8,009,000 and its immediate payment up‑front, but by this stage the purpose had been well established and pursued to obtain the money sum of $12,000,000 and thereby to make a profit or gain from the proposed transaction. 119 The ultimate purpose of the payment and receipt of $8,009,000 in November 1988, rather than $12,000,000 on completion of construction and occupation of the premises, may have been to ensure that JGL was commercially bound and had committed itself to the project and completed it, but it still remained that a significant purpose of the transaction involving the payment of an inducement amount remained operative. 120 I am satisfied that at an early point of time, well prior to October 1987, PMM, and later PMH, set out to exploit what each firm regarded as its valuable tenancy for the purpose of obtaining a financial advantage. Each firm, by virtue of its space requirements, was an attraction to a building owner or developer as a tenant and each firm recognised this fact. This was recognised, for example, in the January 1987 advertisement in which Colliers, on behalf of PMM, sought innovative proposals whereby, inter alia, PMM could "Participate as joint venturers in a major development". 121 The objective was to obtain appropriate new premises and to minimise the cost of so doing. Slide 1 presented to the PMH partners shortly prior to or at their meeting on 28 October 1987 expressed the objective as being "to minimise long term rent costs" having regard to certain parameters relating to the building. The means by which this objective was to be achieved was "the use of reputation and combined purchasing power of KMG and PMM… now PMH". 122 This desire and intention as at October 1987 to exploit PMH's reputation and goodwill to obtain a financial benefit in whatever leasing arrangement was made was also demonstrated in Mr Spencer's important paper on "Allocation of Cash Inducement" when Mr Spencer explained under the heading "EVENTS LEADING UP TO OUR AGREEMENT WITH JGL" that PMM had "a 'valuable' tenancy" the value of which could be maximised in a number of ways which he identified (par [76] above). 123 That was the situation before the merger, and it was carried through after the merger into October 1987, as Mr Spencer explained in his paper: "The opportunity to 'participate' in the T & G development arose and, in October 1987, the partners of PMH at the time voted to accept it. Our strategy then was, inter alia, to maximise the value of our tenancy by convincing JGL that we were a quasi joint venture partner - notwithstanding that they owned the freehold. This, through Jack O'Connell and Colliers, was achieved and we have secured a tenancy which is regarded as: · highly suitable to our physical needs; · in a prime location, and · at competitive future rentals because of the low rise nature of the building and because the large floor areas make the building less attractive to most other potential tenants and for which the inducement offered is highly satisfactory." 124 There was debate in submissions and in cross‑examination of Mr Spencer as to what he meant by "quasi joint venture partner". Obviously a joint venture strictly so‑called was not contemplated: see United Dominions Corporation Limited v Brian Proprietary Limited (1985) 157 CLR 1 at 10. But what Mr Spencer made clear was that he was referring to the fact that what he contemplated was a mutually beneficial arrangement whereby JGL would build and PMH would occupy and obtain a substantial inducement. 125 PMH, and in particular Mr Spencer and Mr O'Connell, were influenced in their approach to the nature of the premises to be chosen by the profit Price Waterhouse had made on its building development. In Mr O'Connell's memorandum to Mr Spencer dated 12 August 1987 he noted that JGL had made a verbal offer which, in JGL's view, would return to KPMG an amount at least equal to the profit earned by Price Waterhouse on its own development. Mr O'Connell agreed that it was attractive to him that PMH might obtain from JGL an amount comparable to the profit earned by Price Waterhouse. Mr Spencer was not prepared to acknowledge that he had concluded that it ought to be possible for PMH to engage to its financial advantage in an office development project as Price Waterhouse had undertaken. However he did accept that one of the objectives by which he would judge the available options was that so far as possible the financial advantage to PMH should be maximised. 126 The purpose of PMH in seeking to exploit the value of its reputation, goodwill and tenancy needs to obtain an appropriate tenancy on financially advantageous terms is also confirmed by Mr Spencer's response to the seven propositions put to him (par [88] above). 127 PMH may not have made any ultimate decision in relation to their quest for new premises which could be classified as "entrepreneurial" but I am satisfied that it had a desire to be entrepreneurial in the sense of exploiting the capital value of its reputation, goodwill and lease purchasing power. This desire was carried through into the firm's use of what Mr Spencer called its "valuable" tenancy and the firm's perception of itself as a "quasi joint venture partner" with JGL. As early as 24 July 1986 Mr O'Connell, in his Long Range Space Plan, was investigating the option of taking an entrepreneurial role whereby, if managed properly, they would generate savings in rental or "earn up front profits". Further, on 24 April 1987 Mr Spencer's memorandum referred to the Dayton Hazama proposal which included the opportunity for PMH to share in the total development profit of the proposed project. From an early stage PMM was prepared to consider innovative proposals whereby it could, inter alia, participate as joint venturers in a major development. These matters support the conclusion that PMM and later PMH was looking to make a profit or gain from its acquisition of new premises. 128 The use and exploitation of PMH's valuable tenancy, reputation, goodwill and capital asset was further acknowledged by Mr Spencer in his "Allocation of Cash Inducement" paper where he said: "The size of the tenancy committed by PMH has been a major element in underwriting the viability of the project. The inducement agreed reflects the importance of our commitment to the project in the pre‑planning stage. Participation as tenants after JGL had committed to the development is likely to have resulted in a significantly smaller inducement." 129 This survey of the evidence shows that from 1986 through to October 1988 PMM and then the merged PMH was intent on seeking to obtain new premises appropriately adapted to its needs and at the same time was seeking to maximise the value of its tenancy requirements so as to obtain a financial gain or profit. As Mr Spencer's "Allocation of Cash Inducement" paper noted, the objective of maximising the value of the tenancy was achieved by convincing JGL that PMH was a quasi joint venture partner through Mr O'Connell and Colliers. The result was, as the paper noted, a highly suitable tenancy and a "highly satisfactory" inducement. 130 Further, the maximising of the value of the tenancy produced what Mr Spencer's paper and the Local Executive Committee called a "quasi venture" profit. Although Mr Spencer sought in cross‑examination to qualify and explain away his use of the expression "profit", it aptly described the $8,009,000 which was to be received. It was paid and received after the cost of fit‑out had been provided for and it was not to be diminished by any offsetting costs. It was the product of PMH being what Mr Spencer and the Local Executive Committee described as "a quasi joint venture partner", that is to say, a partner in the project who made an early commitment to the project by agreeing to become a substantial tenant. 131 The notion of PMH sharing in the profit of the proposed development by JGL had been recognised at the time of the decision taken on 28 October 1987 in slide 5 prepared for the meeting on that day by Mr O'Connell (par [50] above). Slide 5 showed that PMH would have distributed to it a fixed proportion of the profit generated by the development of the building, $25,000,000, which would rise to $30,000,000 once JGL's profit rose to $41,139,000. At that stage no apportionment of the amount to be received by PMH was proposed between covering fit‑out costs and the amount being available for payment to the partners. Slide 10 referred to fit‑out costs as one of the options for which JGL could pay (par [51] above). Slide 10 noted that as between the three options, it was too early to "provide any further details at this stage", although the second resolution in slide 12 contemplated the incentive being used to cover costs including fit‑out costs. 132 I am satisfied that at the time the PMH partners resolved on 27 October 1988 to enter into an agreement for a lease with JGL a significant and substantial motivating factor and purpose in their decision to pass the resolution was the receipt and distribution of the proposed incentive payment. They were using their reputation and exploiting their tenancy requirements to achieve that result. I reject Mr O'Connell's evidence that the inducement offered by JGL did not enter into consideration in deciding which was the most acceptable proposal. He ultimately accepted that as at October 1987 he regarded the distribution of the incentive as of paramount importance. 133 I am satisfied that from an early stage, PMM, and certainly by October 1987 PMH, was looking to obtain a financial advantage from its need to obtain new premises for the merged firm and that it sought to exploit its tenancy requirements to obtain a substantial financial incentive. 134 I am satisfied that the inducement agreement entered into on 23 November 1988 was a commercial transaction entered into with a view to profit or gain. Obtaining that profit or gain was a significant purpose of the negotiations with JGL and the conduct of PMH in 1987 and 1988. 135 Mr O'Connell acknowledged that at the time he made his recommendation in October 1988 that PMH should enter into the inducement agreement and the agreement to lease he was aware that the cash payment of $8,009,000 would provide an opportunity for PMH to make a cash distribution to the partners in PMH. I reject his evidence that at that time it was only a possibility. At that time it was a certainty. He had been present at the meeting of the Local Executive Committee on 17 October 1988 at which Mr Spencer's "Allocation of Cash Inducement" paper had been discussed and he presented his paper which referred to the amount of the inducement payable. 136 I am also satisfied that in and around October 1987 and November 1988 the offer and receipt of cash incentives was an ordinary incident of leasing commercial and business premises in the Melbourne CBD. Mr O'Connell submitted that the incentive deal or transaction negotiated by PMH was out of the ordinary course of business of PMH. I do not accept that submission. Although there were unusual features of the transaction, the evidence of both Mr Johns and Mr Alyward was that by 1988 the payment and receipt of lease incentives was known in the workplace and was part of the ordinary incident of leasing office premises in the Melbourne CBD. It should also be noted that Mr Spencer agreed that for a firm like PMH generic expansion and space pressures were facts of life and his firm had to deal with them from time to time. As I have found in par [78] above, PMH was aware by October 1988 that the receipt of an incentive was a normal incident of leasing premises. 137 The Commissioner submitted that the receipt of the inducement amount fell directly within the principles set out in Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199 ("Myer") as it was a receipt from a commercial transaction entered into by PMH with the intention or purpose of making a relevant profit or gain. In Myer the High Court focused on the intention or purpose of a taxpayer entering into a transaction in circumstances where the transaction was entered into otherwise than in the ordinary course of carrying on the business and was thereby extraordinary. The High Court said at 209‑210: "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." The isolated nature of a transaction does not preclude the receipt from it constituting income if the relevant intention or purpose exists, as Myer makes clear. At 211 the High Court said: "The important proposition to be derived from Californian Copperand Duckeris that a receipt may constitute income, if it arises from an isolated business operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction." At 215‑216 the High Court said: "If the profit be made in the course of carrying on a business that in itself is a fact of telling significance. It does not detract from its significance that the particular transaction is unusual or extraordinary, judged by reference to the transactions in which the taxpayer usually engages, if it be entered into in the course of carrying on the taxpayer's business. And, if it appears that there is a specific profit‑making scheme, it is pointless to say that it is unusual or extraordinary in the sense discussed. Of course it may be that a transaction is extraordinary, judged by reference to the course of carrying on the profit‑making business, in which event the extraordinary character of the transaction may reveal that any gain resulting from it is capital, not income." 138 What Myer makes clear is that: · a gain or profit made in the ordinary course of carrying on a business is invested with a profit‑making purpose and is therefore characterised as income because a business is carried on with a view to profit; · a gain or profit made otherwise than in the ordinary course of carrying on a business, but which arises from a transaction, albeit extraordinary, entered into with the intention or purpose of making a profit or gain will constitute income if the intention or purpose of the taxpayer was to make a profit or gain from the transaction. 139 The application of the Myer principles to the findings I have made leads to the conclusion that the receipt of the $8,009,000 and Mr O'Connell's share of that amount was the receipt of a gain or profit which was the receipt of income for the purposes of s 25(1) of the Act. 140 There have been a number of decisions which apply the Myer principles to payments by lessors to lessees in the context of the receipt of financial inducements to enter into leases of business premises. A consideration of these cases demonstrates that the receipt of the $8,009,000 by PMH and Mr O'Connell's share of that amount is properly characterised as the receipt of income, and not the receipt of capital. 141 In Commissioner of Taxation v Cooling (1990) 22 FCR 42 ("Cooling") the Full Court of the Federal Court held that a payment to a firm of solicitors by an owner of premises, as an inducement to move its offices to the owner's building, was assessable income within s 25 of the Act. The firm's existing premises were not completely satisfactory, at the relevant time there was an oversupply of office space, and incentives such as rent‑free periods and cash payments were a feature of the market for the rental of commercial premises. 142 Hill J, delivering the leading judgment of the Court, considered the quality of the payment in the hands of the recipient and applied the Myer principles to which I have referred. Hill J rejected the Commissioner's submission that Myer established a new principle that all gains made by a business entity were assessable. His Honour then considered the firm's submission that its business was the performance of professional services and not the receipt of incentive payments but observed that the firm did not cease business when it moved from one leased premises to another leased premises. Hill J said at 56: "Where a taxpayer operates from leased premises, the move from one premises to another and the leasing of the premises occupied are acts of the taxpayer in the course of its business activity just as much as the trading activities that give rise more directly to the taxpayer's assessable income. Once this is accepted, the evidence established that in Queensland in 1985 it was an ordinary incident of leasing premises in a new city building, at least where the premises occupied were of substantial size, to receive incentive payments of the kind in question. Why then should a profit received during the course of business where the making of such a profit was an ordinary incident of part of the business activity of the firm not be seen to be income in ordinary concepts?" (This passage was approved by the majority in Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at 676 ("Montgomery") to which I shall refer.) 143 Hill J then turned his attention to whether the transaction was properly described as a profit‑making scheme. His Honour said at 56‑57: It was submitted that the evidence illustrated that the firm was reluctant to move. That may be so. But the firm did commit itself to the move and it was an integral part of this commitment that it receive the incentive payment which is properly a profit of the partnership. It is true that the incentive payment was not the sole purpose of the firm moving premises. The previous premises had the disadvantages to which I have earlier referred and the securing of premises in what may be assumed to have been a prestige building was a clear purpose of the firm in taking the course it did which led both to Bengil entering into the lease and to the receipt of the incentive payment. A scheme may be a profit making scheme notwithstanding that neither the sole nor the dominant purpose of entering into it was the making of the profit. In Myerthe assignment of the right to interest was an integral part of the total reorganisation entered into by the Myer Group. While the judgment of the High Court in Myerreferred to the case as involving the intention or the purpose of making the profit there is no suggestion that the Court dissented from the factual finding of Murphy J that the motivating purpose of the transaction was for Myerto obtain working capital to enable it to diversify. It should however be noted that on the facts of that case the obtaining of working capital was possible only if the profit contemplated by the taxpayer was made. … In my view the transaction entered into by the firm was a commercial transaction; it formed part of the business activity of the firm and a not insignificant purpose of it was the obtaining of a commercial profit by way of the incentive payment." 144 In my view the principles in Cooling when applied to the present circumstances under consideration confirm my conclusion that the receipt of $8,009,000 was the receipt of income. The facts I have found fall within Hill J's reasoning at 56, (par [142] above). PMH's move to new leased premises and the leasing of the new premises were acts of PMH in the course of its business activity and the evidence was that in Melbourne in 1988 it was an ordinary incident of leasing premises in a city building of substantial size to receive incentive payments. Consistently with the reasoning in Cooling, the receipt of the $8,009,000 was income according to ordinary concepts. 145 Further the finding that a significant purpose of the transaction leading to the inducement agreement and the agreement to lease premises at the T & G site was the obtaining of a financial incentive demonstrates the existence of a profit‑making scheme. It was not the sole or dominant purpose, but it was a significant purpose of the transaction as it developed. 146 Mr O'Connell placed significant reliance on Selleck v Commissioner of Taxation (1997) 78 FCR 102 ("Selleck") where the Full Court of the Federal Court distinguished Myer and Cooling. Two firms of solicitors occupying separate premises merged to form Arthur Robinson & Hedderwicks ("AR & H"). The merged firm needed to obtain new premises as the existing premises of the two firms could not accommodate the merged firm. The Australian Mutual Provident Society Limited ("AMP") offered suitable premises and as an incentive offered sums totalling $1,066,000 to the merged firm as a contribution towards fit‑out costs. The amounts were paid into the firm's general bank account and fit‑out costs were disbursed from the same account. The decision by the merged firm to move to the AMP premises was not prompted by the AMP contribution to fit‑out costs. There was no direct payment to the partners of the merged firm of the amounts received from AMP at the time the payments were received. Lockhart J (with whom Black CJ agreed), at 104, found it: "impossible to draw the inference that AR & H regarded the AMP offer of a cash contribution to fit out as giving it the opportunity to make a substantial cash distribution to the partners." 147 Lockhart J was also influenced in reaching his conclusion that the payments by AMP were not assessable as income by the fact that: · the evidence did not establish that it was intended to make immediate cash distributions to the partners of the amounts contributed by AMP towards the cost of fit‑out; and · neither the decision to move and find new premises nor the decision to choose the AMP premises in preference to another site was influenced by, or had as a purpose, the receipt by the partnership of the AMP contribution to the fit‑out. 148 Lockhart J continued at 105‑106: "The only purpose of AR&H entering into the lease with the AMP was to obtain premises from which the new firm would conduct its legal practice. It is clear from both Myerand Coolingthat whether a gain is assessable depends on the circumstances of the case. The facts of Coolingare different. In Coolingthe relevant firm had not decided that it was essential or even important to move. The real estate agents acting for AMP in Coolinginitiated the attempt to have the firm move premises, and the agents recommended to AMP that they offer an inducement to make the move more attractive. The firm chose to have the incentive paid to the individual partners rather than to the firm. The partners used the funds they received individually to fund the fit out; but notwithstanding this, there was no requirement for them to do so. The proceeds of the sale and lease back were paid back to the partners, unlike the present case. In Coolingthe promised receipt by the partners individually of the incentive payment was a not insignificant purpose in the firm's decision to move to the AMP premises. In Coolingthe decision to leave the firm's old premises and take up a lease with the AMP was influenced by the incentive payment to a not insignificant degree. In the present case the primary judge correctly found that the decision to take up the premises with the AMP rather than Rialto was not influenced by the payment from the AMP. The need to find new premises for the new firm was a capital occasion. This could not be transformed into a revenue occasion because AR&H desired the AMP contribution to the fit out to be higher than had been first offered. In my opinion AR&H did not have any relevant purpose of profit‑making when entering into the lease with AMP." 149 Although Mr O'Connell placed considerable reliance on Selleck, it is of no assistance to him having regard to the findings in that case which distinguish it from the present circumstances. This last passage from the reasons of Lockhart J supports, indeed confirms, the proposition that if a not insignificant purpose in a decision by a firm to move to particular premises is the promised receipt by the partners of the firm individually of an incentive payment, then the receipt of the payment will be considered as a receipt of income and not of capital. 150 Unlike the conclusion of Lockhart J (par [146] above), the facts of this case make it possible to draw an inference that the offer of the $8,009,000 gave PMH the opportunity to make a substantial cash distribution to the partners in PMH. I consider that such an inference should be drawn for the reasons to which I have already referred. In particular Mr Spencer agreed that in October 1988 he regarded JGL's offer of a cash contribution of $8,000,000 to the partners in PMH as giving it the opportunity to make a cash distribution to the partners. 151 In Selleck Lockhart J was influenced by the fact that the evidence did not establish that an immediate cash distribution to partners of the payment was to be made, nor that the decision to find new premises and to choose the premises which were in fact chosen was influenced by, or had as a purpose, the receipt of the payment by the partnership. However the evidence in the present case does enable me to find such facts and reach such conclusions. I am satisfied that PMH, and in particular Mr O'Connell, in deciding to enter into the inducement agreement and the agreement to lease, were influenced in favour of the proposal by, amongst other things, the offer of the cash contribution of $8,009,000. Mr Spencer agreed he was so influenced. Mr O'Connell said he was not so influenced but I have rejected that evidence; it is inconsistent with the contemporaneous documentation to which I have referred and the views of Mr O'Connell expressed in it. By 28 October 1987 it was intended by PMH and, in particular, by Mr O'Connell to make cash distributions to the partners of at least part of the amount to be paid by JGL. This was evidenced in particular, by resolution 2(C) in slide 12 (par [53] above). I have also found that the decision to find new premises and the decision to choose the T & G site was significantly influenced by, and had as a significant purpose of, the receipt by PMH of the inducement amount. 152 The case more directly on point is Montgomery in which a firm of solicitors moved their offices to a new building. The firm entered into an inducement agreement, an agreement to lease and a deed of acknowledgement whereby some members of the firm guaranteed the obligations of the corporate lessee. Under the inducement agreement the lessors agreed to pay the firm $15,890,000 (later increased) against which the lessee could draw for certain expenses before the term of the lease commenced and the balance of which was payable to the lessee after fitting‑out of the new premises was completed. The Commissioner assessed the respondent, a member of the firm, on the basis of including in his taxable income an interest in the net income of the firm, which included amounts received by the firm under the inducement agreement. The High Court, by a majority (Gaudron, Gummow, Kirby and Hayne JJ), held that the payments under the inducement agreement were received as income on the grounds that: · the payments arose from a singular transaction in the nature of trade undertaken in the course of a wider business activity; and · the partners of the firm had used or exploited their capital in the course of carrying on their business to obtain the inducement payments which were received for their separate benefit and not as an increment to their profit‑yielding structure. 153 In Montgomery, as in the present case, the evidence was that at relevant times it was an ordinary incident of leasing premises in the Melbourne CBD that lessees received incentive payments as an inducement to take up leases in new buildings. In the present case the evidence was that these arrangements existed in 1988 against a background of looming oversupply. 154 In Montgomery the primary judge found (and his finding was not disturbed by the majority in the High Court) that one purpose of the firm in entering into the transaction was to secure a gain and that the transaction occurred in the course of the firm carrying on its business. The primary judge found that the firm did not think itself devoid of choice at the relevant time between staying where it was and leaving for other premises. The primary judge found that the partners in the firm "set upon making a choice between the alternatives placed before them in the papers prepared for the meeting" (cited at 665). That observation may be aptly made as to what the partners of PMH undertook in and prior to the meeting on 27 October 1987. The majority of the High Court also thought it significant that the papers put before the partners of the firm noted that the firm's size made it a particularly attractive tenancy target and should therefore obtain "a substantial or total fit‑out contribution and some initial rent incentive" at 666. 155 The majority rejected the submission that the payments were on capital account because the transaction which gave rise to the receipts was not in the ordinary course of business of the firm. The majority said at 672: "But it is well established that the singularity of the receipts that now are in question, or (to put it another way) the fact that they are receipts standing apart from or outside the ordinary course of the ordinary business of the firm, does not inevitably stamp those receipts as capital receipts." [Footnotes omitted] The majority quoted the passage from Myer referred to in par [137] above and went on to say at 676‑678: "The singularity of a transaction may very well invite close attention to whether it is in business. The singularity of a transaction may suggest that there is a mere realisation of a capital asset or change of investment rather than a transaction on revenue account. The purpose of profit‑making may be an important consideration in deciding these questions. But, as Myerdemonstrates, a singular transaction, in business, even if unusual or extraordinary when judged by reference to the transactions in which the taxpayer usually engages, can generate a revenue receipt. And that is why, in Federal Commissioner of Taxation v Cooling, the Full Court of the Federal Court rightly emphasised the fact that, in that case, the receipt was an ordinary incident of part (albeit an extraordinary and unusual part) of the firm's business activity. It can be seen, then, that two of the different ways in which the Commissioner put his case (receipt as an ordinary incident of transaction in course of business, and gain from profit‑making undertaking or scheme) intersected or overlapped. The 'gain' alleged was the gross amount of the receipts under the inducement agreement. The 'profit‑making undertaking or scheme' was the entry into these agreements as a step in the conduct of the taxpayer's business. The receipt was, so the argument went on, a receipt from carrying on the business (albeit by means of an unusual transaction). The receipt was an ordinary incident of transactions of this kind. Its receipt was, then, neither an unexpected nor unintended by‑product of the transaction; its receipt was a purpose of entering the transaction." [Footnotes omitted] 156 Finally, the majority turned their attention to the manner in which the firm exploited its capital. The majority said at 677‑678: "The inducement amounts received by the firm did not augment the profit‑yielding structure of the firm. The lease was acquired as part of that structure; the inducement amounts were not. There was, in the words of Pitney J in Eisner v Macomber "not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being 'derived,' that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal". To put the matter another way, the firm used or exploited its capital (whether its capital is treated for this purpose as being the agreement to take premises or its goodwill) to obtain the inducement amounts. As the papers presented to the firm in August 1989 said, the firm was then 'of a size which makes it a particularly attractive tenancy target'. And it was because it was a particularly attractive tenancy target that it was suggested in those papers that the firm should receive a good inducement offer to take premises. The firm used or exploited its capital in the course of carrying on its business, albeit in a transaction properly regarded as singular or extraordinary. And the sums it received from the transaction were not as some growth or increment of value in its profit‑yielding structure - the receipts came in or were derived for the separate use, benefit and disposal of the firm and its members as they saw fit." These observations may be applied to the manner in which PMM and then PMH approached and conducted their process of obtaining new premises. 157 In Montgomery it was accepted (as it was in Cooling) that the receipt of the incentive was an ordinary incident of the business, albeit from an unusual transaction and what therefore followed was a finding of a profit‑making purpose without further evidence. 158 What is made clear in Cooling,and confirmed in Montgomery,is that if a purpose of a transaction, albeit not the only purpose, but nevertheless a significant purpose, is a profit‑making scheme then the receipt from it will be regarded as income notwithstanding that there is another purpose of the transaction which does not warrant the conclusion of a profit‑making scheme. 159 The point made by the majority in Montgomery about the exploitation of capital is an aspect of identifying a profit‑making scheme or purpose. It is not a separate head of identifying a taxable situation but rather an exposition based on Myer principles. The point about exploitation of capital is no part of the application of the Cooling principle that was endorsed by the majority of the High Court in Montgomery at 676, (par [142] above). 160 Mr O'Connell submitted that Montgomery was to be distinguished as the facts presently before the Court were different in an important respect. In the present case both PMM in 1986, and the merged PMH in 1987, needed further office space whereas in Montgomery the firm did not have to move from BHP House, the firm had a choice. That distinction does not render inapplicable the reasoning of the majority in Montgomery or the application of the principles which the majority identified. 161 In Montgomery, the firm involved was not moving or seeking to move premises in the context of a recent merger. That is not a relevant basis on which to distinguish the application of Cooling and Montgomery in relation to the circumstances under consideration. The merger did not change the purposes, intention or objectives which had been conceived and sought to be implemented and attained by PMM and then PMH. The space requirements increased, but the purposes sought to be achieved remained the same, namely the attaining of new premises satisfying certain criteria and the exploitation of the firm's reputation, purchasing power and capital to achieve a financial advantage, gain or profit. 162 Accepting that PMM and then PMH had to move and seek new premises does not deny or negate the application of the principle set out by Hill J in Cooling at 56, and endorsed by the majority in Montgomery at 676, as follows: "But, as Myerdemonstrates, a singular transaction, in business, even if unusual or extraordinary when judged by reference to the transactions in which the taxpayer usually engages, can generate a revenue receipt. And that is why, in Federal Commissioner of Taxation v Cooling, the Full Court of the Federal Court rightly emphasised the fact that, in that case, the receipt was an ordinary incident of part (albeit an extraordinary and unusual part) of the firm's business activity." 163 Further, the fact that PMM and then PMH had to move and seek new premises can be accepted at the same as it can be found (as I have found) that as well as having a purpose of obtaining new premises both firms had a significant purpose of obtaining a gain from a profit‑making scheme, namely exploiting its reputation, goodwill and tenancy requirements to obtain a financial gain or advantage. Again I refer to the slides shown to the PMH partners in October 1987 as a result of which they resolved to enter into an agreement with JGL, and to Mr Spencer's "Allocation of Cash Inducement" paper of 24 October 1988 which was approved by the Local Executive Committee and as a result of which the inducement agreement and agreement to lease were executed. 164 Both purposes had their genesis in the need of both PMM and then PMH to obtain additional space and they continued concurrently, as an end sought to be achieved, through 1986, 1987 and up to November 1988 when they, and the relevant transaction, were consummated. 165 Mr O'Connell submitted that the application of the Cooling principle required a finding of a profit‑making purpose but that submission misunderstands the content of Cooling. The passage at 56 referred to in par [142] above is predicated upon a transaction generating a receipt as an ordinary incident of part of a firm's business activity, not upon the finding of a profit‑making undertaking or scheme. If a receipt is received as an ordinary incident of a business or part of a business, it is stamped with a profit‑making purpose. If it is not received in the ordinary course of business, but still in the course of business, it is necessary to find a profit‑making purpose before the receipt from the transaction is taxable as income. 166 Mr O'Connell submitted further that Cooling should be read and understood in the light of Westfield Limited v Commissioner of Taxation (1991) 28 FCR 333 ("Westfield") especially at 342 where Hill J (with whom Lockhart and Gummow JJ agreed) said: "The transaction of sale may be one which arises in the ordinary course of the taxpayer's business, but that profit will not ordinarily be income, particularly where, at the time of acquisition of the site, there was no intention or purpose of profit‑making by sale when the premises became too small. The profit in Cooling(supra), the receipt of a leasing incentive payment, was one intended to be made at the time the transaction with the lessor was entered into, just as the profit in Myerwas one which underlay the whole transaction." This passage does not assist Mr O'Connell having regard to my findings as to the purposes of PMH and Mr O'Connell in entering into the inducement agreement. In any event the majority of the High Court in Montgomery has endorsed the passage in Cooling at 56 (par [142] above) with the result that, properly understood, it is no part of that passage in Cooling that there be a profit‑making scheme or purpose. Rather the principle focuses upon whether the relevant receipt arises from a transaction which is an ordinary incident of part, albeit an extraordinary or unusual part, of the firm's business. 167 If a receipt arises from a transaction which occurs in the ordinary course of business, albeit as an unusual transaction, it is not necessary for the Commissioner to show that the transaction is part of a profit‑making scheme because the fact that it occurs in the course of business stamps it with a profit‑making purpose because one is in business to make a profit. This was made clear in Westfield where Hill J said at 342‑343: "When in Myerthe High Court spoke of profits made in the ordinary course of business, their Honours were not speaking in a temporal sense. Rather, as the judgment of the Full Court of this Court in Commissioner of Taxation (Cth) v Spedley Securities Ltd(1988) 88 ATC 4126 at 4130 points out, it is necessary that the purpose of profit‑making must exist in relation to the particular operation. In a case where the transaction which gives rise to the profit is itself a part of the ordinary business (eg a profit on the sale of shares made by a share trader), the identification of the business activity itself will stamp the transaction as one having a profit‑making purpose. Similarly, where the transaction is an ordinary incident of the business activity of the taxpayer, albeit not directly its main business activity, the same can be said. The profit‑making purpose can be inferred from the association of the transaction of purchase and sale with that business activity." 168 When the principles in the cases to which I have referred are applied to the findings of fact I have made, I reach the conclusion that the amount of $8,009,000, and Mr O'Connell's share thereof was received by PMH and Mr O'Connell from a transaction: · which had as a significant purpose a profit‑making scheme entered into with a significant, albeit not sole, intention or purpose of making a profit or gain; · in which the receipt was received in the course of PMH's business as an ordinary incident of part of the firm's business. 169 The amount received by PMH as an incentive payment and Mr O'Connell's share thereof was therefore correctly assessed by the Commissioner as "income" for the purposes of s 25(1) of the Act and the Commissioner did not err in disallowing Mr O'Connell's objection to that assessment made on the basis that the payment ought properly to have been characterised as "capital". 170 The appeal will be dismissed with costs. I certify that the preceding one hundred and seventy (170) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Goldberg.

O'Connell v Commissioner of Taxation

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Judgment (11 paragraphs)

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Cases Cited (7)