Proctor and Commissioner of Taxation [2005] AATA 389; (2005) 59 ATR 1064; (2005) 87 ALD 247; 2005 ATC 2132 (2 May 2005)

Proctor and Commissioner of Taxation [2005] AATA 389; (2005) 59 ATR 1064; (2005) 87 ALD 247; 2005 ATC 2132 (2 May 2005) - AATA 2005 case summary — Zoe

[98]

PMH had been losing senior and middle level staff to competitors which were able to offer far more congenial working conditions in the sense of larger offices and personal secretarial assistance as well as highly competitive salary packages and overseas' secondments. At that stage, the future growth of the firm was uncertain. Economic forecasters were predicting a slow down in Australia's economic growth over the following few years and the supply of experienced accountants and recently qualified tertiary graduates and consultants was very tight. If PMH were to commit itself to a large floorspace of 4,500 square metres and if its projected growth were not realised, there would be a significant cost in the form of unused or underutilised space.
He was not convinced that the financial evaluation fully resolved the issues related to fringe area offices for small businesses and consulting staff who did not have, or had few, city based clients.
JGL had only offered the financial incentive verbally and it was not clear when the additional sum of $5M would be paid. There was also a risk inherent in the calculation of the building's profit performance.
Given Colliers' assessment of market rents, Mr Proctor was sceptical about JGL's guarantee of $25M and was concerned about the effect it would have on PMH's negotiating strength with JGL regarding lease terms.
Mr O'Connell's memorandum did not model the financial outcome if the incentive payment were not received because, for example, there were conditions attached to the verbal offer or the additional amounts were not realised.
Mr Proctor considered that insufficient work had been done regarding the fit out of the new premises. The existing fit out in the National Bank Building, although portable, would be unacceptable in a new purpose built building. That meant that one of the major costs of the project was uncertain.
Mr Proctor also considered that further work needed to be done on the alternative proposal that PMH purchase its own building despite the difficulties attending ownership.

[140]

In the mid to the end of the eighties, the emerging practice of property developers making payments described as "Lease Incentives" to encourage prospective tenants to commit to a development project, became more prevalent. The securing of a head tenant was, in most cases, one of the deciding issues in a financing arrangement being considered by financiers.
From a banker's prospective, "Lease Incentive" payments were a useful mechanism to reduce the overall project risk and flowed through to such areas as interest rate considerations and ensured the viability of the project depending on the financial strength of the intended lessee and the lessor.
From my experience as a Banker, while Lease Incentives were being used to attract and secure future tenants, the practice was not as wide spread as generally believed in the industry. There were many cases of finance being provided by lenders to well established (and in some cases not so well established) construction groups and investors, to either erect new buildings or to renovate old buildings for new tenancies without any pre-established incentives. [In late 1986 or early 1987][50] Barclays Bank signed an agreement to move its Melbourne Head Office to a building at 410 Collins Street during renovation of the entire building. No lead tenant had been secured prior to construction commencing. Incentives were offered when construction was near completion, but not as part of the financing package in this case. I am aware of some high profile buildings in Melbourne, which were constructed without a lead tenant and in some cases the owners of those buildings encountered financial difficulty. A further branch office of Barclays Bank was established in 1986 in a building at 21 Victoria Street, which had also been funded without a lead tenant. The Chief executive of an overseas bank, based in Sydney, which specialised in property/construction finance was not aware of up front cash payments being made as part of a financing proposal at that time.
In most cases Lease Incentive payments were used to attract tenants to buildings, which had already been constructed or were under construction and which were to a large or lesser extent untenanted. This was particularly the case when in the period up to 1986/1990 there was surplus space in city and city fringe developments and demand for tenancies in such new buildings was slow. Developers/Owners used the Lease Incentive mechanism as a way of not only securing tenants but also to mitigate their high holding cost on development funding.
Further, in my experience, the quantum of Lease Incentives was generally not large. In economic terms the real beneficiary of the Lease Incentive was the Developer/Owner of the building in securing a long-term tenancy.
In the case of incentives offered to tenants, where developments had not commenced, I took the view that there was a sharing of benefits or a transfer of the developers equity to secure a quality tenant. The primary beneficiary was the prospective tenant as such payments to some degree mitigated the risk to the tenant that the building would not go ahead or would be completed behind schedule but the developer also benefited as explained above (Para 8)."[51]

[216]

100. As far as PMH was concerned in October 1987, it is clear that the offer of the lease incentive was not only an integral part of PMH's accepting JGL's offer, it was an essential feature. Mr O'Connell's briefing to partners dated 22 October 1987 included it as one of the features of JGL's proposal before concluding that JGL's proposal was the most cost effective of the alternatives examined in the CBD. The slide presentation described the tax and distribution of the lease incentive as being "of paramount importance". Those issues were to be explored further but that did not lessen their importance. That the lease incentive was of paramount importance to Mr O'Connell at least was underlined by his subsequent correspondence with Mr Spencer in April 1988. That maximising the lease incentive was of importance to the LEC was clear from the minutes of its meeting held on 18 May 1988. That it was of considerable importance to the partners was clear from the minutes of the partners' meeting held on 27 May 1988 and from Mr O'Connell's subsequent correspondence and advice to the partners. The lease incentive was clearly seen as a benefit to the partners. Certainly there was a further sum that was to be used for the fit out of the new premises. That was used to improve their capital investment as found by the Full Court in Selleck v Commissioner of Taxation. The lease incentive with which I am concerned was seen quite differently. It was seen as a sum that was to be distributed among the partners. They were concerned as to how it was to be distributed amongst them when they had different entitlements as partners and they were concerned that their tax on that benefit should be minimised. Their concerns were consistent with their seeing the lease incentive as something that was a gain to them. It was also consistent with PMM & Co's initial wish to take an entrepreneurial approach to its finding new accommodation and wish to benefit from the asset that its need represented. It was not consistent with their regarding the lease incentive as a gain accruing to capital.

At a glance

Court

Decision date

Source

Judgment (282 paragraphs)

Proctor and Commissioner of Taxation [2005] AATA 389; (2005) 59 ATR 1064; (2005) 87 ALD 247; 2005 ATC 2132 (2 May 2005)

Legislation Cited (6)

Cases Cited (23)