Starline Drive-In Theatre Ltd v Commissioner of Taxation

This reference by a Board of Review pursuant to s. 196 (2) of the Income Tax and Social Services Contribution Assessment Act 1936-1957 Cth is concerned with questions which have arisen under s. 88 (2) of the Act in the course of an appeal to the Board by the taxpayer against the assessment of income tax payable by it in respect of income derived in the year ended 30th June 1957. In particular, the objections related to the disallowance of a deduction, or deductions, claimed under the latter section.

Transmitted to this Court with the instrument of reference is a statement of facts agreed to by the parties and the documents therein referred to are annexed to the statement. It is unnecessary to set out the agreed facts in full but it may be observed that by a lease and sub-lease respectively the taxpayer became the lessee and sub-lessee of two adjoining parcels of land upon which it proposed to erect or provide "a drive-in theatre". The grantor of the lease and of the sub-lease was a company known as Eastern Areas Properties Limited. So far as material the lease and sub-lease contain similar covenants and it will suffice for the purposes of the case if I refer to the taxpayer as the lessee of the two adjoining parcels and to the two adjoining parcels as the demised land.

For the purposes of the case it is desirable to set out the following covenants which were contained in the lease:

A(4) The lessee shall use the said land as a drive-in theatre (which shall include a cafe and provision for light refreshment, confectionery and cool drinks) and for any other form of like entertainment and shall not use the said land for any other purpose without the consent in writing of the lessor in each instance being first had and obtained.

A(8) The lessee shall construct and erect on the said land or cause to be constructed thereon all such buildings and other erections and works including posts and cables for the transmission of electric light and power as the lessee shall consider necessary or desirable for any of the purposes specified in paragraph (4) of this clause in accordance with plans and specifications prepared by the lessee's architect.

A(9) The lessee shall and will immediately prior to the expiration or other sooner determination of the said term or any extension thereof at its own expense remove from the said land all such erections and works (other than the said fence) erected by the lessee before or at any time during the said term and electric wires and cables (whether above or under the surface of the said land) brought and installed on the said land before or at any time during the said term and properly fill in and level off all excavations made by the lessee on the said land.

As I have already said similar covenants were contained in the sub-lease and although it might be thought that the literal effect of the covenants was to require the erection of a drive-in theatre on each parcel no point was made of this. On the contrary, it was expressly stated in the statement of agreed facts that the works described in par. (3) thereof, and to which reference will be presently made, "were improvements" which the taxpayer "was required to make under the provisions of its said lease and sub-lease". The term of the lease was ten years less one day from 1st May 1956, the term of the sub-lease was a like period, and the rent reserved was £525 and £650 per annum respectively. It should be added that it was agreed by counsel that at the time of the execution of these instruments there were in existence "plans and specifications prepared by the lessee's architect" and that these had received the approval of both parties.

Between 1st June 1956 and 17th December 1956 the taxpayer carried out the work of erecting a drive-in theatre on the demised land. Brief particulars of the work which this entailed and the cost involved are given in the statement of agreed facts:

(1) Cyclone boundary fencing £3,126 (2) Electrical installations £2,840 (3) Earthworks (filling, levelling, grading etc. for car ramps, roadways and holding area) £6,450 (4) Brick buildings for Cafe and Services Bio Box Storerooms, Office and Ticket Box including all necessary plumbing and water services but not including electrical installations £20,404 (5) Concrete kerbing and stone walling around playground and flower beds £364 (6) Floor tiles in Cafe Building £342 (7) Gardens, trees and shrubs £377 (8) Bitumen surfacing of car ramps, roadways and holding areas £5,147 £39,050

In view of the terms of cl. A(9) of the lease no question arises as to the first item. However, with respect to the remaining items, the question which is referred to this Court is, in effect, whether all or any and which of the improvements specified in the remaining items "were improvements not subject to tenant rights within the meaning of sub-s. (2) of s. 88" of the Act.

According to the statement of agreed facts it is likely that the cost of removal of the improvements in question will exceed the value of materials likely to be recovered though the removal of some items, unspecified, is likely to result in salvage exceeding the cost of the removal. With respect to other items it is likely to cost more to remove them than the value of the resultant salvage and with respect to yet other items it cannot be estimated whether the net result of removal would be a loss or a gain. But in the view I have formed these are, as will appear, irrelevant considerations.

The inquiry into the problem in this case must of necessity commence with the decision of this Court in Consolidated Metal Products Ltd. v. Federal Commissioner of Taxation [1] where the effect and interrelation of ss. 87 (1) and 88 (2) were discussed and the meaning of the expression "not subject to tenant rights", as used in those sections, was considered. It was held that the expression "tenant rights" was not used in any limited or technical sense and that it was apt to describe the right of a lessee to remove from the demised land at the expiration of his term improvements which he had made in accordance with his obligations under the lease. In that case the improvements made by the taxpayer in pursuance of its obligations under its lease consisted of the erection of a factory, office building and fencing and it was held that the right given to the taxpayer as lessee to remove these improvements was a "tenant right" within the meaning of that expression as used in s. 88 (2). But no question based upon a comparison of the cost of removal and the value of the resultant salvage was raised nor was it suggested that any of the improvements were not physically capable of removal. It is, however, necessarily implicit in the decision that it is limited to the case of improvements which in the nature of things are capable of removal. It could, of course, have no application where the improvements in question consist of, for instance, ring-barking and the clearing of timber on land (cf. Morrison v. Federal Commissioner of Land Tax [2] ) or the eradication of prickly pear (cf. McGeoch v. Federal Commissioner of Land Tax [3] ) even if, in either case, the lease in question should purport to secure to the lessee a right to remove improvements at the expiration of his term. But it must be taken to apply to all improvements which are physically capable of removal.

1. (1962) 108 C.L.R. 120. 2. (1914) 17 C.L.R. 498. 3. (1929) 43 C.L.R. 277.

In the present case item (3) above referred to would, at once, appear to fall outside this category. Improvements in the nature of earth works consisting of the "filling, levelling, grading etc. for car ramps, roadways and holding area" are not in any sense susceptible of removal and what I shall, for the moment, call the right of removal given by cl. A(9) of the lease is incapable of application to improvements of this character. Rather, the concluding words of the clause - "and properly fill in and level off all excavations made by the lessee on the said land" - seem to have been designed to define the ultimate position of the lessee with respect to such so-called improvements. Much the same may be said concerning item (8) which, viewed from a practical point of view, seems to have been part of or accessory to item (3). The improvements constituted by the remaining items in question are, however, all physically capable of removal but because it is possible - and upon the agreed facts it is impossible to put it higher - that the cost of removal will exceed the value of the resultant salvage it is contended that deductions in respect of them should not have been disallowed.

But, in my view, even if it were established that the cost of removal would exceed the value of the resultant salvage that would not be a material matter. The relevant condition for the operation of s. 88 (2) is merely that the improvements should not be subject to tenant rights and it is not to the point to inquire whether, if there be a tenant right, the right is a valuable one or not. And, I add, that even if this were a relevant question the value of such a right could not be determined exclusively by a comparison of the cost of removing improvements with the value of the resultant salvage; their value in situ and the consideration which might be obtained by a lessee for foregoing his right to removal would also be a matter to be taken into account. But, however this may be, that the value to the lessee of the so-called tenant right is not a material consideration is borne out by an examination both of the form of s. 88 (2) and the purpose which it was so obviously intended to serve. As I have already said the relevant condition for the operation of the sub-section is expressed simply by the words "Where a taxpayer has incurred expenditure in making improvements not subject to tenant rights" and it has been held by this Court that a right to remove improvements is just as much a "tenant right", in the sense in which that expression is used in the section, as a right to compensation for improvements made on the subject land by the lessee. Such a conclusion was, I think, inevitable for the obvious purpose of the section was to enable a lessee to obtain appropriate deductions from his assessable income - the other conditions of the sub-section being satisfied - in respect of expenditure on improvements which the lessor has by the terms of the lease required him to make or which have been made with the lessor's written consent or pursuant to an agreement of the character referred to in sub-s. (2) (a). In other words, it is the purpose of the sub-section to treat such expenditure in the same manner as the payment of a premium and, therefore, as an expenditure enuring for the benefit of the lessor in cases where the improvements are "not subject to tenant rights". The reason for this is as Windeyer J. said in a'Beckett v. Federal Commissioner of Taxation [1] that Div. 4 of the Act "contains provisions which, speaking very broadly, make premiums and other payments by a lessee to a lessor, and also certain expenditure by a lessee in connexion with leased premises, equivalent to rent payable under the lease" [2] . It is for this reason that expenditure of the character specified in s. 88 (2) is treated as part of the consideration for a lease where the improvements are "not subject to tenant rights" and as Kitto J. observed in Consolidated Metal Products Ltd. v. Federal Commissioner of Taxation [3] "the reason for excluding from the application of s. 88 (2) the case of a tenant who has a right to compensation for improvements which he must leave at the end of his lease is in common sense a reason for excluding also the case of a tenant who has a right after the term to remove what otherwise would remain as improvements" [4] . In each of such cases the resemblance of the expenditure incurred in making the improvements to a premium or rent paid to the lessor is entirely lost. In other words, the expenditure in such cases is not for the benefit of the lessor and fails to be recognizable as a consideration provided for the lease; it is an expenditure incurred for the benefit of the lessee alone and, in my view, falls outside the sub-section whether, in the case where the tenant right consists of a right to remove the improvements, the cost of removal will or will not exceed the value of the resultant salvage.

1. (1959) 104 C.L.R. 508. 2. (1959) 104 C.L.R., at p. 511. 3. (1962) 108 C.L.R. 120. 4. (1962) 108 C.L.R., at p. 125.

One matter remains to be mentioned. So far I have discussed the case on the assumption that the lessee is, by its lease and sub-lease, given a right to remove the improvements made by it. But this is disputed by the lessee who asserts that the obligation to remove the improvements from the demised land which the lease and sub-lease imposed upon it is not equivalent to a right to remove them. The basis of this submission is that the relevant covenants are solely for the benefit of the lessor and it is contended that the latter may waive its rights thereunder and so prevent the removal of the improvements by the lessee. This proposition was based upon observations in Soames v. Edge [1] and Hawksley v. Outram [2] both of which cases dealt with the right of a party to a contract to obtain a decree for specific performance notwithstanding non-fulfilment by the other party of, or unwillingness on his part to perform, a condition inserted in the contract for the sole benefit of the former. In such cases the former may waive his right to a performance of the condition and obtain a decree. The principle involved in these cases has been applied in other cases in which specific performance was sought such as Morrell v. Studd & Millington [3] and, in this Court, in George v. Roach [4] . But to my mind the principle applied in these cases has no relevance to the present case for, apart from any other consideration, it is, I think, quite impossible to say that the covenant in question was simply and solely for the benefit of the lessor. Whether, if it were, the principle might be invoked so as to enable the lessor to prevent the lessee, it being ready and willing to do so at the appropriate time, from performing its obligations under the lease is a question which need not be further considered. Accordingly, I am of the opinion that such of the improvements as are physically capable of removal are subject to tenant rights.

1. (1860) John. 669 [ 70 E.R. 588]. 2. [1892] 3 Ch. 359. 3. [1913] 2 Ch. 648. 4. (1942) 67 C.L.R. 253.

For these reasons the question raised should be answered as follows: The improvements specified in par. (3) of the agreed statement of facts as items (3) and (8) are not subject to tenant rights within the meaning of s. 88 (2) of the Act.

The improvements specified in the said paragraph as items (2), (4), (5), (6) and (7) are improvements subject to tenant rights within the meaning of the said sub-section.

In the circumstances I think there should be no order as to the costs of the reference.

I agree that the questions should be answered in the way proposed, for the reasons given in the judgments that have been delivered.