Victoria Power Networks Pty Ltd v Commissioner of Taxation

Counsel for the Respondent: Mr GJ Davies QC with Dr JE Jaques

BETWEEN: VICTORIA POWER NETWORKS PTY LTD Applicant

AND: COMMISSIONER OF TAXATION Respondent

JUDGE: MOSHINSKY J DATE OF ORDER: 7 FEBRUARY 2019

1. Within 14 days the parties provide minutes of proposed orders to give effect to these reasons. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

BETWEEN: VICTORIA POWER NETWORKS PTY LTD Applicant

AND: COMMISSIONER OF TAXATION Respondent

JUDGE: MOSHINSKY J DATE OF ORDER: 7 FEBRUARY 2019

1. Within 14 days the parties provide minutes of proposed orders to give effect to these reasons. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

BETWEEN: VICTORIA POWER NETWORKS PTY LTD Applicant

AND: COMMISSIONER OF TAXATION Respondent

JUDGE: MOSHINSKY J DATE OF ORDER: 7 FEBRUARY 2019

1. Within 14 days the parties provide minutes of proposed orders to give effect to these reasons. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

BETWEEN: VICTORIA POWER NETWORKS PTY LTD Applicant

AND: COMMISSIONER OF TAXATION Respondent

JUDGE: MOSHINSKY J DATE OF ORDER: 7 FEBRUARY 2019

1. Within 14 days the parties provide minutes of proposed orders to give effect to these reasons. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

Introduction 1 The applicant, Victoria Power Networks Pty Ltd (VPN), previously known as CHEDHA Holdings Pty Limited, was during the relevant years of income the head company of a consolidated tax group. Powercor Australia Ltd (Powercor) and CitiPower Pty Ltd (as trustee for the CitiPower Trust) (CitiPower) were subsidiary members of that group. Each of Powercor and CitiPower (the Distributors) held a distribution licence under the Electricity Industry Act 2000 (Vic) and carried on the business of distributing electricity to customers in Victoria. 2 These proceedings, which are appeals against appealable objection decisions under s 14ZZ of the Taxation Administration Act 1953 (Cth), concern the substituted accounting periods ended 31 December 2007, 31 December 2008, 31 December 2009 and 31 December 2010 (in lieu of the years ended 30 June 2008, 30 June 2009, 30 June 2010 and 30 June 2011). 3 Under the terms of their electricity distribution licences, Powercor and CitiPower were required to connect customers to the electricity network when requested to do so. The work involved the construction and installation of assets necessary for the delivery of electricity from the transmission grid to the customer. 4 Certain works were required to be carried out by the Distributor (referred to as non-contestable works), while other works could be carried out by the Distributor or the customer, at the customer's option (referred to as contestable works). Depending on the type of connection works involved and the choice made by the customer, either: (a) the Distributor undertook construction of the connection works; or (b) the customer undertook construction of the connection works. Upon completion of the connection works, the works were transferred to the Distributor (the Transferred Assets) and the Distributor paid a rebate to the customer (the Rebate). Where the works were contestable, and thus the customer had a choice, the situation where the works would be undertaken by the Distributor was described as "Option 1" and the situation where the customer would undertake the works was described as "Option 2". I will adopt those expressions in these reasons. 5 Under the applicable regulatory regime, in every case a calculation was made by the Distributor of the incremental cost in relation to a new connection (the incremental cost or IC) less the incremental revenue in relation to the new connection (the incremental revenue or IR) (the IC less IR calculation). The incremental cost and the incremental revenue were both present day values. There were two distinct situations referred to by the parties: (a) where the incremental revenue was greater than the incremental cost, referred to in some of the submissions and evidence as an 'economic connection'; and (b) where the incremental revenue was less than the incremental cost, referred to in some of the submissions and evidence as an 'uneconomic connection'. 6 As explained later in these reasons, the labels 'economic' and 'uneconomic' are in some respects inaccurate; nevertheless, it is convenient to adopt these labels on some occasions in these reasons. However, it needs to be emphasised that they are merely labels for the two situations described in [5] above. 7 The issues in dispute in this proceeding concern only situations where the connection was 'uneconomic'. There is no dispute between the parties in relation to situations where the connection was 'economic'. Nevertheless, it is necessary to refer to certain facts and matters pertaining to 'economic' connections in order to provide context for the issues relating to 'uneconomic' connections. 8 In relation to the situation where the Distributor undertook the construction works, if the connection was 'uneconomic', the Distributor was entitled to charge the customer an amount equal to the incremental cost less the incremental revenue (the Customer Cash Contribution). 9 In relation to the situation where the customer undertook the construction works, if the connection was 'economic', the Distributor paid the customer a Rebate equal to the estimated cost of construction. However, if the connection was 'uneconomic', the customer was in effect required to make a contribution equal to the incremental cost less the incremental revenue (the Customer Contribution). In such a case, the Distributor paid the customer a Rebate equal to the estimated cost of construction less the Customer Contribution. 10 The different scenarios can be illustrated by the following four examples, which were set out in a document prepared by VPN for the purposes of the hearing. The examples are necessarily simplified, but assist in understanding the transactions. Examples 1 and 2 concern an 'economic' connection. Examples 3 and 4 concern an 'uneconomic' connection. In each of the examples, the incremental cost is the total of the "Estimated Cost of Construction" amount plus the "Future Upstream & Opex" amount, and the incremental revenue is the amount specified as "Future Revenues". Although Example 3 refers to "Option 1", I was told by senior counsel for VPN in opening submissions that the example works identically where the works are contestable and where they are non-contestable. 11 As noted above, the issues between the parties are confined to connections that were 'uneconomic' (represented by Examples 3 and 4, above). The positions of the parties can be summarised as follows: (a) In relation to the situation where the Distributor undertook the works and the connection was 'uneconomic' (ie, Example 3), the respondent (the Commissioner) contends that the Customer Cash Contribution (ie, the $40 in Example 3) was income according to ordinary concepts and thus included in VPN's assessable income under s 6-5(1) of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act). VPN disputes this. VPN contends that the Customer Cash Contribution was an "assessable recoupment" within the meaning of s 20-20 of the 1997 Act. The Commissioner accepts that, if the Customer Cash Contribution was not income according to ordinary concepts, it was an "assessable recoupment" within s 20-20 of the 1997 Act. (b) In relation to the situation where the customer undertook the works and the connection was 'uneconomic' (ie, Example 4), the Commissioner contends that the Customer Contribution (ie, the $40 in Example 4) was income according to ordinary concepts and thus included in VPN's assessable income under s 6-5(1) of the 1997 Act. VPN disputes this. In the alternative, the Commissioner contends that: the Transferred Assets were a "non-cash business benefit" for the purposes of s 21A of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act); the arm's length value of the Transferred Assets was equal to the estimated cost of construction (ie, $100 in the example); the recipient's contribution was equal to the Rebate (ie, $60 in the example); and accordingly, the amount included in VPN's assessable income under s 6-5 of the 1997 Act pursuant to s 21A of the 1936 Act (being the arm's length value less the recipient's contribution) was, in the example, $40. In response, VPN: accepts that the Transferred Assets were a non-cash business benefit for the purposes of s 21A of the 1936 Act; says that the arm's length value of the Transferred Assets was equal to the amount of the Rebate (ie, $60 in the example); says that the recipient's contribution was equal to the Rebate; and accordingly, says that the amount included in VPN's assessable income under s 6-5 of the 1997 Act pursuant to s 21A of the 1936 Act (being the arm's length value less the recipient's contribution) was, in the example, $0. 12 The issues that arise for determination may be summarised as follows: (a) In relation to the situation where the Distributor undertook the works and the connection was 'uneconomic' (ie, Example 3): (i) was the Customer Cash Contribution (ie, the $40 in the example) income according to ordinary concepts within s 6-5(1) of the 1997 Act? (ii) was the Customer Cash Contribution an "assessable recoupment" within the meaning of s 20-20 of the 1997 Act? (b) In relation to the situation where the customer undertook the works and the connection was 'uneconomic' (ie, Example 4): (i) was the Customer Contribution (ie, the $40 in the example) income according to ordinary concepts within s 6-5(1) of the 1997 Act? (ii) what amount (if any) is included in the assessable income of VPN under s 6-5 of the 1997 Act pursuant to s 21A of the 1936 Act? 13 For the reasons set out below, I have concluded, in summary, as follows: (a) In relation to the situation where the Distributor undertook the works and the connection was 'uneconomic' (ie, Example 3): (i) the Customer Cash Contribution was income according to ordinary concepts within s 6-5(1) of the 1997 Act; and (ii) the Customer Cash Contribution was not an "assessable recoupment" within the meaning of s 20-20 of the 1997 Act. (b) In relation to the situation where the customer undertook the works and the connection was 'uneconomic' (ie, Example 4): (i) the Customer Contribution was not income according to ordinary concepts within s 6-5(1) of the 1997 Act; and (ii) for the purposes of s 21A of the 1936 Act: the Transferred Assets were a non-cash business benefit; the arm's length value of the Transferred Assets was equal to the estimated cost of construction; the recipient's contribution was equal to the Rebate; and accordingly, the amount included in VPN's assessable income under s 6-5 of the 1997 Act pursuant to s 21A of the 1936 Act (being the arm's length value less the recipient's contribution) was, in the example, $40. 14 These reasons will be structured under the following main headings: (a) The evidence. (b) Factual findings. (c) Admissibility of expert economic evidence. (d) Issues relating to the situation where the Distributor undertook the works. (e) Issues relating to the situation where the customer undertook the works. (f) Conclusion.

The evidence 15 At the hearing of the proceeding, VPN called evidence from the following lay witnesses: (a) Shane Breheny, a former Chief Executive Officer of the group of companies of which VPN is the ultimate parent company (the VPN Group); (b) Colin Hoole, a retired former employee of the VPN Group; and (c) Mark de Villiers, an employee of the VPN Group. 16 Each of these witnesses was cross-examined. Each of the witnesses gave evidence clearly and confidently and displayed a deep knowledge of the subject-matter. I generally accept their evidence. To the extent that there were differences between their affidavit evidence and oral evidence, I prefer the oral evidence. 17 The Commissioner did not call any lay witnesses, but tendered a number of documents. 18 Each party relied on expert valuation evidence. The valuation experts called by the parties were: (a) Antony Samuel, a valuer and forensic accountant at Sapere Research Group Limited (called by VPN); and (b) Jannaya James, a business valuation specialist at Grant Thornton Australia (called by the Commissioner). 19 Expert reports were prepared by each of Mr Samuel and Ms James. Mr Samuel also prepared a reply report. The experts together prepared a joint report. They gave evidence concurrently at the hearing. I discuss their evidence further below. 20 In addition, the parties prepared expert evidence from two economists regarding the economic consequences of the transactions. The experts prepared separate reports and a joint report. There is an issue regarding the admissibility of this material. The experts were: (a) Jeffrey Balchin, an economic consultant who is the Managing Director of Incenta Economic Consulting (called by VPN); and (b) Robert McMillan, an economic consultant who is a director of Farrier Swier (called by the Commissioner). 21 Mr Balchin prepared three reports. Mr McMillan prepared one report. The two experts together prepared a joint report. This evidence was admitted provisionally, subject to relevance. The Commissioner contends that the evidence is not relevant. He submits that all of this material should not be admitted; he relies on the evidence of Mr McMillan only if the evidence of Mr Balchin is admitted. I will consider the admissibility of this material later in these reasons. In any event, neither Mr Balchin nor Mr McMillan was required to attend for cross-examination. 22 Another issue of admissibility concerned the documents filed by the Commissioner pursuant to r 33.03 of the Federal Court Rules 2011 (appearing under tabs 5, 6, 7 and 8 of the Court Book prepared by the parties). These documents were admitted subject to a relevance objection by VPN. In my view, these documents are relevant insofar as they provide background and context to the issues in dispute in the proceeding. Beyond this, I do not consider it necessary to have regard to these documents.

Factual findings 23 I now set out my factual findings based on the lay affidavit evidence, the documentary evidence and the oral evidence given during the hearing. There was little dispute about the facts.

The National Electricity Market 24 There is a national wholesale electricity spot market, known as the National Electricity Market (NEM), through which all electricity is traded through a centralised pool. Generators supply electricity to the NEM at a price, and wholesale purchasers (who are mainly electricity retailers) buy their electricity requirements from the pool of electricity supplied. At the relevant times, the NEM was managed by the National Electricity Market Management Company Limited (NEMMCO), which later became the Australian Energy Market Operator. 25 Distribution system operators provide a service to retailers by distributing that electricity to their customers, for which those distributors are paid a fee under a Use of System Agreement. Distributors pay fees to the transmission system operators for the transmission of electricity to their distribution networks.

The businesses of CitiPower and Powercor 26 CitiPower and Powercor carry on businesses as electricity distributors. They own, operate, augment and maintain that part of the electricity network that connects the transmission network owned by transmission network operators (in Victoria, that operator is AusNet) to the premises of the customers who are the consumers of electricity. At the relevant times, each operated in an almost exclusive geographical area of which there were five in Victoria. In the case of Powercor, the area was approximately 165,000 square kilometres in the west of the State. In the case of CitiPower, it was around 5,400 square kilometres within Melbourne, including the central business district and some parts of the inner suburbs. 27 To conduct a business as an electricity distributor, each of CitiPower and Powercor had distribution licences granted to them by the Essential Services Commission (ESC). 28 Powercor's and CitiPower's revenues came primarily from fees paid by electricity retailers. Electricity retailers are companies that buy electricity from generators on the NEM and sell it to consumers. Electricity retailers do not own network infrastructure assets and have no obligations to maintain the network, but instead pay fees to the distribution network operators for the use of their networks in order to supply electricity to the retailer's customers. 29 End users of electricity within a distributor's geographical area were referred to colloquially as "customers", even though they did not directly pay tariffs to the distributor. Such end users were referred to both as "customers" and "consumers" in the evidence. The distributors had a relationship with the customers because the distributors had obligations to connect them to the distribution network and to maintain supplies of electricity to them. 30 CitiPower and Powercor could not control the number of customers (since all customers within its geographic areas were connected to its distribution network) nor the demand of those customers for electricity.

Price regulation 31 Electricity is a highly regulated industry. Prior to 2007, the ESC regulated the electricity industry in Victoria. In the period 2007-2010, the Australian Energy Regulator (AER) assumed responsibility broadly for pricing and the ESC regulated licensing of energy distributors (and others) and monitored compliance with licensing requirements. The Energy Industry Ombudsman primarily dealt with complaints by customers. As noted above, NEMMCO managed the NEM. 32 Regulations were in place that set the maximum amount that distributors, like CitiPower and Powercor, could charge retailers for the use of the distribution system. The regulations set out a methodology by which the regulator determined an Annual Revenue Requirement (ARR), which was re-calculated every five years as part of the distributor's price determination. The ARR was set in a way which (if the forecasts on which it was based were met) provided the distributor with the recovery of its operating costs, a return of the amount the distributor was taken to have invested in the network (known as the distributor's Regulatory Asset Base) (RAB) and a regulated return on the distributor's RAB. The ARR was converted into a weighted average price cap by dividing the ARR by the expected level of electricity demand. 33 The distribution determination (or price determination) relevant to the period in question in this proceeding was issued by the ESC on 19 October 2005 and was effective from 1 January 2006 to 31 December 2010 (2006 Determination). It replaced an earlier five-year determination and was later replaced by another five-year determination. 34 The 2006 Determination was made following submissions from VPN. When Mr de Villiers began with VPN in 2005, VPN had just submitted its initial regulatory proposal. Once it had been provided to the regulator, a draft decision was released and VPN was given an opportunity to respond to the draft decision and submit a revised proposal. 35 By the time the 2006 Determination was made, the National Electricity Rules (NER) had come into effect. These were standardised rules made to apply to all States that had privatised their energy industries. The 2006 Determination was not made by reference to the NER. All later distribution determinations were made under the NER, which adopted similar principles to those that had been used in Victoria. However, some of the terminology changed.

The Annual Revenue Requirement 36 A price determination dealt with a number of things. One of the most important was the calculation of what is now called the annual revenue requirement (referred to in these reasons as the "ARR"). In the 2006 Determination it was referred to as the building block revenue requirement. 37 An ARR was calculated for each distributor by the regulator and recalculated every five years with each new price determination. The ARR simulated the revenue that a distributor would receive in a competitive market, incurring efficient costs and allowing an adequate return to investors, while also providing an incentive to reduce costs and improve services. 38 The ARR for a distributor was determined using a "building block" approach, which estimated the components of allowable revenue, having regard to efficient capital and operating costs requirements of providing distribution services. In simple terms, it worked by adding up a number of components of revenue, dividing them by the estimated demand for electricity and arriving at a price. 39 A number of the components of the ARR related to the RAB of a distributor. The RAB represents the depreciated value of network investments made by the distributor. At the time of privatisation in 1994, an RAB for each distributor had been set. For each regulatory period since, these values were adjusted for inflation, capital expenditure, depreciation, customer contributions, and any disposals for which the distributor received payment. 40 The key components of the ARR were: (a) a return on capital, being an amount calculated by multiplying the RAB by the weighted average cost of capital (WACC) determined by the regulator; (b) depreciation of the RAB (ie, a return of capital); (c) efficient operating and maintenance expenditure; (d) incentive scheme financial rewards/penalties. In the relevant period, there was an incentive known as the "efficiency carryover scheme". This was a mechanism for allowing a distributor that made operating and capital expenditure savings or improvements to keep the benefit of those savings or improvements over six years. It was symmetrical and so also served as a penalty if operating and capital expenditure was in excess of the forecast; and (e) an amount for the distributor's forecast tax liability, which was reduced by the assumed value of imputation credits. The calculation of tax assumed that the customer contributions in relation to new connections were assessable to the distributor. 41 The forecast profit produced by the model was a function of the return on capital and the incentive scheme rewards/penalties. The other components of the ARR were intended to cover the distributor's forecast expenses and recover the distributor's costs. Because the return on capital was calculated as a return on the RAB, an amount that was not included in a distributor's RAB could not generate a return on capital. 42 The RAB was calculated every five years at the time of a distribution determination by taking the RAB value originally set in 1995 and adjusting it annually for depreciation, inflation and actual capital expenditure made to the year prior to the start of the forecast regulatory period. This RAB value was adjusted through to the end of the forecast regulatory period for forecast depreciation, inflation and capital expenditure. In this way, the RAB represented the cumulative depreciated value of the cost of the distribution network or, put another way, the approximate cost incurred by the distributor in building the network today in its existing configuration and condition. 43 The ARR was a calculation that fed into the weighted average price cap (WAPC) that the distributor was permitted to charge. It was not an actual amount of revenue that a distributor earned. A distributor could in fact earn more or less revenue than the ARR.

The Weighted Average Price Cap 44 The WAPC was calculated annually using the following formula: WAPC = (1 + CPI) x (1 - X) x S x L 45 CPI is the consumer price index. The first element of the formula ensured that distributors could charge prices that reflected any CPI increase or decrease since the previous distribution determination. 46 X (or the X factor) was a critical variable. The main purpose of the submissions made to the regulator every five years was to calculate and justify an appropriate value for the X factor for each of the five years in the regulatory period. The X factor represented the real price change (ie, stripping out inflation) from one year to the next. It was determined by the regulator after considering a number of factors including the WACC, the RAB, incentives and the forecast volume of electricity distributed. The X factor could be positive or negative. 47 S (or the S factor) represented the distributor's performance against a number of reliability and customer service benchmarks. It was calculated annually, based on performance in the year that was two years prior. Save for one matter, it was a mechanical calculation once the method was set out in the regulator's determination. For example, one element of the customer service target was answering customer service calls within 30 seconds, and one reliability target related to the frequency of interruptions to supply. The level of performance on this target was fed into a formula that calculated the S factor. The one area of potential uncertainty with the S factor was that certain events were excluded from calculations. For example, if service delivery was affected by a transmission outage (which was not the fault of the distributor), then this would be excluded so as not to penalise a distributor for something beyond its control. 48 L (or the L factor) is a provision for the pass through of licence fees or levies used to fund the regulator. 49 Under a WAPC, the distributor was exposed to the risk or opportunity of any differences between forecast and actual volume of electricity distributed. A distributor could increase its profits by underspending on the forecast operating expenditure or capital expenditure. A proportion of that underspend was retained by the distributor. Further, if the distributor's debt financing costs were lower than the regulatory assumption, the whole of that reduction in debt financing costs was retained by the distributor. There was also a benefit where the distributor was able to leverage its financing to a greater degree than assumed for regulatory purposes while maintaining relatively low debt rates.

Tariff schedules 50 Once the WAPC had been calculated, it was for the distributor to determine how to meet it. In the case of Powercor and CitiPower, there were around 30 different tariffs, which varied depending on whether the end user of that electricity was domestic or business, their size, their usage, etc. Within each tariff, there were different components, for example a fixed portion and a variable portion. Network tariffs comprised the sum of distribution tariffs (set by reference to the WAPC) and transmission tariffs (set by reference to a revenue cap being the amount that Powercor was charged for transmission costs). Retailers were charged separately for metering services provided by distributors. 51 Each year, Powercor and CitiPower decided how much to increase and decrease the various tariffs and their components, known as rebalancing the tariffs. This was essentially an economic calculation, done to maximise revenue. No matter how the tariffs were set, the distributor had to ensure that the weighted average tariff was no more than the WAPC. To calculate this, volumes from two years earlier were used. The tariff schedule had to be approved by the regulator before it could be used.

The prices charged by CitiPower and Powercor 52 Although the regulations only set an upper limit on the prices that a distributor could charge and did not prescribe the minimum prices, in practice CitiPower and Powercor always charged the maximum permitted prices.

Overview of the process 53 Under their distribution licences, distributors were required to connect a new customer to the distribution network on request. This was required to be carried out in accordance with Electrical Industry Guideline No 14 - Provision of Services by Electricity Distributors (Guideline 14), a Victorian regulation. The Distributors were required to comply with Guideline 14 as a condition of their licence. 54 Before setting out the relevant terms of Guideline 14, it will be convenient to describe the processes that CitiPower and Powercor undertook when a new customer asked to be connected to the distribution network. Those processes can be summarised as follows. (The following summary is based on Mr Hoole's affidavit evidence, as supplemented by his evidence during cross-examination.) (a) If augmentation of the distribution network was required in order to provide an offer for connection services, then for those works that were contestable services, CitiPower and Powercor were required to call tenders in accordance with the regulatory guideline. (b) Works that were deemed to be eligible for tenders were referred to as "contestable services". Contestable services were limited to certain types of work, generally on greenfield sites where there was no existing CitiPower or Powercor infrastructure. Works on existing CitiPower or Powercor assets were not eligible for tenders because, for safety reasons, those works could only be performed by CitiPower or Powercor. Those works were referred to as "non-contestable" services. (c) The next step after a customer request for connection depended on whether the distributor was CitiPower or Powercor: (i) For Powercor customers, Powercor sent an option selection form to the customer, asking the customer to choose whether it wanted Powercor to construct the entirety of the works (referred to by Mr Hoole and in these reasons as "Option 1"), or to carry out the contestable works itself (referred to by Mr Hoole and in these reasons as "Option 2"). For Option 2, the customer was also asked to choose whether it wanted to conduct the tender itself, or whether it wanted Powercor to do so. (ii) For CitiPower customers, there was no separate option selection form. Customers were asked to confirm their option as part of the offer. (d) In every case where the distributor was requested to connect a new customer, the distributor made an estimate of the cost of construction in relation to the new connection. That estimate was made before, or as part of, the IC less IR calculation. The estimated cost of construction became one of the inputs in the customer contribution model (ie, the model for calculating the customer contribution set out in Guideline 14). (e) CitiPower or Powercor made an assessment of the incremental cost and incremental revenue associated with the customer request, and determined which was the greater (ie, the IC less IR calculation). The assessment was made in order to determine the amount of the customer contribution, if any, under Guideline 14. Such an assessment was made in every case where the distributor was requested by a new customer to connect the customer to the network. (f) An offer for connection services was then sent to the customer: (i) In the case of CitiPower, the offer was made on the basis of Option 1, and asked the customer to confirm that they did not require an Option 2 process. Under the heading "Customer Statement" in the Network Connection Proposal, the customer was asked to tick one of three boxes. The first box (waiving the right to tender) was Option 1. The other two boxes related to Option 2. (ii) In the case of Powercor, the offer was sent on the basis of the option chosen by the customer under the option selection form. (g) If the customer chose Option 1, the distributor constructed the connection. If the assessment of the incremental cost was greater than the assessment of the incremental revenue, the customer was required to pay the distributor up-front the difference between the two as a customer contribution (referred to in these reasons as the "Customer Cash Contribution"). The Customer Cash Contribution was payable when the contract was entered into. (h) If the customer chose Option 2, a third party engaged by the customer undertook the contestable services. CitiPower's or Powercor's offer for connection services set out the customer contribution based on the incremental cost less the incremental revenue. It also included the amount of any Rebate to be paid to the customer by the distributor for the contestable services being undertaken by the third party engaged by the customer. The Rebate paid was dependent on the outcome of the IC less IR calculation, hence it could be the amount of the assessed cost of the Transferred Assets or a lesser amount. 55 Where a customer believed it could undertake the works more cheaply than the distributor could, it could save money by choosing Option 2. Customers choosing Option 2 took on the risk of the actual costs they incurred being greater than the distributor's assessment of the costs. Adverse weather and issues of coordinating the other contractors working on the site were common causes of cost overruns. The distributors bore the risk of cost variations under the Option 1 process. In other words, they bore the risk that the actual cost might be more than the estimated cost of construction. 56 Whether Option 1 or Option 2 was chosen, the distributor would ultimately become the owner of the infrastructure installed. In Option 1, the distributor was the owner throughout the process. In Option 2, the distributor became the owner when it certified that the works were completed in accordance with the distributor's technical standards, thereby taking ownership of the assets, which were then tied into the network by the distributor (referred to in these reasons as the "Transferred Assets" and referred to internally by the Distributors as "gifted assets"). The infrastructure installed by the customer, upon energisation by the distributor, became part of the distribution network. From then on, the distributor was responsible for all ongoing maintenance and asset replacement. 57 Where a new customer asked to be connected to the network, the distributor carried out calculations of the connection's "incremental revenue" and "incremental cost", as required by Guideline 14. Included in the incremental cost were: the distributor's estimation of the cost of constructing the connection; the estimated incremental cost of augmentation of the broader network to support that connection; and the estimated incremental operating and maintenance costs to support the connection. 58 Incremental revenue was a calculation of the distribution tariff revenue to be received from the customer over a specified period, either 15 years (for businesses) or 30 years (for domestic customers). Distribution tariff revenue was calculated by multiplying the forecast distribution tariffs by the forecast amount of electricity to be supplied to that customer. In calculating the forecast tariffs to be charged by the distributor, Guideline 14 required distributors to apply the known X factors to the end of the regulatory control period, and then apply the X factor for the final year of that regulatory control period for the duration of the 15 or 30 years, as applicable. The revenue forecasts were then discounted back to a present value using the regulated WACC. 59 There were four possible situations where a customer requested a new connection (corresponding to Examples 1 to 4 set out in [10] above): (a) the distributor carried out the construction works, where the incremental revenue exceeded the incremental cost; (b) the customer undertook the construction works, where the incremental revenue exceeded the incremental cost; (c) the distributor carried out the construction works, where the incremental revenue was less than the incremental cost; (d) the customer undertook the construction works, where the incremental revenue was less than the incremental cost. (These situations appear in a different order in Mr de Villier's affidavit, but it is convenient to set them out in the same order as Examples 1 to 4 in [10] above.) 60 In situation (a), no amounts were paid by the customer to the distributor or the distributor to the customer. In situation (b), the distributor paid the customer a Rebate equal to the distributor's estimated cost of constructing the connection asset. In situation (c), the customer paid a Customer Cash Contribution to the distributor equal to the excess of the incremental cost over the incremental revenue. In situation (d), the distributor paid the customer a Rebate equal to the estimated cost of construction less the Customer Contribution. (In relation to situation (d), I note that Mr de Villiers made a correction in oral evidence to [47] of his affidavit. Further, he said during cross-examination, and I accept, that the Rebate was simply the difference between the estimated cost of construction and the amount of the customer contribution.) 61 For completeness, I note that, in relation to situation (d), it appears that on some occasions the Customer Contribution was greater than the estimated cost of construction. It seems that, in such cases, no Rebate was paid and an amount (being the Customer Contribution less the estimated cost of construction) was payable by the customer to the distributor. The evidence of Mr Breheny during cross-examination was that such cases were unusual. The parties did not focus on such situations in the course of their submissions and such situations can be put to one side for present purposes. 62 As explained in [50] of Mr de Villier's affidavit, the effect of Guideline 14 was that, where someone connected to the distribution network, the existing customers did not bear the excess cost of constructing a connection through increased tariffs where the incremental cost exceeded the incremental revenue. This was achieved by new customers contributing to the cost of connection when the incremental cost exceeded the incremental revenue (either directly, by the customer paying a Customer Cash Contribution, or indirectly, by the Distributor paying the customer a Rebate that was less than the estimated cost of constructing the asset). During cross-examination, Mr de Villiers accepted a series of propositions relating to the objective and operation of Guideline 14. Mr de Villiers gave the following evidence, which I accept: The prices which the distributors can charge are heavily regulated? - Correct. The structure of the regulations are such as to - on the basis that the assumptions are accurate, the pricing schedule is set up to enable the distributor to make profits on their operations without the profits being too much? - Well, the prices serve to first allow the distributor to recover the efficient costs of running the network, and to earn a reasonable return on their investment. That's how I would put it. And in meeting those objectives, the pricing regulations recognise that new connections are made as part of the business of the distributors, and they recognise that they put in place a structure to enable the distributors to make a charge for the new connections in some circumstances. And the circumstances in which the charge can be made, and the amount of the charge that can be made, by and large the objective is to ensure that making [and] operation of the new connection won't add to the price burden on existing customers? - Yes. I agree. So that where the costings are such that the distributor will need to recover more because of the costings, guideline 14 is put in place in order to achieve the objective that the burden of the additional cost is borne by the new customer as opposed to being built into the system and being imposed upon the existing customers? - Correct. So the way in which that's achieved is twofold. The first is guideline 14 sets out the circumstances in which a charge up-front can be made on the customer for the new connection? - Yes. And the second is to ensure that the pricing going forward is not affected by the capital expenditure in relation to the new connection, so far as it's covered by the contribution? - Yes. So with the calculation of the RAB, the general rule is that capital expenditure is added to the RAB, so that the revenue requirements can be determined thereafter, but so far as there is a customer contribution that has been obtained from the new customer, that reduces the RAB? - Correct. So that the existing customers then don't bear any price increases for the job if there hadn't been capital expenditure in relation to the new connection? - Correct. 63 Mr Breheny and Mr Hoole gave evidence during cross-examination, which I accept, that with the exception of certain requests by the State Government, the Distributors always charged the maximum that they were entitled to charge under Guideline 14. It does not appear that the exception is material for present purposes. 64 Mr de Villiers gave evidence during cross-examination, and I accept, that there were situations where Option 1 and Option 2 were in effect "meshed together" in a project. In such situations, the net payment could have been either way (ie, from the distributor to the customer or vice versa).

Guideline 14 65 I now set out the relevant terms of Guideline 14. Clause 3 of Guideline 14 was titled "New Works and Augmentation". Clauses 3.1 to 3.3 provided as follows: 3 NEW WORKS AND AUGMENTATION 3.1 Background 3.1.1 Under clause 5.7.3(h) of the Tariff Order, a distributor may levy an excluded service charge as follows: ... capital contributions for new works and augmentation ... 3.1.2 In clause 5 of this guideline the Commission regulates generally for excluded services and excluded service charges. For example, clause 5 applies to the excluded service charge distributors may levy on customers under clause 5.7.3(b) of the Tariff Order, for connection to distributors' distribution systems. However, clause 5 does not apply to the excluded service charge that distributors may levy for new works and augmentation under clause 5.7.3(h) of the Tariff Order. Instead, the specific regulations in this clause 3 apply to that excluded service charge and the related excluded service [see also clause 5.1.4]. 3.1.3 New works and augmentation may form part of the connection services a distributor provides to a customer so as to allow the supply of electricity from the distributor's distribution system to an electrical installation of the customer. 3.1.4 Under their distribution licences, distributors are required to offer such connection services. Clause 5.1 of the distribution licences provides: If a retailer or a customer requests the Licensee to offer: (a) to provide connection services so as to allow the supply of electricity from the Licensee's distribution system to an electrical installation of the relevant customer; and (b) to supply electricity from the Licensee's distribution system to that electrical installation, the Licensee must make such an offer ... 3.1.5 Clause 10.3 of the distribution licences requires distributors to include in any such offer a price and other terms and conditions which are fair and reasonable and consistent with, among other things, any relevant guideline. 3.1.6 As noted in clause 1.2, this guideline is a relevant guideline. 3.2 Customers must contribute to the capital cost of new works and augmentation In making a connection offer, a distributor must include a price that has been determined on the basis that: (a) the customer is not to contribute towards the capital cost of new works and augmentation unless the incremental cost in relation to the connection offer is greater than the incremental revenue; and (b) the amount of any such customer capital contribution is not to be greater than the amount of the excess of the incremental cost in relation to the connection offer over the incremental revenue. 3.3 Calculating the customer's capital contribution 3.3.1 In determining the price to include in its connection offer, a distributor must calculate the maximum amount of a customer's capital contribution for new works and augmentation, as contemplated by clause 3.2, as follows: CC = [1C - IR]+SF where: CC is the maximum amount of the customer's capital contribution; IC is the amount of incremental cost in relation to the connection offer; IR is the amount of incremental revenue in relation to the connection offer; and SF is the amount of any security fee under the connection offer as contemplated by clause 3.5. 3.3.2 For the purposes of clauses 3.2 and 3.3.1: (a) incremental cost, in relation to the connection offer, is the sum of: (1) in respect of any relevant new works, the present value of the incremental capital, operating, maintenance and other costs the distributor will incur in providing services as a result of also providing the connection services offered, in respect of which services the distributor is remunerated by way of distribution tariff revenue. To avoid doubt, this excludes: (A) transmission costs incurred by the distributor; and (B) the cost of providing excluded services; and (2) in respect of any relevant augmentation, the difference between: (A) the present value of the incremental capital costs the distributor will incur in undertaking that augmentation at an earlier date as a result of the customer having connected to the distributor's distribution system; and (B) the present value of the incremental capital costs the distributor would otherwise incur in undertaking that augmentation at a later date, if the customer had not connected to the distributor's distribution system. To avoid doubt, for the purposes of this clause 3.3.2(a) the costs a distributor will incur include those costs the distributor will incur in engaging other persons to provide services or to undertake augmentation, as the case may be, on behalf of the distributor; (b) incremental revenue, in relation to the connection offer, is the present value of the incremental distribution tariff revenue the distributor will earn in providing services as a result of also providing the connection services offered. To avoid doubt, this excludes any component of distribution tariff revenue referable to transmission costs incurred by the distributor; and (c) each of: (1) the amount of the incremental cost; and (2) the amount of the incremental revenue, is to be such amount as fairly and reasonably estimated by the distributor. 3.3.3 In making calculations under clause 3.3.1: (a) it is to be assumed that: (1) the term over which the connection services offered will be provided is 30 years for domestic customers and, unless the distributor fairly and reasonably determines some other term is more appropriate in any particular case, 15 years for all other customers; (2) the distribution tariff earned by the distributor over that term is: (A) for the period over which the prevailing Price Determination applies, the distribution tariff the distributor is entitled to earn under that Price Determination; and (B) after then, the distribution tariff the distributor would be entitled to earn under that Price Determination if it were to continue to apply, with the applicable X-factor being the same X-factor that applies in the last calendar year in respect of which that Price Determination applies; (b) the amount of electricity supplied to the customer is to be fairly and reasonably estimated by the distributor having regard to the customer's load and connection characteristics; and (c) incremental costs include a margin of up to 10% for overheads. This must be the same % margin as contemplated by clause 2.3.2(b). 66 Several matters may be noted about the text of Guideline 14: (a) Guideline 14 did not refer to "economic connections" or "uneconomic connections"; rather, it used the expressions "incremental cost" and "incremental revenue". (b) Guideline 14 did not refer to Options 1 and 2 and did not refer to rebates. Its provisions appear to be more apposite to a situation where the distributor undertook the construction work than a situation where the customer did so. Nevertheless, in practice, the provisions of Guideline 14 relating to customer contributions were applied both where the construction works were undertaken by the distributor and where the construction works were undertaken by the customer. 67 Clause 3.2 of Guideline 14 placed a prohibition on the distributor from requiring the customer to contribute to the capital costs of the new works unless the incremental cost in relation to the connection was greater than the incremental revenue. The second part of cl 3.2 provided that where the incremental cost did exceed the incremental revenue, the amount of the customer capital contribution was not to be greater than the amount of the excess. 68 Under cl 3.3.2(a), the incremental cost included the present value of the incremental capital, operating, maintenance and other costs that the distributor would incur in providing services as a result of the new connection. 69 The incremental revenue calculated under cl 3.3.2(b) was the present value of the incremental distribution tariff revenue that the distributor would earn in providing services as a result of the connection. 70 Mr Hoole gave evidence during cross-examination, and I accept, that: the same IC less IR calculation was carried out whether the works were to be undertaken by the distributor or the customer; that calculation determined the amount of any customer contribution and the value of any Rebate payable to the customer; and the amount of the customer's capital contribution referred to in cl 3.3 would be the same whether the work was to be undertaken by the distributor or the customer. Mr de Villiers's evidence during re-examination was consistent with this. He said, and I accept, that: the Rebate was calculated by reference to the customer contribution calculated under Guideline 14; and the customer contribution in relation to Option 2 was effectively calculated in the same way as the customer contribution under Option 1.

Regulatory Asset Base 71 As noted above, an important regulatory concept for distributors is the RAB. This represents the financial value of regulated investments made by the distributor. The RAB was set in 1995 (at the time of privatisation) by statute, then the 2006 opening value was enshrined in legislation again with the introduction of the NER. There is no record of individual assets matched to the RAB. Broadly, the RAB is used in calculations of the distributor's regulated returns and depreciation. 72 The investments, the value of which is included in the RAB, are the amounts of expenditure on assets used by the distributor to provide prescribed distribution use of system services, called standard control services under the NER. This consists of the distributor's network assets, which broadly include connection assets, replacement assets and augmentation assets, information technology, and other non-network costs including property and vehicle costs. Each year, the distributor reports how much capital expenditure has been spent on the regulated business. 73 Distributors have three separate RABs in their business: one for prescribed distribution use of system services (now called standard control services); one for prescribed metering services (now called metering alternative control services); and one for public lighting excluded services (now called alternative control public lighting services). Standard control services are the distribution of electricity to customers. The metering RAB includes the value of smart meters in the distributor's area. Public lighting includes the replacement public lighting assets. The regulations relating to each of those RABs are slightly different. For present purposes, it is sufficient to refer to the prescribed distribution use of system services RAB. The description that follows relates only to this RAB. 74 Every year, all amounts spent by the distributor that are eligible to be included in the RAB (gross capital expenditure, less any contributions made by the customer) were reported to the regulator in regulatory accounts (now "regulatory information notices"). 75 At the end of each five-year regulatory period, the RAB was recalculated and a new price determination was made by the regulator and (among other decisions) a forecast was made at that point of the expenditure the distributors were expected to make during the next five-year regulatory period. 76 During cross-examination, Mr de Villiers was taken to p 322 of the 2006 Determination (which set out the RAB for each distributor for the years 2006 to 2010) and gave the following evidence, which I accept, regarding the way in which the estimated cost of construction and any customer contribution were taken into account in the RAB: And the gross capital expenditure will include the estimated cost of constructing all the assets by the distributors? - No. It will also include - so the way we report it - the way that gross capital expenditure was calculated for our networks was that [it] also included the expenditure estimated for the connecting customers as well. And why did you include that? - So it was - so the way we treated - so, you know, I've mentioned that we had option 1 or option 2 projects, so if we just talk about option 1 projects, if you can imagine - so in that situation where we have an option 1 project, and let's just say it cost $100, and the customer contribution was $40, so we would have $100 going into the gross capital expenditure, $40 being the customer contribution, so the net amount going into the RAB is 60. Now, if you can imagine - so now that same project has been undertaken as an option 2 project, so we would estimate that the construction costs to the customer would be 100 and we would put that into gross capital expenditure and, then, we would report the customer contribution as being the difference between the $100 that the customer pays less the rebate that we pay them. The rebate would be 60 in this instance. So, once again, we have 40, effectively, going into customer contributions and the net amount being 60. So the way we treated those option 1 and option 2 projects would have the same impact on the RAB. But just a couple of things arising out of that, Mr de Villiers. The first is that what goes into the RAB in relation to option 1 is the gross capital expenditure, which increases the RAB, and then there's a separate line item for decreasing the RAB by the customer contribution? - Correct. In relation to option 2, you mentioned the rebate, but the fact is, Mr de Villiers, isn't the rebate simply the difference between the estimated cost of construction and the amount of the customer contribution? - Yes. Yes, it is. Yes. So the RAB is dealt with in the same way. The estimated cost of construction increases the RAB and is reduced by the capital contribution in relation to that particular project? - Yes. 77 Were an asset to be later sold or otherwise disposed of, any payment received by the distributor was deducted from the RAB. If there was no consideration received for the asset, the RAB was not reduced. 78 Depreciation affects the RAB. A component of each price determination was a depreciation allowance on actual net capital expenditure known at the time of the determination and forecast net capital expenditure to the end of the forthcoming regulatory period, based on the economic life of the asset. At the end of the 2010 distribution period, that amount of depreciation was deducted from the RAB, regardless of actual capital expenditure. 79 The economic life of distribution system assets is close to 50 years for VPN (51 years Powercor, 49 years CitiPower). This is an average life of those assets, proposed by VPN and approved by the regulator in the 2005 determination of prices over 2006 to 2010.

Negotiation of connection agreements 80 Within CitiPower and Powercor, one of Mr Hoole's responsibilities was for connection policy and ensuring compliance with all regulatory obligations relating to connecting new customers. In addition, he managed a team of six people who were responsible for negotiating new connection agreements with larger customers who required more than a 2MW connection or connection of an embedded generator. A connection of 2MW or more was needed for customers requiring supply to sites like large apartment buildings and large factories. 81 A team of around 90 people resided in the Network Services business unit, which had responsibility for negotiating new connection agreements with all customers who were not otherwise serviced through Mr Hoole's team of six. The vast majority of connection agreements were managed through the Network Services team.

New connections - technical aspects 82 CitiPower's and Powercor's distribution networks include zone substations that transform the electricity from the voltage level provided at the terminal station point of supply to a lower level, commonly referred to as high voltage. CitiPower's and Powercor's high voltage distribution networks operate at 22,000 volts, 12,700 volts, 11,000 volts or 6,600 volts, depending on the area. The distribution networks also include distribution substations that transform from high voltage to the lowest voltage level on the network, being 415 volts three phase or 240 volts single phase, with the latter being the level commonly required to supply a residential home. 83 Where a new customer needed to be connected to the network, depending on the amount of electricity required by the customer and the type of development, a new distribution substation may have been required. 84 New residential housing estates typically required distribution substations known as "kiosk substations", which were free-standing metal enclosures with electrical equipment including transformers and switches located within the metal enclosure. 85 Electricity supply to new homes other than in new housing estates was commonly provided by means of an overhead low voltage service cable from an adjacent electricity pole with existing low voltage conductors, or by means of an underground low voltage service cable from an adjacent pole to a pit on the property boundary. 86 Large developments, such as a new building within a regional centre (for Powercor) or the Melbourne CBD or Docklands (for CitiPower), typically required a new distribution substation located within the customer's building, within a room constructed by the customer to the distributor's specifications. CitiPower or Powercor (as relevant) extended their high voltage network to the new distribution substation and the customer was provided with a low voltage (415 volt) point of supply from within the new distribution substation, to which the customer's Registered Electrical Contractor (ie, an electrician) ran electrical cables. In the course of Mr Hoole's cross-examination, he stated, and I accept, that a different calculation of the incremental cost was carried out depending on whether assets being constructed by the customer were low voltage or high voltage. He stated, and I accept, that in relation to low voltage assets, the amount of the Rebate was the estimated cost of construction of the assets that were provided by the customer less the amount of the customer's contribution worked out under Guideline 14. For the purposes of the issues to be determined in this proceeding, both parties focussed on the calculations that were carried out in relation to low voltage assets. In closing submissions, senior counsel for VPN indicated that the calculations relating to high voltage assets were not part of the case and it was unnecessary for me to deal with these. I understood the Commissioner to adopt the same position. 87 CitiPower and Powercor's obligation was to maintain electricity supply up to the customer's point of supply. 88 The distributor's offers for connection services were based on the "Least Cost Technically Acceptable" method of providing electricity supply, commonly known in the industry as the "LCTA method" of providing electricity supply. 89 Occasionally, a customer asked for a point of supply or an electrical arrangement costing more than the LCTA method. Where the request could be accommodated the customer was required to fully fund the cost of the additional works and the additional works were not included in the assessment of the incremental costs. Wherever the point of supply was, the distributor was responsible for maintaining electricity supply up to it.

The course of dealings with customers 90 As noted above, CitiPower and Powercor each had an obligation under their distribution licence to provide an offer for connection services to all customers in their geographic areas. The customers ranged in sophistication from "mum and dad" type customers with little or no knowledge of electricity to large residential and commercial developers, hospitals, train and tram operators and large energy intensive-industries such as mining companies and data centre operators. The smaller customers generally had a Registered Electrical Contractor acting on their behalf, while the more sophisticated customers often engaged electrical consultants to work with the distributor. 91 Once the Registered Electrical Contractor or electrical consultant identified that a network connection was required, they contacted the relevant distributor. This contact could be in written form, by telephone, email or via the distributor's web site. On Powercor's website, there was a document that could be downloaded entitled "Powercor's Customer Guideline for Making an Electricity Supply Available", which described the process for a customer connecting to the distribution network. 92 Upon receiving a customer request for a new or additional electricity supply, an officer of the distributor was assigned to each customer enquiry. The assigned officer's role was to work with the customer to confirm their requirements, to determine what physical assets were required and to make an estimate of the cost of the works. These functions were undertaken by the assigned officer or by reference to specialist personnel within the business, depending on the amount of electricity supply requested and the location. 93 In some locations, even though the customer request may have involved a relatively large amount of electricity (for example, to supply a large building) the work required might constitute a relatively small amount of augmentation because there was capacity in the existing network to add the new customer. On the other hand, if the network was already at capacity or the location meant that significant additional infrastructure was needed to service the customer, the work required could be extensive, even for a small development. 94 In addition to calculating the estimated cost of construction, calculations were done to determine the incremental cost and the incremental revenue in order to determine the customer contribution and, where the customer was undertaking Option 2 works, the amount of any Rebate that might be applicable. From these calculations, an offer for connection services was given to the customer. 95 If the distributor's offer for connection services was based on the distributor undertaking the works (ie, Option 1), the works were included in the distributor's work program upon receipt of the customer's written acceptance of the offer and payment of the required customer contribution. 96 If the distributor's offer for connection services was based on the distributor undertaking the non-contestable services and the customer engaging a contractor to undertake the contestable services (ie, Option 2), the tie-in works by the distributor were included in the works program upon receipt of the customer's written acceptance of the offer, payment of the required customer contribution and the distributor's audit confirming the Option 2 assets installed met the distributor's technical standards. 97 Upon the Option 2 assets being transferred to the distributor, and receipt of a properly rendered invoice, the distributor paid any Rebate stated in the offer for connection services to the customer (or their agent). 98 Depending on the amount of supply required and the location, the above steps could be extremely straightforward, and capable of being completed in days, or could involve extensive assessment by management and different engineering and technical experts within the company, with the entire process requiring several months or years to complete.

Estimating the cost of works 99 The estimated cost of the works required to provide electricity supply were built up from the cost components listed below. This is not the same as the "incremental cost" calculation, which excluded some costs and included others. The relevant cost components for the estimated cost of the works were: (a) the estimated internal company labour (in person-hours) and plant and equipment required to undertake the work. Internal resources were utilised for activities including constructing and augmenting overhead power lines, fitting out substations, design, road management consent process, project management, customer negotiations, testing and commissioning of new works and asset records updating; (b) the estimated external contract labour and plant required to undertake the work. External contract resources were used for activities including underground civil works such as trenching and installing new conduits, underground cable installation and jointing, constructing and augmenting overhead power lines, fitting out substations, design, traffic management, road and footpath reinstatement and the removal and treatment of contaminated soil and water; (c) the estimated material required to undertake the work such as new poles, cables and substations; and (d) an amount for overheads. Guideline 14 limited overheads to 10% of the sum of the labour, material and contract costs (estimated under subparagraphs (a), (b) and (c) above).

Estimating the incremental cost 100 If all of the works required to provide electricity supply provided a benefit solely for the customer requesting electricity supply, then all of the estimated costs of those works were included in the assessment of the "incremental cost" calculated to assess the customer contribution to the works. However, if any works provided a broader network benefit, the cost of those works were not included in the "incremental cost" calculation. The cost of the works solely benefitting the customer were the first element of the calculation of the "incremental cost". 101 The assessment of the incremental cost also included three other cost components, being: (a) an allowance for the impact of the connection on the network capacity upstream of the new works. This was known as the Marginal Cost of Reinforcement (MCR) component. The MCR component was intended to ensure each connecting customer contributed a fair and reasonable amount to the upstream infrastructure regardless of whether any upstream augmentation was required at the time of application for electricity supply; (b) an allowance for the additional operations and maintenance costs associated with the new assets being constructed; and (c) for customer requests for supply to new residential housing estates, a high voltage equalisation component. This was calculated as a fixed dollar per lot in the developer's request for supply. The actual cost of high voltage works undertaken within the estate was not included in the incremental cost for any customer as they were considered to be providing a benefit to future stages of the area's development. 102 When calculating the incremental cost, the relevant responsible officer entered specific information into the customer contribution model. That information included the cost of the work, the cost of the work directly attributed to the customer, the amount of supply requested and the relevant MCR level.

Estimating the incremental revenue 103 Calculating the estimated incremental revenue from a new connection involved understanding the nature of the premises being connected and determining their likely long-term electricity consumption, based on historical data about similar premises and information provided by the customer requesting the new or additional electricity supply. 104 Powercor and CitiPower had created a customer contribution model that included 21 consumption profiles for non-residential premises and four (for Powercor) and two (for CitiPower) residential profiles. The first step in determining the estimated incremental revenue was to choose the appropriate profile for the customer. 105 The commercial profiles differed depending on a number of variables. One was the number of days per week the business was expected to operate (five, six or seven). Another was the number of hours per day the business was expected to operate (standard business hours only, 16 hours per day or 24 hours per day). A further variable was the expected daily load shape of the customer's utilisation profile (low, average or high utilisation). High utilisation meant the customer's demand for electricity was consistent over the course of the day whilst low utilisation meant the customer's maximum demand only occurred for a short period during the day and the demand could be quite low at other times. 106 The CitiPower residential profiles simply differentiated between a large and a small residential property or unit, whilst the Powercor residential profiles included options to differentiate different heating and hot water options available to customers. 107 If none of the standard profiles suited a specific customer, an option was available to input the characteristics of a specific customer. 108 In accordance with the requirements of Guideline 14, the customer contribution model calculated the incremental revenue from a residential customer as a net present value over a 30 year period and the incremental revenue from a non-residential customer over a 15 year period.

Examples 109 The evidence included a number of examples to illustrate the calculations that were made in relation to new connections. The first three examples set out below are from Mr Hoole's affidavit. I will refer to these as Examples 5, 6 and 7 to avoid confusion with the four examples referred to in [10] above. I will then refer to two examples that were the subject of a letter dated 18 September 2013 from VPN to the Australian Taxation Office (Exhibit R2). I will refer to these examples as Examples 8 and 9.

Example 5 - Based on electricity supply to 23 Lennox St, Richmond 110 This example (based on 23 Lennox St, Richmond) is representative of a new commercial building requiring a connection, where CitiPower built the connection and the incremental cost exceeded the incremental revenue. Annexure "CH-2" to Mr Hoole's affidavit is a bundle documents relating to this example. 111 This was a new community health centre requiring a supply of 173kVA and Option 1 works by CitiPower. 112 The following table shows how the incremental cost was calculated. Option 1 works by CitiPower $138,720 Marginal cost of reinforcement component $48,545 Operations and maintenance component $11,413 Total (Incremental Cost) $198,678

113 The incremental revenue for the connection was assessed as $102,215, hence the incremental cost less the incremental revenue was $96,463 (being $198,678 less $102,215). 114 There were no Transferred Assets, hence no Rebate was applicable. 115 CitiPower's offer for connection services required a customer contribution of $96,463.

Example 6 - Based on Manor Lakes estate Stage 82 116 This is an example (based on Manor Lakes estate Stage 82) of a new residential housing estate: (a) involving both contestable and non-contestable works; (b) where the customer chose to build the contestable assets (Option 2); and (c) where the incremental cost exceeded the incremental revenue. 117 Annexure "CH-6" to Mr Hoole's affidavit is a bundle of documents relating to this example. 118 This was a new residential housing estate, with Powercor asked to provide electricity supply to 40 new housing lots with Option 2 contestable works including a new kiosk substation and high voltage and low voltage cables. 119 The following table shows how the incremental cost was calculated. Non-contestable works undertaken by Powercor (construction costs incremental) $20,502 Operations and maintenance component $82,222 Incremental Capital Cost Marginal cost of reinforcement component $88,582 High voltage equalisation component (for 40 lots) $26,000 Assessed estimated cost of low voltage gifted assets $37,033 Total Incremental Capital Cost $151,615 Total (Incremental Cost) $254,339

120 The incremental revenue for the connection was assessed as $214,887. 121 As a result, the incremental cost less the incremental revenue equalled $39,452 (being $254,339 minus $214,887). This figure was calculated in accordance with Guideline 14. 122 The cost of the low voltage Transferred Assets was assessed as $37,033 and this amount was included in the assessment of the incremental cost. 123 The cost of the high voltage Transferred Assets was assessed as $98,477. This amount was not included in the assessment of the incremental cost because those works did not solely benefit the customer. Instead, a high voltage equalisation component (in this case, $26,000) was included in the calculation of incremental cost in respect of the high voltage assets within the estate. As there were 40 lots in this stage of the estate, 40 lots worth of the high voltage equalisation charge were included. 124 In this case, the estimated cost of construction of the low voltage Transferred Assets was $37,033 and the Customer Contribution (being the incremental cost less the estimated revenue) was $39,452. Accordingly, the customer did not receive any Rebate towards the low voltage Transferred Assets and an amount of $2,419 was payable by the customer to the distributor (being the amount by which the Customer Contribution exceeded the estimated cost of construction of the low voltage Transferred Assets). However, the customer was entitled to a Rebate of $98,477 towards the high voltage Transferred Assets. 125 The above description of the customer contribution does not include payments relating to any excluded services provided as part of the connection or for any public lighting works as those activities were not part of the IC less IR calculation.

Example 7 - Based on Manor Lakes estate Stage 85 126 This is an example (based on Manor Lakes estate Stage 85) of a new residential housing estate: (a) involving both contestable and non-contestable works; (b) where the Customer chose to build the contestable assets (Option 2); and (c) where the incremental revenue exceeded the incremental cost. 127 Annexure "CH-3" to Mr Hoole's affidavit is a bundle of documents relating to this example, including a Payment Calculation Sheet. Mr Hoole said during cross-examination, and I accept, that this is typical of a document that was provided to the customer at the time the offer was made. 128 This was a new residential housing estate involving electricity supply to 21 new housing lots with Option 2 works including new high voltage and low voltage cables from a kiosk substation installed in a previous stage. 129 The following table shows how the incremental cost was calculated: Non-contestable works undertaken by Powercor (being $38,961 minus $3,264 for the "Powercor HV Rebate") (construction costs incremental) $35,697 Operations and maintenance component $20,443 Incremental capital cost Marginal cost of reinforcement component $43,012 High voltage equalisation component $13,650 Assessed cost of low voltage Transferred Assets $23,816 $80,478 Total (Incremental Cost) $136,619

130 While the non-contestable works were stated in the Payment Calculation Sheet as $38,961, $3,264 of this was deducted from that figure. This was to take account of certain high voltage works carried out in a previous stage of the Manor Lakes development and already factored into the high voltage equalisation component. This is described in the Payment Calculation Sheet as the "Powercor HV Rebate". 131 The incremental revenue for the connection was assessed as $190,643, which exceeded the incremental cost (being $136,619). 132 The cost of the low voltage Transferred Assets was assessed as $23,816 and this amount was included in the assessment of the incremental cost. This figure also represented the distributor's estimated cost of construction in relation to the low voltage assets. 133 The cost of the high voltage Transferred Assets was assessed as $48,058. This amount was not included in the assessment of the incremental cost because those works did not solely benefit the customer. Instead, a high voltage equalisation component (of $13,650) was included in respect of the high voltage assets within the estate. 134 Powercor's offer for connection services included the following charges and Rebates to the customer: (a) there was no customer contribution based on the IC less IR calculation, as the incremental revenue exceeded the incremental cost; and (b) the customer received a Rebate of $23,816 towards the low voltage Transferred Assets and was entitled to receive a Rebate of $48,058 towards the high voltage Transferred Assets. 135 The above description of the customer contribution does not include payments relating to any excluded services provided as part of the connection or for any public lighting works as those activities were not part of the IC less IR calculation.

Example 8 136 This is the first example set out in Exhibit R2. It concerned an Option 2 project. In summary, the calculations for this project were as follows: Incremental Cost (IC) $198,950 Incremental Revenue (IR) $174,802 Amount by which IC exceeds IR [A] $24,148 Estimated cost of construction [B] $30,600 Rebate paid to customer [B-A] (GST exclusive) $6,512

137 In this example, the amount of the customer contribution calculated under Guideline 14 was $24,148, being the incremental cost less the incremental revenue. 138 The amount of the Rebate ($6,512) equalled the estimated cost of construction ($30,660) less the customer contribution calculated under Guideline 14 ($24,148). The amount of $6,512 was payable by the distributor to the customer after 'tie-in' (see [56] above).

Example 9 139 This is the second example set out in Exhibit R2. It concerned an Option 2 project. The calculations for this project were, in summary, as follows: Incremental Cost (IC) $348,525 Incremental Revenue (IR) $445,393 Amount by which IC exceeds IR [A] $0 Estimated cost of construction [B] $64,350 Rebate paid to customer [B-A] (GST exclusive) $64,350

140 In this example, the incremental revenue was greater than the incremental cost. Accordingly, the customer contribution under Guideline 14 was $0. The Rebate was $64,350, which equalled the estimated cost of construction. This was the estimated cost of construction by the distributor, not the customer's actual cost of construction. The amount was payable by the distributor to the customer after 'tie-in'.

Accounting treatment of Customer Cash Contributions 141 The Commissioner sought to rely on the accounting treatment of the Customer Cash Contributions in the financial statements of VPN. However, Mr Breheny did not accept during cross-examination the propositions put to him regarding the accounting treatment. I do not consider it necessary to reach a conclusion on this matter. Had it been necessary to reach a concluded view, I would have accepted Mr Breheny's interpretation of the financial statements, given that he previously held the position of Chief Executive Officer of the VPN Group and the absence of any contrary witness evidence.

The amended assessments and amounts in dispute 142 In its income tax returns for the relevant years, VPN treated the Customer Cash Contributions as assessable, did not include the Customer Contributions or the Transferred Assets in its assessable income, and claimed deductions for the Rebates. 143 The Commissioner issued amended assessments for the relevant years to VPN to include amounts in respect of the Transferred Assets in VPN's assessable income. In addition, the Commissioner denied the deductions for the Rebates, but brought to account as income the arm's length value of the Transferred Assets reduced by the amount of the associated Rebates as recipient's contributions under s 21A of the 1936 Act. 144 VPN objected against the amended assessments for the relevant years, contending that the Customer Cash Contributions and the amounts relating to the Transferred Assets were not assessable. 145 On 25 August 2017, the Commissioner disallowed the objections. 146 On 20 October 2017, VPN appealed to this Court from the objection decisions. 147 The Commissioner has included the following amounts in VPN's assessable income in respect of Customer Cash Contributions received by VPN: Income Year Customer Cash Contributions 2008 $49,927,813 2009 $55,852,610 2010 $63,294,280 2011 $61,480,910

148 In relation to the Transferred Assets, the Commissioner's amended appeal statement sets out amounts that were included in VPN's assessable income in relation to Transferred Assets and the amounts of the Rebates. It is stated that the Rebates relate to both 'economic' and 'uneconomic' connections. A footnote states that VPN had not provided the Commissioner with the breakup of the various amounts between 'uneconomic' connection Rebates and 'economic' connection Rebates.

Admissibility of expert economic evidence 149 It is convenient now to refer to the expert evidence of Mr Balchin and Mr McMillan in respect of which there is an objection to admissibility based on relevance. Each expert was instructed to address the following question, as set out in [2] of their joint report: Having regard to the operation of the regulatory regime that applies to electricity distribution network providers (Distributors) in Victoria, please describe the economic consequences to Distributors of the receipt of transferred connection assets (gifted assets), the provision of customer rebates in respect of the construction of such assets and the payment by customers of cash contributions to the construction of connection assets in the years ended 31 December 2007 to 31 December 2010. 150 Although the evidence of Mr Balchin and Mr McMillan is framed as addressing the "economic consequences" of the Customer Cash Contributions, the Transferred Assets and Rebates, in substance it is largely descriptive of the regulatory regime. As such, I consider the material to be relevant and admissible. However, the material adds little to the evidence of VPN's lay witnesses, namely Mr Breheny, Mr Hoole and Mr de Villiers, which has been largely set out above. To the extent that there are differences between the two expert economists (see [27] of the joint report), it is unnecessary to resolve this difference in order to determine the issues in dispute. To the extent that there are differences between the evidence of VPN's lay witnesses and the expert economists, I prefer the evidence of VPN's lay witnesses, as they have personal knowledge of the way the regulatory regime operated in practice. In particular, in relation to the way that the relevant transactions were taken into account in the RAB, I prefer the evidence of Mr de Villiers during cross-examination, set out at [76] above, to the description provided by the experts at 12 of the joint report. Further, in relation to the way the Rebate was calculated, I prefer the evidence of VPN's lay witnesses that it was the estimated cost of construction less the customer contribution (T82-83, T101) to the evidence of Mr Balchin at [2] of his report dated 29 October 2018.

Issues relating to the situation where the Distributor undertook the works 151 As noted in the Introduction, the issues between the parties are confined to connections that were 'uneconomic' in the sense that the incremental cost exceeded the incremental revenue (represented by Examples 3 and 4 in [10] above). 152 In relation to the situation where the Distributor undertook construction of the connection works and the connection was 'uneconomic' (eg, Example 3), the issues that arise for determination are: (a) was the Customer Cash Contribution (ie, the $40 in the example) income according to ordinary concepts within s 6-5 of the 1997 Act? (b) was the Customer Cash Contribution an "assessable recoupment" within the meaning of s 20-20 of the 1997 Act?

Applicable principles 153 Section 6-5(1) of the 1997 Act provides that a taxpayer's assessable income includes income according to ordinary concepts, which is called "ordinary income". In Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199, Mason ACJ, Wilson, Brennan, Deane and Dawson JJ stated (at 209) that it was "well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income". Their Honours explained that "[b]ecause 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". The word "gain" is not here used in the sense of the net profits of the business, for the topic under discussion is assessable income, that is, gross income: Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 at 318 per Barwick CJ, Kitto and Taylor JJ. 154 In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 (GP International Pipecoaters), the High Court (Brennan, Dawson, Toohey, Gaudron and McHugh JJ) approved (at 136) the statement of Windeyer J in Scott v Federal Commissioner of Taxation (1966) 117 CLR 514 at 526 that "[w]hether or not a particular receipt is income depends upon its quality in the hands of the recipient". In GP International Pipecoaters, the High Court went on to quote with approval the statement of Cozens-Hardy MR in Hudson's Bay Co Ltd v Stevens (1909) 5 TC 424 at 436 that "if the money is otherwise liable to income tax it cannot escape taxation by reason of its being applied to a capital purpose". 155 The issue in GP International Pipecoaters concerned the character of certain establishment costs as receipts in the hands of the taxpayer. The High Court emphasised (at 138) the "importance of ascertaining the scope of a business and a recipient's purpose in engaging in it as a means of determining the character of a receipt". The High Court stated (at 141) that, applying a "business conception to the facts" (see Federal Commissioner of Taxation v Becker (1952) 87 CLR 456 at 467), the receipt of the establishment costs must be classified as a receipt of income. The High Court in GP International Pipecoaters then stated (at 142): Next, it is necessary to consider the taxpayer's submission that the cases show that a receipt of moneys intended by payer and payee to recoup a recipient's capital expenditure is a receipt of a capital nature. That proposition can be accepted when the amount is received by way of gift or subsidy to replenish or augment the payee's capital, for in such a case the receipt cannot fairly be said to be a product or incident of the payee's income-producing activity: see Hayes v Federal Commissioner of Taxation [(1956) 96 CLR 47, at pp 54-56]; Federal Coke Co Pty Ltd v Federal Commissioner of Taxation [(1977) 77 ATC 4,255]; Reckitt & Colman Pty Ltd v Federal Commissioner of Taxation [(1974) 23 FLR 58; 3 ALR 381]; Seaham Harbour Dock Co v Crook (HM Inspector of Taxes) [(1931) 16 TC 333]. But it cannot be accepted that an intention on the part of a payer and a payee or either of them that a receipt be applied to recoup capital expenditure by the payee determines the character of a receipt when the circumstances show that the payment is received in consideration of the performance of a contract, the performance of which is the business of the recipient or which is performed in the ordinary course of the business of the recipient. 156 The High Court then considered two cases relied upon by the taxpayer in which payments made under a contract to recoup capital expenditure were held to be capital in the hands of the recipient - Boyce (HM Inspector of Taxes) v Whitwick Colliery Co Ltd (1934) 18 TC 655; [1934] All ER 706 and APA Fixed Investment Trust Co Ltd v Federal Commissioner of Taxation (1948) 8 ATD 369; 4 AITR 105. The High Court doubted the correctness of Boyce and distinguished APA. The High Court concluded (at 145) that the establishment costs were received as part of the taxpayer's assessable income. This was because they "were not received as the price of a capital asset, nor as a payment dissociated from the taxpayer's business; they were received as part of the remuneration earned by the carrying on of its business which consisted in the performance of the contract, that is, in constructing the plant and coating the pipe required". 157 The mere fact that a taxpayer is engaged in a business at the time of receiving a payment and the payment bears some connection to that business will not be sufficient to stamp the receipt with a revenue character: Federal Commissioner of Taxation v Spedley Securities Ltd (1988) 88 ATC 4126 at 4130; Westfield Ltd v Federal Commissioner of Taxation (1991) 28 FCR 333 at 342; Federal Commissioner of Taxation v Hyteco Hiring Pty Ltd (1992) 39 FCR 502; First Provincial Building Society v Federal Commissioner of Taxation (1995) 95 ATC 4145. 158 Subdivision 20-A of the 1997 Act deals with insurance, indemnity or other recoupments for deductible expenses. The guide to the Subdivision in s 20-10 explains that a taxpayer's assessable income may include an amount that the taxpayer receives by way of insurance, indemnity or other recoupment if it is for a deductible expense and it is not otherwise assessable income. Subdivision 20-A relevantly provides (and provided during the relevant years) as follows: 20-20 Assessable recoupments Exclusion (1) An amount is not an assessable recoupment to the extent that it is *ordinary income, or it is *statutory income because of a provision outside this Subdivision. Insurance or indemnity (2) An amount you have received as *recoupment of a loss or outgoing is an assessable recoupment if: (a) you received the amount by way of insurance or indemnity; and (b) you can deduct an amount for the loss or outgoing for the *current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act. Other recoupment (3) An amount you have received as *recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if: (a) you can deduct an amount for the loss or outgoing for the *current year; or (b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year; under a provision listed in section 20-30. 20-25 What is recoupment? General (1) Recoupment of a loss or outgoing includes: (a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and (b) a grant in respect of the loss or outgoing. Amount paid for you (2) If some other entity pays an amount for you in respect of a loss or outgoing that you incur, you are taken to receive the amount as recoupment of the loss or outgoing. … 159 It is not necessary for present purposes to set out the table of deductions in s 20-30. 160 The concept of "indemnity" in s 20-20(2) was considered in Batchelor v Federal Commissioner of Taxation (2014) 219 FCR 453 at [12]-[13] and [83]-[84] and in Denmark Community Windfarm Ltd v Federal Commissioner of Taxation (2018) 107 ATR 384 at [36]-[38]. In Batchelor, Edmonds and Pagone JJ expressed the view (at [13]) that, generally speaking, a payment will not be regarded as an indemnity unless the entitlement to its receipt precedes the event in respect of which it is paid.

Consideration 161 VPN's submissions in relation to whether the Customer Cash Contributions constituted ordinary income of VPN can be summarised as follows: (a) Under the terms of their distribution licences, distributors were required to connect new customers and to undertake connection works. However, that is not the end of the matter. It is necessary to understand what the Customer Cash Contributions were for and to examine the relationship between what the relevant payment was for and the scope of the taxpayer's business. In determining what a payment is for regard should be had to the entire matrix of circumstances to elucidate "how and why it came about": Squatting Investment Co Ltd v Federal Commissioner of Taxation (1953) 86 CLR 570 at 627-628; Rotherwood Pty Ltd v Federal Commissioner of Taxation (1996) 64 FCR 313 at 324; Federal Commissioner of Taxation v Cooling (1990) 22 FCR 42 at 53. (b) In order to understand why the Distributors received a Customer Cash Contribution, it is necessary to consider the reasons for and the basis of the Customer Cash Contribution made by the customer. Because of the terms of their distribution licences and the regulatory framework in which they conduct their businesses, not everything done in the course of each Distributor's business has a revenue character. The Distributors were required to connect customers even if the incremental cost exceeded the incremental revenue. However, in those circumstances, because the connection was uneconomic, the customer was required to make a Customer Cash Contribution. Customer Cash Contributions were calculated to correspond to a shortfall arising from the Distributor being required to build an uneconomic electricity connection. This ensured that, to the extent that a connection was uneconomic, the cost was borne by the customer requesting the connection. (c) Because Customer Cash Contributions were paid only if and to the extent that the distributor would incur an economic loss, the Customer Cash Contributions were not the product of the Distributor's income-earning activity. Customer Cash Contributions were paid precisely because revenues would not be sufficient to recover the costs associated with the new connection. Because the Customer Cash Contributions were not included in the RAB, they were excluded from price determinations. Prices were therefore not set in a way that enabled the Distributor to earn the regulated rate of return on the amount of the Customer Cash Contribution. The amount of the contribution did not add to the Distributors' ability to earn revenue. (d) These circumstances are distinguishable from those considered in GP International Pipecoaters. In that case, the receipts in question were simply a portion of the total contract revenue, which portion was dedicated by the taxpayer to capital expenditure. The receipts were part of the aggregated revenue from carrying on that business. Here, the reason for and the effect of the Customer Cash Contributions was to reimburse the Distributor for costs that it would not otherwise recover through its business activities of operating the electricity distribution system. The Customer Cash Contributions were thus referable to an economic loss and not to the operation of the electricity network. (e) The High Court in GP International Pipecoaters accepted the proposition (at 142) that a "receipt of moneys intended by payer and payee to recoup a recipient's capital expenditure is a receipt of a capital nature … when the amount is received by way of gift or subsidy to replenish or augment the payee's capital". Here, the Customer Cash Contributions were not paid to the distributor as a reward for the construction of connection works. Nor were they paid as a reward for performing a contract. They were paid only because of, and to the extent of, an anticipated economic loss. The Distributors undertook the construction of connection works because they were required by regulation to do so, not because the construction was economically rational. Unlike the payments received in GP International Pipecoaters, the Customer Cash Contributions were not revenue of the Distributor's business and, in that sense, were not a product of the payee's income-producing activity. They were, to use the words of Burchett J in Federal Commissioner of Taxation v Rowe (1995) 60 FCR 99 at 114 (and as adopted by the majority of the High Court: Federal Commissioner of Taxation v Rowe (1997) 187 CLR 266 at 279-280), payments of reparation not remuneration. 162 In my view, for the reasons that follow, the Customer Cash Contributions constituted ordinary income of VPN. 163 Pursuant to contracts between the Distributors and their customers, the Customer Cash Contributions were either all or part of the consideration for the Distributor providing a new connection to the customer. In the case of the CitiPower contract with customers, the Customer Cash Contribution including GST was the "Total Amount Payable" for the network connection (see, eg, p 27 of annexure "CH2" to Mr Hoole's affidavit). To accept CitiPower's proposal, the customer had to sign and return the Network Connection Proposal and make the payment. In the case of the Powercor contract (namely, the Augmentation Agreement), the Customer Cash Contribution was included in the "Charges" that, under cl 5, constituted consideration for Powercor constructing the works (ie, the new connection) (see, eg, Exhibit R3). 164 The Distributors each carried on a business of distributing electricity pursuant to a licence issued by the ESC. It was a condition of that licence that the Distributor connect new customers to the electricity network when requested to do so. New connections were a significant part of the Distributors' businesses: in the relevant years, they had 96 staff working on arranging new connection agreements. The Distributors' businesses included connecting new customers to the electricity network. 165 As the Distributors' businesses included connecting new customers to the electricity network, and as the Customer Cash Contributions were gains (in the sense that they were amounts derived) in respect of new connections, it follows that they constituted ordinary income of VPN. The Customer Cash Contributions were derived by the Distributors under transactions that occurred as an ordinary incident of their electricity distribution businesses. 166 As set out above, VPN submits that, because Customer Cash Contributions were paid only if and to the extent that the Distributor would incur an economic loss, they were not the product of the Distributor's income-earning activity. I do not accept this submission. Insofar as this submission relies on the description of certain connections as 'uneconomic', this label is in some respects inaccurate. The reference to 'uneconomic' is to those cases where the incremental cost exceeded the incremental revenue. In such cases the regulatory regime (in particular, Guideline 14) provided for a customer contribution. The customer contribution in effect reduced the RAB, so that existing customers did not bear the burden of the cost of the new connection to the relevant extent. If the regulatory regime had not included the provisions relating to the customer contribution, the cost of construction would have been built into the pricing structure going forward. The objective and effect of the regulatory regime was that the burden of the new connection fell, to the relevant extent, on the new customer rather than the existing customers. It cannot be said that the Distributor was required to enter into a loss-making transaction. 167 Further, the connection of new customers to the electricity network was a recurrent and regular activity that the Distributors were required to carry out as part of their businesses by the conditions of their licences. The connection of new customers resulted in the production for the Distributors of tariff income from the ongoing use of the connection for the distribution of electricity, in addition to the receipt of the Customer Cash Contributions. 168 The Customer Cash Contributions formed part of the consideration payable to the Distributors for new connections under the contracts entered into with their customers. They were not amounts "received by way of gift or subsidy to replenish or augment the payee's capital" as submitted by VPN (quoting GP International Pipecoaters at 142). 169 The Customer Cash Contributions were ongoing and recurrent, generated by the ongoing business activity of connecting new customers to the electricity network. Contrary to VPN's submissions, the Customer Cash Contributions were the remuneration provided to the Distributors for making the new connections; the Customer Cash Contributions were not payments of reparation. 170 Accordingly, I conclude that the Customer Cash Contribution was income according to ordinary concepts within the meaning of s 6-5 of the 1997 Act. 171 It follows from this conclusion that the Customer Cash Contribution was not an "assessable recoupment" within the meaning of s 20-20: see s 20-20(1).

Issues relating to the situation where the customer undertook the works 172 In relation to the situation where the customer undertook construction of the connection works and the connection was 'uneconomic' (eg, Example 4), the issues that arise for determination are: (a) was the Customer Contribution (ie, the $40 in the example) income according to ordinary concepts within s 6-5(1) of the 1997 Act? (b) what amount (if any) is included in the assessable income of VPN under s 6-5 of the 1997 Act pursuant to s 21A of the 1936 Act? 173 It is convenient to note at the outset that it is common ground that the Transferred Assets were received on revenue account.

Applicable principles 174 The applicable principles relating to income according to ordinary concepts have been set out above. 175 Sections 21 and 21A of the 1936 Act relevantly provide (and during the relevant years provided) as follows: 21 Where consideration not in cash (1) Where, upon any transaction, any consideration is paid or given otherwise than in cash, the money value of that consideration shall, for the purposes of this Act, be deemed to have been paid or given. (2) This section has effect subject to section 21A. 21A Non-cash business benefits (1) For the purposes of this Act, in determining the income derived by a taxpayer, a non-cash business benefit that is not convertible to cash shall be treated as if it were convertible to cash. (2) For the purposes of this Act, if a non-cash business benefit (whether or not convertible to cash) is income derived by a taxpayer: (a) the benefit shall be brought into account at its arm's length value reduced by the recipient's contribution (if any); and (b) if the benefit is not convertible to cash - in determining the arm's length value of the benefit, any conditions that would prevent or restrict the conversion of the benefit to cash shall be disregarded. (3) Where: (a) a non-cash business benefit is income derived by a taxpayer in a year of income; and (b) if the taxpayer had, at the time the benefit was provided, incurred and paid unreimbursed expenditure in respect of the provision of the benefit equal to the amount of the arm's length value of the benefit - a once-only deduction would, or would but for section 82A, and Subdivisions F, GA and G of Division 3 of this Part, of this Act, and Divisions 28 and 900 of the Income Tax Assessment Act 1997, have been allowable to the taxpayer in respect of a percentage (in this subsection called the deductible percentage) of the expenditure; the amount that, apart from this subsection, would be applicable under subsection (2) of this section in respect of the benefit shall be reduced by the deductible percentage. … (5) In this section: arm's length value, in relation to a non-cash business benefit, means: (a) the amount that the recipient could reasonably be expected to have been required to pay to obtain the benefit from the provider under a transaction where the parties to the transaction are dealing with each other at arm's length in relation to the transaction; or (b) if such an amount cannot be practically determined - such amount as the Commissioner considers reasonable. income derived by a taxpayer means income derived by a taxpayer in carrying on a business for the purpose of gaining or producing assessable income. non-cash business benefit means property or services provided after 31 August 1988: (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. … provide: (a) in relation to property - includes dispose of (whether by assignment, declaration of trust or otherwise); and (b) in relation to services - includes allow, confer, give, grant or perform. recipient's contribution, in relation to a non-cash business benefit, means the amount of any consideration paid to the provider by the recipient in respect of the provision of the benefit, reduced by the amount of any reimbursement paid to the recipient in respect of that consideration. … (6) Notwithstanding section 21, the consideration referred to in the definition of recipient's contribution in subsection (5) of this section is consideration in money. … 176 The following principles, relating to the determination of the arm's length value, are common ground between the parties. The determination of the arm's length value must be made in light of the statutory context: Walker Corporation Pty Ltd v Sydney Harbour Foreshore Authority (2008) 233 CLR 259; Leichhardt Council v Roads and Traffic Authority (NSW) (2006) 149 LGERA 439 at [35]-[36]; Federal Commissioner of Taxation v Resource Capital Fund III LP (2014) 225 FCR 290 at [47]. "Arm's length value" is defined in s 21A(5)(a) to mean "the amount that the recipient could reasonably be expected to have been required to pay to obtain the benefit from the provider under a transaction where the parties to the transaction are dealing with each other at arm's length in relation to the transaction". Unlike the definition of "arm's length consideration" formerly in s 136AA of the 1936 Act, this definition of arm's length value requires the amount that could reasonably be expected to have been required to pay to be determined having regard to the position of the actual recipient and not some notional "independent party": cf Federal Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149 at [99]; Chevron Australia Holdings Pty Ltd v Federal Commissioner of Taxation (2017) 251 FCR 40 at [44], [119].

Income according to ordinary concepts 177 I will first consider the Commissioner's contention that the Customer Contribution was ordinary income of VPN. 178 The Commissioner submits that: no distinction should be drawn between a customer contribution in relation to Option 1 (ie, the Customer Cash Contribution) and a customer contribution in relation to Option 2 (referred to in these reasons as the Customer Contribution); in both cases the customer contribution formed part of the consideration paid by the customer to the Distributor for the new connection; whether the payment of the customer contribution was by way of cash payment or by way of set-off against the value of the Transferred Assets (where the customer chose to construct the contestable assets itself) does not alter the assessability of the customer contribution; and, in either case, the full benefit of the customer contribution was conferred on the Distributor. 179 While it is true that the customer contribution was calculated in the same way (under Guideline 14) whether the construction works were to be carried out by the Distributor or the customer, there were significant distinctions between the transactions that took place in each case. In the latter situation, the transaction involved: the customer undertaking the construction works; the customer transferring the assets to the Distributor; and the Distributor paying an amount (the Rebate) to the customer, calculated as the estimated cost of construction less the Customer Contribution. There was no obligation as such on the customer to pay the Customer Contribution to the Distributor (even assuming that Guideline 14 applied to an Option 2 situation). Rather, the Distributor was entitled to charge a price determined on the basis that the customer was not to contribute to the capital cost of the works unless the incremental cost was greater than the incremental revenue, and the amount of any such customer contribution was not to be greater than the incremental cost less the incremental revenue. In practice, in relation to the situation described in Example 4, the Distributor offered to pay the customer an amount (the Rebate) calculated as the estimated cost of construction less the Customer Contribution. The customer accepted that offer. In these circumstances, in my view, the Customer Contribution was not a payment or gain received by the Distributor; it was merely a component used in the calculation of the amount to be paid by the Distributor to the customer. I accept that a settlement of accounts by which items on one side are agreed to be set off against items on the other side may amount to payment of the sums stated in the account: see JC Williamson's Tivoli Vaudeville Pty Ltd v Federal Commissioner of Taxation (1929) 42 CLR 452 at 478. But that is not the case here in the situation described in Example 4. The customer was not under an obligation to pay the Customer Contribution. It was merely a component in the calculation of the Rebate. Accordingly, in my view, the Customer Contribution was not income according to ordinary concepts.

Sections 21 and 21A of the 1936 Act 180 I turn now to consider ss 21 and 21A of the 1936 Act. 181 Although the parties' written submissions referred to s 21, no detailed submissions were made in relation to this provision. Accordingly, I put it to one side. 182 In relation to s 21A, there is no real issue between the parties that the Transferred Assets constituted a "non-cash business benefit" within s 21A, being "property or services provided … wholly or partly in respect of a business relationship". VPN submits that this was the case. The Commissioner submits that this was the case in the alternative to his submission that the Customer Contribution was income according to ordinary concepts. I accept that the Transferred Assets constituted a "non-cash business benefit". 183 As noted above, it is common ground that the Transferred Assets were received on revenue account. 184 The real issue between the parties in relation to s 21A concerns the "arm's length value" of the Transferred Assets. The definition of "arm's length value" in s 21A(5) has been set out above. VPN contends that the arm's length value of the Transferred Assets equals (or does not exceed) the amount of the Rebate (in Example 4, $60). The Commissioner contends that the arm's length value of the Transferred Assets equals the estimated cost of construction (in Example 4, $100). 185 It is common ground that the "recipient's contribution" in relation to the Transferred Assets (being the amount of any consideration paid to the provider (here, the customer) by the recipient (here, the Distributor) in respect of the provision of the Transferred Assets reduced by the amount of any reimbursement paid to the recipient in respect of that consideration) is the amount of the Rebate (in Example 4, $60). 186 It follows that: (a) If VPN's contention as to the "arm's length value" of the Transferred Assets is correct, the amount brought to account under s 21A(2) (the arm's length value reduced by the recipient's contribution) is, in Example 4, $0. (b) If the Commissioner's contention as to the "arm's length value" of the Transferred Assets is correct, the amount brought to account under s 21A(2) (the arm's length value reduced by the recipient's contribution) is, in Example 4, $40. 187 The Commissioner submits that it is not necessary to refer to the expert valuation evidence (of Mr Samuel and Ms James) in order to resolve the issue of "arm's length value" of the Transferred Assets. The Commissioner submits that: the Distributors and the customers were at arm's length from each other; and the arm's length value of the Transferred Assets was the value credited by the Distributors under the agreements with the customers, being the estimated cost of construction. VPN disputes this and relies on the expert evidence of Mr Samuel. VPN submits that the consequence of the Commissioner's position is anomalous, in that the Distributors make a taxable gain when making an 'uneconomic' connection (Example 4) but make no gain when making an 'economic' connection (Example 2). VPN submits that the anomalous consequence follows from the Commissioner attributing a value to the uneconomic connection assets that exceeds the "arm's length value" of those connection assets. 188 In my view, the "arm's length value" of the Transferred Assets for the purposes of s 21A is able to be determined by reference to the factual findings and it is not necessary to refer to the expert valuation evidence. We are concerned here with the situation described in Example 4, that is, where the customer carries out the construction works and the incremental cost exceeds the incremental revenue. In such a case, the Distributor will have calculated the estimated cost of construction and this will have formed the basis of the offer made by the Distributor to the customer in relation to the new connection. As set out in [54] above, a calculation of the estimated cost of construction was carried out in every case, before the offer to the customer was made. As set out in [99] above, the estimated cost of the works was built up from a number of cost components, namely: (a) the estimated internal company labour (in person-hours) and plant and equipment required to undertake the work; (b) the estimated external contract labour and plant required to undertake the work; (c) the estimated material required to undertake the work such as new poles, cables and substations; and (d) an amount for overheads. 189 The estimated cost of construction was calculated in the same way whether the works were to be carried out by the Distributor or the customer. 190 Where the works were to be carried out by the customer, the Distributor offered to pay an amount to the customer (the Rebate), calculated as the estimated cost of construction less the customer contribution (if any) calculated under Guideline 14. In the situation described in Example 2, the Rebate was equal to the estimated cost of construction, as there was no customer contribution. In the situation described in Example 4 (which is the example we are concerned with here), the Rebate was equal to the estimated cost of construction less the Customer Contribution. In the situation described in Example 4, as a matter of substance, the amount attributed to the Transferred Assets by the Distributor and (at least implicitly) by the customer was the estimated cost of construction. It is true that the amount paid by the Distributor to the customer (the Rebate) was not the estimated cost of construction but rather the estimated cost of construction less the Customer Contribution. But that was an adjustment made as part of the regulatory regime described above, an objective of which was to ensure that existing customers did not bear the burden of the cost of the new connection to a certain extent in certain circumstances: see [62] above. The way this was achieved was twofold. First, Guideline 14 provided that the Distributor was entitled to charge a price determined on the basis that the customer was not to contribute to the capital cost of the works unless the incremental cost was greater than the incremental revenue, and the amount of any such customer contribution was not to be greater than the incremental cost less the incremental revenue. Secondly, the RAB was calculated in a way that ensured that the pricing going forward was not affected by the capital expenditure relating to the new connection so far as it was covered by the customer contribution. Thus, notwithstanding that the amount paid by the Distributor to the customer was equal to the estimated cost of construction less the Customer Contribution, as a matter of substance the amount attributed to the Transferred Assets was the estimated cost of construction. 191 The Distributor and the customer were at arm's length from each other in relation to the transaction. 192 In these circumstances, applying the definition of "arm's length value" in s 21A(5) in relation to the Transferred Assets, the amount that the recipient (here, the Distributor) could reasonably be expected to have been required to pay to obtain the Transferred Assets from the provider (here, the customer) under a transaction where the parties to the transaction were dealing with each other at arm's length in relation to the transaction, was, in my view, equal to the estimated cost of construction. 193 I turn now to the expert valuation evidence. VPN relies on the expert valuation evidence of Mr Samuel. The Commissioner relies, in the alternative to his submission that it is unnecessary to refer to the expert valuation evidence, on the evidence of Ms James. 194 Each expert was instructed in effect to express an opinion on the amount that CitiPower and Powercor could reasonably be expected to have been required to pay to obtain the benefit of network connection assets constructed by customers (referred to as Gifted Assets in the expert reports, but as Transferred Assets in these reasons) under a transaction where the parties to the transaction are dealing with each other at arm's length in relation to the transaction in the years ending 31 December 2007 to 31 December 2010. In answering this question, Mr Samuel was instructed to have regard to the first report of Mr Balchin. Ms James was also provided with a copy of Mr Balchin's first report. 195 Mr Samuel and Ms James agreed on the methodology to be applied in determining the amount that VPN could reasonably be expected to have been required to pay for the Transferred Assets. The experts agreed that this was the lower of: (a) the replacement cost of the Transferred Assets; and (b) the net present value (NPV) of the expected future net cash flows to VPN from ownership of the Transferred Assets. 196 The experts also agreed on the following matters: (a) that the NPV of expected future net cash flows should include the present value of revenues to the Distributor, and the present value of incremental upstream costs; (b) in the examples used in the joint report (referred to in the joint report as Scenarios 1 and 2 - these were substantially the same as Examples 3 and 4 as set out in [10] above), the present value of incremental upstream revenues was assumed to be $80, and the present value of the incremental upstream costs was assumed to be $20 (in discussing the expert evidence, I will use the labels "Scenario 1" and "Scenario 2" for consistency with the expert evidence); (c) the NPV was calculated by discounting the distributor's cash flows at a WACC. The WACC reflected the risks and returns of the Distributor and its business; (d) a customer contribution of $40 arose where the customer: (i) contributed $40 to the Distributor, when the Distributor had built the asset (as in Scenario 1); or (ii) incurred $100 to build an asset, and received a $60 rebate (and therefore incurred a contribution of $40) (as in Scenario 2); and (e) broadly speaking, unless specifically identified in Section 3 of the joint report, the experts made the same assumptions for the purpose of their reports and adopted the same definition as to parties dealing at "arm's length". 197 The experts agreed that the replacement cost of the Transferred Assets was equal to the estimated cost of construction ($100 in Scenario 2). 198 The principal disagreement between the experts was their respective approaches to determining the NPV of the expected future cash flows to the Distributor in relation to Scenario 2. In summary: (a) Mr Samuel's approach was to include cash flows only, being the Distributor's incremental upstream revenues and upstream costs. Mr Samuel concluded that: ... in my opinion the amount that VPN could reasonably be expected to have been required to pay to obtain the benefit of the Gifted Assets under a transaction where the parties to the transaction are dealing with each other at arm's length is equivalent to the rebate actually payable by VPN upon acquisition of the Gifted Assets. (b) Ms James's approach was to include the receipt by the Distributor of the customer contribution, in addition to the revenues to the Distributor and its incremental upstream costs. Ms James concluded that: In this case, the customer contribution is included in the future cash flows and therefore the cost to replace the assets and the present value of the future cash flows are equivalent. Therefore the Distributor should pay an amount equivalent to the replacement cost for the Gifted Assets. 199 In addition to Scenarios 1 and 2, Ms James relied on a further scenario, referred to as Scenario 3. That scenario was as follows: 200 Ms James utilised this scenario to illustrate her view that, in all circumstances, in order for the Distributor to have a neutral outcome, the Distributor would be required to pay the cost of the connection assets to the customer, as the financial benefit to the Distributor was the sum of the customer contribution and the present value of incremental upstream revenues from the customer less the present value of incremental expenses. Scenario 3 was a hypothetical scenario developed by Ms James to illustrate her view as set out above; it was not suggested that the customer was required to pay an additional customer contribution in cash if it had transferred connection assets to the Distributor. Scenario 3 was designed to break down the rebate into its component parts, being the amount the Distributor should pay for the Transferred Assets ($100) less the customer contribution ($40) that the Distributor would otherwise receive if it had built the assets itself. 201 In the joint report at [3.6], Ms James stated that it was her observation that the rebate was merely a mechanism to enable the settlement of: (a) the transfer of the Transferred Assets from the customer to the Distributor; (b) the payment to the customer for the Transferred Assets at the cost of the assets ($100); and (c) the payment from the customer to the Distributor of the customer contribution required to connect the customer to the network ($40). During cross-examination, Ms James referred to this as her "interpretation" of the calculations. In response to questions during cross-examination, Ms James stated that: she was not saying that the payments were required or that they were obligations; rather, she was saying that the rebate was "a payment which is the net of the cost of the assets and the customer contribution". 202 Ms James expressed the opinion (see the joint report at [3.7]) that: the settlement via rebate avoided the need to separately transfer cash relating to the customer contribution, but the Distributor nonetheless received the financial benefit of the customer contribution via the transfer of the Transferred Assets and the payment of the rebate; and therefore that financial benefit should be included in the assessment of the future benefits flowing to the Distributor. 203 In response to Mr Samuel's comments to the effect that to include non-cash items in an NPV calculation would be inconsistent with fundamental valuation principles, Ms James expressed the opinion (see the joint report at [3.8]) that: this comment was contrary to the practical application of discounted cash flow valuations; and there are circumstances where it is appropriate to impute a notional cash amount in an NPV calculation as a substitute for a financial benefit or obligation that may not necessarily be paid in cash. Ms James provided examples of this. Ms James expressed the opinion (see [3.9]-[3.10] of the joint report) that: in this case, the NPV calculation should impute a notional cash amount for the customer contribution received in the form of assets; the customer contribution was a key component of the financial benefits received; and therefore there was no difference between the replacement cost of the Transferred Asset and the NPV of the expected future net cash flows. 204 In relation to Scenario 3, Mr Samuel expressed the opinion (see the joint report at [3.12]) that the asset contribution is not a future cash flow that can be derived from the same asset, and it is simply wrong to treat it that way. Mr Samuel expressed the view (see the joint report at [3.13]) that the following items identified in Scenario 3 were incorrect: (a) the "net cash flow" of $140 was not a net cash flow, as the customer would never have to pay a customer contribution of $40 in cash when it had incurred the $100 cost of the assets and therefore would never have to pay $140 in cash; and (b) the "hypothetical cash payment for Gifted Assets" by the Distributor to the customer of $100 could never occur in reality. 205 Mr Samuel expressed the opinion (see the joint report at [3.14]) that: Ms James's assertion that the Distributor would be required to pay the cost of the connection assets to the customer was simply wrong; Ms James had ignored the NPV of the benefits that would be derived from the Transferred Assets, which was only $60; Ms James's assertion that "the financial benefit to the distributor is the sum of the customer contribution and the present value of incremental upstream revenues from the customer less the present value of incremental upstream expenses" was incorrect as, in Scenario 2, there was no customer cash contribution; the financial benefit to the Distributor was only the present value of incremental upstream revenues from the customer less the present value of incremental upstream expenses, being a net outcome of $60. 206 In response to Ms James's opinion relating to Scenario 2, Mr Samuel expressed the opinion (see the joint report at [3.14]) that Ms James's approach was wrong because: (a) it was inconsistent with the agreed cash flows for Scenario 2, which did not include a customer contribution cash flow; and (b) it did no more than redefine the NPV of future cash flow benefits as the replacement cost. It set aside both the actual circumstances (being an actual payment of the rebate of $60) and the NPV of the future cash flow benefits (which was $60). 207 Mr Samuel stated (see the joint report at [3.16]) that: in his experience as a valuer over the last 26 years, he had never previously encountered an NPV calculation that included non-cash items; and in his opinion, to include non-cash items in an NPV calculation would be inconsistent with fundamental valuation principles and NPV calculations. After responding to the examples relied on by Ms James, Mr Samuel expressed the opinion (see the joint report at [3.18]) that: the examples did no more than demonstrate that all cash flow benefits or expenses should be included in an NPV calculation; in contrast, the only cash flows that arose from the Distributor's ownership of the connection assets were the incremental upstream revenues ($80) and upstream expenses ($20), producing a net amount of $60; and Ms James's notional $40 customer contribution in contributed assets could never give rise to any further cash flow or financial benefit as it could not be sold without the Distributor foregoing the incremental upstream revenues and upstream expenses (net amount of $60) and did not increase, in any way, the only cash flows generated by the Distributor, being the incremental revenues and upstream expenses (net amount of $60). 208 Mr Samuel expressed the opinion (see the joint report at [3.19]-[3.20]) that: the examples provided by Ms James in support of the inclusion of non-cash items in an NPV calculation bore no resemblance to her notional $40 customer contribution; Ms James's approach of including a notional $40 customer contribution in assessing the NPV was flawed because the purpose of the NPV is to determine, in effect, the value of the connection assets, and Ms James's approach included, as an input to the NPV, a notional $40 of the same connection assets that were being valued; Ms James's approach was therefore circular, as it valued the assets by reference to themselves; in other words, she had not applied an NPV approach, but instead had redefined the NPV calculation as replacement cost. 209 In my view, if the methodology adopted by both experts (namely that the arm's length value is the lower of the replacement cost of the Transferred Assets and the NPV of the expected future net cash flows to VPN from ownership of the Transferred Assets) is applicable for the purposes of s 21A of the 1936 Act, I prefer the opinion of Mr Samuel to that of Ms James. There is no difference of opinion between the experts as to the replacement cost of the Transferred Assets (the first element of the agreed methodology). The difference relates to the NPV of the expected future net cash flows to VPN from ownership of the Transferred Assets (the second element of the agreed methodology). Ms James's approach essentially involved looking at the component parts of the Rebate. While her analysis of how the Rebate was calculated is correct (the Rebate was the estimated cost of construction less the customer contribution calculated under Guideline 14), I do not accept that the customer contribution was a cash flow for the purposes of applying the agreed methodology. The customer contribution was merely an input in the calculation of the Rebate. Accordingly, in my view, the only cash flows that arose from the distributor's ownership of the connection assets were the incremental upstream revenues (in Scenario 2, $80) and upstream expenses (in Scenario 2, $20), producing a net amount of $60. 210 However, I do not consider the agreed methodology to be applicable for the purposes of s 21A of the 1936 Act in the circumstances of this case. Section 21A(5) relevantly defines the "arm's length value" in relation to a non-cash business benefit (here, the Transferred Assets) as being the amount that the recipient (here, the Distributor) could reasonably be expected to have been required to pay to obtain the benefit from the provider (here, the customer) under a transaction where the parties to the transaction are dealing with each other at arm's length in relation to the transaction. The difficulty with the agreed methodology in the circumstances of this case is that it pays insufficient regard to the regulatory regime described above, an objective of which was to ensure that existing customers did not bear the burden of the cost of the new connection to a certain extent in certain circumstances: see [62] above. As noted above, the way this was achieved was twofold. First, Guideline 14 provided for the customer contribution. Secondly, the RAB was calculated in a way that ensured that the pricing going forward was not affected by the capital expenditure relating to the new connection so far as it was covered by the customer contribution. When regard is had to these matters, it becomes problematic to determine the arm's length value as defined in s 21A(5) on the basis of the NPV of future cash flows without taking into account the customer contribution and the way in which it was taken into account in the RAB and thus affected the pricing going forward. Accordingly, I do not consider the expert valuation evidence to assist in determining the arm's length value of the Transferred Assets for the purposes of s 21A. 211 I therefore conclude that the arm's length value of the Transferred Assets for the purposes of s 21A is equal to the estimated cost of construction (in Example 4, $100). 212 As noted above, it is common ground that the "recipient's contribution" for the purposes of s 21A was equal to the Rebate (in Example 4, $60). 213 Accordingly, the amount included in VPN's assessable income under s 6-5 of the 1997 Act pursuant to s 21A of the 1936 Act (being the arm's length value less the recipient's contribution) was, in Example 4, $40. 214 As noted above, VPN submits that the consequence of the Commissioner's position is anomalous, in that the Distributors make a taxable gain when making an 'uneconomic' connection (Example 4) but make no gain when making an 'economic' connection (Example 2). I do not accept this submission. It fails to have regard to the gains that are made by the Distributor through the tariff revenues it derives in the case where it makes an 'economic' connection. In such a case, the estimated cost of construction increases the RAB and is thus taken into account in the pricing going forward. The assessable gain up-front in the 'uneconomic' connection situation relates to an amount (the customer contribution) that reduces the RAB and thus is not taken into account in the pricing going forward.

Conclusion 215 VPN's written submissions refer to an issue concerning depreciation, but there does not appear to be any dispute between the parties once the issues discussed above have been resolved. It seems to be common ground that the depreciation treatment follows from the resolution of the above issues. 216 For the reasons set out above, I have concluded as summarised in [13]. In each proceeding, I will make an order that the parties provide proposed minutes of orders to give effect to these reasons. I certify that the preceding two hundred and sixteen (216) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Moshinsky.