Parfew Nominees Pty. Ltd. v. Federal Commissioner of Taxation.
Judges:Gobbo J
Court:
Supreme Court of Victoria
Gobbo J.
This is an appeal against the decision of a Board of Review upholding the Commissioner's disallowance of the taxpayer's objection [reported as Case S22,
85 ATC 241]. Parfew Nominees Pty. Ltd., herein called ``the taxpayer'' in this case, pursues its objection under sec. 18(8) of the Taxation (Unpaid Company Tax) Assessment Act 1982. Under that Act the taxpayer as the beneficial owner of shares in a holding company, which owned all the shares in Hanover Developments (Queensland) Pty. Ltd., was the subject of tracing that enabled recovery of tax due by this company. The taxpayer was entitled to exercise the same rights of objection and appeal against the company's assessment as were available to the company itself.
The issue in respect of this assessment issued by the Commissioner arose in this way. A company called Fifteen Collins Street Pty. Ltd. (``Collins'') had been formed to develop a site at 15 Collins Street, Melbourne into residential strata title units. In 1970 a 23 storey building was erected for a cost of some $2.5 million, excluding the cost of the land. The development was not a success, partly because there was little or no demand for residential units and partly because of the condition of the building. The state of the external brickwork was such that eventually it had to be replaced. In 1972 the Hanover Group purchased a controlling interest in the shares of Collins. In June 1975 a partnership was created between Collins and two other companies in the Hanover Group. These were Deemac Engineering Pty. Ltd. (``Deemac'') and Hanover (Queensland) Pty. Ltd. Both of these were profitable companies, whereas Collins had accumulated substantial losses.
By the partnership agreement which took effect on 13 June 1975 the parties agreed to carry on the partnership business in the proportions of 50 per cent to Collins, 25 per cent to Deemac and 25 per cent to Hanover Queensland. On 11 August 1975 the three companies gave notice that there was a change of ownership in the trading stock of Collins and that they would be relying upon sec. 36A(2) of the Income Tax Assessment Act. Section 36A provided as follows:
``(1) Where, for any reason, including -
- (a) the formation or dissolution of a partnership; or
- (b) a variation in the constitution of a partnership, or in the interests of the partners,
a change has occurred in the ownership of, or in the interests of persons in, property constituting the whole or part of the assets of a business and being trading stock, standing or growing crops, crop-stools, or trees which have been planted and tended for the purpose of sale, and the person, or one or more of the persons, who owned the property before the change has or have an interest in the property after the change, section 36 applies as if the person or persons who owned the property before the change had, on the day on which the change occurred, disposed of the whole of the property to the person, or all the persons, by whom the property is owned after the change.
(2) Where -
- (a) property in relation to which sub-section (1) applies has become, upon
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the change in ownership or interests, an asset of a business carried on by the person or persons by whom the property is owned after the change;- (b) the person or persons by whom the property was owned before the change holds or hold, after the change, an interest or interests in the property of a value equal to not less than one-quarter of the value of the property;
- (c) the value of the property as ascertained in accordance with paragraph 36(8)(a) is greater than the value (if any) that would have been taken into account at the end of the year of income if no disposal had taken place and the year of income had ended on the date of the change; and
- (d) the person or persons by whom the property was owned before the change together with the person or persons by whom the property is owned after the change give notice to the Commissioner, in accordance with this section, that they have agreed that this sub-section shall apply in respect of the property,
the value of the property, for the purposes of section 36, shall be, instead of the value specified in paragraph 36(8)(a), the value (if any) that would have been taken into account at the end of the year of income if no disposal had taken place and the year of income had ended on the date of the change.''
The value of the property in the present case fell to be decided by sec. 31 of the Act. This provided as follows:
``(1) Subject to this section, the value of each article of trading stock (not being live stock) to be taken into account at the end of the year of income shall be, at the option of the taxpayer, its cost price or market selling value or the price at which it can be replaced.''
In the present case, the date of disposal of the property became the closing date for valuation of the trading stock of Collins. It was claimed in the relevant tax returns that the value of the trading stock of Collins, calculated as replacement price, was $3,350,000 and that the disposal value was $1,839,230. The three companies in their partnership return for the year ended 30 June 1975 elected to revalue stock on hand at 30 June 1975 at the lower of cost or market value, and thus at the figure $1,839,230.
It was advantageous for Collins to be selling a part interest at a high price because that high price gave it income which was absorbed by its accumulated losses. On the other hand the new partners were paying a high tax entry price which they could set off against their profits. Replacement cost was adopted to fix the value of the unsold units at 13 June 1975 on the basis that this would result in a higher figure than market value. The latter was adopted for the end of year value with the result that there was a significant loss in the intervening 17 days and so a large deduction became available to the partnership. The consequence was a significant reduction in the tax otherwise payable by the companies concerned. It needs to be said, however, that there was no suggestion that the course adopted was not properly open to the three companies. The issue rather was whether replacement price was open at all in this case and if it was, did the amount put forward accurately represent such replacement cost. The Board of Review held that the figure of $3,350,000 put forward on behalf of the companies should properly be $1,839,230, the value at the end of the year of income, with the consequence that the three companies were denied a deduction of $1,510,770.
On behalf of the Commissioner it was first argued that in the circumstances of this case replacement cost was not an alternative available to the taxpayer. Alternatively, it was argued that replacement price should be determined by reference to the market value of the units. Finally, it was submitted that in any event replacement cost of the units was not more than $1.9 million. All of these matters were disputed by the taxpayer, who contended that replacement price was properly open and that this was the sum of $3,350,000 for the 27 unsold units.
There is really only one authority that bears on the present case, namely the decision of the High Court in
F.C. of T. v. St Hubert's Island Pty. Ltd. 78 ATC 4104; (1977) 138 C.L.R. 210. It was there held that land was capable of being trading stock within the meaning of sec. 36(1). Mason J. said at ATC pp. 4111-4112; C.L.R. p. 225:
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``I acknowledge that some of the provisions contained in sec. 28 to 36 of the Act are so expressed that they cannot readily be given an operation in relation to land. But this is not enough in itself to sustain the conclusion that the provisions in their entirety were not intended to apply to land.''
Stephen J. considered the reference to replacement in the section and the argument that land was not trading stock. At ATC p. 4107; C.L.R. p. 218 he said:
``It is said that any parcel of land is, inherently, both unique and incapable of obsolescence, so that these words are inapt to refer to land. An examination of the use made of the first two of these words in the section disposes of this argument: `replaced' and `obsolescence' each occurs in the description of only one of the three alternative courses open to the taxpayer or the Commissioner (as the case may be) and, if it be the case that the nature of land renders them inappropriate, the consequence is only that in the case of land the choice of courses is narrowed down to only two. The phrase `of the same kind', in the sense in which it is used in sec. 31(2)(c), is, I think, as readily applicable to some parcels of land, for instance some subdivisional lots, as it would be to some paintings or sculptures in an art-dealer's trading stock or to some jewellery, precious stones or bloodstock in the stock-in-trade of a jeweller or dealer in racehorses; no doubt in all these cases some items of stock would be unique: if so, para. (c) would be inapplicable but it does not follow that the whole of the provisions of the Act dealing with trading stock are thereby rendered inapplicable.''
Aickin J. at ATC p. 4121; C.L.R. p. 242 referred to the various expressions that are used in relation to trading stock that are not readily applicable to land and then went on to say:
``No doubt occasions could arise in which one piece of land could be said to be `of the same kind' as another, as in the case of adjoining blocks in some subdivisions, and it may in some instances be possible to say that one allotment could be `replaced' by another in the same subdivision, or perhaps even some other subdivision. In the case of business premises the word `replaced' might be used by saying e.g. that a branch at one location has been replaced by another at a new location.
It does not seem to me however that the conception of trading stock necessarily involves that the articles which are bought and sold must be identical or that what replaces one item of trading stock must be identical with that which it replaces. It is easy enough to formulate examples where this would be so. One such example is the case of an art dealer whose business comprises the buying and selling of paintings, including old masters. It would be as proper to describe each of the latter as being `unique', as it would be to use that expression in relation to a particular parcel of land. Yet it would be difficult to say that the art dealer does not have trading stock comprising pictures bought for purposes of sale and that when he sells a number of masterpieces and buys other paintings by other painters, or even of the same painter, that he is not replacing the stock which he has sold. The expression `of the same kind' cannot be read too strictly. It would be an affront to common sense to require absolute identity, particularly in sections of the Act dealing expressly with business transactions. Common sense alone would tell us that in the ordinary course of trade in goods one line may be discontinued but none the less accurately described as `replaced' by another.''
It was argued on behalf of the Commissioner that replacement price or cost was only a meaningful option where it was not a fanciful exercise and where it had a measure of commercial reality. In this context reference was made to the passage in the judgment of Fullagar J. in
Australasian Jam Co. Pty. Ltd. v. F.C. of T. (1953) 88 C.L.R. 23 at p. 31, where he said of ``market selling value'' in sec. 31 that such expressions ``must be interpreted in a commonsense way with due regard to business realities''.
It was said that the exercise of arriving at the replacement price as proposed by the taxpayer did not comply with this criterion. The price of each of the unsold units in a multi-unit strata title building some four years old was arrived at by assuming the construction of the same building again on the same site and then apportioning the cost to arrive at the price of each of the unsold units. It was put that the
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appropriate course was either to regard replacement price as effectually not open as an option under the section or alternatively to treat the cost of purchasing the unsold units as being the relevant replacement price.The main criticism by the taxpayer of this approach was that there was nothing unrealistic in the notional exercise proposed and that the possible purchase of stock from oneself was inconsistent with a realistic transaction.
There is none the less real difficulty in my opinion in postulating a replacement price that involves a notional rebuilding of the entire development and then abstracting the portions still unsold. Each of the unsold strata units has a distinct identity and its price or cost must ultimately be ascertained as a separate price. It is an approach that would appear to mean that a manufacturer seeking to fix the replacement price of some items of equipment would have to arrive at replacement price by notionally replacing all the likely items he had already manufactured and sold and then allocate an overall cost, including design and initial tooling up, to arrive at replacement price.
Reliance was placed on behalf of the taxpayer on the passage in St Hubert's case, where Aickin J. said that it could be possible to say that one allotment could be replaced by another in the same subdivision or perhaps even some other subdivision. But this very reference does not really recognise a new or notional subdivision. Rather, it is implicit in his Honour's description that the replacement is secured by taking the appropriate price for a like allotment or by purchasing an allotment elsewhere. Where one is seeking to arrive at the replacement price of say 20 unsold allotments in an existing 50 allotment subdivision, one would not readily approach this task by assuming purchase and subdivision of an area of land sufficient to provide 50 allotments and then apportioning the cost. If this approach were to be adopted at all, it is more logical to assume subdivision of a parcel sufficient to yield 20 allotments.
Where there is replacement stock available I am of the view that replacement price is in the great majority of cases to be ascertained by identifying the price that is to be paid to secure that replacement item. This needs to reflect a price that is the relevant one for the particular taxpayer. Thus it would not be appropriate for a retailer to use a price that is the retail cost of replacement. The correct price would be the price that is normally paid by a retailer when buying in his own stock. Again, if the relevant taxpayer were a wholesaler, it would usually be inappropriate to find a replacement cost for, say, certain components, by calculation of actual design tooling up and manufacture by the taxpayer, for that would mean including the possibly expensive creation of dies and tools that are only economical for a production run. Nor should this approach be necessary because, for example, there were no supplies held by a wholesaler at the relevant time. One can presumably arrive at the appropriate price by a resort to past practice and margins, or even by making a deduction of the relevant margin from the retail price.
No doubt there will be cases where the article in question could be the subject of a cost assessment by calculation of actual expenditure on labour and materials, and by engagement of those with the necessary skills. But, by and large, replacement price should not generally be ascertained by such an approach. Even where the article cannot be bought in, it will not necessarily follow that articles must then be the subject of precise replacement. Either the article can be the subject of replacement by an equivalent as referred to by Aickin J. or it may be that there is no room for the replacement option at all in the particular circumstances.
It may be thought that the resort to the purchase of replacement stock or an equivalent is in effect a denial of replacement price as an option and the adoption of the other option of market selling value. In my view this does not follow, for a replacement price so arrived at is not market selling value. The latter reflects the price at which the particular taxpayer may sell, not the price at which he buys in.
Much emphasis was sought to be placed in argument on what was said to be the nature of the business of Collins. In particular it was said that Collins was in effect a manufacturer of units that it was in the process of selling and that it was therefore not correct to consider the sale price of the unsold units or even the price of equivalent units elsewhere. This arose because there was evidence of the prices for which the unsold units were being offered for sale by Collins. There was also evidence that there were no other similar units for sale at the relevant time.
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The evidence as to the business carried on by Collins was somewhat meagre. Such evidence as existed leads me to find that the company in question was created to develop this particular site and that there is nothing to suggest that this was to be the first of a number of such developments. As to Collins' business, it was at the relevant date involved in selling the balance of already developed units. In that sense only, it was a seller of units and it would then be legitimate to consider the buying-in price as indicating replacement price. There was much force in the submission on behalf of the Commissioner that if Collins' business at the relevant time was of importance, then its business was restricted to that of selling, for it was in no sense any longer in the business of development.
I have come to the conclusion that, as Stephen J. indicated in the passage from the St Hubert's case already cited, there may be circumstances where replacement price is not an option under sec. 31 and that this is so here. I so find for the reasons already discussed, the main factor being the unreality implicit in a notional redevelopment of a series of separate and different strata title units, which can only have cost arrived at by an apportionment of a larger development, only parts of which are the items of trading stock under consideration.
It is true that actual replacement is not the question and that a notional replacement only is required. But it must be possible and not defy business reality. One, but only one, method of considering whether the replacement price approach is unrealistic is to ask whether a holder of trading stock in these circumstances would have seriously asked whether it could replace the stock and, if so, at what price. That is the type of question that would be commonly asked by holders of trading stock in order to arrive at its value. In the present circumstances I am of the view that an owner would have dismissed the replacement of these unsold strata units as a wholly unrealistic exercise.
I further conclude that if replacement price is open in this case, then the price at which the units in question could be replaced is more appropriately arrived at by recourse to the selling prices of those units than by the notional redevelopment that is postulated on behalf of the taxpayer. It is to be noted that the sale prices varied according to the location of the units and their size. It is true that these were selling prices rather than buying-in prices, that is to say the price which Collins might have been expected to pay to buy in these or equivalent units, but it is clear that the latter prices would have been less than the sale prices of the units. There was evidence of the actual sale prices of the units at about the relevant time. There was also evidence from a valuer, Mr Sully, as to the market selling value of each unit at the relevant date. Mr Sully gave evidence that the total of these likely selling prices was $1,996,000. He also said that if the units were priced on the basis of a sale in one line, there would have been a discount for expenses, interest, holding charges and profit, and that the likely value on this basis would have been in the vicinity of $1,500,000. I conclude from the whole of his evidence that the buying-in price, more particularly the total replacement price of the units in question, would have been about $1,500,000. There is nothing to suggest that the value of the units varied as between 13 June 1975 and 30 June 1975.
It was agreed between the parties, however, that the Commissioner would not contend that the value of the units was less than $1,839,230, being the figure put forward by the taxpayer as the market selling value on 30 June 1975. I am therefore prepared to adopt this figure - namely $1,839,230, rather than the lower figure of $1,500,000 - as the replacement price of the units at 13 June 1975. This is all on the basis that replacement price is an available option and, as already stated, I find that this is not so in this case.
The foregoing renders it strictly unnecessary for me to make findings on the matter of the replacement price exercises put in evidence. This occupied a great deal of hearing time. It is both desirable and convenient however whether because of questions of costs or otherwise, that I make findings in respect of this evidence.
Mr Forsyth, who with Mr Havin, appeared for the taxpayer, submitted that there were three steps in calculation of replacement price. These were, firstly, ascertainment of the value of the land; secondly, ascertaining the cost of the building; and thirdly, apportionment to the unsold units. I am prepared to assume that mathematical apportionment was appropriate, though I am not persuaded that it is correct, given the differing locations and characteristics of view and position of the units. Moreover,
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the selling prices themselves did not simply reflect differences in size.It was put by counsel for both parties that on the main issue, namely the calculation of a replacement cost, the answer would depend substantially, if not wholly, on which of the two quantity surveyors I accepted, between whom there was a considerable divergence in their evidence. Mr Barlow, the quantity surveyor called on behalf of the taxpayer, arrived at his figure for replacement cost of the whole development by building up his cost estimate from basic items. He arrived at his two estimates as follows. In his first assessment he did so by updating the original contract sum by use of building cost indices. This began with an original cost of $2,808,000 which, when updated to an assumed mid-contract date of June 1975, resulted in a figure of $5,027,000. This approach was not the preferred one of the witness. This was understandable for it suffered from some disabilities, including the fact that the building contract was never found and put into evidence. It was not possible to tell whether the starting price was competitive or inflated. More significantly, Mr Barlow's senior colleague said his firm recommended that the updating period not exceed about five years. Here it is not clear what was the starting point because the actual cost was not tied to a known contract price or a known contractual starting date, but on any view the period was either more than five years or very close to that period. I am not satisfied that the updating approach is in the circumstances a reliable one in this case, and the better course is to consider the evidence of the two experts on the basis of a comparable method, namely estimates of replacement cost as at 1983, backdated to 1975 by reference to building cost indices.
As to these, neither expert had the benefit of the original drawings or specifications. Mr Barlow did an elemental and measured cost estimate as at August 1983 by reference to what he described as being current rates for building work within his firm's responsibility at the relevant time. The work on which the rates were based was not identified. Sometimes an average rate was set down and then special loadings added; in other cases, general rates were used. Mr Packham took squarage estimates for all sections of the building work and then applied rates extracted from the Rawlinson's Construction Handbook 1983. Rawlinson was a firm of construction cost consultants and quantity surveyors which compiled rates for a whole variety of building work according to particular localities. The rates were drawn from information secured by the firm as to current building work. There was some criticism of the usefulness of these rates but I do not find these criticisms significant. Rather, they should be regarded as cautions as to the manner in which the handbook was to be used.
Both witnesses were thoroughly tested on their approach. Mr Barlow, though he preceded Mr Packham, had the benefit of access to Mr Packham's workings and was thus afforded a better opportunity to comment than might have been possible in ordinary cross-examination.
I have decided that Mr Packham's estimate is to be preferred to that of Mr Barlow. The following are the main considerations that led me to my conclusion. In the first place, I found Mr Packham more persuasive and cogent. There were some inconsistencies in Mr Barlow's account that, by comparison, reduced the weight of his evidence. Secondly, Mr Packham's estimate had the firm foundation of published rates that were readily able to be discussed. By comparison, Mr Barlow's rates were founded on rates which were described as drawn from his firm's experience. Though that firm was one of considerable size and standing, it was more persuasive to look at a variety of published rates produced for general consumption than to be asked to adopt a particular rate said to be drawn from some current experience but not otherwise illustrated or tabulated in evidence. The absence of any such illustrative material or any similar, albeit less comprehensive compilation like the Rawlinson publication, was all the more significant in view of the evidence that Mr Barlow's firm kept a record of all their projects in a data bank of information going back 20-30 years. Thirdly, Mr Barlow's estimate of cost was shown to be significantly above average costs for like construction. He sought to justify this by reference to what he said were unusual features of the subject site and building. These were said to be the shape of the site and the higher wall to floor ratio. In particular, it was said that the site meant higher construction costs and underpinning and site retention. This led Mr Barlow to add the full cost of site retention and underpinning works to the
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Rawlinson rates to show that his own rates were reasonable. But this very illustration failed in its object, for there was an error as to the underpinning required and it was not reasonable to proceed on the assumption that the Rawlinson averages for multi-level buildings did not contain any provision at all for site retention or underpinning. There were other indications of how Mr Barlow could only sustain the level of rates used by him by recourse to what were said to be unusual features. Yet he ultimately agreed that 15 Collins Street was a fairly average city building. I am not satisfied that there was a basis for significant increases over what were average rates that included within them a wide range of constructions including buildings generally similar to the subject building. Finally, I prefer Mr Packham's analysis because it had the benefit of some check or verification from an alternative calculation founded on the use of 1975 rates. The figure arrived at for the total building by use of June 1975 rates was $3,728,989 which, when allocated back proportionately for 27 units, was $1,901,000. His equivalent figures for the 1983 backdated calculation were $3,859,465, or for 27 units $1,968,327. It is true that Mr Packham preferred the latter method, but it is not without significance that a quite separate method, founded on 1975 current rates drawn from sources other than the Rawlinson book which was not in existence in 1975, produced a 1975 replacement cost that was not markedly different from Mr Packham's more detailed and elaborate method.I was reinforced in the conclusion I arrived at by one item of evidence that came forward indirectly. At the time of the 1975 transactions, Hanover Holdings Ltd. had some calculations and investigations carried out in order to arrive at replacement cost. Included in these workings, which formed the substance of exhibit N, there was an estimate provided by Mr Barlow's firm to Hanover Holdings Ltd. for the replacement cost of 520 Collins Street. This estimate was used as a comparison in arriving at the replacement cost figure for 15 Collins Street and was based on building costs as at July 1975. These showed both a minimum cost per square foot of $33 and a maximum cost per square foot of $35. This figure did not include design fees at 11 per cent, which were separately shown. When the total of cost and fees is added and converted to rates per square metre, it represents an estimate of the order of $400 per square metre for maximum cost. The average square metre cost represented by Mr Barlow's main calculation was some $500 per square metre. When I put the 1975 calculation to Mr Barlow, he agreed it was quite a bit below his own figures and suggested that the difference could be explained by the unusualness of the subject building. I do not find this explanation persuasive for the reasons already discussed. Moreover, it is to be noted that Hanover Holdings, an experienced property developer, must have thought 520 Collins Street a reasonable basis for comparison.
I accordingly find that if the replacement cost approach proposed by the taxpayer was to be open to it then such approach, if properly employed, would result in a figure of $1,968,327 at 13 June 1975, not including land, for the relevant trading stock consisting of the unsold 27 units and parking areas.
Finally, there is the dispute as to the value of the land. In 1975 Mr Gill, a very experienced valuer, was asked to value the land and did so by ascribing a rate of $150 per square foot. Years later, when called upon to give evidence, he stated that he thought that his estimate was a conservative one and that the figure was more in the range of $160-$170 per square foot. I am prepared to accept his evidence that his earlier figure should be modified to some extent, even though it had the benefit of being arrived at at the time. I find that the true value of the land at the relevant date was $160 per square foot. This figure would result in a total land value of $497,556 upon the hypothesis that it is proper to attribute 51 per cent of the land value to the 27 unsold units. I should not be taken as indicating that I find that it is reasonable and appropriate to make such an allocation where units differing in size and value to those already sold constitute the stock in question.
I will not make a final order in relation to assessment as the parties requested that I defer a formal order until I had given my decision on the issues of principle.
The remaining matter that was debated before me concerns the appropriate date to take for calculation of replacement cost. More particularly, is the replacement cost to be arrived at by assuming that the article has
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already been ordered and is in effect to be paid for at the date in question, here 13 June 1975? A second approach is one that asks what is the cost, assuming that the replacement process is at mid-term in June 1975. Or again, is the date to be one arrived at by assuming that replacement commences only at the relevant date, even though it may take some time to complete, and so may reflect later price. The figure contained in Mr Packham's assessment assumed a mid-contract date as at June 1975. There is some attraction about this approach. In view of my decision that replacement cost is not open as proposed by the taxpayer, it is unnecessary for me to decide this question and I say nothing further about it.The result is that, for the reasons given, the taxpayer's appeal must fail. The primary basis for my decision is that the replacement price option is not open. On this basis, it would mean that the value that is appropriate is market selling value at 13 June 1975 which, having regard to the common view put by the parties, is the sum of $1,839,230. If replacement price is open, then for the reasons already given, the same figure of $1,839,230 is the stock value at 13 June 1975. Finally, I have made findings on building replacement and land value, if the approach submitted by the taxpayer is the correct one.
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