ROTHERWOOD PTY LTD v FC of T

Judges:
Carr J

Court:
Federal Court

Judgment date: Judgment handed down 31 August 1994

Carr J

Introduction

This is an appeal by the applicant taxpayer, Rotherwood Pty Ltd (``Rotherwood'') against the decision of the respondent, The Federal Commissioner of Taxation (the ``Commissioner'') to disallow its objection to the inclusion of an amount of $250,317 in its assessable income for the year ended 30 June 1989. This amount represents what can conveniently be described as Rotherwood's share of a sum of $6 million paid for the surrender of a head lease of office premises occupied (pursuant to a sub-lease) by a firm of solicitors in Perth.

On 28 July 1993 Lee J. ordered that there be a separate trial of the three following issues:

1. Is the sum of $6 million (``the payment'') received by Chancery Services Pty Ltd from Colpenarm Pty Ltd, or some lesser amount, assessable income of the Chancery House Unit Trust (``CHUT'') pursuant to sections 25(1) or 25A of the Income Tax Assessment Act 1936 (``the Act'')?
2. Is the payment assessable income of CHUT pursuant to the operation of sections 160M(7), 160Z, 160ZC and 160ZO of the Act?
3. If the answer to questions 1 or 2 above is ``yes'', is the amount of $250,317 assessable income of the Applicant under section 97 of the Act?

The parties are agreed that if either of questions 1 or 2 is answered in the affirmative then question 3 should be answered in the same way.

Factual background

Rotherwood was, at the relevant time, a beneficiary under a discretionary trust for the benefit of the family of a Mr J.R.B. Ley (``Mr Ley''), a partner in the firm of Messrs Freehill Hollingdale & Page (``Freehills'' - which, unless otherwise stated may be taken to include a reference to Freehills and its predecessor firms), solicitors. The trustee of that discretionary trust was a company called Eason Pty Ltd (``Eason''). Mr and Mrs Ley are the directors and shareholders of Eason. Eason held units in the unit trust known as the Chancery House Unit Trust, the trustee of which was Chancery Services Pty Ltd (``Chancery Services''). Chancery Services, in its capacity as trustee of the Chancery House Unit Trust (a capacity which, unless otherwise stated, can be taken to have applied to all of its activities described hereunder), provided certain secretarial, administrative and other services to Freehills. Those other services included sub- leasing office premises to Freehills and providing the use of office furniture and equipment to that firm for the purposes of its legal practice.

There were two classes of units in the Chancery House Unit Trust, namely ordinary units and special par units, but for present purposes it is not necessary to distinguish between them.

All but one of the relevant units in the Chancery House Unit Trust were held by nominees of the partners of Freehills from time to time. The remaining unit was held by a partner personally. The Board of Directors of Chancery Services comprised the partners in Freehills from time to time.

On 6 December 1983 Chancery Services (then known as Chancery Nominees Pty Ltd) entered into a lease with Austmark Investments Pty Ltd (``Austmark''), pursuant to an agreement to lease made on 1 November 1982, whereby Chancery Services leased, unfurnished, four floors (``the Premises'') of a ten storey building known as 15-17 William Street, Perth for a term of ten years commencing on 1 November 1982 (``the Old Lease''). The Old Lease contained three options for renewal, each for further terms of five years, although Mr Ley in his affidavit referred to only two of those options. Payment of the rent and performance of Chancery Services' obligations under the Old Lease were guaranteed by the partners of Freehills. Simultaneously, Austmark and Chancery Services entered into a licence (``the Old Licence'') whereby Chancery Services was granted the right to use certain car parking bays in the same building as the Premises, for a term which was co-extensive with the term granted by the Old Lease.

Chancery Services borrowed moneys which eventually amounted to a total of approximately $1.5 million which it applied in carpeting the Premises and in furnishing and fitting out those portions of the Premises which were to be occupied by Freehills. Payment of that loan and interest upon it was guaranteed by the then partners of Freehills and their wives. By deeds of charge, Chancery Services charged the

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partitioning, other fittings, and furniture further to secure payment of those moneys.

Towards the end of November 1982 Chancery Services took possession of the Premises. On 22 November 1982 Freehills took up occupation of two floors of the Premises pursuant to a sub-lease from Chancery Services and at the same time Chancery Services granted to Freehills an oral sub-licence of the parking bays. All or part of the balance of the Premises was sub-let to unrelated parties, until required by Freehills. By 1988 Freehills was occupying the whole of floors 8 and 9 and part of floor 7. Freehills occupied almost one third of the building and was its largest tenant. On 30 October 1984 Austmark (the head lessor) changed its name to Colpenarm Pty Ltd (``Colpenarm''). Colpenarm was a wholly- owned subsidiary of West Australian Trustees Ltd in its capacity as the trustee of the Armstrong Jones Property Fund of which Armstrong Jones Management Ltd (``Armstrong Jones'') was the manager.

During 1986 and 1987 the partners in Freehills were concerned about Chancery Services' level of indebtedness in respect of the moneys borrowed to furnish, fit out and carpet the Premises, particularly as the partners and their wives had entered into the guarantee referred to above. In 1986 two former partners in Freehills and all of the partners' wives who had executed that guarantee were released from liability. The concern reached the level of being a major factor in the resignation of five of the six partners in Freehills who resigned in 1987. By early 1988 that concern had spread to the capital gains tax and stamp duty implications, which arose out of the retirement of partners and the admission of new partners in Freehills, of holding units in the Chancery House Unit Trust. Professional advice was sought and received which was to the effect that the Chancery House Unit Trust should be replaced with a discretionary trust. At about the same time, the company which lent the above moneys to Chancery Services indicated that it would like the loan repaid before its due date (21 October 1989). Freehills' Management Committee considered that the request for early repayment of the loan was a good opportunity to put in place a new structure to replace the Chancery House Unit Trust. Although Chancery Services sought and obtained a number of proposals to refinance its debt, none was thought to be acceptable and on 28 June 1988 Freehills' Management Committee decided to defer the question of such refinancing.

By deed dated 24 May 1988 a new service trust, the ``FHP Service Trust'' was created, the trustee of which was FHP Services Pty Ltd (``FHP Services''). When the FHP Service Trust was settled, the Directors of FHP Services were the then partners of Freehills. The FHP Service Trust was a discretionary trust, the beneficiaries of which were the partners of Freehills or their nominees. The trust deed provided that the beneficial interest of a beneficiary could be determined from time to time by a committee known as the ``Partnership Committee'' (comprising two senior partners of Freehills) on the basis of a merit system.

By letter dated 10 August 1988 addressed to one of the partners in Freehills, Armstrong Jones offered, on behalf of Colpenarm, to pay Chancery Services $750,000 towards an improved fit-out and refurbishment of the Premises and to contribute up to $250,000 towards replacement of the carpet in the Premises if Chancery Services would then agree to exercise the option to extend the term of the Old Lease for five years from 1 November 1992.

This was not the first time that Chancery Services, as lessee of premises sub-leased to a firm of solicitors, had been pressed by its landlord to exercise an option to renew such lease. In late 1980 Chancery Services was the assignee of a lease of office premises at Law Chambers, Cathedral Square in Perth which it sub-leased to Messrs Muir Williams Nicholson & Co, a predecessor of Freehills. The landlord of those premises pressed Chancery Services to exercise an option to renew the term for five years from 1 December 1980. Chancery Services exercised that option, but there is no evidence of this being other than at or about the time of the expiry of the then current term and certainly no evidence or suggestion of the landlord giving any consideration in return for the exercise of that option. Two years later, when Muir Williams Nicholson (as the firm was then named) moved to the Premises, the Law Chambers lease was assigned to W.A. Bar Chambers Ltd for no consideration other than the future performance of the lessee's obligations under that lease.

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By mid 1988 Freehills was receiving approaches from leasing agents of buildings under construction or to be constructed in the Perth Central Business District, offering the firm various inducements to take leases of premises in those buildings. There is evidence that Armstrong Jones had become aware of these approaches.

At a partners' meeting held on 16 August 1988, the partners of Freehills considered the letter from Armstrong Jones and resolved to obtain advice from a Mr Ian Sanderson, a property consultant, about alternative premises and the likely rental that would be payable in respect of the Premises and other similar premises in Perth in the years to come.

The matter had been considered at a meeting of the Freehills Management Committee earlier that day. The following is an extract from the minutes of that meeting:

``It appeared that the owners were considering selling the building and therefore wanted to get a long term commitment from FHP as the major tenant. There was a premium value to the owners from securing the major tenant on a long term basis and it was agreed that THR [Mr T.H. Reinold, a partner in Freehills] should attempt to get an indication of that value before the Partners' meeting later in the day.''

On or about 22 August 1988 Freehills received a formal offer on behalf of the owners of the building under construction next door to 15-17 William Street to lease office space in that building. That offer included a proposed incentive payment of $1,935,000.

Freehills' Management Committee met on 13 September 1988 and considered Mr Sanderson's letter of advice dated 5 September 1988. The Management Committee decided to seek further advice as to the value to Colpenarm of Chancery Services agreeing, at that time, to exercise the option. That further advice was not obtained in view of the further developments referred to below.

By October 1988 Freehills had not responded to the offer from Armstrong Jones which had neither been withdrawn nor increased. At about that time one of the partners in Freehills, a Mr Bruno Camarri, began to take an interest in the Armstrong Jones offer. Mr Camarri had been a member of the Management Committee from its formation on 1 July 1979 until his resignation from it in February 1987 and until that resignation, had for many years been the de facto managing partner of the firm. Mr Camarri told the Management Committee that he thought Armstrong Jones ``could be persuaded to increase its offer''. He was authorised by Freehills' Management Committee to approach Armstrong Jones, on behalf of Chancery Services, to see if an increased offer could be obtained. Mr Camarri engaged another property consultant, Mr Warren Tucker of Warren Tucker Pty Ltd, to assist him in his negotiations with Armstrong Jones.

By 22 November 1988 those negotiations had proceeded to the extent that a full meeting of the partners was convened at which Mr Camarri tabled particulars of what was described as the ``anticipated offer'' in these terms:

``$4 million to $4.5 million, payable $3 million on 1 January 1989 balance in 4 equal 6 monthly instalments on the basis that existing lease is renewed for ten years commencing on 1 January 1988 at rental of $300 m².''

[I have taken the reference to 1988 in the above passage as being intended as a reference to 1989, although I do not think that anything turns on this.]

Mr Camarri's memorandum then set out some figures which showed that if the total payable by the Landlord was $4,500,000 certain loans (which were described as ``Partnership Loans'') could be repaid, leaving a balance of $1,685,000 ``to be invested''. The partners agreed in principle to accept an offer of $4.0 to $4.5 million, if and when it was made, subject to the receipt of detailed analyses which two of the partners agreed to prepare. The meeting was adjourned to 24 November 1988 at which Mr Camarri was authorised to continue negotiating with Armstrong Jones with a view to obtaining a higher offer.

On 7 December 1988 there was a quarterly meeting of the partners of Freehills. The relevant extract from the minutes of that meeting reads as follows:

``3. Premises

BGC [Mr Camarri] told Partners that, subject to the approval of the Board of Armstrong Jones and the approval of the Trustee of the Armstrong Jones Property Trust, agreement could be reached with the

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landlord whereby Chancery Services Pty Ltd would surrender its existing lease and FHP Services Pty Ltd would take a new lease for 10 years commencing on the 1st January 1989 at a commencing rental of $300.00 per square metre per annum with rent reviews every 2 years. He also said that Armstrong Jones would be prepared to give us their legal work which could amount to as much as $300,000.00-$500,000.00 in fees per annum.

BGC sought authority to complete the arrangement with Armstrong Jones. It was moved by BRJ and seconded by PJM that such authority be given and that resolution was carried unanimously. BGC said that he would meet with the managing director of Armstrong Jones on 9 December 1988.''

The applicant's evidence was that Mr Camarri mentioned the amount which the landlord was prepared to pay, although this was not minuted. That evidence did not extend to specifying the amount mentioned by Mr Camarri.

On or about 14 December 1988 agreement was reached and, in a letter dated 16 December 1988, Armstrong Jones set out the terms and conditions for the surrender of the Old Lease and the Old Licence and the grant of a new lease and car park licence of the Premises. To indicate their acceptance of those proposals, Chancery Services and FHP Services caused their respective common seals to be affixed to the last page of that letter. The same two directors, Mr Camarri and a Mr John Robert Hayward, also a partner in Freehills, witnessed the fixing of those respective seals. In summary, the matters agreed to (subject to ratification from the Boards of Armstrong Jones and West Australian Trustees Ltd) were as follows:

• Chancery Services was to agree to an early surrender of the Old Lease and the Old Licence on 31 January 1989 in consideration of receiving $6 million from Colpenarm;
• The existing guarantees of the obligations of Chancery Services would be released;
• Stamp duty associated with that surrender would be borne in full by Colpenarm;
• Freehills would be placed on a panel of lawyers to be considered from time to time by Armstrong Jones to carry out Armstrong Jones property-related work throughout Australia;
• ``In consideration of that appointment and acknowledging the consequential value of the opportunity to do the legal work on behalf of Armstrong Jones, Freehill Hollingdale & Page will through FHP Services Pty Ltd, in its capacity as trustee of the FHP Services Trust, agree to enter into a new Lease and Carpark Licence in respect of the above premises'';
• The new lease was to commence on 1 February 1989 for a term of ten years with two five year options. Initially the annual rent was to be $1,488,000 ($300 per square metre) per annum;
• There was provision for a separate car park licence;
• Except for changes to reflect the above and certain other stipulated exceptions, the terms and conditions would be identical to the Old Lease and the Old Licence.

By deed of surrender and a surrender of lease, both dated 31 January 1989, made between Colpenarm and Chancery Services, Chancery Services surrendered the Old Lease and the Old Licence in return for the payment of $6,000,000 which was made on or about that date by bank cheque paid to ``Chancery Services Pty Ltd as trustee of the Chancery House Unit Trust.'' The deed of surrender attracted liability for Western Australian stamp duty of $250,525.00 which was duly paid.

By deeds, both dated 8 February 1989, Colpenarm as lessor and FHP Services as lessee entered into a lease of the Premises (``the New Lease'') and a parking licence (``the New Licence'') for a term of ten years commencing on 1 February 1989 with options to renew for two further terms each of five years. The annual rent for the Premises was $300 per square metre reviewable at the expiration of each two years of the term. The terms of those deeds were substantially in accordance with the terms and conditions contained in the letter dated 16 December 1988 referred to immediately above. The partners in Freehills executed the deeds as covenantors, thereby guaranteeing the performance by FHP Services of its obligations under the New Lease and New Licence.

In its report dated 13 January 1989 for the ``National Committee Meeting'' of the nationally-organised firm of which Freehills

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was a part, what was then about to take place was described in the following terms:

``Premises

As the result of the spate of office building construction occurring in Perth at the moment, the Firm had received numerous approaches from developers offering substantial incentives to move to a new building. The Firm had also been offered attractive incentives from the landlords of its existing building to make a commitment to stay. In the result, the Firm accepted the landlord's proposal and, as a consequence, will surrender its existing lease (which was due to expire on 31 October 1992) and enter into a new lease for 10 years on 1 February 1989.''

Chancery Services ceased to operate as a service company to Freehills on 1 February 1989 and from that date those services formerly provided by it to the firm were provided by FHP Services. Numerous leases of office equipment which Chancery Services had been making available, for reward, to Freehills were transferred to FHP Services for the same purpose.

The directors of Chancery Services and FHP Services were the partners for the time being of Freehills. The shareholders of both Chancery Services and FHP Services were at all material times M.W.N. Administration Pty Ltd and Muirwill Nominees Pty Ltd and the directors and shareholders of each of those two companies were the partners for the time being of Freehills. The inescapable conclusion is that Chancery Services and FHP Services were each controlled by the partners from time to time in Freehills.

The sum of $6,000,000 received by Chancery Services was disbursed (in terms of cash movements) in payment of fees to Warren Tucker Pty Ltd ($310,000), repaying the moneys borrowed by Chancery Services and certain moneys borrowed by Freehills. The balance of $3,141,659 was held on deposit pending a decision of the partners as to its disbursement.

On 13 February 1989 the partners of Freehills resolved that the abovementioned balance of $5,690,000 remaining after payment of the fee of $310,000 referred to above should be distributed (in terms of beneficial interest) by Chancery Services equally between the holders of special par units in the Chancery House Unit Trust. There were 22 such unit holders, all except one of whom were nominees of the partners in Freehills. The other was a nominee of a Mr Peter Lark, a director of a company associated with Freehills. The effect of this resolution and a resolution made on 29 June 1989 by the board of directors of Chancery Services was that each such holder would receive a beneficial entitlement in the amount of either $258,636 or $258,637. Eason as trustee of the Ley Family Trust thus became entitled to receive $258,637.

On 29 June 1989 the Board of Directors of Eason resolved that the net income of the Ley Family Trust for the year ending 30 June 1989 be distributed as to $6108 to a named beneficiary and as to the whole of the balance to the applicant. The resolution continued in these terms:

``To the extent that there is an assessable accretion to the Trust fund (arising from the beneficial holding by the Trust of ordinary units in Chancery House Unit Trust) during the Accounting Period ended 30 June, 1989 the Trustee determines in terms of clauses 7 and 8 of the Trust Deed that those accretions be distributed as follows:

a. [to each of four named beneficiaries the sum of $2080]; and

b. the balance to Rotherwood Pty Ltd.''

On 30 June 1989, Eason executed a declaration under seal in similar terms in relation to the net income of the Trust and what was described as any assessable accretion to the Trust Capital.

On 27 April 1990 the Commissioner issued to Rotherwood a notice of assessment of income tax for the year ended 30 June 1989 and on 19 June 1991 issued to Rotherwood notice of an amended assessment of income tax for that year. The amended assessment included the distribution of $250,317 from the Ley Family Trust in Rotherwood's assessable income.

Rotherwood, by notice dated 16 August 1991, objected to that amended assessment. By notice dated 5 August 1992 the Commissioner disallowed that objection. On 8 September 1992 Rotherwood appealed to this Court against the Commissioner's decision on 5 August 1992 to disallow that objection.

On 4 August 1992 the Commissioner made determinations pursuant to s. 177F(1)(a) and

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177F(2) of the Act in relation to the amount of $250,317 and on 20 August 1992 issued a further notice of amended assessment to give effect to those determinations. However, the question whether Part IVA of the Act applies is the subject of separate proceedings the hearing of which has been deferred pending the answering of the three questions above.

The sum of $250,317 referred to in the third question to be answered in these proceedings is calculated by deducting from the above amount of $258,637 an amount of $8320 being the sum of the four amounts of $2080 referred to above. If the amount of $258,637 received by Eason was income then it may be that the amount to which the applicant is entitled passed to it pursuant to the first of Eason's resolutions and declarations i.e. that the amount involved may be some $2212 greater than the figure stated in the relevant question. It would seem very likely that the parties will be able to sort that matter out but, if not, it can be resolved in due course.

The contentions

Rotherwood submitted that the amount of $6 million was not assessable income because it was a capital sum paid to and received by Chancery Services in consideration for the disposal by it of a capital asset, namely the Old Lease together with the Old Licence (which I shall, for convenience, usually refer to jointly as ``the Old Lease''). That capital asset had been acquired prior to 20 September 1985 and accordingly did not attract what is colloquially referred to as capital gains tax. It was further submitted that the ``deemed disposal'' provisions of s. 160M(7) of the Act could not apply to the transaction; first because there was an actual disposal of an asset and secondly because in this matter the actual disposal was of an asset acquired prior to 20 September 1985. As mentioned earlier in these reasons, it was common ground that if the sum of $6 million was income when received by Chancery Services then the sum of $250,317 received by Rotherwood would likewise be income.

The respondent's contentions can be summarised as follows:

1. The payment of $6 million was made so that Freehills ``through its new service company FHP Services'' would enter into a new lease of the Premises and would remain as tenants of the Premises. The transaction was entered into by Freehills in the course of its business activities ``just as much as the trading activities that gave rise more directly'' to the assessable income of Freehills and its partners. The profit was an ordinary incident of part of the business activities of Freehills and thus was income in the hands of Chancery Services according to ordinary concepts. The decision of the Full Court of this Court in
The Federal Coke Company Pty Ltd v. FC of T 77 ATC 4255; (1977) 34 FLR 375 was distinguishable.
2. Alternatively, the transaction comprising the surrender of the Old Lease for $6 million and the entry into the New Lease and the New Licence was a profit-making scheme in the sense that those words were used by the High Court of Australia in what has come to be described as the ``first strand'' in
FC of T v. Myer Emporium Ltd 87 ATC 4363; (1987) 163 CLR 199. The transaction was a commercial one which formed part of the business of Freehills and a not insignificant purpose of it was the obtaining of a commercial profit by way of an incentive payment.
3. For either or both of the above reasons, the payment was assessable income of Chancery Services pursuant to s. 25(1) of the Act as income according to ordinary concepts.
4. If, as suggested by Hill J. in
S.P. Investments Pty Ltd v. FC of T 93 ATC 4170 at pp. 4177-4178; (1993) 112 ALR 443 at p. 452, for the profit to be assessable income the property generating the profit must have been acquired for the requisite profit-making purpose then, in this case the property generating the profit was the New Lease and the New Licence and the payment was made to Chancery Services, the alter ego of Freehills and distributed to the applicant for the benefit of Mr Ley, a partner in Freehills.
5. Alternatively, even absent what was described as the interdependent transaction of FHP Services entering into the New Lease and the New Licence, the sum of $6 million was still assessable under s. 25(1) of the Act as income according to ordinary concepts because:
- (a) the Old Lease had no or no significant surrender value; and
- (b) the profit (computed by deducting from the payment of $6 million the value of Chancery Services' interest under the
  
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  Old Lease which was either nil or an insignificant amount) was from a transaction in the ordinary course of the business carried on by Chancery Services; or
- (c) was a profit from a transaction in the course of Chancery Services' business, although not within the ordinary course of that business, and Chancery Services entered the transaction with the intention or purpose of making a profit; or
- (d) if the transaction was not in the course of Chancery Services' business, it was a business operation or commercial transaction which Chancery Services entered into with the intention or purpose of making a profit or gain.
6. Alternatively, the $6 million payment received by Chancery Services was a profit arising from the carrying on or carrying out of a profit-making undertaking or scheme and was therefore assessable income pursuant to s. 25A(1) of the Act. This was not the mere realisation of a capital asset as the Old Lease had no surrender value. The profit-making undertaking or scheme was the surrender of the Old Lease and Old Licence by Chancery Services and the entering into of the New Lease and the New Licence by FHP Services.

The relevant statutory provisions (other than those relating to ``Capital Gains Tax'')

I set out below relevant extracts from s. 25(1) and s. 25(A1) of the Act:-

``25(1) [Assessable income to include gross income]. The assessable income of a taxpayer shall include-

(a) where the taxpayer is a resident-

the gross income derived directly or indirectly from all sources whether in or out of Australia; and...

25A(1) [Sale of property - profit-making scheme] The assessable income of a taxpayer shall include profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit- making by sale, or from the carrying on or carrying out of any profit-making undertaking or scheme.''

WAS THE $6 MILLION ASSESSABLE INCOME UNDER EITHER OF THE ABOVE SECTIONS?

Whether there was a mere disposal of a capital asset?

The traditional starting point for an examination of the relevant legal principles is the very well-known test suggested in
Californian Copper Syndicate v. Harris (1904) 5 TC 159 by the Lord Justice Clerk (the Rt. Hon. J.H.A. Macdonald) at pp. 165-166 where his Lordship explained the distinction between a mere realisation or change of investment and ``an act done in what is truly the carrying on, or carrying out, of a business'' in these terms:

``Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?''

That statement has been quoted and approved in countless cases including many in the High Court of Australia, for example by Gibbs C.J. in
FC of T v. Whitfords Beach Pty Ltd 82 ATC 4031 at pp. 4037-4038; (1982) 150 CLR 355 at p. 367-368 and the Full Court in
FC of T v. Myer Emporium Ltd 87 ATC 4363 at p. 4367; (1987) 163 CLR 199 at p. 210. The relevant passage in Gibbs C.J.'s reasons in Whitfords Beach is in these terms:

``The question whether the profits were income within ordinary concepts depends on the application of the tests laid down in Californian Copper Syndicate v. Harris and in the cases that have followed that decision. Was what was done merely a realization of the taxpayer's asset, or was it something done in what was truly the carrying on or carrying out of a business? In other words the question is `whether the facts reveal a mere realization of capital, albeit in an enterprising way, or whether they justify a finding that the [taxpayer] went beyond this and engaged in a [business of profit-making] in land albeit on one occasion only': see McClelland v. F.C. of T. at ATC p. 4120; C.L.R. p. 496, where however the words used are `a trade of dealing in land'; the words which I have ventured to substitute seem more consonant with the Australian authorities. The words `merely' and `mere'

ATC 4523
in these statements seem to me to be an important part of the definition of the line between profits that are taxable and those that are not. If the taxpayer does no more than realize an asset, the profits are not taxable. It does not matter that the taxpayer goes about the realization in an enterprising way, so to secure the best price. As I have said in F.C. of T. v. N.F. Williams, at ATC p. 4194; C.L.R. p. 249:

`The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of subdivision and sale or by the fact that he carries out work such as grading, levelling, road building and the provision of reticulation for water and power to enable the land to be sold to its best advantage.'

Further, the mere magnitude of the realization does not convert it into a business:
Commr of Taxes v. British Australian Wool Realization Association [1931] AC 224 at p. 252. But if the taxpayer does engage in an operation of business, the proceeds are income and taxable.''

His Honour then noted that the question was one of fact which depended upon the particular circumstances.

An important part of the foundation of the applicant's primary submission is that there existed an asset having any value at all. I propose first to consider that matter and then, in turn to consider:

• Whether the profit or gain was derived from a transaction in the ordinary course of the business carried on by Chancery Services and should for that reason be characterised as an income receipt;
• If not, whether the profit or gain though derived from a transaction otherwise than in the ordinary course (i.e. an extraordinary transaction) of that business was entered into by Chancery Services in the course of its business with the intention or purpose of making a profit or gain from that transaction by the means giving rise to the profit. It seems to me that this step in the analysis is required by what was said in Myer (at ATC pp. 4366-4367; CLR pp. 209-210) in the following passage:
- "Although it is well settled that a profit or gain made in the ordinary course of carrying on a business constitutes income, it does not follow that a profit or gain made in a transaction entered into otherwise than in the ordinary course of carrying on the taxpayer's business is not income. Because a business is carried on with a view to profit, a gain made in the ordinary course of carrying on the business is invested with the profit- making purpose, thereby stamping the profit with the character of income. But a gain made otherwise than in the ordinary course of carrying on the business which nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain may well constitute income. Whether it does depends very much on the circumstances of the case. Generally speaking, however, it may be said that if the circumstances are such as to give rise to the inference that the taxpayer's intention or purpose in entering into the transaction was to make a profit or gain, the profit or gain will be income, notwithstanding that the transaction was extraordinary judged by reference to the ordinary course of the taxpayer's business. Nor does the fact that a profit or gain is made as the result of an isolated venture or a `one-off' transaction preclude it from being properly characterized as income (
  Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd 82 ATC 4031 at pp 4036-4037, 4042; (1982) 150 CLR 355 at pp 366-367, 376). The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit."
It has been suggested that the last sentence of the above passage refers only to non- business taxpayers: see Mr R.C. Allerdice's article ``The Voice of the Profit'', Taxation in Australia (1992) Vol. 27 No. 7 p. 408 at p. 409. I do not agree with that suggestion. In that passage the High Court makes no reference to non-business taxpayers but in fact makes express reference to judging the transaction by reference to the ordinary

ATC 4524
course of the taxpayer's business. In my view, the High Court was simply expounding the principles applicable to a profit or gain made as the result of an isolated venture or a ``one-off'' transaction which was extraordinary judged by reference to the ordinary course of the taxpayer's business.

Finally, before turning to the provisions of Part IIIA of the Act, I propose briefly to consider:

• Whether the $6 million was income in accordance with ordinary usages and concepts for any other reasons, or was income pursuant to s. 25A(1) of the Act.

Was there an asset capable of being realised?

Mr David Bloom QC, counsel for the applicant, sought to draw an analogy between the cancelled agreements in
Van Den Berghs Ltd v. Clark [1935] AC 431 and the disposal of the Old Lease which he described as ``the essential income-producing asset'' of Chancery Services. Mr Bloom described the leasehold estate as one that had produced substantial income for some years, and was in 1988 producing income in excess of $1.6 million; income which would inure for another thirteen years. It was submitted that the leasehold estate and other rights created by the Old Lease constituted a valuable asset in the hands of Chancery Services.

At this stage I make two comments in relation to that submission. First, in my opinion whether that leasehold estate and other rights constituted a valuable asset should be balanced, in a taxation case such as this, by a consideration of the net position i.e. after taking into account the liabilities directly created by the Old Lease and also the then current market circumstances. Taxation law, although respecting form where appropriate: The Federal Coke Company Pty Ltd v. FC of T 77 ATC 4255; (1977) 34 FLR 375, is very much concerned with practical realities. As Mr Bloom observed during his submissions in reply: ``The liability [to pay rent] is not separate from the rights which form the asset...''.

Secondly, although the Old Lease was needed as part of the arrangements whereby income was generated, the other essential part was, of course, the sub-lease to Freehills. The immediate source of any income was the sub- lease and in particular the rent and other outgoings payable to Chancery Services pursuant to that sub-lease. Reference would need to be made to the Old Lease not for the purposes of identifying or quantifying income but rather for the purposes of identifying and calculating as allowable deductions the rent and other outgoings payable pursuant to the Old Lease. Obviously there could be no sub-lease without the Old Lease but on its own the Old Lease generated no income.

Curiously, although the existence of the sub- lease was admitted, that document was never put into evidence. Nor was there any evidence concerning the surrender of the sub-lease from Freehills to Chancery Services.

The submission that the income would inure for another thirteen years loses a great deal of its impact when one considers that:

• the initial term had only some three years and nine months to run;
• assuming that the sub-lease had options which mirrored the options in the Old Lease, it was really up to Freehills whether they would cause Chancery Services to exercise the option (as Armstrong Jones initially urged them to do in advance) and then, in turn, exercise what was presumably a similar option in the sub-lease.

It becomes necessary to scrutinise in some detail the evidence which bears upon the proposition that Chancery Services was in a position where it had a valuable asset which could be realised for profit.

As appears from the documents which in this matter constitute the pleadings the following is common ground between the parties.

• In late 1988 it was common knowledge that if all the buildings projected for the Perth Central Business District (``the CBD'') were completed then there was likely to be an over supply of office accommodation in the CBD in 1991 or thereabouts;
• Armstrong Jones and Freehills were aware that inducements to enter new leases, which took a variety of forms such as cash payments, reduced rent, rent-free periods, fit-out subsidies or other tangible benefits were offered to some prospective tenants by leasing agents.

Mr Christopher Glass was called by the applicant to give evidence. Mr Glass, a property consultant, was employed by Armstrong Jones

ATC 4525

between 1976 and May 1992 and when he resigned in May 1992 was Director in charge of property asset management. He then took up a position as a partner with a firm called Property Bank Australia. In 1988-1989 Mr Glass was responsible, amongst other things, for ensuring that the properties owned by the Armstrong Jones group of property trusts were securely leased to financially strong tenants on long leases. Mr Glass was aware that the Old Lease was to expire on 30 October 1992 and from 1987 he was personally involved in attempts to get Chancery Services to extend that lease. Mr Glass was the signatory of the letter dated 10 August 1988 making the initial offer of payments totalling $1 million in the event that Chancery Services would within nine days of the date of that letter exercise its five year option to extend the initial term of the Old Lease. I refer to the following paragraphs in Mr Glass's affidavit:

``... the time seemed opportune to approach Chancery to again attempt to gain extended tenure from them.

...

I was concerned about losing Chancery as anchor tenant and the further risk that the departure of Chancery (and with it FHP) [a reference to Freehills] could initiate a domino effect resulting in the loss of more tenants from the building. These losses could have stigmatised the building making it extremely difficult to lease to new tenants resulting in a deterioration of the value of the property.

...

The leasing market at that stage [November- December 1988] was already showing signs of fiercer competition.

...

My intent was to extend the existing tenure, but I knew that this would not be considered without something in return.

...

As at December 1988, there were a number of new buildings under construction in the Perth central business district... Competition to attract tenants was becoming fierce, especially to attract tenants of the calibre of FHP. The cost associated with refilling the space left by FHP and others (in particular the loss of rent while waiting to secure other tenants, and the incentive that would have had to have been paid to secure other tenants) would have been substantially greater than the amount offered.''

Mr Glass, in his affidavit swore that the loss of the anchor tenant would have had an immediate and detrimental effect on the capitalisation rate of the building of between ½ and ¾ per cent. This would have led to a substantial fall in the value of the property, such fall being in excess of $6 million. There was also, so Mr Glass deposed, an opportunity to resolve the rent review pending in mid 1989 by agreeing a base rental which would set a precedent for the remainder of the building.

In the final paragraph of his affidavit Mr Glass referred to the fact that he had been asked to assume that in January 1989 Armstrong Jones had a prospective anchor tenant (``A'') for the Premises, such as Chancery Services. (bringing with it a sub-tenant of the calibre of Freehills), willing to enter a lease and licence on the same terms as the New Lease and the New Licence but that there was an existing tenant (``B'') of the same area with a lease and car parking licence on the same terms as held by Chancery Services, including the option provisions. Mr Glass said that in those circumstances Armstrong Jones would, for much the same reasons as mentioned above, have been willing to pay a sum of $6 million or even more to persuade ``B'' to surrender its lease in order to allow the lessor to enter into the new lease with ``A''.

It would seem that this hypothetical example was intended to counter that portion of the evidence of a Mr Ross Burvill (referred to below) in which he gave his opinion that from about mid 1988 onwards a prospective lessee such as Chancery Services (bringing with it a sub-tenant of the calibre of Freehills) would have been able to obtain a substantial incentive for entering into a lease of premises in the Perth Central Business District on the terms of the New Lease.

I do not find the hypothetical example contained in Mr Glass's affidavit helpful. To start with there is the implication that ``A'' and ``B'' are unrelated parties. In the market circumstances then current, it seems to me that it would be rather odd, even somewhat unreal, that in the circumstances posited the incoming tenant would not seek to have the incentive

ATC 4526

payment made to it or go elsewhere rather than see the incentive paid to ``B''.

In his oral evidence, Mr Glass said that if Chancery Services had simply asked to surrender the Old Lease, Armstrong Jones would have been likely to have held it to the terms of the Old Lease rather than have been prepared to let it vacate the Premises. Owners of buildings in the Perth Central Business District were at that time prepared, so Mr Glass said, to offer cash payments, rent-free periods, fit-outs or a combination of those incentives in order to attract or keep tenants. Mr Glass agreed that the only situation in which a lessor would be prepared to pay a premium or incentive in one form or another to a tenant to vacate was where the lessor wished to terminate the lease and ``force'' the tenant to vacate the building. As to the matter of the $6 million being paid to Chancery Services, Mr Glass said that he was directed by a partner in Freehills that that sum was to be paid to that company.

In a memo dated 20 December 1988 [Exhibit 6] prepared by Mr Glass to his superior, recommending the payment of $6 million, Mr Glass stated the objective in the following terms:

``It is vital to retain Freehills as the major tenant on a longer lease term and, at the same time, set a new rental precedent for the building of $300.00 per square metre per annum exceeding the previous highest full floor rental rate of $270.00 per square metre per annum by $30.00 per square metre per annum which, in turn, off-sets a major portion of the level of inducement.

This amount quotes to $1209 per square metre and is consistent with inducements currently being offered by the developers of QVI and Exchange Plaza.''

Mr Ross Burvill, a licensed valuer was called by the respondent to give evidence. The portions of both Mr Glass's affidavit and Mr Burvill's affidavit which dealt with the value of the Old Lease were objected to on the grounds of relevance but were received into evidence subject to the question of relevance. I have decided to admit all that evidence on the basis that it sheds useful light on the circumstances existing in the market for office space in the Perth Central Business District at the relevant times when the transaction or transactions which generated the payment of $6 million were entered into. I consider that evidence to be directly relevant to the question whether the receipt of that sum should be characterised as the proceeds of the mere realisation of a capital asset, or income. If something has no market value on its own and its owner is paid $6 million for its surrender, then this suggests to my mind that a proper characterisation of what has taken place requires a somewhat wider focus. To focus, in those circumstances, only on the payment made for the surrender of that thing will give a distorted view of the transaction. A wider focus may not require the receipt to be characterised as income but a truer overall picture will emerge. A truer overall picture often assists in the characterisation of a receipt - an exercise which is very much of a factual nature.

I should add that on this aspect of the matter I have accepted the evidence of both Mr Glass and Mr Burvill as being credible and accurate. I saw no real conflict between their evidence concerning what might be described as the then current market situation.

Mr Burvill, in his affidavit swore:

``In view of the anticipated oversupply of office space in the CBD from mid 1990 and the availability of incentives to prospective tenants from about mid 1988, it is my opinion that the Old Lease had no marketable value at the time of its surrender in January 1989.''

Mr Burvill set out in his affidavit the materials (concerning such matters as vacancy factors, rentals and buildings under construction in the Perth Central Business District) upon which he relied in forming his opinion.

In cross-examination Mr Burvill was asked to assume a situation in which there was a sub- lease of premises which sub-lease generated an income of $1.6 million in the 1988 year and that the head lease and sub-lease would continue for a term of thirteen years with normal escalating factors. He agreed, on those assumptions, that ``that asset'' (which was probably understood as the Old Lease but that is not entirely free from doubt) would have a value to Chancery Services substantially in excess of nil ``if it was continued through that period''.

In view of:

• the assumption that the lease and sub-lease would continue for a further 13 years;

ATC 4527
• the use of a gross rental income figure without any regard to the rent and outgoings payable under the Old Lease (which in the year ended 30 June 1988 was slightly over $1 million);
• the somewhat confusing blurring, in the cross-examination, of the distinction between the Old Lease and the sub-lease to Freehills resulting from the description of the asset which was ``productive of $1.6 million in income in 1988'';

I do not regard this piece of evidence as being of much assistance in answering the questions raised in this matter.

There was in evidence [p. 45 of Exhibit 5] a written proposal dated 20 October 1988 from the owner of the new QVI building in St. George's Terrace, Perth, offering Freehills three floors in that building on a fifteen year initial term with two five-year options. The incentives proposed were:

• the discharge of Freehills' remaining current debt in relation to the fit-out at 15-17 William Street, estimated at $750,000;
• indemnifying Freehills for the cost of all rentals, outgoings and charges in relation to the Old Lease until 31 October 1992 (being the expiry date of the initial term of the Old Lease) from the date of commencement of the proposed lease at the QVI building;* and
• payment to Freehills of the sum of $3 million with a condition expressed in the following terms ``This amount would be negotiated to suit both parties to optimise tax effectiveness and could be taken by you as rent free periods, fit out costs, rental subsidies, etc, etc.''
* In a memo dated 12 July 1988 to Freehills' Management Committee which foreshadowed this offer, Mr TH Reinold of Freehills described this as ``some arrangement (presumably financial) for what we were stuck with here in terms of the residue of our lease''. (my emphasis)

There was no suggestion that Chancery Services was enjoying a particularly low rent or that the Old Lease was otherwise on such favourable terms that its surrender would be valuable to Colpenarm. The evidence was that Chancery Services was paying a rent of $180 per square metre per annum with a rent review due on the 1 May 1989 at which time Mr Glass was predicting that the rent would be reviewed to a level of $265 per square metre per annum. On the basis of the evidence outlined above, I have concluded that these were not circumstances which would give Chancery Services any leverage to obtain a payment for the surrender of its lease.

In my view, all of the evidence points to and supports Mr Burvill's original assessment that the Old Lease had no marketable value at the time of its surrender and I accept his evidence to that effect. I have given my reasons above for rejecting what might at first glance appeared to have been some undermining of his opinion in cross-examination. I propose here to expand slightly on those reasons.

It is true that Chancery Services might have been making a profit on its dealings with Freehills resulting from the mark-up which it charged that firm on the rent which Chancery Services in turn paid to Colpenarm. However, the situation was the opposite of an arm's length transaction. It is one thing for Freehills to be content to pay a mark-up on the actual rent paid by Chancery Services when beneficiaries nominated by the partners of Freehills are the recipients of any profit thereby derived. It is quite another thing to infer that, absent the relationship between Chancery Services and Freehills, each option to extend would be exercised on terms which would allow an independent sub-lessor to derive such a profit.

Mr Bloom pointed to the fact that Freehills was put on a panel of solicitors who would be retained to render professional services to Armstrong Jones, which he described as ``not [an] unimportant matter''. I do not think that is a factor which assists to characterise the nature of the receipt of the $6 million in the hands of Chancery Services. Furthermore, it emerged from Mr Glass's evidence and the draft documentation itself that the final wording of the paragraph in the letter of 16 December 1988, which dealt with this matter, was substantially drafted by Mr Camarri and inserted in that final form by Mr Glass at Mr Camarri's suggestion. Finally, Mr Ley conceded in cross-examination that the placement of Freehills on the panel was not itself adequate consideration to induce that firm through FHP Services to enter into the New Lease, without the payment of $6 million.

Mr Bloom submitted that the only consideration moving from Chancery Services

ATC 4528

was the surrender of the Old Lease and that the characterisation of the $6 million in the hands of Chancery Services should be done by characterising what it parted with in exchange for the $6 million which it received.

I did not understand Mr Bloom to be submitting that in characterising the $6 million received I was to be confined to a consideration of the terms of the deed of surrender.

On the question of the extent to which regard may be had to other matters, a useful starting point is the observation of Hill J. in
FC of T v. Cooling 90 ATC 4472 at p. 4479; (1990) 22 FCR 42 at p. 50:

``The cases make it quite clear that whether an amount is income in ordinary concepts depends upon its quality in the hands of the recipient:
Scott v. FC of T (1966) 117 CLR 514 at p 526;
Hayes v. FC of T (1956) 96 CLR 47 at p 55;
Federal Coke Co Pty Ltd v. FC of T 77 ATC 4255 at p 4273; (1977) 34 FLR 375 at p 402 per Brennan J.''

Nevertheless, it is clear that in the determination of the present case one is not confined to an examination of the deed of surrender entered into between Colpenarm and Chancery Services. As Hill J. further observed in Cooling (at ATC p. 4481; FCR p. 53):

``This however does not mean that in determining the legal effect of a contract between parties (and therefore the characterisation of the payment made under it as being income or capital), regard may not be had to the whole factual matrix of which the contract forms part.

Nothing in which his Lordship [Lord Tomlin in
Inland Revenue Commissioners v. Duke of Westminster [1936] AC 1 at p. 19-20 said requires the conclusion that regard cannot be had to the whole context in which the agreement was made to determine the character of a receipt.''

Hill J. also referred with approval to a comment by Lord Wilberforce (with whom Lord Russell of Killowen, Lord Roskill and Lord Bridge of Harwich agreed) in
W.T. Ramsay v. Inland Revenue Commissioners [1982] AC 300 at p. 323 in relation to the principle in the Duke of Westminster case:

``This is a cardinal principle but it must not be overstated or overextended. While obliging the court to accept documents or transactions, found to be genuine, as such, it does not compel the court to look at a document or transaction in blinkers, isolated from any context to which it properly belongs...''

Similarly in
S.P. Investments v. FC of T 93 ATC 4170 at p. 4181; (1993) 112 ALR 443 at p. 456 Hill J. commented:

``... the Court is required to consider the character of the receipt in the hands of the recipient having regard to all the circumstances of the transaction without a disproportionate emphasis upon the form in which the transaction has been structured (cf
Reuter v. F.C. of T. 93 ATC 4037 at 4045-4047.''

In similar vein is this extract from the joint judgment of the Full Court of this Court in
Reuter v FC of T 93 ATC 5030 at p. 5036:

``The consideration for the payment described in the Deed of Covenant is only part of a matrix of relevant events providing the context in which the Deed was executed and in which the character of the payment must be found. The record in the Deed that the payment made to Reuter had connection with the covenants to be provided by Reuter in the Deed, did not exclude connection with other events and was not conclusive of the nature of the payment received by Reuter. The issue to be decided was whether, in fact, the payment was a `product' of the taxpayer's services having regard to all relevant material.''

The Commissioner also relied upon
IRC v. Church Commrs for England [1974] 3 All ER 529 at p. 551:

``First, the starting point is the ascertainment of the true character in law of the actual transaction, and not of some other transaction that might have been effected but was not. Second, to do that involves construing the documents; but the true construction of the documents, though important, is not always conclusive. In respect of the revenue authorities, extrinsic evidence is admissible if it tends to show the true character of the transaction. Third, the consideration given for an asset may, on the true character of the transaction, be wholly capital, wholly income, or partly one and partly the other... Fourth, in determining the nature of any consideration, the true nature of the bargain is of high importance.''

ATC 4529

In terms of the proposition that what took place was merely the surrender of a capital asset, it might be over-pedantic to point out that the deed of surrender effected more than simply the surrender of the leasehold interest. By clause 3.2 of that deed Chancery Services released Colpenarm, in fairly standard terms, from liability for breach of any covenant term or condition.

I was invited to find that the rent stipulated in the New Lease ($300 per square metre per annum) was some $25 to $35 p.s.m. per annum higher than the likely true market value of the rent for the Premises which would have been fixed in May 1989 under the terms of the Old Lease had the Old Lease not been surrendered. It would seem that this finding was sought so that the inference could be more readily drawn that the Old Lease had no surrender value or that the rent payable under the New Lease was fixed at a level of between 9% and 13% higher than the likely true market rent payable under the Old Lease in May 1989 so that a higher payment would be made to Chancery Services as part of the arrangements for the surrender of the Old Lease and the grant of the New Lease.

In my view, the evidence established that the true market rent which Chancery Services would have been required to pay in May 1989 was in the range of $265 to $275 p.s.m. per annum compared with the rent of $300 p.s.m. per annum stipulated in the New Lease. Mr Glass's projected figure (in Exhibit 7) was $265 p.s.m. per annum. Mr Tucker's letter of 28 October 1988 suggests a then current (admittedly some 6 months prior to the review) rent of $270 p.s.m. per annum. Mr Burvill put the range at $265 to $275 p.s.m. per annum. Mr Burvill was cross examined on this aspect but I accept his evidence. It was based on his knowledge of the office rental market at the time coupled with the other evidence to which he referred. His evidence was also consistent with the evidence (originating from the applicant) referred to above. I refer to and rely also on the other evidence referred to at pp. 187-191 of the transcript as indicating that $300 p.s.m. per annum was significantly above what was likely to be the market rate in May 1989.

On the basis of this evidence of a modestly- inflated rent I infer that the sum paid to Chancery Services was probably somewhat higher than would have been the case if the initial rent payable under the New Lease had been fixed at market value as projected for May 1989. I do not rely on that inference in order to characterise the receipt of the $6 million.

In my view, the other evidence referred to above establishes that, on its own, the Old Lease at best was of no value and to characterise it as an asset would be artificial. It was the sub-lease that generated income. Admittedly the sub-lease depended upon the Old Lease for its existence. However, this was not a case in which a package consisting of the head lessee's interests under the Old Lease together with its rights as head lessor under a sub-lease was being assigned for value. This was a case where a bundle of rights proprietary and otherwise arising out of the Old Lease which either had no value or had a value which was far outweighed by the concomitant obligations to pay rent and outgoings was being extinguished in return for the payment of $6 million.

I now turn to consider whether what happened can be described as the mere realisation of a capital asset and thus fall on the capital side of the line referred to by Gibbs CJ in Whitfords Beach or whether the transaction should be characterised as being on revenue account.

Was the profit or gain derived from a transaction in the ordinary course of the business carried on by Chancery Services?

Chancery Services was incorporated on 30 May 1977 and according to an Australian Security Commission Company extract (Exhibit 3) its principal activity was to act as trustee of the Chancery House Unit Trust. An examination of its income tax returns for the years ended 30 June 1982 to 30 June 1989 (both years inclusive) shows that for the first year the business or income-producing activity shown in its income tax return was ``trading trust'' but thereafter the description ``management'' was substituted.

A perusal of those income tax returns shows that, in round and approximate terms, Chancery Services generated the following income:

(a) year ended 30 June 1982: rental income $634,000, administrative services (which included the provision of computer services, photocopying, binding, search fees, courier, telexes and other administrative services) $350,000;

ATC 4530
(b) year ended 30 June 1983: rental income $1 million, administrative services $380,000;
(c) year ended 30 June 1984: rental income $1.1 million, administrative services $544,000;
(d) year ended 30 June 1985: rental income $1.0 million, administrative services $810,000;
(e) year ended 30 June 1986: rental income $1.5 million, administrative services $1.7 million;
(f) year ended 30 June 1987: rental income $1.5 million, administrative services $2.4 million;
(g) year ended 30 June 1988: rental income $1.6 million, administrative services $2.6 million;
(h) year ended 30 June 1989: rental income $1.1 million, administrative services $2.0 million.

As mentioned earlier in these reasons, Chancery Services took an assignment of the lease of certain premises at Law Chambers, Cathedral Square, Perth which it sub-leased to Freehills' predecessor Messrs Muir Williams Nicholson & Co. on 1 July 1977. The evidence was that by 1980, those premises had become run down and inadequate. Accordingly the directors of Chancery Services decided to seek alternative premises to lease. Despite the problems with the Law Chambers premises, Chancery Services exercised an option in the lease to renew the term for a further period of five years from 1 December 1980. Mr Ley deposed to the fact that this was done because the directors of Chancery Services were unaware of suitable alternative premises and furthermore its lessor was pressing it to exercise the option. On 23 December 1982 Chancery Services assigned the balance of the term of that lease to W.A. Bar Chambers Ltd without receiving any valuable consideration other than an indemnity from any further obligations under the lease.

The applicant's income tax returns also show that from time to time Chancery Services acquired (frequently by lease) furniture and office equipment, including computers, which it made available to Freehills. The returns show several examples of personal property being disposed of (or in the case of one photocopier, being scrapped). The balance of the term of the Law Chambers lease could also be described as having been ``sold'' to Bar Chambers Ltd, in the sense that the consideration moving from that company was its agreement to discharge Chancery Services' future obligations pursuant to that lease.

There is no doubt that Chancery Services was carrying on a business undertaking on quite a large scale with gross annual revenue (quite apart from this transaction) in excess of $3 million, excluding a distribution from the FHP Service Trust, in the year ended 30 June 1989.

Based on the evidence, I would describe the business of Chancery Services as being to conduct a solicitors' service trust through the acquisition by lease or otherwise of real and personal property, the acquisition of personal and other services, the making available of that property and those services, for reward, to Freehills and the disposal of that property (and dispensing with those personal and other services) when Freehills no longer wished to avail themselves of that property or those services from Chancery Services. The question is whether the disposal of the Old Lease, by surrender, was an ordinary incident of that business?

At first I was inclined to the view that the surrender of the Old Lease was a transaction in the ordinary course of the business carried on by Chancery Services. It had previously disposed of an unwanted head lease of office premises and the only difference between the two disposals of head leases and the disposal of surplus or obsolete plant and equipment no longer required by Freehills would seem to be that the latter comprised personal estate. The disposal, by surrender, of the leasehold estate was part of a carefully-planned business operation, carried out in the course of the business of profit-making. Even if one were to ignore the previous disposal of a head lease the disposal might be taken as being part of an extension of Chancery Services' ordinary business:
Jennings Industries Ltd v. FC of T 84 ATC 4288 at p. 4294. The fact that the disposal took place as part of the closing down of Chancery Services' business would not preclude the receipt from being characterised as income:
Moana Sand Pty Ltd v. FC of T 88 ATC 4897 at pp. 4904-4905 and the cases there cited.

Sometimes the disposal of these assets may not have yielded much to Chancery Services

ATC 4531

and sometimes the asset had to be scrapped, but on this occasion there was what might have been described as a bonanza had it been unexpected or the result of good luck. But this was not unexpected or the product of good luck; it was a well thought-out and well-executed piece of business. The Freehills partners, with expert help hired for the purpose, did the planning. At the initial stage of the planning no distinction seems to have been made between the different roles which the various principals would carry out. Matters of distinct legal personality were not considered and it was as if Chancery Services were a division of the large commercial enterprise which Freehills had become. Then, when planning moved to execution, the separate but vitally interdependent functions were assigned, all of which are described above. The sum of $6 million might thus be considered as having been received in the ordinary course of Chancery Services' business and accordingly should be characterised as income.

However, the decision of the Full Court of this Court in
FC of T v Hyteco Hiring Pty Ltd 92 ATC 4694 has caused me to pause. I have come to the conclusion that if, contrary to my view, the Old Lease can be regarded as an asset then its disposal in the present matter was not an ordinary incident of Chancery Services' business. I fully appreciate that these are factual matters where sometimes subtle factual distinctions lead to different conclusions. Nevertheless, given:

• the frequency of the sale transactions in Hyteco;
• the proportion which the sales business comprised in relation to the total business of the taxpayer in that case; and
• the unanimous decision of the Full Court that the sales made in that case were not in the ordinary course of the taxpayer's business;

I am not inclined to find that the surrender of the lease here was in the ordinary course of Chancery Services' business.

I should perhaps say something about Cooling. The facts in that case bear some similarity to the facts of the present case save that in that case the incentive payment was made to the firm of solicitors, the payment was not expressed as having been made for the surrender of a lease and there was no change in the solicitors' service corporate trustee. Whilst I see those factual differences as sufficient reason for a differing conclusion in disposing of this aspect of the present matter, I have derived significant guidance from that case in reaching conclusions in respect of some of the remaining issues.

Whether the profit or gain if derived from a transaction otherwise than in the ordinary course (i.e. an extraordinary transaction) of Chancery Services' business was entered into by it in the course of its business with the intention or purpose of making a profit or gain from that transaction by the means giving rise to the profit? Or was it merely the realisation of a capital asset in an enterprising way?

From the extracts in the cases referred to above it can be seen that a transaction does not cease to be the mere realisation of a capital asset if the realisation is effected in an enterprising way. Each case depends upon its particular facts. In the case of the sale of land, the re-zoning, sub-dividing and laying out of roads may not automatically lead to the proceeds of the sale of the sub-divided lots being characterised as income:
FC of T v. Williams 72 ATC 4188; (1972) 127 CLR 226;
Statham v. FC of T 89 ATC 4070. With the results in those cases can be contrasted the observations of Deane J. in
Whitfords Beach Pty Ltd v. FC of T 79 ATC 4648 at p. 4666 and Mason J (as he then was) on appeal in that case 82 ATC 4031 at p. 4048; (1982) 150 CLR 355 at p. 385 and the decision of Jenkinson J. in
Stevenson v. FC of T 91 ATC 4476. All the surrounding circumstances including the circumstances of acquisition and purpose at that time together with the existence or otherwise of a course of dealings or the carrying on of a business have to be taken into account.

Similarly, in this matter it is necessary to concentrate on the method by which a leasehold estate and bundle of rights arising out of the Old Lease became the subject matter of a transaction in which $6 million was paid for their surrender.

In my opinion, what Chancery Services did went well beyond a mere realisation of a capital asset in an enterprising way. What happened was that its officers, in their dual capacity as officers of that company and also of FHP Services, negotiated with Armstrong Jones and with each other. Those officers also negotiated with each other as partners in Freehills, for

ATC 4532

Freehills' involvement as future sub-lessee was, of course crucial to the whole transaction. Those negotiations achieved the result that a bundle of rights arising out of the Old Lease, including the right to a leasehold estate, (which were, on my view of the evidence, worthless in the then current market) were transformed into something for the surrender of which Colpenarm was prepared to pay $6 million. The efforts of Mr Camarri and any other director who assisted him were the efforts of both Chancery Services and FHP Services alike. Through those efforts Chancery Services, in my view, earned $6 million. What was done went beyond the steps taken, for example, in FC of T v. Williams to secure the best price for the land which was the source of the moneys received by Mrs Williams. Here steps were taken to create value in what was to be surrendered. Property consultants were engaged to advise and assist in what was essentially a business venture. The key part of that venture was to link the surrender of the Old Lease to the agreement by FHP Services to take the New Lease and New Licence with Freehills guaranteeing performance and taking the sub-lease and sub- licence. By the arrangements made between the directors of the two companies (the same people in their dual capacities) and Freehills a situation was achieved in which Chancery Services received this very substantial sum for carrying out its role and for which it would otherwise have received nothing. Absent achieving this arrangement with FHP Services and Freehills, Chancery Services might well have even had to pay a substantial premium to persuade Colpenarm to accept the surrender of the lease had it wished to effect such surrender. It is in this sense that I would characterise what took place as earning the moneys so received. The moneys so received were the fruits of a very successful, well-planned and well- executed joint enterprise.

The type of value enhancement here is reminiscent of that achieved in Fox's Case [
Official Receiver v. FC of T (1956) 11 ATD 119; (1956) 96 CLR 370].

In my view, the facts disclose that Chancery Services derived a profit of nearly $6 million (Mr Tucker's consultancy fees amounted to $310,000) in a business operation and commercial transaction carrying out a profit- making scheme. In essence, the transaction or scheme was to exploit a market situation in which Freehills' preparedness to commit itself to long-term occupancy of office space (whether by lease or sub-lease) was something of value which could be turned to good account. Freehills' part in the scheme was to make the commitment by way of guaranteeing the performance by FHP Services of its obligations under the New Lease and the New Licence and also by taking the new sub-lease and sub- licence. It was of no concern to Colpenarm whether there was a direct commitment of this type by Freehills to it or whether, instead, there was a commitment by FHP Services, guaranteed by Freehills. FHP Services' part in the scheme was to take the New Lease and New Licence and grant the sub-lease and sub-licence to Freehills. Chancery Services' part in the scheme was to surrender the Old Lease and Licence and it did so, not as an independent transaction, but as part of the scheme. In my view, when it received the $6 million that money was income in its hands:
FC of T v The Myer Emporium Ltd 87 ATC 4363 at pp. 4367-4369; (1987) 163 CLR 199 at pp. 210-213 and the cases there cited. This conclusion is not dependent on any finding that Chancery Services acquired the Old Lease with the intention or purpose of realising it subsequently at a profit. There is no evidence of that. However, the absence of such evidence does not require a holding in this case that the receipt was a capital receipt. The land in Whitfords Beach, when originally purchased by the taxpayer, was not acquired with the intention or purpose of realising it at a profit. Nevertheless, on the facts of that case the profit realised by the taxpayer upon disposal of the land was held by the High Court to be income in accordance with ordinary concepts and usages.

In my view Chancery Services derived a profit or gain from an extraordinary but profit- making transaction undertaken in the course of its business. The profit or gain can be ascertained by comparing the position before and after the transaction: see
S.P. Investments Pty Ltd v. FC of T 93 ATC 4170 at p. 4178. Before the transaction was entered into, Chancery Services had a lease which either had no value or was a liability. Upon carrying out its role in the scheme in conjunction with the steps taken by the other parties, as described above, a net figure of nearly $6 million was realised. In my view, the present case falls

ATC 4533

within what is usually referred to as ``the first strand'' of the reasoning in Myer.

The applicant argued that Myer was not applicable to the present circumstances because the Old Lease was ``the property generating the profit or gain'' and was not acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit. The applicant relied on a passage in Myer at ATC p. 4367; CLR p. 210:

``The authorities establish that a profit or gain so made will constitute income if the property generating the profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means giving rise to the profit.''

Further, reliance was placed on what was said on this point by Hill J in
Westfield Ltd v. FC of T 91 ATC 4234 at p. 4243; (1991) 99 ALR 510 at p. 521:

``Once it is clear that the activity of buying and selling, which generated the profit, was not an activity in the ordinary course of business, or, for that matter, an ordinary incident of some other business activity, the profit in question will only form part of the assessable income of the appellant, by virtue of its being income in accordance with the ordinary concepts of mankind, if the appellant had a purpose of profit-making at the time of acquisition.''

His Honour made similar observations in
Henry Jones (IXL) Ltd v. FC of T 91 ATC 4663 at p. 4668; (1991) 31 FCR 64 at p. 69 and in
S.P. Investments Pty Ltd v. FC of T 93 ATC 4170 at pp. 4176-4178; (1993) 112 ALR 443 at pp. 451-452.

I agree, respectfully, with Hill J's analysis of the first strand of thought in Myer. However, neither Henry Jones nor S.P. Investments bear any factual similarity to this case or Westfield, for that matter - those two cases did not concern profit generated by buying and selling. Similarly, in Westfield the observation above is predicated on it being ``clear'' that it was the activity of buying and selling which generated the profit. That is not the case in this matter. In S.P. Investments, at ATC p. 4177-4178; ALR p. 452, Hill J stressed that in that case there were not two interdependent actions that together could be referred to as a profit-making scheme. On the previous page his Honour referred to the emphasis placed by the members of the Full High Court in Myer on the significance that there were two interdependent transactions.

Similarly, in the present matter it is, in my view, quite unreal to say that it was the activity of acquiring and surrendering the Old Lease and the Old Licence which generated the profit. That is taking too narrow a view of the scheme or transaction which I have described above.

To adapt the words of the Full Court of this Court in
FC of T v. Spedley Securities Ltd 88 ATC 4126 at p. 4130, Chancery Services had a purpose of profit-making in relation to the particular transaction. The particular transaction being the one which I have described above as the scheme.

I should stress that I am not using the word ``scheme'' in any pejorative way whatsoever. Everything done by those involved was perfectly proper and above board. When the income tax returns were filed, the Commissioner's attention was expressly and specifically drawn to the transaction and his ruling was sought. It hardly seems necessary to include these remarks, but I would not wish there to be the slightest misunderstanding on this point.

Whether the $6 million was assessable income for other reasons

If Chancery Services had not been carrying on a business then, for the same reasons as I have outlined above, in my opinion, the receipt of this money would have been assessable income in Chancery Services' hands as income according to ordinary usages and concepts.

I would have put this on two bases. First, the scheme which I have described above was very much a ``business deal'';
McClelland v. FC of T 70 ATC 4115 at p. 4120; (1970) 120 CLR 487 at p. 495.

Secondly, the moneys can be seen to have been channelled from either FHP Services or Freehills who in commercial terms were entitled to them (by being prepared to enter into the long-term commitment sought by Colpenarm), into the hands of Chancery Services. The Old Lease had no value to Chancery Services at the relevant time and the sum of $6 million so channelled bears all the hallmarks of a gift or distribution without any real consideration. The situation is comparable to the discretionary distributions made in
FC of T v. Squatting Investment Co Ltd

ATC 4534

(1954) 10 ATD 361; (1954) 88 CLR 413. There was here, in my opinion, a sufficient connection between the payment and the income-generating activities of Chancery Services for the payment to be on revenue account.

For the above reasons I consider that the sum of $6 million constituted income both pursuant to ss. 25(1) and the second limb of s. 25A(1). It is thus not necessary for me to deal with the other contentions put forward by the Commissioner, in particular those which involve distinguishing Federal Coke and the applicability or otherwise of that case to the present matter.

Whether the sum of $6 million was assessable income pursuant to Part IIIA

Strictly speaking, in view of my above findings, it is also not necessary to deal with the Commissioner's submission that this sum of $6 million was caught by the capital gains tax provisions of Part IIIA of the Act. To the extent that the $6 million is included in Rotherwood's assessable income pursuant to s. 25 or s. 25A(1) then any capital gain will be reduced so that it will not be assessable under Part IIIA see s. 160ZA(4) in its form at the relevant time.

However, the matter was dealt with briefly in the alternative by both counsel and I shall similarly deal with it briefly. Mr Owen- Conway, for the respondent submitted that there was an assessable capital gain by reason of the operation of s. 160M(7).

Section 160M(7) in its form at the relevant time provided:-

``160M(7) Without limiting the generality of subsection (2) but subject to the other provisions of this Part, where-

(a) an act or transaction has taken place in relation to an asset or an event affecting an asset has occurred; and

(b) a person has received, or is entitled to receive, an amount of money or other consideration by reason of the act, transaction or event (whether or not any asset was or will be acquired by the person paying the money or giving the other consideration) including, but not limited to, an amount of money or other consideration-

(i) in the case of an asset being a right - in return for forfeiture or surrender of the right or for refraining from exercising the right; or

(ii) for use or exploitation of the asset,

the act, transaction or event constitutes a disposal by the person who received, or is entitled to receive, the money or other consideration of an asset created by the disposal and, for the purposes of the application of this Part in relation to that disposal-

(c) the money or other consideration constitutes the consideration in respect of the disposal; and

(d) the person shall be deemed not to have paid or given any consideration, or incurred any costs or expenditure, referred to in paragraph 160ZH(1)(a), (b), (c) or (d), (2)(a), (b), (c) or (d) or (3)(a), (b), (c) or (d) in respect of the asset.''

It was put on behalf of the respondent that the entering into of the New Lease and the New Licence by FHP Services and Colpenarm constituted an act or transaction taking place in relation to an asset, or constituted the occurrence of an event affecting an asset. That asset was the building at 15-17 William Street, Perth and/or the Premises. Cooling's case (per Lockhart J. at 90 ATC p. 4474; 22 FCR p. 43 and Gummow J. at ATC p. 4475; FCR p. 45) and
Hepples v. FC of T 91 ATC 4808; (1991-1992) 173 CLR 492 per Dawson J. at ATC pp. 4823-4824; CLR p. 520, Toohey J. at ATC p. 4825; CLR p. 522, Gaudron J. at ATC p. 4828; CLR p. 528 and McHugh J. at ATC p. 4836; CLR p. 540 were relied on as authorities for the proposition that the ``asset'' referred to in s. 160M(7)(a) does not have to be an asset of the taxpayer. It was said that by reason of the entering into of the New Lease and Licence by FHP Services and Colpenarm (being a relevant act, transaction or event as described above), Chancery Services received the sum of $6 million and accordingly the entering into of the New Lease constituted a disposal by Chancery Services of an asset created by the disposal and the $6 million constituted the consideration in respect of the disposal within the meaning of s. 160M(7). If, contrary to the primary submission, the remaining term of the Old Lease had some value then s. 160ZD(4) would apply to allow an apportionment of the consideration received.

ATC 4535

Mr Bloom argued that:

1. There was an actual disposition of an asset which existed and was acquired prior to 20 September 1985 (the Old Lease).
2. S. 160M(7), which is a deeming provision, must be read subject to s. 160L which deals with what Mr Bloom described as ``actual dispositions of pre CGT assets'' because s. 160M(7) is expressly stated to be ``subject to the other provisions of this Part''.
3. As there was an actual disposition of a pre CGT asset the situation is governed by s. 160L and s. 160M(7) has no application.

Alternatively, Mr Bloom submitted that if s. 160M(7) applied then the expression ``affecting an asset has occurred'' in s. 160M(7)(a) must mean an adverse effect whereas the surrender of a lease has a favourable effect in respect of the property concerned or the building in which the leased premises are situated.

Mr Owen-Conway, in response, submitted that the payment of $6 million was made for entering into the New Lease. He accepted that s. 160M(7) did not apply where an amount is received for the actual disposal of an asset whether or not the asset was acquired before 20 September 1985.

I think that Mr Owen-Conway's concession was well made and that s. 160M(7) does not apply where an amount is received for the actual disposal of an asset.

However, as mentioned above, the respondent does not rely upon the surrender of the Old Lease as being the fact, matter or circumstance which gives rise to a deemed disposal under s. 160M(7).

The respondent relies on the entering into of the New Lease and the New Licence by FHP Services and Colpenarm as being both an act or transaction or, in the alternative an event affecting an asset. The asset affected by the act or transaction or event is the interest of Colpenarm in the building and/or the Premises.

In those circumstances it is not necessary to consider Mr Bloom's argument that the ``affecting'' must be adverse in nature.

It was held both by the majority in the Federal Court in
FC of T v. Cooling 90 ATC 4472 and by a majority in numbers in Hepples [see the helpful table set out by Heerey J. in his reasons in
Paykel v. FC of T 94 ATC 4176 at p. 4181] that the operation of s. 160M(7) is not confined to assets of the taxpayer.

In my view, in this matter an act or transaction has taken place in relation to an asset and an event affecting that asset has occurred. I refer to the entry by FHP Services into the New Lease. Chancery Services has received an amount of money by reason of that act, transaction or event. The consequence is that the act, transaction or event constitutes, by the deeming provisions of s. 170M(7), a disposal by Chancery Services of an asset created by the disposal. Furthermore, s 160M(7)(c) and (d) operate so that the $6 million constitutes the consideration in respect of the disposal and Chancery Services is deemed not to have paid or given any consideration in respect of the asset. I consider that the reasoning of the majority on this point in Cooling applies and that the $6 million was a capital gain within the meaning of Part IIIA of the Act.

Accordingly, I would hold that the sum of $6 million was assessable income by virtue of those provisions of Part IIIA of the Act referred to in the second of the questions raised. However, in view of my answer to the first question, I consider that s. 160ZA(4), in its then relevant form, requires the amount of the capital gain to be reduced to nil.

Conclusion

For the above reasons I propose to answer the three questions raised, in the following manner:

Question 1:

Is the sum of $6 million (``the payment'') received by Chancery Services Pty Ltd from Colpenarm Pty Ltd, or some lesser amount, assessable income of the Chancery House Unit Trust (``CHUT'') pursuant to sections 25(1) or 25A of the Income Tax Assessment Act 1936 (``the Act'')?

Answer:

Yes, the sum of $6 million is assessable income of the Chancery House Unit Trust pursuant to section 25(1) and section 25A of the Income Tax Assessment Act 1936.

Question 2:

Is the payment assessable income of CHUT pursuant to the operation of sections 160M(7), 160Z, 160ZC and 160ZO of the Act?

ATC 4536

Answer:

No, because by virtue of the answer to Question 1 above s. 160ZA(4) requires the amount of the capital gain to be reduced to nil.

Question 3:

If the answer to questions 1 or 2 above is ``yes'', is the amount of $250,317 assessable income of the Applicant under section 97 of the Act?

Answer:

Yes. A further amount of some $2212 may also be assessable income of the Applicant depending upon the true construction and the effect in all the circumstances of the resolutions and declarations passed and made by Eason Pty Ltd on 29 June 1989 and 30 June 1989.

The matters of costs and any other further orders be reserved to a date to be fixed which date is hereby fixed as the date from which the time for filing any notice of appeal or application for leave to appeal shall be calculated.

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ROTHERWOOD PTY LTD v FC of T

Whether there was a mere disposal of a capital asset?

Was there an asset capable of being realised?

Was the profit or gain derived from a transaction in the ordinary course of the business carried on by Chancery Services?

Whether the $6 million was assessable income for other reasons

Whether the sum of $6 million was assessable income pursuant to Part IIIA

Question 1:

Answer:

Question 2:

Answer:

Question 3:

Answer:

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