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SELLECK v FC of T

Judges:
Drummond J

Court:
Federal Court of Australia

Judgment date: 16 September 1996

Drummond J

I have before me appeals against the respondent's decisions disallowing the applicant's objections to the inclusion of the amounts of $21,362.00, $15,492.00 and $1,701.00 in his assessable income for the years ended 30 June 1985, 30 June 1986 and 30 June 1987, respectively. Those amounts represent the applicant's share in the benefit to Arthur Robinson & Hedderwicks (AR&H), a firm of solicitors of which he was a member, from the sum of $1,066,000 paid to it by the Australian Mutual Provident Society Limited (AMP). AMP paid the moneys as a contribution to the cost of fitting out premises leased by it to AR&H in 1984. The only issue for determination is whether the $1,066,000 forms part of the assessable income of the AR&H partnership. If so, it is not disputed that the three amounts received by the applicant are assessable as income in his hands. $1M was paid by AMP to AR&H in 1985 in respect of its agreement to take a lease of a certain area in the AMP's building and $66,000 was paid in 1986 in respect of AR&H's decision to lease an additional area there. The circumstances in which AR&H acquired the entitlement to both payments are relevantly identical. It is therefore sufficient, in order to dispose of the case, to set out my reasons for thinking that the $1M receipt is income in the hands of AR&H.

AR&H was created by the merger of two law firms, Arthur Robinson & Co (Arthur Robinson) and Hedderwicks Fookes & Alston (Hedderwicks), which took effect from 31 July 1984. Arthur Robinson and Hedderwicks were long established Melbourne firms; each had always leased the premises from which it conducted its business. For many years before the merger, Arthur Robinson leased premises in the National Mutual Centre at 447 Collins Street, while Hedderwicks had occupied premises in the St James Building at 121 William Street. By 26 September 1984 a decision had been taken by all the partners of the then newly merged firm to accept a proposal to lease premises in the ``AMP Tower'' in Bourke Street. It was part of that proposal that the lessor, AMP, would pay $1M to AR&H as a contribution to fitting out its new premises. The applicant's account in the books of the partnership was credited with capital receipts of $21,362 as at 30 June 1985; $15,492 as at 30 June 1986 and $1,701 as at 30 June 1987.

Mr Robinson was the managing partner of the merged firm from its formation in mid-1984 until 31 December 1988. From 1980, he had been the managing partner of Arthur Robinson. The issue of office accommodation for the merged firm was a matter on which Robinson had to seek the approval of the partners prior to any commitment being made, a course he followed. Robinson was assisted by a Partnership Committee (which evolved from an earlier Merger Committee) and also by an Occupancy Committee. The Partnership Committee comprised partners of both Arthur Robinson and Hedderwicks and was set up as a liaison body to ensure effective communication during the merger negotiations. It also had a role in making recommendations to the partners of the merged firm in relation to the selection of the premises for that firm.

I accept that the merger was considered attractive by all involved for a number of reasons, notably:

  • (a) Each of Arthur Robinson and Hedderwicks had a particular reputation and experience in different areas of law, the one in commercial practice, the other in litigation: the merger would enable the new firm to offer a broader range of services to clients Australia-wide and also to forge alliances with major interstate firms.
  • (b) The size of, and the diversity of skills within, the merged practice would enable greater specialisation, which was seen as important to success in legal practice in the future.
  • (c) The merged firm would have increased resources, enabling it to take on large scale matters without the rest of the practice suffering.

    ATC 4906

  • (d) The combination of the two firms would give AR&H a broader client base, making it more marketable to prospective clients than each individually would have been.

Emphasis was placed by the partners on AR&H being presented in the market place as a new entity, rather than the continuation, in association, of the two original firms. The development of a similar attitude on the part of all members and employees of the merged firm was also encouraged from the outset. These considerations, together with the reasons for the merger, were relied on to support the applicant's contention that the payments received from AMP could not be part of AR&H's assessable income as they were not received in the course of the firm's business, but from the activity of setting up a new business.

The partners of both Hedderwicks and Arthur Robinson were understandably keen for the merged firm to be accommodated in one building as soon as possible after the merger. For a time, it was not clear whether sufficient space could be obtained in the National Mutual building, the premises occupied by Arthur Robinson at the time of the merger and which were considered suitable for the merged firm. (The St James Building, Hedderwicks' premises, was never considered suitable.) Alternative accommodation opportunities needed to be investigated. The joint Occupancy Committee, formed pre-merger in May 1984, was set up for that purpose. As well as investigating premises for the new firm, the Occupancy Committee made recommendations as to how the existing office space leased by each firm could best be used until the merged firm could move into its own premises: an interim arrangement was adopted whereby, on the first day of trading of the merged firm, 1 August 1984, half the Arthur Robinson partners and staff moved to Hedderwicks' premises in the St James Building and half the Hedderwicks partners and staff moved to the National Mutual Centre. These arrangements remained in place until early August 1985, when the entire AR&H operation commenced to operate from the AMP Tower.

The Occupancy Committee looked at a number of premises, but quickly narrowed consideration down to the existing AMP Tower and the ``Rialto'' building (which was being built at 525 Collins Street, Melbourne) as the only acceptable alternatives to the National Mutual building.

In July 1984, the Committee had received a submission from the letting agents of premises to be constructed at 575 Bourke Street (the ``Lustig/Moor development'') which indicated that a ``$1.5m rent free/fit out assistance package'' would be available to a tenant such as AR&H. But notwithstanding this lease incentive, those premises were quickly ruled out, partly because of their unsatisfactory location and partly because of the distant completion date of the building. About the same time, the letting agent for the Rialto submitted an offer of premises there. Negotiations produced an offer on 1 August 1984 which included a twelve month rent-free period. This represented a saving of approximately $1,094,000 and was described as ``a concession... to assist in moving and establishing [AR&H's] tenancy at Rialto''.

In August 1984, Mr Gill, the general manager of AR&H, was given responsibility for conducting negotiations with the property managers of the AMP Tower and the Rialto. He was briefed by the Occupancy Committee, which then effectively disbanded. Gill dealt with Mr Sheridan, of AMP, whose first offer of accommodation in the AMP Tower, dated 30 August 1984, included the following:

``Rent Free period: A two month fitting out period plus a further period of six months to apply to your immediate occupation requirements. The lease to commence at the end of the two month fitting out period.

OR

A cash lump sum contribution to your partitioning costs with rent to commence upon expiry of the two month fitting out period.

Either of the above alternatives or a combination of both not to exceed in value the sum of $500,000.00.''

The ultimate agreement struck between AR&H and AMP was the result of extensive negotiating by Gill, on behalf of AR&H, in which Robinson also took part from time to time. Gill responded to the AMP offer of 30 August 1984 by letter dated 14 September 1984, after the partners' meeting of 11 September 1984, at which the majority favoured the AMP Tower and the Partnership Committee was authorised to negotiate the best

ATC 4907

possible deal with the AMP. In his letter of 14 September 1984, Gill raised various requests on behalf of AR&H and suggested that a contribution greater than the $500,000 offered would be appropriate (although he did not specify a sum). He proposed further discussions. Gill, Robinson and Mr Rogers, one of the two joint senior partners of AR&H, met Sheridan on 14 September. Sheridan agreed to most of AR&H's requirements and in response to Gill's suggested increase in the fit out contribution, he said that the AMP would probably increase it to $750,000. The final offer made by AMP is contained in Sheridan's letter to Gill dated 17 September 1984. This included the offer of a contribution to fit out costs of up to $1M, in lieu of any rent-free period (other than the three month fit out period also offered). It was due to the efforts of Robinson and Gill that the AMP increased its offer of contribution from $750,000 to $1M. On 13 July 1984, the Occupancy Committee had sent a memo to the Partnership Committee which set out the ``best offer'' made by Richard Ellis to attract AR&H to the Rialto and noted: ``Even if this offer is to be rejected, it should be held `alive' as a bargaining tool to be employed in negotiation with the AMP and National Mutual''. (It was not until mid-August 1984 that the National Mutual confirmed that space would not be available for the new firm there.) Gill agreed that the other offers received by AR&H were used as ``bargaining tools'' with AMP, to drive up its offer to the $1M.

AR&H made a deliberate decision ``around August [1984]'', ie, before the agreement with AMP was entered into, to choose the cash lump sum payment rather than the extended rent-free period, the two options offered by the AMP. Robinson, as managing partner, played a central role in this decision, for which he gave a number of reasons, including:

  • (a) The cost of the fit out was estimated at approximately $2.5M and there was concern about indebtedness if the firm had to borrow that whole amount. Robinson spoke of both component firms being traditionally very ``conservative'', in respect of their financial arrangements, hence the attraction of a $1M contribution, which would reduce the borrowings required to fund the fit out.
  • (b) A rent-free period would benefit only those who were partners in the year of the rent holiday and would have to be paid for by the future partners as the years unfolded, whereas all who were partners during the term of the lease would benefit from a $1M cash contribution expended on fit out.

These are valid reasons for the election to take the lump sum contribution. Although he did not mention it in his evidence, there was another consideration that I think also caused Robinson to favour the cash contribution: he told Gill, prior to finalisation of the agreement with AMP, that he had decided the firm should take the cash contribution rather than the rent holiday and it was in that context that he mentioned to Gill his view that the lump sum payment would be a tax-free capital receipt in the hands of the partners. Donaldson, a member of the Occupancy Committee, said that he understood at the time that that would be the position. I think that, by that early stage, AR&H saw the AMP offer of a cash contribution to fit out as giving it the opportunity to make a substantial cash distribution to the partners, a course that was especially attractive to it because it then believed such a cash distribution would be tax-free.

Following receipt of AMP's final offer, Gill prepared a report for the Partnership Committee containing information regarding both the AMP Tower and the Rialto, which was tabled at a partners' meeting on 26 September 1984. It was at this meeting that the decision to accept the AMP Tower offer was made. The report showed that, on a comparative analysis of the costs for the first two years, the AMP Tower represented a saving of about $1M, although the lessor's contribution to fit out was $1M for each premises. Gill's reasons for proposing AMP Tower, set out in his report, were:

  • (a) The AMP Tower was owner occupied and appeared to be well maintained and serviced. He was of the view this may not apply to the Rialto in the long term, as other buildings owned by the owner of Rialto were not well maintained.
  • (b) AR&H would be the principal tenant in the AMP Tower and would be treated accordingly.
  • (c) The AMP Tower was closer to the Courts and barristers' chambers.
  • (d) As Rogers, the joint senior partner of AR&H, was a director of AMP, a rapport between AR&H and its landlord might more readily be established.

    ATC 4908

  • (e) New buildings (such as the Rialto) often experience air-conditioning and other service problems during the early years.
  • (f) Convenient low cost storage space was available at the AMP Tower.
  • (g) The AMP Tower also had the advantage of already being constructed; the partners were keen to have the new firm occupying single premises a soon as possible and there was some concern about the likely completion date of the Rialto.

It is not disputed by the respondent that such factors played a part in AR&H's decision to move to the AMP Tower. I accept that all were reasons which caused AR&H to select the AMP Tower in preference to the Rialto.

Evidence was called on behalf of the applicant to the effect that the cash contribution from AMP did not influence either AR&H's decision to move to new premises or to accept the offer of premises in the AMP Tower in preference to, eg, the Rialto. The applicant, Mr Selleck, was the senior partner of Arthur Robinson at the time of the merger and joint senior partner of the merged firm until November 1987, when it appears he retired. He said that in accepting the recommendation that the AMP Tower was the most suitable accommodation, he was not himself influenced by AMP's offer to contribute to the cost of fitting out the premises. However, it was apparent that, although a truthful witness, he had a very limited recall of the detail of the relevant discussions which took place 11 years before he gave evidence. Gill and Robinson both said that the offers of contribution to fit out costs made by the AMP and the Rialto respectively were immaterial to their recommendations to accept the AMP offer. Robinson pointed out that a similar contribution package had been offered by the owners of the Rialto: it therefore seems that his position was that, since the same fit out contribution incentive was being offered by both lessors, AMP's offer of $1M was not a material factor in selecting the AMP Tower in preference to the Rialto. I accept this.

But the $1M offer was still a matter of importance to AR&H when it decided on the move to AMP Tower. This is evidenced by Gill's discussions with Robinson, to which I have referred and which took place before the AMP offer was accepted in early October 1984, and by the action he and Robinson took to press AMP to increase its offer to $1M and to agree that AR&H, rather than AMP, would have title to the fit out. Subsequent to the AMP proposal being accepted by the partners, by Robinson's letter of 8 October 1984 to AMP, discussions took place between Gill and representatives of AMP, including Sheridan, in December 1984 and January 1985, about the basis on which the $1M would be paid. AR&H and AMP were initially in disagreement about this. Gill recorded the two positions in his note of 28 December 1984:

``$1m. contribution is to apply to fitout only and will remain the property of AMP. For the purpose of rent reviews, these assets would not be considered in determining rental levels...

EJG's (Gill's) view was that the $1m. was a monetary contribution towards fitout costs and in AR&H terms, the payment was of a capital nature....''

AR&H's position with respect to the contribution was repeated in Gill's letter to Sheridan of 24 January 1985:

``The understanding of Mr Rogers, Mr Robinson and myself of our earlier discussions was that this amount was to be paid to Arthur Robinson & Hedderwicks as a contribution towards our relocation costs. Your letter dated 30th August, 1984 refers to a `cash lump sum contribution to your partitioning costs' although the terminology does change in later correspondence. Hopefully, this amount is still to be paid in this manner.''

AR&H's insistence on its owning the assets purchased with the AMP contribution moneys prevailed. Following a further meeting on 29 January 1985, AMP agreed that the $1M contribution would be paid in the form of a capital payment to AR&H and that the assets purchased using these funds would be the property of AR&H, although AMP insisted, and AR&H agreed, that AR&H would apply all these moneys to payment of the fit out.

Moreover, Gill described the contribution offer as ``a relevant business consideration'' and agreed that it was one of a range of commercial considerations which had to be taken into account. Donaldson agreed that the contribution was ``one of many factors and (sic) by far not the most important factor'' that he considered in deciding on the move to the AMP

ATC 4909

Tower. Robinson said much the same thing: while the cash lump sum contribution was ``a part'' of the matters considered in deciding to enter into the AMP lease, it was ``by no means the most important issue''. I accept this as a fair statement of the attitude of the members of the firm to that element of the AMP proposal that comprised the offer of the $1M contribution to fit out.

The $1M contribution was paid by AMP to AR&H between 28 March and 7 August 1985 in five instalments, as AR&H made its progress payments to the builder who installed the fit out. As to the additional $66,000, AMP contributed $19,000 to the fit out costs for level 24, which was paid on 6 May 1986 and $47,000 to the fit out costs for level 18, paid on 29 December 1986. On receipt, each of the contribution payments from AMP was paid into AR&H's general operating account, and then credited to a capital suspense account, the ``AMP Suspense Account'', with, as Gill says, ``the intention that the credit would be appropriated to each of the then partners by equal instalments over the ten year period of the lease''. The assumption then was that the AMP receipts were not taxable in the hands of the partnership. Following the issue of a general tax ruling, which Gill said indicated the amounts received from AMP might be taxable, there was a change in the arrangement. The partners agreed to allocate fully to the then partners of AR&H the balance of moneys held in the AMP Suspense Account and the further moneys to be received from AMP; the partners of AR&H who received distributions from the suspense account agreed to forego amounts of future income from the partnership, so that newly admitted partners of AR&H would receive a higher amount of income to compensate for their not receiving the benefit of the capital receipt from AMP.

The fit out in fact cost approximately $2.5M. This was paid from the $1,066,000 of AMP's contributions, with the balance coming from the firm's ordinary working capital, including temporary overdraft accommodation sought by Gill and provided by Westpac.

As Gill says, neither the applicant nor any of the other partners of AR&H shared directly in any of the moneys received from AMP. However, I have found that, prior to entry into the agreement with AMP, one element of which involved the payment of the $1M, the firm formed the intention of utilising that payment to enable it to make a substantial cash distribution to the partners. A reason why it could not distribute the AMP moneys directly to the partners was AMP's insistence that those moneys be expended on payment of the fit out costs incurred by the firm. But the firm was able to carry its intention into effect indirectly. On 25 March 1985, soon after work commenced on the fit out, Gill reported to the Partnership Committee that he intended to seek proposals from Westpac and a number of other lending institutions ``in relation to the sale and lease back of the assets acquired in the fit out''. AR&H's ownership of the fit out was essential to such a finance arrangement, an issue that had become contentious between AR&H and AMP by early December 1984, although later resolved in AR&H's favour. Gill links his approach to Westpac and other financiers in March 1985 to certain arrangements the firm had made with Westpac (the firm's banker) and which are set out in the bank's letter of 4 January 1985. The letter makes no reference to any proposed financing by the bank of the fit out. But Gill's decision to seek these finance proposals from Westpac and others must have flowed from a direction or indication to do that given to him on behalf of the firm before 28 March 1985.

In December 1985, a few months after the fit out was complete and AR&H had moved into the AMP Tower, AR&H entered into a contractual arrangement with Westpac under which it sold the fit out to the bank and then leased it back from the bank, effectively receiving, in the form of the sale proceeds, $1.5M in cash. The firm was able, by this means, to ensure that it was in a position to distribute to the partners an amount equal to the whole of the $1,066,000 it received from AMP, as well as having the benefit of tax deductions in respect of the fit out costs that were probably additional to the deductions which it would have had if it had not entered into this sale and finance lease.

I accept that the decision to move premises was not prompted by a desire by the partners to obtain a cash payment from the landlord: the decision to move necessarily followed from the decision to merge. But the partners were not indifferent to the opportunity, presented by the need to move, to obtain a contribution from the landlord. Incentives having been offered to

ATC 4910

move to 575 Bourke Street ($1.5M), to the Rialto ($1M) and to the AMP Tower (initially $0.5M), the need to move presented the firm with this opportunity and it set about maximising the amount of the incentive it could extract from the landlord of the AMP Tower, its preferred premises. The negotiating strategy the firm followed to persuade the AMP to increase its incentive offer from $500,000 to $750,000 and then to $1M and then to make that contribution in the form of a cash payment to the firm and then to agree to the firm, rather than AMP, having title to the property bought with those moneys confirms that the firm saw the necessity to move as also presenting an opportunity to obtain a cash payment from the landlord that would generate assets over which it would have control, an opportunity it took advantage of to the maximum extent it could.

I infer that, at the time AR&H entered into its agreement with AMP in September 1984, it intended, by an arrangement of the kind it ultimately entered into with Westpac, to be able to distribute, by what it believed to be tax-free capital payments, an amount equal to the whole of the fit out contribution to be received from AMP. Robinson's early statements to Gill explaining why the cash contribution option was selected in preference to the rent holiday, the firm's insistence in its dealings with AMP that it, rather than AMP, have title to the fit out and the approach made by Gill to Westpac in early 1985 are particular pointers to this; so is the way the AMP's cash contributions were dealt with in the firm's books by being posted, as each instalment was received, to the capital suspense account from which $1,066,000 was later distributed to the partners after the Westpac moneys were received. While the lump sum contribution was not the only and not even the most important factor leading to AR&H's acceptance of the AMP Tower proposal and while the $1M contribution did not influence the final choice of AMP over the Rialto, I consider that one of the firm's purposes in negotiating the final form that its agreement with AMP took and one of its purposes in entering into that agreement was to take advantage of the offer of the cash contribution by AMP to enable the firm to distribute to the partners by one means or another an amount equalling that cash contribution.

The applicant seeks to distinguish
FC of T v Cooling 90 ATC 4472; (1990) 22 FCR 42 and contends that the payments made by AMP were not received by AR&H as part of that firm's assessable income because the move to the AMP Tower was not undertaken by AR&H in the course of its business, but as one of the initial steps in setting up its new business and that there was no profit-making scheme, as the move was not made in order to obtain any part of AMP's contribution for the purpose of obtaining a commercial profit. The applicant also reserved its position by formally submitting that Cooling, a decision binding on me, was wrongly decided.

The Commissioner relies on
FC of T v The Myer Emporium Ltd 87 ATC 4363; (1986-1987) 163 CLR 199 and Cooling and contends that the lease incentive payments were income according to ordinary concepts and are assessable under s 25(1) of the Act. He argues that the payments arose from a business operation or commercial transaction entered into in the ordinary course of carrying on the partnership business and with a profit element in mind.

There has been debate as to the scope of the ratio in Myer. Decisions in which Myer has been applied are not all easy to reconcile. But I consider that Myer, as applied and explained by the Full Court in Cooling and
Westfield Ltd v FC of T 91 ATC 4234, establishes that a gain made by a taxpayer will be assessable as income within the ordinary concept of income in any one of the following circumstances:

  • (a) If it is a gain made by a taxpayer from a transaction forming part of the ordinary course of the taxpayer's business: the identification of the transaction as having that character ``will stamp the transaction as one having a profit-making purpose''. Westfield Ltd v FC of T, supra, at 4242.
  • It was for this reason that the Full Court in
    Rotherwood Pty Ltd v FC of T 96 ATC 4203, a decision from which the High Court has refused leave to appeal, regarded that as a case involving the obtaining of an assessable gain and not the mere realisation of a capital asset. The surrender of the lease in exchange for the payment to the service company trustee, that was distributed to the taxpayer and the other beneficiaries of the service trust, was not a discrete transaction of disposal of a capital asset of the trust, but

    ATC 4911

    rather an integral part of a wider transaction in which the surrender payment was offered as an incentive to those associated with the trustee to replace that lease with a new leasing arrangement of premises, which the trustee then made available to those associates. Since it was held to be part of the trustee's ordinary business to provide its associates with business premises and personal property needed by them to run their own business and to dispose of such property, when no longer required by the associates, and since incentives of the kind paid to the trustee to surrender the old lease and enter into the new lease were commonly offered, at the time, to induce businesses to take up leases of new premises, the receipt constituted by the lease surrender payment was a payment made to the trustee in the ordinary course of the trustee's business and so income in its hands and, in turn, income in the hands of the beneficiary-taxpayer. See pp 4212 lhc and 4213 rhc-4214 lhc.
  • (b) If it is a gain made from a transaction that is not itself part of the ordinary course of the taxpayer's business but which is an ordinary incident of the business activity of the taxpayer: ``the profit-making purpose can be inferred from the association of the transaction... with that business activity.'' Westfield, ibid;
  • Cooling, on the first basis upon which it was decided, is an example: receipt of the moneys by the taxpayer paid as an incentive to move its business from one set of leasehold premises to another set of leasehold premises was, on the evidence as to the prevalence, at the relevant time, of the practice of offering lease incentives in the Brisbane leasing market, ``an ordinary incident of part of the business activity of the firm'', which activity was held to include making such moves from time to time. See 90 ATC at 4484; 22 FCR at 56.
  • (c) If the activity which generates the gain is not within (a) or (b), the gain will be assessable as income only if it was realised in a business operation or commercial transaction in circumstances in which the taxpayer, at the time it engaged in the transaction, had the intention or purpose of making a gain from that transaction by the means giving rise to the gain: Myer, supra, at ATC 4366-4367; CLR 209-210; Westfield, supra, at 4243. Such a gain will be assessable as income even though the taxpayer did not enter into the transaction that generated it for the sole purpose of making a profit: it will be enough if a not insignificant purpose of the taxpayer, at the time it entered into the transaction, was to obtain a profit: see Cooling at ATC 4484; FCR 56-57.

Myer and Westfield were both cases which involved profits or gains generated from ``one-off'' transactions involving the sale of property of the taxpayer that were outside the ordinary course of the taxpayer's business; the sale of the right to a stream of interest payments payable under a mortgage in Myer and the sale of land in Westfield. But Cooling, in so far as it was decided on the second basis shows that this principle is not limited to transactions of sale, but extends to any gain-producing transaction. See also Westfield, supra, at 4242 lhc.

Cooling, on the second basis upon which it was decided, is an example of the class of case referred to in (c) above: see 90 ATC at 4484; 22 FCR at 56-57. The context in which it was received shows that the incentive payment was clearly a profit or gain in the hands of the partners. It was paid to them, rather than to the partnership; they did not divest themselves of anything of equivalent worth in return for that payment. Although they used those funds to pay for the fit out, they did that by advancing to the partnership the moneys they each received by way of what the trial judge described at 89 ATC at p 4,733 as ``bridging finance'' and they were repaid that loan from the proceeds of the subsequent sale of the fit out to a financier from whom the partnership then leased back the fit out. The availability to the partners of this profit was an integral part of a transaction of a commercial or business kind, which comprised the move of the partners' business operations to premises newly leased by the partners' associated company on terms that included the payment to them of the incentive. And at the time the partners entered into that transaction, they intended to receive from the transaction the payments in question for their own use.

Hill J in summarising his reasons for deciding Cooling against the taxpayer on

ATC 4912

this alternative basis, said, at ATC 4484; FCR 57:

``In my view the transaction entered into by the firm was a commercial transaction; it formed part of the business activity of the firm and a not insignificant purpose of it was the obtaining of a commercial profit by way of incentive payment.'' (emphasis added)

The applicant, in reliance on this passage, submitted that an extraordinary transaction, ie, one not occurring in the ordinary course of the taxpayer's business, will only be capable of generating a gain that is assessable as income if, in addition to the taxpayer having the requisite profit-making purpose, the transaction also forms part of the business activity of the taxpayer; it was then said that the transaction that generated the gain here could not be so characterised because it was, in contrast, an isolated, ``one-off'' transaction that comprised the establishment of a new business. But granted all that, the transaction here in question was still both a commercial one and a business activity of AR&H for the purposes of the rule in (c): it was a business transaction or activity by AR&H in contrast to, eg, a private, recreational, charitable or other non-business activity. That is all that is required to give the gain derived from that activity the character of income in the hands of AR&H, once it can be seen that the firm engaged in that activity for the purpose, or for a range of purposes that included the purpose, of making that gain.

Hill J, in identifying these two features of the transaction in this passage in his judgment in Cooling, was applying the statement of principle in Myer. It is the existence of the gain-producing purpose at the time of entry into the transaction that ultimately generates the gain that is of critical importance in stamping the gain as income, even in circumstances in which, but for that purpose existing at that time, the gain would have been a capital gain. But it is apparent from Myer at ATC 4366-4368; CLR 211-213 that the High Court deliberately limited the principle to cases in which the activity generating the profit or gain, and entered into for that purpose, is an activity that answers the description of ``a business operation or commercial transaction'' of the taxpayer: the Court held that that additional requirement had to be satisfied before a receipt arising from a transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business would be income because it was not prepared to accept what it referred to at ATC 4367; CLR 211, as ``the simple proposition that the existence of an intention or purpose of making a profit or gain is enough in itself to stamp the receipt with the character of income'', a proposition that denies the possibility of a business taxpayer ever being able to make a capital profit. It is, however, plain in my opinion that the Court did not intend that this particular limitation could only be satisfied by showing that the gain was generated by a transaction forming part of the carrying on of the taxpayer's business, ie, part of a series of recurrent activities. The point of the decision in Myer in this respect is to demonstrate that gains made from transactions outside that activity of the taxpayer, including isolated and unique transactions in which the taxpayer engages, can still be income, provided the requisite profit-making intention is present and, at ATC 4369; CLR 213, the Court referred to the additional significance, so far as the characterisation of a gain as income or capital is concerned, of the gain not only being derived from a transaction of sale entered into for the purpose of making a profit, but also of all that occurring ``in the context of carrying on a business or carrying out a business operation or commercial transaction''. That the context in which the gain is made includes any one of these three features is equally significant in showing that it is a gain that has an income character.

I do not think that the $1M was received by the firm in, or as an incident to, its ordinary course of business, ie, it is not an income receipt within either category (a) or (b) above. The transaction generating that $1M receipt was not, on the evidence, a transaction in the ordinary course of the merged firm's business, but was, in my opinion, one entered into in respect of what I accept was the establishment by a new business of its first base of operations. The merged firm was, I think, a new business: it was the merger of two firms with different areas of expertise and practice into a firm offering a

ATC 4913

service significantly different from that offered by the two component firms. Hedderwicks abandoned its partnership structure to adopt what was for it a new one, that used by Arthur Robinson. I accept the evidence concerning the reasons for the merger, which also show why the new firm can fairly be regarded, as a matter of fact, as a different business entity from the two merging firms. It is true that for 12 months prior to the location of the entire merged firm in the AMP Tower, the firm carried on business as such, albeit from two separate locations. But that was, I think, always recognised by all concerned as an interim measure only, pending selection and acquisition of premises which the merged firm would be able to use as its sole base of operations. Nor am I prepared to find, on the evidence that six years later the merged firm moved to new premises and that it received a cash incentive to make that move, that its move to the AMP Tower in which, for the first time, the firm had a home for its entire establishment, should be inferred to be but the first of a number of recurring activities engaged in, in the course of its ordinary business. Six years, a quite long period, passed between the two moves; I have the bare fact of the second move; there is no evidence of any subsequent move, actual or planned, and there is evidence that each of the two merging firms rarely moved premises. But even if the move to the AMP Tower could be regarded as an activity engaged in in the ordinary course of the merged firm's business, given the limited evidence as to the extent of the practice of landlords offering cash incentives to prospective tenants at relevant times in the Melbourne market, I do not consider that the payment to the firm of the fit out contribution can be regarded as an ordinary incident of the business activity of the merged firm.

It remains to consider whether the $1M receipt was income because the activity that generated it was one of the class I have described in category (c) above. This requires identification of the scope of the transaction in which the firm received the $1M and also identification of the firm's purpose or purposes in engaging in that transaction, in order to determine whether the receipt was on income or capital account. In
GP International Pipecoaters Pty Ltd v FC of T 90 ATC 4413; (1989-1990) 170 CLR 124 the issue was whether a payment received under a contract for the provision of a manufacturing service in return for an agreed fee was on income or capital account, the payment being intended to be used and in fact used by the payee to acquire a capital asset. The Court said at ATC 4420; CLR 137-138:

``Although the amount received as establishment costs was expended by, and was intended by [the payer] to be expended by, the taxpayer to meet the costs of constructing the plant so far as that amount would extend, and although the amount expended on the construction of the plant was a capital expenditure, it does not follow that the taxpayer's receipt of the establishment costs was a receipt of capital. To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The factors relevant to the ascertainment of the character of a receipt of money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.''

(emphasis added)

The Court there identified three considerations, any one of which may, in a given case, govern whether a receipt is income or capital. As to the first consideration, the receipt here in question, though paid by instalments, was essentially a one-off payment. But that does not of itself denote a capital receipt:
FC of T v Whitfords Beach Pty Ltd 82 ATC 4031 at 4043; (1981-1982) 150 CLR 355 at 376. The second consideration is irrelevant here because the firm did not dispose of anything in exchange for the $1M receipt. It is the third consideration that is of particular relevance to this case.

In determining the true character of a receipt paid under a contract, as was the $1M, it is also well-established that it is necessary to have regard to the whole context in which the contract was made: cf Cooling at ATC 4481; FCR 53. This rule complements what was said in Pipecoaters as the correct approach for

ATC 4914

determining whether a receipt under a contract is income or capital in the hands of the payee. It was by placing the lease surrender payment received by the trustee in its factual context that the Court in Rotherwood was able to deny it the character of a mere realisation of a capital asset and identify it as a gain on income account: see pp 4213 rhc-4214 rhc.

Whether the relevant transaction is defined narrowly, as limited to the contract between the firm and AMP, but evaluated in its factual context, or whether it is defined widely, as including elements of that context, the result here is the same. In order to determine the character, for taxation purposes, of the $1M receipt by the firm, regard must, in my opinion, be had to the following facts and circumstances:

  • (a) That it was received as part of the consideration to the merged firm in return for its agreement to take the lease.
  • (b) That the firm was obliged under that contractual agreement to expend the $1M on acquisition by the firm of fit out, a capital asset.
  • (c) That one of the firm's purposes in entering into the contract was to utilise the $1M receipt to enable it to make cash distributions of equal amount to the partners.
  • (d) That the firm ensured the contract was structured to enable it to meet that particular purpose by ensuring that the firm had title to the fit out.
  • (e) That the firm promptly set about implementing this purpose by opening discussions with Westpac soon after entry into the contract, which discussions produced the funds used to make the cash distributions to the partners, even though the firm could not use the $1M itself for that particular purpose.
  • (f) That the receipt was a gain to the firm because, but for that receipt, the firm would have had to find the means to pay the entire cost of the fit out out of its own resources, including its capacity to borrow, and also because it provided the firm with the means to enable the cash distributions to be made to the partners, which the firm would not otherwise have made.

This evidence shows that the contribution payments, in the hands of AR&H, were not merely moneys demanded, received and used to acquire a capital asset for the firm. They were, in addition, always intended by AR&H to be the means of enabling a cash distribution to be made to the partners. And the firm promptly carried that purpose into effect.

In my opinion, this shows that the $1M contribution paid by AMP to the firm was income in the hands of the firm because it was a gain generated from a commercial, as opposed to a private, recreational, charitable or other non-business transaction entered into by the firm for a number of purposes, one not insignificant one being to make that gain from the $1M received in that transaction.

All three appeals are dismissed with costs.

THE COURT ORDERS THAT:

1. The appeal is dismissed with costs.


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