BHP PETROLEUM (BASS STRAIT) PTY LTD & ANOR v FC of T
Judges:Kenny J
Court:
Federal Court of Australia
MEDIA NEUTRAL CITATION:
[2002] FCA 189
Kenny J
Introduction
1. The Court has before it 39 tax appeals brought by BHP Petroleum (Bass Strait) Pty Ltd (``BHPPBS'') and Esso Australia Resources Ltd (``EARL'') against decisions of the Commissioner of Taxation (``Commissioner''). BHPPBS is the applicant in 16 of the appeals and EARL in 23. The appeals raise the same or very similar issues and arise out of the same or very similar circumstances. They were for this reason heard together.
2. The primary issue before the Court concerns the status, for tax purposes, of sums of money to which the applicants claimed an entitlement under certain third party contracts of supply. In particular, the Court must decide whether the Commissioner's assessments of their tax liability for the tax years ended 1991-96 (for BHPPBS) and 1991-97 (for EARL) were excessive, as the applicants contend.
Factual background
3. In the mid-1960s, EARL and BHP Petroleum (North West Shelf) Pty Ltd (``BHPPNW'') became jointly engaged in the exploration and production of petroleum products in the Bass Strait. Shortly thereafter they began to supply two products, natural gas and ethane, to 6 companies (``buyers'') under individual contracts of supply (``Supply Contracts''). The Gas and Fuel Corporation of Victoria (``GFC'') and the State Electricity Commission of Victoria (``SECV'') were each supplied gas by EARL and BHPPNW (contracting jointly). Hydrocarbon Products Pty Ltd (``HPPL'') and Kemcor Olefins Limited (``Kemcor'') were each supplied ethane by EARL (contracting independently). Huntsman Chemical Company Australia Pty Ltd (``Huntsman'') and Mobil Oil Australia Limited (``Mobil'') were each supplied ethane by BHPPNW (contracting independently). The rights and obligations of BHPPNW under its Supply Contracts with the GFC, the SECV, Huntsman and Mobil were assigned to BHPPBS from 1 June 1988. HPPL's rights and obligations under its Supply Contract with EARL were assigned to Huntsman from 25 July 1978. Save for these assignments and for various amendments to terms not presently relevant (as well as the actual petroleum product supplied) the 6 Supply Contracts are identical in all respects material to the current proceedings and remained in force throughout the years in issue. Except where the contrary is indicated, reference throughout these reasons to individual Supply Contracts is thus restricted to those involving EARL and BHPPBS (``sellers'') on the one hand, and the GFC or SECV on the other (``GFC and SECV Contracts'').
1. The Supply Contracts
4. Under the terms of the GFC and SECV Contracts, the sellers jointly agreed to sell and deliver requested quantities of gas for and to the buyers on a daily basis. The gas became the property of the buyers at the Point of Delivery (as defined): see GFC Contract cl 11.1 and SECV Contract cl 13.1. In exchange for the gas the buyers undertook to pay an annually- determined amount (``Contract Price'') to the sellers calculated in accordance with the GFC and SECV Contracts: see GFC Contract cl 12 and SECV Contract cl 19. The Contract Price was paid monthly upon statements prepared and issued by the sellers under the GFC and SECV Contracts (``Standard Monthly Invoices''): see GFC Contract cl 14 and the SECV Contract cl 22. Each monthly amount was calculated by the sellers on the basis of an agreed average price for gas supplied in the preceding month with additional provision, in the twelfth month of each contractual year, for any necessary adjustment to ensure that the total amount paid by each buyer over that year reflected the Contract Price. Payment of the Contract Price was required by the buyers within about a fortnight of receipt or delivery of a Standard Monthly Invoice. Any default in payment entitled the sellers to charge a fixed rate of interest on the amount due unless, amongst other things, the default was the result of a bona fide dispute between the parties: see GFC Contract cl 14.7 and SECV Contract cl 22.5. Provision was also made in each Supply Contract for a redetermination of the Contract Price in certain circumstances upon request by one of the parties.
5. Two additional provisions of the Supply Contracts are of particular importance to the current proceedings. The first of those
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provisions required an adjustment of the Contract Price to reflect any change in the sellers' tax liability arising from the introduction of new imposts attributable to the production or supply of gas (or ethane) for and to the relevant buyer. Clause 12.8 of the GFC Contract stated as follows.``12.8 The payment for gas determined in accordance herewith shall be:
- (a) increased to take into account the full amount of any new royalties, taxes (other than income tax), rates, duties or levies imposed on Sellers after 1st January, 1975 and attributable directly to the production of natural gas for Buyer or the supply of gas to Buyer;
- (b) increased to take into account the increase in amount resulting from any increase in the rate or any change in the basis of calculation of royalties, taxes (other than income tax), rates, duties or levies above the levels existing at 1st January, 1975 and directly attributable to the production of natural gas for Buyer or to the supply of gas to Buyer;
- (c) decreased to take into account the decrease in the amount resulting from any decrease in the rate or any change in the basis of calculation of royalties, taxes (other than income tax), rates, duties or levies below the levels existing at 1st January, 1975 and directly attributable to the production of natural gas for Buyer or to the supply of gas to Buyer;
Any such increases or decreases shall be effective upon the imposition thereof. In the event of any such increase or decrease Sellers shall provide Buyer with details of the increase or decrease and the method and distribution of such royalties, taxes, rates, duties or levies;
BUT
any increase in the amount of any royalties, taxes (other than income tax), rates, duties or levies above the levels existing at 31st May, 1974 attributable to any change in the basis of calculating the well-head value resulting from the review then current and undetermined at the date of this Contract shall not be taken into account.
For the purpose of this Clause, the expression `Income Tax' shall mean any tax of general application imposed on income, but shall not include any tax specifically imposed on income derived from the production and sale of natural gas or more generally, on income derived from the production and sale of petroleum and other minerals to the extent to which such tax is attributable to income derived by Sellers or either of them from the production of gas for Buyer or the supply of gas to Buyer.''
I note that the equivalent clauses of the other Supply Contracts (e.g., SECV Contract cl 19.5) referred to imposts ``attributable to'' the production or supply of gas or ethane, rather than to imposts ``attributable directly to'' such production and supply as in the GFC Contract. Nothing turns on this distinction in these proceedings.
6. The second provision of particular importance to the current proceedings required that any dispute arising under the Supply Contracts be referred by the contracting parties to arbitration for resolution. Clause 23 of the GFC Contract relevantly provided as follows.
``23. Any controversy or claim arising out of or relating to this Contract or the alleged breach thereof shall be settled by arbitration in accordance with the Arbitration Act of the State of Victoria, and in accordance with the following:
- ...
- (c) the award shall be made in writing and signed by the arbitrators or the umpire as the case may require and shall be final and binding on the parties; the parties shall abide by the award and comply with the terms and conditions thereof;...''
I observe that the reference in this and the equivalent clauses of the other Supply Contracts (e.g., SECV Contract cl 25) to the Arbitration Act of Victoria is to be read as a reference to the Commercial Arbitration Act 1984 (Vic) (``CAA'') in accordance with the terms of that Act (s 3(2)(b)).
2. The secondary tax regime
7. From the outset of their joint venture, the sellers have been liable to pay tax and other imposts in respect of petroleum recovered from the Bass Strait. Immediately prior to 1991 that liability arose from three principal sources. The first was the Petroleum (Submerged Lands) Act 1967 (Cth) (``PSLA'') and the Petroleum
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8. The Petroleum Resource Rent Legislation Amendment Act 1991 (Cth) (``Amendment Act''), which received Royal Assent on 26 June 1991, altered the secondary tax regime applicable in the Bass Strait. For the purpose of these proceedings, that Act can be considered as having had two principal effects. First, it subjected the sellers retrospectively to the general obligations of the PRRT Act regarding petroleum recovered from the Bass Strait since 1 July 1990 including, in particular, the obligation to pay tax in respect of assessable petroleum receipts derived in relation to a petroleum project under ss 4 and 22 of that Act: see Amendment Act, ss 31, 38. Secondly, it limited the application of the PSLRA to the North-West Shelf petroleum fields from 1 July 1991, thereby removing the sellers' previous liability to pay royalties on the Bass Strait petroleum products. The Amendment Act also effectively removed any excise duties that had been payable on petroleum products recovered from the Bass Strait. It did not affect the sellers' liability to pay income tax under the ITAA.
9. In its original announcement regarding the Amendment Act (published in the 1990- 1991 Budget Statement of 21 August 1990), the Federal Government described the effect of that Act as being to increase the efficiency of the secondary tax regime by replacing the then existing excise and royalty arrangements with a tax ``based on profits rather than production'' that would be ``sensitive to changes in prices and costs'' (para 4.6). This flexibility would, the Government stated, ``remove the pressure for continual changes in excise rates as production declines or market conditions vary'' (para 4.6). The Government also recognised, however, that the Amendment Act's retrospective extension of the PRRT Act to cover the Bass Strait petroleum-related projects would require certain transitional arrangements, which it foresaw as operating in the following way (para 4.7).
``[T]he Bass Strait producers will continue to be liable for excise and royalty until the amending legislation is enacted. It is expected that a reconciliation between the tax liabilities of the two regimes will occur when the 1990-1991 [PRRT] final assessment is made. These interim payments are expected to equate broadly with the [ PRRT] liabilities on 1990-91 production.''
The transitional arrangements referred to here are reflected in ss 39 to 42 of the Amendment Act.
3. The issues for determination in the current proceedings
10. By virtue of s 17 of the ITAA as it stood at the relevant time, income tax was levied ``upon the taxable income derived during the year of income by any person''. By virtue of s 6, ``taxable income'' meant ``the amount remaining after deducting from the assessable income all allowable deductions''. Section 25(1)(a) relevantly provided that, where the taxpayer is a resident, the assessable income of a taxpayer includes ``the gross income derived directly or indirectly from all sources whether in or out of Australia''.
11. Section 4 of the PRRT Act imposed a tax in respect of ``the taxable profit of a person of a year of tax in relation to a petroleum project''. Section 5 set the rate of tax at forty per cent. The PRRT Assessment Act provided, in s 21, that:
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``Subject to this Act, tax imposed in respect of the taxable profit of a person of a year of tax in relation to a petroleum project is payable by the person.''
The term ``taxable profit'' was calculated as the amount by which assessable receipts exceeded deductible expenditure and the amounts (if any) transferred under ss 45A and 45B: see PRRT Assessment Act, s 22. The term ``assessable receipts derived by a person in a financial year in relation to a petroleum project'', as defined in s 23(1)(a) of the PRRT Assessment Act, included ``assessable petroleum receipts'' in relation to a petroleum project. By virtue of s 24, the sellers' assessable petroleum receipts were, for relevant purposes, ``the consideration receivable, less any expenses payable, by the person in relation to the sale''. The parties proceeded on the basis that the term ``consideration receivable'' meant ``payable'': cf
West v Miller (1868) 6 LR Eq 59 at 64; also
Clyne & Anor v DFC of T & Anor 81 ATC 4429 at 4433; (1981) 150 CLR 1 at 10. The PRRT Assessment Act, like the ITAA, provided for the annual taxation of profits where the relevant tax year was the year ending 30 June in each year.
12. The issue at the centre of the current proceedings is whether the Commissioner erred in including in his assessments of assessable income and assessable receipts certain amounts to which the sellers were entitled under cl 12.8 of the GFC Contract (or cl 19.5 of the SECV Contract and the equivalent provisions of other Supply Contracts) because of the changes in tax liability introduced by the Amendment Act. In respect of this it was accepted by the parties that, in the particular circumstances of the present case and for the purpose of these proceedings, the operation of the concepts of ``income derived'' and ``consideration receivable'' under the ITAA and PRRT Act respectively were not materially different. The parties accepted that the Court's findings in respect of the former should apply in respect of the latter. Accordingly, save where the contrary is indicated, I refer below only to the ITAA. Thus, the Commissioner's case was based on the proposition that the amounts claimed in the pass-on letters and invoices (terms explained below) were (1) income derived by the sellers when they supplied the gas (or ethane) and (2) the consideration receivable for the gas (or ethane) since these amounts constituted part of the price charged for the products. For the reasons set out below, the sellers contested these propositions.
13. Before considering the central issue, it is necessary to give some further explanation of the events following the Federal Government's announcement of the changes that were to be made to the secondary tax regime. The sellers' case was largely that these events - including the disputes that arose between the sellers and the buyers about the impact of the Amendment Act on the Contract Price payable by the buyers - rendered any entitlement on the sellers' part to an increase in the Contract Price non- assessable for tax purposes, at least until the disputes had been finally resolved. This resolution, so the sellers said, came with the settlements in 1996 (for the GFC and SECV Contracts) and in 1994 (for the remaining Supply Contracts). The result (so it was said) was that only the amounts received by the sellers under the terms of such settlements were assessable for income tax and PRRT purposes.
4. The disputes between the parties to the Supply Contracts
4.1 Introduction
14. On 27 August 1990, only 7 days after the Federal Government's announcement of the proposed extension of PRRT to the Bass Strait, the sellers notified the buyers that they intended to pass on the impact of the PRRT to the buyers under cl 12.8 of the GFC Contract (and 19.5 of the SECV Contract and the equivalent provisions of the other Supply Contracts). Thereafter, the sellers adopted a practice of endorsing their Standard Monthly Invoices with a note in the following (or equivalent terms):
``The Federal Government has replaced the Royalty and Excise Regime with a Resource Rent Tax effective from 1 July 1990. The effect of this change on the gas price is currently being calculated and the Sellers reserve the rights to make appropriate adjustments to the gas price once the process of calculating the impact of the Resource Rent Tax has been completed.''
15. On 21 December 1990, the sellers received a written response to their notice and endorsements from the GFC, reserving the GFC's rights to reject any claim for further payments under clause 12.8 following introduction of the PRRT. This notification was followed, in July 1991, with a further exchange
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of correspondence between the sellers and the GFC contesting the implications of the Amendment Act for the Contract Price payable under the Supply Contracts. Whilst agreeing that some adjustment of the Contract Price was required, the parties disputed just what that adjustment was. At the heart of their disputes was their disagreement over whether or not the newly extended PRRT was ``attributable (directly)'' to the production or supply of gas (or ethane), with effect that the sellers became entitled to pass on the value of their PRRT liability to the buyers. The GFC argued that it was not, and that the only adjustment of the Contract Price required by clause 12.8 and equivalent provisions was its reduction to take account of the Amendment Act's effective abolition of PSLA royalties. The sellers maintained their entitlement to increase the Contract Price to cover the net burden of the new PRRT, and rejected the GFC's claimed entitlement to off-set that increase to take account of the abolition of royalties.16. Before long the dispute involving the GFC Contract spread to the remaining Supply Contracts, with the buyers under those Contracts adopting essentially the same position as the GFC.
17. Despite the sellers having consistently maintained an entitlement to increase the Contract Price under each of the Supply Contracts following announcement of the Amendment Act in 1990, it took them over a year to calculate the extent of such entitlement. Claims based on these calculations were first made on or soon after 13 November 1991, when the sellers sent letters to each of the buyers requesting the payment of additional monies owed to them in respect of gas and ethane supplied from 1 July 1990. The sums claimed in these letters took into account both the introduction of PRRT and the abolition of PSLA royalties.
18. The (net) amount of the increase ultimately claimed by the sellers was referred to throughout these proceedings as ``pass-on amounts'', and the individual letters or invoices by which they were periodically claimed as ``pass-on letters'' or ``pass-on invoices''. For the purpose of these reasons, I retain this usage of ``pass-on letters'' or ``pass-on invoices''. I use the expression ``pass-on amounts'' to mean the amounts to which the sellers were entitled under cl 12.8 of the GFC Contract (or cl 19.5 of the SECV Contract and equivalent provisions) as a result of the Amendment Act, rather than to mean the amounts to which they claimed to have an entitlement.
19. The buyers paid none of the pass-on amounts. In addition, from September 1991 in the case of the GFC and February 1992 in the case of the SECV, the GFC and the SECV withheld the payment of all PSLA royalties claimed by the sellers in their Standard Monthly Invoices (``withheld royalties''). This practice resulted in additional claims by the sellers against those companies for interest on the withheld royalties in reliance on the GFC and SECV Contracts: see GFC Contract cl 14.7 and SECV Contract cl 22.5. From 1992, the other buyers took up this practice of withholding PSLA royalties using the calculation of the royalties contained in the sellers' pass-on letters.
20. The contractual disputes between the sellers and each of the buyers were further complicated by the repeated requests of the latter for provision of full details regarding the method by which the pass-on amounts were calculated, and by claims that, when eventually provided, the details did not satisfy the requirements of cl 12.8 of the GFC Contract (or cl 19.5 of the SECV Contract and equivalent provisions). There were, furthermore, requests by Mobil, Huntsman and Kemcor for a redetermination of the Contract Price under each of the Supply Contracts to which they were party.
21. The disputes between the various contracting parties concerning the impact of the Amendment Act on the Contract Price payable by the buyers followed a similar path, and were ultimately referred by the sellers for resolution by arbitration in accordance with the terms of each Supply Contract in late 1991 (for the GFC and SECV Contracts) and early 1992 (for the other Supply Contracts). Of the proceedings thus instituted only those involving the SECV Contract (``SECV arbitration'') resulted in an Award. The other proceedings were abandoned following settlement of the disputes in 1996 (for the GFC Contract) and in 1994 (for the remaining Supply Contracts).
4.2 The SECV arbitration
22. In 1993, the sellers applied unsuccessfully for an interim Award requiring the SECV to pay the withheld royalties with interest. More successful was their substantive
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claim, heard and decided the following year, to recover from the SECV as monies owed under cl 19.5 of the SECV Contract the pass-on amounts claimed in their pass-on letters and invoices (as amended) from 1991. In determining that claim the arbitrators were required to resolve four main issues, which were described in an Award of 30 November 1994 (``Award'') as follows.``1. Whether the tax imposed by the [PRRT Act] and the [PRRTA Act] falls within the description contained in clause 19.5(a)(i) of the [SECV Contract]... and can thus be passed onto the Buyer by way of an increase in the amount Buyer pays for the product supplied [`pass-on issue'].
2. Assuming that there is a pass on, is the amount of the [PRRT] pass on itself an `assessable receipt' under Section 23 of the [ PRRTA Act], so that such amount can be `grossed up', i.e. `so as to recover the tax upon the tax recovered?' [`gross-up issue']
3. Assuming there can be a pass on, what is the fairest and most reasonable method to determine the difference between the assessable receipts received by Sellers for the supply of natural gas, and the deductible expenditure in respect of such receipts, so as to calculate the amount of taxable profit upon which the 40% [PRRT] is imposed? To ascertain that profit required the allocation of the costs of production of natural gas, which costs include joint costs of the production of both oil and gas. This required the identification and application of the fairest and most reasonable method of allocating such joint costs. Sellers contend such a method is the revenue allocation method. Buyer contended that this method was manifestly unreasonable and unfair, and should be rejected... [`method issue'].
4. Assuming a pass on, there is the further question of the allocation of [PRRT] amongst customers. Relevantly Buyer takes approximately 13% of natural gas produced, and [the GFC] 82% and there are some other minor purchases [`customer issue'].''
(There may have been some misstatement of issues, but if so, nothing turns on this in these proceedings.)
23. Each of these issues was decided in substance against the SECV. In respect of the pass-on issue, the arbitrators held that the sellers' ability to calculate the taxable profit arising from the production of gas - albeit by a method strongly opposed by the SECV - meant that the PRRT payable on that profit could be said to be ``attributable'' to the production of gas within the meaning of cl 19.5. The arbitrators also relied on this reasoning to support a similar conclusion in respect of the ``attributability'' of the PSLA royalties. The result was that both the imposition of PRRT and the abolition of PSLA royalties were held to require an adjustment of the Contract Price under cl 19.5.
24. In respect of the gross-up issue, the arbitrators again found against the SECV on the basis that all of the monies received by the sellers as part of the Contract Price under cl 19 were assessable for PRRT purposes. This meant that if, so the arbitrators reasoned, the intention of cl 19.5 was to enable the sellers to pass on in full the net cost to them of any new imposts falling within cl 19.5, then the clause was to be read as requiring adjustment of the Contract Price on a gross-up basis. (I note in this context that only EARL's claim to gross up the amount of PRRT for which it was liable under cl 19.5 was accepted by the arbitrators, since BHPPBS had not at the time of the Award been assessed for PRRT on the pass-on amounts claimed from the SECV.)
25. The method issue was also decided in favour of the sellers. According to the arbitrators, the SECV had failed to show either that the revenue allocation method adopted by the sellers was not a fair and reasonable method of cost allocation, or that such method was manifestly inferior to any alternative method proposed by the SECV.
26. A similar finding resolved the fourth issue. Specifically, the arbitrators rejected the SECV's claim that the production of gas supplied to it by the sellers resulted in little or no profit because of the unprofitable sources from which the gas was taken, and that the sellers' proportionality-based method of allocating PRRT in respect of such gas was for this reason unfair and unreasonable.
27. Finally, the arbitrators held that there was a bona fide (in the sense of a real and genuine) dispute between the sellers raising a serious issue to be tried. This meant that interest was not payable on the withheld royalties or on any other monies that the SECV had refused to pay in default of cl 19.
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28. The arbitrators' Award reflected these findings. The SECV subsequently sought to challenge the validity of the Award by two proceedings instituted in the Supreme Court of Victoria. The sellers also sought to appeal against the arbitrators' rejection of their claim to interest and, in the event that the SECV succeeded on their appeal, against the arbitrators' finding in respect of the ``attributability'' under cl 19.5 of the (abolished) PSLA royalties. The Court heard applications for leave to appeal but the parties settled their dispute in 1996 before the Court delivered judgment.
4.3 Resolution of the disputes by settlement
(a) The disputes involving the sellers and the GFC and SECV
29. On 20 November 1996, the sellers and the State of Victoria (``State'') entered into two deeds of settlement with, respectively, GASCOR (``GASCOR deed'') and Generation Victoria (``GenVic deed''). For all purposes material to the current proceedings GASCOR entered into that deed as successor in law of the GFC, and Generation Victoria (``GenVic'') as successor in law of the SECV.
30. Under the terms of the GASCOR and GenVic deeds, the State agreed to pay a lump sum to each of the applicants in full and final settlement of the sellers' past and future claims under the Supply Contracts to pass-on amounts, including withheld royalties (GASCOR deed cls 4, 5; GenVic deed cls 5, 6). That agreement was made in the context of wider negotiations between the settling parties arising out of the State's desire to introduce structural reforms and increased competition into the Victorian gas industry (GASCOR deed recital E; GenVic deed recital D). The lump sum to be paid by the State was comprised of two (grossed-up) payments representing, respectively, all:
``(a) amounts outstanding to [the sellers] on partially paid invoices for gas sold and delivered... and unpaid invoices and letters of demand for the pass-on of PRRT in respect of gas sold and delivered to [the buyers] between 1 July 1990 and 31 October 1996 ( `payment 1' ); and
(b) future entitlements to pass on PRRT from 1 November 1996 pursuant to the [ Supply Contracts] ( `payment 2' ).''
(GASCOR deed cl 6.3; GenVic deed cl 8.2).
31. Each of these payments, including the amount of PRRT and income tax referable to them and the agreed after-tax amount of each to the sellers, was valued and expressly agreed upon by the parties for the purpose of the deeds (GASCOR deed cl 6.4; GenVic deed cl 8.4). In consideration for such agreement the sellers provided, among other things, a conditional covenant not to challenge the assessability of the payments for tax purposes. The covenant, which is contained in cl 6.3 of the GASCOR deed and 8.3 of the GenVic deed, stated as follows.
``The parties acknowledge and agree that each of Esso and BHP have entered into letters of understanding [dated 23 and 24 October 1996 respectively] with the Australian Taxation Office in relation to the liability of Esso and BHP to pay PRRT and Income tax on payment 1 and payment 2. Esso and BHP covenant to the State (for the benefit of the State and the Commonwealth of Australia) that:
- (a) Esso and BHP will not by way of objection or otherwise challenge the assessability of payment 1 to PRRT and Income tax provided that the State acknowledges each of Esso and BHP have reserved the right to contest the timing of derivation of that amount for the purposes of determining the relevant amount of PRRT and Income Tax payable in respect of payment 1 ; and
- (b) Esso and BHP will not by way of objection or otherwise challenge the assessability and derivation in the year receivable of payment 2 to PRRT and Income Tax.''
[emphasis added]
32. The ``letters of understanding'' between each of the applicants and the Australian Taxation office (``ATO'') referred to in this clause concern the sellers' PRRT and income tax liability. Their terms are materially the same. Broadly speaking, they acknowledge the terms of settlement contained in the GASCOR and GenVic deeds, and record the proposed basis of the ATO's assessment of the sellers' PRRT and income tax for the several years of tax from the year ended 1991, as well as the undertaking in respect of such assessment given by the sellers to the State in the GASCOR and GenVic deeds (see above). This undertaking, which records expressly the disagreement at the
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centre of the current proceedings, is relevantly described in the letter of understanding between BHPPBS and the ATO as follows.``1.1 For PRRT years ended 30th June, 1991 through to and including 30th June, 1996, the ATO proposes that assessments, where appropriate amended assessments, will issue on the assessable receipts derivation basis being the highest of:
- - Date of letter of demand
- - Date of gas delivery
- - Arbitration award
1.2...
1.3 Assessable income for years of income ended 31st May, 1991 to 1997 will similarly be based on the highest of three bases outlined above for PRRT, albeit with allowance for different year end. Income tax assessments, amended assessments where appropriate, will issue to accord with this approach.
1.4 BHPPBS acknowledges for the purposes of the settlement of the Pass- on dispute that it will not by way of objection or otherwise challenge the assessability of pass-on amounts paid to BHPPBS by way of Payment 1. However, BHPPBS reserve the right to contest the timing of derivation and therefore, year of assessment of such pass- on amounts for income tax and PRRT purposes. Further, BHPPBS will seek to establish by way of objection and, if necessary, litigation that pass-on amounts are not derived until settlement of the dispute. BHPPBS contends that it is not until this time that entitlement and quantum are sufficiently certain so as to constitute derivation ....
3.1 BHPPBS agrees that upon settlement date pursuant to the Deeds of Settlement or such other date as is mutually agreed by BHPPBS and the ATO, to immediately pay to the ATO by way of early payment both the PRRT and income tax referable to the payment(s) made in consideration of the relinquishment of the PRRT Pass-on; ie payment 2.''
[emphasis added]
(b) The disputes involving the sellers and Mobil, Kemcor and Huntsman
33. The disputes involving the two Supply Contracts to which Huntsman (one by operation of assignment from 25 July 1978) was a party were resolved by deeds of settlement dated 30 December 1994 and 13 February 1995. Those deeds provided respectively for lump sum payments by Huntsman of $3.3 million to BHPPBS and of $3.5 million to EARL in full and final resolution of both the pass on disputes and Huntsman's request for redetermination of its Contract Prices. The same applies for the settlements of the disputes involving Mobil and Kemcor, which were reached on 29 September 1994 and 7 February 1995 respectively, by lump sum payments by Mobil to BHPPBS of $3.596 million, and by Kemcor to EARL of $5.681 million.
5. The dispute between the sellers and the Commissioner
34. Since the announcement of the Amendment Act in 1990, and notwithstanding the disputes precipitated by that announcement regarding the impact of cl 19.5 and equivalent provisions on calculation of the Contract Price under each of the Supply Contracts, the sellers have at all times material to the current proceedings continued to file tax returns with the ATO. Of particular significance in this context is the sellers' treatment, for the purpose of such returns and their financial accounts generally, of two categories of payment. The first comprises the sums to which the sellers claimed to have an entitlement under the Supply Contracts following introduction of the Amendment Act; namely, the pass-on amounts. The second comprises the lump sums that were received by the sellers in settlement of the claims to those amounts (``settlement amounts'').
5.1 The sellers' treatment of the contested and settlement amounts
(a) EARL
35. EARL's financial accounts are prepared on the basis of a financial year ended 31 December.
36. In the year ended 31 December 1990 (and consistent with its previous accounting practice), EARL treated all sums claimed in its Standard Monthly Invoices as ``income'' that was ``assessable'', for income tax purposes, from the date on which payment by the buyers was claimed as due. Since EARL made no claims for pass-on amounts during 1990, no pass-on amounts were recorded in its accounts to 31 December of that year.
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37. EARL's accounting practice for 1990 continued unchanged to 31 December 1992, and was extended during that period to cover pass-on amounts. EARL treated such amounts in 1991 and 1992 as both ``income'' and ``receipts'' that were ``assessable'', for income tax and PRRT purposes respectively, from the date it claimed that payment by the buyers was required.
38. A change in EARL's accounting practice was introduced the following year when, from 1 January 1993, it began to record both pass-on amounts and withheld royalties as ``deferred revenue'' items that were assessable for neither income tax nor PRRT purposes. EARL (relevantly) explained the reason for this change in its letter to the ATO of 30 July 1993 as follows.
``In the present circumstances, it clearly cannot be said that the right to receive the pass-on amounts has been earned or established. The validity of the amounts claimed is subject to legal proceedings in which both the principle (i.e. whether EARL and BHP are legally entitled to pass on these amounts under the terms of the contracts) and the quantum (i.e. assuming that legal right to be established, the amount of PRRT and royalty that is properly attributable to gas) are in dispute. To this extent, EARL's right to receive these amounts is at present both contingent and defeasible.
Accordingly, we do not believe that any part of these disputed amounts should be included for PRRT or income tax purposes until such time as EARL's legal entitlement to receive them has been determined and the amounts receivable can be reasonably ascertained. Until the arbitrator holds that EARL does have a fixed and enforceable right in this respect, the pass-on amounts merely represent disputed sums that have not only not been received but indeed may never be received.''
39. As has been seen, the arbitrators' findings in respect of EARL's entitlement to the contested amounts was challenged in the Supreme Court of Victoria, and thus did not deliver the legal resolution anticipated in EARL's letter. The matter was not resolved until the parties reached a commercial settlement in 1996. It is for this reason that EARL did not record any of the contested amounts as assessable for tax purposes after 1992, and that the only amounts that it did record were the settlement monies received in lieu of the contested amounts, less the value of contested amounts that EARL had previously recorded as assessable in the years ended 31 December 1991-92. (EARL also made additional adjustments, which are not currently relevant, in its accounts from 1995 to take account of further, post-settlement supplies of gas to each of Huntsman, Mobil and Kemcor.) Earl's accounting treatment is generally consistent with the applicants' argument, in the current proceedings, that the revenue to which the sellers were entitled under clauses 19.5 and 12.8 of the SECV and GFC Contracts respectively was only assessable for income tax and PRRT purposes at the point at which it was actually received by them, being the date of settlement, and that the quantum of the revenue so assessable was the quantum of the settlement amounts.
(b) BHPPBS
40. Unlike EARL, BHPPBS adopts a financial accounting period ending 30 June.
41. Prior to 30 June 1990, BHPPBS's practice was to record all sums claimed in its Standard Monthly Invoices as assessable for PRRT and income tax purposes as at the date of delivery of gas (or ethane). From the year ended 30 June 1991, BHPPBS continued this practice for all invoiced amounts, including withheld royalties. It did not, however, extend the practice at any time to cover the pass-on amounts, which it treated from the outset as non- assessable. Such treatment, also adopted by EARL from 1 January 1993, was justified by BHPPBS in its letter to the ATO of 8 January 1992 in essentially the same terms as in EARL's letter of 30 July 1993. Accordingly, none of BHPPBS's financial accounts recorded the contested amounts as assessable for income tax or PRRT purposes. The only amounts that were recorded were the settlement monies received in lieu of those contested amounts in 1994 and 1996.
5.2 The Commissioner's response to the sellers' treatment of the contested and settlement amounts
42. The principles underlying the accounting practice adopted by BHPPBS from the outset and by EARL from 1 January 1993 in respect of the contested and settlement amounts were approved by the Commissioner in his initial
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rulings in respect of the matter, dated 20 January 1992 and 24 October 1994 respectively. Those rulings, both of which responded to a request by BHP Petroleum Pty Ltd (made on behalf of BHPPBS) for an opinion as to PRRT assessability, supported the views: (a) that the disputes between the contracting parties regarding the existence and extent of the sellers' right to the contested amounts made such amounts non-assessable for PRRT purposes; and (b) that, consistent with (a), the contested amounts would remain non- assessable for PRRT purposes unless and until the buyers had assumed the relevant liability by actual payment of the amounts, by agreement, or by legal resolution of the contractual disputes. Hence the following excerpt from the Commissioner's ruling of 20 January 1992.``The effect of the... judicial pronouncements on the issue raised by the company [BHP Petroleum Pty Ltd] is that it cannot be said that any consideration is receivable where no money has in fact been paid, the company has not passed on the PRRT in the sale price and the very basis of the liability is disputed by the purchasers. Where the purchasers subject themselves to the liability either by actual payment of an amount or by agreement or by legal resolution of the dispute, at that point there will be a derivation of assessable receipts for the purposes of section 23 in the form of assessable petroleum receipts under paragraph 24(b) of the Act.''
43. The sellers' ultimate practice of treating the contested amounts as non-assessable for PRRT purposes was thus consistent with the view formally expressed by the Commissioner in 1992 and 1994. This changed, however, in August 1995 with the Commissioner's publication of a position paper for each of the applicants entitled ``Proposed amendment action and ancillary matters''. That paper gave notice of the ATO's revised preference for a different, ``dual assessment approach'' to the treatment of the pass-on amounts for PRRT purposes, which it relevantly described as follows.
``[The ATO] believes that derivation of the pass-on amount occurs at one of two possible points in time. It occurs either at the time the joint venturers issue invoices or other demands for payment in respect of the pass-on amount, or alternatively, at the time the arbitrators make a final award in relation to a reference to them on the issue under the terms of the natural gas supply agreements. Accordingly, the ATO will raise an amended assessment or assessment, as the case may be, on the following bases:
- (a) `a date of invoice/demand for payment basis' under which it will include in assessable receipts an amount equal to the total of the pass-on amounts invoiced/demanded in the year of tax (This amount will be adjusted to include the gross-up of the pass-on amount);
- (b) `a date of arbitration award basis' under which it will include in assessable receipts for the year in which a final award is made an amount equal to the total pass-on amount for the period specified in the award. (The amount to be included under this basis of assessment will also reflect the gross-up of the pass- on amount) (Also, the ambit of this `date of arbitration award basis' of assessment may be altered upon the receipt of further advice from Senior Counsel on this matter).
The ATO will, of course, only seek to recover the tax payable in relation to one of these bases of assessment.''
44. Consistent with this approach, the Commissioner notified the applicants of the ATO's intention to amend their PRRT assessment for the tax years ended 30 June 1992-94 (and 30 June 1993-94 in the case of EARL) adopting a ``date of invoice'' approach and, subject to its ``review of further detailed advice from Senior Counsel'', to assess their PRRT liability for the tax year ended 30 June 1995 by reference to the same approach. By return letters of 9 and 10 August respectively, BHPPBS and EARL objected to this proposal and argued that PPRT ``should only be payable in respect of amounts actually received from [ the buyers]''. The Commissioner affirmed his approach in a second position paper dated 27 October 1995 (for EARL) and 24 July 1996 (for BHPPBS), entitled ``Derivation of the PRRT pass-on amount''. In that paper the Commissioner confirmed the ATO's 1995 position, whilst making some allowance for deferred payments by the sellers of their outstanding tax debts from the years ended 30 June 1993-95. (The Commissioner also notified EARL of the ATO's refusal to refund any of the
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tax paid by it on the pass-on amounts in the years ended 30 June 1992-93.) The Commissioner on 1 May 1997 issued similar position papers in respect of the applicants' tax obligations under the Supply Contracts involving Huntsman, Mobil and Kemcor.5.3 Conclusion: the current status of the disputes between the sellers and the Commissioner
45. The GASCOR and GenVic deeds, and the letters of understanding between the sellers and the Commissioner that preceded them, were concluded soon after the ATO's publication of its second position paper for BHPPBS in 1996. As already noted, those letters of understanding signalled the ATO's intention to assess the applicants' PRRT and income tax liability post-1990 and to assume, for the purpose of assessment, that the pass-on amounts were derived by the applicants on whichever of - (a) the date the amounts were claimed, (b) the date the gas the subject of the claims was delivered, or (c) the date of the Award - produced the highest tax assessment. Following such letters the ATO notified the applicants of its preference for the second of these bases, and proceeded to issue assessments and amended assessments accordingly.
46. The applicants objected to the 39 assessments thus issued. The Commissioner disallowed BHPPBS's objections for each of the 1991 to 1996 years on 31 July 1998. In his written notice he stated in part as follows.
``The Commissioner is of the view that the Pass-on amounts are derived for the purposes of Section 23 and Section 24 of the PRRT Act [Section 25 of the ITAA] on the date of sale (including the date of the delivery) of the gas. However, the Commissioner recognises that the issue is finely balanced. Accordingly, in the event that the pass-on amount is held not be derived on the date of sale (including the date of delivery) of the product to which it relates, the Commissioner is of the view that the date of derivation is the date of issue of the invoices and Letters of Demand. If this view is also not accepted, then the Commissioner is of the opinion that derivation will take place on the date of the earliest occurrence of one of the undermentioned specified events:
- (a) where there is an arbitration award handed down in relation to the Pass-on amount arising out of a dispute referred to arbitrators under the terms of a product supply agreement - the date of the arbitration award; or
- (b) where a Deed of Settlement has been entered into in respect of a dispute concerning claims to PRRT Pass-on under a product supply agreement - the date of execution of the Deed of Settlement.''
47. On 5 August 1998, the Commissioner disallowed EARL's objections for each of the 1991 to 1997 years upon the same basis as he had disallowed BHPPBS's objections. As noted at the outset of these reasons, it is from the Commissioner's decisions of 31 July 1998 and 5 August 1998 that the current appeals are brought.
The issues that arise on the appeals
1. The task of the Court
48. The sellers appeal to the Court, pursuant to s 14ZZ of the Taxation Administration Act 1953 (Cth) (``the Administration Act''), against appealable objection decisions of the Commissioner. By virtue of s 14ZZO(b) of the Administration Act, the sellers have the burden of proving that the assessments and amended assessments under challenge are excessive. Then, as Barwick CJ observed in
Henderson v FC of T 69 ATC 4049; 70 ATC 4016 at 4018-4019; (1968-1970) 119 CLR 612 at 648 (``Henderson''):
``... But the question of onus apart, the issue on such an appeal is what in fact is the assessable income of the taxpayer derived in the relevant year of tax. No doubt, where the Commissioner's figure is the result of the application of some method of computation to figures not otherwise in dispute, the contest may appear to be one as to the appropriate method of computation of the income derived: and the determination of such a method of computation will resolve the issue, which is what is the amount of the assessable income derived. But unless the method of computation yields what is in fact the correct figure for that income, it cannot be said to be appropriate in the circumstances or to be not inconsistent with the provisions of the Act.''
49. The parties have invited the Court to resolve the question of principle, which will determine the correct basis for the computation
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of tax, and to leave to them the task of working out the consequences of the Court's determination for each of the 39 assessments in issue. The parties have proposed that, if appropriate, they would submit a minute of the orders that reflected this working out. I agree that this is the appropriate course in the circumstances.
2. The parties' submissions
50. As already noted, the Commissioner assessed the sellers to income tax in the relevant years on a number of bases, including that they derived assessable income by way of the pass- on amounts at the time they supplied gas to the buyers, or at the time they issued the pass-on invoices to the buyers. At the hearing, the Commissioner pressed the first, and not the second of these alternatives. He contended primarily that the pass-on amounts claimed in the pass-on letters and pass-on invoices were assessable income derived by the sellers when they supplied the gas (or ethane) to which the relevant letter or invoice related.
51. The sellers' case was that they did not derive income for income tax purposes until the sellers and the buyers agreed on the amounts payable by way of the pass-on amounts in settlement of the disputes between them. The sellers' assessable income was, on this basis, limited to the amounts payable under the terms of the various commercial settlements.
52. The parties did not dispute that ordinarily the income that, for income tax purposes, the sellers derive from supplying gas and ethane to the buyers should be calculated on an accrual, and not a receipts basis. That is, income is computed by reference to the (net) revenue earned or accrued, and not by reference to the (net) payments received: see
Commissioner of Taxes (S.A.) v Executor Trustee and Agency Co of South Australia Ltd (1938) 5 ATD 98 at 133-134; (1938) 63 CLR 108 at 157 (``Carden's case'') per Dixon J, with whom Rich and McTiernan JJ agreed. This is because in most cases the adoption of an accrual basis for a commercial entity running a trading account will give ``a substantially correct reflex of the taxpayer's true income'': cf Carden's case at ATD 131-133; CLR 154-156 and
Brent v FC of T 71 ATC 4195 at 4200; (1971) 125 CLR 418 at 428-429 (``Brent''). By contrast, although for the same reason, a receipts basis is generally adopted in computing the income of an individual offering professional services in exchange for fees: see Carden's case at ATD 134; CLR 158.
53. The sellers did not dispute that, generally speaking, they derived income from the sale of gas or ethane under the Supply Contracts when they supplied those products, because the Contract Price was payable by virtue of this supply. They also accepted that it was appropriate to compute this income on an accrual basis. Further, the sellers did not challenge the adoption of an accrual basis in computing the income derived by way of the pass-on amounts. Their case was that, even if this were the correct basis, in the case of the pass-on amounts, no income was derived until the parties agreed on the amounts payable in settlement of the disputes over the sellers' pass- on claims.
54. Where the Commissioner or a taxpayer has departed, or sought to depart, from the usual system of accounting employed in determining the taxpayer's income for income tax purposes, the courts have emphasised the need to have regard to the ``truth and reality'' of the situation. They have referred, in particular, to the need to ensure that the accounting system adopted for an assessment of income is not misleading: see
Ballarat Brewing Co Ltd v FC of T (1951) 9 ATD 254 at 258; (1951) 82 CLR 364 at 369 per Fullagar J;
Barratt & Ors v FC of T 92 ATC 4275 at 4282; (1992) 36 FCR 222 at 231 (``Barratt''). Drawing on this approach, the sellers contended that the truth and reality of the present situation made the adoption of the approach ordinarily used in assessing their income misleading. The Commissioner erred, so they said, in treating this income as having been derived when the gas or ethane was supplied since the truth and reality of the situation dictated that it be treated as derived when agreement on the amount payable was reached at settlement. The truth and reality to which the sellers referred consisted of the disputes between them and the buyers about the sellers' right to the pass-on amounts, the reference of the disputes to arbitration under the Supply Contracts, and the settlements of the disputes.
55. There were three ways in which the sellers relied on these matters in support of their contention that the truth and reality of the situation required the Commissioner to consider that income by way of the pass-on amounts was not derived until the parties agreed to the
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amounts payable in settlement of the disputes. First, the disputes created genuine uncertainty about the sellers' right to the pass-on amounts. Prior to settlement, this uncertainty, so it was said, prevented the sellers' right from maturing into a recoverable debt in respect of which income was capable of being derived. Secondly, the disputes illustrated the inherent uncertainty and defeasibility of the sellers' right in so far as the right or its enjoyment depended on the further agreement of the sellers and the buyers and, failing such agreement, a final and binding Award (or, in the event of appeal, curial determination). Thirdly, the disputes and the matters associated with them created a situation in which it would be misleading to conclude that income had been derived prior to settlement. In this context, the sellers referred to the position in the United States of America, Canada and United Kingdom, as appeared fromNorth American Oil Consolidated v Burnet (1932) 286 US 417;
London-Butte Gold Mines Co v Commissioner of Internal Revenue (1940) 116 F 2d 478;
The Cold Metal Process Company v Commissioner of Inland Revenue (1951) 17 TC 916;
M.N.R. v Colford Contracting Co Ltd (1960) 60 DTC 1131;
Commonwealth Construction Company Limited v R (1964) 64 DTC 6420;
M.N.R. v Benaby Realties Limited (1967) 67 DTC 5275;
R v Johnson and Johnson Inc (1994) 94 DTC 6125; and
WS Try Ltd v Johnson [1946] 1 All ER 532. The Commissioner referred to
United States v Lewis (1951) 340 US 590. As appears below, I had not found it necessary to refer to these cases to resolve the issues with which these proceedings are concerned.
56. The Commissioner rejected the sellers' conception of the truth and reality of the situation, including the sellers' submissions concerning the appropriate basis for assessment. The Commissioner's case was that the truth and reality resided exclusively, or almost exclusively, in the terms of the Supply Contracts. The disputes between the sellers and the buyers were, so the Commissioner said, immaterial to any relevant reality. The Commissioner contended that each Supply Contract conferred a right on the seller or sellers to adjust the Contract Price owed in consideration of the sale of gas or ethane to the buyers during the relevant tax years by an amount representing the value of the pass-on amounts. If this were accepted as correct, then the Commissioner was entitled, so he said, to treat the pass-on amounts as part of the Contract Price and, more particularly, to treat the amounts in the pass-on letters and invoices as income that the sellers derived on the date the gas or ethane was delivered.
57. I interpolate here that there are essentially three approaches the Commissioner might have taken in calculating the value of the pass-on amounts and hence the sum of assessable income or assessable receipts. He might have chosen to accept the value that the sellers claimed in their pass-on letters and invoices. He might have attempted to value the pass-on amounts afresh, by reference to the pass-on clause of each supply agreement. He might have chosen to accept the approach sanctioned by the arbitrators in the SECV arbitration to the extent (if any) it differed from the method used to calculate the claims in the pass-on letters and invoices. The Commissioner favoured the first approach. He treated the monies claimed in the pass-on letters and invoices as the income derived by the sellers under the Supply Contracts on the date of the supply of the gas or ethane in connection with which the letters or invoices were sent.
58. As we have seen, these proceedings called into question the proper approach for assessing the pass-on amounts for income tax (and PRRT) purposes. So far as income tax is concerned, there are two aspects to this: first, assuming the amounts were income in the hands of the sellers, when was that income derived by them? Secondly, by reference to what matters is the value of the pass-on amounts and hence the quantum of income to be ascertained? As already noted, the parties conducted the proceedings on the basis that the answers to these questions would also determine the PRRT issues.
59. On the one hand, so far as the sellers were concerned, these issues were essentially interdependent, since their contention was that they did not derive the pass-on amounts until they and the buyers reached agreement on the amount payable in settlement of the disputes. That is, the amount of the sellers' income referable to the pass-on amounts was said to be the quantum of the sum representing these amounts paid at settlement. On the other hand, so far as the Commissioner was concerned, the issues remained separate. Thus, the Commissioner argued that the sellers derived
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income on the delivery of the gas or ethane as required by the Supply Contracts and the quantum of the income was whatever the sellers claimed in their pass-on letters or invoices.60. The sellers criticised the Commissioner's approach, contending that the Commissioner had proceeded on the mistaken basis that a taxpayer's income for income tax purposes includes all monies to which the taxpayer claims entitlement regardless of the validity of the claim. There may be some force in this criticism. If, as the Commissioner contends, the sellers were properly treated as having derived income on the date the gas or ethane was delivered under the Supply Contracts because that event made the Contract Price payable, then the quantum of the (net) income thus derived must be equal to the value of the pass- on amounts to which the sellers were entitled under the Supply Contracts. If so, then a question may arise as to whether the pass-on letters and invoices in fact state the pass-on amounts to which the sellers were entitled under the Contracts. I return to this below.
61. The issues in these proceedings are whether the Commissioner erred in treating the sellers as having derived income from the pass- on amounts on the date on which the gas or ethane was delivered under the Supply Contracts and, if not, whether the income so derived was equivalent to the amounts set out in the pass-on letters and invoices. Two further questions arise. The first concerns the nature of the sellers' right to the pass-on amounts during the relevant years of tax, and the second relates to the significance, so far as the right is concerned, of (a) the disputes between the sellers and the buyers as to whether the right to pass on covered PRRT; (b) the arbitration clause in each supply agreement; and (c) the SECV arbitration and the negotiated settlements.
3. The nature of the sellers' right to the pass-on amounts during the relevant tax years
62. The nature of the sellers' right under the pass-on provision in each of the Supply Contracts falls to be considered having regard to the whole of the relevant Supply Contract.
63. As we have seen, the Supply Contracts provided that property in the gas or ethane would pass from the sellers (or seller) to the buyer at the point of delivery, and the buyer was obliged to pay for the gas at a rate referable, amongst other things, to the quantity of gas supplied during a previous period. Although the amount of the payment was not calculated until the gas had been supplied, the calculation was for one amount according to a previously agreed rate. The buyer was notified by the sellers of the quantity of gas supplied and the amount payable by a monthly statement, and the buyer was obliged to make payment within a specified period after the receipt of the statement. The pass-on provision (e.g., cl 12.8 of the GFC agreement and cl 19.5 of the SECV agreement) included provision for an upwards adjustment in the payment to take account of any new tax imposed on the sellers attributable to the supply. Save for the GFC agreement, the Supply Contracts contemplated that any adjustments should be dealt with in the ordinary way by monthly statements. Prima facie at least, under the Supply Contracts an adjustment effected pursuant to a pass-on provision was part of the consideration payable by the buyer for the supply of the relevant product.
64. As from 26 June 1991, the sellers incurred a liability to pay PRRT in respect of their taxable profit of the year of tax ended 30 June 1991 in relation to the Bass Strait project. The Commissioner's assessments (including amended assessments) were based on the premise that PRRT was a tax ``attributable directly'' or ``attributable'' to the supply of gas or ethane. The Commissioner's case was that, pursuant to the pass-on provisions in the Supply Contracts, the sellers were entitled to make an upwards adjustment in the payment required of the buyers as from 26 June 1991 for the year ended 30 June 1991 and other relevant tax years. The sellers' case was that they had no legally indefeasible entitlement to the pass-on amounts; rather they had a legal entitlement to the settlement monies as agreed in the settlement agreements (upon satisfaction of any conditions precedent).
65. As we have seen, the board of arbitrators in the SECV arbitration considered the question whether PRRT fell within cl 19.5(a)(i) of the SECV agreement and, having concluded that it did, the board held that the tax could be passed on to the buyer ``by way of an increase in the amount Buyer pays for the product supplied''. In this connection, I note that the parties accepted (correctly in my view) that, for present purposes, the pass-on provisions in the Supply Contracts were not materially different one
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from the another. Bearing in mind the subsequent applications to the Supreme Court, this is not to say that either party to the arbitration necessarily accepted that the meaning attributed by the arbitrators to cl 19.5(a)(i) of the SECV agreement was entirely correct. This is relevant because, as appears from the case now put by the Commissioner and the sellers respectively, a question arises in these proceedings concerning the operation of the pass-on provisions such as cl 19.5(a)(i) of the SECV agreement. Specifically, did the sellers have a right to pass on PRRT to the buyer during the relevant years of tax?66. Before discussing the sellers' submissions in this regard, it is helpful to consider the legal status of the Award in the SECV arbitration. This in turn assists in identifying more precisely the ambit of the dispute in these proceedings. The Award was the outcome of a commercial arbitration conducted and concluded within the framework of the CAA. By virtue of s 28 of the CAA and the parties' own agreement (set out in cl 25 of the SECV agreement), the SECV Award was final and binding as between them, at least in the absence of a successful appeal or relevant order of a competent court to the contrary. The Award was akin to a judgment in its creation of a res judicata and issue estoppel providing each party with a means of preventing the other from relitigating the arbitrated claim or issues. Following publication of the Award, neither the sellers nor the SECV could validly have taken their dispute to a court other than as an appeal from the Award on a ground permitted by the CAA: see CAA, ss 28 and 38. Nor could the sellers have sought to recover any monies owing under cl 19.5 of the SECV agreement without reference to the Award. (It seems that the jurisdiction at common law to set aside an arbitral Award for error of law appearing on its face no longer exists: see CAA, s 38(1); contrast
Racecourse Betting Control Board v Secretary for Air [1944] 1 Ch 114 at 119, 124 and 127.)
67. This is not to gainsay the observations of Emmet J in
Hi-Fert Pty Ltd v Kiukiang Maritime Carriers Inc (No 5) (1998) 90 FCR 1 at 14 (``Hi-Fert'') (Beaumont and Branson JJ agreeing) that:
``A distinction exists between the powers exercised by an arbitrator to whom the parties have agreed to refer a dispute and powers exercised by a court. Thus, an arbitrator does not have power to make a determination which is directly enforceable in the manner in which an order by a court is enforceable. Where a court makes a determination and a judgement is entered or an order made, that judgment or order will be enforced by the court.
An award by an arbitrator, however, gives rise only to contractual rights and obligations which are enforceable by or against the parties who have agreed to abide by that award. An award is binding on the parties only by force of the agreement since they have agreed that their rights and obligations are to be as stated in the arbitrator's award. If one of the parties fails to comply with or give effect to the award, it is necessary for proceedings to be brought in an appropriate court to enforce the award.''
That is, the Award in the SECV arbitration gave rise to contractual rights and obligations enforceable by or against the parties who had agreed to abide by the Award. If, for example, the buyer had failed to comply with the Award, then the sellers would need to have made application to the Supreme Court for leave to enforce it: see CAA, s 33.
68. Of course, the foregoing discussion merely establishes that the Award had legal effect as between the sellers and the buyer (the SECV), not as against the Commissioner. As between the parties to the Award, its publication gave rise to a new cause of action based on the parties' contractual agreement to perform the Award. The Award extinguished any right of action in respect of the matters formerly in difference.
69. The sellers did not seek to persuade the Court in these proceedings that, contrary to the arbitrators' determination, PRRT fell outside cl 19.5(a)(i) of the SECV agreement and the equivalent provisions in the other Supply Contracts. They accepted, at least implicitly, that the arbitrators correctly construed cl 19.5(a)(i) as extending to the imposition of PRRT. Their case was that, assuming the imposition of PRRT fell within this and the other pass-on provisions, nonetheless these pass-on provisions did not confer an indefeasible right on the sellers to an upwards adjustment of the Contract Price at the time of delivery of the product.
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4. Was the sellers' right to the pass-on amounts uncertain and defeasible?
70. As already noted, in these proceedings the sellers relied on the disputes between themselves and the buyers about the pass-on amounts and on the submission of the disputes to arbitration in support of an argument that, at the time the Supply Contracts were made, the pass-on provisions were so inherently uncertain or otherwise defeasible as to be incapable of giving rise to a recoverable debt. According to this argument, these provisions could be made certain and indefeasible only by the parties' further agreement or, in the absence of agreement, by a final and binding Award (or, in the event of appeal, curial determination). As there was no binding and final Award or determination in this case, so the sellers said, the right to the pass-on amounts was not certain and indefeasible until the agreement with the buyers to settle the disputes on commercial terms. In support of their case, the sellers:
- • emphasised the bona fide nature of the disputes over the existence and quantification of the sellers' right to the pass-on amounts;
- • described the arbitration under the Supply Contracts as akin to an expert determination, in the sense that the arbitration was part of the performance or ``working out'' of the parties' obligations under the Supply Contracts; and
- • relied on their alleged inability to enforce any right to the pass-on amounts by means of civil proceedings absent any settlement agreement with the buyers or final Award.
71. I reject the sellers' submission that the pass-on provisions were so uncertain as to be unenforceable. Let it be assumed that the pass- on provisions relied on by the sellers to recover the burden of PRRT from the buyers were each capable of bearing more than one meaning, only one of which would result in the sellers' recovering what they claimed. Let it be assumed that the disputes between the parties were genuine. This kind of uncertainty in interpretation does not of itself render a contractual provision unenforceable at law. Since the decision of the High Court of Australia in
Upper Hunter County District Council v Australian Chilling and Freezing Co Ltd (1968) 118 CLR 429 (``Upper Hunter''), the courts have accepted that, if a contractual provision can bear more than one meaning, it will bear the meaning that a court or, in an appropriate case, an arbitrator decides that it bears upon its proper construction. As Barwick CJ (with whom McTiernan, Kitto and Windeyer JJ agreed) stated in Upper Hunter at 436-437:
``[A] contract of which there can be more than one possible meaning or which when construed can produce in its application more than one result is not void for uncertainty. As long as it is capable of meaning, it will ultimately bear that meaning which the courts, or in an appropriate case, an arbitrator, decides is its proper construction: and the court or arbitrator will decide its application. The question becomes one of construction, of ascertaining the intention of the parties, and of applying it.''
72. Each pass-on provision relied on by the sellers to support an upwards adjustment in the Contract Price was capable of meaning. This much is established by the SECV arbitration. That is, as between the parties to this arbitration, the Award of the arbitrators settled the meaning and operation of cl 19.5(a)(i) of the SECV agreement, more particularly as the applications for leave to appeal were not ultimately pursued. Since there is no material difference between cl 19.5(a)(i) of the SECV agreement and the pass-on provisions in the other Supply Contracts, then these pass-on provisions must be capable of bearing the same meaning and having the same operation as 19.5(a)(i) of the SECV agreement. Indeed, this was essentially the meaning attributed by the sellers to the pass-on provisions from the time PRRT was imposed in respect of their Bass Strait operations. They relied on this meaning to issue the pass-on letters and invoices to the buyers. Accordingly, I also reject the further submission now made by the sellers that their entitlement under the pass-on provisions was incapable of quantification at the time the entitlement first arose.
73. I also reject the sellers' submission that the right to recover the pass-on amounts from the buyers pursuant to the pass-on provisions in the Supply Contracts was dependent on a further agreement between the sellers and the buyers, or upon a binding and final Award or, in the event of appeal, judicial determination. First, I do not consider that the process contemplated by cl 25 of the SECV agreement (or the equivalent provisions in the other
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Supply Contracts) is properly described as akin to a reference to an expert for an expert's determination. These provisions specifically provided that ``[a]ny controversy or claim arising out of or relating to'' the Supply Contract was to be settled ``by arbitration in accordance with the [State's] Arbitration Act''. These were ``arbitration agreements'' within the meaning of s 4(1) the CAA and any arbitration under them took place within the framework of the CAA. Under the CAA, the arbitrators were bound to make a determination after a hearing conducted in a judicial manner: see CAA, ss 14-26. The questions for the arbitrators were primarily ones of construction of the contract, and were to be determined by reference to the terms of the contract and the applicable law: see CCA, s 22. In these circumstances, cl 25 of the SECV agreement and the equivalent provisions in the other Supply Contracts plainly provided for arbitration, and not a reference to an expert for an expert opinion: see generally Halsbury's Laws of Australia, vol 1(2) at [25-1 - 25-25].74. I do not accept that the various submissions to arbitration constituted merely a ``working out'' of the parties' contractual obligations in the sense used by the sellers. It is true that the SECV Award effected a resolution of the dispute between the parties on, amongst other things, the proper construction of cl 19.5(a)(i) of the SECV agreement. Whilst the Award declared the scope of the parties' contractual rights and obligations, these rights and obligations were initially created when the agreement was first made. The Award did not of itself create the sellers' right to the pass-on amounts. Each pass-on provision created the right. Upon the making of an Award in an arbitration such as the SECV arbitration, the parties' rights under the pass-on provision would pass into the Award, in much the same way as a plaintiff's cause of action would pass into judgment once it is delivered by a court: cf
Onerati v Phillips Constructions Pty Ltd (in liq) (1989) 16 NSWLR 730 at 749. Such an Award might, with leave of the court, be enforced in the same manner as a judgment of the court to the same effect: see CAA, s 33. It does not seem to me that the possibility of an appeal to a court is any more relevant in this connection than the possibility of a submission to arbitration.
75. None of the foregoing discussion is necessarily fatal to the sellers' submission that a final and binding Award was a condition precedent to their right to the pass-on amounts, or the ability on their part to enforce the right.
76. In some cases, the courts have held that, on the proper construction of an arbitration clause, arbitration is a condition precedent to liability or the commencement of an action, notwithstanding the absence of express words to this effect. However, in the words of the High Court in
Anderson v GH Michell & Sons Ltd (1941) 65 CLR 543 at 550 (``Anderson''):
``In spite of the intermittent appearance of a tendency to search and discover in contracts containing arbitration clauses some ground for saying, notwithstanding the absence of express words, that arbitration is made a condition precedent to liability, it remains true that where there are promises to pay money or to do any act or acts expressed without reference to arbitration an agreement in the same instrument to refer disputes to arbitration is to be treated as distinct and collateral unless the contrary appears from express language or necessary intendment: See Dawson v Fitzgerald [ (1876) 1 Ex. D. 257, at p 260].''
77. There is nothing in the Supply Contracts that expressly or by necessary implication would make arbitration a condition precedent to the sellers' right to recover the pass-on amounts under the Supply Contracts. The conclusion of the Court in Anderson aptly describes the position here. The Court said, at 554-555:
``The parties did not turn their attention to the question whether they would make arbitration a condition precedent to cause of action or suit. They made an absolute contract creating unconditional rights and liabilities covering a large variety of matters incident to a sale, and they superadded an arbitration clause..... But they went no further.
To give the clause a wider operation than its language expresses needs implication, and we can see no ground upon which an implication could be based.''
This, I think, is the position with respect to the arbitration provisions in the Supply Contracts under consideration in these proceedings.
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78. As already noted, the sellers also submitted that, prior to a final Award (or, in the event of appeals, a determination made by a court at the highest level) and in the absence of agreement, they would have been unable to recover the pass-on amounts by way of a civil action for debt. Accordingly, so this argument ran, the sellers' right under the pass-on provisions (e.g., cl 19.5(a)(i) of the SECV agreement) should be regarded as no more than an inchoate right. The right was inchoate in the sense that it gave the sellers no more than a right to submit the dispute about the pass-on amounts to arbitration with the hope or expectation of receiving an Award in their favour (that would be upheld were any appeal brought).
79. This submission on the sellers' part ignores what in Anderson was described, at 549, as ``[t]he basal distinction... between, on the one hand, the constituent facts and conditions forming the title to substantive rights and, on the other hand, the jurisdictions and remedies provided by law for the enforcement of those rights''. That is, the submission confuses the substantive question, ``Does the seller have a substantive right under cl 19.5(a)(i) (and equivalent clauses) to recover the pass-on amounts?'', with the question, ``Will curial procedure permit the sellers to enforce this right without there first being, as the contracting parties agreed, an arbitration of the dispute (or judicial resolution of an ultimate appeal)?''.
80. There is no absolute right to obtain a stay of court proceedings under the CAA, even though a party to an arbitration agreement (as, e.g., cl 25 of the SECV agreement) has commenced them against another party to the agreement in respect of a matter covered by the agreement (and therefore contrary to the agreement). In this situation, the other party to the proceedings may (or may not) at any time after appearance, and before serving any pleadings or taking any other step in the proceedings, apply to the Supreme Court to stay the proceedings, and the Court may grant the stay: see CAA, s 53. Before the Court can consider whether it will grant a stay, however, it must first be satisfied:
``(a) that there is no sufficient reason why the matter should not be referred to arbitration in accordance with the agreement; and
(b) that the applicant was at the time when the proceedings were commenced and still remains ready and willing to do all things necessary for the proper conduct of the arbitration.''
The leave of the court must be sought to make an application under s 53(1) where the applicant has delivered pleadings or taken any other step in the proceedings other than the entry of an appearance: see s 53(2). An application that invoked the Court's inherent power to stay proceedings would rarely succeed where an application under the statute failed.
81. Moreover, a court to whom a stay application was made would not necessarily have occasion to consider the substantive rights or obligations that were in dispute. Much would depend on the circumstances of the case. If the court did consider these rights and obligations, then it would do so only in the context of the stay application. It would, therefore, be unlikely in the ordinary course to determine finally the existence or scope of the rights and obligations at issue in the arbitration.
82. Further, for the reasons given, I reject the sellers' submission that a right of the kind under consideration in these proceedings was inchoate until all avenues of appeal were exhausted (or agreement was reached with the buyer). An appeal from a judgment of a court does not of itself operate as a stay, and any applicant for a stay bears the burden of satisfying the court that the discretion to grant the stay should be so exercised. Similar considerations may apply if a stay is sought from an arbitrator's Award, pending an appeal or application for leave to appeal: see CAA, s 47;
Proprietors of Strata Plan 3771 v Travmina Pty Ltd (1989) 4 BCL 91;
Nauru Phosphate Royalties Trust v Matthew Hall Mechanical and Electrical Engineers Pty Ltd [1994] 2 VR 386 at 408-409 per Smith J;
Christmas Island Resort Pty Ltd v Geraldton Building Co Pty Ltd (No 5) (1997) 18 WAR 334; but contrast
Imperial Leatherware Co Pty Ltd v Macri & Marcellino Pty Ltd (1991) 22 NSWLR 653 at 667; and see, generally, MS Jacobs, ``The Spectre of Section 47 of the Model Uniform Legislation'', (1995) 69 The Australian Law Journal 822.
83. For the above reasons, I also reject the sellers' submission that, by reason of curial power to stay a proceeding, for the recovery of the pass-on amounts, the sellers' right to the pass-on amounts was in any sense an inchoate
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right. I conclude that neither the disputes between the sellers and the buyers about the pass-on amounts, nor the submissions to arbitration, in isolation or in combination, rendered the pass-on provisions sufficiently uncertain as to be unenforceable or otherwise defeasible in the manner for which the sellers contend.84. Although I have rejected the sellers' submissions regarding the uncertainty or defeasibility of the right to the pass-on amounts, a further question remains. This is whether the truth and reality of the situation - including the disputes over the pass-on amounts - prevented this right from maturing into a ``recoverable debt'' of a kind that permitted the Commissioner to say that income was derived before the settlement agreements were made. The determination of this question requires some consideration of the relevant authorities.
5. The truth and reality of the situation and the sellers' right to the pass-on amounts
85. In the case of trading enterprises, which generally operate on an accrual basis of accounting, income will ordinarily be derived when a debt comes into existence, irrespective of when the debt is paid or becomes payable: see Carden's case at ATD 132-133; CLR 155-156; Henderson at ATC 4060; CLR 636 per Windeyer J and ATC 4020; CLR 650 per Barwick CJ (McTiernan and Menzies JJ agreeing);
J. Rowe & Son Pty Ltd v FC of T 71 ATC 4157 at 4159; (1970-1971) 124 CLR 421 at 448-450 (``Rowe'') per Menzies J (with whom Barwick CJ agreed); and Barratt at ATC 4282; FCR 231 per Gummow J (with whom Northrop and Drummond JJ agreed). The corollary of this principle is that where a debt represents the consideration for goods supplied under a contract of sale, the time when the debt is created is the date when the sale of the goods is completed. This is generally when the goods are supplied to the debtor. As von Doussa J explained in
Gasparin v FC of T 94 ATC 4280 at 4285; (1994) 50 FCR 73 at 79-80 (``Gasparin'') (Jenkinson and Spender JJ agreeing), the reason is that it is on that date that the contract of sale ceases to be executory. That is:
``... A debt has accrued due; the debtor has become subject to an obligation to pay a sum certain in money even though the debt may not be payable forthwith.''
86. In the present case, the Supply Contracts provided for the sale of gas or ethane by the sellers to the buyers on the terms provided. In all respects relevant to these proceedings, the Supply Contracts are equivalent to standard contracts for the sale of goods on terms: see, e.g., Gasparin at ATC 4285; FCR 79-80. Since the pass-on amounts formed part of the consideration payable for the product supplied, it follows that the Commissioner was prima facie correct in treating the pass-on amounts as income derived by the sellers on the date on which the gas (or ethane) was delivered to the buyers. There are, however, a number of situations in which the courts have found that the date when the debt representing the consideration for a sale of property (or services) gives rise to the derivation of income is not necessarily the same as the delivery date under the contract. I turn to these situations.
87. The first situation is where the sale of the trading stock does not constitute an entire disposal of the stock on a seller's part. Gasparin may be regarded as such a case. In Gasparin the trading stock was real property. The Commissioner argued unsuccessfully that the sellers derived income when contracts for the sale of land became unconditional. The Full Court of this Court held, however, that the sellers derived income from the sale only at settlement ``when a debt became due from each purchaser'': Gasparin ATC 4288; FCR 83. Von Doussa J, with whom Jenkinson and Spender JJ agreed, held, at ATC 4288; FCR 83, that:
``... [E]ach allotment remained trading stock on hand until settlement, that being the point of time in a transaction for the sale of land under a contract of sale in the terms of those before the Court when the vendor finally loses all dispositive power, and the contingency that the sale will not proceed to completion disappears.''
88. His Honour rejected, at ATC 4285; FCR 79, the proposition that ``there is no difference in the present case from a Department store sale of articles on 30 days terms'' since ``[i]n that example there has been a delivery of the articles sold. The contract of sale is no longer executory''. As his Honour explained, at ATC 4286; FCR 81:
``... Prior to settlement, under the contracts of sale the purchasers undoubtedly acquired interests in equity and rights to specific performance, but the vendors did not
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become bare trustees for the purchasers. The vendors retained substantial interests in the allotments which they enjoyed as beneficial owners....''
89. Referring to
Farnsworth v FC of T (1949) 9 ATD 33; (1949) 78 CLR 504 (``Farnsworth''), the Court held that, only upon settlement, when the land had been transferred to the purchaser and the proprietary interest of the vendor extinguished, would there be a loss of dispositive power on the vendor's part. Until then the purchaser's right to the land remained a contingent one, being subject to the payment of the purchase money, and subsisting only so long as the contract remained specifically enforceable at the purchaser's suit.
90. The Commissioner relied on the discussions in Gasparin (and Farnsworth) about the significance of a seller's loss of dispositive power over the sale property as further supporting his contention that, in this case, the sellers derived income from the sale of gas or ethane when the gas or ethane was delivered to the buyers. The Commissioner submitted that, under each Supply Contract, the legal title to and responsibility for the gas (or ethane as the case may be) passed from the sellers to the buyer on the delivery of the gas (or ethane). The Commissioner specifically referred to cl 11.1 of the GFC agreement and 13.1 of the SECV agreements. They respectively provide as follows.
``11.1 All Gas to be delivered under this Contract and all other gas which Buyer agrees to accept from Sellers under this Contract shall be delivered to Buyer at the Point of Delivery and all of the gas so delivered shall be deemed to be the property of Buyer and out of the possession and control of Sellers who shall have no responsibility with respect to the gas thereafter, but nothing in this Clause shall be deemed to affect in any way any remedies available to Buyer for recovery of loss or damage sustained by reason of inherent defect in gas delivered by Sellers to Buyer hereunder.
13.1 Title to and risk of loss of all Gas sold and delivered hereunder shall pass from Sellers to Buyer at the Point of Delivery.''
91. I accept that the transfer of title that, under the Supply Contracts, took place on delivery extinguished the sellers' dispositive power over the gas and ethane. I also accept that, as the Commissioner submitted, these provisions and equivalent provisions in other Supply Contracts supported the Commissioner's characterisation of the truth and reality of the situation. That is, when the sellers delivered the gas and ethane to the buyers under the Supply Contracts, the sellers lost all dispositive power over these products and satisfied all conditions precedent to their right to recover the Contract Price (which included the pass-on amounts). This characterisation of truth and reality supports the Commissioner's case that the sellers are to be treated as having derived income from the pass- on amounts as at the date of delivery.
92. The correlation between the delivery of something sold under a sale contract, the creation of a debt referable to the unpaid purchase price, and the derivation of income may also break down where the circumstances of the taxpayer are relevantly exceptional. In such a case, the usual ``signposts'' of the passing of property and satisfaction of conditions precedent to recovery of a debt are of limited use.
FC of T v Australian Gas Light Co & Anor 83 ATC 4800; (1983) 52 ALR 691 (``AGL'') is illustrative. The taxpayers were public utilities supplying gas to domestic and commercial customers. They existed and operated exclusively within a statutory context. Within this context, they were obliged to supply gas on a quarterly basis, although they were prohibited by regulations from demanding payment for the gas until an account had been rendered. An account could not be rendered until a customer's gas meter was read in order to determine the quantity of gas supplied. An issue arose as to whether the taxpayers were bound to bring into account as income derived sums in respect of gas supplied but unbilled prior to the end of the relevant tax year. The Commissioner submitted that, as the taxpayers had done all that was required of them under their obligation to supply gas and the property in the gas had passed ``beyond recall'' to the customers, then the taxpayers should bring the unbilled gas into account. The Full Court of this Court rejected the submission, saying at ATC 4806; ALR 699:
``The registration of a customer's gas meter is prima facie evidence of the quantity of gas supplied and determines the quantitative basis on which he is obliged to pay. The
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reading of the meter and the giving of notice to the customer of what is registered are more than mere procedure. They are conditions precedent to the making of demand for payment.''
93. The Court observed at ATC 4804-4805; ALR 697-698:
``Many tests have been propounded and many expressions adopted by the Courts in attempting to state when income is derived. Those tests have inevitably been conceived in different circumstances and to determine different facts and issues.....
Helpful as these tests may be as signposts, each of them has been conceived in and applied to varied and contrasting circumstances. As signposts they indicate that invariably something more than provision of goods or services by the taxpayer is required. It is necessary to determine whether the consequence is that a debt has been created or whether the taxpayer is obliged to take further steps before becoming entitled to payment. It may often be possible to reach the proper conclusion by the application of these tests if the circumstances of the taxpayer are unexceptional. However, the taxpayers in this case operate under exceptional circumstances. They contend that these circumstances dictate the manner in which they bring their revenue to account.''
94. The Court ultimately accepted the submission that the circumstances were exceptional in the sense that ``as at 30 June in each year their claims against customers for current liabilities for gas supplied had not matured into recoverable debts''. AGL at ATC 4806; ALR 699.
95. I have set out the facts in AGL in some detail in order to show that the circumstances of the sellers in the present case are not relevantly similar to those of the utilities in AGL. Unlike those utilities, the sellers were listed trading entities engaged in the production and provision of their products to the buyers on freely negotiated commercial terms. Indeed, the circumstances of the sellers vis-à-vis the buyers, as defined in the Supply Contracts, were distinctly ``unexceptional'' within the meaning of AGL. I reject the sellers' submission that the disputes about the pass-on amounts warrant a different conclusion. This matter does not bear on the relevant question, namely, whether the circumstances in which the sellers supplied their products to the buyers (as defined in the Supply Contracts) were so unusual that the usual ``signposts'' were of limited use. As Gummow J noted in Barratt at ATC 4283; FCR 232, in distinguishing AGL from Barratt (next discussed):
``The AGL case is an illustration of a statutory regime having the effect that until various conditions precedent are satisfied no debt comes into existence. That being so, it is a short step to decide that there is, at that stage, no derivation of income by the prospective creditor.''
In the present case the sellers were entitled to require the buyers to pay for the gas as provided for in the Supply Contracts (i.e., once the relevant time after delivery or receipt of the Standard Monthly Invoices had passed) and, as from 26 June 1991, an amount attributable to PRRT was a component of that payment.
96. Yet another situation in which the delivery or disposition of goods under a contract of sale may not be determinative of the creation of a debt and the derivation of income is where there is an impediment to the vendor's right to recover the debt. The principles governing such a situation were considered by the Full Court of this Court in Barratt.
97. The issue in Barratt was whether the appellant medical practitioners, whose income was determined for tax purposes on an accrual basis, were properly treated as having derived income from their professional services upon the rendering of accounts for fees in respect of those services. The practitioners contended that they were not. They argued that they could not derive income until a claim against a patient had matured into a ``recoverable debt'' and this did not happen until after they rendered their accounts to their patients. The practitioners pointed to the constraints imposed on their right to recover their fees by the New South Wales Medical Practitioners Act 1938. The legislation expressly provided that they were not entitled to sue to recover their fees until six months after an account had been rendered without the exercise during that time of a patient's right to have the fees reviewed: see Barratt at ATC 4281-4283; FCR 230-231. In opposition, the Commissioner submitted that ``the income was derived when the debt for the fee arose, notwithstanding that it was subject to an
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impediment as to recovery such that it could not be sued for until after an interval'': Barratt at ATC 4281; FCR 231. In considering the issue, Gummow J (with whom Northrop and Drummond JJ agreed) stated, at ATC 4281-4282; FCR 231, as follows:``No doubt a debt that is presently recoverable by action generally will be an amount `derived' in the relevant sense by the creditor. The creditor will have a present right to receive the amount in question, something both earned and quantified, without the presence of any element of contingency or defeasibility. At the other end of the scale, where the right of the taxpayer is contingent, there will be no derivation before the contingency is satisfied: see Parsons, `Income Taxation in Australia', §11.49. Nor will there be derivation if the debt is yet to be quantified:
Farnsworth v FC of T (1949) 9 ATD 33 at 37; (1949) 78 CLR 504 at 513, per Latham CJ.The present case is at neither extreme of the spectrum.''
The debt in Barratt lay in an intermediate category. It was neither contingent upon the satisfaction of a condition precedent nor unquantified as to value, although it was not ``presently recoverable'' by reason of the express legislative impediment.
98. As Gummow J recognised in Barratt, there is no hard and fast rule for determining when income is derived. Much depends on the ``truth and reality'' of the situation. In Barratt the truth and reality was that the practitioners' fees were regularly paid without regard to the six-month period specified in the State law - either by the patient (with or without insurer) or, after the introduction of ``bulk billing'', by the patient (with or without insurer) and the Commonwealth. In this circumstance, Gummow J concluded, at ATC 4283; FCR 233, that the statutory limitations upon actions or suits for recovery of fees or remuneration did not constitute conditions precedent to the existence of any debt, but were merely impediments to enforcement. His Honour held, at ATC 4282; FCR 232, that:
``... In the light of all the facts, it would be to depart from the truth and reality of the situation to treat the provisions of the State statute as deferring what otherwise would be the earlier derivation of income.''
Accordingly, the Court held that the practitioners' income was properly computed on an accrual basis.
99. The sellers relied on Barratt in connection with their submission that the right conferred by the Supply Contracts to the pass- on amounts was contingent, thereby occupying the extreme end of the spectrum referred to by Gummow J in that case. For the reasons already stated, I reject these propositions. Similarly, for the reasons previously given, I reject the sellers' submission that the provision for arbitration in each of the Supply Contracts relevantly impeded directly or indirectly the sellers' ability to recover the pass-on amounts. The sellers' reliance on Barratt was, in my view, misplaced. Rather, the principles outlined in Barratt support the case for the Commissioner.
100. There is another circumstance in which, notwithstanding the completion of a contract for the sale of goods, an unpaid but due purchase price may not lead to a derivation of income on the vendor's part. This is where the taxpayer would have no means of reversing the attribution of income in the event that the taxpayer's claim for payment fails. In the present case, the sellers submitted that, if their claim for the pass-on amounts had been found untenable, then they would have been unable to write off these amounts as bad debts under the ITAA (and PRRT Act). They would thus have been liable to pay tax in respect of the amounts even though they had no legal entitlement to them. In this context, they referred to
Commonwealth-New Guinea Timbers Ltd v The Chief Collector of Taxes [1973] PNGLR 388. The sellers also relied on statements in the authorities as to the importance of the bad debt provisions to the accrual based system of income assessment. They referred to Carden's case at ATD 132-133; CLR 156; Rowe at ATC 4159; CLR 448-449; Brent at ATC 4200; CLR 429, and Farnsworth, followed in Gasparin at ATC 4287-4288; FCR 82-83.
101. In Rowe at ATC 4159; CLR 448-449, Menzies J noted:
``... It is accepted that, for taxation, as well as for business purposes, the income of... a business is derived when it is earned and the receipt of what is earned is not necessary to bring the proceeds of sale into account. The acceptance of this basis of accounting is
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recognised by the provisions of the Act relating to the writing off of bad debts which `have been brought to account by the taxpayer as assessable income of any year': see s 63.''
102. In Farnsworth, the taxpayer was unable to treat the income attributed to her in one year of tax as a written-off debt under s 63 of the ITAA (or other allowable deduction) in another year if the monies claimed by the Commissioner to income were not in fact ultimately received. This factor was held to be a strong indication that the Commissioner's assessment was wrong. Dixon J explained, at ATD 40-41; CLR 519, that:
``A third ground was taken for the Commissioner in support of the assessment. It is said that she carried on a business in which she produced a commodity and turned it into money. The proceeds of such a business should be assessed, it is urged, on an earnings basis, that is by, a comparison of the position of the business at the beginning and end of an accounting period, taking into account all accruals and outstandings.... The argument has, I think, weight; but it involves difficulties. The sum expected to arise from the pool cannot be described as a debt. If the sum was not realised in the ensuing accounting period, the deficiency could not be brought within s 63. If the deficiency could be brought in as a loss or debit it must be on general principles of accounting. To bring it in somehow would be essential to a fair assessment. Yet the structure of the Act is hardly consistent with a debit which will not fall within any category of authorized deduction. It could not readily be brought within s 51. These are some of the difficulties.''
(In view of my conclusion below, it is unnecessary to consider whether a deduction might have been available under s 51(1) of the ITAA if the sellers' claim for the pass-on amounts had been found to be misconceived: cf
FC of T v National Commercial Banking Corporation of Australia Ltd 83 ATC 4715 at 4719; (1983) 72 FLR 116 at 120 and
Commonwealth Aluminium Corporation Ltd v FC of T 77 ATC 4151 at 4161; (1977) 32 FLR 210 at 224.)
103. The applicability of the authorities to which the sellers referred depends on the sellers' other submission (which I rejected above) that the right under cl 19.5 of the SECV agreement and equivalent provisions in other Supply Contracts did not give rise to a recoverable debt since the so-called right was uncertain or otherwise defeasible. The instant case is relevantly different from cases such as Farnsworth and Gasparin that involved contingent or defeasible rights that, in law, did not give rise to the existence of a ``debt''. These authorities offer little guidance in the circumstances of this case.
104. I accept that the effect of the parties' settlement of their contractual disputes was to extinguish the buyers' debts in respect of the pass-on amounts. In consequence, these debts could not be treated as ``bad'' for tax purposes: see
GE Crane Sales Pty Ltd v FC of T 71 ATC 4268 at 4272; (1971) 126 CLR 177 at 186-187. This was, so it seems to me, merely one of the factors to have been taken into account by the sellers in negotiating the terms of any commercial settlement with the buyers: cf Henderson at ATC 4020; CLR 650. It does not require acceptance of the sellers' case.
105. As already noted, the sellers accepted that the income that the sellers derived from supplying gas or ethane to the buyers should be calculated on an accrual, and not a receipts basis. Their case was ultimately that the Commissioner erred in treating as income derived the pass-on amounts claimed in the pass-on letters and invoices since this did not give ``a substantially correct reflex of the taxpayer's true income'': cf Carden's case at ATD 131, 132-133; CLR 154, 155-156. As Gummow J made clear in Gasparin at ATC 4285; FCR 80, income is ordinarily said to be derived when goods the subject of a contract of sale are delivered because of a presumed need to match disposals from trading stock to the derivation of income. The matching is in order ``to ensure a correct representation of a trader's financial position'', and is justified only to the extent that the need exists in fact. If such matching does not achieve a correct representation, then the approach ordinarily adopted in assessing a trader's income will not be appropriate.
106. In this case the sellers submitted that their evidence showed that matching the disposal of the gas and ethane under the Supply Contracts to the derivation of income from the disposal resulted in an incorrect representation of their trading position. They relied on the
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unchallenged expert opinion of Professor R G Walker, who is Professor of Accounting at the University of New South Wales, regarding the appropriate accounting treatment of the pass-on amounts during the relevant years of tax. Although evidence of accounting practice of the kind presented by Professor Walker is not binding on a court, it can certainly be persuasive and may in some cases assist the court ``[i]n determining the reality of the situation'': Gasparin at ATC 4285; FCR 79; also Carden's case at ATD 129-130; CLR 151-153 andArthur Murray (NSW) Pty Ltd v FC of T (1965) 14 ATD 98 at 99-100; (1965) 114 CLR 314 at 318.
107. In determining what was an appropriate accounting treatment for the pass-on amounts for the relevant tax years, Professor Walker relied primarily on the Statement of Accounting Concepts SAC 4 ``Definition and Recognition of the Elements of Financial Statements''. Professor Walker observed, at par 23 of his report:
``Statement of Accounting Concepts SAC 4 `Definition and Recognition of the Elements of Financial Statements' is a key source of authority for consideration of the accounting issues in the situation being examined.... SAC 4 takes the position that uncertainty about valuations means that certain items which are regarded as assets or liabilities should not be brought to account (i.e. reported as assets or liabilities in financial statements, with the values attributed to those assets or liabilities included in the statement totals).''
108. He relied (at par 31) on the criteria in SAC 4 that:
``An asset should be recognised in the statement of financial position when and only when:
- (a) it is probable that the future economic benefits embodied in the asset will eventuate; and
- (b) the asset possesses a cost or other value that can be measured reliably.''
109. Referring to these criteria, Professor Walker rejected the principle underlying the ATO's position paper of August 1995, that ``revenues are properly recognised for accounting purposes either when amounts are invoiced or sums are demanded'', on the ground that:
``Those events are not determinative of whether future `economic benefits' are controlled by an entity, or of whether it is probable that future economic benefits embodied in the asset will eventuate, or of whether the value of those economic benefits can be measured reliably .''
(par 42, emphasis original)
110. Looking at the question whether the sellers should be treated as having accrued revenue in respect of the pass-on amounts on the date of delivery of the gas or ethane under the Supply Contracts, the Professor stated (pars 46-47):
``In my view, on the delivery of gas to the Point of Delivery the Sellers... were certainly entitled to recognise revenue from the sale of the quantities of gas conveyed to the Delivery Point, as defined in the GFC Supply contract. The quantum of that revenue would encompass the contractual price for a `daily quantity of gas'.
The issue to be addressed is whether the Sellers' revenues at that point should also encompass the dollar value of PRRT claimed by the Sellers to be applicable or attributable, directly or indirectly, to the quantity of gas delivered and thereby sold to the Sellers.''
111. That is, Professor Walker conceded the appropriateness, from an accounting perspective, of treating the Contract Price as income derived by the sellers on the date of delivery of the gas and ethane. But there was a question, so far as he was concerned, as to whether the same treatment was justified in respect of the pass-on amounts. If, however, these amounts are properly to be regarded as part of the Contract Price (as I hold), then this question does not arise. If the Contract Price is appropriately treated as income derived by the sellers on the date of delivery of the gas or ethane, then so too were the pass-on amounts.
112. Having asked himself a question which, in my view did not arise, Professor Walker concluded that the disputes between the sellers and the buyers regarding the pass-on amounts created, ``[f]rom the Sellers' point of view... uncertainty about whether any claims it might make for PRRT associated with the delivery and sale of gas [and ethane] at the delivery point would be accepted by the Buyers'' (par
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49). According to him, the effect was the creation of a further uncertainty``as to whether Sellers controlled the economic benefits represented by those claims, and hence whether those claims would constitute `assets'. It also gives rise to uncertainty as to whether it was probable that those future economic benefits would eventuate, and hence whether any `asset' should be recognised at the end of the Sellers' respective financial years.''
113. According to Professor Walker, nothing that occurred prior to settlement was sufficient to have resolved the uncertainty in the sellers' minds about their entitlement to the pass-on amounts, with the result that they were required to recognise such amounts as assets within the meaning of SAC 4. In his opinion, it was only at settlement that the sellers were reasonably required to record the pass-on amounts as accrued income. Hence he observed, at par 76, that:
``Consideration of what were appropriate accounting treatments for the Sellers in their financial years ended 31 May 1995 (BHPP) and 31 December 1995 (EARL) involves a careful assessment of whether it could be said that the Sellers' claims against the buyer constituted an `asset', and whether it could be recognised. The SECV Awards of October and November 1994 suggested that the Sellers were entitled to recover (and gross up) PRRT from one buyer. However the matter had not been finally resolved, given that the SECV was seeking to appeal the decisions. On this basis, I do not consider that the Sellers had reached the point where they could be confident that they `controlled' the future disposition of the claims for the pass-on of PRRT from SECV, let alone from GFC. Hence I am of the view that it would have been inappropriate for either Seller to recognise those claims as an `asset' in these circumstances. In my experience, it is extremely rare for entities to record claims which are subject to litigation as `assets'.''
114. Professor Walker concluded, at pars 80-82, that:
``For various commercial and possibly political reasons, the parties decided to resolve the dispute, and to agree upon future conditions and terms under which gas would be supplied to the Buyers. The Deed of Settlement clearly established what sums were to be payable to the Sellers in respect of past claims for the pass-on of PRRT in respect of gas sold and delivered to GASCOR between 1 July 1990 and 31 October 1996. In my view these sums were properly regarded as assets at that time, since the Deed of Settlement established that the Sellers `controlled' economic benefits, and ensured that the sums involved could now be measured `reliably', within the meaning of SAC 4.
Accordingly, I have no hesitation in saying that in the ordinary course of events, revenues should have been recognised in the annual accounts of both Sellers for the accounting periods which ended after the date of settlement i.e. the year ended 31 December 1996 (EARL) and 31 May 1997 (BHPPBS), and not in any earlier year.
For accounting purposes, I have no concerns that the effect of this treatment would mean that revenues nominally attributable to or derived in earlier years would be recorded in a single year. That is an inevitable consequence of the use of rules governing the preparation of periodic financial reports. In the absence of such rules, a range of abuses have occurred, leading to the presentation of annual reports which convey a misleading impression of financial performance.''
115. There are difficulties with this approach. Just as the assertion of a legal entitlement to payment cannot of itself make that payment assessable for income tax purposes, equally the denial of a legal entitlement to payment cannot of itself make that payment non-assessable for income tax purposes. Yet this is the effect of Professor Walker's opinion, relying as it does on the impact of the disputes about the pass-on amounts as lessening the sellers' confidence in their claim. There is a difficulty in omitting any consideration relating to the merits of the sellers' claim from the kind of analysis made by him. Moreover, Professor Walker's reliance on the taxpayer's own confidence (or lack of confidence) in a claim would, if correct, lend an unacceptable degree of unpredictability and potential irrationality to inquiries of the present kind. Finally, there is the difficulty referred to by Professor Walker himself at par 82, namely, that the revenues ``attributable to or derived in
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earlier years would be recorded in a single year''.116. I am not persuaded that the expert opinion of Professor Walker assists the Court in determining the truth and reality of the present situation since it is premised on the mistaken assumption that the pass-on amounts were separate from, and did not form part of, the Contract Price, and because of the other difficulties referred to above.
117. For the foregoing reasons, I accept the Commissioner's characterisation of the truth and reality of the situation. That is, on the imposition of PRRT on 26 June 1991, the sellers had a contractual right to be paid the pass-on amounts by the buyers as part of the Contract Price under the Supply Contracts. The sellers have not shown that the Commissioner erred in treating these amounts as income derived by them on the date of delivery. Nor have the sellers shown that the Commissioner erred in treating them as the ``consideration receivable'' for PRRT purposes.
118. The quantum was the amount of the adjustment to the Contract Price which the sellers were entitled to make in respect of the gas (or ethane) supplied in the relevant tax year under cl 19.5(1)(a) of the SECV agreement and the equivalent provisions in the other Supply Contracts. The Supply Contracts contained no provisions for calculating the amount of any pass-on amount. I accept that, as the Commissioner submitted, the Supply Contracts left the calculation of the adjustment amount to the sellers. The sellers were obliged to make the calculation in a fair and reasonable manner, and to notify the buyer of the amount and the manner of calculation. In the SECV arbitration, the arbitrators construed cl 19.5(b) of the SECV agreement in this way (Award, pars 20.11-2.13). I see no good reason to depart from the arbitrators' approach, and the other Supply Contracts should be similarly construed.
119. As we have seen, the arbitrators held, in relation to the SECV agreement, that the buyer failed to establish that the method of calculation adopted by the sellers in the Sellers' Manual Part II dated 27 January 1993, as amended in February 1994 (``the Sellers' Manual''), was not an appropriate one for the purposes of the SECV agreement. They went on to declare that the buyer was obliged to pay the sellers sums representing the pass-on amounts to which they were entitled by virtue of cl 19.5(a)(i) of the SECV agreement. In these proceedings, the parties referred to the Sellers' Manual in the their statements of agreed facts in connection with arbitration under the SECV and GFC agreements. In each case, the parties agreed:
``Because [the buyer] had already indicated its opposition to being liable to pay any Pass-on Amount, however calculated, the 13 November 1991 Pass-on Letter [i.e., the first of such letters] was sent on the basis of the methodology then available to Sellers but consistent with the principles of its claim.''
120. I see no reason to doubt that, in relation to the SECV agreement, calculations made in accordance with the Sellers' Manual resulted in amounts equal to the sellers' entitlement to the pass-on amounts under that agreement. Notwithstanding this, it may be that, for the purposes of these proceedings, nothing is said to turn on any change in the sellers' methodology between November 1991 and the production of the Sellers' Manual, as amended. Bearing in mind that the Supply Contracts left the calculation of adjustments under the pass-on provisions to the sellers (subject to the qualification to which I have referred), this may be, although no party has specifically said so. In this circumstance, it is appropriate to give the parties an opportunity to consider this specific aspect of the matter, bearing in mind the fundamental principle that the quantum of the income on which the sellers are to be assessed in the relevant tax year is the amount of the adjustment to the Contract Price which the sellers were entitled to make in respect of the gas (or ethane) supplied in the relevant tax year under each of the Supply Contracts. The outcome of the parties' consideration will be relevant to the orders subsequently to be made by me.
121. Accordingly, I would afford the parties not only an opportunity to consider the last- mentioned matter, but also an opportunity to formulate appropriate minutes of orders, in accordance with these reasons and preferably by agreement. For this purpose, I would direct that the parties file and, in the event of disagreement, serve a minute of proposed orders and any submissions they wish to make concerning this proposal within fourteen days of the delivery of these reasons.
THE COURT ORDERS THAT:
1. The parties file and, in the event of disagreement, serve proposed minutes of orders
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and any submissions in support within fourteen days of the date hereof.2. The matter be adjourned to a date to be fixed.
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