Standard Sawmilling Co. Pty. Limited v. Federal Commissioner of Taxation.

Judges:
Taylor J

Court:
Supreme Court of New South Wales

Judgment date: Judgment handed down 18 March 1974.

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Taylor J.: These are appeals by the taxpayer against the decision of the Deputy Commissioner of Taxation upon the company's objection against assessments of income tax based upon income derived during the years ended 30 June 1964, 1965, 1966,1968, 1969 and 1970. In respect of the years ended 30 June 1964, 30 June 1968 and 30 June 1969 the claims are either abandoned or not pressed, and in the result I am concerned only with objections for the years ended 30 June 1965, 1966 and 1970.

The taxpayer has for many years carried on business as a sawmill operator at Murwillumbah. It has an extensive business in procuring logs from State Forests and from private properties, milling the timber at its sawmill and selling it. Its business has expanded considerably. The company's Crown log quotas have increased from 1.3 million super feet in 1960 to 6.4 million super feet as at 20 June 1970. Over the years, the amount of timber available from private property has diminished, to the extent that at the present time 80% or 90% of the timber cut in the area in which the company operates is Crown timber.

Crown timber comes from State forests which are administered by the Forestry Commission established by the Forestry Act (1916-1969), which was the Act in force when the matters with which I am concerned arose. There have been substantial amendments by the Forestry Act of 1972.

The Act provides for the issue of general and special licences which authorise the holder, subject to the regulations and subject to the conditions and limitations of the licence to take timber or products of the specified description from the State forests. The term of a general licence shall not exceed twelve months and the term of a special licence shall not exceed 20 years. By sub-sec.

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ATC 4086

(3) of sec. 26 a special licence shall confer exclusive rights on the holder and when applicable to a defined locality may be sold by auction or by tender. In practice general licences have not been issued for many years; according to the evidence of one of the deputy Commissioners the last one issued was in 1920. Special licences may be issued by the Commission or any person authorised by the Commission. If the licence exceeds or may exceed five years it may only be issued by the authority in writing of the Commissioner.

In practice, special licences are issued by the District Forester for a period of one year from 1 January to 31 December. The licence specifies the compartment or compartments of the State forest from which the timber may be cut, the type of timber, e.g. hardwood, brushwood - the royalty rates to be paid to the Crown, and for some years past the licence has contained a clause specifying that the maximum volume to be cut under this and any other licence issued to the same person shall not exceed the annual quota, i.e. the maximum amount of sawn timber that may be cut at the sawmill during the current quota year. Licences provide that logs shall be cut at the licencee's own sawmill, and in respect of all sawmills a sawmill licence must be held. This is a licence issued pursuant to sec. 28 of the Act. It authorises the holder, subject to the regulations and subject to the conditions and limitations of the licence, to work a mill for the sawing and treatment of timber. The licence is not to exceed ten years but may be renewed for a term not exceeding ten years. There is no provision for the renewal of a special licence.

Section 27 of the Forestry Act provides penalties for any person who, except in pursuance of a licence issued under the Act or an exclusive right issued under the Act, cuts timber on Crown land.

The timber industry has developed largely around special licences and quotas. The practice is, and has been for many years, for the Commission to issue a special licence to a person who holds a sawmill licence. When the special licence expires the holder is given a special licence for the next twelve months, provided presumably he has worked the first licence satisfactorily. This process can continue indefinitely. Special licences issued after the first one are in some instances entitled ``Renewal'' of the special licence which they replace. The new licence issued bears a different number from the previous licence and these licences are described as successive licences.

During their currency special licences from time to time are amended as to the rates of royalty to be paid, the areas that may be cut and additional timber or products that may be taken. Forms for special licences, sawmill licences and transfer of licences are prescribed by the regulations. Quotas are fixed for a year which runs from 1 June to 31 May. Broadly speaking they are fixed so that a sawmill owner will be able to have a continuous operation over the year. There has been a practice of the Commission requiring that the quota be used over the whole year, and specifying quotas for each quarter, requiring that the quota be not exceeded in the quarter. However, if the holder of a licence did not wish to comply with this provision he could seek an exemption. The company with which I am here concerned always sought and was granted exemption and thus could have cut the quota allocated to any of the special licences at any time within the quota period.

It will thus be seen that although the licence year runs from 1 January to 31 December the quota year runs from 1 June to 31 May, and in practice the new quotas are often not notified until July or August. A further complication is that the taxation year, of course, runs from 1 July to 30 June.

On 11 April 1962, the appellant company by its accountants forwarded to the Commissioner a letter as follows -

``The above company has recently purchased a sawmill for £15,000. Its dominant motive in purchasing the mill was the acquisition of the Forestry licence which permits the cutting of a quota of 1.2 million super feet of timber per annum.

These licences expire each year and, although they are invariably renewed, it is actually a fresh licence which is issued.

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ATC 4087

In the Agreement for the purchase of the Mill the sum of £11,394 has been apportioned as the value of the licence, and the above Company intends to claim in its return for the year ended 30 June 1962 for a deduction for this sum in terms of sec. 124J.

The argument for this deduction is that the tax payer has paid this sum to acquire a right to fall standing timber in the terms of that Section and, as the right permits the cutting of any amount of timber up to the quota limit, it is proposed to base the claim on total cut up to the expiration of the licence.

We realise that it is not your policy to give rulings in matters such as this normally, but in the present case the matter has already been completed and, if the Company tax payer is entitled to the deduction as outlined above, it proposes to purchase another Mill in a similar manner in the near future.

Whether or not a deduction is allowed in these circumstances has a very material bearing on the price the tax payer is prepared to pay and therefore, on the taxpayer's behalf, we ask that you kindly advise if, in the circumstances set out,

• 1. A deduction is allowable.
• 2. A deduction is not allowable or
• 3. The question is open to doubt.

Any information you can offer could be of great assistance to our client.''

The Commissioner replied on 31 July 1962: -

``In connection with your letter of 11th April, 1962, you are informed that the company will be allowed a deduction of the amount of £11,394 paid for licence to fell timber. The deduction allowable in any year will be based on the proportion which the quantity of timber cut in that year bears to the estimated total quantity of timber available in the area allotted to the company and on the total amount of instalments of purchase price paid to the end of that year.''

Thereafter the appellant claimed a deduction in each tax year of 2/15ths of the amount paid for the licence, that is $3,038. This amount was allowed as a deduction, then disallowed and an amended assessment issued; subsequently a further amended assessment was issued allowing the amounts. I am not concerned in this case with this deduction which was in respect of a special licence J5791 held by Hancock & Gore Limited.

In the year 1964 the appellant company bought all the shares in Hollingsworths (Sawmills) Pty. Limited with a view to acquiring that company's right to cut timber from Crown lands. Prior to the execution of the agreement to purchase the shares the appellant company bought Hollingsworths' special licence for a price of £40,000. In giving its approval of the transfer of the special licence a letter from the District Forester stated:

``In addition it would be logical if the sawmill licence No. 5024 be cancelled after completion of the transfer. The Crown timber rights pertaining would be applied to your present licence No. 1302.''

I am prepared to accept that in this transaction the whole of the money was paid in consideration of the transfer of the special licence. Hollingsworth executed a form of transfer of this special licence No. L38320 and sawmill licence No. 5042 on 19 June 1964. The consideration was not apportioned as between the sawmill licence and the special licence. Mr. Alleyne Frederick Withey, the managing director of the appellant company, in his affidavit and in his evidence has said that the reason for this was that the licence was of no value to Standard, and the only reason for its inclusion in the sale was to comply with the Forestry Commission's requirements that if the special lease was to be transferred by the special licence holder who held also a licence for a sawmill where he had cut the timber under the special licence, this should also be transferred. There are, no doubt, good reasons why the Forestry Commission should insist on this requirement being observed.

On 24 June 1965 the appellant bought from Roseberry Sawmilling Company Pty. Limited for the sum of £70,000 ($140,000) all

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ATC 4088

that company's right, title and interest in sawmill licence No. 66 and special licence No. L40393. The transfer of the licence was executed on that day by the vendor. This transfer was duly consented to by the Forestry Commission. Since 1965 successive special licences have been issued to the appellant and quotas fixed for each year in respect of the areas formerly worked under the special licence transferred from Roseberry Sawmilling Company Pty. Limited.

According to the evidence of Mr. Withey, the sawmill licence was not used by the appellant but it permitted another company to operate the mill for a short period for the purpose of cutting private property logs. After a brief period the balance of the mill plant and equipment was either sold or scrapped, and the sawmill licence allowed to lapse. I am prepared to accept that in this instance the $140,000 was paid for the special licence and that the sawmill licence was included in the transaction to meet the requirements of the Forestry Commission.

On 26 March 1970, the appellant bought from West & Sharpe Pty. Limited for $30,000 special forestry licence No. L8688 and sawmill licence No. 407 for $1,000, and the transfer by West & Sharpe Pty. Limited of all its rights, title and interest in those licences was executed on that day. The sawmill licence was allowed to lapse, and since the acquisition of the West & Sharpe special licence the Forestry Commission has issued to Standard successive special licences on the expiry of the preceding licence.

The appellant taxpayer claims that it is entitled to deduct the amounts paid for these licences together with stamp duty and legal costs incurred in obtaining the transfers from its income because of the provisions of sec. 124J of the Act. That section provides -

``Where -

(a) a taxpayer has acquired -

(i) land carrying standing timber and part of the price paid for the land is attributable to that timber, or

(ii) a right to fell standing timber; and

(b) during the year of income, the whole or a part of the timber is felled -

(i) for sale, or for use in manufacture, by the taxpayer for the purpose of producing assessable income; or

(ii) in pursuance of a right to fell timber granted by the taxpayer to another person in consideration of payments to be made to the taxpayer as or by way of royalty,

so much of that part of the price so paid by the taxpayer to acquire the land, or so much of the amount paid by him to acquire the right, as the case may be, as is attributable to the timber felled during the year shall be an allowable deduction.''

The appellant claims that as a result of the amount paid for these licences it acquired a right to fell standing timber and is entitled to deduct from the year of income in which it has felled timber so much of the amount paid by it to acquire the right as is attributable to the timber felled during the year of income. It is not disputed that the timber felled came within para. (b)(i) of the section.

The first question to be decided in each case is: has the taxpayer acquired a right to fell standing timber? Mr. Ellicott, Q.C., for the appellant, submits it clearly has. The timber in question is timber owned by the Crown, on the State Forests. The right to cut timber can only be conferred by the Forestry Commission by the grant of a licence. This licence was duly granted in each instance to a company which has transferred it to the appellant with the approval of the Forestry Commission, and the appellant has thus become entitled as a matter of right to enter and cut timber in accordance with the provisions of the licence. Mr. Priestley, Q.C., for the Commissioner, made three main submissions to the contrary. Firstly he says that the licence does not confer a right. He points to the various conditions which appear in the licence and which the licencee has to observe; he points to the rights conferred by the Commission to enter upon the land and cut timber and to allow others so to do; and he says that having regard to all these matters the document does not confer a right.

There is no doubt that the licence imposes many restrictions upon the person who seeks under it to enter upon the Crown land and

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ATC 4089

fall timber, but in my opinion these are restrictions and conditions imposed upon a right given. They determine the manner and extent to which the right may be exercised and they contain provisions reserving - notwithstanding the right granted - rights to the Commission itself to go upon the land. It may be said that these conditions are onerous and restrictive, but in my opinion their effect is not to preclude the document from conferring a right to enter and cut, but rather they prescribe the manner in which the right may be exercised. Section 26 provides the authority given is subject to the conditions and limitations of the licence and sub-sec. 3 of that section, as I have earlier set out, speaks of the licence conferring exclusive rights on the holder.

Mr. Priestley next submitted that no right to cut timber was acquired unless and until a quota was fixed, and it was the quota which was the really important and effective administrative act which gave the licence-holder a right to cut. I do not agree with this submission. I think the quotas are no more than a determination by the Forestry Commission, and notification thereof to the licence-holder, that the amount of timber he may cut at his sawmill under his special licence may not exceed the quantity of super feet specified in respect of each species of timber in the quota document. The licence confers the right to go upon the land specified and cut timber. If there were no quotas fixed the licencee is still entitled as a matter of right to go in and cut timber subject to the other conditions of the licence.

The third submission made by Mr. Priestley raises a matter of considerable difficulty. It is that the appellant taxpayer paid the amount he now claims to deduct not for the right he acquired by transfer from the existing holder of the licence but for the future grant to him by the Forestry Commissioner of successive special licences, which undoubtedly he believed he would be given and was in fact given, the successive licences being to cut Crown timber within the limits fixed by specified quotas; and that it was for this continuity of the right to obtain Crown timber over the future years - which could continue indefinitely - that the money was really paid. This was not money paid for a right but for an expectation.

Mr. Withey frankly admitted that to his company the licence was as valuable on the last day of its currency as it would have been on the first, and what it was really concerned with was to obtain an indefinite supply of timber from the Crown forests. This supply could be indefinite since it is the practice of the Forestry Commission and has been for many years to carry out programmes of replanting, and since the rate of growth of trees planted is higher than the natural rate of growth, forests prudently and properly worked could be an indefinite source of timber supply.

The difficulty with this argument, is that the appellant taxpayer does not acquire for the sum of money paid any of these rights or expectations which are so valuable. The Forestry Commission is not bound to issue successive licences and, if it does not, the appellant taxpayer is without any remedy. When the section speaks of rights it must, I think, be taken to speak only of legal rights and what these rights are is ascertained from an examination of the provisions of the contract documents; in this case the licence and the instrument of transfer. It is not, I think, correct to say that the appellant when it became the transferee of the licence acquired any rights from the Forestry Commission except those conferred by the licence itself. The fact that licence-holders have for many years been granted successive licences to cut down timber by the Commission on an annual basis is, I think, no more than the situation in which special licences are transferred, and it is this circumstance which no doubt makes them so valuable. Nevertheless, what the appellant acquired by way of transfer were the rights under the special licence for the unexpired portion of its term, which the previous holder had, and nothing more. It acquired a right, in terms of the licence to enter on to Crown lands and fall timber as specified in the licence for the unexpired term of the licence. It could cut no more than the amount specified as the quota for the ensuing quota year but if during the term of the

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ATC 4090

licence a further quota was fixed it could, within the period of the licence, cut up to the amount of that quota. In my opinion, this is a right to fall standing timber, and the amount paid by the taxpayer to the previous licence-holder was paid to acquire that right.

The question then is what is the amount of that price which may be deducted during a year of income in which timber is felled? The section only gives a right for a deduction for timber felled during an income year and the timber must be felled during the currency of the licence. It is not necessary, in my opinion, for timber to have been felled in the income year in which the money was paid for the transfer of the licence.

A statement of agreed facts sets out the quantities of timber cut under the three special licences with which I am now concerned -

    ``Special Licence L38320 originally
    issued to Hollingsworths (Sawmills)
    Pty. Limited and transferred to taxpayer
    on 19th June 1964.
                                                  Super Feet

        1 June 1963 to 31 December 1963            771,358
        1 January 1964 to 31 May 1964              498,119
        1 June 1964 to 19 June 1964                  Nil
        19 June 1964 to 30 June 1964                 Nil   (So far as compart-
                                                         ments 43, 64, 67 and
                                                            68 are concerned)

      1 July 1964 to 31 December 1964              530,487     "      "

    Special Licence L40393 originally
    issued to Roseberry Sawmilling Co.
    Pty. Limited and transferred to taxpayer
    on 24 June 1965.
                                                  Super Feet

        1 January 1965 to 31 May 1965              518,537
        1 June 1965 to 24 June 1965                100,793
        24 June 1965 to 30 June 1965                 Nil
        1 July 1965 to 31 December 1965            553,133

    Special Licence L86821 originally
    issued to West & Sharpe Pty. Limited
    and transferred to taxpayer on 26
    March 1970.

                                                  Super Feet

        1 January 1970 to 26 March 1970            17,157
        26 March 1970 to 31 May 1970               48,334
        1 June 1970 to 30 June 1970                 Nil
        1 July 1970 to 31 December 1970           122,369        "     "''
        

For the Hollingsworths licence the appellant claimed to deduct for the year of income ended 30 June 1965 $81,165, being the whole of the amount paid for the transfer of the licence, stamp duty and costs. As appears from the agreed facts, it acquired the licence on 19 June 1964. No timber was felled in that financial year, but in the next financial year from 1 July 1964 to 31 December 1964, the licence expired and the appellant thereafter cut under a successive licence issued to it. It had a quota notified in July 1964 in respect of the

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ATC 4091

Hollingsworth licence transferred to it for the quota year ending 30 May 1965, some 1,215,345 super feet (see Exhibit G folio 24). At the expiry of the licence it had cut less than half this quota.

Mr. Ellicott contended, however, that the appellant was entitled to deduct the whole amount paid for the licence in the financial year ended 30 June 1965 since this was attributable to the timber felled during the financial year 1965. It could not after 21 December fall any more under the right acquired from the licence and it mattered not, he submitted, that although under the licence it had a right to cut 1,215,345 it had cut 530,487. Since this quantity was attributable to the price paid for the right, the whole of the price was to be deducted.

This is not, in my opinion, a correct interpretation of the section. Section 124J incorporates former sec. 69 and 70 and enlarges their scope. Section 69 was in the following terms -

``Where the taxpayer has acquired land carrying standing timber for the purpose of felling that timber for sale and part of the price paid for the land is attributable to that timber so much of that part as is attributable to the timber felled in the year of income shall be an allowable deduction.''

Section 70 provided -

``So much of the amount paid for a right to fell timber for sale as is attributable to the timber felled during the year of income shall be an allowable deduction.''

These sections were enacted to permit deductions in respect of the exhaustion of wasting assets in the timber industry, i.e. assets which consisted of the right to cut timber which the taxpayer had acquired by ownership of land or by purchase of the right itself. The Privy Council in
Kauri Timber Co. Limited v. The Commissioner of Taxation of New Zealand, 1913 A.C. 771 decided that a taxpayer carrying on the business of sawmill and timber merchant was not entitled to make any deduction from the gross proceeds of its business in respect of the value of standing timber which it had cut.

Section 124 enlarges the area in which deductions may be claimed. It maintains, however, the same method for determining the amount of the deduction in an income year, i.e. it is so much of the amount paid for the right as is attributable to the timber felled during the year of income. The section when it deals with the purchase of land carrying standing timber or a right to fell standing timber for which a price has been paid contemplates that what has been acquired may be cut and used over a period of time. In each income year where the whole or part of the timber covered by the right is felled there is to be a deduction and the deduction is to be determined by attributing an amount of the purchase price to what has been felled during the income year. The fraction of the purchase price to be deducted is determined by taking as the nominator the amount of timber felled during the income year=A and as the denominator the total amount of timber which may be cut under the right purchased =B, the integer, the purchase price, is X and the formula is A/B x X. If the right purchased is not to cut a specified quantity of timber but a right to cut an unspecified quantity over a period of time the amount of the deduction would be determined by the same formula, the nominator would be the amount cut in any specified year and the denominator would be the total amount that could be cut under the right. No doubt there may be difficulties in the working out of the formula and a number of assumptions might have to be made, but I agree with Mr. Ellicott that once a taxpayer comes within the section and he has paid a purchase price for a right to cut timber and has felled timber under this right within an income year, it is for the Commissioner and the taxpayer to work out the application of the section. If they cannot agree no doubt it is for the Court to do it. I have been informed by the parties that it is not necessary for me to become involved in questions as to the amount of timber felled and to work out the arithmetic, but rather to indicate the principles upon which the deduction should be assessed and if I do this the parties themselves will work out its application. This formula would thus determine the amount that was to be paid in

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ATC 4092

respect of the 1965 income year for the Hollingsworth transaction.

The appellant taxpayer, however, submitted that sec. 170(3) of the Act precluded the Commissioner from issuing an amended assessment, and contended that, since in its 1965 return it had made a full and true disclosure of all the material facts necessary for its assessment, then the Commissioner could not amend the assessment increasing the liability of the taxpayer except to correct an error of calculation or a mistake in fact.

I am of opinion that the taxpayer did not make a full and true disclosure, within the meaning of the section, in respect of its 1965 return. It failed to disclose to the Commissioner that the purchase price was paid as to $10,000 in June 1964 and the balance of $70,000 was paid on 29 June 1965. It stated that the company purchased the special Forestry licence for £40,582.10.0 whereas the agreement provided that the purchase price included a sawmill licence. This should have been disclosed to the Commissioner because, whatever the taxpayer's views were as to it being of no value, the Commissioner was at least entitled to be told the facts so that he could make up his own mind on this matter. It did not disclose to the Commissioner that at the time the licence was transferred the quota year had expired, on 31 May 1964, and the amount of the quota granted in August 1964 was for the 1964/65 year but could all have been cut in the licence period.

It is no answer to the Commissioner's contention that there was a failure to make a full and true disclosure to say that, since the Commissioner took the view that amounts paid for a special licence were not deductible under sec. 124J, information as to how the licence was paid for and the other matters earlier referred to are irrelevant. In 1965, the Commissioner held the contrary view and was in fact allowing deductions for amounts paid for the purchase of special licences. Apart from this, the section requires the taxpayer to make, inter alia, a full and true disclosure of matters claimed as deductions, since these are necessary for the assessment to be made, and this obligation on the taxpayer is not, in my opinion, affected by the fact (if it be the fact) that in the Commissioner's view the amount was not an allowable deduction. I hold therefore that the Commissioner was not prevented by sec. 170 from issuing the amended assessment.

The 1966 Return, the Roseberry Transaction.

On 24 June 1965, the appellant taxpayer purchased from Roseberry Sawmilling Co. Pty. Limited all that company's right, title and interest in Sawmill Licence No. 66 and Special Licence No. L40393 for the sum of £70,000 ($140,000) and the transfer was duly consented to by the Forestry Commission. No timber was cut under this licence between 24 June and 30 June 1965. From 1 July 1965 to 31 December 1965 the taxpayer cut under this licence 553,133 super feet.

The 1964/65 quota year had expired on 31 May 1965. A fresh quota letter was issued in August 1965 fixing as the quota for the licence transferred 1,500,000 super feet (see Ex. G, File Document No. 38). The amount to be deducted for the year 1966 is to be determined by applying the same formula to the total purchase price including costs and stamp duty.

The West & Sharpe Pty. Limited Transaction.

On 26 March 1970 the taxpayer bought from West & Sharpe Pty. Limited all that company's right, title and interest in Sawmill Licence No. 407 for $1,000 and Special Forestry Licence No. L86821 for the sum of $30,000. The purchase price was paid by a deposit of $3,100 on 24 March 1970 and the balance, $27,900, on 26 March 1970. The licence contained the usual provision -

``The licencee shall remove not less than........ per month and not more than the annual quota during the currency of the licence.''

No quota was specified on the licence.

The licence expired on 31 December 1970. Between the date of acquisition and 30 June 1970 the taxpayer cut in pursuance of this licence 48,334 super feet. From 1 July 1970 to 31 December 1970 the taxpayer cut under

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ATC 4093

this licence 133,279 super feet. It is not clear what quota was fixed for the year 1 June 1970 to 31 May 1971.

The amount of the purchase price to be deducted for logs felled during the year of income ended 30 June 1970 is to be determined in accordance with the same formula, i.e. the amount cut in that financial year is the nominator and the total quantity that could be cut under the licence is the denominator, the integer being the toal purchase price. I do not have before me the 1971 income tax assessment but I have been asked to give an indication how the deduction for that year is to be determined. In the financial year ended 30 June 1971 there was cut under this licence between 1 July 1970 and 31 December 1970 122,369 super feet and if a deduction were claimed for logs felled in that year the amount would be determined in accordance with the formula.

These are the conclusions to which I have come. They will involve upholding the objections to the extent that deductions are to be allowed in each of these three years of income. I will leave it to the parties to work out the figures and I will list the matter fourteen days from to-day to make the necessary consequential orders and deliver final judgment.