Federal Commissioner of Taxation v. E.A. Marr and Sons (Sales) Ltd.

Judges:
Bowen CJ
Toohey J
Lockhart J

Court:
Full Federal Court

Judgment date: Judgment handed down 3 August 1984.

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Bowen C.J., Toohey and Lockhart JJ.

These are three appeals from the Supreme Court of New South Wales which raise the question whether the taxpayer was entitled to deduct from its assessable income for the financial years ended 30 June 1975, 1976 and 1977, pursuant to the second limb of sec. 51(1) of the Income Tax Assessment Act 1936 (``the Act''), payments made by it to finance companies in relation to leases of plant and machinery. The payments, which totalled $396,289, were made by the taxpayer during 1972 when it was in receivership and liquidation. The winding up was stayed in October 1972 and the receivers and managers retired in December 1972. The taxpayer sought to carry forward the losses represented by those payments and deduct them from its assessable income for the three years in question.

The Commissioner disallowed the deductions claimed and his decisions were referred to a Board of Review which confirmed the assessments. The taxpayer appealed to the Supreme Court of New South Wales which allowed the appeals with costs. The appeals were heard together. One set of reasons for judgment was delivered, but separate orders were made in each appeal. The Commissioner

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brought these appeals to this Court, by leave, from the Supreme Court's judgment and orders in each case. All appeals were heard together by consent before this Court.

The taxpayer is a member of a group of companies known as the McDonald Industries Group, the ultimate holding company of which is McDonald Industries Limited, a listed public company. The taxpayer itself has six subsidiaries. This company structure existed at all relevant times. The companies in the McDonald Industries Group were organised into three administrative divisions namely, a construction division, a mining division and a machinery and plant division. The taxpayer and all its subsidiaries operated as the machinery and plant division.

The taxpayer's principal activities were:

• (i) holding shares in its subsidiaries;
• (ii) owning and leasing to its subsidiaries land and buildings used by the subsidiaries in their respective businesses. The taxpayer received the following rental from the leases of its land and buildings to subsidiaries during the years 1 July 1968 to 30 June 1972:

                             $
        1968/69.........  46,000
        1969/70.........  58,264
        1970/71.........  77,430
        1971/72.........  22,135
            

• (iii) providing management and administrative services of an accounting and technical nature for its subsidiaries and other companies in the McDonald Industries Group. For these services the taxpayer sent monthly invoices charging administration fees to the companies concerned in order to recoup most of the expenses it incurred in providing the services. Income derived by the taxpayer from this activity during the period 1 July 1968 to 30 June 1971 was as follows:

                             $
        1968/69.........  34,000
        1969/70.........  59,611
        1970/71......... 114,067
            

• (iv) leasing to its subsidiaries and others machinery and plant owned by the taxpayer. The principal lessee of this machinery and plant was a company, Frances Creek Mining Corporation Pty. Ltd., which owned and operated an iron ore mine at Frances Creek in the Northern Territory. The taxpayer received from the lessees a ``mine plant management fee'' which was designed to recover ``ownership costs'' in respect of the machinery and plant. ``Ownership costs'' included depreciation, estimated replacement costs, an interest factor and a mark up to yield profits. The ``mine plant management fees'' received by the taxpayer in the years 1 July 1969 to 30 June 1971 were as follows:

                              $
        1969/70..........  16,335
        1970/71.......... 100,976
            

• (v) acquiring machinery and plant on lease from finance companies and thereafter making it available to its subsidiaries and other companies for use by them in their respective operations or for hiring by them to others. No formal instruments of leasing were entered into by the taxpayer. This case is concerned essentially with this machinery and plant, to which we shall refer for convenience as ``the leased plant''.

The first payment of rent for the leased plant, and usually the second payment, was made by the taxpayer itself to the finance company concerned under the relevant lease. The taxpayer then recovered the amount of the rent paid by it by invoicing the subsidiary which was using the leased plant in its own business or had hired it to others. Most of the leased plant passed into the custody of the taxpayer's subsidiary, Emar Engineering Services Pty. Ltd. (``Emar''), which in turn hired it to others, in particular a company Surveys & Mining Pty. Ltd. Subsequent payments of rent under the leases were customarily made to the finance companies by the subsidiary concerned which gave orders on its bankers for the payment of rent direct to the finance companies.

When subsidiaries of the taxpayer hired the leased plant to others they charged a fee which took into account the rent under the head lease, the likelihood that owing to heavy use the value of the leased plant at the expiration of the lease would be less than the residual value stated in the lease, and a mark up to cover the overheads of the subsidiaries and to provide a profit. The subsidiaries issued invoices for hiring charges and took steps to collect the amounts invoiced. It was left entirely to the subsidiaries and hirers from them to use the plant in such way as they thought appropriate.

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In the period prior to the appointment of the receivers the taxpayer claimed no deductions in its returns of income for rental payments made or obligations incurred in respect of the leased plant; nor did it show any income derived from its use.

The procedure usually adopted by the taxpayer when it purchased or leased plant was that, upon request from an officer of a company in the McDonald Industries Group for a particular item of plant, Mr. Soden who was ``the plant manager of the Marr group of companies'' (it appears that this last mentioned reference is to the taxpayer and its subsidiaries) considered the matter. A decision was then made by Mr. Doherty ``the General Manager of the taxpayer and of the Marr group of companies'' whether the particular item of plant should be obtained. A discounted cash flow was prepared for the different possible methods of acquisition namely, purchase, lease or hire purchase and sent to the Financial Controller of the McDonald Industries Group. If approved, the proposal was then submitted to the board of directors of the taxpayer for its approval.

Many items of plant were purchased or leased by the taxpayer before the appointment of the receivers in 1971. Most of the plant leased for use by companies in the McDonald Industries Group was leased by and in the name of the taxpayer.

Some idea of the scale of the leasing activity at the date of the appointment of the receivers may be obtained from the fact that about ten finance companies were then leasing plant to the taxpayer. They claimed to be owed approximately $1,900,000. The leased plant included motor cars, tractors, trailers, dozers, cranes, welders, air compressors, trucks, drills and compressors. The leased plant was leased to the taxpayer principally between May and December 1970.

In 1964 the taxpayer executed a deed of equitable mortgage over its assets and undertaking in favour of The Commercial Banking Company of Sydney Limited. On 18 March 1971 the bank, pursuant to powers conferred by that deed, appointed William James Hamilton and Ian Douglas Ferrier receivers and managers of the taxpayer and all its subsidiaries. On 27 September 1971 an order was made by the Supreme Court of New South Wales winding up the taxpayer and appointing Mr. Hamilton and Mr. Ferrier liquidators. All but one of the taxpayer's subsidiaries were wound up in 1972 and 1973 and Mr. Hamilton and Mr. Ferrier were appointed liquidators of them.

The taxpayer continued to carry on business after the receivers were appointed. The receivers realized some of the taxpayer's assets and discontinued some unprofitable trading activities, but those steps were taken by them to enable the taxpayer to continue trading and pay the taxpayer's creditors. Although the receivership and liquidation of the taxpayer overlapped, it seems that those steps were taken by Mr. Hamilton and Mr. Ferrier principally in their capacity as receivers and managers.

At the time of the appointment of the receivers the taxpayer had defaulted under most, if not all, the leases of the leased plant. The receivers decided to retain such of the leased plant as they thought was necessary for the continuation of the business of the taxpayer and its subsidiaries and to sell the remainder. It was agreed between the finance companies concerned and the receivers that the receivers would sell the unnecessary items of plant. The receivers sold those items and paid the proceeds of realization to the finance companies. The amounts paid represented arrears of rental under the leases, future rentals (with rebates in some cases) and the residual value of the plant sold. Certain credits were given by the finance companies; but there were deficiencies, so the finance companies lodged proofs of debt with Mr. Hamilton and Mr. Ferrier, presumably in their capacity as liquidators. It is the payments made to the finance companies in respect of those deficiencies, totalling $396,289, which are the subject of these appeals.

The receivers thought that the taxpayer and its subsidiaries could be rescued from their financial difficulties. They held the view generally throughout their receivership that the taxpayer and its subsidiaries should continue to carry on business. On 30 October 1972 the winding up of the taxpayer was perpetually stayed. The debts due by the taxpayer to unsecured creditors amounted to $665,864, but there was a surplus of cash over liabilities. Mr. Hamilton and Mr. Ferrier paid out all the unsecured creditors of the taxpayer the full amount of their indebtedness. The share capital of the taxpayer was also restructured pursuant to an arrangement between it and McDonald Industries Limited which was the major creditor

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of the taxpayer. McDonald Industries Limited appears to have capitalised part of the debt due to it by the taxpayer. On 11 December 1972 Mr. Hamilton and Mr. Ferrier retired as receivers and managers of the taxpayer.

The learned primary Judge found that the activities of the taxpayer the subject of these proceedings namely, providing the leased plant to its subsidiaries, constituted the carrying on of business by the taxpayer; that the business was carried on for the purpose of gaining or producing assessable income; that the payments in question constituted losses or outgoings necessarily incurred in carrying on that business; and that those losses or outgoings were not of a capital nature.

The Commissioner submitted before us that the primary Judge erred in making each of those findings. It was argued that the taxpayer never derived, and did not intend to derive, any assessable income from the relevant leasing activity. The provision by a taxpayer to its subsidiary of plant leased by the taxpayer from a finance company, at no cost to the subsidiary (as between the taxpayer and the subsidiary), could not, it was submitted, give rise to a deductible loss or outgoing for the taxpayer unless it was done by the taxpayer in anticipation of the receipt by it of dividends from the subsidiary's activities; and there was no such anticipation in the present case. It was argued that the taxpayer did not enter into the leasing transactions in its own name in order to earn dividends, nor did it carry on its business with a view to receiving assessable income by way of dividends from subsidiaries. The taxpayer derived no income from the activity of leasing the leased plant in its own name and passing it into the hands of its subsidiaries so that those subsidiaries themselves could produce assessable income from its use. The payments made to discharge the liabilities of the taxpayer to finance companies were said not to have been made in the course of carrying on the business of the taxpayer and not to have been part of its trading activities or operations. It was argued that the payments were made in the course of realizing assets in the winding up of the taxpayer. These are, in summary form, the submissions of the Commissioner on this appeal. Essentially the same submissions were put to the primary Judge and he found against the Commissioner on all of them.

The argument before the Supreme Court and this Court proceeded on the basis that the case turned solely on the second limb of sec. 51(1) of the Act namely, whether the payments in question were necessarily incurred in carrying on a business of the taxpayer for the purpose of gaining or producing its assessable income except to the extent to which they were of a capital nature.

Central to the Commissioner's case is that it is permissible to sever the taxpayer's leasing activities the subject of these proceedings from its other activities. As we mentioned earlier the taxpayer was at all relevant times a member of the McDonald Industries Group of companies. McDonald Industries Limited was its ultimate holding company and the taxpayer itself wholly owned a number of subsidiaries which leased substantially all the leased plant from it. The taxpayer and its subsidiaries constituted the machinery and plant division of the McDonald Industries Group and all its activities related thereto. In addition to the subject leasing activity, the taxpayer engaged in the other activities mentioned above namely, leasing land and buildings to subsidiaries for which the taxpayer received income; owning and leasing plant to its subsidiaries and other members of the McDonald Industries Group in return for a ``mine plant management fee''; and the provision of management and administration services in return for payment. Plainly those activities were part of the business of the taxpayer; indeed, the contrary was not asserted.

It is true that the arrangements between the taxpayer and its subsidiaries for the use of the leased plant were very informal. There were, for example, no formal instruments of reletting or rehiring. It is also true that no income was derived by the taxpayer from its leasing activities in question here, at least until after the appointment of the receivers. The first, and usually the second, rental payments due by the taxpayer to the finance companies were paid by it and it was reimbursed by the subsidiary concerned. Thereafter the subsidiaries paid the rental payments due by the taxpayer direct to the finance companies. But the subsidiaries were all wholly owned by the taxpayer. It controlled their activities and was in a position to channel their resources in whatever direction it wished. Although the subsidiaries did not pay rental to the taxpayer under the subleases (if that be the correct description of the arrangement between them), they in turn relet the leased plant to generate profits or used it in their own businesses. The taxpayer could, if and when it

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wished, direct profits from its subsidiaries to itself, for example, by having the subsidiary declare dividends.

There is also some evidence that the taxpayer hoped to derive profit from this leasing activity in question in the long term. The taxpayer's public company status for income tax purposes ensured that no income tax liability would be borne by it if this was done. Doubtless, in selecting which subsidiaries should have the use of the leased plant an important consideration was which of them would incur the least liability for income tax arising out of the receipt of hiring charges from the person to whom the plant was ultimately hired. By not requiring its subsidiaries to return profits to it, the taxpayer was in effect allowing them to build up and improve their capacity to do so. It is one way whereby a parent may give working capital to its subsidiary.

The taxpayer's leasing activities in question must be viewed as part of its activities as a whole and it is unrealistic to separate them. The taxpayer's business was treated as a whole in its accounts and by its accountants. This is not a compelling consideration, but it is a relevant matter to be taken into account in seeking to characterize the activities of a taxpayer for income tax purposes. It must also be remembered that, in the provision of management and administration services by the taxpayer to its subsidiaries in return for payment, there was no distinction made between the various categories of service provided by the taxpayer to the subsidiaries. Although the evidence is not very clear on this point it seems that those last mentioned services probably included the services provided by the taxpayer to its subsidiaries in relation to the leasing activities the subject of these appeals. Informal though the leasing activities of the taxpayer were, they were nevertheless part of its business activities. The taxpayer's leasing activities have a commercial explanation. Indeed, if they were not part of the carrying on of the taxpayer's business it is difficult to see how else they could be properly described.

There was some argument before us whether the relevant leasing activity of the taxpayer, if correctly described as the carrying on of business, was part of the business of the taxpayer viewed as a whole or a business separate from its other businesses. Nothing turns on this point; but in our view the former approach is correct and accords with the evidence.

In our opinion the findings of the Supreme Court that the activity of the taxpayer in leasing plant from finance companies and making it available to its subsidiaries constituted the carrying on of a business for the purpose of gaining or producing assessable income were correctly made.

We turn to the Commissioner's argument that there was no relevant nexus between the making of the payments in question to the finance companies and the carrying on of the taxpayer's business for the statutory purpose; that they were not part of its trading operations; and that they were made in the course of realizing assets in the winding up of the taxpayer's business.

The Commissioner relied upon the judgment of the High Court in
Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295 in support of this argument. In De Bavay's case the taxpayer carried on the business of treating tailings and producing zinc concentrates and other metalliferous substances and it employed mine workers in those operations. It discontinued that business in 1924. Whilst it carried on business it was liable to contribute to a fund to provide compensation for mine workers suffering from certain diseases, the liability arising from a statutory obligation under the Workmen's Compensation (Broken Hill) Act, 1920 (N.S.W.). The liability of the taxpayer to contribute to the fund still continued after 1924. In the years ended 30 June 1932 and 1933 the taxpayer paid certain contributions to the fund which it claimed as deductions. During those years the taxpayer did not derive any income from the treatment of tailings or the production of zinc concentrates or other metalliferous substances. The assessable income of the taxpayer in those years was derived from investments and from a hall at Broken Hill in which it had an interest. It was held that the taxpayer was not entitled to the deductions claimed as the amounts paid were not outgoings ``actually incurred in obtaining or producing the assessable income'' within the meaning of sec. 23(1)(a) of the Income Tax Assessment Act 1922 (Cth.) and could not be deducted under sec. 26(1)(a) of that Act as a loss made ``in carrying on a business''. It was held that the outgoings had no relation whatever to the assessable income of the years in question and that there was an entire lack of connection

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between the assessable income and the expenditure. The sources from which the assessable income of the taxpayer arose in that case included no business operations in the course of which the relevant payments were made. It was a payment made independently of the production of the income and was not an expenditure incurred in the course of its production.

De Bavay's case is plainly distinguishable from the present case. Although made towards the end of the receivership and winding up of the taxpayer, the payments had a relevant nexus with the carrying on of the taxpayer's business. The payments were made by Mr. Hamilton and Mr. Ferrier, probably in their capacity as liquidators and therefore in discharge of the claims of the finance companies as creditors of the taxpayer. It is not entirely clear from the evidence whether the payments were made to the finance companies by Mr. Hamilton and Mr. Ferrier as receivers or as liquidators. They were probably made in their capacity as liquidators since the finance companies were unsecured creditors in respect of deficiencies remaining after the sale of the lease plant and had lodged proofs of debt. But that is not conclusive against the taxpayer. All the relevant circumstances must be examined. Mr. Hamilton and Mr. Ferrier formed the view early in their receivership that it was desirable to retain the taxpayer as a going concern in the best interests of the secured creditors and the creditors generally. They did not regard the taxpayer as a company without a future. They originally intended that the taxpayer should continue to trade. At some time thereafter that intention may have waivered; but even after the leased plant had been sold in May 1972 some staff were retained.

It is not clear from the evidence whether the taxpayer had ceased altogether to carry on business at the time the payments in question were made by Mr. Hamilton and Mr. Ferrier to the finance companies; but it seems that the principal activities of the taxpayer during the period May to December 1972 were the necessary financial transactions to enable Mr. Hamilton and Mr. Ferrier to complete their activities. Even if the taxpayer was not carrying on business when the payments were made it would not necessarily follow that those payments were not on revenue account:
South Behar Railway Co. Ltd. v. I.R. Commrs. (1925) A.C. 476 per Lord Sumner at p. 488. The payments in question in this case were made by Mr. Hamilton and Mr. Ferrier after they sold the leased plant pursuant to an arrangement of convenience with the finance company. The occasion for the making of the payments is to be found in the carrying on of the taxpayer's business, in particular its leasing activities in question here. The payments were in discharge of the taxpayer's liabilities to the finance companies which had arisen from the leases entered into between those companies and the taxpayer and which had crystallized upon default in payment and the subsequent appointment of the receivers. The requisite nexus exists between the carrying on of the taxpayer's business and the payments in question.

Payments to creditors by liquidators following lodgment of proofs of debt would often not answer the description, for the purposes of sec. 51(1) of the Act, of outgoings necessarily incurred in carrying on the company's business. But in this case they were made when the taxpayer was solvent, the unsecured creditors were paid 100 cents in the dollar, and some assets and staff were retained. They were made in discharge of the taxpayer's liabilities incurred in the course of carrying on its business which included its leasing activities. The payments are properly characterised as being of a revenue nature and deductible under the second limb of sec. 51(1) of the Act.

In our opinion these appeals should be dismissed with costs.

THE COURT ORDERS THAT:

(1) The appeals be dismissed.

(2) The Commissioner of Taxation of the Commonwealth of Australia pay to E.A. Marr and Sons (Sales) Limited its costs of the appeals.