Raymor (N.S.W.) Pty. Limited v. Federal Commissioner of Taxation

Judges:
Lockhart J

Court:
Federal Court

Judgment date: Judgment handed down 19 October 1989.

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Lockhart J.

These are two references to the Court by the applicant, Raymor (N.S.W.) Pty. Ltd. (``Raymor''), of decisions of the respondent, the Commissioner of Taxation (``the Commissioner''), disallowing Raymor's objections to assessments to income tax in respect of the years of income ended 30 June 1984 and 30 June 1985.

The issues are whether the amounts of $600,113.16 and $584,388.61 claimed by Raymor as allowable deductions in the 1984 and 1985 years of income respectively, pursuant to sec. 51(1) of the Income Tax Assessment Act 1936 (``the Act''), constituted outgoings incurred by Raymor in those years of income in gaining or producing its assessable income or were necessarily incurred in carrying on its business for the purpose of producing such income; and whether the said amounts were outgoings of capital or of a capital nature.

Raymor is one of a number of related companies (to which I shall refer collectively as ``the Raymor Group'') which manufacture, sell and distribute plumbing goods and accessories throughout Australia. Raymor itself sells and distributes such goods in New South Wales and the Australian Capital Territory. Raymor Australia Pty. Limited (``Raymor Australia'') conducts the manufacturing business of the Raymor Group, acts as its treasurer and performs its head office administrative functions.

Included amongst the goods and accessories which Raymor sells and distributes is copper tubing, the majority of which is supplied to it by Metal Manufacturers Ltd. (``MML'') on a regular basis. Raymor's business involves in effect reselling the products, including copper tubing, which it purchases from its suppliers.

In about May or June 1983 Mr W.M. Kelly, the managing director of Raymor, had a telephone conversation with Mr J.A. Allen, who was at the time the group general manager, finance and a director of MML. Mr Kelly asked Mr Allen if MML would be interested in making an agreement with Raymor for the latter to purchase a supply of copper tubing with payment in advance of delivery at a price then to be agreed. Mr Kelly said that Raymor would only be prepared to do this on the basis that MML would ensure delivery as and when Raymor required it. Mr Allen asked how long it would be until delivery of the order was completed and Mr Kelly said three or four months or perhaps a little more. Mr Allen then said he would have to talk to his people in MML and let Mr Kelly know the result.

About a week or two later Mr Allen telephoned Mr Kelly and said that MML would agree to Mr Kelly's proposal subject to finalising the terms including the purchase price. Mr Allen said MML could not hold the price of copper over the period of the agreement as that was out of its control. Mr Kelly said that this could be covered by a clause being inserted in the agreement allowing for the rise and fall in the price of copper; but that otherwise the price of product sold would be held. Mr Kelly and Mr Allen discussed the question of Raymor's obtaining an additional discount, i.e. additional to the normal discount which MML gave Raymor as a large purchaser of copper products; and they agreed on an overall discount of 8.5%. Mr Kelly said that he would instruct Raymor's solicitors to draw up the appropriate agreement and send it to MML. Mr Kelly subsequently gave those instructions to Raymor's solicitors who prepared an agreement which was executed by the two companies on 30 June 1983 (``the 1983 agreement'').

The 1983 agreement provided for the sale by MML to Raymor of copper tubing for a total price of $661,351.83 less a discount of 8.5% namely, $56,214.91, leaving a balance of $605,136.92.

The 1983 agreement was followed by agreements in substantially the same terms in 1984 (``the 1984 agreement'') and 1985 (``the 1985 agreement'') which are the agreements with which these proceedings are concerned as they relate respectively to the two years of income ended 30 June 1984 and 30 June 1985.

The 1984 agreement was executed by Raymor and MML on 29 June 1984. I shall refer only to the provisions that are material for present purposes. The recitals, of which there are five, include recitals that:

• The purchaser (Raymor) has, from time to time, acquired a substantial part of its trading stock from the vendor (MML) (recital A).
• The vendor has informed the purchaser that in order to assist with the expected level of orders for its products it will be necessary

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  ATC 5176

  for firm arrangements to be made as regards the scheduling of production runs so as to satisfy orders from customers (recital C).

MML agreed to sell and Raymor agreed to purchase the goods which are described in an annexure to the agreement in the quantity and quality and at the price shown therein (cl. 1).

Clauses 2, 3, 4, 5, 7 and 8 provide as follows:

``2. All goods shall remain at the risk of the Vendor until they have been delivered to the Purchaser in accordance with Clause 3 such that only those goods which have been delivered to the Purchaser shall be at the risk of the Purchaser.

3. The Vendor shall deliver the goods to the Purchaser in the quantity specified in the Annexure hereto. Delivery shall take place at such times and places as are nominated to the Vendor from time to time by the Purchaser or one of its responsible officers.

4. The Purchaser shall be deemed to have accepted (as to description, quality and quantity) the goods forming a delivery when the Purchaser or one of its responsible officers acknowledges to the Vendor that the Purchaser has accepted such goods or where the Purchaser retains such goods for fourteen (14) days or more without the Purchaser or one of its responsible officers advising the Vendor or one of its responsible officers that the Purchaser has rejected them.

5. In the event of rejection of the whole or any part of goods forming a delivery:

• (a) the Purchaser shall be entitled to either require the Vendor to make a further delivery of goods in accordance with the Annexure to replace those rejected or to require the Vendor to issue a credit note in favour of the Purchaser in an amount equal to the price of the goods rejected;
• (b) the Vendor shall upon re-delivery of the rejected goods to the Vendor be at liberty to deal with the goods as the Vendor sees fit.

...

7. As consideration for the goods sold by the Vendor pursuant to the terms of this Agreement and as specified in the Annexure hereto the Purchaser shall pay to the Vendor on the execution of this Agreement the total purchase price as specified in the Annexure hereto of Six hundred thousand, one hundred and thirteen dollars and sixteen cents ($600,113.16) (the receipt whereof is hereby acknowledged by the Purchaser).

8. The parties acknowledge that notwithstanding the payment made pursuant to Clause 7 hereof, the price of each item of goods set out in the Annexure hereto may be subject to variation in accordance with the provisions of this Clause and in the event of any such variation being required to be made hereunder then the parties will make the appropriate financial adjustment in accordance with their normal trading terms. The price of each item of goods set out in the Annexure hereto shall be varied in the event of the Australian Copper Price increasing above or falling below $1,560.00 per tonne at the date of delivery of each item of goods in which event the price for such item shall become the Vendor's List Price as applicable at that time determined by reference to the Australian Copper Price at the date of such delivery and discounted by 8½%.''

The annexure to the 1984 agreement states that the total price is $655,861.38 less a discount of 8.5%, $55,748.22, showing a balance of $600,113.16.

The solicitors for Raymor wrote a letter dated 29 June 1984 to MML enclosing the 1984 agreement and a cheque for $600,113.16 expressed in the letter as ``being the purchase price payable under the Agreement''. The cheque was drawn by Raymor Australia on one of its banking accounts with Westpac Banking Corporation and was paid by Raymor Australia on behalf of Raymor. The relevant books and ledgers of Raymor Australia and Raymor record the payment as having been made in this manner. As mentioned earlier, Raymor Australia acts as banker for the Raymor Group. In the normal course of business payment of all invoices rendered to the companies within the Raymor Group, including Raymor, is made by Raymor Australia on behalf of the invoiced company. The payments are debited to the account of the invoiced company at the time payment is made and are subsequently recorded in the books of the invoiced company by means of a journal entry. The payment of $600,113.16

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ATC 5177

was treated in this manner by Raymor and Raymor Australia and in their respective books and ledgers.

The evidence establishes that deliveries of stock under the 1984 agreement had not commenced by 30 June 1984 and were made over a period of several months commencing in early July 1984.

On each occasion that stock was delivered to Raymor pursuant to the 1984 agreement the procedure adopted was that MML delivered stock to the branch of Raymor which had requested it. Delivery of stock was accompanied by a delivery note. At about the time of the delivery of the stock an invoice was received by the administrative office of Raymor. On receiving the stock Raymor entered the information contained on the delivery note and invoice in its records by generating an ``accounts payable advice''. From that last-mentioned document Raymor produced a report of all stock received in any particular month.

On 27 June 1985 MML and Raymor entered into the 1985 agreement for the sale by MML and the purchase by Raymor of copper tubing with pre-payment of the purchase price expressed in cl. 7 as $584,388.61. The terms of the 1985 agreement are in substance the same as those of the 1983 and 1984 agreements, though the discount applied was 15.25%.

On 27 June 1985 Raymor Australia sent to MML its cheque drawn on one of its banking accounts in the sum of $584,388.61. Like the cheque with respect to the 1984 year of income this cheque was paid by Raymor Australia on behalf of Raymor and the payment was treated in the books of Raymor and Raymor Australia in the same way as were the previous years' payments. None of the stock delivered pursuant to the 1985 agreement was delivered to Raymor as at 30 June 1985. Deliveries commenced in the early part of July 1985 and continued over several months thereafter. The same procedures for delivery of stock were followed for the 1985 year of income as had been followed for the 1984 year.

The price of copper moves considerably during a year and is influenced by many factors. When Raymor thinks that the price of copper is likely to rise it seeks to enter into contracts with its suppliers of copper tubing before the price rises sharply in order to maintain its prices to its own purchasers of the products. I am satisfied that, in order to ensure that it could meet its contractual commitments to its own customers and hold the price of its products Raymor entered into the contracts with MML having as a prime consideration the objective of keeping the price of the copper tubing purchased from its suppliers as constant as possible during the relevant year. Although it is not unusual for Raymor to renew its contracts of supply with its suppliers towards the end of each financial year, as well as at other times during the year, the only occasions during the three years commencing 1 July 1982 and ending 30 June 1985 on which Raymor paid in advance for purchases of its stock were the three occasions mentioned earlier, two of which are the payments with which this case is concerned.

Evidence was given by Mr Kelly and Mr Allen relating to the discount of 8.5% for the 1983 and 1984 years and 15.25% for the 1985 year. The discount appears to have been given partly because Raymor was one of MML's largest customers and partly because of the pre-payment of the purchase price. The evidence does not permit any conclusion as to the particular component of the percentage discount attributable to the pre-payments.

Mr Kelly and Mr R.G. Cook, the finance director of Raymor and of a number of other related companies in the Raymor Group, gave evidence by affidavit and orally. Mr Allen gave evidence by affidavit but was not cross-examined.

Mr Kelly's evidence was that the prime consideration in entering into the 1983, 1984 and 1985 agreements with MML for payment in advance for the copper tubing was not to obtain the maximum tax benefit for Raymor, but to ensure that Raymor would obtain a reliable supply of copper tubing. He said it was a coincidence that each of the payments made in the two years of income with which these appeals are concerned, although sums of magnitude, was made within a few days of the close of the relevant financial year.

Mr Allen swore in his affidavit that MML entered into the relevant agreements with Raymor because he considered it was of commercial benefit or advantage to MML to secure payment in advance for the purchases since MML both had the security of payment in advance and the use of the money.

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ATC 5178

The tax advantage which accrued to Raymor as a result of the pre-payment for trading stock was the benefit of a deduction under sec. 51(1) in that year of income whilst the opening value of the trading stock in question did not have to be brought into its books of account until the following year.

I accept the evidence of Mr Allen and of Mr Cook. I also accept the evidence of Mr Kelly, although there was some degree of rationalisation in his evidence as to his perception of the commercial benefits that flowed from the pre-payments to MML and of the significance of the tax benefits which accrued to Raymor from the pre-payments. In my opinion the proper conclusion to draw from the evidence, both on the probabilities and on my observations of the witnesses (and noting that Mr Allen was not cross-examined), is that there was a commercial advantage perceived by Raymor in making the pre-payments under the agreements in question. That advantage was MML's assurance that Raymor would receive the copper tubing from MML as and when required by Raymor so that Raymor could honour its commitments to its customers. I also conclude that Raymor perceived that it would derive a tax advantage in entering into the agreements and making the payments in question. I am satisfied, however, that notwithstanding the element of perceived tax advantage, the copper tubing purchased by Raymor from MML and sold by it to its customers was supplied to it and sold by it in the ordinary course of its business.

It is common ground between the parties that the 1984 and 1985 agreements were for the purchase of future goods and that property did not pass until delivery of the goods: sec. 23, r. 5 of the Sale of Goods Act, 1923 (N.S.W.) whereby in the case of a contract for the sale of unascertained or future goods by description, when goods of that description in a deliverable state are unconditionally appropriated to the contract, either by the seller with the assent of the buyer or by the buyer with the assent of the seller, the property in the goods thereupon passes to the buyer.

It is not in issue that the stock in question became trading stock of Raymor when delivered to it and that it was in fact sold by it to its customers in the ordinary course of its business.

Counsel for the Commissioner argued that the moneys in question did not represent outgoings incurred for the purchase of stock during the relevant year of income but were outgoings paid for the receipt of the benefit of the contractual rights given by each of the contracts to Raymor, namely, promises by MML that it would in the future deliver goods that by then would be ascertained and in a deliverable state. It was argued that the amounts expended by Raymor under the agreements were outgoings of capital or of a capital nature and therefore not allowable as a deduction under sec. 51(1). Counsel drew the distinction between the acquisition of trading stock and the right to acquire trading stock in the future. The case was said to fall within the latter category leaving no scope for the operation of sec. 51(2). The rights acquired under the agreements were rights to have copper tubing delivered to Raymor in the future and the rights to have the benefits ``in account of the sums which it had paid on execution of the agreements''. They were rights to have the amounts pre-paid by Raymor applied by way of set-off against the obligations accruing on delivery of the copper tubing by MML to Raymor during the following years of income.

The question on which this case turns is the identification of the true legal character of the two payments made by Raymor to MML. The Court is not, of course, confined to the terms of the agreements in determining the character of the payments. The Court must look at all the relevant circumstances surrounding the incurring of the expenditure including the two agreements:
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 47;
Commr of I.R. v. Europa Oil (N.Z.) Ltd. (No. 1) 70 ATC 6012 at p. 6019; (1971) A.C. 760 at pp. 771-772;
F.C. of T. v. Isherwood & Dreyfus Pty. Ltd. 79 ATC 4031.

The two payments were made by Raymor in consideration of the purchase by it of the copper tubing from MML which, upon delivery, became part of the trading stock of MML and which was sold by it to its customers in the ordinary course of its business. It is true that the stock was paid for by Raymor in June 1984 and 1985 and was not received by it until the month of July in each year; but upon receipt it was thereafter applied to satisfy the contracts which Raymor held with its customers in the ordinary course of its business. The payments were made pursuant to the contractual

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ATC 5179

obligations with MML created by the two agreements and in satisfaction of those obligations.

Although the two pre-payments for stock were made in the concluding days of each of the financial years 1984 and 1985 and no stock was delivered until the commencement of the next financial years, it must be remembered that delivery of stock commenced soon after 1 July in each year and continued progressively thereafter for some months.

The rights created by the agreements were not rights which were severable in some way from the trading stock itself or rights which would themselves yield the trading stock; what Raymor obtained for the purchase price was the trading stock itself. This case is therefore distinguishable from cases such as
Kauri Timber Co. Ltd. v. C. of T. (N.Z.) (1913) A.C. 771 and
Stow Bardolph Gravel Co. Ltd. v. Poole (1954) 1 W.L.R. 1,503 where the distinction is drawn between the purchase of trading stock itself and the purchase of a right to obtain such trading stock or the purchase of a source of trading stock.

In my opinion the payments made were outgoings incurred in gaining or producing Raymor's assessable income or, alternatively, were necessarily incurred in carrying on its business for the purpose of gaining or producing such income within the meaning of sec. 51(1) of the Act. The payments were made in the course of the derivation by Raymor of its assessable income and were incidental and relevant to that end: Ronpibon Tin at pp. 56-58. The payments therefore fall within the first limb of sec. 51(1). The payments also fall within the second limb of the subsection because they were appropriate or adapted for the purpose of earning such assessable income: Ronpibon Tin at p. 56;
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412; (1977-1978) 140 C.L.R. 645 especially per Gibbs A.C.J. at ATC pp. 4416-4417; C.L.R. pp. 653-655.

Counsel for the Commissioner argued that it was only a fiscal benefit that was received by Raymor and that the evidence as to the commercial benefit that was said to have been derived should be disregarded or rejected. It is plain that one of the reasons for Raymor entering into its contractual arrangements and making the payments with which these proceedings are concerned was to gain the tax advantage which pre-payments for trading stock would give it. For the purposes of sec. 51 the relevance of the existence of that purpose must now be doubted following the judgment of the High Court in
John v. F.C. of T. 89 ATC 4101; (1989) 63 A.L.J.R. 166 at pp. 168-171.

The two payments were not outgoings of a capital nature. The principles to be applied in determining whether outgoings are made on capital account are expounded in the classical judgment of Dixon J. in
Sun Newspapers Ltd. & Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-363. One must add to the three matters which his Honour said are to be considered, the further test applied by Gibbs A.C.J. in South Australian Batteries at ATC p. 4417; C.L.R. p. 655, namely, ``to decide what was the advantage sought by the taxpayer by making the payments''. See also the speech of Viscount Cave L.C. in
British Insulated & Helsby Cables Ltd. v. Atherton (1926) A.C. 205 at pp. 213-214; and
John Fairfax & Sons Pty. Ltd. v. F.C. of T. (1958-1959) 101 C.L.R. 30.

It is plain that in making the two payments Raymor sought to acquire trading stock for use in its business of buying and selling copper tubing. Also, as I have found that the two payments constituted expenditure incurred in the purchase of stock used by Raymor as trading stock, it must follow from sec. 51(2) that the payments shall be deemed not to be outgoings of capital or of a capital nature.

The Commissioner's argument that the payments were of capital or of a capital nature fails.

It was agreed between the parties that in the event and to the extent that Raymor succeeds in the appeals the Commissioner would remit additional tax imposed under sec. 222 of the Act proportionately.

I would allow the appeals with costs.