FEDERAL COURT OF AUSTRALIA

SPI PowerNet Pty Ltd v Commissioner of Taxation [2014] FCAFC 36

THE COURT ORDERS THAT:

1.    The appeal be dismissed.

2.    The appellant pay the respondent’s costs.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

EDMONDS J:

INTRODUCTION

1        This is an appeal from a judgment of a single judge of this Court holding that the appellant (“SPI”) was not entitled to allowable deductions from its assessable income under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (“the 1997 Act”) for payments it made to the State of Victoria pursuant to an Order of the Governor in Council made under s 163AA of the Electricity Industry Act 1993 (Vic) (“the EIA”) and consequent upon its acquisition of assets, including the Transmission Licence hereinafter referred to, from Power Net Victoria (“PNV”).

2        The primary judge rejected SPI’s claim on two alternative bases:

(1)    The s 163AA imposts were not a cost of SPI deriving its income. The s 163AA imposts were payments out of SPI’s profits after the calculation of SPI’s taxable income. The imposts did not satisfy either limb of s 8-1(1) of the 1997 Act: Reasons (“R”) [79]; [80].

(2)    While it was strictly unnecessary to consider this aspect of the claim (R [81]), the s 163AA imposts were outgoings of capital or of a capital nature: R [93].

3        I disagree with the first of these alternative bases for two reasons. First, it has no factual foundation; second, it is predicated on a process of reasoning which, with the greatest respect to its provenance, is, at best, attended with considerable doubt. I explore this more fully in the analysis below.

4        On the other hand, I agree with the second of these alternative bases, that deductibility is denied by s 8-1(2)(a) of the 1997 Act, and, in consequence the appeal must, in my view, be dismissed. I do so, however, for reasons additional to those relied on by the primary judge and it is necessary that I state and develop these in the analysis below.

5        The relevant facts are uncontroversial and are comprehensively set out in the primary judge’s reasons at R [1]–[37].

ANALYSIS

Section 8-1(1)

6        At R [79], the learned primary judge said:

The s 163AA imposts were payments out of SPI’s profits after the calculation of SPI’s taxable income.

If that is a finding of fact, it has no evidentiary foundation. Indeed, even the learned primary judge recognised as much. After considering what Lockhart J had said about the franchise fees under s 163A of the EIA in United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169, at R [70] her Honour said:

Section 163AA is in different terms. It does not prescribe how the impost is to be calculated. Having regard to the express terms of s 163AA alone, the Court could not be satisfied that the impost payments were payments of “profits”, being a payment out of profits after the calculation of the entity’s taxable income. Put another way, there is nothing on the face of s 163AA to suggest that SPI made the payments for any reason other than discharging an obligation to pay imposed upon it as the holder of the transmission licence.

7        It is just not possible to identify the source from which outgoings are paid at any moment in time. The moneys so paid might represent capital, unappropriated revenue profits, reserves, current revenues (less outgoings to date) or any or all of them. But as a matter of fact, the moneys cannot be identified as coming out of any particular fund or source, let alone “profits after the calculation of … taxable income”. Such outgoings might be expressed to be payable only out of profits/taxable income of a year, in which case there might well be a lack of a sufficient connection or nexus between the outgoing and the process of income derivation to qualify for deductibility. But there is no such embargo or impediment in the present case. The fact that outgoings are charged or debited to unappropriated profits in a company’s financial accounts does not take the matter any further although, as indicated, if they are required to be so charged or debited, it may bear on the question of deductibility under s 51(1) of the Income Tax Assessment Act 1936 (Cth)/s 8-1 of the 1997 Act: see Commissioner of Taxation (WA) v Boulder Perseverance Ltd (1937) 58 CLR 223; Emu Bay Railway Co Ltd v Federal Commissioner of Taxation (1944) 71 CLR 596; and Federal Commissioner of Taxation v Midland Railway Co of Western Australia Ltd (1951–1952) 85 CLR 306.

8        Factual matters aside, the primary judge’s process of reasoning at R [53]–[80] dealing with s 8-1(1) seems to be heavily influenced by the reasoning of Lockhart J in United Energy. At R [59] her Honour said:

The Court described the s 163A imposts as “franchise fees”. The issue before the Court was whether the franchise fees, levied against United Energy and paid, were deductible? Justice Lockhart decided that the franchise fees were akin to the State taking a share of United Energy’s profits leaving United Energy with what the Treasurer determined to be a reasonable return on the capital of United Energy used in deriving its income: at 180. Justice Lockhart described the franchise fees as being in the nature of the payment of a dividend or the residual distribution of profits or dividends to the State: at 181. Put another way, Lockhart J stated that because they were compulsory exactions directed at United Energy’s profits they were in the nature of a State tax on profits not a payment for services rendered or a cost incurred in the process of deriving income: at 180. Justice Lockhart said that the franchise fees were not deductible under s 51(1) of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act) (the predecessor to s 8-1 of the 1997 Act). The majority (Sundberg and Merkel JJ) agreed with Lockhart J that the franchise fees were a compulsory exaction imposed by the Victorian Government to extract a share of the profits of United Energy: at 193.

9        At R [68] her Honour said:

Justice Lockhart gave considerable weight to “the purpose of the State in imposing the liability to pay the tax”. In doing so, Lockhart J had regard (at 180) to the legislation – the terms of the provision imposing the franchise fee (s 163A): see [58] above. Having regard to the manner in which the amount of the franchise fee was to be determined under s 163A, Lockhart J found (at 180) that:

Properly analysed the franchise fees are in reality akin to the State of Victoria taking a share of the profits from the [distribution companies] (in this case the applicant), leaving the applicant an amount determined by the Treasurer to be a reasonable return on the capital of the company used in deriving the income (s 163A(2)(c)). The residue is taken by the State as its share of profits; it has similar characteristics to a payment by way of dividend.

(Emphasis added)

10        With great respect, I cannot agree with this process of reasoning, either in United Energy, or in so far as her Honour sought to embrace its applicability to the facts of this case. To say that an outgoing is “in reality akin” to a share of profits might bear on its character as a revenue or capital outgoing, but it does not thereby become a distribution of profits. I am not alone in this view. As the Full Court in City Link Melbourne Ltd v Commissioner of Taxation (2004) 141 FCR 69 said of Transurban’s claim for a deduction for the concession fees paid from toll revenue at [48]:

No doubt it is possible in commercial or political speech to refer to the State of Victoria as sharing in the profit made by Transurban in that the concession fee falls ultimately, to be paid by Transurban from revenues which it collects by way of tolls. The balance in the distribution account after project finance is repaid and a percentage profit recouped may be seen to represent some sort of cash flow profit of Transurban, although not profit in a strict sense. But just because this may be so does not establish either that the relationship between the State of Victoria and Transurban is a joint venture as the learned primary judge held, or that the State of Victoria and Transurban are in some legal sense sharing profits.

In United Energy, the reasoning and conclusion of the joint judgment of Sundberg and Merkel JJ is to be preferred. The franchise fees under s 163A of the EIA were not deductible because they were outgoings of capital or on capital account; they secured exclusivity from competition.

Section 8-1(2)(a)

11        On the other hand, I do agree with the learned primary judge’s conclusion that the outgoings, the s 163AA imposts, were outgoings of capital or capital in nature; although my reasons for doing so go beyond those given by her Honour at R [88]–[92].

12        In my view, the s 163AA imposts were outgoings of capital or of a capital nature because they were part of the cost (to SPI) of acquiring the assets of the business, specifically, the Transmission Licence, unarguably a capital asset. Prior to Cliffs International Inc v Commissioner of Taxation (1978–1979) 142 CLR 140 there would have been no doubt about this proposition; for the reasons articulated below, it remains my position post-Cliffs International, at least on the facts of this case. Pre-Cliffs International, the position is perhaps best summed up by Fullagar J (with whom Kitto and Taylor JJ agreed) in Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428 at 454:

[I]t is incontestable here that the moneys are paid in order to acquire a capital asset. The documents make it quite clear that these payments constitute the price payable on a purchase of land, and that appears to me to be the end of the matter. It does not matter how they are calculated, or how they are payable, or when they are payable, or whether they may for a period cease to be payable. If they are paid as parts of the purchase price of an asset forming part of the fixed capital of the company, they are outgoings of capital or of a capital nature. It does not indeed seem to me to be possible to say that they are incurred in the relevant sense in gaining or producing assessable income or in carrying on a business—any more than payment of a lump sum would have been so incurred if the purchase price had been a lump sum payable on transfer. The questions which commonly arise in this type of case are (1) What is the money really paid for?—and (2) Is what it is really paid for, in truth and in substance, a capital asset?

13        It is true that the s 163AA imposts did not form part of the “Total Purchase Price” of the “Assets” agreed to be sold and purchased (see recital E and cl 4.4(a) of the Asset Sale Agreement), but the total value contributed by the parties to the sale of the Assets, viz., $2,555,000,000 made up of Total Purchase Price of $2,502,600,000 and Estimated Duty of $52,400,000, was expressed to be “(net of Creditors and Contract Liabilities)”. See, too, the definition of “Total Purchase Price” in cl 1.1 of the Asset Sale Agreement. The s 163AA imposts are prospective obligations/liabilities of the Seller (PNV) and therefore the State is a Creditor for the purpose of the parenthetical expression: “net of Creditors and Contract Liabilities”: see the definitions of “Creditors” and “Contract Liabilities” in cl 1.1 of the Asset Sale Agreement.

14        The term “Assets” is defined in cl 1.1 of the Asset Sale Agreement to include “the Licences”; the term “Licences” is defined in the same clause to include “the Transmission Licence”; and the expression “Transmission Licence” is defined by the same clause to mean “… the transmission licence issued to the Seller [PNV] under Part 12 of the Electricity Act by the Office of the Regulator-General on 3 October 1994 as amended on 7 August 1995 and 1 March 1996 and to be amended in accordance with the draft amendments included in the Data Room Documentation”.

15        Clause 4.3 of the Asset Sale Agreement sets out the conditions precedent to Completion, which include:

(a)    the State, the Seller and the Buyer shall procure that the Office of the Regulator-general approves the transfer of the Transmission Licence from the Seller to the Buyer with effect from Completion;

(b)    the State shall procure the publication in the Government Gazette of an Order in Council declaring that the Buyer is a transmission company for the purposes of the Electricity Act, to take effect when the Buyer holds a licence to transmit electricity issued under Part 12 of the Electricity Act;

…

(d)    the State shall procure the publication in the Government Gazette of the Licence Fee Order; …

16        The “Licence Fee Order” is defined in cl 1.1 to mean the order in substantially the form set out in annexure G. Annexure G was in the following form:

Electricity Industry Act 1993

Order under section 163AA

Order declaring the charges payable by Power Net Victoria to the Treasurer for payment into the Consolidated Fund in respect of the licence to transmit electricity issued to Power Net Victoria under Part 12 of the Electricity Industry Act 1993.

The Governor in Council acting on the recommendation of the Treasurer under section 163AA of the Electricity Industry Act 1993 declares that the amounts payable as an impost by Power Net Victoria, as the holder of a licence (“the Transmission Licence”) to transmit electricity issued under Part 12 of the Electricity Industry Act 1993, to the Treasurer for payment into the Consolidated Fund under section 163AA of the Electricity Industry Act 1993 are as follows:

(a)    $37,500,000 in respect of the financial year ending 30 June 1998, payable in arrears in two instalments, being $25,000,000 on 31 March 1998 and $12,500,000 payable on 30 June 1998;

(b)    $50,000,000 in respect of each of the financial years ending 30 June 1999 and 30 June 2000, payable in arrears in four equal instalments on 30 September, 31 December, 31 March and 30 June in each relevant financial year; and

(c)    $40,000,000 in respect of the 6 months ending on 31 December 2000, payable in arrears in two equal instalments on 30 September 2000 and 31 December 2000.

This Order applies to any person or persons (jointly and severally) to which the Transmission Licence is transferred or any person or persons (jointly and severally) which acquires all or substantially all the business of Power Net Victoria or any subsequent holder of the Transmission Licence and which is or are issued with a licence to transmit electricity under Part 12 of the Electricity Industry Act 1993.

Dated:        1997.

Responsible Minister:

Alan R Stockdale

Treasurer     Clerk of the Executive Council

17        At Completion, cl 4.2(c)(1) required the Seller (PNV) to deliver to the Buyer (SPI) “the Transmission Licence, transferred so that the Buyer has replaced the Seller as the licensee”.

18        Critically, the transfer of the Transmission Licence to SPI carried with it the s 163AA liability of PNV; equally critically, the s 163AA impost was not made on SPI post the transfer of the Transmission Licence on Completion. The liability was assumed by SPI on the transfer of the Transmission Licence, not by Order under s 163AA, and as such, forms as much part of the cost of acquisition of the Assets as the Total Purchase Price.

19        So understood, the liability assumed is on capital account and the outgoings incurred by SPI as and when that liability falls due to be discharged over the relevant years of income have the same character.

20        Does the process of reasoning of the majority (Barwick CJ, Jacobs and Murphy JJ) in Cliffs International require one to revisit this orthodoxy? In my opinion, the answer to this is no. The reasoning of the Chief Justice is, with great respect, more notable for its absence of reasons and reliance on a sequence of conclusionary statements. His Honour was not even prepared to express a view on whether Colonial Mutual was rightly decided upon its own facts (at 151). In respect of the payments in Cliffs International, his Honour concluded (at 151):

The payments were, in my opinion, disbursements by the appellant in the course of its business and were not of a capital nature.

A little later he said (at 151):

My conclusion is that, whilst the promise to make them in the events which occurred formed part of the consideration for the transfer of the shares of Howmet and the Agnew Co. in Basic, the payments themselves when made were outgoings incurred in gaining the appellant’s assessable income consisting of royalties paid by the consortium and that they were not of a capital nature.

His Honour got to this conclusion by focusing on the occasion of the making of the payments rather than the nature of the liability discharged or the character of the asset/advantage obtained. Jurisprudence both before and after Cliffs International does not support that approach. See, for example, Federal Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1 at [147]–[154] per Crennan J with whom Gleeson CJ, Gummow, Callinan and Heydon JJ agreed.

21        Significantly, Jacobs J (at 173) said:

I have not been able to discover a case where payments have been held to be outgoings of a capital nature when all the following features are present: (a) the asset right or advantage was of a depreciating character and of limited life; (b) the obligation to make the payments in question continues throughout the life of the asset right or advantage or the entitlement of the taxpayer to the asset right or advantage; (c) the amount of the payments is recurrent; and (d) the amount of the payments is not fixed but is dependent on the use made of or profits derived from the asset right or advantage.

22        The asset which his Honour was referring to was, of course, not the shares in Basic the subject of the transaction in question, but the underlying mining tenements owned by Basic. Arguably, his Honour’s focus was on the wrong asset. Whether that is right or not, the second feature referred to by his Honour – the obligation to make the payments in question continued throughout the life of the asset – is not present in the case at hand, as the s 163AA imposts are only to be paid over a three year period; and the final feature referred to by his Honour – the amount of the payments is not fixed but is dependent on the use made of or profits derived from the asset right or advantage – is not present in the case at hand because the s 163AA imposts are fixed in amount ($177.5 million) and are in no way dependent on the use to which the transmission network is put.

23        Murphy J (at 176) said:

The fact that payment of the outgoings was agreed as part of the consideration for the acquisition of a capital asset is not decisive. There is a strong analogy with an agreement to pay rent as part of the consideration for acquisition of a lease.

The acquisition of the asset did not depend upon the payment of any “deferred payment”. The “deferred payments” if any were made, would be for currently exercising the right to mine the ore in pursuance of the agreement. The amount of deferred payments was indeterminate; the rate of 15 cents per ton was certain but the amount to be paid in any year or during the life of the agreement was uncertain and depended on the exercise of the rights to mine.

24        With great respect, the analogy with an agreement to pay rent as part of the consideration for acquisition of a lease, like many analogies, is apt to mislead. The lease and the rent payable thereunder is for the exclusive use of the property the subject of the lease, not its ownership. Moreover, here the amount of the deferred payments was not indeterminate but fixed in the sum of $177.5 million and did not depend on the exercise of the rights under the licence.

25        For all these reasons, there is nothing in the reasons of the majority in Cliffs International which would cause me to depart from the orthodoxy of the reasoning of Fullagar J in Colonial Mutual leading to the conclusion that the s 163AA imposts were outgoings of capital or capital in nature.

26        In my view, the appeal must be dismissed with costs.

Associate:

Dated:    7 April 2014

REASONS FOR JUDGMENT

MCKERRACHER J:

27        The appellant (SPI) contends that amounts it paid to the State of Victoria were allowable deductions under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (1997 Act). The respondent (Commissioner) disagrees. The primary judge agreed with the Commissioner (SPI PowerNet Pty Ltd v Commissioner of Taxation [2013] FCA 924). SPI appeals.

28        The payments (the Imposts) were made by SPI pursuant to an order of the Governor in Council made under s 163AA of the Electricity Industry Act 1993 (VIC) (EIA).

29        In my view, the primary judge was correct in concluding that the Imposts were not allowable deductions. Rather, they were capital payments incurred in order to acquire an asset. On that basis I would dismiss the appeal. I would, however, accept SPI’s submission that the Imposts would otherwise have qualified for general deduction as an outgoing necessarily incurred for the purpose of gaining assessable income.

BACKGROUND FACTS

30        In August 1993, the Victorian Government announced its intention to disaggregate the State owned electricity commission into three new operating businesses each of which would respectively undertake the generation, transmission and distribution of electricity. In October 1993, National Electricity which was later known as PowerNet Victoria (PNV) was established as a State body under the State Owned Enterprises Act 1992 (VIC). PNV, the transmission entity, started operations in January 1994. In April 1997, the Government announced its intention to privatise the business of PNV. As part of the privatisation process, but through mechanics which are, in my view, not determinative of the question of whether the Imposts were capital payments, the Victorian Government made clear that an order would be made pursuant to s 163AA of the EIA imposing specified charges on the holder of the transmission licence (Transmission Licence) up to 31 December 2000.

31        As a result of negotiations, on 12 October 1997, an asset sale agreement was executed between PNV and SPI (then known as the Australian Transmission Corporation (ATC)) (Asset Sale Agreement). Before the Asset Sale Agreement was concluded, on 28 October 1997, the Governor in Council made, amongst other things, an order under s 163AA of the EIA declaring that the holder of the Transmission Licence would pay the Imposts to the Treasurer totalling $177,500,000 for the period to 31 December 2000 (Imposts Order). On 30 October 1997, ATC changed its name to GPU PowerNet Pty Ltd (GPU). The transfer of the Transmission Licence to GPU under the Asset Sale Agreement was approved on 3 November 1997 and Completion of the Asset Sale Agreement was effected on 6 November 1997.

32        Thereafter, the Imposts were paid, but this was prior to the acquisition by Singapore Power of the shares in SPI from GPU, which occurred on 30 June 2000. Two days later, GPU changed its name to SPI.

THE STATUTE

33        SPI having paid the Imposts, the question is whether they were deductible under s 8-1(1) of the 1997 Act (the first limb) or excluded under s 8-1(2) (the second limb). That section provides:

8-1    General deductions

(1)    You can deduct from your assessable income any loss or outgoing to the extent that:

(a)    it is incurred in gaining or producing your assessable income; or

(b)    it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

…

(2)    However, you cannot deduct a loss or outgoing under this section to the extent that:

(a)    it is a loss or outgoing of capital, or of a capital nature; or

(b)    it is a loss or outgoing of a private or domestic nature; or

(c)    it is incurred in relation to gaining or producing your *exempt income or your non assessable *non-exempt income; or

(d)    a provision of this Act prevents you from deducting it.

…

(3)    A loss or outgoing that you can deduct under this section is called a general deduction.

THE ASSET SALE AGREEMENT

34        The Asset Sale Agreement was made between the State of Victoria, PNV as the seller and ATC as the buyer. It was guaranteed by GPU.

35        It appears to be common ground (correctly) that although the Transmission Licence to which the Imposts attached was part of the assets sold, the Imposts were not part of the purchase price under the Asset Sale Agreement. (Duty was not payable on the Impost component). On the other hand, there was, under the same agreement, an obligation imposed on ATC to pay the Imposts. A fair reading of the Asset Sale Agreement suggests that in addition to any statutory obligation, the State sought to and did ensure that ATC would be contractually committed to make the Impost payments and that GPU would guarantee this.

36        The recitals to the Asset Sale Agreement provided that PNV was the owner of the assets and that PNV agreed to sell and ATC agreed to buy the assets on the terms and conditions of the Asset Sale Agreement. By recital E, the total value attributed by the parties to the sale of the assets (net of creditors and contract liabilities) was expressed thus:

E.    The total value attributed by the parties to the sale of Assets (net of Creditors and Contract Liabilities) the subject of this agreement is $2,555,000,000 made up of:

Total Purchase Price            $2,502,600,000

Estimated Duty                         $ 52,400,000

                                 ______________

                                   $2,555,000,000

                                 ______________

F.    The parties agree that the total payments to the State in connection with the privatisation of [PNV] are $2,732,500,000 (including future licence fees of $177,500,000 payable by ATC, which the State values in net present value terms at approximately $161,000,000).

(emphasis added)

37        It follows, as indicated, that the Imposts were not part of the total purchase price. But they were part of the payment to be made to the State. “Assets” was a defined term and included the Transmission Licence (the Assets): cl 1.1 of the Asset Sale Agreement. The Imposts were excluded from the Assets as defined in cl 1.1 of the Asset Sale Agreement by reason of the deduction of creditors.

38        Clause 4.3 of the Asset Sale Agreement set out the conditions precedent to completion of the Asset Sale Agreement (Conditions Precedent) as follows:

4.3    Conditions Precedent

As conditions precedent to Completion:

(a)    the State, the Seller and the Buyer shall procure that the Office of the Regulator-General approves the transfer of the Transmission Licence from the Seller [PNV] to the Buyer ATC with effect from Completion;

(b)    the State shall procure the publication in the Government Gazette of an Order in Council declaring that the Buyer is a transmission company for the purposes of the Electricity Act, to take effect when the Buyer holds a licence to transmit electricity issued under Part 12 of the Electricity Act.

…

(d)    the State shall procure the publication in the Government Gazette of the Licence Fee Order;

…

The Buyer, the Guarantor, the State and the Seller must use their respective best endeavours to satisfy these conditions precedent as soon as practicable following execution of this agreement and shall keep all parties informed of progress in satisfying the conditions precedent.

(emphasis added)

39        The licence fee order referred to in cl 4.3(d) was the Imposts Order as defined in cl 1.1 and Annexure G. Under the Imposts Order and by virtue of the Conditions Precedent, PNV (and any transferee of the Transmission Licence) was to pay the Imposts.

40        Once those Conditions Precedent were met, the first item of “completion” (under cl 4.2(c)(i)) was the delivery to ATC of the Transmission Licence which, of course, included PNV’s liability to pay the Imposts, now ATC’s liability to pay the Imposts.

41        The effect of execution of the Asset Sale Agreement was that ATC was bound contractually to make those payments over and above any statutory obligation.

42        This contractual obligation was further reinforced by the warranties under cl 13 of the Asset Sale Agreement under which cl 13.3(d) provided:

(1)    the amounts to be payable by [ATC] pursuant to the Licence Fee Order are an integral part of the regulatory framework of the industry and [ATC] accepts that it must pay the amounts set out in the Licence Fee Order in order to carry on the Business transferred from [PNV];

(2)    [ATC] must not challenge the validity of the Licence Fee Order or the amounts, or the basis of calculating the amounts, specified in the Licence Fee Order;

(3)    [ATC] agrees to pay to the Treasurer the amounts specified in the Licence Fee Order in accordance with the terms of, and at the times specified in, the Licence Fee Order, whether or not the Licence Fee Order is valid or enforceable; and

(4)    [ATC] must not transfer the Transmission Licence or allow any person to become a licensee under the Transmission Licence unless the proposed licensee has first delivered to the State a covenant (in form and substance satisfactory to the State) agreeing to be bound by this clause 13.3(d) as if it were the Buyer.

(emphasis added)

43        In short then, it was a condition precedent to completion of sale as imposed under the Asset Sale Agreement that ATC undertake to pay the Imposts. ATC warranted to do so. GPU guaranteed this. Put another way, without its commitment to pay the Imposts, ATC would not acquire the Assets (including the Transmission Licence) under the Asset Sale Agreement.

WERE THE IMPOSTS CAPITAL PAYMENTS?

44        Against that commercial background, the first question I propose to consider is whether the payment of the Imposts was on capital or revenue account.

45        In John Fairfax & Sons Pty Ltd v Federal Commissioner of Taxation (1959) 101 CLR 30, the High Court considered the deductibility of certain legal expenses incurred in defending an equity suit brought in relation to an allotment of shares. The approach taken by Dixon CJ was to ascertain first, whether or not the legal expenses were of a capital nature. The Chief Justice said (at 37) that the determination of whether the deduction was of a capital nature was the question of “more general importance…than the question whether it qualifies under the earlier part of s 51(1)” which depends “… much more on the view taken of the specific facts”. John Fairfax provides an illustration of the convenience of first addressing the negating limb (s 8-1(2) of the ITAA 1997).

46        Various cases were put to the Court by the parties in support of the contentions advanced on this topic. As has frequently been recognised, determination of the capital or revenue question turns largely on the facts in each case. But the Court was, appropriately, taken to a number of (mainly) High Court authorities which provide guidance as to the nature of the inquiry on the capital or revenue question.

47        The early cases appear to have stressed the importance of the nature of the expenditure as either recurrent or once and for all. In Vallambrosa Rubber Co Ltd v Farmer (1910) SC 519, Lord President Dunedin upheld a claim for deductions in respect of expenses incurred on an annual basis in weeding and superintending portions of a property where trees had not yet reached production age, and were incurred in view of profit to be earned in future fiscal years. His Lordship said (at 525):

Now, I do not say that this consideration is absolutely final or determinative, but in a rough way I think it is not a bad criterion of what is capital expenditure—as against what is income expenditure—to say that capital expenditure is a thing that is going to be spent once and for all, and income expenditure is a thing that is going to recur every year. Therefore, prima facie, weeding, which does occur every year, seems to me to be an income expenditure.

(emphasis added)

48        The Imposts are, in effect, once and for all, but it is certainly not the case that all payments made once and for all will be capital expenditure.

49        SPI relies upon Moffatt v Webb (1913) 16 CLR 120 where the High Court concluded that land tax paid by a grazier was a disbursement of money wholly and exclusively laid out or expended for the purpose of the trade of being a grazier such that the grazier was entitled to deduct the expenditure from his income. Griffith CJ rejected the Commissioner’s argument that the land tax was a capital expenditure (at 130). The Chief Justice distinguished the cases relied upon by the Commissioner on the basis that they were cases in which money or money’s worth was paid as the price of something to be used in order to earn income, whereas, according to Griffith J, it was “impossible to say that land tax is paid for the purpose of acquiring anything…it certainly adds nothing to his capital.”

50        Rowlatt J in Ounsworth (Surveyor of Taxes) v Vickers Ltd [1915] 3 KB 267 (at 273) emphasised that “the real test is between expenditure which is made to meet a continuous demand, as opposed to an expenditure which is made once and for all”. When Dixon J, as his Honour then was, came to consider Rowlatt J’s approach in Sun Newspapers Ltd v Federal Commissioner of Taxation; Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 his Honour said (at 362) that recurrence was simply one consideration, the weight of which depends upon the nature of the expenditure in question.

51        A little later in British Insulated and Helsby Cables Limited v Atherton (1926) AC 205 Viscount Cave LC enumerated another factor of relevance to determining whether payments are capital or revenue expenditure. The Lord Chancellor’s formula (at 213-214), since cited in a number of decisions, was:

When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is a very good reason (in the absence of special circumstances leading to an opposite conclusion) that treating such an expenditure as properly attributable not to revenue but to capital.

(emphasis added)

52        Again, however, the notion of an enduring benefit has not been regarded as the sole test. As Dixon J noted in Sun Newspapers, this was simply a factor the relevance of which would play a part in determining the character of the advantage sought by the expenditure. In Sun Newspapers where the question for determination was whether moneys paid under an agreement were capital or otherwise, Dixon J enumerated a threefold test which has been adopted as the Australian approach to determining whether expenditure is capital or revenue in character. His Honour said (at 363):

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

(emphasis added)

53        Against that synopsis, his Honour went on to analyse the character of the payments that had been made. First, the expenditure was a large sum incurred to remove Sun Newspaper’s competition. Secondly, the expenditure could only be regarded as recurrent in the sense that the risk of a competitor arising must always be theoretically present. Thirdly, the chief object of the expenditure was to preserve the existing business organisation from immediate impairment and dislocation. His Honour concluded (at 364) that the advantage obtained as a result of the expenditure was a capital asset as in principle the transaction was to strengthen and preserve the business organisation and affected the capital structure.

54        Slightly different terminology was used a few years later by Dixon J in Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634. In that decision, certain legal costs and expenses incurred were held to be outgoings of revenue not of a capital nature and, therefore, deductible. The observations of Dixon J (with whom McTiernan J agreed, but both being in dissent) have also since been cited in a number of decisions. His Honour said (at 648):

What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.

(emphasis added)

55        Latham CJ and Starke JJ (at 641 and 644) in the majority followed the decision of Viscount Cave LC in British Insulated and Helsby Cables outlined above. The Chief Justice formed the view that the expenditure by the company on legal costs was not made for the purpose of acquiring an asset, nor of adding to the profit yielding subject which constituted the capital structure of the business, and accordingly was of revenue nature. Williams J (at 655) distinguished the legal expenditure from the capital expenditure in Sun Newspapers in which the taxpayer obtained the benefit of a covenant against competition by potential trade competitors and thereby improved the value of the taxpayer’s goodwill.

56        In Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428 the Court treated periodical payments made over 50 years equalling 90 per cent of rents received in respect of buildings or land as being the price for which the land was bought and therefore regarded the payments as being outgoings of capital nature and not allowable deductions. In reaching this conclusion, Fullager J observed (at 454):

...[I]t is incontestable here that the moneys are paid in order to acquire a capital asset. The documents make it quite clear that these payments constitute the price payable on a purchase of land, and that appears to me to be the end of the matter…If they are paid as parts of the purchase price of an asset forming part of the fixed capital of the company, they are outgoings of capital or of a capital nature. It does not indeed seem to me to be possible to say that they are incurred in the relevant sense in gaining or producing assessable income or in carrying on a business - any more than payment of a lump sum would have been so incurred if the purchase price had been a lump sum payable on transfer. The questions which commonly arise in this type of case are (1) What is the money really paid for? - and (2) Is what it is really paid for, in truth and in substance, a capital asset? …

(emphasis added)

57        In John Fairfax, Dixon CJ quoted Viscount Cave LC in British Insulated and Helsby Cables, and again noted, as his Honour had previously in Sun Newspapers, that it is a “logical fallacy” to say that an expenditure cannot be attributable to capital unless it is made once for all and is made with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade.

58        In contrast with Colonial Mutual Life, the Privy Council was of the view in BP Australia Ltd v Federal Commissioner of Taxation (1965) 112 CLR 386 that lump sums paid by a petrol distributing company for the purpose of securing a trade tie covenant over a period of years were not capital outgoings, but deductible income expenditure.

59        In Cliffs International Inc v Federal Commissioner of Taxation (1978–1979) 142 CLR 140, the High Court (by majority, namely Barwick CJ, Jacobs and Murphy JJ) concluded that recurrent payments of 15 cents per tonne of iron ore mined and sold could not be regarded as part of the purchase price of a capital asset acquired by the taxpayer. Accordingly they were revenue in character. The majority considered that the payments were analogous to rent agreed to be paid on the grant of a lease or to royalties agreed to be paid on the grant of a licence to use a patent (at 151 and 176). The minority (Gibbs and Stephen JJ), however, followed the approach of Fullagar J in Colonial Mutual Life. Their Honours placed particular weight on the fact that the payments, even though they were recurrent and indefinite, were properly to be considered as being made as part of the consideration for the acquisition of an advantage which had the character of capital (at 156 and 167).

60        In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1989–1990) 170 CLR 124 the question for the High Court was whether “establishment costs” paid to the appellant under a contract which required the building of a plant were capital or revenue in nature. It held (at 137) “…the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid” (emphasis added). Although the asset acquired was a capital asset and the expenditure by the taxpayer in its construction was an outgoing of a capital nature, the establishment costs were held to be assessable remuneration earned by the carrying on of the taxpayer’s business.

61        More recently in Federal Commissioner of Taxation v CityLink Melbourne Ltd (2006) 228 CLR 1 the High Court considered whether concession fees payable by CityLink Melbourne Ltd to secure concession rights and impose and collect tolls for its use were capital or revenue expenditures. After citing Dixon J in Sun Newspapers and in Hallstroms, Crennan J with whom Gleeson CJ, Gummow, Callinan and Heydon JJ agreed, (Kirby J dissenting) concluded that the concession fees were revenue in nature. In reaching this conclusion, Crennan J reiterated the danger recognised by the Full Court in arguing by analogy in circumstances where the arrangements are sui generis commercial arrangements specific to a particular project (at [151]). Crennan J concluded (at [154]) (footnotes omitted):

154    The concession fees are only payable during the term of the concession period. The respondent does not acquire permanent ownership rights over the roads or lands used. All rights granted under the Concession Deed revert to the State at the expiry of the concession period. Unlike periodic instalments paid on the purchase price of a capital asset, the concession fees are periodic licence fees in respect of the Link infrastructure assets, from which the respondent derives its income, but which are ultimately “surrendered back” to the State. Accordingly, they are on revenue account.

(emphasis added)

62        Although the cases give some guidance in how commercial dealings might be considered, this “danger” of arguing by analogy (referred to by Crennan J (at [151] in CityLink) requires that the individual commercial transaction be assessed. Preliminary payments, as the cases show, may in some instances be on revenue account and on others, capital. The primary judge noted the elements of the three considerations referred to by Dixon J in Sun Newspapers which, as Crennan J observed (at [147] in CityLink) is the starting point. As Crennan J (at [148]) (and the primary judge) noted (footnotes omitted):

The characterisation of an outgoing depends on what it "is calculated to effect", to be judged from "a practical and business point of view". The character of the advantage sought by the making of the expenditure is critical.

SPI’s arguments

63        SPI contends that the payment of the Imposts did not secure any advantage to it which was not otherwise conferred upon it as holder of a licence to transmit electricity, apart from discharging the liability imposed on it. It argues that it obtained the right to conduct its business of electricity transmission upon its acquisition of the Transmission Licence pursuant to the Asset Sale Agreement. The Imposts formed no part of the total purchase price payable under that agreement. Nor were they payable to the vendor of those assets, namely, PNV.

64        SPI also argues that undue weight was attributed by the primary judge to the references to the Imposts in the Asset Sale Agreement. Senior counsel for SPI submitted that a reference to, or even the imposition of an obligation to make, a payment in the same agreement pursuant to which a capital asset is acquired, is not determinative of the character of the payment for the purposes of s 8-1 of the 1997 Act. Rather, the question was whether the “payment was part of the price paid for the acquisition of a capital asset”. SPI emphasises that the documents made it clear that the obligation to pay the Imposts did not constitute any part of the price payable for the Assets of the business. According to SPI, those parts of the Asset Sale Agreement relied upon do not support a conclusion to the contrary and they do not identify what the payments were “for”. Nothing in cl 13.3(d) imposed an obligation to pay the Imposts independently of the licence.

Analysis

65        In my view, an approach confined to the question as to whether the payment is part of the purchase price under the Asset Sale Agreement would be too narrow. As SPI acknowledges, the appropriate inquiry requires an examination of the nature of the advantage sought and obtained by the Imposts.

66        As the primary judge concluded (at [85]), the Imposts were imposed on SPI, the licence holder, as part of the regulatory framework in which the transmission business was conducted. Clause 13.3(d) and Recital F of the Asset Sale Agreement recognised that fact and provided that the Imposts were to be made as part of the acquisition of the transmission business. Importantly, various warranties were secured from SPI under the Asset Sale Agreement which were additional to any statutory liability it would incur.

67        Secondly, as explained above, it was a Condition Precedent to the Asset Sale Agreement, which was accepted by the Buyer by execution of the Asset Sale Agreement, that liability for the Imposts would be incurred. Put another way, on the face of the Asset Sale Agreement, the Assets could not have been acquired unless contractual liability to make the payments including the Imposts was also incurred.

68        A third factor to consider is that it was on its face an integral part of the Asset Sale Agreement that the liability to make the Imposts was guaranteed by SPI’s then parent, GPU Inc. There is no indication or evidence that this guarantee would be obtained independently of the Asset Sale Agreement. The Assets were not to change hands without the guaranteed obligation to pay the Imposts.

69        Fourthly, it is also significant, in my view, that the Imposts were determined in advance. They were a fixed amount. Although the amount of the Imposts may have been notionally referrable to anticipated profits;

(a)    there would be no ongoing payments after the initial Imposts;

(b)    significantly, there would be no provision for any adjustment of the amount should the profitability of the business disappoint; and

(c)    there would be no increase in the Imposts if the profitability was greater than expected.

70        It follows that SPI by entry into the Asset Sale Agreement assumed liability to the State to pay the Imposts independently from the effect of the EIA, separately from the Imposts Order and separately from the terms of its licence. In addition, the liability under the Asset Sales Agreement was guaranteed by its then parent.

71        The provisions of the Asset Sale Agreement imposed a separate contractual liability to pay the Imposts in order to acquire the Assets, including the Transmission Licence. The payment was therefore a capital amount.

THE FIRST LIMB OF S 8-1 OF THE 1997 ACT

72        In light of the conclusion that the payment of the Imposts was a capital payment, deductibility under the first limb of s 8-1 of the 1997 Act would be negated. However, for completeness and if I am wrong on the negating limb, I accept the submissions made for SPI on this topic.

73        As the primary judge held consistent with authority, the mere fact that an exaction is compulsory cannot deny deductibility. Examples of deductible imposts abound including land tax, sales tax, council rates and payroll tax.

74        If the Imposts were not capital, they would be deductible under s 8-1 of the 1997 Act. The Imposts were incurred by SPI in relation to carrying on its business for the purpose of gaining or producing assessable income. There was sufficient nexus between the expenditure and SPI’s income producing operations and activities. That nexus is to be ascertained by reference to the purpose for which the Imposts were incurred from the perspective of the taxpayer, being the payer of the Imposts, as distinct from the recipient of the payment.

75        On an objective analysis, the Imposts were incidental to and arose as a consequence of the conduct of SPI’s business and were imposed by reason of SPI holding a licence to transmit electricity under Pt 12 of the EIA. SPI derived its assessable income from that business, for which it was required to hold a transmission licence by s 159 of the EIA.

76        As SPI submits, the very thing which produced the assessable income was the thing which exposed SPI to the liability.

77        For my part, I do not, however, consider that the decision in United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169 compels one to a different conclusion. Although Lockhart J in United Energy was of the view that the payment of franchise fees were “akin” to a form of profit sharing arrangements between the State of Victoria and United Energy, or “akin” to dividend payments by a company to its shareholder, the circumstances governing the Asset Sale Agreement are different from those his Honour considered. Further, as with Edmonds J, as a matter of analysis, I respectfully prefer the approach of the plurality (Sundberg and Merkel JJ) in United Energy and the Full Court in CityLink as referred to by Crennan J (at [151]) on appeal to the High Court.

78        But if that be wrong, and even assuming the correctness of Lockhart J’s “profit sharing” approach in United Energy, there was no feature about the obligation to pay the Imposts which took a form of sharing of profits – legal or otherwise. In terms of being “akin” to that concept, there was no joint venture relationship between the State of Victoria and SPI nor was the State a partner or shareholder in SPI. In this transaction, the State was a regulator not a joint venturer, partner or shareholder, albeit a regulator able to reinforce its statutory position by the terms of the Asset Sale Agreement. Once the particular facts in United Energy are distinguished, there is no reason, in my view, why the Imposts would not be brought within s 8-1.

CONCLUSION

79        I would dismiss the appeal with costs.

Associate:

Dated:    7 April 2014

REASONS FOR JUDGMENT

DAVIES J:

INTRODUCTION

80        In issue in this appeal is whether the primary judge was correct to hold that amounts that the appellant (“SPI”) paid to the State Treasurer as an impost charged under s 163AA(1) of the Electricity Industry Act 1993 (Vic) (“EIA”) were not deductible under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (“97 ITAA”). The primary judge concluded that the imposts were not a cost that SPI incurred in deriving its income, but were payments out of SPI’s profits after the calculation of SPI’s taxable income and were therefore not deductible under s 8-1(a). The primary judge also concluded that if it were necessary to decide, the payments were outgoings of capital, or of a capital nature.

81        With respect I disagree with both conclusions and for the reasons that follow would allow the appeal.

THE FACTUAL BACKGROUND

82        In November 1997, SPI (then known as Australian Transmission Corporation Pty Ltd) acquired the assets of Power Net Victoria (“PNV”), a Victorian State-owned corporation that owned Victoria’s high voltage transmission network. The assets were acquired pursuant to an Asset Sale Agreement entered into in October 1997 and included the licence to transmit electricity which was required by s 159 of the EIA (“the transmission licence”).

83        At the time, a tariff order, in effect up to 31 December 2000, regulated the price that PNV could charge for the provision of transmission services, calculated by reference to the total estimated revenue that PNV would be permitted to earn. This was called the Maximum Allowable Revenue (“MAR”). The tariff was set in a way that enabled PNV to recover the cost of its assets over time and its estimated operating and maintenance costs, and provide PNV with a return on the capital required to fund the assets.

84        Before selling off PNV’s assets, the government decided to extend the tariff order for a further two years in order to promote price certainty for prospective purchasers. However, a review of the tariff order revealed that some of the assumptions in setting the MAR were no longer correct and, as a result, that the level of MAR that the tariff order permitted PNV to earn was higher than that required to provide a reasonable return on capital having regard to expected operating costs (“the adjusted MAR”). As there were issues about resetting the transmission price under the current tariff order, it was decided that the difference between the gross revenue that would accrue to PNV under that tariff order before it lapsed in December 2000 and the adjusted MAR would be recovered from PNV by way of a “special licence fee” referable for the period up to 31 December 2000 and levied under s 163AA of the EIA, with the transmission price to be reset in a new tariff order applicable for the period from 1 January 2001 to 31 December 2002.

85        Sub-sections 163AA(1) and (2) of the EIA are in the following terms:

(1)    The Governor in Council, on the recommendation of the Treasurer, may, by Order published in the Government Gazette, declare that specified charges, or charges calculated in a specified manner, are payable as an impost by the holder of a licence at such times and in such manner as are so specified.

(2)    The holder of a licence must pay to the Treasurer for payment into the Consolidated Fund the charges determined under sub-section (1) and applicable to the licence at the times and in the matter so determined.

(italics added for emphasis)

86        On 28 October 1997, the Governor in Council made an order under s 163AA declaring the amounts “payable as an impost” by PNV “as the holder of a licence … to transmit electricity” in respect of the financial years ending 30 June 1998, 1999 and 2000 and the six months ending on 31 December 2000 (“the Order”). The Order stated:

Electricity Industry Act 1993

ORDER UNDER SECTION 163AA (1)

The Governor in Council acting on the recommendation of the Treasurer under section 163AA (1) of the Electricity Industry Act 1993 declares that the amounts payable as an impost by [PNV], as the holder of a licence (the “Transmission Licence”) to transmit electricity issued under Part 12 of the Electricity Industry Act 1993, to the Treasurer for payment into the Consolidated Fund under Section 163AA (2) of the Electricity Industry Act 1993, are as follows:

(a)    $37,500,000 in respect of the financial year ending 30 June 1998, payable in arrears in two instalments, being $25,000,000 on 31 March 1998 and $12,500,000 payable on 30 June 1998;

(b)    $50,000,000 in respect of each of the financial years ending 30 June 1999 and 30 June 2000, payable in arrears in four equal instalments on 30 September, 31 December, 31 March and 30 June in each relevant financial year; and

(c)    $40,000,000 in respect of the 6 months ending on 31 December 2000, payable in arrears in two equal instalments on 30 September 2000 and 31 December 2000.

This Order applies to any person or persons (jointly and severally) to whom the Transmission Licence is transferred or any subsequent holder of the Transmission Licence or any person or persons (jointly and severally) who acquire all or substantially all the business of [PNV] and who is or are issued with a licence to transmit electricity under Part 12 of the Electricity Industry Act 1993.

(italics added for emphasis)

87        PNV’s transmission licence was transferred to SPI as part of the assets acquired by SPI pursuant to the Asset Sale Agreement. The transfer was approved by the Office of the Regulator-General on 3 November 1997 and the Asset Sale Agreement was completed on 6 November 1997.

88        SPI paid the charges levied under the s 163AA order and it is those payments that are the subject of the deduction claim.

WERE THE S 163AA IMPOSTS A COST OF DERIVING ASSESSABLE INCOME?

89        The primary judge held that the s 163AA imposts were not deductible because they were “in substance and effect” a share of profits, not a cost of SPI deriving its income. The primary judge relied on the decision of Lockhart J in United Energy Ltd v Commissioner of Taxation (1997) 78 FCR 169 (“United Energy”) to reason at [76] to [78] that the s 163AA imposts represented the amounts to be derived by SPI from its business that were over and above the adjusted MAR cap and that the “residue or surplus” was taken by the State “as its share of profits”, “leaving the holder of the licence with an amount determined to be a reasonable return on the capital of the company deriving that income”.

90        The issue in United Energy was whether the taxpayer, a state-owned company that distributed and sold electricity under an exclusive licence from the State of Victoria, was entitled to a deduction under s 51(1) of the Income Tax Assessment Act 1936 (Cth) for amounts that it paid to the State as annual imposts levied pursuant to orders of the Governor in Council under another provision of the EIA, s 163A (“the s 163A(2) imposts”). The s 163A(2) imposts were set by the Treasurer, who in recommending the amount of the impost in each financial year:

    … must be satisfied that the amount reasonably represents the amount by which the income of the company derived from the sale of electricity to franchise customers in that year is likely to exceed the sum of –

(a)    the costs of deriving the income; and

(b)    taxes payable in deriving that income; and

(c)    an amount determined by the Treasurer to be a reasonable return on the capital of the company used in deriving that income –

having regard to –

…

(italics added for emphasis)

91        The Full Federal Court (Lockhart, Sundberg and Merkel JJ) held that the s 163A(2) imposts were not deductible: the majority (Sundberg and Merkel JJ) on the basis that the payments were outgoings of capital because the advantage sought and obtained by the payments was the exclusive right to sell and distribute electricity in a defined area; and Lockhart J on the basis that the payments were compulsory exactions imposed by the Victorian Government to extract a share of the taxpayer’s profits, rather than a cost incurred by the taxpayer in the derivation of income. Lockhart J described the payments as “akin to” and “in substance” a distribution of profits or dividends to the State as the ultimate shareholder.

92         The primary judge’s conclusion that the s 163AA imposts similarly were not outgoings incurred by SPI in the derivation of its assessable income was based on reasoning that the structure of the s 163AA and s 163A(2) imposts was the same. Her Honour noted that the Treasurer’s calculation of the s 163A(2) imposts was to be undertaken after, or at least in part by, determining the taxpayer’s taxable income, not its assessable income and that the excess taxed as the impost was the amount that reasonably represented the amount by which the assessable income was likely to exceed the total of the taxable income and the return on capital. Her Honour said at [69]:

Section 163A(2) expressly provided that the Treasurer’s calculation of the franchise fee was to be undertaken after, or at least in part by, determining the distribution company’s taxable income, not its assessable income … One step in the calculation was to determine the amount of income the company derived from the sale of electricity to franchise customers (the assessable income) less the costs of deriving that income (giving rise, in general terms, to the company’s taxable income). A further step was then to deduct the taxes payable in deriving that income. Two further amounts were then calculated – a reasonable return on the capital used in deriving the assessable income and any “surplus”. The “surplus” was expressed by s 163A to be the amount that reasonably represented the amount by which the assessable income was likely to exceed the total of the taxable income and the return on capital. The excess was “taxed” as the franchise fee. As is apparent, the franchise fee was a payment out of profits but a payment out of profits after the calculation of the entity’s taxable income. It was not an outgoing incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such assessable income.

93        Her Honour then went on to consider the s 163AA imposts and noted at [77] that:

[Those imposts] represented amounts to be derived by the licence holder from the provision of ‘Prescribed Services’ that were over and above all capital and operating costs (including borrowing costs) and after allowing for an appropriate return to shareholders.

94        Her Honour said that “[t]hose elements necessarily included calculation of [the licence holder’s] taxable income – revenue less estimated operating and maintenance costs and depreciation”: at [73].

95        This analysis led the primary judge to conclude that the s 163AA imposts were payments out of SPI’s profits after the calculation of SPI’s taxable income. Her Honour said:

78    As is apparent, although the integers in the calculation of the MAR and the licence fee were not disclosed in the express terms of s 163AA, the structure of the imposition of the franchise fee in s 163A and the licence fees under s 163AA was the same – in substance and effect, a share of the profits leaving the holder of the licence with an amount determined to be a reasonable return on the capital of the company deriving that income. The residue, or surplus, was taken by the State as its share of profits.

79    That analysis does not involve characterisation by reference to some other, different transaction. There is no element of “economic equivalence”: see [City Link Melbourne Ltd v Commissioner of Taxation (2004) 141 FCR 69 at 83]. As the Full Court said in [City Link Melbourne Ltd v Commissioner of Taxation (2004) 141 FCR 69 at 81], Lockhart J’s analysis in United Energy was “orthodox analysis”:

It is not difficult to see on the facts of the case why Lockhart J saw the fee as “akin” to the State taking a share of profits but the conclusion reached by his Honour was not dependent upon there being some joint venture between the State and the distributor. Rather it depended upon the more orthodox analysis that the fee was not a cost of the distributor of deriving its income.

The position here is no different. The s 163AA imposts were not a cost of SPI of deriving its income. The s 163AA imposts were payments out of SPI’s profits after the calculation of SPI’s taxable income. They were not an outgoing incurred in gaining or producing SPI’s assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such assessable income.

80    The imposts do not satisfy either limb of s 8-1(1).

96        I would be in agreement with the primary judge that the amounts in question did not satisfy the criterion for deductibility under s 8-1(1) had those amounts actually been profits payable out of taxable income: Midland Railway Co of Western Australia Ltd v Federal Commissioner of Taxation (1950) 81 CLR 384 at 393 (Kitto J); on appeal Federal Commissioner of Taxation v Midland Railway Co of Western Australia Ltd (1951-1952) 85 CLR 306 at 313 (Dixon J). With respect however, it cannot be said that the amounts in question were payments out of SPI’s profits after the calculation of SPI’s taxable income.

97        First, unlike the computation of the s 163A(2) imposts, the s 163AA imposts cannot be seen to be determined by reference to any amount equivalent to taxable income. The s 163AA imposts were calculated as the forecast difference between the gross revenue that SPI would earn under the tariff and the adjusted MAR that the modelling concluded should be derived in the period before the tariff order lapsed. Significantly, the three elements making up the MAR neither reflected, nor corresponded with, taxable income nor was the MAR an amount based on taxable income: cf Federal Commissioner of Taxation v Midland Railway Co of Western Australia Limited (1951-1952) 85 CLR 306 at 316 (Dixon J). Nor were the s 163AA imposts calculated as a portion of SPI’s taxable income.

98        Secondly, although the primary judge characterised the s 163AA imposts as “in substance and effect” a profit share, they were not in fact ascertained as a percentage of actual profits and did not represent “real net profits”, constituting some division or application of those profits between the State and SPI: cf British Sugar Manufacturers Ltd v Harris (H.M. Inspector of Taxes) (1938) 21 TC 528 at 548; United Energy at 182 (Lockhart J). The amounts in question were fixed irrespective of actual profits made, and were referrable to the amount of gross revenue to be derived by the licence holder that exceeded the cap on revenue that the licence holder was permitted to earn.

99        Thirdly, the issue in the present case does not fall to be determined by whether “profits” paid to the State are deductible. Lockhart J’s “orthodox analysis” in United Energy dealt with what his Honour had there classified as “residual profit” but the reasoning that led Lockhart J to classify the s 163A(2) imposts as “residual profit” related to a different statutory impost and different regulatory framework. Here, the s 163AA imposts were not sourced out of profits and, even if they could be so described, it could not be said that they were payable out of taxable income. As the authorities make clear, it is not decisive for the purposes of s 8-1(1) of the 97 ITAA simply that an amount is payable out of profits: Midland Railway Co of Western Australia Ltd v Federal Commissioner of Taxation (1950) 80 CLR 384 at 393; on appeal Federal Commissioner of Taxation v The Midland Railway Co of Western Australia Ltd (1951-1952) 85 CLR 306 at 313.

100        Accordingly the question of the deductibility of the s 163AA imposts cannot be determined just by reference to the “integers in the calculation” of those amounts. Whether they are deductible will depend on whether they were payments on revenue or capital account.

ARE THE PAYMENTS CAPITAL?

101        The question is whether the s 163AA imposts were payable for the right to conduct the transmission business, that is as an element of the acquisition of the transmission business (as the primary judge held), or were a cost of conducting the business operations (as SPI contended).

102        The primary judge’s reasoning that the s 163AA imposts were payable as an element of the acquisition of the transmission business and were therefore outgoings of capital, was based upon a consideration of the Asset Sale Agreement to which SPI, PNV and the State were all parties. Relevantly, SPI acknowledged and agreed with PNV and the State in clause 13.3(d) of the Asset Sale Agreement in relation to payment of the impost that:

(1)    The amounts to be payable by [SPI] pursuant to the Licence Fee Order are an integral part of the regulatory framework of the industry and [SPI] accepts that it must pay the amounts set out in the Licence Fee Order in order to carry on the Business transferred from the Seller;

(2)    [SPI] must not challenge the validity of the Licence Fee Order or the amounts or the basis of calculating the amounts, specified in the Licence Fee Order;

(3)    [SPI] agrees to pay to the Treasurer the amounts specified in the Licence Fee Order in accordance with the terms of, and at the time specified, in the Licence Fee Order, whether or not the Licence Fee Order is valid or enforceable; and

(4)    [SPI] may not transfer the Transmission Licence or allow any person to become a licencee under the Transmission Licence unless the proposed licencee has first delivered to the State a covenant (in form and substance satisfactory to the State) agreeing to be bound by this clause 13.3(d) as if it were [SPI].

103        Recital F to the Asset Sale Agreement also stated that:

The parties agree that the total payments to the State in connection with the privatisation of [PNV] are $2,732,500,000 (including future licence fees of $177,500,000) payable by [SPI] …

104        After referring to these provisions, and also noting that the s 163AA imposts were not ongoing and were calculated on a prospective basis with no provision for adjustment, the primary judge concluded at [88] that:

The s 163AA imposts were not made for the purpose of earning the profits of the business. The obligation to make the s 163AA imposts was specifically included in the Asset Sale Agreement as an element of the acquisition of the transmission business, although not part of the Purchase Price.

105        The starting point for the analysis should be s 163AA as it is clear from a consideration of that section that SPI, in making the payments, was discharging a statutory liability that fell upon it as the licence holder. Section 163AA(1), which was the legislative authority for the Order, provides that the Governor in Council may declare that charges are payable as an impost by “the holder of a licence” and s 163AA(2) provides that the “holder of [the] licence” must pay the charges determined under s 163AA(1) and “applicable to the licence”. By force of s 163AA the statutory criterion for liability is holding the relevant licence and any charges so declared are a statutory impost payable by the “holder of the licence”.

106        As authorised by s 163AA, the Order declared the charges payable as an impost by the holder of the licence, being PNV at the time, and stated that the Order applied to any person to whom the transmission licence was transferred. By force of s 163AA, the Order applied to SPI upon acquiring the licence from PNV (to which the imposts were applicable) and, as the licence holder, SPI became liable to pay the amounts in question in lieu of PNV.

107        The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure as it is the character of the advantage sought by the making of the expenditure that is the chief, if not the critical, factor in determining the character of what was paid: GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1989-1990) 170 CLR 124 at 137. When assessing the character of the advantage sought by the making of the payments in the present case, it is to be borne in mind that the s 163AA imposts were imposed as part of the regulatory framework which capped the gross revenue that a licence holder was permitted to earn. As the licence holder SPI was obliged by law to pay the statutory imposts, calculated as the amounts by which the tariff order would enable SPI to derive gross revenue from its business activity in excess of the adjusted MAR. The obligation to pay the imposts flowed as a necessary consequence of holding the licence, so that the thing that produced the assessable income was the thing that exposed SPI to the liability discharged by the expenditure: Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113 at 118. The imposts are therefore to be seen as an expense in the business operations of SPI and on revenue account rather than as a cost in securing the right to conduct the transmission business. A consideration of the terms of clause 13.3(d) does compel a different conclusion. By clause 13.3(d), SPI acknowledged and agreed as part of the terms of the Asset Sale Agreement that it would discharge the statutory liability, but the occasion for the incurrence of the liability to make the payments pursuant to the Order was not clause 13.3(d) but the fact that SPI was the holder of the licence when the amounts became payable.

108        The Commissioner contended that the imposts could also be seen to confer an advantage of an enduring kind on SPI by securing for SPI ongoing and predictable revenue streams and certainty as to the principles to be applied by the regulator in setting prices for the future regulatory periods. That contention can be rejected for the simple reason that it was the licence, not the payment of the imposts, that was the means by which such advantage was secured.

CONCLUSION

109         Accordingly I would allow the appeal.

Associate:

Dated:    7 April 2014