Cape Flattery Silica Mines Pty Ltd v Commissioner of Taxation
[1997] FCA 706
•28 JULY 1997
CATCHWORDS
No QG 121 of 1995
TAXATION - appealable objection decisions - whether payments made by mining company to trustee company for an aboriginal community are deductible under s 51 Income Tax Assessment Act 1936 (Cth) - characterisation of payments made pursuant to two deeds of compensation - whether on capital or revenue account
No QG 122 of 1995
TAXATION - appealable objection decisions - characterisation of payments made pursuant to two deeds of compensation - whether on capital or revenue account - whether payment in the nature of a rent or royalty - recurrent payments in lieu of compensation for deprivation of possession of land which is the subject of mining lease on revenue account - whether annual bursary for the purpose of training a recipient in areas relevant to mining deductible
No QG 123 of 1995
TAXATION - appealable objection decisions - whether legal expenses incurred in negotiations with aboriginal community and in relation to the application for renewal of mining lease, discussions in respect of the validity of that application and advice relating to defending the validity of the application in the Mining Warden’s Court deductible
Income Tax Assessment Act 1936 s 51
Mineral Resources Act 1989 (Qld)
John Fairfax & Sons Proprietary Limited v Federal Commissioner of Taxation (1959) 101 CLR 30
Federal Commissioner of Taxation v Sherritt Gordon Mines Limited (1977) 137 CLR 612
Hallstroms Pty Ltd v The Federal Commissioner of Taxation (1946) 72 CLR 634
Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 140
Barrett v Federal Commissioner of Taxation (1968) 118 CLR 666
CAPE FLATTERY SILICA MINES PTY LTD (ACN 000 586 096) v COMMISSIONER OF TAXATION
Nos QG 121, QG 122 and QG 123 of 1995
SPENDER J
BRISBANE
28 July 1997
IN THE FEDERAL COURT OF AUSTRALIA
QUEENSLAND DISTRICT REGISTRY No QG 121 of 1995
GENERAL DIVISION
BETWEEN:CAPE FLATTERY SILICA MINES PTY LIMITED
(ACN 000 586 096)
Applicant
AND:COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
Respondent
CORAM: Spender J
PLACE: Brisbane
DATE: 28 July 1997
MINUTES OF ORDER
THE COURT ORDERS THAT:
The objection decision of the respondent made on or about 27 July 1995 to disallow in full the taxpayer’s objection dated 10 April 1995 against the Commissioner’s Amended Assessment issued 22 February 1995 in respect of the applicant’s income year ended 30 June 1994 or substituted accounting period be set aside;
The applicant’s objection dated 10 April 1995 be allowed in full;
The applicant be allowed a deduction in the sum of $652,998.00 for the income year ended 30 June 1994 or substituted accounting period;
The respondent pay the applicant’s costs of this application on a party and party basis to be taxed or agreed.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA
QUEENSLAND DISTRICT REGISTRY No QG 122 of 1995
GENERAL DIVISION
BETWEEN:CAPE FLATTERY SILICA MINES PTY LIMITED
(ACN 000 586 096)
Applicant
AND:COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
Respondent
CORAM: Spender J
PLACE: Brisbane
DATE: 28 July 1997
MINUTES OF ORDER
THE COURT ORDERS THAT:
The objection decision of the respondent made on or about 27 July 1995 to disallow in full the taxpayer’s objection dated 10 April 1995 against the Commissioner’s Amended Assessment issued 22 February 1995 in respect of the applicant’s income year ended 30 June 1993 or substituted accounting period be set aside;
The applicant’s objection dated 10 April 1995 be allowed in full;
The applicant be allowed a deduction in the sum of $398,183.00 for the income year ended 30 June 1993 or substituted accounting period;
The respondent pay the applicant’s costs of this application on a party and party basis to be taxed or agreed.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA
QUEENSLAND DISTRICT REGISTRY No QG 123 of 1995
GENERAL DIVISION
BETWEEN:CAPE FLATTERY SILICA MINES PTY LIMITED
(ACN 000 586 096)
Applicant
AND:COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
Respondent
CORAM: Spender J
PLACE: Brisbane
DATE: 28 July 1997
MINUTES OF ORDER
THE COURT ORDERS THAT:
The objection decision of the respondent made on or about 27 July 1995 to disallow in full the taxpayer’s objection dated 8 February 1993 against the Commissioner’s Amended Assessment issued 11 December 1992 in respect of the applicant’s income year ended 30 June 1992 or substituted accounting period be set aside;
The applicant’s objection dated 8 February 1993 be allowed in full;
The applicant be allowed a deduction in the sum of $49,867.00 for the income year ended 30 June 1992 or substituted accounting period;
The respondent pay the applicant’s costs of this application on a party and party basis to be taxed or agreed.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA
No QG 121 of 1995
QUEENSLAND DISTRICT REGISTRY No QG 122 of 1995
No QG 123 of 1995
GENERAL DIVISION
BETWEEN: CAPE FLATTERY SILICA MINES PTY LIMITED
(ACN 000 586 096)
Applicant
AND: COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
Respondent
CORAM: Spender J
PLACE: Brisbane
DATE: 9 July 1997
REASONS FOR JUDGMENT
These are three appeals against appealable objection decisions made by the Commissioner of Taxation (‘the Commissioner’). The central issue is whether, in the circumstances, payments made by a mining company to a trustee company for an aboriginal community are deductible under s 51(1) of the Income Tax Assessment Act 1936 (‘the ITAA’).
The appeal in No QG 123 of 1995 is from the decision of the Commissioner made on or about 27 July 1995 to disallow in full the objection by Cape Flattery Silica Mines Pty Limited (‘the taxpayer’) dated 8 February 1993 against the Commissioner’s amended assessment issued on 8 February 1993 in respect of the taxpayer’s income year ended 30 June 1992. In respect of that appeal, the taxpayer seeks that the objection decision be set aside such that the taxpayer be allowed a deduction for legal fees in the sum of $49,867.00 associated with the negotiations for a compensation package paid by the taxpayer to the Hope Vale Aboriginal Council (‘HVAC’) and the application for renewal of an existing mining lease, ML 2806.
In QG 122 of 1995, the appeal is from the objection decision of the Commissioner disallowing in full the taxpayer’s objection dated 10 April 1995 against the Commissioner’s amended assessment issued 22 February 1995 in respect of the taxpayer’s income year ended 30 June 1993. In that appeal, the taxpayer seeks the objection decision to be set aside such that the taxpayer be allowed a deduction in the sum of $398,183.00 for compensation paid to the HVAC pursuant to two deeds of compensation.
The third appeal, No QG 121 of 1995, is an appeal from the decision of the Commissioner made on or about 27 July 1995 to disallow in full the taxpayer’s objection dated 10 April 1995 against the Commissioner’s amended assessment issued 22 February 1995 in respect of the applicant’s income year ended 30 June 1994. In that appeal, the taxpayer seeks that the appealable objection decision be set aside such that the taxpayer be allowed a deduction in the sum of $646,498.00 for compensation paid to the HVAC pursuant to the two deeds of compensation.
The three appeals were heard together and proceeded by way of a statement of agreed facts. The principal question is the characterisation of the payments made pursuant to the two deeds of compensation. As is not uncommon, there are some indicia of the payments which suggest that they were made on capital account and some which suggest that they were made on revenue account. The appeals therefore involve the familiar problem of the correct characterisation of the payments.
The taxpayer has a registered office at 88 Abbott Street, Cairns and at all material times carried on mining and beneficiation of silica sand at Cape Flattery, Queensland, as its principal activity, and carried on “mining operations” within the meaning of that expression in Division 10 of the ITAA.
The taxpayer commenced mining operations at Cape Flattery in 1968 and production levels have increased gradually since 1978 from about 300,000 tonnes per annum to the present level of about 2.2 million tonnes per annum.
Cape Flattery is located approx 200 kilometres north of Cairns and about 80 kilometres north of Cooktown. It was named by Captain Cook in the course of seeking to find an opening through the Great Barrier Reef to the open sea. The journal of his first voyage records:
“ We now thought we saw a clear opening before us and hoped that we were once more out of danger: in this hope, however, we soon found ourselves disappointed and for that reason I called the headland CAPE FLATTERY. It lies in latitude 41D56MS longitude 214D43MW...”
As at January 1991, the taxpayer held four mining leases for mineral sands on land at Cape Flattery. When the taxpayer was originally granted those mining leases, one of the special conditions which applied to each of the leases was a requirement that 3 per cent of the taxpayer’s annual net profit in each year be paid to the Department of Aboriginal & Islander Affairs (subsequently called the Department of Community Services) for the benefit of the aboriginal inhabitants of the Hope Vale Reserve. The areas the subject of each of the mining leases were at the date of the grant of those mining leases within the area of the Hope Vale Aboriginal Reserve.
I was informed from the Bar table by Mr D Bloom QC, senior counsel for the applicant, that each of the payments of the 3 per cent of annual net profit had been claimed by the taxpayer, in the relevant tax year, and allowed by the Commissioner as a s 51(1) deduction.
On 18 July 1986, a Deed of Grant of Land in Trust Volume N1321 Folio 62, was issued to HVAC, an incorporated body as trustee of that land for the benefit of the aboriginal inhabitants in respect of an area of approximately 110,000 hectares (‘The Hope Vale Reserve’). Cape Flattery lies within the land the subject of the Deed of Grant of Land in Trust (‘DOGIT’) under the Land Act 1962-1986.
One of the reservations specified in the DOGIT was:
“ All minerals (as defined by the Mining Act 1968-83) on and below the surface of the land.”
The particulars of the four mining leases are as follows:
“(a) Mining Lease No. 401 in the Cooktown Mining District granted 1 August 1974 for a term of 17 years from 1 September 1974 for a total area of 6,422 hectares that was due to expire 31 August 1991 (subsequently called Mining Lease No. 2806).
(b)Mining Lease No. 409 in the Cooktown Mining District granted 17 October 1974 for a term of 18 years from 1 November 1974 that was due to expire on 31 October 1992 (subsequently called Mining Lease No. 2807).
(c)Mining Lease No. 1061 in the Cooktown Mining District granted on 14 February 1985 for a term of 21 years commencing on 1 March 1985 that was due to expire on 28 February 2006 (subsequently called Mining Lease No. 2965).
(d)Mining Lease No. 687 in the Cooktown Mining District granted 10 October 1974 for 20 years from 1 November 1974 that was due to expire on 31 October 1994 (subsequently called Mining Lease No. 2869).”
The Mineral Resources Act 1989 (Qld) (‘the Mineral Resources Act’) commenced operation on 1 September 1990. As a consequence of that Act, the numbers allocated to mining leases and applications for mining leases were changed. For convenience, mining leases and applications will be referred to by the subsequent numbering, as indicated in the above particulars for the original four leases.
It is necessary to set out details of the applications for and renewal of mining leases by the taxpayer.
On or about 27 February 1990, the taxpayer applied for the grant of a new mining lease (‘ML’), subsequently ML 7069, for a term of twenty-one years, over an area of 3,677 hectares close to ML 2806. That application was made pursuant to the Mining Act 1968-86 because the Mineral Resources Act did not commence until 1 September 1990.
The HVAC demanded increased payments by the taxpayer to HVAC. After negotiations, an arrangement was reached between the taxpayer and certain representatives of HVAC (subject to approval by HVAC) for the grant of a special lease of land over the area of the new mining lease for a rental of $60.00 per hectare per annum.
On or about 10 August 1990 the taxpayer applied for the renewal of ML 2806 for a term of twenty-one years.
Pursuant to s 7.43(5) of the Mineral Resources Act, (subsequently renumbered as s 286(6)), and cl 3(11) (subsequently renumbered as cl 3(13)) of the Second Schedule to that Act), ML 2806 continued in force:
“ ...until the application is granted unless it is sooner withdrawn or rejected.”
The HVAC subsequently sought legal and other advice and did not approve the previous arrangements made with representatives of HVAC for the grant of a special lease of land.
HVAC claimed compensation in the sum of more than $1 million per year in relation to the renewal of ML 2806 and ML 7069. The taxpayer rejected that claim.
On or about 27 May 1991 the Mining Registrar issued a certificate of application for ML 7069.
On or about 24 June 1991, HVAC objected to the Application for ML 7069.
On or about 8 July 1991, officers of HVAC applied for a mining lease in respect of an area that included the area of ML 7069. That application is referred to as ‘the Ngaarbaarl Application for a Mining Lease’.
On 9 July 1991 the Mining Registrar wrote rejecting the Ngaarbaarl application on the basis that the taxpayer’s Application for ML 7069 was a validly existing application.
On or about 5 August 1991, HVAC appealed the rejection by the Mining Registrar of the Ngaarbaarl application to the Mining Warden’s Court. The agreed facts recite that:
“ After a breakdown in negotiations between the taxpayer and HVAC, the taxpayer applied to the Mining Registrar to have the Warden’s Court determine the compensation payable to HVAC in respect of the renewal of Mining Lease 2806 (formerly ML 401) and the terms and conditions and times of payment thereof.”
In submissions made to the Warden in connection with the compensation proceedings, HVAC claimed amongst other things that the matter was not properly before the Warden’s Court because HVAC had not been served with the taxpayer’s application for the Court to determine compensation; that the Mining Act 1968-1986 did not authorise an application for renewal of reduced area of a mining lease which, it was contended, was the true interpretation of the taxpayer’s application for renewal; and that as a result, there was no valid application for renewal which meant that the Warden did not have jurisdiction to hear the compensation proceedings.
On or about 22 November 1991, the Warden made an order that he had jurisdiction to hear and determine the compensation application and adjourned the hearing of the application for determination of compensation to a later date.
HVAC appealed against the Warden’s order to the District Court of Queensland. That appeal was dismissed.
HVAC subsequently applied to the Supreme Court of Queensland for a declaration that ML 2806 expired on 31 August 1991; a declaration that the taxpayer was not a person entitled to make an application in writing to the Mining Registrar to have the Warden’s Court determine the amount of compensation and the terms and conditions and times of payment thereof pursuant to s 7.38 of the Mineral Resources Act in respect of ML 2806; an injunction to restrain the taxpayer from doing any act or thing to further prosecute its application for determination of compensation in the Warden’s Court at Cairns in respect of ML 2806; and finally, an injunction to restrain the taxpayer from extracting or removing any minerals or other materials from ML 2806.
That application to the Supreme Court was dismissed on 11 March 1992. The HVAC appealed to the Court of Appeal Queensland, which by order dated 23 March 1992 dismissed the appeal.
The taxpayer subsequently entered into negotiations with HVAC. The purpose of those negotiations was to obtain the consent of HVAC for the grant of ML 7069; to agree to an amount payable in relation to the renewal of ML 2806 and the grant of ML 7069; to maintain good relations with members of the Hope Vale community which made up a substantial section of the workforce and on whose land the sandmining operations were being carried on; and also to improve the safety for the local inhabitants and thereby reduce the risk of claims against the taxpayer.
On or about 30 April 1992, the taxpayer and HVAC executed two deeds, referred to as Deed of Compensation “A” and Deed of Compensation “B”. The recitals of Deed of Compensation “A” (‘Deed A’) refer to the holding by the taxpayer of specified mining leases and application for a new mining lease, the Ngaarbaarl application by HVAC for a mining lease; and the fact that HVAC had unsuccessfully appealed to the District Court, the Supreme Court and the Court of Appeal in relation to the renewal of ML 2806, with an order that HVAC pay the taxed legal costs of the taxpayer. Deed A also recites that before ML 2806 could be renewed, compensation to be paid to HVAC pursuant to s 7.36 of the Mineral Resources Act had to be agreed or determined; and that the grant of a lease over part of ML 7069 was dependent, amongst other things, upon HVAC’s consent to the lease (s 7.6) and the execution of a compensation agreement between the taxpayer and HVAC (s 7.36).
Section 7.36 of the Mineral Resources Act relevantly provided:
“ A Mining Lease shall not be granted or renewed unless -
(a)compensation has been determined (whether by agreement or by determination of the Wardens Court) between the applicant and each person who is the owner of land the surface of which is the subject of the application and of any surface access to the mining lease land;
(b) ...
and the conditions of the agreement or determination have been or are being complied with by the applicant.
...”
Section 7.38 deals with determination of compensation by a Wardens Court. Section 7.38(3) provides that on such a determination:
“ Upon an application made under subsection (1), a Wardens Court shall settle the amount of compensation an owner of land is entitled to as compensation for -
(a)in the case of compensation referred to in section 7.36 -
(i) deprivation of possession of the surface of land of the owner;
(ii) diminution of the value of the land of the owner or any improvements thereon;
(iii) diminution of the use made or which may be made of the land of the owner or any improvements thereon;
(iv) severance of any part of the land from other parts thereof or from other land of the owner;
(v) all loss or expense that arises,
as a consequence of the grant or renewal of the mining lease;
...”
Section 7.6 provided:
“ (1) A mining lease shall not be granted over the surface of land that is a reserve except with -
(a)the consent of the owner of that land lodged in writing with the mining registrar;
or
(b)the consent of the Governor in Council which shall be expressly stated in the grant of the lease.
(2) A mining lease shall not be granted over the surface of land of an owner that, at the time the application for the grant of the mining lease is lodged at the office of the mining registrar, is -
(a)within 100 metres laterally of -
(i) a dwelling-house, or other building of the owner (not of a temporary nature) on that land principally used for accommodation of persons or used for the conduct of business;
or
(ii) a building (not of a temporary nature) on that land currently used for community, sporting or recreational activities or as a place of worship;
or
(b)within 50 metres laterally of -
(i) a principal stockyard or a dam, bore or artesian well of the owner of that land or other artificial water storage of that owner connected to a supply of water;
or
(ii) a cemetery or burial place,
except with the written consent of the owner of that land lodged with the mining registrar on or before the date on or before which objections to the application for the grant of the mining lease may be lodged.
For the purposes of this section, a dwelling-house or building means a fixed structure that is wholly or partly enclosed by walls and is roofed.
Consent referred to in this subsection, once given, cannot be withdrawn.”
Clause 4 of Deed A is headed “SUBJECT MATTER”. Clause 4.1 provides:
“ The terms of this Deed are intended to cover and relate to:-
4.1.1Mining operations by CFSM upon the DOGIT for so long as such operations continue, and
4.1.2The conditions under which CFSM will surrender Mining Leases ML 2807 and ML 2849, and
4.1.3The holding of CFSM of Mining Lease 2965, and
4.1.4The renewed term of ML 2806 and
4.1.5Consent to ML 7069, and
4.1.6The Mining Lease referred to in Clause 5.5 of this Deed.
4.1.7The compensation payable by CFSM to Hope Vale which Hope Vale acknowledges is full and complete compensation to Hope Vale in respect of mining operations on the DOGIT.”
The letters CFSM refer in the present case to the taxpayer, and DOGIT refers to the Deed of Grant in Trust.
Clause 5.2 provided:
“ Hope Vale will agree to accept compensation in relation to mining operations on the DOGIT as provided in this Deed and the Collateral Deed in lieu of determination of the amount of compensation by the Mining Warden in relation to ML 2806, ML 2965, ML 7069 and the Mining Lease referred to in Clause 5.5 hereof and renewal of any such leases during the term of this Deed, provided that any renewed term does not exceed the term hereof unless otherwise mutually agreed by the parties.”
The “Mining Lease referred to in cl 5.5” of Deed A is one which was to be applied for by the taxpayer to enable installation and maintenance of a conveyor belt or other like equipment for the purpose of transporting silica sand mined on ML 7069 to ML 2806.
By cl 5.7.1 of Deed A, the taxpayer agreed to withdraw its application for renewal of ML 2807, to surrender ML 2849 and to reduce the area of ML 7069 to a maximum of 1,000 hectares in such a way as to ensure water supply from Lookout Point to the wetlands inland of Lookout Point; to prevent severance of access to Flattery Bay; and to facilitate access to Lookout Point. The taxpayer also agreed to provide some specified roads.
Clause 5.7.5 provided:
“ (a) CFSM will pay to Hope Vale an amount of 2.5 per centum of the gross sales proceeds of the silica, sand and other products won by CFSM from ML 2806, ML 2965 and ML 7069 as declared by CFSM in its quarterly royalty return to D.R.I. or the equivalent thereof on and from the date of execution of this Deed.”
That sum was to be payable quarterly in arrears.
Clause 5.7.5(c) provided:
“ Payment of 3% of annual pre tax profit payable under ML 2806 and ML 2965 shall continue to be payable to the Department of Family Services and Aboriginal and Islander Affairs for the 1991 year and thereafter to the date of cessation of liability to pay such compensation. The payments due by CFSM under Clause 5.7.5(a) shall be reduced by the amount of any payment made under the profit participation condition calculated where necessary on a pro-rata basis by reference to the number of days in the period from the date of execution of this Deed to the date of cessation of liability to pay such compensation as compared with the number of days in the period in respect of which the profit participation is payable.”
The deed provided for interest in default of payment of any compensation amount due and owing under the terms of Deed A at the prime overdraft rate of the ANZ Bank on overdrafts exceeding $100,000.00.
Deed B gave voice to a policy of preference for members of HVAC for employment in all aspects of the taxpayer’s operations. Under this deed, the taxpayer agreed to the provision of the employment of the Hope Vale community as a liaison officer, and further agreed to provide the funding for two new Hope Vale apprenticeships each year commencing in 1992 until eight Hope Vale apprentices were employed at any one time. The taxpayer also agreed to provide and fund at least one $7,000.00 bursary for the purpose of enabling a student of the Hope Vale community to pursue studies and to acquire qualifications in trades or professions relevant to the needs of the taxpayer and the Hope Vale community.
Clause 7.8 of Deed B referred to compensation and provided in part:
“ [The taxpayer] will pay to Hope Vale an amount of 0.5 per centum of the gross sales proceeds of the silica sand and other products won by CFSM from ML 2806, ML 2965 and ML 7069 as declared by CFSM in its quarterly royalty return to D.R.I. or the equivalent thereof on and from the date of execution of this Deed.”
It is agreed between the parties that pursuant to the obligations in those deeds, the taxpayer paid HVAC $398,183.00 during the year of income ended 30 June 1993 and $646,498.00 during the year of income ended 30 June 1994.
It is further agreed between the parties that the taxpayer paid $49,867.00 in legal expenses to its solicitors in the year of income ended 30 June 1992. Those fees were allocated between negotiations with HVAC (which amounted to $29,700.00) and $20,167.00 to assistance in relation to the application for renewal of existing ML 2806, discussions in respect of the validity of that application and subsequent advice in relation to defending the validity of the application in the Mining Warden’s Court. It is also agreed between the parties that in accordance with the terms of the deeds, the taxpayer paid a $6,500.00 bursary payment to fund the education of a student from the Hope Vale community during the year of income ended 30 June 1994.
In September 1992, the taxpayer lodged its income tax return in respect of the year of income ended 30 June 1992 together with an application for a s 169A ruling in respect of the deductibility of legal expenses totalling $49,867.00 incurred in respect of the year of income ended 30 June 1992.
By this s 169A ruling dated 10 December 1992, the Commissioner notified the taxpayer that all the expenses were considered to be of a capital nature and not deductible under s 51(1) of the ITAA. By notice of amended assessment dated 8 February 1993 the Commissioner disallowed the expenses of $49,867.00 claimed in respect of the year of income ended 30 June 1992.
The taxpayer lodged a notice of objection dated 8 February 1993 against the disallowance of the legal expenses and the Commissioner has treated the objection as an objection against the amended assessment in respect of the year of income ended 30 June 1992.
The taxpayer lodged its income tax return in respect of the income tax year ended 30 June 1993 and on or about 8 September 1994 the taxpayer lodged its income tax return in respect of the income tax year ended 30 June 1994. In an application dated 15 September 1994 the taxpayer sought a private ruling from the Commissioner, regarding the deductibility of the financial commitments under the Deed A and Deed B.
By a notice of private ruling dated 3 November 1994, the Commissioner ruled that the financial commitments under the two deeds were not deductible and by notices of amended assessment in respect of the income years ended 30 June 1993 and 30 June 1994 the Commissioner disallowed the amounts of royalty payments and the bursary payment claimed as deductions.
The taxpayer by notices of objection dated 10 April 1995 objected to the amended assessments but these three objections were disallowed by the Commissioner on 27 July 1995.
On 7 August 1995 the taxpayer applied to the Federal Court for each of the three objections decisions in respect of the relevant years of income to be set aside or varied.
Section 51(1) of the ITAA relevantly provides:
“ All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.”
The primary contest between the taxpayer and the Commissioner is whether the relevant amounts are payments on revenue account , as the taxpayer contends, or on capital account, as the Commissioner contends. The Commissioner submits as a subsidiary argument that, even if the payments were on revenue account, they were made at a point too soon properly to be regarded as an expense incurred in gaining or producing assessable income or carrying on a business for the production of that income.
This latter submission can be summarily rejected: whether the proper characterisation be capital or income, the timing of the payments, being quarterly in arrears in respect of tonnage production as certified by the taxpayer in its quarterly royalty return to the Department of Resources Industries (Qld) is not premature. In my opinion there is, in this case, no question of a conclusion similar to that of the majority in the interesting and contentious case of Steele v Deputy Commissioner of Taxation 97 ATC 4239.
The taxpayer submitted that the payment is in the nature of a rent or royalty, being a recurrent and regular outgoing that is very much part of the cost of earning each dollar of income which the taxpayer earns. As the provisions of the compensation deeds indicate, the obligation to pay is predicated on sales. The amount is a percentage of gross sales.
The amounts in question are not strictly royalty payments.
In Federal Commissioner of Taxation v Sherritt Gordon Mines Limited (1977) 137 CLR 612, Sir Anthony Mason referred at 626 to the observations of Dixon CJ, Williams, Webb, Fullagar and Kitto JJ in Stanton v FederalCommissioner of Taxation (1955) 92 CLR 630 at p 642, where their Honours said of the word “royalty”:
“ In other words it is inherent in the conception expressed by the word that the payments should be made in respect of the particular exercise of the right to take the substance and therefore should be calculated either in respect of the quantity or value taken or the occasions upon which the right is exercised.”
Mason J (as he then was), said of this passage:
“ ...the passage already quoted [makes] it clear that it is of the essence of a royalty that the payments should be made in consideration of the grant of a right, that they should be made in respect of particular exercises of the right and therefore should be calculated in the manner stated.”
His Honour held that:
“ ...the substantial, if not the sole, consideration for the payments was not the grant of a right but for the provision of technical assistance and information which Western Mining was entitled to use once it was supplied, without the grant of any additional right so to do.”
Gibbs CJ agreed with Mason J.
In Barrett v Federal Commissioner of Taxation (1968) 118 CLR 666, Owen J held that payments received by the owner of land and quantified by reference to the amount of soapstone removed from his land were not payments of royalties because the owner of the land did not own the minerals. The payments therefore were not made in consideration of the grant of rights with respect to the soapstone.
In McCauley v The Federal Commissioner of Taxation (1944) 69 CLR 235, Latham CJ observed at 240 that use of the term “royalty” is not confined to patents, copyrights and minerals and that:
“ The term has been used to describe payments for removing furnace slag from land (Shingler v P. Williams & Sons (1933) 17 Tax Cas. 574), and to payments for flax cut (Akers v Commissioner of Taxes (NZ) (1926) GLR (NZ) 259), the person paying the royalties becoming the owner of the slag or of the flax.”
In the present case the minerals are not owned by HVAC: the payments can not therefore be described as royalties in the precise sense of that word.
It is the taxpayer’s contention, nonetheless, that the payments are in the nature of a rent or royalty. The sand is owned by the Crown; and the land, apart from the sand, is owned by HVAC. In effect, the payments are for the right to occupy the land to work on the sand and are in the nature of a rental, being for the exclusive possession of the land so as to remove sand which is the property of the Crown.
The submissions for the Commissioner directed attention at what the taxpayer got in consideration for the payments which it had made and which are the subject of the claim for deduction. It was submitted that cl 5 of Deed A listed a number of covenants or promises given by the aboriginal community in return for the promise of payment made by the taxpayer.
It is necessary to set out cl 5 in full. The clause is headed “AGREEMENT”, and provides:
“5.1 Hope Vale agrees that it will proceed no further with a proposed Appeal or Application for Special Leave to Appeal from the decision of the Queensland Court of Appeal in proceedings between Hope Vale and CFSM handed down on Monday 16 March 1992.”
5.2Hope Vale will agree to accept compensation in relation to mining operations on the DOGIT as provided in this Deed and the Collateral Deed in lieu of determination of the amount of compensation by the Mining Warden in relation to ML 2806, ML 2965, ML 7069 and the Mining Lease referred to in Clause 5.5 hereof and renewal of any such leases during the term of this Deed, provided that any renewed term does not exceed the term hereof unless otherwise mutually agreed by the parties.
5.3Subject to Clause 5.7.1(c), Hope Vale will withdraw its objection to CFSM’s Application for ML 7069 and will inform the Mining Warden’s Court and all relevant officers of the Queensland Department of Resource Industries that it supports any varied application or applications by CFSM for ML 7069 and will lodge a notice of consent in writing with the Mining Registrar pursuant to Section 7.6(1)(a) and (if requested by CFSM) Section 6.3 of the MRA.
5.4For the term of this Deed, Hope Vale shall not pursue the claim referred to in recitals J and K.
5.5Hope Vale will if requested by CFSM grant a licence or (if this is not practicable) other similar rights to CFSM to allow the construction of an access road between ML 2806 and ML 7069 and will consent to the grant to CFSM of a mining lease of adequate dimensions as determined by CFSM to enable installation and maintenance of a conveyor belt or other like equipment for the purpose of transporting silica sand mined on ML 7069 to ML 2806. Hope Vale will lodge an appropriate notice of consent in writing with the Mining Registrar pursuant to s 7.6(1)(a) of the MRA. CFSM shall construct a means of access over or under the conveyor belt equipment at a point as determined by the Co-ordinating Committee referred to in Clause 7.6 of the Collateral Deed.
5.6Hope Vale acknowledges that CFSM may use sand gravel quarry materials natural water resources and any overburden occurring on ML 2806, ML 2965, ML 7069 and the Mining Lease referred to in Clause 5.5 hereof without charge or payment of any royalty to which Hope Vale may otherwise be entitled.”
It was therefore submitted that there was a composite consideration ranging beyond simply the compensation element recorded in cl 5.2 of the lease.
The second main submission by the Commissioner was that where an amount was paid by a miner to a landholder who was not the owner of the mineral rights by way of compensation for damage which the miner may do to the land in exploiting mineral rights granted by another, the outgoing is prima facie if not always on capital account and the receipt in the hands of the landowner is a capital receipt. This second submission focuses on payment as compensation for damage rather than payment for a right to possession and use.
It was accepted by Mr Nettle QC, senior counsel for the Commissioner, that the constituent elements under s 7.38(3) of the Mineral Resources Act are an amalgam, some of which are more of a revenue character than of a capital character. The overriding submission for the Commissioner is that the payment represents an amount or amounts which must be paid, or agreed to be paid, at the outset, before permission is granted for the issuing of a new lease or the renewal of the old lease. Whether the payment be by a lump sum “up front”, or by a series of payments, the payments are on capital account, because the payments are necessary for the grant of a capital asset, that is, the lease.
The principles underlying s 51(1) have been the subject of much exposition. It is sufficient for present purposes to refer first to the observations of Dixon J (as he then was) in Hallstroms Proprietary Limited v The Federal Commissioner of Taxation (1946) 72 CLR 634, where his Honour at 647 referred to:
“ ...the general consideration that the contrast between the two forms of expenditure [ie., on capital account and on revenue account] corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organization and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.”
Earlier, in Sun Newspapers Limited v Federal Commissioner of Taxation (1938) 61 CLR 337, Dixon J said at 359:
“ The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.”
His Honour continued at 361:
“ In the attempt, by no means successful, to find some test or standard by the application of which expenditure or outgoings may be referred to capital account or to revenue account the courts have relied to some extent upon the difference between an outlay which is recurrent, repeated or continual and that which is final or made ‘once for all’, and to a still greater extent upon a distinction to be discovered in the nature of the asset or advantage obtained by the outlay. If what is commonly understood as a fixed capital asset is acquired the question answers itself.”
His Honour at 363 made the statement so often later cited:
“ 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.”
In John Fairfax & Sons Proprietary Limited v Federal Commissioner of Taxation (1959) 101 CLR 30, Menzies J (with whom Dixon CJ, Kitto and Taylor JJ agreed) said at 48:
“ To make a payment to acquire or to defend the acquisition of a favourable position from which to earn income or to enter into arrangements that will yield income is not in general an outlay incurred either in gaining or in carrying on business for the purpose of gaining assessable income; such a payment in the case of a trading company, occurs at a stage too remote from the receipt of income to be so regarded. To be deductible an outlay must be part of the cost of trading operations to produce income, i.e., it must have the character of a working expense.”
At 50 his Honour said:
“ ...the essential element [for the applicability of s 51(1)] is that the expense has been incurred ‘in carrying on business’ rather than...for the purpose of enabling a person to carry on’ trade and earn profits.”
In G P International Pipecoaters Proprietary Limited v Federal Commissioner of Taxation (1990) 170 CLR 124, Brennan, Dawson, Toohey, Gaudron and McHugh JJ said at 137:
“ 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, for 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: Sun Newspapers Ltd and Associated Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337, at p 363; Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428, at pp 445-447, 454; Cooper v Federal Commissioner of Taxation (1957) 97 CLR 397, at p 404 (affirmed on other grounds (1958) 100 CLR 131); and see the differing analyses of what the subject expenditure was for in Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 140.”
[emphasis added]
These principles have been considered and applied recently by the Full Court of the Federal Court in Labrilda Pty Ltd v Commissioner of Taxation (1996) 65 FCR 119 and in Steele v Deputy Commissioner of Taxation (supra). Each of these cases indicate that judicial minds have differed as to the determination of the character of a payment.
In Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 140, the taxpayer paid $US 200,000.00 plus a royalty amount of US 15c per ton of ore in exchange for the shares in a company which owned an iron ore mine. The High Court held by a majority of three to two, that the royalty was not of a capital nature and, it being conceded that they were outgoings incurred in gaining assessable income, were allowable deductions under s 51(1) of the Act. The successful argument for the taxpayer in that case was that:
“ ...though the promise to make [the payments] was part of the consideration for the agreement to transfer the shares, they do not thereby become capital payments but are analogous to the payment of rent agreed to be paid on the grant of a lease at a premium or to royalties agreed to be paid on the grant of a money sum of a licence to use a patent.”
Barwick CJ held at 150:
“ ...the appellant by agreeing to make the recurrent payments was prepared to admit the vendors of the shares to participation in the result of the mining of the iron ore. They were made, and necessarily made, by the appellant as disbursements in its business. They were none the less so by reason of the fact that the appellant had agreed to make them: nor does the fact that the agreement to make them formed part of the consideration for the purchase of the shares made them payments of a capital nature.”
And at 151 Sir Garfield continued:
“ If an analogue is felt to be of assistance, an analogy may be found in the grant of a licence to use a patent upon payment of a cash price and a continuing royalty on what might be produced by employment of the patent. The promise to pay the royalties is, in my opinion, in such a case part of the consideration for the grant of the licence but neither the receipt nor the payment of the royalty is for that reason a capital receipt or payment. The reasoning in Egerton-Warburton v Deputy Federal Commissioner of Taxation.(1934) 51 CLR, at pp 572-573 strongly suggests the conclusions at which I have arrived. The payments were, in my opinion, disbursements by the appellant in the course of its business and were not of a capital nature.”
Jacobs J at 171 said:
“ To the question for what purpose is the expenditure made, the answer in the case of a pre-existing obligation could always be that the expenditure was made for the purpose of performing that obligation. The answer is but a conclusion of law. But that leaves no room for the ‘practical and business point of view’ to which Dixon J referred in Hallstroms’ Case (1946) 72 CLR 624, at p 648, nor does it enable a solution of the problem to be found, not in ‘any rigid test or description’ but from ‘many aspects of the whole set of circumstances,’ to use the phrases appearing in the BP Case (1965) 112 CLR, at p 397; [1966] AC, at p 264. In order to solve the problem in a practical way it is necessary to look at the payments at the time each is made and to ask - what is that payment calculated to effect? Is it merely payment for the capital asset, the shares, already wholly acquired, and which are to be paid for over a period? Or is the purpose of the payment from the practical and business point of view to pay for the current mining operations?”
[emphasis added]
His Honour noted at 175:
“ Each case depends on its own facts and circumstances but it may be stated that when the consideration for a depreciating asset right or advantage of limited life is a series of regular recurrent payments related to the life of the asset right or advantage then it is very likely that the recurrent payments will be found to be outgoings on revenue account. Particularly is this so when the amount of the payments is related to the use made of the asset right or advantage.”
True it is that payment calculated by reference to production or use has been held to be on capital account in the particular circumstances of the case: Barrett v Federal Commissioner of Taxation (1968) 118 CLR 666; H J Rorke Ltd v Inland Revenue Commissioner [1960] 1 WLR 1132; Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428.
The factual position in this case is that HVAC was aware that before the taxpayer could be granted a mining lease by the Crown, the taxpayer had to satisfy the requirements of s 7.38 of the Mineral Resources Act. In my opinion, the history of the litigation earlier outlined indicates that HVAC was attempting to make life as difficult as possible for the taxpayer, with the intention of extracting the best deal possible in respect of the obligation imposed by s 7.38 on the taxpayer, as a condition precedent to the grant of a mining lease to the taxpayer by the Crown under the Mineral Resources Act.
This is not a case, such as Broken Hill Theatres Pty Ltd v Federal Commissioner of Taxation (1951-52) 85 CLR 423, where an amount is paid in order to protect or preserve the profit yielding structure. Of course there would be no lease (and hence no mining and therefore no profit) granted to the taxpayer without it satisfying the requirements of s 7.38 of the Mining Resources Act. However, that factor does not necessarily make the payments on capital account.
Unless rent for a factory is agreed to be paid to the landlord, there can be no occupation of the factory (and hence no production, and therefore no profit), yet it is clear that payments pursuant to the agreement to pay rent are not on capital account.
In each case it is necessary to determine the character of the payment. To determine what it is that the moneys were paid for in this case requires one to focus on what the deed says, but as Jacobs J pointed out in Cliffs Case (supra) at 172, the problem is to be solved by reference to the “many aspects of the whole set of circumstances, some of which may point in one direction, some in the other”, adopting the phrase of Pearce LJ in BP v Federal Commissioner of Taxation (1965) 112 CLR 386 at 397.
The payments in question, as cl 5.2 of Deed A indicates, are “compensation,...as provided in this Deed and the Collateral Deed, in lieu of determination of the amount of compensation by the Mining Warden” under s 7.38(3) of the Mineral Resources Act.
The quantum of the payments (under both deeds) is 3% of gross sales.
These payments are recurrent payments (calculated as a percentage of gross sales) in lieu of compensation for deprivation of possession, diminution in value, diminution of the use which may be made of the land, severance of any part of the land, compensation for any surface rights of access, and for loss and expense that arises as a consequence of the renewal of the mining lease.
Looking at the matter realistically, in my view, the payments when made, were made essentially as compensation for the deprivation of possession of the land the subject of the mining leases.
Barrett (supra) was a case that dealt with assessability rather than deductibility, and the question was whether the so called royalties were assessable in the hands of the recipient. In Barrett, Owen J said at 671:
“ It is true that the amounts paid to the appellant were calculated on the basis of the tonnage of soapstone mined in each year but, in my opinion, they are not for this reason to be regarded as payments of royalties. The soapstone belonged to the Midland Company and not to the appellant and a royalty - when one is speaking of mining operations - is a ‘payment to the owner of minerals for the right of working the same on every ton or other weight raised’: Wharton’s Law Lexicon, 14th ed.”
Owen J continued:
“ Nor do I think that the payments are to be regarded as having been received by the appellant as income in return for the grant of a licence to use his land for the purpose of mining thereon.”
His Honour’s conclusion appears at 672:
“ The payments were in my opinion made and received for the purposes set out in cl 4 of the deed of 17th October 1953, that is to say, to make good the estimated diminution in the value of the land and the amount of damage to it which it was anticipated might result from the carrying on of mining operations.”
While one of the factors in s 7.38 is damage to the land, in my opinion it is not likely in this case that there will be any diminution in the value of the land, particularly given the obligations under the mining lease to rehabilitate the land, which include the obligations imposed by s 7.33 of the Mineral Resources Act.
The essential character of the payments in issue in the present case is that of a series of recurrent payments in the nature of rental, for the right of occupation by the taxpayer, a right which otherwise would be enjoyed by the aboriginal community. The quantum of the recurrent payments is calculated by reference to the value of silica sand that is won from the mining lease.
In my opinion the payments made under the compensation deeds are on revenue account.
Further, and independently of my conclusion based on what I understand to be the fundamental principles earlier set out, it seems to me that this case cannot sensibly be distinguished from the judgment of the High Court in Cliffs International case (supra). In my opinion, this is a much stronger case for the taxpayer than Cliffs.
I am of the same opinion in relation to the payments in respect of the bursary. The bursary is an annual bursary of up to $7,000.00 and is for the purpose of training a person to enable something useful to be done in relation to the mine. The field of study to which the bursary is directed is something that could be put to utility in the operations of the taxpayer. The bursary winner is not obliged to work for the taxpayer. In circumstances where the members of the Hopevale community make up a substantial section of the workforce at the operations of the taxpayer at Cape Flattery, and where it is clear that good relations between the taxpayer and the community is important to the success of the taxpayer’s business activities and operations, it seems to me that the payment of the annual bursary is properly to be regarded as a business expense and on revenue account.
As regards the final matter of legal expenses, this aspect can be resolved on the basis of a concession made on behalf of senior counsel for the Commissioner. Mr Nettle QC submitted that in relation to legal expenses:
“ ...if the taxpayer wins on its principal case then it will win on its legal expenses, and if it loses on its principal case, it will lose on its expenses. The nature or character of legal expenses follows the advantage which was sought to be gained by incurring them. If one spends money on legal expenses in buying a building, then ordinarily it is on capital account unless one trades in buildings. If one spends legal expenses in making a takeover offer, it is on capital account unless one is a dividend stripper, because one is seeking through the legal expenses to acquire or to augment the capital basis of the operation.”
Reference was made to Sunraysia Broadcasters Pty Ltd v Federal Commissioner of Taxation 91 ATC 4530, a decision of Davies J, where the authorities on this aspect are reviewed.
While it may have been possible to draw distinction between the amount of legal expenses of $29,700.00 which, according to the agreed facts, were legal expenses concerning negotiations with HVAC, and the amount of legal expenses of $20,167.00 which, according to the agreed facts, related to “assistance in relation to the application for renewal of existing Mining Lease No 2806, discussions in respect of the validity of that application and subsequent advice in relation to defending the validity of the application in the Mining Warden’s Court”, in the light of the concession on behalf of the Commissioner, I ought also to hold that the legal expenses the subject of the agreed statement of facts are also on revenue account.
I will hear the parties as to the orders that I should make in the light of these reasons.
I certify that this and the preceding thirty (30) pages are a true copy of the reasons for judgment herein of the Honourable Justice Spender.
Associate
Date: 9 July 1997
Counsel for the applicant : Mr D Bloom QC, with him Mr G T Pagone
instructed by : Clayton Utz
Counsel for the respondent : Mr G Nettle QC, with him Mr G O’Grady
instructed by : Australian Government Solicitor
Date of hearing : 7 August 1996
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