Citibank Ltd v Commissioner of Taxation; Citicorp Finance Pty Ltd v Commissioner of Taxation; Citicorp Wholesale Pty Ltd v Commissoner of Taxation

[1994] HCATrans 211

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IN THE HIGH COURT OF AUSTRALIA

Office of the Registry

Sydney Nos Sl41, S142 and S143 of 1993

B e t w e e n -

CITIBANK LIMITED

Applicant

and

COMMISSIONER OF TAXATION OF THE

COMMONWEALTH OF AUSTRALIA

Respondent

Office of the Registry

Sydney No Sl44 of 1993

B e t w e e n -

CITICORP FINANCE PTY LIMITED

Citibank 1 11/2/94

Applicant

and

COMMISSIONER OF TAXATION OF THE

COMMONWEALTH OF AUSTRALIA

Respondent

Office of the Registry

Sydney No Sl45 of 1993

B e t w e e n -

CITICORP WHOLESALE PTY LIMITED

Applicant

and

COMMISSIONER OF TAXATION OF THE

COMMONWEALTH OF AUSTRALIA

Respondent

Applications for special leave

to appeal

BRENNAN J
DEANE J

GAUDRON J

TRANSCRIPT OF PROCEEDINGS

AT SYDNEY ON FRIDAY, 11 FEBRUARY 1994, AT 10.29 AM

Copyright in the High Court of Australia

MR D.M.J. BENNETT, QC:  May it please the Court, I appear

with my learned friend, MR B.J. SULLIVAN, for the applicants in each of those matters. (instructed

by Thomas Eugene O'Callaghan, Solicitor, Citibank

Limited)

MR A.H. SLATER, QC: If the Court please, I appear with my

learned friend, MR S.J. McMILLAN, for the

respondent in each matter. (instructed by the

Australian Government Solicitor)

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BRENNAN J:	Mr Bennett.
MR BENNETT:	Your Honours~ the central question in this

appeal is one of the basic questions which can

arise in relation to the ·meaning of the phrase

"income according to ordinary concepts". The one

sentence issue is whether, in determining whether

something is income according to ordinary concepts

one looks to the legal characterization of the

transaction or its substance.

There are a number of cases which deal with

the distinction between substance and form in cases

where there is something approaching a sham. If a

tax were imposed on leases as such, the existence

of a Radaich v Smith arrangement in which something

was described as a licence but held ultimately to

be a lease would not prevent the tax being

attracted. One would look to the substance, not

the form. And one gets similar problems of

characterization in cases like K.D. Morris where

one has a series of roll-over transactions and

bills and that is held really to be a loan.

But this case is not concerned with sham; nor

is it concerned with labelling in the way that

Radaich v Smith or K.D. Morris are. We do not

submit that this transaction is not really a lease.

If leases were taxed, we would be caught. The

problem which arises in the present case is whether

a transaction should be taxed where it falls within

a legal concept which normally or generally is

income according to ordinary concepts but is, as a

matter of commercial substance, differently

characterized.

BRENNAN J: What do you mean - are there two substances we

are looking at: one legal, one commercial?

MR BENNETT: Yes, Your Honour. And may I just explain that

briefly to show the nature of the transaction.	My
client is a bank, not a car dealer. It does not
have a stock of cars which it sells. A customer

comes to it with a car to be acquired by it, or the

car the customer owns for the sole purpose of the

car being financed. The method used - if one can

make the pun, the vehicle used - is a commercial

lease. That lease is a lease for legal purposes.

The lessor is the owner, the lessee is the lessee, and at the end of the lease the lessor offers the

lessee the right to purchase the vehicle for what

is called the residual.

The important point is that there is no

obligation to do that. There is no implied term,

there is no nod and wink, and if the lessor were to

refuse to sell the vehicle at the residual because

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it had a higher value, the lessee would have no

legal recourse. However, as a matter of commercial

necessity the lessor would always make the offer.

The lessor will never say, at the end of the lease,

"This Rolls Royce has kept it's value very well; it

is worth more than the residual; I do not think I

wil.l offer it to you." If a lessor were to say

that it would be legally justified but its business

would probably collapse within 24 hours. It is a

matter of common commercial knowledge that lessors

act in that way.

Now, when one comes to look at the taxation significance of the transaction, that must be taken

into account. One does not just say, as a matter

of law there is no obligation to do it. One says,

this is a type of transaction in which that is done

every day. So that emphasizes that the real

nature, the commercial nature of the transaction is

a financing transaction. The risks taken by the

lessor are financing risks, not the risks of

ownership, and the transaction is designed so the

lessor receives no more and no less than his

capital and interest.

It is important to note that there are many

situations where the whole of the sum received as

rent is not necessarily income according to

ordinary concepts or vice versa. Suppose you have

a house where the commercial rental value of the

land for a year is $1000 and there is a house on it

worth $9000. If a demolisher takes a lease for a

year for $10,000, with the right to demolish and

take away the house, a court would have little

difficulty in saying, we would submit, that $1000
was rent and $9000 was a capital payment.

One could imagine a reverse situation, if you have a block of land which has a rental value of

$10,000 and there is a rent of $1000 and an

obligation to build a $9000 house. There would be

rent of $10,000, not because it is really rent, not	little difficulty there in saying that it is really
because it falls within the concept of rent as a
matter of landlord and tenant law, which it does
not, but because it is income according to ordinary concepts. And that point is made in the South Australian Battery Makers case in a judgment of the
Acting Chief Justice with which two other members
of the majority agreed.

We submit that issue is fundamental to the

concept of income. We have here - - -

DEANE J: What about the converse, Mr Bennett? In this

case, looking at it from the point of view of the

customer, would you say so much of what he pays can

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be attributed to the use of the vehicle and so much

can be attributed. to the opportunity of acquiring

it at the end of the period?

MR BENNETT:  That would be the probably consequence, in my

submission. Obviously one would have to look at each case on its merits and look at the taxpayer

and so on, but in general that would be the logical

consequence.

BRENNAN J: Will that not be, equally, the end of your

client's business?

MR BENNETT:  No, Your Honour, because no doubt that would

become the normal method used by all finance

companies. There might be market matters my client

would have to take into account obviously,

depending on what others did. But what has

happened here, we submit, is that the Full Court, unlike the trial judge, has really applied a very simple syllogism. It said, well, all rent or

periodic payments in consideration of bailments -
because there is some question if you use the word

"rent" for lease - is income. This is a periodic

payment for a bailment, therefore it is income.	We
submit the fallacy lies - - -

DEANE J: One would have thought the Commissioner would be

supporting your approach in that event, bearing in

mind the tax rate of the people who normally hire

these vehicles under these arrangements and the

lower corporate tax rate.

MR BENNETT:  One wonders. It may be, of course, that a lot

of vehicles in this category are not deductible at

all to their users. Maybe that is a naive

submission.

DEANE J: Except if they were not deductible at all, one

would have thought this form of transaction would

be quite inappropriate.	You would have a
transaction where you were entitled to - - -

MR BENNETT:  Your Honour, there are other reasons why one

may want to have a lease, rather than a hire

purchase arrangement. There may, for example, be

question of disclosing one's debts to banks,

matters of that sort, which may affect people. But

it is surprising that there is no direct

authority - there are a number of general comments

of looking at substance, not form; there is no

direct authority on it.

The nearest line of authority is the annuity cases; cases like Egerton-Warburton which my

learned friend relies on in the High Court. What

we submit there is that if one goes right back to

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the earliest authorities on annuities, the courts

do recognize a distinction between a life annuity

and a term annuity. What seems to be said is that

prior to the provisions of the Act dealing with
annuities, if one pays $10,000 for an annual
payment for ten years, which uses up the whole
amount, that is apportionable between interest and

principle. But if one pays $10,000 for an annuity

for the rest of one's life at a fixed amount, that

is all income because, in effect, it has been

converted by the risk taken by the other party.

That analogy is not disadvantageous to me

because it is my submission that in the present

case the analogy is closer to the term annuity.

Now it is significant - I have not referred to it

yet, but Your Honours will be aware it is referred

to at great length in the written submissions and

the judgments - that the accounting standards

require the use of the finance method and that is

significant, we submit, not because the approach of

accountants determines whether something is income

under the Act or not but because it does illustrate very clearly the proposition we make about the true

commercial nature of the transaction.

The case can be put at a second and lower

level of generality. Finance leasing involves

something like $4.9 billion per year, according to

the evidence, and the question of how these

transactions should be treated for tax purposes is

an important one. It is not only depreciation on

luxury cars. That is what has caused the large

amounts to arise in this case, but it is of

importance as a timing matter in all leases of all

chattels which method is adopted and we would

submit, with amounts of tax like that involved, it

is an important issue to the industry. That is the
issue of how you tax a finance lease as opposed to

the more general issue of just one look to the

commercial substance of the transaction. Whatever

happens, the case involves $18,000 million to my

clients.

The point is a basic one. If leave is granted

this will probably be the first case referred to by

lecturers in income tax when they start telling

their students what income according to ordinary

concepts is. We submit it is a very central and
very basic point. It is an important one. It is a

short point and, in our respectful submission, it

is an appropriate case for special leave. May it

please the Court.

BRENNAN J:  We need not trouble you, Mr Slater.

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The decision of the Full Federal Court on the issues raised by the application is not attended

with sufficient doubt to warrant the grant of

special leave to appeal from the unanimous decision

of a court which, as this Court has repeatedly

said, is ordinarily the final court of appeal in

tax matters.

Accordingly, special leave will be refused.

MR BENNETT: If the Court pleases.

MR SLATER:  We seek costs, if Your Honours please.

BRENNAN J: It will be refused with costs.

AT 10.44 PM THE MATTER WAS ADJOURNED SINE DIE

Citibank 11/2/94