G.P. International Pipecoaters Pty Ltd v The Commissioner of Taxation

[1989] HCATrans 25

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry

Perth No P28 of 1988

B e t w e e n -

G.P. INTERNATIONAL PIPECOATERS

PTY LTD

Applicant

and

COMMISSlONER OF TAXATION

Respondent

Application for special
leave to appeal

BRENNAN J GAUDRON J McHUGH J

Pioeco:1ters

TRANSCRIPT OF PROCEEDINGS

FROM PERTH BY VIDEO LINK TO CANBERRA

ON FRIDAY, 17 FEBRUARY 1989, AT 1.27 PM

Copyright in the High Court of Australia

C2T21/l/HS 1 17/2/89

MR P.F. FLETCHER:  May it please the Court, I appear for

the applicant in this matter. (instructed by

Solomon Brothers.

MR C.J. CARR:  May it please the Court, I appear with

my learned friend, MRS. BHOJANI, for

the respondent. (instructed by the Australian

Government Solicitor)

BRENNAN J:	Yes, Mr Fletcher.
MR FLETCHER:	The factual context from which the application

arises is best established, Your Honours, by

referring to pages 13, 14, 53 and 54 of the

application book. Page 13 is from the reasons

for judgment of His Honour Mr Justice Pidgeon

of the Supreme Court of Western Australia.	At
the top of page 13 His Honour states that:

The taxpayer entered into a contract

with the State Energy Commission of Western

Australia (SECWA) whereby the taxpayer

would coat externally and internally pipes

that were to be used on the Dampier to

Perth Natural Gas Pipeline project.

Over the page on page 14 His Honour goes to say

at point 10:

The agreement that arose following the

acceptance of the tender require the

contractors to instal plant which would

be owned by them in a workshop and

storage area on land they leased at

Geraldton. The contractors sought and

obtained from SECWA a payment of the

amount referred to -

the amount ref erred to, Your Honours, is $4.6 mil lion -

plant and its installation. It was paid

for the purpose of paying for this

by SECWA by the three instalments -

and Your Honours, the three instalments were each

of approximately $1.5 million -

during a six month period while the plant

was being installed and before any coated
pipe had been delivered. The cost of
installing the plant was almost equal

to the amount received.

Your Honours, in fact it was found that the cost

of installing the plant ultimately exceeded the

amount received.

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MR FLETCHER (continuing): "The plant was of no use to the

taxpayer at the end of the contract and it was sold

for salvage value at a much less than the cost of

purchasing and installing it. It is the taxpayer's

claim that the total amount in question is not

income, but was received as a capital payment. It

is the Cormnissioner's claim that it was remuneration

under the contract, although applied to a capital

purpose and as income!' If I might emphasize that

last sentence, Your Honours, that is the key question

of fact that was to be decided and it also involved

a question of law. Your Honours, at pages 53 and 54,

there continues, and this time in the reasons for

judgment of the Full Federal Cour4 a surmnary which

will suffice to provide the factual background, other

than to surmnarize facts found.	At page 53, at point 50,
Their Honours stated that:

the same question arises in each appeal.

There were three appeals:

It is whether a sum of $4,675,931 received by

the appellant taxpayer under a contract with

the State Energy Cormnission of Western Australia

('SECW~) is assessable income under

section 25(1) of the INCOME TAX ASSESSMENT ACT .....

The sum was received for what were sometimes

described as establishment costs, and at

other times as mobilization costs, incurred in

erecting a plant for the sole purpose of

coating, both externally and internally, the

pipes being used to create the 1500 km long

Dampier to Perth natural gas pipeline.

The taxpayer was the successful tenderer

for the coating work; the coating work could
not be carried out without first constructing

a plant at a strategically convenient point

along the pipeline's route; and the overall

contract between the taxpayer and SECWA provided

in substance for the plant to be built by the

taxpayer and paid for by SECWA, although it

remained the property of the taxpayer.

Your Honours, the case was certainly factually complex

and I anticipate that my learned friend will argue

that it turns on its own peculiar facts. As I shall

hopefully demonstrate, that is not the issue .at all before

Your Honours today. It is by virtue of the fact that

despite established principles the Full Federal Court

considered that it was justified in not applying

those principles to bhe facts as found, and in that

process it effectively proposed contrary principles.

And it is on that issue that the applicant relies

entirely. The fact that there is clearly an error

C2T22/l/SR	17/2/89
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in terms of the decision, but far more fundamentally

there has been in the course of arriving at the decision

a proposal of erroneous principles which, if are not

corrected, will lead to certainly difficulties in

the fut~re and for that reason there is a general
question of considerable importance in terms of law -
the law involved. There are two matters of evidence

before you, despite the fact that in four days of

evidence the applicant had to prove and did prove

to the complete satisfaction of the trial judge,

all the facts that he had relied upon and I would

refer to page 31 of the application book in that

regard. Under the heading, "Facts Found", it is

stated:

(Continued on page 5)

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MR FLETCHER (continuing):

The taxpayer sought to establish certain facts in its favour and led evidence for this purpose. The evidence that was led on behalf

of the taxpayer to establish these facts

impressed me and I unhesitatingly accept it.

Now, the facts can be most conveniently surrn:narized,

Your Honours, in the following way; that is to say,

the key facts and it is out of these facts having

been found that the applicant says the errors of law

have arisen. Those facts are, firstly, that there is

no hint of tax avoidance in any of the facts,

transactions, agreements in this matter. Secondly,

that the appellant intended to profit from the

activity of coating 150,000 lineal metres of pipe

and it did so profit to the extent of assessable

income in excess of $27 million. Thirdly, the

existence of a suitable coating plant was a
necessary prerequisite to the commencement of this
productive process. Fourthly, the appellant always
intended and required that SECWA meet the cost of
construction of that plant and fifthly, the formal
contract which expressly distinguished between the
payment of the estimated cost of plant construction
and the remuneration of the pipe coating did accurately
express the agreement between the parties. Sixthly,
the contract contained no rise and fall clause
applicable to construction cost. It was a fixed

payment with no allowance made for the contingency

that costs, on which the estimate of costs was based,

might rise.

Seventhly, it was a requirement of the contract

that the establishment costs, the $4.6 million, be

used to build the plant and that is precisely the

purpose for which they were used and no other.

Eighthly, because the possibility existed that the

actual costs of construction might be less than the

estimate, there was a possibility of a profit emerging.

The ninth point is that there was no profit in the

sense of any surplus of receipts over costs of
construction. Tenth, there was no intention by the
applicant to profit from the activity of plant

construction.

Now, in relation to this, the Federal Court,

I hasten to add, expressed some misgivings as to the

findings of fact but, nevertheless, this finding was

adopted by the Federal Court, and finally - - -

BRENNAN J: Profit in that sense being a difference between

the amount paid and the cost incurred, is that the

proposition?

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MR FLETCHER:  Yes, Your Honour, that there was a possibility

that is highlighted in the decision of the Full

Federal Court that if it was the case that,

notwithstanding that, clearly on the facts, the

amount to be paid by SECWA was intended to meet

carefully calculated costs, it was nevertheless

an estimate in advance of what those costs would

be and, that being the case, if the costs came in

at somewhat less than the estimate, then there would

emerge a profit and the possibility of that profit

emerging was dwelt upon in the decision of the

Full Federal Court.

Finally, the contract provided tha~ in the

event of default by the applicant, SECWA would

acquire certain rights in the plant.

BRENNAN J:  Can I take you back to that notion of profit again.

How would it appear in a balance sheet? Would not one find on one side that there was an asset represented by that which would be an expendant, namely, the plant?

MR FLETCHER:	Yes, indeed.
BRENNAN J:	So that the taxpayer received both the plant and

the cost of creating it?

MR FLETCHER:  The plant certainly became the property of the taxpayer. That was a requirement of the contract.

BRENNAN J: Well, why does one determine a profit, as it were,

by some consideration of a difference between the

cost of acquiring one's assets and what one was

paid in order to acquire them?

(Continued on page 7)

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MR FLETCHER:  For the reason, Your Honour, that at the

end of the contract there was no asset of

any appreciable value.

BRENNAN J:	Would that not be covered by depreciation?
MR FLETCHER:	Yes, it is covered by depreciation but, as is set out in the outline of submissions
that have been provided to Your Honours,
depreciation deductions, if we are talking
about the income tax regime, are allowable
in respect of the use of capital assets irrespective of the source of the funds from
which those assets have been provided.
BRENNAN J:	Your proposition, I should have thought, was

that this was a payment in respect of a capital

asset and takes itscharacter from the asset in

respect of which it was a payment.

MR FLETCHER:	Your Honours, it was a payment made on the express contractual requirement that it be
expended in a certain fashion and the expenditure
was to be made on the creation of a very
production facility. That certainly is a capital substantial classically capital asset, a very major
asset and certainly that became the property
of the taxpayer, but there is clear authority
which the Federal Court acknowledged, as did
the supreme court, that that does not decide the issue. There is the matter of, as I have described
it in the outline of submissions, the contribution
to capital principal, a term applied by
Professor Parsons, but seems to sum up the
circumstances quite adequately.  The point is
that it will not be every receipt within the
context of the business activity which will
be income. If it be the case that there is
a requirement by one party that another party
create a capital asset and then use it to the
benefit by providing goods or services to the
paying party, it will nevertheless not be
income, unless it be the case that the
provision of the money to apply to the creation of that asset is in reality part of the remuneration for the profit making business to be conducted using that asset. And that
is a very important qualification which the
applicant does not shy from because that is
what distinguishes this case from other cases where it could be said that by some sort of
sleight of hand it is transforming what is really
revenue by paying it in advance, agreeing to
apply it in a certain fashion and saying, "Well, that's not income". But that is not the case here.
That occurred in this case to a limited extent and
it was returned as income in relation to the costs of expanding the plant. It was required

C2T24/l/JM	7	17/2/89
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by SECWA that there be further expenditure and

that expenditure was funded by an advance in

respect of the cost of coating further pipe -

clearly income and returned as such. But it

does not answer the point that before this

company could go into business profitably

coating pipe, it needed a very substantial

capital asset. It, on the evidence, did not care
who owned the asset; it merely wanted the

opportunity to coat the pipe profitably. It

always required that SECWA provide the funds

to pay for that asset and SECWA agreed and did

so provide the funds. Over and above that,

a corrnnercial rate for the coating of the pipe

was struck and paid and produced very substantial

assessable income.

But on all the authorities - and this is

where the Full Federal Court had such difficulty,

as they acknowledged; they made a point of saying

that this is a difficult case, difficult task,

borderline issue, without direct precedent - that

was a capital receipt, unless it be the case that

the factual difference in this particular case

was of some importance. The factual difference

which lead the Full Federal Court to say that
there was no direct precedent was that here

the capital asset had a significantly short

life. Now, if that is sufficient reason for

departing from the authorities, then the applicant

has little to complain about, but in so doing,

in so distinguishing the authorities, in my

submission, what has clearly occurred and
can be demonstrated is that the Full Federal Court
has made several propositions which are simply,

with all due respect to the Full Federal Court,

erroneous and require the intervention of this

honourable Court.

(Continued on page 9)

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MR FLETCHER (continuing): If I might turn to that aspect of

the matter, Your Honours. At page 61 of the application

book, at point 30, the Full Federal Court referred to two general contentions made by counsel for the applicant appearing before them and those contentions

are in essence a statement of the basic principle,

the contribution to capital principal and they said:

There can, in our view, be no quarrel with

these propositions.

Now I envisage that my learned friend for the

respondent is going to argue that, well having

identified the general principl~ this case simply

concerns the application of that general principle,

but in applying that principle or declining to apply

it, in distinguishing the authorities there have

emerged further contrary principles.' On page 76

of the application book, there begins the heart of

the matter. At point 5, Their Honours stated:

In our view, the most significant feature

of this case is that -

and then the first of, really, two significant

features is stated. Firstly:

the taxpayer was brought into existence for

the sole purpose of executing a single

profitable contract.

Secondly:

And the nature of the task was such that, at

the end of the contract, any assets of the

taxpayer in the shape of buildings, plant or

equipment would have little more than salvage

value.

Then going on to the next paragraph, Their Honours, and in following paragraphs, in reliance upon what

they have identified as the most significant feature
or features, develop certain propositions.	They
say that:

In these circumstances it seems to us to

be somewhat artificial to distinguish between

the early payments received by the taxpayer

which were, in effect -

and if I may interpose, I believe that to mean,

in substance -

to compensate it for its unproductive preparatory

work, and the later payments which related

directly to the productive pipe-coating process.

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That, Your Honours, in my submission, is a proposition

that compensation for the outgoing on the asset is

no different in nature than remuneration for the

services to be rendered using that asset. In other

words, it was income under the contract, subsequently

applied to a non-revenue purpose. Now there is

simply no factual basis for such a finding and that

appears to be implicit in that proposition. In

the following paragraph it is stated that:

We believe that, if a company is brought

into existence for the sole purpose of performing

one contract for profit, and particularly if the

life of the contract is comparatively short -
to be measured in months rather than years,

then all payments made under the contract are

likely to be income rather than capital receipts

in the hands of the company. The business of

such a company is the performance of the contract,

and the receipts are in the ordinary course of

that business.

That, in my submission, involves a proposition that

if business commences with the first obligation under

a contract, therefore all receipts are in the ordinary

course of that business and will ordinarily, therefore,

be income. And that is a proposition which is, in my

submission, simply not correct.

(Continued on page 11)

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MR FLETCHER (continuing):  It completely denies the

contribution to capital principal. It denies
the prospect of receipts such as loan funds,

share capital, any other receipt which cannot

properly be characterized as the proceeds of the
carrying on of the profit-making activity as

income, and as was said in the decision in the

SPEDLEY case, that is contrary to authority and

to the Act and to all basic principles.

McHUGH J:  Their Honours did not say, though, that they

were ordinarily likely to be income.

MR FLETCHER:  The judgment goes on on page 77 of the

application book to say at point 35:

Looking at the matter broadly, we
think the construction of the pipe-coating

plant was simply the first stage of a

continuous but strictly finite operation

I emphasize the words "strictly finite" -

for which regular payments were made

under the one contract. Gearing-up

for such a contract must necessarily

involve the accumulation of men and

materials and the carrying out of

preliminary works of one sort or another.

In this case the preliminary work was

substantial and unusually expensive but,

none the less, impermanent.

BRENNAN J:	Mr Fletcher, can you hear us?
MR FLETCHER:	Can you hear me, Your Honours?

BRENNAN J:  We can hear you. Can you hear us?

We will adjourn until this problem is resolved.

AT 1.51 PM SHORT ADJOURNMENT

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UPON RESUMING AT 2.10 PM

BRENNAN J:	Mr Fletcher, can you hear us?
MR FLETCHER:	I certainly can, Your Honour.

BRENNAN J: It was regrettable that we had to interrupt your

argument in that way but we were unable to have the

connecting link made, I gather. But it is restored

now.

MR FLETCHER:  Yes, Your Honour. It took me a while to appreciate

that you were not - I was not able to hear you.

Could I ask Your Honour how long I had been speaking for whilst you were unable to be understood?

BRENNAN J: Only a minute or two.

MR FLETCHER:  A minute or two.

BRENNAN J: Yes. We were able to understand you.

MR FLETCHER: Throughout.

BRENNAN J: Throughout, yes.

MR FLETCHER:  Yes. Your Honours, I was outlining the fact that

in order to deny the application of the contribution to capital principal in this particular case, it was necessary for the Full Federal Court to develop

contrary propositions, in my submission, and if I

might just revert to a question Your Honour

Justice Brennan asked earlier, and that is was it

not the case that there was a gain in the sense that

the taxpayer derived the asset upon which the money

was expended, it depends upon the way in which the

word "gain" is used and, in my submission, in the

relevant way, for the purposes of the INCOME TAX

ASSESSMENT ACT, there is no relevant gain. If there

is and if, therefore, the amount is to be assessed

as revenue or income, then it is the case, in my

submission, that the application of the principle

which lies behind the High Court decision in APA

INVESTMENTS - His Honour Mr Justice Owen - and

also lies behind BOYCE V WHITWICK COLLIERY which

is the case referred to at length by both His Honour

Mr Justice Pidgeon and Their Honours in the Full

Federal Court, that that principle is denied any

application in Australia. If that principle does

continue to have application in Australia then, in

my submission, it had to be applied here. The facts

admitted of no other result and, as a consequence,

in arriving at a contrary result, it was necessary

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to develop propositions which do not stand up in

the face of established principles.

If I might ask Your Honours to refer to page 78

of the application book, this is the final key

paragraph in ternsof the rationale or the ratio

behind the decision. At point 25, Their Honours

stated:

The two chief factors to which the

taxpayer can point as supporting a

characterization of the payments as

capital are (a) the nature of the activity
for which the payments were made, namely

the construction of a production plant -

and I emphasize, once again, that it is there
acknowledged that there was a specific purpose for

which the payments were made and were utilised -

and (b) the fact that the payments were

allocated to this purpose and represented a
genuine estimate of the actual cost of

construction.

There is no doubt that this was no sham or fiddling

with figures. It was a genuine exercise. That

has been found in all courts below.

The construction of a production plant would

normally be seen as a capital activity - and

the taxpayer's expenditure on it was so
treated in the present case. However, in

this case, we believe the usual clear

distinction, referred to by Dixon Jin the

passages cited above - ·

and I will return to those in a moment -

between the creation of a profit-yielding

subject and the process of operating it,

is somewhat blurred - because the subject

is to be used once only as part of a total

indivisible contract. For this reason, any

inference that receipts to be spent on a

capital purpose are capital purpose are
capital receipts is weakened.

Now, this is the key proposition which Their Honours are forced to state in order to avoid the application of the principle and the proposition is erroneous.

The passage - - -

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BRENNAN J:	What is the basic principle for which you contend?
MR FLETCHER:	The basic principle for which I contend, or the

applicant contends, Your Honour, is set out - if I

might ask Your Honour to refer to the - it may be

most convenient to refer to the outline of submissions;

they are reasonably detailed but it is set out there.

On page 5 of those submissions,at paragraph 16, at

the bottom of the page: the applicant's submission

is that there has been a clear misunderstanding by

the Federal Court of the principles and concepts

expressed in the SUN NEWSPAPERS case, and a large

excerpt, Your Honours .will be aware, was quoted

from the decision of His Honour Mr Justice Dixon

in that case in the judgment.

As a consequence of misdirecting itself as to those principles and concepts, it has wrongly

distinguished BOYCE and the APA case. BOYCE and

the APA are merely examples of the principle that,
to have the character of income an item must be a

gain to the taxpayer who derived it and I would

hasten to add, Your Honours, that in both of those

cases the capital asset upon which the funds were

expended became the property of the taxpayer. There

is no distinction between this case and those cases

on that point. In the APA case the moneys were

expended on the creation of a substantial building

to be rented back to the payer of those moneys.

His Honour Mr Justice Owen found that nevertheless

they were of a capital nature.

In the BOYCE case the moneys were expended on

a very substantial pumping station which became the
property of the recipient of the moneys and which
it used to pump water for which it received payment

over a long period of time and the distinction that

was relied upon was the fact that there it was over

a long period of time and, in my submission, that

is not sufficient reason to distinguish the cases.

The second proposition which reflects the principle

that I have stated is that there is no gain if an

item is derived by the taxpayer as a contribution to

capital. The corollary to that is that an item

derived as a contribution towards deductible outgoings

incurred, or to be incurred, is income. That is

clearly referred to by both Professor Parsons in

his text and also the decision of the Supreme Court

of New South Wales, RECKITT AND COI.MAN, and that is a

gain which is a compensation tor an item which has

the character of a cost of deriving income has

itself the character of income.

But that is not the case here. These were

non-deductible capital outgoings and therefore a

payment made, which Their Honours in the Federal Court

acknowledged was compensatory. It was a compensation,

in their conclusion, for the unproductive costs of

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the preliminary work, the creation of the necessary

prerequisite to the productive activity and that

compensation cannot be said to have been in respect

of a deductible outgoing. Then, at paragraph 18,

the key to the applicant's case is found and that is

that the decision of Mr Justice Dixon in SUN NEWSPAPERS,

which has been used for many, many years as the guiding

light in terms of distinguishing between capital

and income, both expenditure and receipts, refers to

the fact that the profit-yielding subject may

consist in a great aggregate of buildings, machinery

and plant, all assembled and systematized as the

material means by which an organized body of men could perform services and that this profit-yielding subject amounts to the source of the income to be derived from

its operation.

In our submission, there could not be any better

description of the profit-yielding subject in this

case.

(Continued on page 16)

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MR FLETCHER (continuing):  The expenditure on the creation of

the pipe-coating plant was classical, capital

expenditure. The emphasis by the Federal Court on

the strictly finite and impermanent life of the

plant and the fact that it was to be used once only

as a part of a total indivisible contract and that

the taxpayer and its assets were brought into

existence for the sole purpose of executing a single

profitable contract is misplaced as a basis for

concluding that that which would normally, on

Their Honours' findings, be capital expenditure is

not here.

The reason why the proposal inherent in

Their Honours' reasons at page 78 is erroneous is

that the test embodied in the decision of

His Honour Mr Justice Dixon in ~UN NEWSPAPERS is

that you must ascertain of what type is expenditure.

Is it ot the type which is made to meet the continual flow of working expenses. In other

words, does its purpose bring it within the class

of things which, in the aggregate torm the constant

demand whicn must be answered out of recurns ot

trade or is it not of that type? If it is not

ot that type then it is ot the alternative class,

that is, capital ana once you have aeterminea
what type or nature or character the expense has,

then the degree of permanence of the advantage

obtained is of limited, if any, relevance.

Now, the character of the advantage obtained here is that of belonging to a class of things

which endure. The fact that this was a contract

designed to last for 16 months which, in fact,

went for 20 and that at the end of the contract the asset

was to be of little use to anyone is simply of

virtually no relevance once it is ascertained that

the expenditure on it was of the type which is

capital expenditure.

GAUDRON J: That may be well and good, I should think, in so far

as you are looking to a capital expenditure or

outgoing which was what SUN NEWSPAPERS was concerned with, but here you are looking at something that has

come in and has come in pursuant to an agreement

executed by the taxpayer and pursuant to which the

taxpayer has done work.

MR FLETCHER:  Yes, indeed, Your Honour, but the point there

is that precisely the same circumstances in essence
applied in both BOYCE and APA and other cases. There

are other authorities which have been referred to in

both courts below and that is not the test. If I

could revert to the point made earlier and that is

that if it is the case that you are diverting a

revenue receipt to the creator of the capital asset

C2T29/l/BR	16	17/2/89
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then that is a most significant point and the

revenue receipt remains a revenue receipt, an

assessable income therefore, regardless of its
ultimate application. But if it is the case that

there is a commercial rate charge for the revenue

producing activity - in this case the coating of
pipe - ana there is clear evidence that that is

the case, including the quotation document which
has been exhibited to the affidavit of Mr Tomkins
filed in these proceedings by the respondent -

then if there is a clearly distinguished separate

amount designed, not to be remuneration for that

process but to compensate for the cost of creating

the agreed capital asset, then provided the asset

is capital then the compensation is of a capital

nature. If the asset and the expenditure on it is

of a deductible nature then on the authority of

RECKITT AND COLMAN and other cases and

Professor Parsons' learned treatise, the receipt is of an assessable nature. It is income.

~o the key really is, what was it agreed to be

paid for? Was it a diversion of revenue which will

otherwise be income applied to another purpose or

was it a receipt of a capital nature other than and

separate and distinct from the revenue receipts.

(Continued on page 18)

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BRENNAN J:	But your proposition is this, is it not, that if within the four walls of one contract
one has a provision for the payment of two
sums of money, and one of those sums of money
is clearly an amount which will be payable
on revenue account, and the other is to pay
for an asset which in the hands of the payee
is a capital asset, the amount which is to
be paid in that latter case is necessarily capital?
MR FLETCHER:	That is the proposition, Your Honour,

and that is the proposition - - -

BRENNAN J: Is there any case which stands for that

proposition?

MR FLETCHER:  Yes, both APA INVESTMENT, which is a

decision of this honourable Court, of a single

judge, and BOYCE V WHI'IWICK COLL.IERY, and a

series of other cases referred to in those

distinguish those cases. If I was to take

cases. That is the reason why the Federal

Your Honours to the basis upon which they were

distinguished it will become apparent that there

is no substance in the distinction, but it was

essential to distinguish those cases to find

against the applicant in this case.

BRENNAN J: 

I can understand it might have been necessary

to distinguish those case, but I do not understand
at the moment why one does not look at all of the
circumstances, and in particular the terms of
the contract under which the money is paid, the

nature of the activity in which the payee is

to engage in consideration of the payment and
the extrinsic circumstances such as the
exhaustion of the asset in the course of the

activity which is incorporated within the

four walls of the contract. 

MR FLETCHER: 

If I might take the last point first, Your Honour,

and that is that if one has regard to the relative

impermanence of the asset, of its finite useful

working life for the parties concerned, one is

necessarily forced to conclude that for that reason

it is not a capital asset and therefore the

expenditure upon it is not capital expenditure.

That being the case, one could certainly, and

quite properly, say that the payment received

is assessable income, but the necessary consequence

is that the expenditure on creating the asset

being a revenue outgoing, a non-capital outgoing

must substantially be deductible. That being the

case, you end up with the position that the

applicant is not to be assessed in any event at

the end of the day. But the key is that it was

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understood, agreed, established and is quite

clearly correct that this is capital expenditure;

it cannot be deductible. It is classical capital,

on all tests, all authorities and accordingly,

there would be no basis for a deduction for the

outgoings.

I have referred to that fact in

BRENN.AN J: If one takes that approach and one allows a

deduction in respect of the costs of the

construction of the plant as on revenue account,
then of course, there would be no occasion for

depreciation, would there?

MR FLETCHER:  That is quite correct, Your Honour, but

the depreciation point is lurking in the background

in the decision of both His Honour Mr Justice Pidgeon

and that of the Full Federal Court and, in my

submission, it is entirely a red herring. The fact

of the matter is that a taxpayer, if it qualifies
in terms of the relevant provisions, will be entitled

to deductions for depreciation which is a notional

allowance for the depreciation in value of a

capital asset from its application in the profit-making

process over its working life. To take

an example, SECWA could very readily have

contributed capital to the joint venture and that

capital could have been contributed on the basis

that it must be spent on a ~apital asset.

(Continued on page 20)

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MR FLETCHER (continuing):  That is not to say that because

even if it is the case that SECWA has no prospect

of getting the capital back because the asset will

be worthless at the end of the day, it will be

represented by nothing as capital contribution or

relatively worthless, that is not say that therefore

because the joint venture company has the benefit

of being able to properly claim depreciation

deductions if it uses the asset in the correct fashion,

that therefore it must be assessed on that contribution

as if it were income rather than capital. It would

be, nevertheless, capital. If it had found the
money by some other means, a gift or a lottery, there
are all sorts of prospects whereby one could say

there would be capital received by a taxpayer and

the depreciation deductions just simply have no

relevance to the characterization of the source of

the money applied to the creation of the asset.

The Full Federal Court emphasized that there

was no apparent injustice to the taxpayer in that

it had the benefit of depreciation deductions. But

that the applicant does not accept in any event; it

has not been analysed what the respective difference

would be between the payments being treated as capital

and the outgoings which exceeded the payments being

treated as deductible. It may well have been

substantially better off. It has not been addressed

because clearly they are not deductible, they are

capital outgoings. So that the further point is that

in terms of justice it is clearly established that

if there was any default by the applicant in

performance of the coating contract, then it would lose

the plant. SECWA had rights in that plant in the

event of default and to take the example of there being

a default prior to any significant coating of pipes,

you would end with the result that the company had

been assessed on $4.6 million and had received nothing

in return. Had a useless plant, in fact lost the

plant, and had no allowable deductions and that is

behind the rationale that establishes the contribution

to capital principle. One can only be assessed on

revenue amounts, which represent the proceeds of a

profit-making activity carried on and are invested

with that profit-making purpose. These amounts were

not. They have been clearly distinguished throughout

by the parties as being earmarked for a specific

purpose.

It boils down to this, Your Honours. Either, in our submission, there is a principle represented

by the BOYCE and APA cases which is applicable in

this country or there is not. And if there is, then

it is applicable here; there is no proper basis

for distinguishing those cases. And if it is

considered by Your Honours that it may not be applicable
here, then that in itself is a very substantial

reason why this application today should succeed.

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The matter of the future of that principle needs to

be considered. I would wish Your Honours to briefly

take you to two brief passages from both the SUN

NEWSPAPER case and the APA INVESTMENTS case, since

they are, as I have indicated, key decisions in

the applicant's submission.

BRENNAN J:  By all means if you think it is necessary, but

is there anything that you wish to say

further than what you have set out iu your outline?

(Continued on page 22)

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MR FLETCHER:  Yes, but it will not involve a lot of

time, Your Honours.

BRENNAN J:	Very well.
MR FLETCHER:	Perhaps, rather than taking Your Honours to the cases themselves, if I could simply point out
that at page 362 of the SUN NEWSPAPERS decision there is stated the fact 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.

Then there is the reference to the key point

being the class to which the expenditure belongs.

The matter of the actual recurrence of the expenditure is not necessarily relevant and nor

is the lasting character of the advantage

necessarily relevant and a case was referred to

by His Honour Mr Justice Dixon with approval as

illustrating that point and it is JOHN SMITH & SON

V MOORE in which coal contracts had a very short term, but despite the fact of their extremely

limited duration they were capital assets and

the expenditure on them was capital expenditure,

and in the APA INVESTMENTS case, Your Honours,

at page 371, His Honour Mr Justice Owen - - -

BRENNAN J:  We shall call on your opponent, I think,

Mr Fletcher.

MR FLETCHER:	May it please the Court.
BRENNAN J:	Dr Carr.
MR CARR:	Do Your Honours have my outline of submissions

for the respondent?

BRENNAN J:  Yes, we do.

MR CARR:  Basically, Your Honours, the respondent's

position is that this case turns, like most cases

involving the dichotomy between income and capital,

very much on its facts, and the Full Court of
the Federal Court has simply decided that because

the taxpayer company was brought into existence

for the sole purpose of executing a single

profitable contract and the life of that contract

was comparatively short, then the payments made

to the company for carrying out the work which
the contract required it to carry out, that is

moneys earned under the contract, were receipts

in the ordinary course of the company's business

and constituted income.

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I would like to pause there and distinguish

the facts of this case, Your Honours, from the

two cases that my learned friend has mentioned.

The key distinction, of course, between the APA

case and WHITWICK COLLIERIES case and this case

is that in both those cases those payments were

precise recoupments, each of which had encrusted

on it interest which is a clear indicium of

capital.

In the WHITWICK case over 30 years the capital outlay was

recouped to the nearest penny with 5 per cent

interest added thereon, in our submission

clearly different from this case. In the APA

case the tenant company paid rent plus a sinking

fund and it is the sinking fund that the case

was concerned about. That sinking fund had

encrusted on it interest. That is a totally

different case in our submission from the case

before the Court today.

BRENNAN J:  The problem is one of characterization of a

payment, is it not?

MR CARR:	Of a receipt, with due respect, Your Honour.
BRENNAN J:	Of a receipt?
MR CARR:	Yes, Your Honour.
BRENNAN J:	And it is one thing to say that it is not

precisely the same sum as that which was outlayed

by the recipient, but is that conclusive as to

the character of the receipt if it is clear enough
that the quantification of the payment had reference

to the likely expenditure to be made by the

recipient?

(Continued on page 24)

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MR CARR:  No, Your Honour. We would submit that in the total

facts of this case it is not fair simply to isolate

those two factors and I will be coming to the question of the provision 15 - 5 per cent over and above the cost plus 15 per cent for- the finding against me -

contingencies. We would say it is not in accordance

with the authorities of the Privy Council which, in

turn, reflected HALLSTROMS' case; it is not. in

accordance with those authorities to single out two

factors and play one off against the other. You have

to take, with due respect, all of the factors: the

incorporation of this company for this special one-off

contract; the binding of the company to construct that

plant; there were covenants in that contract that the

taxpayer had to construct the plant.

It was important to SECWA that that plant be

constructed in accordance with its engineers' drawings,

that it be constructed on time. There was a bar chart;

all this is in the application book. In exchange for

that convenant or in exchange, perhaps, for the

fulfilment of that covenant in respect of the two

subsequent payments ,there being three payment& SECWA

agreed to pay the money. So it was, in fact, earned,

and that, in our submission, what most cases on the

distinction between capital and income are all about.

The teaching of the BP case which just simply reflects

HALLSTROMS' case, is that you approach it on a fact-by-

fact basis and the fact that in one case there is a

factor missing which was determinative in a previous

case, does not decide the issue. One must take a total

approach. In this case there is no new statement of

principle - - -

McHUGH J:  Dr Carr, what about the findings at 78:

(a) the nature of the activity for which the

payments were made, namely the construction of

a production plant, and

(b) the fact that the payments were allocated

to this purpose and represented a genuine

estimate of the actual cost of construction.

Do not those two findings so dominate that it is very difficult to see how the receipt can be characterized

other than as a capital receipt?

MR CARR: Well, to start with, Your Honour, they are, in my

respectful submission, not findings but part of the

taxpayer's argument. It is quite clear that the court

is saying:,

The two chief factors to which the taxpayer can point as supporting a characterization of the payments ..... are (a) the nature of the

activity.

If one takes (a) then any building contractor who

constructed plant for reward, capital items for reward

24 MR CARR 17/?./89

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for a building owner, if you took the reverse of it,
those receipts - I will start again - if one takes

the first point, that a building contractor constructs

an item of capital plant for a building owner then he

could turn round and say, "Well, it is capital plant

that I have been paid to build,therefore it is not

income."

BRENNAN J: It is not capital in his hands, surely?

MR CARR:  No, it is my submission, Your Honour, that this is what

is being put forward:  that the nature of the activity,

namely, the construction of the production plant somehow

or other changes the income or receipt, to use a

neutral term, from being income in the hands of the

building contractor into capital. In our submission,

that would be quite wrong.

BRENNAN J:  But this must have been treated by the Commissioner

as capital in the hands of the taxpayer.	He allowed
depreciation on it.

MR CARR:  Yes, Your Honour. The logical sequence there is that

it came in as income to a building contractor, which
this company was for the first six months of its

existence. It was applied in constructing the plant

in accordance with the specifications and drawings

in the building contract and it was rightfully
entitled to depreciate that plant under section 54
in a very brief period of time, being the period of
the contract, because it was no use to anybody else

after that, on the findings, it was only salvage.

McHUGH J: Well, it had salvage of a million dollars.

MR CARR:  With due respect, Your Honour, I think it was half a

million, but there is no issue on that, Your Honour.

McHUGH J:  Yes.

MR CARR:  But it was a one-off job. This plant was no use for

any other purpose than scrap.

McHUGH J: Yes, but the fact that it is a one-off payment is

not very significant - there is the BP case -

MR CARR: Well, that, of course, is an expenditure case,

Your Honour, it is a very different case and I think

that is most important when one is characterizing

the payment. What is this money in the hands of this

taxpayer? In all the circumstances, it is money which

it has earned. The fact that it has spent it on a

piece of capital equipment for the building owner in

the case of an ordinary contract for a construction

would make absolutely no difference to it being income.

The fact is here that it was a white elephant; nobody

wanted it.

C2T33/2/VH	25	17/2/89
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MR CARR (continuing): In the Federal Court, counsel

for the taxpayer explained that it was a

political embarrassment for SECWA to be

seen with an expensive piece of capital

equipment that had absolutely no use. That is

why the taxpayer was allowed to keep it;

that is why the cost of coating the pipe was

less.

But, in our submission, the judgment

appealed from is clearly correct because, as

I said a moment ago, for the first seven months

of its corporate life it was carrying on

business as a civil engineering construction

company building the plant; it was paid money

pursuant to the contract for building the plant.

These were moneys earned by carrying out

contractual obligations. I have made the point,

as I make at point 2 there, that the receipts

in the building and engineering company are not
deprived of the character of income because

they were engaged to build something which may

itself later produce income.

The key aspect in this case is that the courts below have been characterizing the receipts

rather than characterizing the expenditure of

SECWA, which is the point that my learned

friend has continually emphasized, that these were

capital expenditure. There is no question

about that. So far as SECWA was concerned, they

were outlaying money on a capital item. On the

facts found by the supreme court and in the

Full Federal Court, this is not a case of

precise recoupment of moneys to be outlaid on

a capital asset; that is not the case at all.

There was before the Federal Court an argument

about this 15 per cent - in fact, two items of

5 per cent and 15 per cent added on to the cost.

In our submission, that is extremely important;

another fact in the equation which the court

took into account. But whether the gain, the increment be described as by way of provision for contingencies, or profit, as we argued,

but the respondent argued that it was a
provision for contingencies, in our submission,
that does not matter. There was room in the
initial construction work for profit to be

derived and if the provision for contingencies

was not used up at 15 per cent, there was money

left over for the benefit of the contractor.

Your Honours, as to whether there is any

principle, we say there really is not a principle

to be taken out of this case and it is a rare case

where the issue is whether it is capital or income.

It is a very rare case where you get a question of principle decided because it is very similar to

C2T34/l/JM	26	17/2/89
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what a judge has to do in a running-down case,

a motor vehicle case. What the judge is looking

for in this type of tax case is: what is income

in accordance with the ordinary concepts and

usages, and that, in our submission, is very

similar to a judge approaching a motor vehicle

accident and saying, "Has there been negligence?

Has there been a breach of the reasonable standard

of care based on the perception of a reasonable

man?''

That is what the court has done here. It

has found the facts in the whole matrix of facts

and then on those facts held that the receipts

fall into the category and should be characterized

as income. In my submission, that is not a

statement of principle, and in the BP case

to which Your Honour Mr Justice McHugh referred,

they make that point - that felicitous phrases are

picked from one case and used in another. Really

that is not what a characterization in a tax

case is all about. Where income and capital is

concerned, usually it is a conclusion based on

fact and very little in the way of principle

involved at all. So, we say there is no

principle in the previous cases. The two cases

to which my learned friend has referred are
very, very different on the facts with the

incrustation of the 5 per cent and the interest

on the sinking fund. Here there was money to

be made; it was a profitable overall contract.

There was money to be made two ways: the

first in completing the overall contract, getting

in all the receipts, some 31 million, less the

epxenses, the outgoings and there was money to

be made specificially on the building of ths

plant. If I can take Your Honours to the
findings of the Full Federal Court - my learned
friend said, before I take Your Honours to that,

that there was a finding that there was no

intention to profit. That, with all due respect,

is quite incorrect. There was no finding at any

stage that there was no intention to make a

profit. The trial judge found that the taxpayer

did not in fact make a profit, but there was no

finding that there was no intention to make a

profit.

(Continued on page 28)

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BRENNAN J: Dr Carr, if you come to the stage, leaving the

profit aside, that there was a receipt by the taxpayer

of a sum of money which was paid for the purpose of
defraying, so far as it might extend, the cost of
the construction of what was in the taxpayer's hands

a capital asset, is it not an important question to

see whether that consideration, if it be right, is

not conclusive of a characterization of the payment?

MR CARR:  Your Honour, we would say, no, because the teaching

of the cases is that you do not isolate that factor

and in any event, I ~ppreciate Your Honour has

posited the question on a different set of facts, but the facts of the matter are different, that there was

an element of gain to be made.

BRENNAN J:  I was leaving aside the element of gain. In

other words, it may be that there would be some other

payment which would not be regarded as a capital

payment because it was a profit-making exercise. But

the payment to a certain extent extended to defray the capital cost that was incurred by the taxpayer.

MR CARR:  Your Honour, it did not defray the net cost. In

fact it was calculated by reference to the expected

overall contr,act sum. It was a sum calculated -

three payments of 5 per cent of the anticipated

contract sum.

BRENNAN J:  I was putting it on a somewhat different basis.

Let it be assumed that there was an outlay by the

taxpayer of x dollars for the purposes of constructing

what is properly to be characterized as a capital

asset. It received a payment. To the extent to which

that payment defrayed that capital outgoing,is not

the payment itself to be characterized as capital?

MR CARR:  No, Your Honour, we would say that a building

contractor who receives those three payments in this

case, in return for carrying out his building contract

must have that included under section 25(1) as
gross income.	The fact that the building owner wants

it spent in a particular way does not change the
characterization of the receipt in the hands of

the taxpayer.

BRENNAN J: But it does not seem that the analogy is entirely

accurate, does it? If, in the case that you

instance of the building contractor, the thing that he

builds is not in his hands a capital asset.	I mean
he brings in work-in-progress, for example?

MR CARR:	Yes, Your Honour.
McHUGH J:	You see the important distinction in this case

is that this was a payment ,for the construction of a

production plant. It was	a payment for a profit-
yielding subject?

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MR CARR:	Yes, Your Honour.
McHUGH J:	Now why does not that raise an important question

of principle as to whether or not a payment for

the cost of constructing a · profit-yielding subject

is not itself capital?

MR CARR:  Because, Your Honour, for two reasons. Eirst of

all it is a very peculiar fact situation which has,

I think, in 50 years been thrown up twice, the

WHITWICK COLLIER':( case and this one. And, secondly,

and it is very unlikely to reoccur, there is an

affidavit in from the Assistant Connnissioner of

Taxation that there are no appeals pending having any

similarity to this. First, that it is a very odd

circumstance, and secondly, that the accident that

ownership of the capital equipment fell into the hands

of the taxpayer was related to the peculiar circumstances
of the contract in question; that the building

owner wanted a capital asset constructed which would

be of absolutely no use to it once the contract was

finished. It wanted it there during the nearly two

years of construction and it had an interest in

keeping it there, but after that it was of no concern

to anybody what happened to it.

(Continued on page 30)

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:t1R CARR (continuing): So, it is a very odd piece of capital

if it is capital - it is a very odd sort of capital

that is highly unlikely to recur again and, once

again, the presence of that element in this case

and absent in a future case would not be

determinative in any future cases on the principles
of the BP case.

But, Your Honours, we do stress the finding of the profit element in this particular case; that there

was room for gain and that was, from the outset, the

planned intent of the taxpayer. Exhibited to

Mr Tomkin's affidavit is exhibit 17 before the

trial judge, the significance of which was not

realized until appeal,but it is clearly demonstrated

in that that the taxpayer was going to take a profit

in the same way that 15 per cent figure for

contingencies was applied not just to the plant but

to all of the work which it was going to execute

under this contract and, in our submission, it is

such an unusual case. It turns peculiarly on its

facts, peculiarly on the terms of the contract,

that it does not raise an important principle of

general application whatsoever.

BRENNAN J: Yes, thank you, Mr Carr. We need not trouble you

in reply, Mr Fletcher. This is a case in which the

Court thinks it is appropriate to grant special leave

and special leave will be granted.

AT 2.55 PM THE MATTER WAS ADJOURNED SINE DIE

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