GP International Pipecoaters Pty Ltd v Commissioner of Taxation

[1988] FCA 564

JUDGMENT No. 5 6 . ! f / . . . 88 .'

CATCHWORDS

INCOME TAX - assessable income - first payments received	I
under contract for pipe-coating - establishment costs -

payments estimated to represent cost of plant specially

I .

constructed for the purpose of the contract - whether such

i i

receipts were of a capital nature.	,.
Income Tax Assessment Act	1936 S 25(1)
Boyce v Whitwick Colllery CO	Ltd [l9341 All ER 706;

18 TC 655 dlstlngulshed.

7 October 1988	I	f
!

G P INTERNATIONAL PIPECOATERS PTY LTD v

THE COMMISSIONER OF TAXATION

Nos. 96, 97 & 98 of 1987

:.

Woodward, Northrop & French JJ.
Perth

..

I

.' CATCHWORDS

INCOME TAX - assessable income - first payments received

under contract f o r pipe-coating - establishment costs -

payments estimated to represent cost of plant specially
constructed for the purpose of the contract - whether such

receipts were o f a capital nature.

Income Tax Assessment Act 1936 S 25(1)

Boyce V Whitwlck Colliery CO Ltd [l9341 All ER 706;

18 TC 655 dlstlnguished.	i
. .

APA Fixed Investment Trust CO Ltd v FCT (1948) 8 ATD 369

distlnguished. -

G P INTERNATIONAL PIPECOATERS PTY LTD v

THE COMMISSIONER OF TAXATION

I .

I

F

Woodward, Northrop & French JJ

Pe r th

7 October 1988

IN THE FEDERAL COURT OF AUSTRALIA

1

WESTERN AUSTRALIA

19

DISTRICT REGISTRY

GENERAL DIVISION

ON APPEAL FROM THE SUPREME COURT OF WESTERN AUSTRALIA

BETWEEN:

G P INTERNATIONAL PIPECOATERS PTY LTD

Appellant

and

THE COMMISSIONER OF TAXATION

Respondent

MINUTES OF ORDER

COURT :	Woodward, Northrop	& French JJ
-	DATE :	7 October 1988
PLACE:	Perth

THE COURT ORDERS THAT:

1.    The appeals be dismissed.

2. The appellant pay the respondent's c o s t s .

!

- Note: Settlement and entry of orders is dealt with in Order

36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA	)
1
WESTERN AUSTRALIA	1
1 Nos. 96, 97 & 98 of 1987
DISTRICT REGISTRY	1
)

DIVISION GENERAL j

ON APPEAL FROM THE SUPREME COURT OF WESTERN AUSTRALIA

BETWEEN:

G P INTERNATIONAL PIPECOATERS PTY LTD

Appellant

and

THE COMMSSIONER OF TAXATION i

Respondent

COURT:	Woodward, Northrop & French JJ
DATE:	7 October  1988
PLACE:	Perth

REASONS FOR JUDGMENT

THE COURT

The Court has before It, on appeal from the Supreme

Court of Western Australia, three appeals against taxation

assessments, relating to two separate years of Income and an assessment of undistributed profits; but the same question

arises in each appeal. It 1s whether a sum of $4,675,931,

received by the appellant taxpayer under a contract with the

I

state Energy Commlssion of Western Australia ('SECWA') is assessable income under S 25(1) of the Income Tax Assessment

Act 1936 ('the Act'). The sum was received for what were

'i	-
i	sometimes described as establishment costs, and at other
tlmes as mobllization costs, incurred in erectlng a plant for
the sole purpose of coating, both externally and internally,
the pipes being used to create the 1500 km long Dampler to Perth natural gas pipeline.

The taxpayer was the successful tenderer for the

coating work; the coating work could not be carried out

without flrst constructlng a plant at a strateglcally

convenient polnt along the plpellne'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.

In its carefully detalled ludgment the Supreme

Court of Western Australia (Pldgeon J ) has set out the

history of the establishment of the taxpayer as a joint

, venture company for the purposes of the pipeline coatlng

contract, and the somewhat complicated	path which was taken
in arriving at the final contract between	the partles.

!

However it is agreed that nothlng turns on the

i

identlty of the individuals or companies representing the embryonic company which became the taxpayer. All their

actions have been afflrmed and adopted by the taxpayer and It

will be convenlent to refer throughout this judgment to the

actions of the taxpayer, even though some important events	..	S	;
. .

(including the acceptance of tender in December 1981)

occurred before the company was incorporated in January 1982.

Similarly it is agreed that, although	the sequence	I .
1:

of events leading to the formulation of the final contract may be relevant to the understanding of its provisions,

nothing turns on the fact that the contract was only signed

in July 1983, very late in the perlod of performance. There

was at all times agreement between the contracting parties as to their respective rights and obligations, and these were

I

finally set out in the written agreement.

I

Indeed the contract negotiations, and the

. .

performance of work under the contract, all seem to have

I

proceeded very smoothly, considering the size of the project.	!
1 ,

It is also agreed that the contract reached between

the parties represented a convenient commercial way of

carrying out the task ahead. Pidyeon J	held that none of the
provisions of the contract was entered	into with a view to

obtaining a tax advantage.	l '
I .
1.
In spite of the openness of the whole transaction, the courts are faced with a difficult problem	in determlnlng
whether the sum received by the taxpayer for constructing	the

I ,

coating plant was income within the meaning of the Act or, as

the taxpayer asserts, a receipt of a capital nature.

In our opinion, the basic facts relevant to thls

questlon, as found by Pidgeon J, are as follows.

1. The taxpayer originally tendered for the whole

contract (plant and coating) by quoting rates per llnear i

metre for internal and external coatlng of different sizes of

pipe. When multiplied by indicated lengths of plpe, thls produced a single estimated price for the whole contract, of

the order of $31m. The taxpayer expressed its tender in this

way because	it felt constrained to	do so by the tender
documents.

Later, in the course of negotlatlons, the taxpayer persuaded SECWA that a better way to provide for the cost of

2 .

I

erecting the plant was	to pay an agreed amount	at the tlme of
its erection, thus avolding	the necessity for the taxpayer	to

borrow money, and pay interest on it, to finance the

construction. Thus it was agreed, in broad terms, that the

I

plant and the coatlng would be paid for separately - the

plant in three instalments of an agreed sum	as it was being
constructed, and the coating	L n a series of progress payments

based on agreed rates for each linear metre coated - the

rates first tendered being adlusted by removing from them the

costs of erecting the plant. The total sum resulting from this revised schedule of rates was essentially the same as the sum originally tendered, after allowing for some minor agreed varlations.

I -

3 . Thc figure for the plant was arrived at, on the

part of the taxpayer, by estimatlng what it would cost to . /

install the plant, apart from leased equipment;	and the 15%	I,
I !

of total cost which was asked for the plant was chosen

because It was a convenient way of framlng the tender and ylelded a figure very close to the actual estimated cost. A separate estimate by SECWA produced a very slmilar flgure, and so $4,675,931 was agreed as the amount to be paid In three equal instalments as the plant was constructed over a

period of six or seven months. These rnstalments were not

directly tied to the progress of construction, although

payments would no doubt have been deferred if construction had not progressed steadily - as It did. A performance bond

was required by SECWA to cover any delays or defects	rn the
construction of the plant.	As counsel for the taxpayer put
it,

"[The] mlnutes show, and the evidence

confirms, that SECWA took the view that this,
in effect, requested a mobllization cost. And
if this was to be consldered, SECWA would

requlre the contractors to produce a bank

guarantee to cover the situation of the

contractors	receiving	payment	a	before
delivery."

4 . The original estimate allowed for some pieces of

equipment to be wrltten off completely after the contract was

concluded. However	some of the plant and buildings were
estimated to have a residual value	of 35% of their cost, and

this was allowed for in the origlnal tender when estimating the appropriate price for SECWA to pay for each linear metre

of pipe coated. The plant was to remain the property of the

\' taxpayer throughout the contract unless it defaulted, in

which case SECWA would acquire rights in the plant.

5. The plant was constructed between December 1981 and

June 1982 on land In Geraldton leased by the taxpayer from

the Industrial Development Corporation. Later it obtalned title to the land and eventually sold it to the Port of Geraldton Authority. The plant was sold by auctlon in Nay 1984 for approximately $500,000.

6.    In the taxpayer's books of account, the payments

from SECWA for the plant were not entered as they were

recelved, but were apportloned over slxteen months, whlch was

expected to be the life of the project. The taxpayer's

accountant explained the reason for this in the followrng

passage of hrs evidence:

"The purpose of that was, as	had been declded
by the management of	GP International, to

bring that money to account over the llfe of

the project and as I recall it was ~n

relation to the amortisatlon of the cost of
the building of the plant and equipment f o r

that project.

From an accountlng point of vlew what would

be the effect of crediting the recelpts

account, the sales account, with the

mobilisation payments over the 16 month

period while at the same time amortlslng the

cost construction of over the same period?---At the end of the prolect the net accountlng effect would have been that the

two would have approximately balanced each

other out."

7 . In the taxpayer's taxation return for the year

ended 30 June 1982, the payment for the plant was shown In

I

.%	the balance sheet as a current liability with	the followlng
note:

"Mobillsation deposits.

The liability relating to mobilisation

deposlts advanced by the State Energy

Commisszon of Western Australia will be extlnguished over the period of a contract between the company and the State Energy

Commission Western of Australia. The

anticlpated completion date of the contract

1 s 1st October 1983.

Securlty for any liability remaining in

relatlon to	the mobilisation deposits the
Company and rts shareholders	have entered
into a performance bond supported by letters	!

of credlt in favour of the State Energy

Commlssion of Western Australia issued by

Cltibank N . A .	and confirmed by the National
Bank of Australasia Limited.	The Letter.of

Credlt ~ssued by Cltibank N.A. 1 s secured by

a floatlng debenture charge over the assets

of the Company. I'

The actual cost incurred to that time in constructing the plant was shown on the balance sheet as 'capital works in progress at cost'.

8 . In the taxatlon return for the following year,

depreciation of the plant was claimed at permitted rates and

an investment allowance was also claimed. These entltlements

have not been disputed by the Commlssioner of Taxation. i

9 . So far as the actual costs of constructing the

plant, and their relationshlp to the contract price, were

concerned, Pldgeon J made the followlng findlngs:

l ' . . . at the tlme the plant was commissioned	an
amount of $4,381,709.82 had been spent	on It.
This does not	take into account lndirect costs
relatlng to supervision in construction of	the

plant. The plant as constructed was not

adequate and the taxpayer spent a further

i

- a -

$970,257.69 cents in upgrading	it of which it
received an accelerated payment of	$550,000

from the Princlpal but it was on account of coated plpes to be delivered and was required

to be brought to account	as they	were
delivered.	Portion	of the sum related to

improving the plant to accelerate delivery

under the contract. The balance was to

improve the plant to meet the existlng

contract. The taxpayer made no profit in

respect of construction of the plant."

In the llght of the findings of fact, the question

to be decided is whether the receipt by the appellant of

$4,675,931 for the construction of the plant should be

treated as income In accordance with the ordinary usages	and
concepts of mankind, thus making	it assessable income withln
s.25(1) of the Act.

The learned trial judge held, in effect, that there

was one contract, in form	and in substance, for the executron
of work by the taxpayer and "the work	to be executed included

constructing the plant and then uslng that plant to deliver

the coated/pipe". The payments to be made to the taxpayer

were "as set o u t ln the schedule of rates which included the

three instalments of the payment in question". His Honour

went on to say,

"If one looked at the contract alone and asked the question what is the price being

paid by the Principal for the coating of the pipes then the answer would In my vlew be the

total sum set out In the schedule of rates and

being payment a In three rnstalments

deslgnated establlshment costs together wlth

the respectlve sums for external coatlng,

internal	coating	and	some	miscellaneous
1 terns.	"

1;;

- 9 - L

..

After consideclng some of the detailed provisions of the contract, his Honour said,

"If an outsider looked at the contract objectively then I conslder	such outslder must
come to the conclusion	that [the receipt in
question] was part	of the prrce belng paid by
the Principal and	being recelved by the

contractor. I do not consrder this character can change because the amount to be pard was a genuine estimate of the actual costs and the amount received approxlmated thls. I would

therefore	see it as	remuneration under the
contract and by reason of	tnat It must	be
classified as gross income."

His Honour concluded by saylng that he was

satisfied that there was no dlfference between the substance and the form of the actual contract. He dlsmissed the appeals.

Before this Court, counsel for the appellant made two 'general contentions' In the followlng terms:

"Moneys which are received by a taxpayer to defray in whole or In part the cost of a capital asset or improvement to be used for the purpose of generatlng income from

activities undertaken by the taxpayer for the

payer may be capltal	recelpts	of the
taxpayer.

Whether a partlcular receipt is of that

character depends upon the clrcumstances of

payment and receipt. Those circumstances

include the terms upon whlch the moneys are

received and the purposes for whlch they can

be deployed. l'

I ' I

1       ;

I There can, in our view, be no quarrel wlth these

propositions.

counsel then proceeded to make some 20 contentlons

of fact, of whlch the following appear to us to be

signlficant:

" 4 . It was of no concern to the Appellant whether

the SECWA rather than Itself owned the plant.

Its Interest was In derlvlng a proflt from performrng the contract to coat the pipe utillsing the plant constructed for that purpose o r alternatively using the existing pipecoating factory owned by one of the 30int venturers.

5. It was accepted by the parties that the

Appellant would construct	the necessary plant
on the basis that the cost was to	be recouped
from SECWA.

7.     The Appellant sought no proflt and made none from the constructlon of the plant.

8. The contract remuneration for coating the

pipe was provlded for In the revlsed schedule

of rates by payment per length of pipe coated which rates reflected the costs of actually coating the pipe and the proflt to be derlved

from that activity, which contained nelther a

cost component for construction of the plant

nor a profit to be derived from that

actlvity.

10.    The pipecoating plant was not an end product of the contract but was the means of obtaining the end product namely coated plpe.

11.    In as much as the establishment costs could be described as a conslderation at all, they

were separate a consideration for the

constructlon of the plant being a genuine

estimate of the cost of construction i.e.

excluding any profitelement.

12.    It was a requirement of the contract that the establishment costs be used for the purpose

of constructlng the plant and they were so

used.

13.	SECWA did not call for accounts regarding the
expenditure of the establishment costs as
there was no need to do so. Fluor Maunsell

as the engineers employed by SECWA had calculated the cost of constructing the plant, were closely supervislng the design

and construction and generally monltoring

expenditure and expected that if the design

was adhered to a plant costing at least $4 .614

i

l

- 11 -

would be produced. Under the special

conditions of contract	the establishment cost
lnstalments were not	payable without the

prior approval of the engineer acting for

S ECWA .

14. SECWA in substance caused a plant to be built

for ltself to Its own requlrements but for

political and policy reasons It dld not wlsh

to either own or operate the plant.

i 17. It was conceded by the Respondent at first

instance that the coating plant was a flxed
asset in the nature of a capital asset and
the expenditure upon it was In the nature of

capital expendlture."

I

There 1 s a degree of overlap in some of those

contentions, but between them they illustrate the thrust of
the appellant's case - that the construction of the plant

represented a severable part of the contract; it was only a

means to an end, that	end being the actual plpe-coatlng
process;	and the appellant neither Intended to derlve, nor

I

In fact derived, proflt from the construction.

In reply, the respondent relied upon the fact that

the plant construction was an lntegral part of the contract

considered as a whole. Counsel pointed out that the taxpayer

was an entity created for the sole purpose of carrylng out

all aspects of the contract. The nature of Its buslness was

to build a plant and then use that plant to coat 1500 kms of

pipe. All payments were	thus received In the ordlnary course
of the taxpayer's business. There was evldence	that 'up front'
mobilisation or establlshment payments were not uncommon	in the
construction industry.	The receipts were essentlally progress

payments in relatlon to the whole contract.

The respondent also relied on the fact that the

payments for the work in question were based on estimates only and there was a distinct posslbllity of profits being made from the plant construction, elther because of savings

on the estlmates or because of the sale of the plant at the

end of the contract. In the first instance the actual cost

of construction was some S4.4m rather than the S4.7m

estimated. It was fortuitous that required improvements to

the plant destroyed any possibllity of a profit being made.

In fact counsel for the respondent went further

than this and argued, on the basis of evzdence not discovered

but adduced during the trial, the full slgnificance of which

was apparently not appreciated at the time, that there was a

profit element for the plant constructron built lnto the

contract figures.

Thls was sald to be so because, when the tender was

origlnally prepared, a 15% profit margln was added to all

estrmates - for both plant and coating - in the course of

calculating the rates tendered per linear metre. When the

contract was flnallsed, it allowed for separate

'mobilizatlon' payments for the plant, and a flgure close to

the actual cost of the plant was taken out of the calculatlon

i of the rate per llnear metre, but the 15% proflt on the plant construction was left in the calculations which produced the amended coatlng rates.

The relevant flgures are as fo l lows:

I . ;

'. .

- 13 -

:. , . L .:

(a) Estimated cost of plant construction : $4,252,600	I >
: .

(b) Estlmated residual value at end of contract : il

$1,115,300 1

(c) Amount sought as mobilizatlon payment : $4,284,300 1. .

(d)	Amount taken Into account in calculating	tender	per	I
l, '

(a-b)	metre	linear	: $3,137,300	I '
K

The 15% profit margin was added to the amount shown

In (d) above.

t '

I - '

Counsel was able to demonstrate to the Court that I .

the total figures quoted In the origlnal tender were carried

through to	the total	figures	set	out	in	the	contract; thus	1::
I .:
l

the proflt element, calculated on the estimated plant cost	1 x~
! .I
I -
less its residual value, was retained in the contract figures.	l ! '
l .
I ,

This circumstance was confirmed by	the evidence of	:-i
F.

the taxpayer's managing director who, when asked whether,	ln	i-:
i '

relatlon to the construction of buildings and the purchase of	I , . -.
1,
plant "that was something in respect of which	there would be

! .'

an allowance for profit risk and contingencies?", replied I

I

i

'Yes'.	I ^
..
l .
t . . .

Counsel for the taxpayer argued that the 1 5 % L

allowance on $3,127,300 (the estimated cost of the plant less

I

recoverable value) was more in the nature of a provlsion for

I , . i ,

contingencies than	an attempt	to make a profit on this	aspect	i i
k-

of the contract.	He pointed out the	'rolled-up' nature of	I
1 .

the question assented to by the managlng director.

;
i ,
!.i

I	- 14 -
I	.
I

There seems to be substance in the respondent's argument on this point, but since it was not	put dlrectly to
witnesses, submztted	to the learned trlal ludge, or dealt
with In his Honour's	reasons for judgment, lt 1s difflcult

for this Court to reach any concluded view on the difference between the two submissions of counsel. We are prepared to assume for present purposes that the allowance referred to was for contingencies.

The respondent also argued that expert evidence of

accounting practlce 1s relevant to questions of

characterization (see Federal Cornmissloner of Taxation v

-

James Flood Pty Ltd (1953) 88 CLR 492 at 506-7; Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation

(1965) 114 CLR 3 1 4 at 318). In this case none of the

accountants called to glve evidence, ~ncludlng those called by the taxpayer, questioned the propriety of the receipts In questlon being credlted to 'sales' (a revenue ~tem). Counsel for the taxpayer replled that the witnesses were not givlng

evldence of accountlng practice, but merely saylng how they dealt, or would have dealt, with a most unusual problem for

an accountant to face.

The authority whlch 1 s most l l k e the present case,

and whlch received close attention both before Pidgeon J and

in this Court, is that of Boyce v Whltwlck Colliery CO Ltd

[l9341 ~ l l ER 706; 18 TC 655. The case was convenlently

summarized by Pidgeon J, and the following paragraphs which

(c)	Interest of 5% per annum on any portion of such costs for the time being unpald.
( a )	of

describe the case are largely	borrowed from his Honour's
judgment.	, _ .

In that case a colliery company needed to dispose

of surplus water and an urban dlstrlct council desired to be

supplied with that water. This resulted in an agreement

which was to continue for 30 years with an optlon to renew

for a further period of 20 years.	The agreement recited the	t
_ .

fact that an extension of	the council's works for the supply
of water was urgently needed and that	the councll and company

!

were willing to contract on the terms set out. The company covenanted to clean out a shaft and to erect the necessary works t o raise and pump the water. The works were to remaln

the property of the company. The company agreed to supply

speclfied quantities of water in bulk at a speclfied pressure to the council's water maln. The company agreed to maintain the works In good repair to the reasonable satisfaction of

the council's engineer.

The council agreed to pay to the company the ? i

following amounts each year by half-yearly payments.

( a ) The sum of two hundred and elghty five pounds.

i

(b) A sum equal to 1/30th part of the costs of the

works.

The sum one penny per thousand gallons of The agreement was to remain in force for 30 years,

but there was a provlso that if the company ceased to work

its colliery it would permlt the councll to continue pumping

the water, and if that happened there was to be a correspondrng reductlon In the annual amount to be paid by the council. The councll could determlne the agreement at

any time and	for	any	reason	but	was required to pay
compensatlon.

The questlon before the Court of Appeal was whether

the amount of the thirty annual instalments to repay, over the inrtlal life of the contract, the capltal expendlture to

install the plant, was	revenue recelved	by the company.
There was	a corresponding appeal raising	the question whether

the amount was an allowable deductlon by the council.

The Court saw It as a dlvisible contract, holdlng

that it provided in effect for two distinct matters, namely a

supply of water at an agreed prlce and the constructlon of

i

the works necessary to provlde the supply, upon terms that

the council would reimburse the company the costs of those

works. It was held that the annual payments equal to

one-thirtieth of such cost were not part of the payments for

the supply of water, but were repayments of the capital costs

of the works and accordingly were capital recelpts not

I

assessable to income tax in the hands of the company; and they were capital expendlture on the part of the council and

so not admissible as deductions.

. . I

Hanworth M.R. said he intended to look at the ,;'

agreement as a whole. Having done s o , he found in it a

capital outlay made not really	for the purpose of the company
but for the purpose of the supply of water.	The outlay was

on assets the use of which in certaln events mlght pass to the council, and In respect of which there was no undertaking or covenant or certainty that the company would continue to use them for the full term of thlrty years. His Lordshlp later said, at p.711 in All ER,

"In the present case the company were not,

when thls agreement was made, trading in

selling water. Their main business, as I have pointed out, was the getting of coal,

and if they were to sell water It involved

them in an immediate capital outlay whlch

they had to	make, the reimbursement of whlch
could	only

take place after a period of contemplatlon that the company may not

years. But there is as a possible event the

go on

for the full period of years."

His Lordship	then referred to	the fact that the agreement did
not provide	for an Inclusive payment	for water over a certain

time in any event and that it	provlded for the repayment of
one sixtieth part of the capltal. This was referring	to a

half-yearly payment. His Lordship concluded that the

relevant payment was an instalment towards the complete

payment of the capital outlay whlch was made at the lnstance

and under the direction of the council and which enured in

:

certain events to the beneflts of the councll even at a time

when the company ceased to operate.

I

Slesser L.J. found there was no question of

principle in the case at all and said (at p.712):-

l

" I t i s a q u e s t i o n whlch must be d e c i d e d w i t h

r e f e r e n c e t o t h e s u b s t a n c e o f t h e a g r e e m e n t

e n t e r e d	i n t o	b e t w e e n	t h l s	company	and	the
c o u n c l l .	AS	I	u n d e r s t a n d	t h e	m a t t e r ,	t h i s
a g r e e m e n t ,	t h o u g h	s t a t e d	i n	t h e	p r e a m b l e	t o

be	a	c o n t r a c t f o r s u p p l y o f w a t e r , d e a l s w l t h
two	d i s t i n c t a n d d i f f e r e n t m a t t e r s , f i r s t ,
t h e	s u p p l y o f w a t e r s l m p l i c i t e r , f o r w h i c h
t h e	company a r e g i v e n t h e r i g h t t o make

c h a r g e s , t h o s e c h a r g e s , a s h a s b e e n p o i n t e d

o u t , b e i n g v a r l e d on t h e e x p i r a t i o n of t h i r t y

y e a r s . T h e n , a l t o g e t h e r a p a r t f r o m t h e

a g r e e m e n t a s t o t h e s u p p l y o f w a t e r , t h e r e	is
a n a g r e e m e n t w i t h r e g a r d t o t h e r e c o u p m e n t t o

t h e company of the expense to which they have

b e e n	p u t	i n	e r e c t i n g	c e r t a i n	w a t e r w o r k s	a n d
a s s o c i a t e d	w o r k s	i n	o r d e r	t o	s a t l s f y	t h e

c o n d i t i o n s o f c o n t r a c t c h e t h e a n d

r e q u i r e m e n t s of t h e c o u n c i l . I t 1 s t r u e t h a t

by c l . 1 i t i s p r o v i d e d t h a t t h e w o r k s s h a l l ,

when c o m p l e t e d , r e m a l n t h e sole p r o p e r t y of

t h e company; and hence i t is a r g u e d , among

o t h e r	t h i n g s ,	t h a t	r e a l l y	t h e	c o u n c i l	a r e
b u y i n g	n o t h l n g ,	a n d	t h a t	t h e r e	i s no	c a p i t a l

e x p e n d i t u r e on t h e i r p a r t . B u t lt a p p e a r s t o

me t h a t t h i s is i n t h e n a t u r e o f a l o l n t

l

a d v e n t u r e b e t w e e n t w o c o n t r a c t l n g p a r t i e s .

I t i s t r u e t h a t u l t i m a t e l y t h e w o r k s become

t h e sole p r o p e r t y o f t h e c o m p a n y , b u t d u r i n g

t h e p e r i o d c o u n c i l d e a l t w l t h by t h e c o n t r a c t t h e

a r e g i v e n many r l g h t s o v e r t h e s e

w o r k s a n d o v e r t h e b u s i n e s s w h i c h is t h e r e t o

b e	c a r r i e d	on	and ,	as	my	L o r d	h a s	p o i n t e d
o u t ,	i n t h e	e v e n t	o	f	t h e	c o m p a n y	f a i l i n g	t o

s u p p l y	t h e	w a t e r	u n d e r	t h e	c o n t r a c t	t h e
c o u n c i l	a r e	t h e m s e l v e s	g i v e n	t h e	p o w e r	t o
e n t e r on	the	works	and	do	t he	pumplng . "

Rorner L . J . s a i d a t p . 7 1 4 :

"The	q u e s t i o n	w h l c h	h a s	t o	b	e	s o l v e d	a p p e a r s
t o	me	t o	b e	o n e	s o l e l y	a s	t o	t h e	p r o p e r

c o n s t r u c t i o n t o b e p l a c e d on t h e a g r e e m e n t o f

J u l y 1 , 1918 . A t t h e t i m e when t h a t

agreement	was	e n t e r e d	i n t o ,	i t	1s
s u f f i c i e n t l y	p l a i n	t h a t	t h e	c o m p a n y ,	t h o u g h

no	d o u b t	wel l	e q u l p p e d	b o t h	r e g a r d s	a s
m a c h l n e r y	a n d	b u l l d i n g s	f o r	t h e	p u r p o s e	o f
c a r r y i n g	on	a	c o l l i e r y	b u s l n e s s ,	was	no t

I p r o p e r l y e q u i p p e d In e i t h e r r e s p e c t f o r t h e

p u r p o s e of s u p p l y i n g w a t e r t o t h e c o u n c i l .

The c o u n c i l w e r e d e s i r o u s t h a t w a t e r s h o u l d b e s u p p l i e d t o t h e m b y t h e c o m p a n y , a n d t h e y ,

t h e r e f o r e , m u s t h a v e r e c o g n l s e d t h a t i f a

c o n t r a c t w a s t o b e e n t e r e d i n t o by t h e

company f o r s u p p l y i n g w a t e r t o t h e m t h e

c o m p a n y m u s t p u t t h e m s e l v e s i n t o a p o s i t i o n ,

by the provlsion of adequate machinery and	L
!

buildings, to do so. If In those

clrcumstances the company had agreed with the councll that they would themselves erect the necessary buildlngs and machinery for the

purpose, and the council had agreed that in conslderation of their so doing the councrl would repay to the company by thlrty yearly

lnstalments the cost to whlch the company had

been thereby put, I cannot conceive that

anyone could contend successfully that the sums so paid by the council to the company were liable to income tax, even though at the

end of the thirty years the buildings and plant, which presumably by that time would

not be worth very much, should remaln the

i

property of the company."

Thus the Court of Appeal held that the payments it

was considerlng were not lncome but capital receipts.

The taxpayer naturally relied on the decision in Boyce's case for the proposition that payments recelved for a capital purpose are prima facie capital payments, and that they retain this character whether they represent payments for actual disbursements or payments In advance of estlmated

costs. Nor 1s lt slgniflcant, rt was submitted, whether the

receipts come in a single payment or In instalments.

Counsel for the respondent argued that Boyce's case

1: .

should be distinguished for one or	more of the following	1 '
I '
reasons	. ..

(a) In that case the buslness In question was merely

incidental to the primary business of the taxpayer,

(b) the receipts were lntended precisely to recoup a

disbursement of a capital nature,

I

(c) the taxpayer In Boyce had no intention of making a

profit on the cost of construction of the plant - the

contrary is strongly arguable in the present case, and

(d) the receipts in Boyce were fixed with a capital character, first, because interest	was payable on the amount
from time to time outstanding and, secondly, by virtue	of the
long length of time over which they were	spread.

In our view there is no substance in the flrst

point but the other three, taken together, are persuasive. The separation, in Boyce, of the receipts directly related to

the capital work was clear cut; the work to	be performed was
of a classzcally capital nature	- major works carried out
once only in order to generate income over a long	period of

years; and the payments were clearly stamped as capital by the addltional payments of Interest on the unpaid portlon. These circumstances make the case, in our view, so different as to be unhelpful to the decision of the present case.

We believe the same can be said, f o r similar

reasons, of the decision of Owen J In APA Flxed Investnent

Trust CO Ltd v Federal Commissloner of Taxation (1948) 8 ATD

369  -

As we have already said, we do not flnd it an easy

task to answer the question before the Court. The case falls, in our view, close to the borderline between capltal and income and there seems to be no dlrect precedent to

assist in resolving the issue. However we have received some

I

!

general guidance from the often-clted words of Dlxon J, as he

then was, in Hallstroms Pty Ltd v Federal Commlssioner of

Taxation (1946) 7 2 CLR 634 at 646-7, where he sald:

"For myself, however, I am not prepared to concede that the distinction between an

expendlture on account of revenue and an

outgolng Of a capital nature is so indefinlte and uncertain as to remove the matter from the operatlon of reason and place It exclusively wlthln that of chance, or that the discrimen is so unascertalnable that it must be placed

I n the category of an unformulated question of

fact. The truth 1 s that, in excludlng as

deductions losses and outgolngs of capltal or of a capltal nature, the income tax law took for Its purposes a very general conception of

accountancy, perhaps of economics, and left

the partlcular appllcation to	be worked out, a
thing whlch it thus became the buslness	of the

courts of law to do. The courts have proceeded with the task without, it is true, any very consplcuous attempt at analysls, but

rather ln the traditional way of stating what

posltlve factor o r factors in each given case led to a declsion asslgnlng the expendlture to

capltal or to income as the case might be. It

is one thing to say that the presence among the clrcumstances of a case of a particular factor places the case wlthin a specific legal

category.	It is another thing to infer that
the absence of the	same factor from some other
case necessarily places that case outslde	the

category and gives It an opposlte description.

But towards that klnd of fallacy human

reasoning constantly tends, and the decisions

upon matcers of capltal and lncome contain

much reasoning that is quite human. I?y own

oplnlons upon the question I have attempted to

explain In Sun Newspapers Ltd. v. Federal

Commissioner of Taxation and I shall not

re-state them. I shall treat the passage to

whlch I refer as Incorporated in this

judgment. Once more, however, I shall endeavour to apply what I concelve to be the prlnciples that determine whether an outgolng

1 s on account of capltal or of revenue. As a

prefatory remark It may	be useful to recall
the	general conslderation that the contrast

between the two forms of expenditure corresponds to the distinction between the

acquisltion of the means of productlon and the

use of them; between establishing or

extending a buslness organizatlon and carrying

on the business; between the implements

I	employed rn 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.”
In the earller case of Sun Newspapers (1938) 61 CLR

3 3 7 , to which his H O n O U C referred, he had sard, at 359-61,

“The distinction between expenditure and
outgoings on revenue account and on capltal

account corresponds wlth the distlnction

between	the	buslness entrty, structure, or
organlzation set	up or established for	the
earning	of	profit and the process by which

such an organlzation operates to obtain

regular returns	by means of regular outlay,
the dlfference between	the outlay and returns
representing profit or loss. The	business

structure or entxty or organlzation may assume
any of an almost inflnlte variety of shapes

and it may be dlfficult to comprehend under

one descriptlon all the forms In which it may

be manifested. In a trade or pursult where

llttle or	no plant is required, i t may be
represented by no more than	the intangible

elements constituting what is commonly called
goodwill, that is, widespread or general
reputation, habitual patronage by clients or

customers and an organized method of servlng

their needs. At the other extreme lt may

consist in a great aggregate of buildlngs,

machlnery and plant all assembled and

systematlzed as the material means by whlch an organized body of men produce and dlstrlbute commodities or perform services. But In spite of the entlrely different forms, material and

immaterial, ~n which It	may be expressed, such
sources of income contain or	consist in what
has been called a ‘proflt-yieldlng subject,’
the	phrase of Lord Blackburn in United

Collieries Ltd. V. Inland Revenue

Commissioners	[(l9301 SC 215 at 2201. As
general conceptlons It	may not be difficult to

distlngulsh between the profit-yielding subject and the process of operatlng it. In

the same way expenditure and outlay upon

establishing, replacing and enlarging the
profit-yieldlng sublect may in a general way
appear to be of a nature entirely different
from the continual flow of worklng expenses
which are or ought to be supplled continually
out of the returns or revenue. The latter can
be considered, estimated and determined only

In relatlon to a period or interval of time,

the former as at a point of time. For the one

concerns the instrument for earning profits

I

- 23 -

and the other the continuous process of ~ t s
use or employment for that purpose. But the

practical applicatlon of such general notions

1 s another matter.	The basal difflculty	in
applying	them	l l e s in the fact that the

extent, condltion and efflciency of the proflt-yleldlnq subject is often as much the product of the course of operatlons as ~t 1 s of a clear and definable outlay of work or

money by way of establishment,	replacement or
enlargement.	In the case of machinery, plant

and other materlal objects, thls is illustrated by the commonplace difficulty of sayrnq what is maintenance and what are renewals to be referred to capital.

....

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 capltal account	or to
revenue account the courts have	relled to some

extent upon the difference between an outlay
which 1 s recurrent, repeated or contlnual and

that which is flnal or made 'once for all',

and to a still greater extent upon a

distlnctlon to be discovered in the nature of the asset or advantage obtained by the outlay.

If what is commonly understood as	a flxed
capltal asset is acquired the questlon	answers

ltself. But the distlnction goes further.

The result or purpose of the expendlture may be to bring into existence or procure some asset or advantage of a lasting character which will enure for the beneflt of the

organization of system or 'proflt-earning

subject.' It wlll thus be distlngulshed from the expendlture which should be recouped by circulating capltal or by working capltal."

It must be remembered that, in both these cases,

Dixon J was concerned to characterlze expendltures rather

than receipts as being either capital or Income. And lt cannot be thought that he had a case such as the present in mind when he was preparing these judgments. Nevertheless his

Honour's broad approach has been referred to with approval

5 %

many times and i t provides a convenient starting point for

the decision in the present case.

In our view, the most significant feature of this case is that the taxpayer was brought Into existence for	the
sole purpose of executing a single profltable contract.	And
the nature of the task was such that, at the	end of the
contract, any assets of the taxpayer In the	shape of

bulldings, plant or equipment would have little more than

I -.

salvage value. Thls was recognized both in the agreement

between the parties and In the taxpayer's statements of
account and claims for high rates of depreclatlon, which were

allowed by the Commissioner.

In these circumstances it seems to us to be

somewhat artiflcial to distingulsh between the early payments received by the taxpayer which were, In effect, to compensate

it for its unproductive preparatory work, and the later

payments whlch related dlrectly to the productive

pipe-coating process.

We believe that, if a company 1 s brought into

existence for the sole purpose of performlng one contract for profit, and partlcularly if the llfe of the contract is comparatively short - to be measured in months rather than

years, then all payments made under the contract are llkely

to be income rather than capltal receipts in the hands of the

I

company. The business of such a company is the performance

of the contract, and the receipts are in the ordinary course

of that business.

i'

The positlon could well be otherwise if It were

shown that certain establlshment costs, deslgned	to put the
contractor in a position to perform its contract,	were being

met dlrectly by the other party to the contract - thus

removing any posslble profit element from those payments.

But that is not the case here. Because the payments for

plant construction were based on estimates (which themselves were expressed in round flgures and contained a 59 element for 'miscellaneous'), and the total contract price contained

I

an allowance of 15% of the larger part of the estimated sum,	r .
f o r 'contlngencies', we think there is no sufficient reason to treat those payments differently from other payments made under the contract.

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,	for

which regular payments were made under the one contract.

Gearing-up f o r such a contract must necessarily	involve the
accumulation of men and materials and	the carrylng out of
preliminary works of one sort or another.	In this case the
preliminary work was substantlal	and unusually expensive but,
none the less, impermanent.
The taxpayer was remunerated for all its work, at regular intervals, over the period of the contract.	The

.' total payments it received added up to the amount

contemplated by the contract, wlth certain agreed variations. The frrst three payments, which are in questlon here, were made before SECWA began to receive the end-product of the contract. Thls was done, in our view, not so that SECwA could pay for the plant as such, but in order to save the taxpayer having to borrow money and pay interest on hlgh

establishment costs whxch it would have had to pass on to

SECWA. There was evidence accepted by Pidgeon J that such 'up-front' payments to cover establishment or mobilisation

costs, are not uncommon In similar construction contracts.

The two chief factors to which the taxpayer can

point as supportlng a characterization of the payments as
capital are (a) the nature of the activity for which the
payments were made, namely the constructlon 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. 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 belleve the usual clear

distinction, referred to by Dlxon J in the passages cited above, between the creation of a profit-yielding sub~ect and the process of operating it, 1 s somewhat blurred - because the sublect is to be used once only as part of a total

indivlsible contract. For this reason, any inference that

receipts to be spent on a capltal purpose are capltal

recelpts 1 s weakened.

i

I

. .

- 2 1 -

We say that the contract 1s indivisible because the

payments made at the time the plant was being erected were not the only payments which related to the plant - the

'contingencies'	allowance was accommodated elsewhere - and	I .
-;

the amounts paid, although genulne estimates, could not have

been expected to work out accurately; any loss to the

taxpayer had to be absorbed by profits from the remainder of the contract, while posslble profits from the construction phase could be added.

For the reasons we have given we can see no

. ,

sufficient reason to treat the payments in question differently from the other moneys received by the taxpayer under its contract. We take some comfort in this finding

from the fact that	the payments represented a precise portion
(15%) of the total anticipated contract sum, from	the way in
which the payments were treated as	'sales' in the taxpayer's

balance sheet, and from the expert evidence of the

accountants who were called - though we do not rely on any of

these factors in reachlng our conclusion.	We	also note,	.	..
..

finally, that the taxpayer's expenditure on the plant having, c

I ,

through depreciation provislons, been treated as fully

deductible from income, there is no in~ustice to the taxpayer

in the conclusion which the learned trial judge reached.

The appeals should be dismissed with costs.

\' I certify that the twenty-seven

( 2 7 ) preceding pages are a true

and accurate copy of the Reasons for Judgment herein of The Court

c

Associate

Dated: 7 . 1 0 . F V

Counsel for the Appell	&
letcher

I	Solicitors for the Appellant: Solomon Brothers
Counsel for the Respondent: MC C.J. Carr & Miss C. Francas
Solicitors for the Respondent:  Australian Government

Solicltor

Date of hearing: 9,10 h 11 May 1988