Kurts Development Limited v Commissioner of Taxation

[1999] HCATrans 90

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
  Brisbane  No B33 of 1998

B e t w e e n -

KURTS DEVELOPMENT LIMITED

Applicant

and

COMMISSIONER OF TAXATION

Respondent

Application for special leave to appeal

GUMMOW J
KIRBY J

TRANSCRIPT OF PROCEEDINGS

FROM BRISBANE BY VIDEO LINK TO CANBERRA

ON FRIDAY, 16 APRIL 1999, AT 12.14 PM

Copyright in the High Court of Australia

MR D.G. RUSSELL, QC:   May it please the Court, I appear for the applicant with my learned friend, MR P.E. HACK.  (instructed by Clayton Utz).

MR H.B. FRASER QC:   May it please the Court, I appear for the respondent with my learned friend, MS C.E. HOLMES.  (instructed by the Australian Government Solicitor).

MR RUSSELL:   Your Honour, to take the Court to the nub of our complaint of the judgment appealed from, if your Honours would go to page 70 of the application book.  The essential error, as we see it, is encapsulated in the last paragraph on that page commencing at ‑ ‑ ‑

GUMMOW J:   This is dealing with the external costs?

MR RUSSELL:    Yes, your Honour, but we say that it is an error that infects the whole judgment, and it is summed up in the words:

it does not matter that the External Costs are remote from the individual subdivided lots.  Nor does it matter whether they are directly related to or directly connected with the individual subdivided lots.

And it goes on to say:

The question is whether the External Costs are properly to be characterised as part of the cost price of the individual subdivided lots.

And the matter which will come to be determined by the Court, if special leave is granted, is whether it matters that the costs are directly related to the lots in question or not if they are to be part of the costs, because we say that the question which the court poses in the next sentence, “They are all expenses which had to be incurred in order to create the individual subdivided lots”, is really a statement, when one analyses it, that they are costs of sale, and we say that is the correct analysis of what they were and we say the consequence of that is that they are not part of the costs of the lots.  So that, put shortly, is the contention, or the issue, which this case would raise before the Court if special leave were granted.

The problem, in our respectful submission, comes from the difficulties that the Court itself recognised in its decision in Federal Commissioner of Taxation v St Hubert’s Island.  The Court recognised, in a number of places in its judgment, that the application of the trading stock provisions, as written, as the Court found largely with articles of goods, in ‑ ‑ ‑

GUMMOW J:   Other things in mind, yes.

MR RUSSELL:    Other things in mind – had, nonetheless, to be applied to land.  For example, Justice Mason at pages 224 and 225, but at page 224, his Honour said:

The application of these words to virgin land acquired by a land developer for the purpose of substantial improvement, subdivision and sale is fraught with some difficulty.

At page 225, his Honour, in the last complete paragraph on that page, says:

That some of the provisions…..are so expressed that they cannot readily be given an operation in relation to land.

And his Honour Justice Aicken, who dissented in result, but who agreed on this point, said much the same thing at 242 about two-fifths of the way down the page:

Neither land itself nor interests in land would ordinarily be thought of as being “things”.  The provisions to which I have just referred are sufficient to indicate at least that there are expressions used in relation to trading stock which are not readily applicable to land.

So the problems, because this no doubt will not be the only one, have been lying in…..ever since they were recognised by those members of the Court at that time.

GUMMOW J:   Yes, but the question really is whether Justice Emmett did not make about as good a fist as could be made of this situation which is an inevitable product, really, of this earlier decision.

MR RUSSELL:    Our submission, your Honour, is that he did not make as good a fist of it as might be made.  In fact, our submission is that he is wrong, and clearly so.  The essence of the error, as we see it, is that the court has proceeded on the assumption that one ignores the infrastructure land.  One treats it as something which is valueless.  That has to be done in order to avoid double taxation.  The fact is that it was real land.  It remains real land.  It passes from the applicant to another entity, as was established in the evidence in the AAT.  Accounting standards actually require that the entity to which it passes, in other words the local authority, to treat that land as a valuable asset.  So that the court has ignored something which has actual and real value in the form of the - I am talking now about the infrastructure land - and has treated it as passing from the taxpayer, in circumstances to which the trading stock provisions do not apply, and then said, “We ignore that land, it does not exist. Now, it is a question of deciding, out of what is left, how do you apply the costs?”. 

We say then, incorrectly characterising the nature of those costs, that applies, with particular consequence, to the cost of what is called “external works”, but as the evidence below, which was not in dispute, established, in fact these are charges paid to government bodies which may or may not see any result in terms of external works related to these developments or, indeed, any other.

It is, perhaps, worth drawing the Court’s attention, at this stage, to the observations made in the outline which were challenged in our learned friend’s response, and have now been brought in the form of evidence in Mr Harrison’s affidavit which points out that these are very substantial sums, at times, actually exceeding the cost of the land.  So there are significant circumstances, we would say public consequences, not just for this taxpayer if this decision is wrong.

The other observation that we would make is that one member of the Court, on a previous occasion, did express a view, admittedly obiter, as to what would be taken into account in determining the cost of land on hand.  It was his Honour Justice Aicken at page 246 of St Hubert’s Island where he says:

If one were to carry the analogy of manufactured goods into the realm of real estate, it would require that land which was purchased as trading stock might, when work is done upon its development, be brought into account at the end of the year, if still retailed, either at cost (which would include cost of all work done on it) or at market value under the English system, or at cost, market value, or replacement cost under ss 28-31.

So his Honour clearly had in mind a direct and proximate relationship between the land as a physical object and the work done on it in order to incorporate an amount into cost, whereas the Federal Court has held, and held expressly, that it is precisely that which is not required.

We would say that it is what Justice Aicken said that is correct, that in order for something to be the cost of an article of trading stock for the purposes of section 28 of the Income Tax Assessment Act, it must have a direct and proximate relationship to the thing itself, not to the legal abstraction called a subdivided lot, which comes into existence only because the law of land subdivision overrides the common law under which land was infinitely divisible and saleable.

GUMMOW J:   Yes, well that is the question.

MR RUSSELL:    As the court said, all that one obtains by paying these amounts to the council, is a “consent to do something which would otherwise be prohibited”.  That appears on page 70 of the application book at lines 20 to 23.

So that the consequence is, we would say, that the court has recognised, and correctly, that this is, effectively, a cost of sale.  It is the cost of obtaining a permission to do something, namely, sell the land in lots which would otherwise be prohibited.  The evidence below was that costs of sale are appropriately not included as costs of the lot.  I did not appear in those proceedings.  My learned friend tells me that aspect of it was not in dispute.  What was in dispute was whether this was properly regarded as a cost of sale.  The court has, in our respectful submission, correctly characterised it as a cost of sale.  The consequence is, it is not a cost of the lots themselves.  To be so required, the direct and proximate relationship which the court expressly denied needed to exist and, in our respectful submission, that is error, and plainly error.

GUMMOW J:   Yes.

MR RUSSELL:    In relation to what has been called the infrastructure land and the infrastructure costs, the error of the court, in our respectful submission, can be seen by examining what would happen if, instead of once the plan of subdivision occurred, or if what was involved was not roads but something else that was going to be vested in the public, say, for example, a park, that was retained by the developer until the time of sale of the land and then vested in the council.  If the approach of the court is right, then either, notwithstanding that those assets remain in the hands of the developer, one treats them as worthless, which would be contrary to the economic reality of the case or, alternatively, one has a situation of double taxation because you would have the cost being allocated both to the physical blocks of land on which the work was actually done, as well as the blocks of land on which it was not done.

One could take that a stage further.  If, as frequently now happens in integrated resorts, that type of land is common property and remains the property of the resort rather than being vested in the Crown, a different principle of cost allocation would be required, not by reference to the articles of trading stock or what is actually done, but by reason of the intended use of the land by the developer.  We would say that the process of cost allocation is not a matter which depends on parties intentions or what might, ultimately, be done with the asset at some later stage.  It requires, as we say, the direct and proximate connection between the asset or “the article”, to use the language of section 28, and the expense incurred.

The court, in our respectful submission, has fallen into error because it seems to have taken into account not issues of cost, but issues of value.  That appears, in our respectful submission, perhaps most clearly at page 69 at about lines 39 to 47:

There is no doubt that the expenditure of money by the Taxpayer on the Infrastructure Works adds to the value of the broadacres as a whole because it makes possible the separate disposition of the proposed individual subdivided lots.

That, of course, is not true except in the formal legal sense that one is paying the local authority for its consent to subdivide the land:

Without the roads, parks and other services and facilities, the individual subdivided lots could not be sold.

Again, that is subject to the same objection as a proposition of law:

In a real sense, the expenditure of the Infrastructure Costs is part of the cost of producing the individual subdivided lots.

So the court seems to be saying that because it adds value to the cost of the subdivided lots - because it adds value to the subdivided lots, it is part of their cost.  And, once again, as a proposition, that has to be wrong.  If one has the developer developing broadacre land which is being turned into subdivision on one side of the road and developing a parcel of land on the other side of the road which is to be turned into a shopping centre, the shopping centre might well add value to the property on the other side of the road because of enhanced proximity to services and the like, but it could not conceivably be said that, although it enhanced the value, it was part of the cost of that land.  So we would say that the trading stock provisions themselves make it perfectly plain that questions of value and questions of cost are quite distinct.

The taxpayer has, under the Act, an option to elect which method will apply.  If he elects to accept cost, that election cannot be set at nought because the Commissioner can turn around and say, “Well, money that has been spent doing something else has nonetheless added value to the lots, therefore we add it to the cost of the land and therefore, as it were, recapture the value or part of it”.  So we would say that the approach that has been

adopted, not only lacks commonsense, but it also denies the taxpayer a right of election which is conferred on him by the Act.

The final proposition that we would put forward is that the approach that has been adopted, effectively denies the taxpayer a right to a deduction in the year of incurrence.  Because if a deduction to which the taxpayer is otherwise entitled under subsection 51(1) is to be taken away because one automatically adds the cost of the amount incurred to the cost of trading stock, then the result of that will be an increase in the value of trading stock and the deduction will be realised, if at all, on final realisation of the property, and that is not the scheme of the Act in such cases. 

So, put shortly, in our respectful submission, the very proposition which the court expressly disavows, namely, the need for a direct and proximate relationship between the articles and the expense, is the correct proposition at law.  The consequences for the industry and the public at large, are before the Court.  There is nothing about this case otherwise that would not make it a suitable vehicle for special leave if the Court were of the view that that matter, itself, ought to be reviewed by the Court.  Those are our submissions, if the Court pleases.

GUMMOW J:   Yes, thank you, Mr Russell.  Mr Fraser, what do you say first as to Mr Russell’s points as to the direct and proximate relationship with the article, the article being the land as such?  Secondly, what do you say about his criticism of the passage at page 69 where he says “cost” and “value” got muddled?

MR FRASER:   In relation to the first point, your Honour, we say that the judgment which the provisions of the Act require is simply whether or not the items of expenditure form part of the cost of the article of trading stock.  In making that judgment, we respectfully submit, there is no restriction to be implied that the expenditure must be physically on the land and, indeed, we would respectfully submit that it would defy commonsense to suggest that the cost of subdivided serviced lots for sale to the developer do not include the costs of the particular subdivision.  Dealing with both sets of costs, both sets of costs were in fact incurred in the particular subdivision which produced the particular lots which form the ultimate form of the developer’s trading stock.  So, in my respectful submission, it is not only open to the court but it appears, with respect, inevitable that the court would form the view that they formed part of the developer’s cost of the trading stock.

GUMMOW J:   Page 69.

MR FRASER:   Your Honours, in working out whether the cost of the expenditure forms part of the costs of the lot, naturally the court focuses on what connecting factors there are between the expenditure and the lot.  The connecting factors include, of course, that the expenditure of the cost adds value to the lot.  But the court below did not confuse the question of value with costs in terms of the statute.  What the statute requires under section 28 is the conceptually simple task of a valuation of the trading stock on hand at the end of the year compared with a valuation of the trading stock on hand at the beginning of the year.  What section 31(1) allowed the taxpayer to do, was to elect to have the value of its articles of trading stock on a cost price basis. 

Now, if the Federal Court had attempted to assess the increment in value of the trading stock with reference to the matters set out on page 69, it would have denied that election to the taxpayer.  But it did not do so.  It relied upon them, that is to say, the majority judgment here relied upon those matters merely as showing the very real closeness of the connection between the expenditure and the loss.  So, in my respectful submission, there is really nothing in the criticism of that passage of the judgment.

GUMMOW J:   There was a third point as to timing of deductions being thrown out.  What do you say about that?

MR FRASER:   Yes, your Honour.  What my learned friend says about the effect of the judgment is quite right.  The effect of including the expenditure in the cost of the lots is effectively to set off the deduction for its expenditure in that year against the increased cost price of the trading stock.  But that is a consequence of doing the exercise which section 28 of the Act requires, and that is always the case when a particular expenditure, which is deductible in the particular year, forms part of the cost price.  Indeed, the reason for it is that it always been recognised that the profits of a business are comprised not only in its receipts but in its trading stock.

GUMMOW J:   Yes, thank you Mr Fraser.

MR FRASER:   The only other mater I was going to raise was that an aspect of the argument which was first ventilated orally here was that some of these costs should be treated as selling costs - perhaps some or all of them, it was not clear, with respect - rather than as costs of the trading stock.  In my respectful submission, it appears one of the significant arguments to be advanced, is another reason why this is not an appropriate vehicle for granting special leave.  Because as your Honours will have noted, no such proposition is dealt with in terms in the judgments in the court below, and that is because the way it was argued below is the way it is argued in the written outline of my learned friend.  At page 86 of the record, firstly in relation to external costs, it was put in paragraph 14 on page 86 of the record below, as it is put in writing here, that they were:

an integral part of the business of subdivision.

We understood that to mean that for some reason, because they were an integral part of the business of subdivision, they could not also be allocated to the cost of the lots.  We understand ‑ ‑ ‑

GUMMOW J:   Yes.  I do not think we need trouble you any further, Mr Fraser.

MR FRASER:   Thank you, your Honour.

GUMMOW J:   Mr Russell.

MR RUSSELL:   Very briefly, your Honours.  My learned friend has submitted that this issue is simply an issue of allocation of costs to land.  That simply cannot be so in the case of the infrastructure land at least, because that land was acquired as trading stock.  It is common ground that it was.  Precisely which aspects of the ultimate subdivided land would ultimately become infrastructure land remained to be determined, because part of the process of subdivision involved identifying that.  So that in respect of that land, at least, it is clear that what is involved is not saying that an amount has been incurred in respect of the subdivided lots.  It is logical to allocate it to them.  It had, in fact, been incurred, on any view in relation to the infrastructure land, and what is engaged in is a process of reallocation, notwithstanding that there is no expense involved.  So in our respectful submission, the propositions that have been put forward have not been responded to.  Those are our submissions, if the Court please.

GUMMOW J:   Thank you.  Despite the thorough submissions made for the applicant, we are not persuaded that there is sufficient prospects of success to warrant a grant of special leave.  Indeed, the reasoning of Justice Emmett in his judgment, which was the leading judgment in the Full Federal Court appears to us to be correct.  Accordingly, special leave will be refused.

You seek costs, Mr Fraser?

MR FRASER:   Yes, your Honour.

GUMMOW J:   I do not think you can resist that, Mr Russell?

MR RUSSELL:   No, your Honour.

GUMMOW J:   Refused with costs.

AT 12.41 PM THE MATTER WAS CONCLUDED