Metal Manufactures Ltd v Federal Commissioner of Taxation - [1999] FCA 1712

FEDERAL COURT OF AUSTRALIA
Metal Manufactures Ltd v Commissioner of Taxation [1999] FCA 1712
TAXES & DUTIES – income tax – deductions under s 51(1) Income Tax Assessment Act 1936 – sale and lease-back of heavy plant and equipment in taxpayer’s factory – deductibility of lease payments made by taxpayer in respect of plant and equipment – whether plant and equipment fixtures or chattels – nature of interest acquired by purchaser in plant and equipment – whether transaction ineffective as sale and lease-back – whether transaction should be characterised as, in substance, a loan – whether payments under lease secured a collateral advantage to taxpayer, being a practical right to reacquire plant and equipment at expiration of lease at a low residual value
TAXES & DUTIES – income tax – schemes to reduce income tax – whether dominant purpose of enabling taxpayer to obtain a tax benefit
Income Tax Assessment Act 1936 (Cth), s 51(1), s177D
Australian Provincial Assurance Co. Ltd v Coroneo [1938] 38 SR(NSW) 700, followed
Eon Metals NL v Commissioner of State Taxation (WA) (1991) 91 ATC 4841, considered
National Dairies WA Ltd v Commissioner of State Revenue [1999] WASCA 152, cited
Re Starline Furniture Pty Ltd (1982) 6 ACLR 312, cited
Eastern Nitrogen Ltd v Commissioner of Taxation [1999] FCA 1536, considered
Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47, cited
Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645, applied
Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404, applied
METAL MANUFACTURES LTD v COMMISSIONER OF TAXATION
NG668 OF 1997
NG669-678 OF 1997
EMMETT J
8 DECEMBER 1999
SYDNEY

IN THE FEDERAL COURT OF AUSTRALIA

NG 668 OF 1997

NEW SOUTH WALES DISTRICT REGISTRY

NG 669-678 OF 1997

BETWEEN:

METAL MANUFACTURES LIMITED
Applicant

AND:

COMMISSIONER OF TAXATION
Respondent

JUDGE:

EMMETT J

DATE OF ORDER:

8 DECEMBER 1999

WHERE MADE:

SYDNEY

THE COURT DIRECTS THAT:
1.The parties bring in short minutes to reflect the conclusions reached in the reasons for judgment of 8 December 1999.

Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

IN THE FEDERAL COURT OF AUSTRALIA

NG 668 OF 1997

NEW SOUTH WALES DISTRICT REGISTRY

NG 669-678 OF 1997

BETWEEN:

METAL MANUFACTURES LIMITED
Applicant

AND:

COMMISSIONER OF TAXATION
Respondent

JUDGE:

EMMETT J

DATE:

8 DECEMBER 1999

PLACE:

SYDNEY

REASONS FOR JUDGMENT
INDEX
Introduction........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... Paragraph 1
The Sale and Leaseback Arrangements........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ Paragraph 8
Statutory Framework........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ...... Paragraph 24
The Commissioner’s Contentions........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ Paragraph 26
Background to the Arrangements........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ Paragraph 32
The Taxpayer’s Security for Retaining Use of the Plant and Equipment........ ........ ........ ........ ........ ....... Paragraph 64
The Taxpayer’s Need for Finance........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ Paragraph 82
The Plant and Equipment........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ..... Paragraph 108
Fixtures or Chattels........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... Paragraph 164
The Effect of the Arrangements........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ . Paragraph 184
Loan of $50,000,000........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ....... Paragraph 202
Collateral Advantage........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .... Paragraph 244
Part IVA........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ .. Paragraph 258
Conclusion........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ........ ..... Paragraph 308
INTRODUCTION

The applicant, Metal Manufactures Limited (“the Taxpayer”), is, and has for many years been, engaged in the manufacture of energy cables and tubes and pipes, in the business of facilitating the transmission of electronic communications and in the merchandising of electrical, electronic and lighting products.
In 1987, the Taxpayer owned land at Port Kembla, New South Wales. In addition, a wholly owned subsidiary of the Taxpayer, Austral Bronze Metal Manufactures Pty Ltd (“Austral Bronze”) was the owner of a parcel of land adjoining the land owned by the Taxpayer. On the land owned by the Taxpayer and Austral Bronze, there were erected factory premises occupied by the Taxpayer. Various items of heavy plant and equipment were contained within the factory premises. Specifically, there were manufacturing lines used by the Taxpayer in its manufacturing operations (“the Plant and Equipment”), which might be shortly described as follows:
·    No. 3 Tube Shell Extrusion Line;
·    Marshall Richards 84 inch diameter Horizontal Bull Block;
·    Marshall Richards Motorised Vertical Continuous Pay Off Block;
·    Wean Vaughn Rotubloc Motorised Continuous Pay Off Block;
·    Continuous Rod Manufacturing Line (sometimes referred to as Kembla Continuous Rod, or “KCR” Line);
·    Two Vaughn High Speed Tandem Wire Drawing Plants;
·    Properzi Aluminium Rod and Wire Continuous Manufacturing Line.
Each of the above lines itself comprised several discrete and separate components, although each component within a line was linked in a way that I shall describe below. Most of the components within each line were securely fixed to the floor of the factory premises in which they were situated. I shall describe below the manner of fixing.
In April 1988, the Taxpayer entered into arrangements with the State Bank of New South Wales (“the Bank”) whereby the Taxpayer purported to sell the Plant and Equipment to the Bank and the Bank purported to lease the Plant and Equipment back to the Taxpayer, in consideration of the payment by the Taxpayer to the Bank of regular half-yearly amounts of Rent. The Taxpayer’s income tax returns were compiled using a substituted accounting period ending 31 December in the year preceding 30 June of the relevant tax year. In respect of the years of income ended 31 December 1988 to 31 December 1995 inclusive (in lieu of 30 June 1989 to 30 June 1996), the Taxpayer claimed the amount of the regular payments of Rent made in these years under section 51(1) of the Income Tax Assessment Act 1936 (“the Act”) as an allowable deduction against its assessable income for those years of income.
The respondent, the Commissioner of Taxation (“the Commissioner”), issued amended assessments disallowing the payments as deductions on several alternative bases. The Commissioner also concluded that, insofar as the payments constituted allowable deductions, the Taxpayer had obtained, or would but for the operation of section 177F of the Act, obtain, a tax benefit in connection with a scheme to which Part IVA of the Act applies. Accordingly, the Commissioner determined under section 177F of the Act that the payments were not allowable as deductions.
The Taxpayer objected against the amended assessments in respect of each year and contended that the assessments should be reduced by the allowance of the deductions claimed. The Commissioner made appealable objection decisions by disallowing the objections. The Taxpayer has now appealed to the Court pursuant to section 175A of the Act and section 14ZZ of the Taxation Administration Act 1953 against those appealable objection decisions and asks for each decision to be set aside.
There are presently eleven separate proceedings before me. There are two proceedings in respect of each of the years ended 30 June 1989, 30 June 1993 and 30 June 1994. The others relate to the years ended 30 June 1990, 1991, 1992, 1995 and 1996. The question of deductibility of the regular payments is raised in respect of each of the years ended 30 June 1989 to 30 June 1996 inclusive. In relation to the other three years, the deductibility of other expenses is also raised. The outcome of the appeals in relation to the other expenses will be determined by the outcome of the appeals in relation to the deductibility of the regular payments of Rent. Precisely the same issues as to deductibility of those payments arise in relation to each of the years in question.
THE SALE AND LEASEBACK ARRANGEMENTS
The arrangements between the Taxpayer and the Bank (“the Arrangements”) were evidenced by several documents (“the Instruments”), being:
·    Credit Purchase Agreement, dated 19 April 1988, between the Taxpayer as “Vendor” and the Bank as “Purchaser”,
·    Invoice, bearing the date 12 April 1988, addressed by the Taxpayer to the Bank,
·    Lease, dated 19 April 1988, between the Bank as “Lessor” and the Taxpayer as “Lessee”,
·    Landlords’ Waiver, dated 19 April 1988, between Austral Bronze and the Taxpayer as “Landlord”, the Taxpayer as “Lessee”, Permanent Registry Limited (“Permanent”) as “Mortgagee” and the Bank as “Bank”.
I shall describe each of them.
The Credit Purchase Agreement
The recitals to the Credit Purchase Agreement were as follows:
“A.     The Vendor has acquired the items of equipment (the ‘Goods’) more particularly described in Column 1 of Schedule 2 (each of which items is referred to as a ‘scheduled item’).
B.        The Purchaser has agreed to purchase the Goods from the Vendor, and the Vendor has agreed to sell the Goods to the Purchaser on the terms and conditions hereinafter referred to.
C.       The Purchaser has agreed to lease back the Goods to the Vendor and to this end after such purchase will enter into a Lease to be made between the Purchaser as Lessor and the Vendor as Lessee (the ‘Lease’).”
Recital “A” describes the subject matter of the Credit Purchase Agreement by reference to Schedule 2, which is in the following form:
“  SCHEDULE 2
Column 1  Column 2
Description of Goods       Location of all Goods         Cost of Goods
$
SEE ANNEXURE A          PORT KEMBLA                  SEE ANNEXURE A”
  NEW SOUTH WALES
Schedule 2 refers to “Annexure A”. The annexure to the Credit Purchase Agreement was an extract from a valuation dated 17 March 1988 conducted by Mason Gray Strange Valuations VIC Ltd (“the Mason Gray Strange Valuation”), to which I shall refer below. The annexure consisted of that part of the Mason Gray Strange Valuation that comprised a detailed inventory of the Plant and Equipment.
The operative provision of the Credit Purchase Agreement was Part 2, which relevantly provided as follows:
“2.1. On a date to be agreed upon in writing (the ‘Delivery Date’), the Vendor as beneficial owner shall sell and the Purchaser shall purchase all the Vendor’s right, title and interest to each scheduled item… in the following manner:-
2.1.1.the Vendor shall deliver each scheduled item to the Purchaser by the delivery…prior to the Delivery Date to the Purchaser of:-
2.1.1.1.an invoice from the Vendor to the Purchaser (which invoice shall give full particulars of the scheduled item including its cost as well as stating the serial or other appropriate identification number for such item, where applicable);
2.1.1.2.a certificate by the Vendor to the Purchaser that the sale price of the Goods will be the value shown against each scheduled item in Column 2 of Schedule 2 and stating that the Vendor is the unencumbered owner of each scheduled item…
2.1.1.3.such other documents evidencing the Vendor’s title to the Goods held by the Vendor;
2.1.2.as from the Delivery Date the Vendor acknowledges that the Vendor holds the Goods as bailee for the Purchaser;
2.1.3.property in each scheduled item shall thereupon pass to the Purchaser upon and by virtue of delivery of such scheduled item being made in accordance with sub-clause 2.1.1 hereof and not by virtue of this Agreement; and
2.1.4.each certificate delivered to the Purchaser pursuant to sub-clause 2.1.1.2. shall constitute a warranty that at the date of delivery of the certificate, the facts stated therein are true and correct in all respects.
2.2. The Purchaser shall pay to the Vendor… the purchase price of the Goods (being the aggregate of the purchase prices specified in Column 2 of Schedule 2 corresponding to each scheduled item) by instalments as set out in Schedule 1.”
Schedule 1 to the Credit Purchase Agreement is in the following form:
“  SCHEDULE 1
Amount of Instalment                Payment Date
$48,000,000.00  the Delivery Date.
$ 1,000,000.00  the date being 6 months and 1 day from the date of this Agreement.
$ 1,000,000.00  the date being 6 months and 7 days from the date of this Agreement.”
The Credit Purchase Agreement also contained the following clause:
“4.3 The Vendor also warrants and represents to and agrees with the Purchaser as follows:-
………………………
4.3.6.the Vendor warrants that the Goods, notwithstanding its construction, manner of fixture to the land upon which the Goods are or shall be installed is and shall always be severable from the Premises and therefore will not either at law or equity form part of the Premises in the nature of a fixture and that title in and to the Goods and each and every part thereof shall at all times be and remain in the Purchaser;
4.3.7.the Vendor acknowledges that while it remains the registered proprietor or lessee of the land the subject of the Premises that the Goods may, until otherwise agreed in writing, remain on the Premises and while the Goods remain upon the Premises will place upon and maintain upon the Premises a plaque identifying the Goods and the rights of the Purchaser in and to the Goods…”
The Credit Purchase Agreement incorporates, by reference, definitions of words, phrases and expressions defined in the Lease. The expression “the Premises” does not appear to be defined either in the Credit Purchase Agreement or in the Lease. However, as will appear, the expression is defined in the Landlords’ Waiver.
The Invoice
Clause 2.1.1.1 of the Credit Purchase Agreement required delivery of an invoice from the Taxpayer to the Bank. The Taxpayer issued an invoice to the Bank. The invoice bears the date “12 April 1988”. A word processing code suggests that the document was brought into existence on 31 March 1988. That was the only invoice delivered in relation to the Arrangements. It is clear that the document was prepared in advance of completion of the Arrangements. While the discrepancy in the date is curious, I do not consider that there is any reason for concluding that the Invoice was not delivered by the Taxpayer to the Bank at completion of the Arrangements.
The Lease
The pivotal provision of the Lease is clause 2.1 as follows:
“2.1. The Lessor hereby leases to the Lessee and the Lessee hereby takes on lease the Goods at the Rent and for the Term and subject to the covenants and conditions contained in this Lease.”
The following expressions are defined in the Lease:
“Goods:the property and each item thereof described in Item 3 of the Schedule together with anything added or attached thereto and replacement parts which are required by law or which are required to make an item complete and functional…
Rent:the rent as set out in Item 5 of the Schedule.”
Item 3 of the Schedule is in the following terms:
“GOODS:-
see Annexure B
LOCATION OF GOODS:-
Port Kembla, New South Wales”
Annexure B to the Lease is also a copy of the inventory contained in the Mason Gray Strange Valuation.
Other relevant provisions of the Lease are in the following terms:
“3.1.    In consideration of the granting of the Lease the Lessee hereby covenants and agrees to pay to the Lessor the Rent by way of rent for the Term at the times and by way of rental instalments as specified…
………………………
4.2.     The Lessor has acquired or will acquire (as the case may be) the Goods for the sole purpose of leasing and nothing herein contained shall confer on the Lessee and the Lessee warrants that the Lessee has not and will not have (apart from these presents) any right or property or interest in the Goods other than as bailee only.
………………………
4.9.     The Lessee acknowledges that:-
4.9.1.the Goods shall at all times be and remain personal property;
………………………
5.1.The Lessee represents, warrants and confirms to the Lessor that:-
………………………
5.1.4.it will not have or acquire any property or interest whatsoever in the Goods and the Lessee will indemnify the Lessor against any loss it may suffer by reason of it transpiring that the Lessor has had any such property or interest.
………………………
10.1.    The Lessor and Lessee hereby agree and declare that occurrence of any one or more of the following events (hereinafter referred to as a ‘Repudiation Event’) shall be deemed to be a breach of an essential and/or fundamental term by the Lessee and shall constitute a repudiation by the Lessee of this Lease thereby entitling the Lessor (at its option) to sue for damages and or repossess the Goods in Accordance with this Lease.
………………………
10.3.    Upon the occurrence of a Repudiation Event the Lessor and Lessee hereby agree that, in addition to any other right or remedy herein provided or available at law, the Lessor may at any time (unless in the meantime the full amount payable under this Lease hereof has been paid) retake possession of the Goods after giving three (3) Business Days’ notice to the Lessee.
………………………
11.1.    If, upon the Goods being received into the Lessor’s possession consequent upon the expiration of the Term or any extension of this Lease, the Goods shall be disposed of by the Lessor at public auction or by private treaty to or through traders dealing in goods of a similar description for the best price the Lessor can reasonably obtain at the time and if the proceeds of such disposal… are less than the residual value stated in Item 6 of the Schedule, the Lessee covenants to pay to the Lessor upon demand the amount of such deficiency by way of indemnity for the capital loss so sustained…
………………………
12.1.    Subject to the conditions hereinafter mentioned the Lessee shall be entitled to renew this Lease…for two (2) further terms of five (5) years each, the first to commence upon the Expiry Date provided that the term of any renewed lease shall not extend beyond the effective life of the Goods (as reasonably determined by an independent expert agreed upon by the parties and failing agreement nominated by the Lessor in good faith)…
………………………
13.5.    No option to purchase the Goods is hereby conferred or implied on the Lessee and there is no option or agreement whether express or implied in the Lessee’s favour for the sale of the Goods to him on expiry of the Lease or at any other time.
………………………
13.15. That all the terms and conditions in relation to and incidental to this Lease are contained herein and that this Lease supersedes and rescinds any other agreement term condition or representation made on the part of the Lessor relating to this Lease and/or the purchase of the Goods unless such agreement term condition or representation is expressly incorporated herein.

The schedule to the Lease specifies that the Term is five years from 30 March 1988, the latter date being defined as the “Commencement Date”. Item 5 in the Schedule specifies that the Rent is to be half-yearly instalments of $5,265,784.65 payable in advance. In addition, the Taxpayer was to make an initial payment of stamp duty of $10,000. Item 6 specifies that the residual value of the Goods at the end of the Term was $18,750,000.
The Landlords’ Waiver
The Landlords’ Waiver defines the term “Premises” in terms of title references. They are references to land owned by the Taxpayer and Austral Bronze on which the Goods were situated as at 19 April 1988. The Landlords’ Waiver relevantly provides as follows:
“2.In consideration of the Lessor agreeing to lease to the Lessee the Goods (herein referred to as the ‘Lease’) which are installed or are to be installed in the Premises which are or are to be occupied pursuant to an agreement between the Landlord and the Lessee (hereinafter called the ‘Occupancy’), the Landlord and the Mortgagee hereby agrees with the Lessor:-
2.1. to the Occupancy;
2.2.that the Landlord and the Mortgagee has no right, title or interest to or in the Goods nor shall the Landlord and the Mortgagee acquire any right, title or interest to or in the Goods by virtue of the Occupancy;
2.3.that notwithstanding that the Goods may be wholly or partly fixed or annexed to the Premises no part of the Goods shall be treated as a fixture;
2.4.after the occurrence of a Repudiation Event (as that expression is defined in the Lease) under the Lease, the Lessor its agents, employees and servants shall have full right and licence to enter the Premises, for the purpose of repossessing the Goods and removing them from the Premises at any reasonable hour during the term of such Occupancy…
2.5.that the Goods are and shall at all times remain the property of the Lessor…
2.6.as between the Landlord, the Mortgagee and the Lessor, the exercise of the right and licence to enter the Premises… shall be conclusive evidence of default by the Lessee under the Lease…”
Completion and Amendments
The first instalment of the purchase price payable as a result of the Arrangements, being the sum of $48,000,000, was received by the Taxpayer on 19 April 1988. That sum of money was applied by the Taxpayer as to $27,000,000 in repaying short term loans. $5,265,784.65 was applied in payment of the first of the regular payments under the Lease. $5,000,000 was invested in the short term money market. The balance was applied in paying dividends that were then payable by the Taxpayer.
On 19 April 1993, a further agreement (“the First Amendment”) was entered into between the Bank and the Taxpayer, which recited the option to renew contained in Part 12 of the Lease. The First Amendment purported to amend the Lease by deleting the schedule and inserting a new schedule. Items 4, 5 and 6 were relevantly different. The Term of the Lease was changed to 10 years ending 18 April 1998. Curiously, the Commencement Date was stated to be 19 April 1993 and the Termination Date 18 April 1998. In lieu of a reference to half-yearly instalments of $5,265,784.65, the new schedule required payments of $1,667,990.17 on 19 April and 19 October in each of the years 1993, 1994, 1995, 1996 and 1997. The residual value was stated to be $7,031,250.
Another agreement (“the Second Amendment”) was entered into on 20 April 1998. The Second Amendment recited the Lease and the First Amendment. It also purported to amend the Lease with effect from 20 April 1998. The Term of the Lease was amended to 5 years commencing on 20 April 1998 and terminating on 19 April 2003. A new schedule of instalments was inserted. It required payments on 20 April and 20 October in each of the years 1998, 1999, 2000, 2001 and 2002. The payments varied slightly from instalment to instalment. The instalment on 20 April 1998 was $599,117.79 and the instalment payable on 20 October 2002 was $597,267.11. The new residual value was $2,636,718.75.
STATUTORY FRAMEWORK
In its income tax returns for the relevant years, the Taxpayer claimed as a deduction from its assessable income the whole of the regular payments made under the Lease and the First Amendment. That claim was made under section 51(1) of the Act. Section 51(1) is in the following terms:
“All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.”
In the assessments which are the subject of the appeals to this Court, the Commissioner, in addition to disallowing the payments as allowable deductions under section 51(1), relied on determinations made under Part IVA of the Act. Part IVA is concerned with “schemes to reduce income tax”. The relevant provisions of Part IVA are in the following terms:
“177A(1)       In this Part, unless the contrary intention appears:
‘scheme’ means:
(a)any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
(b)any scheme, plan, proposal, action, course of action or course of conduct.
………………………
177A(5)          A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.
177C(1)          …a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to –
(a)      …
(b)a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;
and, for the purposes of this Part, the amount of the tax benefit shall be taken to be –
(d)in the case to which paragraph (b) applies – the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph.
………………………
177DThis Part applies to any scheme… where -
(a)a taxpayer (in this section referred to as the ‘relevant taxpayer’) has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and
(b)having regard to –
(i)the manner in which the scheme was entered into or carried out;
(ii)the form and substance of the scheme;
(iii)the time at which the scheme was entered into and the length of the period during which the scheme was carried out;
(iv)the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;
(v)any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;
(vi)any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;
(vii)any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out, and
(viii)the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi),
it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme…
177F(1)          Where a tax benefit has been obtained, or would but for this section be obtained, by a taxpayer in connection with a scheme to which this Part applies, the Commissioner may –
(a)…
(b)in the case of a tax benefit that is referable to a deduction or a part of a deduction being allowable to the taxpayer in relation to a year of income – determine that the whole or a part of the deduction or of the part of the deduction, as the case may be, shall not be allowable to the taxpayer in relation to that year of income;
and, where the Commissioner makes such a determination, he shall take such action as he considers necessary to give effect to that determination.
………………………
177F(3)          Where the Commissioner has made a determination under subsection (1) in respect of a taxpayer in relation to a scheme to which this Part applies, the Commissioner may, in relation to any taxpayer (in this subsection referred to as ‘the relevant taxpayer’) –
(a)      …
(b)      if, in the opinion of the Commissioner –
(i)an amount would have been allowed or would be allowable to the relevant taxpayer as a deduction in relation to a year of income if the scheme had not been entered into or carried out, being an amount that was not allowed or would not, but for this subsection, be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income; and
(ii)it is fair and reasonable that the amount or a part of that amount should be allowable as a deduction to the relevant taxpayer in relation to that year of income,
determine that that amount or that part, as the case may be, should have been allowed or shall be allowable, as the case may be, as a deduction to the relevant taxpayer in relation to that year of income;
and the Commissioner shall take such action as he considers necessary to give effect to any such determination.
………………………”
THE COMMISSIONER’S CONTENTIONS
The Commissioner’s first contention is that, because the Plant and Equipment consisted of fixtures, the Credit Purchase Agreement was ineffective to vest any title in the Bank. Therefore, the Lease was ineffective to confer any right in respect of the Plant and Equipment on the Taxpayer. Accordingly, the payments in question made by the Taxpayer to the Bank cannot be characterised as payments made under a lease for the purpose of securing the right to use property owned by the Bank as lessor.
Rather, having regard to a series of factors identified by the Commissioner, the payments should be characterised as the making of a loan by the Bank to the Taxpayer of $50,000,000 and the repayment of that loan together with interest by regular instalments during the period of 5 years and by a balloon payment at the termination of that period. The regular payments were said to comprise partly repayment of principal and partly payment of interest. Therefore, the payments were said to be deductible only to the extent that they represented interest.
Alternatively, irrespective of whether the Plant and Equipment were fixtures or chattels, if the Lease is to be treated as securing to the Taxpayer the right to continue to use the Plant and Equipment free of any contractual entitlement on the part of the Bank to interfere with that use, a collateral advantage secured to the Taxpayer was the right, upon payment of the amount of the residual value, to unfettered dominion, possession and control and ownership of the Plant and Equipment after the expiration of the Term of the Lease or any renewal thereof.
As a practical matter, it was expected that, upon payment of the residual value, the Bank would no longer assert any rights in relation to the Plant and Equipment. Thus, the Arrangements secured for the Taxpayer the right to regain unfettered dominion, possession, control and ownership upon payment of the residual value. The residual value was substantially less than the value that the Plant and Equipment would have at the expiration of the Term of the Lease. Thus, by payment of the residual value, the Taxpayer would reacquire the rights that it had conferred on the Bank by the Credit Purchase Agreement, or would secure the extinguishment of those rights. To the extent that the periodical payments under the Lease were consideration for the opportunity to acquire or to extinguish the Bank’s rights, they were of a capital nature. Accordingly, they were not deductible under section 51(1) of the Act. If that analysis is correct, the result is the same, in the sense that the periodical payments were deductible only to the extent of the interest element.
The Commissioner also maintains that there was a scheme to obtain a tax benefit in the form of a deduction for the regular payments to be made by the Taxpayer under the Lease. If the Commissioner’s determination under Part IVA stands, no part of the payments would be deductible. It may be that the Commissioner, in the exercise of his discretion, would make certain allowances. For example, it may be appropriate for the Commissioner to make an allowance against assessable income of the notional amounts of interest paid by the Taxpayer in the years in question. However, that is not a question which arises at this stage in these proceedings, because the Commissioner has not yet exercised his discretion in that regard under section 177F(3).
It may also be appropriate, if the Commissioner’s determination under Part IVA were upheld, to defer the consideration of penalties until after the exercise of that discretion by the Commissioner. The question of penalties has already been deferred until after decision of the question of whether the payments in question are deductible. It may be appropriate that the question of penalty, if it ensues, should be deferred not only until a decision has been made in these proceedings but until, if necessary, the Commissioner has exercised his discretion under section 177F(3) in relation to any such allowance.
BACKGROUND TO THE ARRANGEMENTS
As at 31 December 1987, the board of directors of the Taxpayer included the following individuals:
·    Mr Friedrich Heinrichs, Managing Director;
·    Mr Benjamin Revett Cant, Non-Executive Director;
·    Mr Glen Bruce Dudley, Executive Director;
·    Mr John Allan Allen, Executive Director – Finance;
The other directors were as follows:
·    Sir David Ziedler, Chairman;
·    Mr R.A. Biggam, Deputy Chairman;
·    Mr G. Billard, Non-Executive Director;
·    Mr J.J. Craig, Non-Executive Director;
·    Mr L.A. Farran, Non-Executive Director;
·    Sir Eric Neal, Non-Executive Director;
·    Mr H.W. Revell, Non-Executive Director; and
·    Mr D.C. Vernon, Non-Executive Director.
Mr Peter Matthew Ryan was the Corporate Secretary of the Taxpayer.
In March 1987, Mr J.B. Anderson was the Corporate Taxation Manager of the Taxpayer. On 5 March 1987, Mr Anderson sent to Mr Allen a memorandum in which he reported a meeting that Mr Anderson had had with Macquarie Bank Limited (“Macquarie Bank”) for the purpose of “discussing suitable ways in which the Group might improve its taxation position”. The memorandum contained the following:
“One tax effective fund-raising proposal suggested was for MM to dispose of the whole or part of its plant and equipment and lease it back under a finance lease.
The benefits of the transaction are that it:
(i)reduces after-tax financing costs;
(ii)increases reported profits;
(iii)improves cash flows;
(iv)improves the balance sheet.
The MB proposal is applicable where a company holds depreciable assets and their current market value is substantially greater than their historical cost. Market value would be determined by an independent valuer.”
Under the heading “Profit and Loss” the following appeared:
“The profit and loss is also enhanced because the company obtains a tax deduction for the whole of the lease payment including that part which is effectively a repayment of principal, i.e. (a contribution to the repurchase of the plant and equipment).”
The memorandum also contained a comparison of the effect on profit and loss of a straight borrowing and a sale and leaseback transaction over a six year period. A summary of the advantage of a lease transaction over borrowing indicated that there was an advantage for the lease transaction to the extent of 3.5% in the effective pre-tax borrowing rate in respect of a transaction that generated $10,000,000 in cash.
On 24 July 1987, Mr Anderson wrote to Macquarie Bank referring to “your innovative proposal to raise funds”, under the heading “Sale and Lease-back of Plant”. Mr Anderson forwarded under cover of his letter an appendix setting out those items of plant which he believed “fit the criteria for your proposal”. Mr Anderson asked for calculations that would show the annual effective after tax cost of the funds. The plant described in the appendix was as follows:
·    KCR plant;
·    high-speed tandem wire drawing machines;
·    Properzi alum rod plant;
·    No. 3 tube shell extruder;
·    Shumag tube line.
The last was never part of the Arrangements.
On 9 September 1987, Mr Anderson sent a further memorandum to Mr Allen concerning “sale and leaseback of plant”, in which he referred to his earlier memorandum of 5 March 1987. The memorandum relevantly said as follows:
“As requested I have now obtained details of the plant items at Port Kembla which would be suitable for sale and leaseback under Macquarie Bank’s proposal.
Subsequent to the proposal by Macquarie Bank the State Bank of NSW and Capel Court approached me about quoting on the transaction. The data supplied by Port Kembla was consequently forwarded to each of the three banks requesting a submission on the effect of the transaction in comparison with conventional borrowing…
Capel Court’s proposal suggested that we adopt a residual value of 10% of the value of the plant leased which is clearly outside the Tax Commissioner’s guidelines. Capel Court’s attitude was that we could get away with 10% residual but they are unable to offer any legal opinion nor did they think it was necessary to obtain one.
The State Bank provided a very comprehensive submission using a 37.5% residual value demonstrating that, assuming that the sale of the plant yielded $55 million with a $5 million up front fee to the State Bank, the company would save $7.8 million over five years compared to a conventional loan of $50 million. This represents an after tax interest rate of 5.68% per annum for the lease compared with 8.38% per annum after tax for a conventional loan.
………………………
Given the significant savings in cost of borrowing there is clearly an arbitrage available to the company by merely investing funds raised in the money market.
……………………
There is a great deal of work to be done before a formal proposal could be submitted to BICC and MM Board. I strongly recommend that we investigate this proposal fully. Perhaps we should discuss how it should be progressed.”
On 30 September 1987, Mr Allen wrote to Macquarie Bank saying, relevantly, the following:
“I refer to your letter of 21 August 1987 to John Anderson regarding our intention to pursue the implementation of sale and leaseback of certain plant owned by this company.
I am pleased to grant Macquarie Bank Limited a mandate to commence to implement this proposal subject to approval by this company’s Board of Directors.
It is understood that the bank’s fee on satisfactory completion of the sale and leaseback would be a flat fee of 0.5% of the sale price of the plant plus an additional fee based on the bank’s ability to effect additional savings measured against a minimum saving yet to be agreed. It is understood that the additional fee would be one quarter of the savings over this yardstick.
………………………
I understand that you intend to seek tenders from parties who you believe will be interested in purchasing the company’s plant and leasing it back. However, until a formal valuation of the plant has been carried out and the company has decided on the amount of the funds it wishes to raise, you will be unable to seek formal tenders. It is therefore suggested that you approach interested parties, including the State Bank of NSW, with whom we have had some discussion, to obtain indicative quotes using a principal sum of $50 million.”

In 1987, Mr R.H. Hocking was a licensed estate agent and licensed auctioneer and valuer with C.J. Ham & Murray Pty Ltd of Melbourne. In early November 1987, Mr Hocking received a letter dated 3 November 1987 from Macquarie Bank, foreshadowing a valuation of plant and equipment on a going concern basis. The letter indicated that the Plant and Equipment would be subject to a sale and leaseback financing arrangement. The letter indicated that the vendor of the Plant and Equipment considered its market value was approximately $50,000,000.
A schedule of the Plant and Equipment in question was attached to the letter from Macquarie Bank. The schedule listed the items shown in the schedule attached to Mr Anderson’s letter to Macquarie Bank of July 1987. The schedule indicated that the total original cost of the items was $11,000,000 and that their replacement value was $66,200,000. Mr Hocking was subsequently told by Mr Stephen Cook of Macquarie Bank that approval for carrying out the proposed valuation had been deferred to the next meeting of the Taxpayer’s Board in February 1988.
At the meeting of the directors of the Taxpayer held on 23 November 1987, consideration was given to a memorandum submitted to the Board by Mr Allen. The memorandum was headed “SALE AND LEASEBACK FINANCING PROPOSAL” and was in the following terms:
“The underlying value of many items of plant at Port Kembla provide MM with an opportunity to raise a significant amount of funds at very low cost. This opportunity has been considered and discussed with a number of independent financial institutions.
Macquarie Bank Limited has now submitted a financing proposal (executive summary attached) which would have the following effects on the group:
1.        Increased reported profit after tax
2.        Improved balance sheet
3.        Lower after-tax finance costs
4.        Reduced income tax payable and improved cash flow
5.        Reduced effective rate of tax on pre-tax profits
The transaction involves the sale and leaseback of major items of plant located at Port Kembla, the market value attributable to each item of plant to be determined by independent valuers. An informal valuation estimates the nominated plant to be worth about $50 million. Formal valuations will be obtained if this proposal is approved.
The lessor has agreed to purchase each item of plant for its market value and to leaseback the plant to MM.   The optimum term of the lease is five years. For taxation reasons the residual value would be fixed at 40% of the principal sum. As is customary with all finance leases, there can be no option for the lessee to acquire the plant at the termination of the lease. Such an option would result in the lease being treated as a hire purchase agreement for taxation purposes and negate the purpose.
THUS MM’S SECURITY FOR RETAINING THE PLANT ON TERMINATION OF THE LEASE IS DEPENDENT UPON THE BUSINESS REPUTATION OF THE LESSOR AND THE RESTRICTED SALEABILITY OF THE RATHER SPECIAL PURPOSE PLANT.
The sale of the nominated plant is expected to generate cash of about $50 million, the exact amount being dependent upon the independent valuations. The sale would give a rise [sic] to profit on sale of $48 million.
Accounting Standard AAS17 on leases requires that profit on sale of assets which are leased-back under a finance lease be amortised in the profit and loss account over the period of the lease. The unamortised profit on sale is included with shareholders funds. The plant leased-back must be capitalised and the lease liability recorded as debt.
The inclusion of the unamortised profit on sale with shareholders funds means equity increases by $48 million while debt increases by $50 million being the lease liability. With a conventional borrowing of $50 million, debt would increase by that amount with no increase in equity. The effect on net gearing of this proposal is therefore an increase from 2.6% to 15.7% compared with 18.0% for a conventional borrowing.
Capitalisation of the leased plant requires a charge to be made to the profit and loss for both notional interest payable under the lease and amortisation of the leased plant. These higher costs are offset by the amortisation of the deferred income. The net effect on operating profit before tax under this proposal is a cost of $24.5 million compared with $24 million for a conventional borrowing. As the amortised deferred income is substantially not subject to income tax, the income tax benefit is significantly higher than with a conventional borrowing.
Consequently, the net effect on operating profit after tax under this proposal is a benefit of $5 million compared with a cost of $13 million for a conventional borrowing.
It is important that the consideration paid by the Bank for the plant is an arm’s length price; the independent valuation will establish the market value of the plant. Further the lease must contain a realistic residual value; 40% of the principal is conservative and well within the Tax Commissioner’s published guidelines.
The tax deduction available for the whole of the lease payments amounting to approximately $10 million p.a. will reduce the tax payable by MM by approximately $5 million each year. The reduction in tax payable will reduce MM’s franking account by 51/49ths of that amount. The reduction in tax payable compared with a conventional borrowing is only 2.5 million. On current estimates MM would still be able to fully frank its dividends provided dividends from ASC and CMA are maximised. It should be borne in mind that investment of the funds raised will generate income upon which tax will be payable which will in turn increase MM’s franking account.
This proposal does not take account of income generated by the funds raised.
Greenwoods & Freehills have advised that payments under the lease will be fully deductible against the income of MM. Advice has also been received that the consideration paid for the plant on termination of the lease, i.e. the residual value, will be depreciable for taxation purposes.
They [sic] are a number of companies which have entered into sale and leaseback of assets and adopted the same accounting treatment proposed by MM. These companies include Linter Group Ltd, Pioneer Concrete Services Ltd and Monier Ltd.
The fees payable to Macquarie Bank Limited for arranging the finance are a flat fee of $250,000 plus an incentive fee based on savings made by the lessor over savings contained in a proposal submitted directly by the lessor. This maximum fee payable to Macquarie Bank is limited to a total of 1% of funds raised.
The proposal provides a most effective method of raising funds at a cost significantly less than other methods currently available and is submitted for the Board’s consideration.
IT IS IMPORTANT, HOWEVER THAT DIRECTORS NOTE MM’S SECURITY FOR RETAINING THE PLANT ON TERMINATION OF THE LEASE IS DEPENDENT UPON THE BUSINESS REPUTATION OF THE LESSOR AND THE RESTRICTED SALEABILITY OF THE RATHER SPECIAL PURPOSE PLANT.”
Some attention was focussed on the two paragraphs in upper case contained in the memorandum. In particular, attention was addressed to the proposition that the Taxpayer’s “security for retaining the plant on termination” was dependent on the “business reputation” of the Lessor and the restricted saleability of the plant.
Annexed to the memorandum was a schedule that was in the following form:
“
EXECUTIVE SUMMARY

Principal:

$50 million

Lessor: State Bank of New South Wales or Citibank

Arranger:
Macquarie Bank Limited

PROPOSAL
CONVENTIONAL

BORROWING

After tax effective
  interest rate:

2%

8%

Increase on gearing:

13.1%

15.4%

Increase in net tangible
assets

$48.0 m

0 *

Reduction in operating

profit before tax:

$24.5 m

$24.0 m

Reduction/(Increase) in

operating profit after tax:

($5.0 m)

$13.0 m

Reduction in dividend

franking account:

$5.0 m

$2.5 m

Savings after tax over
conventional borrowing
over term discounted at
   10% p.a.:
$10.0 m

-

*    An increase in net tangible assets could be achieved by revaluing the relevant plant. The revaluation increment would never be reflected in profits.”

The minutes of the meeting of the directors of the Taxpayer held on 23 November 1987 record that, after discussing the proposal set out in Mr Allen’s memorandum, the Board resolved to defer a decision pending the receipt of further information. During the course of the meeting, two matters occupied discussion. The two matters were:
· concern that the Taxpayer could lose the use of the Plant and Equipment at the expiration of the lease term in 5 years’ time;
· the desire of those at the meeting to obtain information about whether other companies were entering into such arrangements.
On 22 December 1987, Macquarie Bank sent two letters to Mr Anderson. In the first letter, there were set out the names of several major companies which, as a matter of public knowledge, have entered into transactions for the lease of major items of property. The property was briefly described. The letter went on to say as follows:
“In each situation questions would have arisen as to the ability of the lessee company to acquire ownership of the property upon termination of the leasing arrangements. In each case, it must be concluded that the lessee was satisfied with the arrangement. In many instances the plant in question has been critical to the company’s operation.”
The other letter contained comments on the probable terms of a lease as follows:
“· The lease will include a stated residual value.
As you know, the stated residual value should represent a bona fide estimate of the fair market value of the plant at the time of expiration of the lease. The taxation office has indicated in rulings that residual values on relatively short term leases should not have an unreal or nominal value. The tax office rulings go so far as to indicate minimum residual values classified according to tax depreciation rates on a prime cost basis. The plant in question is subject to a prime cost depreciation rate for tax purposes of 10%. The proposed residual of 40% in five years time is higher than the minimum residual value as provided in tax office rulings and should therefore be acceptable to the taxation office.
·The lease will not contain a right or option on behalf of Metal Manufactures to purchase the equipment. Otherwise, the transaction will be treated as a hire purchase agreement for income tax purposes.
·Under the terms of the lease Metal Manufactures will be granted a right to renew the lease on termination of the original period. We would like to discuss the terms of this second lease (period and rental).
·The lease will provide for the equipment to be auctioned at the end of the period of the primary lease, unless Metal Manufactures exercises its option to renew the lease. Metal Manufactures will be appointed as exclusive selling agent of the equipment for the purpose of this auction.”
Macquarie Bank subsequently received a letter dated 11 January 1988 from the Bank confirming that approval had been given “to acquire certain nominated assets from [the Taxpayer] for $50 million and lease those assets back to [the Taxpayer]”. The letter set out a summary of the terms and conditions of the proposed “facility”. The relevant conditions were as follows:

“Amount:
$50 million.

Lessee:
Metal Manufactures Limited.

Term:
Five years.

Equipment:
To be agreed.

Lease Payments:
Semi-annually in advance (equal amounts).

Residual:
$20 million (40%).

Security:
To the Bank’s legal requirements and to include satisfactory sale and lease documentation incorporating various conditions precedent, representations, warranties and events of default common to this type of transaction.

Pricing:
Establishment fee:

0.4% ($200,000) of the Amount of the Facility.

Interest Rate:

To be the Bank’s cost of funds plus a margin of 0.65% p.a. (includes Counter Party Risk Margin for swap). An all-up fixed interest rate for the term of the lease will be quoted to the Lessee.

All legal fees, stamp duties and reasonable out-of-pocket expenses to be to the account of the Lessee.”

The letter enclosed draft documentation and went on to say:
“We assume that the equipment is capable of movement and will not be regarded as fixtures. Please advise the location of the relevant equipment and the owner of the land where the equipment is located.”
At a meeting of the directors of the Taxpayer held on 22 February 1988, the Board considered a further memorandum from Mr Allen entitled “Resubmission of Sale and Leaseback Financing Proposal”. The memorandum repeated material that had been contained in the memorandum considered by the Board at its meeting in November 1987. The memorandum also said:
“PROPOSAL
Directors will recall that the proposal involves the sale and five year leaseback of major items of plant located at Port Kembla, the market value attributable to each item to be determined by independent valuation. A preliminary valuation estimates the plant identified to be worth about $50 million.
The re-submitted lease agreement proposes that MM be granted a right to renew on termination of the original period on terms which are very satisfactory from MM’s point of view. If MM fails to exercise its option to renew, the plant would be auctioned. The agreement appoints MM as exclusive selling agent of the plant for the purpose of this auction. MM may if it wishes bid at this auction.
………………………
INCOME TAX
Greenwoods & Freehills have advised that payments under the lease will be fully deductible. Advice has also been received that the consideration paid for the plant on termination of the lease, i.e. the residual value, will be depreciable for taxation purposes. For taxation reasons the residual value is to be fixed at 40% of the principal sum. As is customary with all finance leases, there can be no option for the lessee to acquire the plant at the termination of the lease. Such an option would result in the lease being treated as a hire purchase agreement for taxation purposes and negate the purpose.
………………………
RECOMMENDATION
The proposal provides a most effective method of raising funds at a cost significantly less than other methods currently available and is recommended.”
Mr Allen’s second memorandum also contained an executive summary as follows:

“Principal:

$50 million

Lessor: State Bank of New South Wales

Arranger:
Macquarie Bank Limited

PROPOSAL
CONVENTIONAL

BORROWING

After tax effective
  interest rate
2% 8%

Decrease on gearing

8%

No change *

Increase in net tangible assets $48.0 m No change **

Reduction in operating profit

before tax over estimated

life of plant

$22.6 m

$22.2 m

Increase (decrease) in
operating profit after tax

over estimated life of plant

$12.0 m

($11.3 m)

Reduction in dividend franking

account per annum ***

$5.0 m

$2.5 m

Savings after tax over
conventional borrowing
over term discounted at
   10% p.a.
$10.0 m

-

*           Assumes new debt would substitute for existing debt.

**        An increase in net tangible assets could be achieved by revaluing the relevant plant, however the revaluation increment would never be reflected in profits.

***       The reduction in dividend franking account is not material. On current forecasts MM dividend will be capable of being franked for some time.”

The minutes of the meeting of Directors held on 22 February 1988 record the following:
“SALE AND LEASEBACK FINANCING PROPOSAL
The Board considered the Sale and Leaseback Financing Proposal set out in Appendix IV to the Agenda [Mr Allen’s memorandum]. Considerable discussion took place concerning the desirability of the proposal and its place in the company’s overall financial planning.
The Executive Director, Finance, commented that longer term financing strategies were, by necessity, part of the companys overall strategic planning which was currently being revised.
Following further discussion, the Board resolved to approve the proposal involving the sale and five year leaseback of certain major items of plant located at Port Kembla as detailed in the Appendix to the Agenda. Messrs F. Heinrichs, J.A. Allen and G.B. Dudley were authorised to complete all necessary documentation on behalf of the Board.”
On 23 February 1988, Mr Hocking received a further telephone call from Mr Cook who told him that the valuation of the Plant and Equipment was approved at the Board meeting the previous day and that it would need to be completed by mid March. Mr Cook said that the valuation was to be of the moveable components of plant on a going concern basis and was not to include footings.
Mr Hocking decided that, in order to complete the proposed valuation by the time specified, he needed some assistance. In consequence, he contacted Mr Noel Mason, the Managing Director of Mason Gray Strange and arranged that Mason Gray Strange would assist with the valuation. Mr Mason then met Mr Cook in Melbourne and also had some contact with an officer of the Taxpayer. Mr Mason was informed that the proposed valuation was required for financing reasons.
Mr Mason and Mr Hocking travelled to the Taxpayer’s factory premises at Port Kembla in early March 1988. The Taxpayer’s asset register and depreciation schedules, including an inventory of spares and tools, were made available for their inspection. Mr Mason and Mr Graham Roberts of Mason Gray Strange inspected the large items of plant. Mr Hocking and Mr Chris Mason, also of Mason Gray Strange, inspected the tools and spares held by the Taxpayer in connection with the relevant plant.
The plant initially examined was as follows:
·    Continuous Rod Manufacturing Line;
·    Two Vaughn High Speed Tandems;
·    Properzi Line;
·    Marshall Richards Horizontal Bull Block.
Mr Mason had been informed that the Taxpayer was looking for assets having a value of $50,000,000. Having inspected the plant just referred to, Mr Mason said more plant would be needed to reach that figure. The Taxpayer then nominated additional plant for inclusion in the valuation, which included the Tube Extrusion Line and two Pay Off Blocks.
After the site inspection, enquiries were made to ascertain the current selling price of the items of Plant and Equipment. That was necessary because, according to Mr Mason, a valuation on a “going concern” basis is arrived at by taking into consideration the depreciated replacement value of the items concerned. After such calculations were carried out, Messrs Hocking, Noel Mason, Christopher Mason and Graham Roberts met at the offices of Mason Gray Strange in Melbourne where they conducted a final review of the valuation. Once the terms and content of the valuation had been settled, it was agreed that the valuation would be issued by Mason Gray Strange.
Mr Mason did not consider that the valuation of $50,000,000 reflected realisable value. Rather, the value adopted was based on the cost of the installed equipment, being the discounted replacement cost, installation cost, spares and a separate figure for tooling. The evaluation approximated about two-thirds of the replacement cost, calculated as half of the replacement cost plus a component for spares. Most of the equipment involved was regarded by Mr Mason as “off the shelf” and was supplied from overseas. No separate valuation was made for each component of plant.
Mr Mason said that he was instructed not to include any excavation work, pits or drainage areas because those could be construed as fixtures and not plant. He said that where building stopped and plant started was a matter of discussion between the Taxpayer and Mason Gray Strange and was recorded in his report.

Mr Mason considered that the plant that he valued was between 15 and 30 years old. He considered that that type of plant could, basically, last indefinitely, except for parts that needed replacing. Its useful life would remain much the same unless there were radical changes in method. As at the time of the valuation, there had been additional items added including computerisation, multiple operation functions and more efficient gauging. The computer equipment and other items that had been added were included in the valuation.
Mr Hocking and Mr Mason both said that a going concern basis produced a considerably higher value than break up for removal basis. On that basis, Mr Mason said that the plant could be worth as low as $15,000,000, since much of the cost is in installation and fabrication costs.
During March 1988, Macquarie Bank received the Mason Gray Strange Valuation. The valuation was sent under cover of a letter dated 17 March 1988 from Mr Mason and was addressed to Mr Cook of Macquarie Bank. It was described as “VALUATION OF MOVABLE ALLOY TUBE, BAR AND WIRE MANUFACTURING PLANT AT METAL MANUFACTURES LIMITED, GLOUCESTER BOULEVARD, PORT KEMBLA, NSW”. After referring to inspection of the items, the covering letter said:
“The various lines inspected by us have been continuously maintained and upgraded in line with technology advances, and are therefore high production and efficient entities.”
After referring to spare parts and tooling, Mr Mason went on to say:
“Each line has therefore been valued by us as a complete operating entity as installed and operating on site and as inspected by us.
No allowance has been made for building installations, concrete floors, under floor excavations, overhead cranes, concrete support structures and pit-works.
Where services i.e. compressed air installations, transformers, electrical control and distribution boards, water cooling and reticulating equipment exist solely for the line being valued, those services have been listed in our inventory and form part of our valuation of each line.
Where services are common to the line being valued by us and to other areas of the plant, they have been excluded from our valuation, except for any support systems and feeder work pertaining specifically to the line being assessed.
Using the foregoing criteria, it is our opinion that the total value of the whole of the items as listed in detail in the enclosed inventory where and now installed and placed as an Active Going Concern is $50,755,000.”
There was then attached a detailed inventory describing each manufacturing line separately and assigning a separate value to each manufacturing line as follows:
·    No. 3 Tube Shell Extrusion Line: $11,860,000;
·    Marshall Richards 84 inch diameter horizontal bull block: $4,210,000;
·    Continuous Pay Off Block (No. 1): $2,055,000;
·    Continuous Pay Off Block (No. 2): $1,370,000;
·    Kembla Continuous Rod Line: $18,640,000;
·    Vaughn High Speed Tandems: $2,870,000;
·    Properzi Line: $9,750,000.
THE TAXPAYER’S SECURITY FOR RETAINING USE OF THE PLANT AND EQUIPMENT
It is clear that, in considering Mr Allen’s proposal, the directors of the Taxpayer were concerned that the effect of the proposed arrangements could be that the Taxpayer would cease to have the right to unfettered use of the Plant and Equipment upon the expiry of the term of the Lease. Their concern was assuaged by three factors:
·    other reputable organisations had entered into such arrangements without apparent detriment;
·    the nature of the Plant and Equipment is such that it is unlikely that any other party would be interested in buying it;
·    the business reputation of the Bank.
The latter appears to be acceptance that the Bank would “do the right thing” by the Taxpayer and would accept an offer made by the Taxpayer at the expiration of the Term of the Lease to buy the Plant and Equipment for the amount of the residual value. Whereas, in theory, the Bank would have been free to do what it liked with the Plant and Equipment at the expiration of the Term, the understanding that the directors had was that the Bank would accept such an offer if made on behalf of the Taxpayer. The directors obtained further comfort by the inclusion in the Lease of successive options that secured to the Taxpayer the right to exclusive use of the Plant and Equipment for a period of fifteen years, whatever happened.
The Taxpayer is a subsidiary of BICC Plc, an English company (“BICC”). On 25 March 1988, Mr Allen sent a memorandum to Mr P. Hooley, of BICC. The memorandum was in response to a facsimile communication not in evidence and was headed “Sale and Leaseback”. The first section appears to be a response to an enquiry concerning the effect of an Australian Accounting Standard. Mr Allen’s memorandum was relevantly in the following terms:
“AAS 17 (paragraphs 36 and 37) requires that assets subject to a finance lease be capitalised and the corresponding liability taken up. The leased asset must be amortised over its effective useful life by making an appropriate charge to operating profit and crediting a provision for amortisation. You will note that in accordance with paragraphs 39 and 40 MM has more than reasonable assurance that it regains ownership at the end of the lease.”
Mr Allen said that, when making that statement, he had in mind the reputation of the Lessor, to which he had referred in his November 1987 memorandum to the Board. He said that if the Lessor was not a reputable person, there would be a concern that the property could be sold to somebody else. He said that his main concern at that time was that it would be sold to the other tube maker in Australia “who are no great friends of us”. He said that the Taxpayer was relying on the Bank’s reputation as a government authority and that they would not be “underhanded… in the way that they disposed of the plant”.
When asked whether he had formed the view that the Taxpayer had more than a reasonable assurance that it would regain ownership at the end of the lease, Mr Allen’s response was that if the Taxpayer wanted to be in the tube business at the end of the five years, it would have been in their interest to buy back the Plant and Equipment. However, he said that at that stage, he did not know whether in fact the Taxpayer would want to be in the tube business at the end of five years.
Subsequently, Mr Allen received a facsimile transmission dated 13 April 1988 from Mr R.F. Morgan, the Finance Manager of BICC. After referring to a “quick note yesterday”, which is not in evidence, Mr Morgan went on to say:
“I think it will be helpful if I go into a little more detail about the renewal option, which to us is the most important single point. Incidentally, it is in this connection very important that the State Bank should not be able to assign the lease without your consent. If it could, an unfriendly successor might seek to exploit any difficulties over the renewal, to your disadvantage.
………………………
Our problem in this connection is that while we understand that it is established custom and practice to allow lessees to purchase back their plant, such customs and practice have an unfortunate habit of changing over the years. For instance, our own Revenue authorities have never had much sympathy with the leasing concept, because they feel, quite rightly, that it allows one company to enjoy the benefits of another’s taxable capacity. There have been a number of cases in recent years which have severely embarrassed a number of big players in the leasing industry.”
On 15 April 1988, Mr Allen responded to Mr Morgan’s two facsimiles. In responding to the facsimile of 12 April 1988, which is not in evidence, Mr Allen said:
“Clause 12 dealing with the renewal options was inserted at MM’s request. The Bank did not want this clause included. It is important to note that the Bank has effectively provided MM a borrowing facility which may be extended at MM’s option for a further 10 years at only 1% p.a. over the Bank’s cost of funds. Fifteen year borrowing on this basis is generally not available to corporations in Australia. In MM’s view the conditions imposed by the Bank are reasonable.
The fact remains that State Bank still prefer [sic] that MM purchase the plant at the end of the lease as they realise that the plant would be virtually unsaleable to another corporation given the cost and difficulty of removal from the site at Port Kembla.
A secondary period with peppercorn rent is unacceptable to the Commissioner of Taxation.”
In responding to the facsimile of 13 April 1988, Mr Allen said the following:
“MM has fought to the limit to achieve the many concessions in the documents, including notice periods, insurance and the 1% margin over cost of the funds for the removal [sic, scilicet renewal] options. In both MM’s view and that of its legal advisers, the provisions in case of default are not especially harsh. The State Bank has absolutely no security or covenants for this financing, the Bank is relying solely on the credit worthiness of MM.”
Mr Allen agreed in cross-examination that he believed that the Bank had no security in terms of the payment of the Rent but that he was not looking at the security over the Plant and Equipment itself which was expressly covered in the Lease.
When asked what he meant by referring to “the business reputation of the Lessor” in his memorandum of November 1987, Mr Allen said that he imagined that there would always have been a concern that, at the end of the Lease, the Plant and Equipment would become the property of the Lessor who was free to do with it “what he will”. He said that the Taxpayer would be looking at the Lessor’s reputation to conduct an auction or a sale in a reputable manner.
Mr Allen was asked, in cross-examination, whether, in fact, he was referring to the likelihood that the Lessor would act in accordance with the usual practice and allow the Plant and Equipment to be purchased by the Taxpayer at its residual value. Mr Allen’s response was that he “wouldn’t have thought 5 years down the track, frankly in that”. He said that business reputation would have meant that, had the Plant and Equipment been sold on the open market, it would have been a fair sale and not “an undercover sale to somebody who may be an MM competitor”.
Mr Allen was being invited to recall his state of mind at a time more than eleven years earlier. I consider that his attempts to recall his state of mind in that regard are not convincing. The passage about which he was being asked follows on a statement in his memorandum that there could be no option for the lessee to acquire the plant at the termination of the lease, since such an option would result in the lease being treated as a hire purchase agreement. The memorandum then went on to set out the passage in upper case set out in paragraph 41 above.
It is clear that, in doing so, Mr Allen was intending to provide to the directors some degree of comfort that, by entering into the Arrangements, with no option to repurchase the Plant and Equipment, the Taxpayer would have some security for retaining the Plant and Equipment at the expiration of the Term of the Lease. First, there was the business reputation of the Lessor. Implicit in that statement is that the Lessor would not act in a way which could be regarded as improper. In the context of the comment, that must mean that, if the Taxpayer wished to repurchase the Plant and Equipment, the Bank would permit it to do so. Such a construction of the November 1987 memorandum is corroborated by Mr Allen’s memorandum to Mr Hooley concerning the operation of AAS 17.
Added to the likelihood that the Bank would not act “improperly” was the pragmatic fact that there would only be a very restricted market for the Plant and Equipment. That is to say, the easiest course for the Bank to adopt would be to sell the Plant and Equipment to the Taxpayer for the residual value, on the assumption that the Bank had no interest in deriving a windfall profit from the transaction, by selling it for more than the residual value.
Mr Cant regarded it as important in 1987 and 1988 that the Taxpayer retain the continuing use of the Plant and Equipment after the five year Term of the Lease which was then being proposed. It did not occur to him that the Taxpayer might not need the Plant and Equipment at the end of the Term and he certainly considered that the Taxpayer needed to have continued use of the Plant and Equipment. He also considered that it was important that, as the Taxpayer was paying substantial lease payments to the Bank over a five year term, it would be able to reacquire the Plant and Equipment at a reasonable figure. He was satisfied that the Plant and Equipment was of a sufficiently special purpose nature that the probability was that there would be no great other demand for it and that therefore the Taxpayer would stand a very good chance of acquiring it at the end of the Lease. He thought that because of its restricted saleability, the Taxpayer would be the only company that would want to buy the Plant and Equipment at the end of the Term. Mr Cant thought it was likely that the Taxpayer would be the purchaser at the end of the Term. He said that the reference to the “business reputation” of the Lessor was understood by him as being that the Lessor “would be a man of integrity”.
Mr Dudley said that, when he considered the proposal at the November 1987 meeting of directors, he was concerned that the Taxpayer would have no security over the use of the assets at the end of five years. He was told that there was no guarantee over the ownership of an asset or the right to use the asset at the end of the five year period and that there could not be an option to purchase.
Further, Mr Dudley said that he did not regard it as inevitable that the Taxpayer would acquire the Plant and Equipment at the residual value at the end of the Term. He said that there were discussions about various types of new technology that might replace parts of the Plant and Equipment. He said that his view was that, if the Taxpayer decided to go down the path of “cast and rolled technology”, the Taxpayer would not have renewed the Lease, notwithstanding that he was aware that if there was any deficiency when the Plant and Equipment was sold elsewhere, the Taxpayer would have an obligation to make up that deficiency. Mr Dudley referred to the fact that a piece of equipment might be made redundant technically overnight.
Mr Ryan said that at the November meeting, there was discussion about whether or not the Taxpayer would be entitled to retain the use of the Plant and Equipment beyond the Term and that that was one of the major concerns. When asked about discussion concerning the reference in Mr Allen’s memorandum to there being no option for the Lessee to acquire at the end of the lease, Mr Ryan said:
“It all related to security, whether the company would be entitled to retain the use of the plant beyond the 5 year term of the lease. It was being proposed as a sale and leaseback and I think Mr Allen was simply making the point there that everything needed to be done to ensure that it could be properly regarded as a lease.”
However, Mr Ryan could not recall any specific discussion about the question of the Taxpayer’s security for retaining the Plant and Equipment on termination of the Lease.
The directors of the Taxpayer were clearly mindful of the proposition that the proposed arrangement with the Bank entailed that the Taxpayer would be divested of ownership of the Plant and Equipment. They were also mindful that there would be no legal guarantee that the Taxpayer would be entitled to reacquire the Plant and Equipment at the end of the Term of the Lease. Nevertheless, they were prepared to accept the risk that the proposal involved for Taxpayer. As a practical matter, the risk was regarded as minimal or theoretical.
THE TAXPAYER’S NEED FOR FINANCE
At a meeting of the directors of the Taxpayer held on 16 September 1986, the directors considered a paper prepared by Mr Cant. The paper was entitled “Towards a Strategy for Metal Manufactures Limited”. In the paper, Mr Cant set out what he referred to as “some financial parameters”. Mr Cant expressed the view that future acquisitions by the Taxpayer should be financed either from the issue of further equity capital or from borrowing facilities not required or likely to be required for the existing businesses. He raised the question of principle as to whether it is better to acquire new activities from additional equity capital rather than from loans or cash. While accepting that there was no absolute answer to that question, Mr Cant expressed the view that:
“as a general rule it is probably sound to maintain that it is on balance wiser to use at least a substantial proportion of new equity to make larger acquisitions.”
Another matter touched on by Mr Cant in his paper was the question of “debt-equity ratio”. The paper contained the following observation:
“The extent to which prospective lenders will be prepared to accept going concern valuations of fixed assets rather than market values will be an important consideration here. It should be noted that the increasing availability of leverage of borrowing facilities secured on the assets of the activity to be acquired does offer a more open ended borrowing potential which may in certain circumstances be more appropriate than committing the value of existing assets to borrowings to acquire new ones.”
It was that proposition which led to the question of principle referred to above.
At the Board meeting on 16 September 1986, it was agreed that a draft growth plan should be prepared for consideration by the Board which was to incorporate details of the recommended financial parameters referred to by Mr Cant. It is not clear whether the strategy suggested by Mr Cant was ever adopted by the Taxpayer. However, Mr Cant, in his evidence, relied on that background as supporting his approach to the proposals for the sale and leaseback of the Plant and Equipment when they came before the Board.
At a meeting of the directors of the Taxpayer held on 21 September 1987, there was discussion concerning possible acquisition of the interests of minority shareholders. The minutes record the following:
“The Managing Director added that MML was adversely affected by the existence of minorities in CMA and ASC which prevented a rationalisation of operations and the consequent achievement of considerable cost savings. He advised that whilst MM’s minority partner in ASC, STC Australia, had not previously been prepared to sell its interest to MM at other than an unacceptably high price, the position may now be changing and STC Australia’s new parent, Alcatel of France, may be willing to part with the holding at a more realistic price.”
The references to CMA and ASC are references to Cable Makers Australia Pty Ltd and Austral Standard Cables Pty Limited.
Mr Allen said that up until that time, while it had been a hope to acquire the minority interests, that report was the first suggestion that there was a real opportunity to do so. That may have some bearing on one of the issues which arises in the proceedings. The prospects of acquiring minority shareholdings in subsidiaries would require an expenditure of funds by the Taxpayer. The prospect of such expenditure could be a justification for raising funds by means of sale of plant and equipment and the lease back of such plant and equipment.
Mr Allen said in evidence that he regarded the Taxpayer’s situation at the end of 1987 as entirely unsatisfactory and not in accordance with prudent business practice. He considered that at that time, the Taxpayer had a need to raise longer term funds to correct balance sheet ratios. He said that the Taxpayer could not have pursued the acquisition policy that it pursued in 1987 and continue to borrow on a short term basis.

Be that as it may, however, it is common ground that there was no legal entitlement conferred on the Taxpayer to acquire the Plant and Equipment. I do not consider that the regular payments to be made under the Lease should be characterised as being attributable to the acquisition by the Taxpayer of the advantage of being able to repurchase the Plant and the Equipment at the expiration of the Term of the Lease for the amount of the residual value.
PART IVA
The question under Part IVA is whether, having regard to the matters referred to in section 177D(b), it would be concluded that the dominant purpose of any of the persons who entered into or carried out the relevant scheme was to ensure that the Taxpayer would be allowed a deduction in relation to a relevant year of income, where the whole or part of that deduction would not have been allowable, had the scheme not been entered into and carried out. It was common ground that, if the relevant dominant purpose was made out, the other requirements for the application of Part IVA were also satisfied in the present case.
The term “dominant” indicates a purpose that is the ruling, prevailing, or most influential purpose. If a taxpayer takes steps that maximise its after tax return, and does so in a manner indicating the presence of the “dominant” purpose to obtain a “tax benefit”, then the criteria that are to be met before the Commissioner might make determinations under section 177F would be satisfied. In other words, those criteria would be met if the dominant purpose was to achieve a result whereby there was deducted from assessable income an amount that might reasonably be expected not to have been deductible if the scheme was not entered into or carried out – Federal Commissioner of Taxation v Spotless Services Ltd (1996) 186 CLR 404 at 416. A person may enter into or carry out a scheme, within the meaning of Part IVA, for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit where the dominant purpose is consistent with the pursuit of commercial gain in the ordinary course of carrying on a business – Spotless Services Ltd at 415.
Thus a taxpayer may have a particular objective or requirement that is to be met or pursued by a particular transaction. The shape of such a transaction need not necessarily take one form. It is only to be expected that the adoption of one form over another may be influenced by revenue considerations. However, the fact that a particular course of action may bear the character of a rational commercial decision does not determine the answer to the question of whether a person entered into or carried out a scheme for the dominant purpose of enabling a taxpayer to obtain a tax benefit – Spotless Services Ltd at 416. Nor, in my opinion, does the fact that a taxpayer chooses one of two or more alternative courses of action, being the one that produces a tax benefit, determine the answer to that question.
Part IVA will be satisfied if it was the obtaining of the tax benefit that directed the relevant persons in taking steps they otherwise would not have taken by entering into the scheme – Spotless Services Ltd at 423. However, more is required than that a taxpayer has merely arranged its business or investments in a way that derives a tax benefit. The scheme must be examined in the light of the eight matters set out in section 177D(b). Further, that examination must give rise to the objective conclusion that some person entered into or carried out the scheme or part of the scheme for the sole or dominant purpose of enabling the Taxpayer to obtain a tax benefit in connection with the scheme. Such a conclusion will seldom, if ever, be drawn if no more appears than that a change of business or investment has produced a tax benefit for a taxpayer – Spotless Services Ltd at 425. Nor should such a conclusion be drawn if no more appears than that a taxpayer adopted one of two or more alternative courses of action, being the alternative that produces a tax benefit.
The Commissioner contended that the relevant scheme was constituted by the Arrangements, together with the steps described above that led to the Arrangements. The steps that led to the Arrangements consisted of the memorandum from Mr Anderson, the communications with Macquarie Bank, the communications with the valuers, Mr Allen’s memoranda to the directors of the Taxpayer and Mr Allen’s communications with BICC. While those steps may constitute a course of conduct, I do not consider that they can be properly regarded as part of a “scheme” within the meaning of that term as defined in section 177A(1). Rather, they were steps that led to a scheme consisting of the Arrangements. While a scheme might consist of a plan, a proposal, an action or a course of conduct, it must be possible, under section 177C(1)(b), to postulate that a deduction was allowable that would not have been allowable if the scheme had not been entered into or carried out. The preliminary steps had nothing to do with the Taxpayer being entitled to an allowable deduction. The allowable deduction became available, if at all, by reason of the Arrangements.
The persons who are said by the Commissioner to have entered into or carried out the relevant scheme are:
·    The Taxpayer, Messrs Anderson and Allen and the members of the Board at the time of the decision to enter into the Arrangements and at the time the amending agreements were entered into.
·    BICC.
·    Mr R.F. Morgan.
·    Austral Bronze and members of its Board.
·    Macquarie Bank and Messrs Calden and Cook of Macquarie Bank.
·    The Bank.
·    Mason Gray Strange Valuations VIC Ltd and Messrs J.N. Mason, G.A. Roberts, C.N. Hocking and R.H. Hocking.
·    C.J. Ham & Murray Pty Ltd.
The only persons among those named above who could be said to have entered into or carried out the Arrangements are the Taxpayer and Austral Bronze and their respective directors, and the Bank. While Mr Anderson was responsible for the communication of the original proposal to Mr Allen, he did not carry out the Arrangements. Nor did Macquarie Bank or anyone connected with Macquarie Bank carry out the Arrangements. The valuers were incidentally involved but they could not be said to have carried out the Arrangements or any relevant steps that would be said to be part of a scheme. BICC and Mr Morgan did not carry out any steps that could be said to be part of a scheme.
The Commissioner identified several matters, which he said pointed towards the relevant purpose, although he did not necessarily categorise any of those matters in terms of section 177D(b). The matters that the Commissioner says point towards the relevant purpose are as follows:
·    purporting to enter into a sale and chattel lease in circumstances where the Plant and Equipment consisted of fixtures;
·    purporting to enter into an arm’s length sale of the Plant and Equipment on the basis of evaluation prepared on a going concern basis where that basis was inappropriate as an indication of the value of the plant to the Bank as purchaser;
·    selecting Plant and Equipment for the purposes of the transaction with a low original cost relative to its current value on a going concern basis;
·    entering into the Arrangements, intending that dominion over and possession and control of the Plant and Equipment would remain with the Taxpayer at all times;
·    setting a residual value that was unrealistic and disproportionate to the price at which the Plant and Equipment was sold;
·    entering into the Arrangements in circumstances where the parties indicated that the Plant and Equipment would be reacquired at the residual value;
I shall deal with each separately:
Fixtures
Notwithstanding that the Plant and Equipment were fixtures, the Bank acquired an equitable interest in them sufficient to support the Lease. While the Plant and Equipment were fixtures, the parties clearly evinced an intention to treat the Plant and Equipment as chattels. On the other hand, while the effect of the Credit Purchase Agreement was to vest in the Bank an interest in the Plant and Equipment which was in the nature of property, the nature of the Plant and Equipment made them inherently unsuitable for a transaction such as that comprised in the Arrangements.
Whether or not the parties to the Arrangements believed that the Plant and Equipment comprised chattels separate from the land and did not constitute fixtures, is not relevant. While the Instruments contemplated severance in some circumstances, there was clearly never any intention to effect any severance at the time of the Arrangements. The intention of both parties, as gleaned from the Instruments, was that the Plant and Equipment would remain in situ quite unaffected by the Arrangements.
In addition, the fact that the residual value was fixed without any reference to the expected value of the Plant and Equipment at the expiration of the Term, having regard to the sale price, indicates that, from the Bank’s viewpoint, the primary “security” of the Bank was the financial standing of the Taxpayer. Those considerations suggest that it was not of great importance to the Bank whether the Plant and Equipment were chattels or fixtures. In that regard, the Bank’s letter to Macquarie of 11 January 1988 is of some significance. At that stage, it appears the Bank had given no consideration to the intended subject matter of the proposed arrangements.
Going Concern Valuation
The adoption of a going concern basis for valuation of the Plant and Equipment is consistent with a desire on the part of the Taxpayer to raise as much money as possible by the Arrangements. The sum of $50,000,000 was contemplated as the amount to be raised. Clearly, the Bank was prepared to rely on the financial standing of the Taxpayer, in addition to any interest in the Plant and Equipment, for assurance that it would obtain a return from the transaction. However, there is nothing to suggest that the Bank was concerned at the time of entering into the Arrangements to ascertain the value of the Plant and Equipment as security.
One could imagine circumstances where a financier, desiring some security, might say that it required either a mortgage of specific chattels, such as plant and equipment, or alternatively, that it required security in the form of ownership of chattels in respect of which it would grant a lease. In either case, the financier would be expected to require a valuation of the chattels indicating the sum that would be realised if the financier were compelled to enforce its “security”. That would be a valuation on a break up sale, not as part of a going concern. The going concern basis upon which the Mason Gray Strange Valuation was carried out was, on the face of it, irrelevant to the Bank.
Low Original Cost
If the Taxpayer sold assets in respect of which a deduction had been allowed for depreciation and the sale price exceeded the written down value of the assets sold, the Taxpayer would be liable for a balancing charge, in effect rendering the excess assessable income to the extent of the depreciation allowed. However, the excess over the cost price to the Taxpayer would not be the subject of any balancing charge and would be free of tax, other than capital gains tax, depending upon when the assets were acquired.
The Commissioner contends that the effect of the Arrangements is that the Taxpayer will have the benefit of the deduction in respect of payments to the Bank which, as to part, are in substance repayments of principal borrowed. Unless the proceeds of sale are free of such a balancing charge, such intended benefit would not be derived.
I do not accept that low original cost and high current value was a selection criterion for the assets to be the subject of the Arrangements. Mr Allen considered it relevant but rejected it as a selection criterion. He said that the only criterion was to get plant with a value to an ongoing business of around $60,000,000. Mr Cant made it clear that he did not consider that to be a selection criterion. I am not satisfied that Mr Dudley regarded it as a relevant criterion. In any event, the subjective state of mind of the directors is not relevant for the purposes of Part IVA.
In fact, as appears from the Mason Gray Strange Valuation, the Plant and Equipment had a value as at 19 April 1988 much greater than the cost to the Taxpayer. However, that of itself is equivocal. If the Taxpayer had arranged to borrow on the security of a mortgage or charge of the Plant and Equipment, assuming that were possible, the Taxpayer would have chosen assets with as high a value as possible in order to maximise the funds to be raised. Whether or not the asset had a low cost relative to its current value would not matter.
If there had been evidence that other assets owned by the Taxpayer could have raised a sum of around $50,000,000, being assets that did not have a low original cost compared to its then current value, that may have indicated that the Plant and Equipment was chosen for its advantageous position in relation to any balancing charge. Mr Allen said that the Plant and Equipment was chosen because it was the only plant and equipment that was 100% owned by the Taxpayer. However, the Taxpayer’s 1987 Annual Report records that the Taxpayer owned plant and equipment with an original cost totalling around $77,000,000. The Plant and Equipment represented only about $10,000,000 of that total. When asked to explain the figure in the Annual Report, Mr Allen said:
“It could have been a lot of rats and mice. It doesn’t take much to build up.”
That rather indicates that Mr Allen’s initial response that the Taxpayer did not wholly own any other plant and equipment was not accurate. Nevertheless, there was no evidence one way or the other as to whether the other plant and equipment had a high current value compared with its original cost. Accordingly, I consider that the fact that the Plant and Equipment had a high current value compared to its original cost is equivocal.
No Change in Control
The fact that dominion over and possession and control of the Plant and Equipment would remain with the Taxpayer is quite equivocal. That would be the position with any sale and leaseback financing arrangement. I have referred above to the concept of constitutum possessorium or constructive delivery.
Residual Value
The residual value under the Lease was unrealistic in the sense that there is reason to conclude that the value of the Plant and Equipment at the expiration of the Term of the Lease was greater than the residual value. If properly maintained, the Plant and Equipment may well not have deteriorated in value. However, that is equivocal in the absence of any right or entitlement on the part of the Taxpayer to reacquire the Plant and Equipment. The purpose of the residual value, from the point of view of the financier, is simply to fix the amount that will be “owed” to the financier at the expiration of the period of the lease. If the financier treats the transaction as purely one of financing, the ultimate destination of the subject matter of the lease will be of no concern to the financier so long as, at that expiration, he receives at least the amount of the residual value. It would be of no consequence to the financier whether the lessee or some third party bought the subject matter, so long as the proceeds were not less than the residual value.
Notwithstanding that it might be regarded as sharp practice by a financier who sought to retain any windfall that might arise upon sale of the subject matter of the lease at the expiration of the period of the lease, that is the legal position that prevails in relation to such an arrangement. As I have said, that is the risk that a lessee must take. The same risk would arise irrespective of whether the arrangement is a sale and leaseback or a purchase of the subject matter by the lessor from a third party in the first instance.
It was, of course, necessary that the Plant and Equipment be properly maintained in order for it not to deteriorate in value. That was a matter within the control of the Taxpayer. On the other hand, the Taxpayer could well have taken the view that the cost of maintenance would be outweighed by the risk that it would not ultimately be entitled to reacquire the Plant and Equipment.
The same considerations arise in relation to the proposition that the residual value was disproportionate to the price at which the Plant and Equipment was sold. That proposition assumes an expectation that the value of the Plant and Equipment would not deteriorate during the Term of the Lease. The relevant tax benefit is said to be the deductibility of the regular payments under the Lease. It is not asserted that the so-called collateral advantage of being able to reacquire the Plant and Equipment for the residual value was a tax benefit. It clearly was not.
Reacquisition
The Taxpayer had some “security” that it would be able to reacquire the Plant and Equipment for the residual value. That security was afforded both by the “business reputation” of the Bank and the nature of the Plant and Equipment itself. The time, effort and cost that would be involved in removal of the Plant and Equipment could be a huge disincentive for the Bank to sell the Plant and Equipment to anyone other than the Taxpayer at the end of the Term depending upon its value at the expiration of the Term. That of itself was a significant circumstance in ensuring that there would ultimately be no adverse consequences to the Taxpayer from disposing of its ownership of the Plant and Equipment.
Of necessity, any taxpayer who enters into a finance lease transaction must make a judgment in weighing the benefits of a finance lease against the disadvantages. So long as a distinction is made for tax purposes between a hire purchase arrangement, under which the “borrower” has a right to acquire the subject matter of the arrangement, and a lease, under which all payments are deductible but there is no security for acquiring goods at the end of the term, such a judgment will always have to be made. It is clear enough that, as a practical matter, there may have been little risk that the Plant and Equipment would not be available to the Taxpayer at the end of the term of the Lease if it were required. However, there was no legally enforceable right to reacquire the Plant and Equipment.
Clearly, if the likelihood of the Taxpayer being able to reacquire the Plant and Equipment at the expiration of the term were translated into a legal right, the residual value may well be a significant factor pointing to a dominant purpose of obtaining the relevant tax benefit. In such a case, of course, there would be no tax benefit in any event. Once it is accepted that the Taxpayer had no right or entitlement to reacquire the Plant and Equipment, this matter becomes equivocal.
I consider that the matters that the Commissioner says point towards the relevant purpose are equivocal, once it is accepted that:
·    in ordinary circumstances, a sale and lease back arrangement ought not to be treated as giving rise to lease payments that are not fully deductible;
·    the Instruments were intended to have effect according to their terms;
·    there is nothing untoward in an arrangement whereby a seller retains custody of the subject of a sale in the capacity of hirer: it would clearly be inconvenient to require a physical delivery by a seller to a buyer and a subsequent re-delivery by new owner to hirer;
·    there was no legal right or entitlement on the part of the Taxpayer to re-acquire the Plant and Equipment, whatever the probabilities might have been.
The primary focus in determining whether a tax benefit ought to be disallowed under Pt IVA is on the “dominant purpose”, objectively ascertained. In that respect, it is necessary to have regard to each of the matters referred to in section 177D(b). Those matters will not all necessarily point to the same purpose. Some of the matters might point in one direction and others point in another direction. Section 177D requires an evaluation of all of them, alone or in combination. The conclusion to which the section refers requires a balancing exercise. I shall deal separately with each of the paragraphs of section 177D(b):

(i) Manner of Carrying Out. The scheme was entered into and carried out in a manner that would be expected, having regard to the amount involved. The Instruments were prepared with the assistance of legal advisers and were entered into with a degree of formality. Having regard to the amount of money involved, that is not surprising. However, there was a degree of carelessness involved in the performance of the Arrangements. That is to say, there is some ambiguity in the description of the Plant and Equipment (see paragraphs 210-211 above). The requirement of the Instruments that a plaque be placed on the Plant and Equipment appears to have been ignored (see paragraphs 215-218). Parts of the Plant and Equipment were replaced or moved without any prior consent of the Bank (see paragraph 219). There was no evidence of complaint by the Bank in respect of those matters.
Those considerations tend to suggest that the Taxpayer treated the Plant and Equipment as though it was still the unencumbered beneficial owner. The absence of complaint from the Bank suggests that the Bank did not regard the Plant and Equipment as its primary security for ensuring that it would be paid the moneys provided for under the Lease.
(ii) Form and Substance. The form of the Instruments was not unusual for a commercial financing arrangement of the nature of the Arrangements. However, the nature of the Plant and Equipment was unsuitable for the Arrangements. The Arrangements were therefore somewhat artificial. Further, as I have indicated above, the form of the Lease was hardly apt for the Arrangements. The inaptness of the language of the Lease emphasises the artificiality of the Arrangements.
The artificiality, and the apparent disinterest of the Bank in the value of the Plant and Equipment to the Bank in the event of default, tend to suggest that the form of the Arrangements may have been regarded as more important than the substance of the rights and obligations that the parties recognised. Nevertheless, the Arrangements were not a sham. The Instruments were intended to have effect according to their terms. Those matters are therefore not decisive as to the dominant purpose of the persons who entered into and carried out the Arrangements.
(iii) Time. The Arrangements were entered into at a time when the Taxpayer had a need for medium to long term finance. The length of period during which the scheme was carried out is unexceptional, having regard to the nature of the Arrangements. That is to say, there has no suggestion that a five year term was out of the ordinary. Nor is there any basis for concluding that the timing of the Arrangements was dictated by anything other than a desire for longer term finance.
The idea of a sale of plant to a financier and its lease back originated in the approach from Macquarie Bank in March 1987. That approach related to ways in which the Taxpayer “might improve its taxation position”. There is a clearly discernible line from that approach to the ultimate consummation of the Arrangements, although it was more than 12 months before the Arrangements were entered into. Further, the decision to grant a mandate to Macquarie Bank was made after a meeting of directors at which the prospect of acquiring minority interests had become a real prospect.
In relation to the time at which the Arrangements were entered into, a very significant factor was the Taxpayer’s requirement for longer term finance. There was no urgency in the steps taken by the Taxpayer to enter into the Arrangements. The time at which the Arrangements were entered into is indicative, if anything, of a purpose of raising finance. The Taxpayer, more likely than not, would have raised finance, in one way or another, at about the time that the Arrangements were entered into.
(iv) Result. The executive summary attached to Mr Allen’s proposals of November and February compared the “sale and leaseback financing proposal” with “conventional borrowing”. However, there was never any concrete proposal advanced for conventional borrowing. The Board was not invited to chose between one of two options. Rather, the directors were being invited to consider the proposal because “the underlying value of many items of plant” provided the Taxpayer with an opportunity to raise a significant amount of funds “at very low cost”. The very low cost was a function of full deductibility for the regular payments of Rent. The executive summary shows that the reduction in operating profit before tax under the proposal and under conventional borrowing would be much the same. On the other hand, there is a significant difference between the operating profit after tax under the proposal and the operating profit after tax under conventional borrowing.
The result that would be achieved by the Arrangements in relation to the operation of the Act is that the Taxpayer will have a deduction for payments that would not be deductible in whole, if the Taxpayer had an enforceable option to reacquire the Plant and Equipment. The Taxpayer would not have been entitled to a deduction of the same amount if it had simply borrowed $50,000,000 from the Bank at a rate of interest equivalent to that adopted by the Bank in calculating the regular payments under the Lease. If further financing arrangements had been entered into, the Taxpayer would have had a deduction for interest payments on its short term borrowings. Its position in that regard would have been similar to its position under a conventional loan.
(v) Change in Financial Position. The financial position of the Taxpayer changed as a result of the arrangements. It ceased to be the unencumbered beneficial owner of the Plant and Equipment. It received $50,000,000 as proceeds of sale and undertook a commitment to make regular payments for five years and to indemnify the Bank in respect of any shortfall under the residual value of any proceeds of sale of the Plant and Equipment at the expiration of the Term of the Lease. That is the position that one would expect to result from any sale and leaseback arrangement.
The Taxpayer had a genuine need to raise medium to long term finance in order to reduce its short-term borrowings. Accordingly, the financial position of the Taxpayer was improved by the Arrangements. That improvement could have been achieved equally well by a conventional loan, without the disadvantage of disposing of ownership.
(vi) Other Persons. There has been no change in the financial position of any other person who has had any connection with the Taxpayer.
(vii) Consequence for Taxpayer. The consequence for the Taxpayer, of the Arrangements having been entered into and carried out, is that the Taxpayer gave to the Bank a proprietary interest in the Plant and Equipment such that, if the Taxpayer defaulted in making the regular payments under the Lease, the Bank would be entitled to require severance of the items of Plant and Equipment from the land of the Taxpayer and Austral Bronze. That is the normal consequence that would follow any sale and leaseback transaction.
The critical factor in this regard is that, while there may have been an expectation on the part of the Taxpayer that it would be able to reacquire the Plant and Equipment if it desired to do so, it had no right to do so. In that regard, the Arrangements were not different from any sale and leaseback arrangements entered into in the ordinary circumstances. The consequence of the Arrangements for the Taxpayer is not conclusive of a dominant purpose of obtaining a tax benefit, although it may tend to point towards that as the purpose for entering into the Arrangements rather than other financing arrangements.
(viii) Connection with Other Persons. There is no relevant change in the financial position of any person connected with the Taxpayer and, accordingly, the question of the nature of any such connection does not arise.
The Arrangements comprising as they did, the Credit Purchase Agreement and the Lease, were effective to raise $50,000,000 by way of medium term finance capable of replacing part of the short term liabilities that the Taxpayer had incurred during 1987. Clearly, finance could also have been obtained by a conventional loan. The form of finance adopted by the Taxpayer was apparently unprecedented so far as the Taxpayer was concerned. The benefit derived by the Taxpayer from having the whole of the regular payments under the Lease deductible made the sale and lease back attractive.
Some of the factors referred to in section 177D(b) point in the direction of a purpose of ensuring a tax benefit. At one level, it would be concluded that the dominant purpose of the Taxpayer, and the Bank for adopting the sale and lease back form of financing was to ensure that the Taxpayer would obtain the relevant tax benefit. That is to say, the sale and lease back form of financing, as distinct from any other form of financing, was chosen because of the tax benefit that would ensue. However, I do not consider that is the relevant level at which to assess purpose.
At another level, it would be concluded that the purpose of the relevant persons for the Taxpayer entering into the Arrangements was to ensure that the Taxpayer had access to medium to long term finance to replace its short term borrowings. The Commissioner accepts that, in ordinary circumstances, a sale and lease back arrangement ought not to be treated as giving rise to lease payments that are not fully deductible. Notwithstanding the artificiality of the Arrangements, the Instruments were intended to be effective according to their terms. The Arrangements would not have been entered into if there had been no increase in current liabilities of the Taxpayer during 1987.
As I have said above, the Taxpayer had a significant short-term debt prior to entry into the Arrangements. The position of the Taxpayer in relation to short term debt had been exacerbated by the acquisition of the minority shareholdings in Balfour Beatty Pty Ltd, Gooder Ltd, Associated British Cables Ltd and Austral Standard Cables Ltd. The level of the Taxpayer’s short term debt was undesirable. That points towards a conclusion that the purpose of entry into a financing arrangement shortly after the acquisition was to raise medium term finance.
The way in which the new funds were applied does not detract from that conclusion. $43,000,000 of the initial $48,000,000 realised under the Arrangements was used to discharge short-term liabilities. $5,000,000 was invested in the short-term money market. That is consistent with having the funds available to discharge other liabilities that were falling due. Thus, the funds realised were substantially used to discharge existing short-term debt. I am satisfied that, in the light of the objective circumstances surrounding entry into the Arrangements, the Taxpayer would have entered into a medium term financial arrangement of one kind or another if the Arrangements had not been available.
I consider, after balancing all of the matters in section 177D(b), that it would not be concluded that any of the Taxpayer, Austral Bronze, the directors of the Taxpayer and Austral Bronze or the Bank entered into or carried out the Arrangements, for the sole or dominant purpose of enabling the Taxpayer to obtain a tax benefit within the meaning of Part IVA of the Act. Accordingly, the Commissioner was not justified in making a determination under section 177F(1)(b).
CONCLUSION
It follows then that the appeals should be allowed and the assessments should be set aside. Ordinarily, the Commissioner would pay the Taxpayer’s costs of the proceedings. However, the Taxpayer was unsuccessful on the issue of whether the Plant and Equipment were fixtures. That issue required considerable evidence. I shall stand the proceedings over to a time convenient for the parties to bring in short minutes to reflect the conclusions that I have reached and to permit the parties to make submissions, if they wish, on the question of costs.

I certify that the preceding three hundred and eight (308) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett.
Associate:
Dated: 8 December 1999

Counsel for the Applicant: R.F. Edmonds SC;
J.R.J. Lockhart

Solicitor for the Applicant: Freehill Hollingdale & Page

Counsel for the Respondent:
J.W. Durack SC;

P.M. Fraser

Solicitor for the Respondent: Australian Government Solicitor

Date of Hearing: 25-29 October, 1 November, 3 November 1999

Date of Judgment: 8 December 1999

IN THE FEDERAL COURT OF AUSTRALIA	NG 668 OF 1997
NEW SOUTH WALES DISTRICT REGISTRY	NG 669-678 OF 1997

BETWEEN:	METAL MANUFACTURES LIMITED Applicant
AND:	COMMISSIONER OF TAXATION Respondent
JUDGE:	EMMETT J
DATE OF ORDER:	8 DECEMBER 1999
WHERE MADE:	SYDNEY

JUDGE:	EMMETT J
DATE:	8 DECEMBER 1999
PLACE:	SYDNEY

Principal:	$50 million
Lessor:	State Bank of New South Wales or Citibank
Arranger:	Macquarie Bank Limited
PROPOSAL	CONVENTIONAL BORROWING
After tax effective interest rate:		2%	8%
Increase on gearing:		13.1%	15.4%
Increase in net tangible assets		$48.0 m	0 *
Reduction in operating profit before tax:		$24.5 m	$24.0 m
Reduction/(Increase) in operating profit after tax:		($5.0 m)	$13.0 m
Reduction in dividend franking account:		$5.0 m	$2.5 m
Savings after tax over conventional borrowing over term discounted at 10% p.a.:		$10.0 m	-
* An increase in net tangible assets could be achieved by revaluing the relevant plant. The revaluation increment would never be reflected in profits.”

“Amount:	$50 million.
Lessee:	Metal Manufactures Limited.
Term:	Five years.
Equipment:	To be agreed.
Lease Payments:	Semi-annually in advance (equal amounts).
Residual:	$20 million (40%).
Security:	To the Bank’s legal requirements and to include satisfactory sale and lease documentation incorporating various conditions precedent, representations, warranties and events of default common to this type of transaction.
Pricing:	Establishment fee: 0.4% ($200,000) of the Amount of the Facility.
Interest Rate: To be the Bank’s cost of funds plus a margin of 0.65% p.a. (includes Counter Party Risk Margin for swap). An all-up fixed interest rate for the term of the lease will be quoted to the Lessee. All legal fees, stamp duties and reasonable out-of-pocket expenses to be to the account of the Lessee.”

“Principal:	$50 million
Lessor:	State Bank of New South Wales
Arranger:	Macquarie Bank Limited
PROPOSAL	CONVENTIONAL BORROWING
After tax effective interest rate		2%	8%
Decrease on gearing		8%	No change *
Increase in net tangible assets		$48.0 m	No change **
Reduction in operating profit before tax over estimated life of plant		$22.6 m	$22.2 m
Increase (decrease) in operating profit after tax over estimated life of plant		$12.0 m	($11.3 m)
Reduction in dividend franking account per annum ***		$5.0 m	$2.5 m
Savings after tax over conventional borrowing over term discounted at 10% p.a.		$10.0 m	-
* Assumes new debt would substitute for existing debt. An increase in net tangible assets could be achieved by revaluing the relevant plant, however the revaluation increment would never be reflected in profits. * The reduction in dividend franking account is not material. On current forecasts MM dividend will be capable of being franked for some time.”

Counsel for the Applicant:	R.F. Edmonds SC; J.R.J. Lockhart
Solicitor for the Applicant:	Freehill Hollingdale & Page
Counsel for the Respondent:	J.W. Durack SC; P.M. Fraser
Solicitor for the Respondent:	Australian Government Solicitor
Date of Hearing:	25-29 October, 1 November, 3 November 1999
Date of Judgment:	8 December 1999