Ransburg Australia Pty Ltd v Commissioner of Taxation

[1980] FCA 37

Re: RANSBURG AUSTRALIA PTY. LIMITED
And: THEAnd: THE COMMISSIONER OF TAXATION FOR THE COMMONWEALTH OF AUSTRALIA
(1980) 47 FLR 177
No. G18 of 1979
Appeal - Income Tax

COURT

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Deane(1), Fisher(2) and Lockhart(3) JJ.

CATCHWORDS

Appeal - Deduction - Payments by Taxpayer to a Company upon terms of agreements whereby the Company agreed to indemnify the Taxpayer against its liability to its employees for holiday and long service leave pay in succeeding years - Determination of the true character and effect of the payments - Whether the payments were made on revenue account by way of consideration for an indemnity or whether made as an investment on capital account.

Income Tax Assessment Act 1936 s.51(1).

Income Tax - Allowable deduction - Payment by taxpayer for "indemnity" against liability to employees for holiday and long service leave pay in succeeding years - True character and effect of payment - How determined - Whether payment for "indemnity" was made on revenue account by way of consideration for indemnity or whether made as investment on capital account - Income Tax Assessment Act 1936 (Cth), s. 51 (1).

HEADNOTE

The taxpayer paid moneys to a company pursuant to an agreement whereby the company agreed to indemnify the taxpayer against its liability to its employees for holiday and long service leave pay in succeeding years. The Supreme Court of New South Wales dismissed the taxpayer's appeal from the Commissioner's decision whereby the Commissioner disallowed the payment as a deduction (pursuant to s. 51 (1) of the Income Tax Assessment Act 1936).

On appeal to the Federal Court of Australia.

Held: Per Deane and Fisher JJ. - (1) If the payments could be properly categorized as consideration for an indemnity, they may be deductible pursuant to s. 51 (1).
(2) On the facts the payments were not in the nature of consideration for an indemnity.
(3) Although the company, on demand by the taxpayer, paid to the taxpayer amounts equivalent to amounts expended by it to meet its obligation re holiday and long service claims, that did not of itself determine the quality of the taxpayer's payments to the company.

Glenboig Union Fireclay Co. Ltd. v. Inland Revenue Commissioners (1922), 12 Tax Cas 427, applied.
(4) The taxpayer and the company had departed from the terms of the agreement and regard should, therefore, be had both to each payment separately in determining the nature of the payments and to the conduct of the parties as well as the contents of the agreement.
(5) Each payment was made to provide future funds which might be applied in relation to future obligations.
(6) The payments made by the taxpayer were not outgoings of revenue, but rather capital set aside to provide for such revenue contingencies and, therefore, not deductible pursuant to s. 51 (1).

Per Fisher J. - (7) The payments made by the company by way of reimbursement to the taxpayer would be capital receipt and not assessable income of the taxpayer.

Per Deane J. - (8) Foxwood (Tolga) Pty. Ltd. v. Federal Commissioner of Taxation (1980), 44 FLR 277, should be distinguished.
(9) The payments were neither calculated to produce nor did they produce a lessening of the obligation to make future payments in respect of holiday and long service leave. That obligation remained unaffected by the payments, so that they could not be properly characterized by reference to the object for which the obligation to make them had been incurred.

Per Lockhart J., dissenting - (1) In order to determine the true legal character of the payments made by the taxpayer, it is not permissible to answer the question by having regard to the end result except as a matter of contractual right. Europa Oil (N.Z.) Ltd. v. Inland Revenue Commissioner, (1976) 1 WLR 464; Federal Commissioner of Taxation v. South Australian Battery Makers Pty. Ltd. (1978), 140 CLR 645, followed. The legal character of the payment made under the agreement for consideration will be determined by reference to that consideration, i.e. to the character of the matter in respect of which the payment is made, although it is permissible to have regard to all surrounding circumstances. Europa Oil (N.Z.) Ltd. v. Inland Revenue Commissioner, (1976) 1 WLR 464; Federal Coke Co. Pty. Ltd. v. Federal Commissioner of Taxation (1977), 34 FLR 375, applied.
(2) The character of the payments made by the taxpayer to the company are determined by reference to the consideration provided by the company, namely its promise to indemnify the taxpayer.
(3) The payments made by the taxpayer to the company were incurred in the course of gaining or producing assessable income and were incurred as expenditure in relation to the management of the taxpayer's income-producing enterprise. The payments fall within each limb of s. 51.

HEARING

Sydney, 1979, October 17; 1980; March 28. #DATE 28:3:1980

APPEAL.

Appeal from the Supreme Court of New South Wales.

R. J. Bainton Q.C. and D. G. Hill, for the appellant.

T. Simos Q.C., Priscilla Fleming and R. V. Letherbarrow, for the respondent.

Solicitors for the appellant: Garland Seaborn & Abbott.

Solicitor for the respondent: B. J. O'Donovan (Commonwealth Crown Solicitor).

SUSAN KIEFEL

ORDER

1. Appeals dismissed

2. Appellant to pay respondent's cost of the appeal.

Appeals dismissed.

JUDGE1

The context in which these appeals fall to be determined appears from the judgment of Fisher J. which I have had the benefit of reading. I agree, for the reasons which he gives, with Fisher J's conclusion that the outgoings in issue were outgoings of capital and were, for that reason, not properly deductible pursuant to the provisions of s.51(1) of the Income Tax Assessment Act, 1936 ("the Act"). I would add some brief comments for myself.

The payments in the present matters are plainly distinguishable from the outgoing which was under consideration in Foxwood (Tolga) Pty. Limited v. Federal Commissioner of Taxation (unreported, 28 March, 1980). On the view I took of the outgoing in that case, its object and effect were, from a practical and business point of view, to remove from that taxpayer the burden of the obligation to make future payments which it had become antecedently certain that, in the absence of special arrangements or circumstances, the taxpayer would eventually have to make in respect of annual and long service leave on account of past periods of employment of persons employed by it in the course of gaining or producing assessable income. On that view of it, the outgoing could be regarded, from a practical and business point of view, as being calculated to procure, so far as the taxpayer was concerned, the effective discharge of the obligation. In those circumstances, it seemed to me that it was appropriate, for the purposes of the sub-section, to go beyond the immediate object of the outgoing and to characterize the outgoing by reference to the object with which the obligation had been incurred (see Herald and Weekly Times Ltd. v. Federal Commissioner of Taxation (1932) 48 C.L.R. 113 at p. 118). The majority of the Court saw the matter differently and concluded that upon proper analysis, the outgoing in respect of long service leave should be characterized as an adjustment upon settlement of the sale of the taxpayer's business and was of a capital nature.

In the present case, the relevant payments neither were calculated to produce, nor did they in fact produce, any discharge or lessening of the obligation to make future payments in respect of annual and long service leave. That obligation remained, for both theoretical and practical purposes, unaffected and unimpaired by the payments. When, in due course, payments were actually made by the taxpayer to its employees on account of annual and long service leave, those payments themselves would be calculated to discharge the obligation and could properly be characterized by reference to the object for which the obligation to make them had been incurred. The outgoings in the present case which were made to provide future funds which were intended to, but which need not necessarily, be applied in relation to such future payments to employees cannot, however, any more be properly so characterized than could a payment by a taxpayer to the credit of a savings bank account properly be characterized, for the purposes of s.51(1) of the Act, by reference to the object or objects to which the taxpayer proposed, at some future time, to apply the proceeds of the account.

The object for which the outgoings in the present matters were incurred was to procure for the taxpayer at some future date funds which it could apply for the purposes of its business or which could replace funds so applied. Putting to one side the question of any excess of the amounts received over the amounts outlaid, those outgoings represented matters of capital and not of revenue. They represented capital set aside to provide for revenue contingencies of the business rather than outgoings of revenue incurred in meeting such contingencies. They were not deductible pursuant to s.51(1) of the Act.

In my view, the appeals should be dismissed with costs.

JUDGE2

This is an appeal against a judgment of the Supreme Court of New South Wales in its Administrative Law Division upholding the decision of the Commissioner of Taxation ("the Commissioner") to disallow a deduction claimed by Ransburg Australia Pty. Limited ("the taxpayer") in its return of income for each of the years ending 30 June 1975 and 1976 respectively. The trial judge found that the deduction claimed in each instance was not allowable under the provisions of s.51(1) of the Income Tax Assessment Act 1936 ("the Act"). In my opinion such findings were correct, though I prefer to base my decision upon my view that each of the payments was of a capital nature. The trial judge did not find it necessary to consider this aspect of the matter which was however relied upon in the alternative by counsel for the Commissioner.

Counsel for the taxpayer conceded that the facts of the matter were, for the most part, correctly set out in the judgment of the trial judge. I am of opinion that for all relevant purposes the facts are, subject to my comments below concerning E. Trainor and his long service leave, as related in that judgment. There was little, if any, discussion before us of the evidence.

Stated very briefly, the taxpayer made both on 30 June 1975 and 30 June 1976, a payment to a company Manipa Pty. Limited ("Manipa") upon the terms of agreements executed on those dates. By these agreements, it was alleged, Manipa agreed to indemnify the taxpayer against its liability to its employees for holiday and long service leave pay in each of the succeeding years. Later in these reasons I will be considering in greater detail the true character and effect of these agreements.

However, because I attach some significance to the point, I will in respect of an alleged error of the trial judge set out what I see as the true position in respect of the year of income ending 30 June 1976. The trial judge found as follows in respect of that year, namely that:
"During the 1976 year the taxpayer made claims for reimbursement by Manipa of payments to employees of both holiday and long service leave. These claims were met."
Before us counsel for the taxpayer agreed that claims made for reimbursement for holiday payments in the 1976 year were met. He went on to say that no long service leave was taken in the 1976 year and that no claim was made in respect of it. Neither the statement of the trial judge nor the statement of counsel concerning long service leave appears on my reading of the evidence to be quite correct. There is evidence to the effect that, contrary to the submission of counsel, long service leave was taken in the 1976 year by one E. Trainor who was on 7 October 1975 paid the amount of $1,015. However the taxpayer does not appear to have made a claim for reimbursement of this payment and there is no evidence to suggest that any reimbursement was made. I will draw attention to this fact and others referred to hereafter as indicating that the taxpayer and Manipa did not deal with each other strictly in accordance with the terms of the agreements. Thus I see justification for looking beyond the mere words of the agreements for the purposes of determining the correct character of the payments by the taxpayer.

It was the contention of counsel for the taxpayer that what was sought each year to be deducted was a recurring annual payment made by it to Manipa in consideration of which Manipa agreed to indemnify the taxpayer in respect of holiday and long service leave payments by it to its employees. If it was proper so to characterise the payments, it might be hard to deny that each of them was deductible under s.51 of the Act. However in my opinion it is not correct, even restricting one's consideration to the terminology of the two agreements, so to characterise the payments, and this view is confirmed when one perceives that the taxpayer and Manipa did not make payments to each other strictly in accordance with the terms of the agreements.

In the first instance I do not see the agreements as amounting to contracts of indemnity. Notwithstanding the use of the word "indemnify" they did not purport to indemnify the taxpayer against the specified liabilities. Rather they provided that upon the occasion of the meeting by the taxpayer of its specified liabilities, Manipa would make a payment to the taxpayer. However the payment did not "indemnify" the taxpayer in respect of the liability, in that the liability of Manipa was not "coterminous with the liability it is intended to cover"; see Stroud's Judicial Dictionary 4th edit. vol.3 p.1349. The agreements did not provide that Manipa would "cover" or indemnify the taxpayer to the extent of its liability, but that payments of pre-agreed amounts or the amounts in fact paid by the taxpayer to its employees, whichever was the lesser, would on demand be made to the taxpayer. Thus to the extent that to meet its liability the taxpayer made payments of an amount in excess of the pre-agreed amount, it was not "indemnified" in respect of the excess.

Furthermore each of the agreements provided that payments could be made by Manipa to the taxpayer on occasions when the taxpayer was not under any liability to and had not made any payment to the employees named in the agreements. This occurred in circumstances where the liability of the taxpayer had been taken over by an associated company as "transmittee" of the taxpayer's business. Such payments can not correctly be described as payments by way of indemnity.

The stated promise of Manipa under the agreements was "to indemnify and make payment to" the taxpayer. Without doubt the obligation is properly identified as an obligation to "make payment", but it is hardly correct to say that the payment had the effect of "indemnifying" the taxpayer. It can not be said that Manipa agreed to indemnify the taxpayer in the full sense of that word and to do no more and no less than that. In my opinion, it is necessary to consider the matter without attaching undue significance to the use in the agreements of the word "indemnify".

The taxpayer entered into these two agreements with Manipa on 30 June 1975 and 30 June 1976 respectively. One payment was made by the taxpayer to Manipa under each of the agreements. It would not be correct, in my opinion, to describe the payments as annual or recurrent payments or as being regular or periodic in nature. Each payment was made once and for all, and each agreement was entire in itself, and the obligation of Manipa was not conditional on annual or any further payments being made by the taxpayer. There was no obligation on the taxpayer to enter into the second agreement, and no loss of any rights under the first agreement if it failed to do so. In fact there was nothing in the latter agreement to suggest that annual renewal of the arrangement was in contemplation.

It follows that I do not consider it proper, as a matter of construction, to characterise the payments which are sought to be deducted as "annual payments under contracts of indemnity in respect of annual and long service leave liabilities". For the reasons which I will discuss in detail later, I consider that it is more appropriate to regard each payment as a capital payment in the nature of an investment by the taxpayer. Each payment was made in order to establish a fund which would be available to the taxpayer, at least in part, at the time when it, or an associated company, made payments to its employees in respect of the aforesaid liabilities. I have arrived at this view after giving due weight to the fact that the payments by the taxpayer to Manipa were under each of the agreements calculated with reference to what would be the taxpayer's then accrued liabilities to its employees in respect of holiday and long service leave. As to the payments by Manipa in some circumstances at least they also bore relation, both as to time and amount of payment, to the meeting by the taxpayer of its obligations in respect of such liabilities. However, such features do not, in my view, conclusively determine the quality for tax purposes of the amounts paid by the taxpayer.

I have already referred to the fact that generally and also in respect of Trainor's long service leave the taxpayer and Manipa did not implement the agreements in accordance with their provisions. The agreements provided that Manipa would make payment to the taxpayer whenever the latter or an associated company made payment in respect of long service leave to any of its employees whose name appeared in the schedules to the agreements. The service of these employees with the taxpayer ranged, as set out in the first agreement, from a few months to 15 years. The employees were divided into three categories of service, 1 to 5 years, 5 to 10 years and over 10 years. Notwithstanding the clear provision in the agreement, concerning payments by the taxpayer to any of its employees, counsel for the taxpayer conceded quite unequivocally that the taxpayer did not see the "indemnity" as covering employees in the 1 to 5 or 5 to 10 year categories. Furthermore, he stated that the taxpayer did not make any payment to Manipa based on the long service leave entitlements of employees in either of these categories. This latter statement is confirmed as correct by the evidence which was given as to the manner in which the payment to Manipa was calculated in respect of long service leave entitlements.

The fact that the parties departed from the terms of the agreements and did not calculate or make payments strictly in accordance with the agreements was further confirmed by happenings in respect of the employee Trainor. His name appeared in the 5 to 10 years category of service, and, consistent with counsel's concession, his entitlement in certain circumstances to long service leave was not taken into account in calculating the amount of the payment to Manipa. Thus when Trainor was paid by the taxpayer for his long service leave, there was no payment by Manipa to the taxpayer. Counsel for the taxpayer subsequently appeared to some extent to resile from his concession that the agreements did not "indemnify" the taxpayer in respect of its long service leave obligation to employees in the first two categories, claiming that as a matter of construction the agreements appeared to give his client "an unexpected bonus" in this regard. However, it is in my view significant that the parties did not implement the agreements strictly in accordance with the terms thereof, and thus there is warrant for determining the true nature of the payments without regard exclusively to the words of the agreements.

In my opinion, it is necessary for the purpose of determining the true character of the payments to Manipa to consider each of them separately. These amounts paid by the taxpayer pursuant to the agreements were determined differently, as were the amounts of and the occasions for the payments by Manipa. Under the first agreement the amount paid by the taxpayer was calculated by reference to the entitlement at 30 June 1975 of its employees to holiday pay and by reference to the entitlement to long service leave of those of its employees who had served for more than 10 years with the taxpayer. The actual amount paid was, according to the evidence, the total of these entitlements (which entitlements were individually set out in the schedules) less a discount calculated by reference to the estimated dates on which the taxpayer would eventually be obliged to pay its employees for their annual and long service leave. In other words, the amount actually paid to Manipa was the estimated present value of the amount of anticipated future payments to employees. The obligation of Manipa was to pay to the taxpayer the amount which it or an associated company paid to the employees, to the extent that the payments did not exceed the scheduled entitlements.

In fact during the year of income ended 30 June 1976 the taxpayer paid its employees for their holiday leave and made claims on Manipa and received payments in accordance with the claims. The taxpayer also made a payment, as set out above, to E. Trainor on account of long service leave, but in this respect neither made a claim on nor obtained a payment from Manipa. The explanation is doubtless that, either by accident or design, the taxpayer had itself made no payment to Manipa by reference to Trainor's possible entitlement because he had served for less than 10 years, and thus it accepted that Manipa was under no obligation to make a payment to it on this score.

The second agreement made on 30 June 1976, was in substantially similar terms. However, clause (3) stated that the promise of Manipa in that agreement to make payments to the taxpayer in respect of its employees' entitlements as at that date in respect of holidays was in substitution for, and not in addition to, the like promise of Manipa in the first agreement. Thus, the agreement stated, the promise of Manipa in clause 2(a) of the first agreement was thereby discharged. Manipa therefore was thereafter under no obligation in respect of employees' holiday entitlements as at 30 June 1975 but remained liable to make payments by reference to entitlements at that date for long service leave. Thus, the second sum claimed as a deduction was the present value of the amount of holiday pay calculated at 30 June 1976, appropriately discounted for future payment, together with a sum in respect of long service leave. But this latter sum was calculated not by reference to the long service leave entitlements of employees who had served more than 10 years on 30 June 1976, but by reference only to the additional entitlements of those employees in consequence of another year's service and doubtless an increase in wages. The actual amount paid was again the present value of such additional entitlements. On this occasion also, in calculating the amount of the payment, the parties to the agreement chose to ignore the fact that the taxpayer might have to make a proportionate payment on account of long service leave to employees in some circumstances prior to their completion of 10 years service, and excluded such a possibility from the calculations.

A consideration of the above matters is justification, in my opinion, for considering the payments under the two agreements as separate and unrelated. The payments were calculated on different bases and the obligations of Manipa in consequence of the receipt of these payments were separate and distinct. The obligation in respect of holiday pay was during the year ended 30 June 1976 satisfied by Manipa making payments to the taxpayer on the appropriate occasions of the lesser of the amounts in the schedule and the actual amounts paid to each employee. This particular obligation was discharged prior to the making of the second agreement. In respect of long service leave entitlements at 30 June 1975, Manipa remained under an obligation until such leave was taken and payments made by the taxpayer or an associated company. In the ordinary couse this obligation would not be discharged for upwards of five years, and longer if there was adherence to the strict terms of the agreements. These obligations were in no way conditional upon the making of another agreement or any further payments by the taxpayer. They were in truth unaffected by the making of the second agreement. The second agreement had no application to the then existing obligations of Manipa, but created new obligations which related to subsequent entitlements to holiday leave and the additional entitlement to long service leave in consequence of the further year's service.

Treating the payments by the taxpayer individually, the question arises whether they were made on revenue or capital account. In this regard it is apparent that the payments have no similarity to payments of premiums under policies of workmen's compensation insurance, sickness or accident insurance. Such insurance is a true indemnity against a loss which may never occur. These premiums are paid regularly and periodically and the continued protection of the insured is conditional upon periodical payment of premiums under the policy. Upon the conclusion of the period to which a premium relates, the protection of the insured thereafter is conditional upon payment of the premium for the ensuing period. No rights or entitlements vest in the insured in consequence of the payment of the earlier premium except in reference to happenings during the period to which the premium relates. If there are no such happenings, the payment of the premium has not produced any continuing advantage of benefit.

The position is of course otherwise in respect of a premium payable under a policy of life assurance, which premium is rather in the nature of an investment. As such it has considerable similarity to the payments in question, and particularly so if the premium is in respect of term life insurance. In the latter circumstances the proceeds are payable on a specified date or earlier death and the premiums are the consideration for such payments. They are not paid in return for an indemnity against a loss which may never happen.

In the present case, the taxpayer made a payment under the first agreement in return for which Manipa agreed to make payments to the taxpayer of specified amounts subsequent to the happening of specified events. By making the payment the taxpayer was in effect establishing a fund in the hands of Manipa from which it was entitled on specified occasions to make drawings. These were the occasions upon which it made payments to its employees on account of holiday pay or long service leave. Such occasions were, in respect of holiday pay, almost certain to occur during the succeeding twelve months and in respect of long service leave during succeeding years. To the extent to which employees remained in the employ of the taxpayer or an associated company and took their annual or long service leave at or about the time of entitlement there was no element of risk or indemnity for risk. It was merely a matter of determining actuarially what amounts presently invested would produce the requisite sums at the appropriate times in the future. In so far as on the strict wording of the agreements they might be seen as granting an indemnity against a risk, the risk was that in consequence of termination of service on a specified ground or in consequence of death, an employee who had served less than 10 years might become entitled to a proportionate payment in respect of long service leave prior to the anticipated time. Such was a risk in respect of which the employer might seek protection and in my view, the agreements did provide in these circumstances a right to claim a payment from Manipa. However, counsel for the taxpayer acknowledged that the taxpayer did not make either of the payments for the purpose of protecting itself against that risk and this is confirmed by the evidence of the manner of calculating the amount of each payment. When in fact this risk did crystallize into actuality in October 1975, no claim was submitted by the taxpayer and no payment was made by Manipa. On the evidence it was proper to find that neither of the payments was made to obtain protection against such a risk.

I have already drawn attention to the fact that Manipa was obliged to make payment, upon claim being made by the taxpayer, of an amount actually specified in the schedules in relation to each employee or the amount actually paid to the employee, whichever be the lesser. In these circumstances the taxpayer, was able to reimburse itself to the extent of at least a portion of the amount it had expended on holiday and long service leave pay, and on the occasions of such expenditure. This expenditure, itself on revenue account, was a deduction allowable under s.51 of the Act. The fact that this expenditure was the occasion for, the condition precedent to, and the measure of the maximum amount of the taxpayer's claim upon Manipa, does not stamp the relevant payments by the taxpayer with the quality of a revenue outgoing incurred in the every day course of the taxpayer's business. The words of Lord Buckmaster in Glenboig Union Fireclay Co. Ltd. v Inland Revenue Commissioners (1922) 12 T.C. 427 at p.464 are very much in point:
". . . there is no relation between the measure that is used for the purpose of calculating a particular result and the quality of the figure that is arrived at by means of the application of that test."
In my opinion, it is equally true to say that there is no necessary relation between the condition precedent to or the occasion for the receipt of a sum and the quality of the consideration paid for the right to receive that sum.

It follows that in my opinion each of the payments, considered separately or together, was made by the taxpayer, not on revenue account by way of consideration for an indemnity but as an investment on capital account. The making of these investments was for the purpose of ensuring that there was available to the taxpayer, on the occasions upon which it or companies associated with it incurred specified expenses, funds for reimbursement of monies laid out in meeting such expenses. I regard the payments as having been made on capital account as investments of the taxpayer's monies. Although the matter does not arise directly for consideration and was not argued, I would also regard the reimbursing payments as capital receipts and not as assessable income of the taxpayer. A question may arise for decision on some other occasion whether the difference between the payments by the taxpayer to Manipa and the corresponding amounts received from Manipa was assessable income under s.25(1) or the second limb of s.26(a). It is not necessary or desirable for me to express any opinion on this aspect.

I would dismiss each of the appeals with costs.

JUDGE3

Two appeals from the Supreme Court of New South Wales in its Administrative Law Division dismissing the taxpayer's appeals against the Commissioner's assessments to tax in respect of the years ended 30 June 1975 and 30 June 1976. By consent the appeals were heard together by the Supreme Court and this court.

The question is whether the taxpayer is entitled to claim as deductions under s. 51 (1) of the Income Tax Assessment Act 1936 as amended ("the Act") payments made by it to Manipa Pty. Limited ("Manipa") under agreements which provided that the payments were made in consideration of Manipa promising to indemnify and make payment to the taxpayer for holiday pay and moneys in respect of long service leave paid by the taxpayer to certain of its employees.

The taxpayer is a wholly owned subsidiary of Wormald International Limited ("Wormald") and carries on business in Australia as an importer and manufacturer of equipment for electrostatic printing.

On 30 June 1975, the taxpayer entered into an agreement with Manipa (the taxpayer being described therein as the "employer") which, so far as relevant, provides as follows: -
"WHEREAS

(a) The employer is on the date hereof the employer of those persons whose names are set forth in either or both of Schedules A and B hereto.

(b) In the event that any of those persons whose names are set forth in Schedule A hereto were to determine his employment with the employer at the close of business on the 30th June 1975 such person would be entitled to be paid by the employer holiday pay in the sum set forth against his name on the said Schedule.

(c) The employer expects that the persons whose names are set forth in the said Schedule A will remain in its employ and will each take his holidays when or after the same fall due.

(d) In the event that any of those persons whose names are set forth in Schedule B hereto were to determine his employment with the employer at the close of business on the 30th June 1975 such person would be entitled to be paid by the employer long service leave in the sum set forth against his name on the said Schedule.

(e) The employer expects that the persons whose names are set forth in the said Schedule B will remain in its employ and will each take his long service leave when the same falls due or become entitled to payment in lieu thereof should his employment be for any reason determined after 30th June 1975.

NOW THIS AGREEMENT WITNESSETH

(1) The employer warrants the accuracy of recitals (a) (b) and (d) hereof and that recitals (c) and (e) are true to the best of its knowledge and belief.

(2) In consideration of the sum of $21,040 paid by the employer to Manipa, the receipt whereof Manipa does hereby acknowledge, Manipa does hereby promise to indemnify and make payment to the employer as follows: -

(a) Whenever the employer or any other company which is an associated company of the employer within the meaning of Section 6 (5) of the Companies Act 1961 (as amended) and which would be a transmittee in respect of that employee within the meaning of Section 4 (11) of the Long Service Leave Act 1955 (as amended) if that Act applied makes any payment for or in respect of holiday pay to any of its employees whose name appears on Schedule A hereto or to the personal representative of such emplyee (sic) in respect of holidays attributable in whole or in part to a period of employment prior to 1st July 1975 Manipa will pay to the employer which ever is the lesser of the amount set against the name of that employee on Schedule A hereto and the amount of holiday pay actually paid to that employee.

(b) Whenever the employer or any other company which is an associated company of the employer within the meaning of Section 6 (5) of the Companies Act 1961 (as amended) and which would be a transmittee in respect of that employee within the meaning of Section 4 (11) of the Long Service Leave Act 1955 (as amended) if that Act applied makes any payment for or in respect of long service leave to any of its employees whose name appears on Schedule B hereto or to the personal representative of any such employee for or in respect of long service leave attributable in whole or in part to a period of employment prior to 1st July 1975 Manipa will pay to the employer whichever is the lesser of the amount set against the name of the employee on Schedule A hereto and the amount actually paid for or in respect of such long service leave to such employee or to his personal representative.

(3) Claim by the employer upon Manipa in respect of such indemnities shall be made as follows: -

(a) So soon as may be after the last day of each month during which a right of indemnity accrues the employer shall present to Manipa its claim for indemnity accompanied by separate schedules in respect of claims under Clause 2 (a) and 2 (b) each showing the date and amount of the employer's payment, employee to or in respect of whom the payment was made and the amount of indemnity claimed.

(b) With each such claim the employer shall present to Manipa a statement under the hand of its principal accounting officer that he has examined the claim and schedules and that he certifies the same to be correct.

(4) Manipa shall pay to the employer the amount of the indemnity to which it is properly entitled under each such claim within two days of the receipt of the same."

There are two schedules to the agreement, each of which sets out the names of the taxpayer's employees. The first schedule relates to accrued annual holidays as at 30 June 1975 and the second to accrued long service leave as at that date. I shall refer to the agreement as "the 1975 agreement."

Pursuant to the 1975 agreement the taxpayer paid Manipa on 30 June 1975 $21,040.00, being the sum referred to in clause (2).

On 30 June 1976, the taxpayer entered into an agreement with Manipa having similar terms to the 1975 agreement. That agreement, which I shall refer to as "the 1976 agreement", provided that the relevant promise of Manipa to indemnify the taxpayer and make payment to it of sums in respect of holiday pay and long service leave paid to employees was in substitution for the similar promise of Manipa in clause (2) (a) of the 1975 agreement and that the last mentioned promise by Manipa was discharged.

Pursuant to the 1976 agreement, the taxpayer paid Manipa on 30 June 1976, $16,371.00, being the sum referred to in clause (2) of the 1976 agreement.

Claims were made by the taxpayer upon Manipa under clause (3) of the 1975 agreement and under clause (4) of the 1976 agreement in respect of moneys paid by the taxpayer to employees for holiday pay. These claims were met by Manipa who paid $25,442.00 to the taxpayer. Nothing was claimed or received in respect of long service leave as none was taken or paid during this period to any employee covered by the agreements.

Manipa was incorporated on 26 May 1975. At all relevant times its shareholders have been Wormald, Sims Consolidated Limited and James Hardie Asbestos Limited. The business of Manipa is entering into agreements of the kind entered into with the taxpayer and, from time to time, placing money on deposit in the money market with interest. At all relevant times Manipa entered into agreements only with companies that are subsidiaries of the three shareholders of Manipa, including the taxpayer.

The two sums paid by the taxpayer to Manipa of $21,040.00 and $16,371.00 are the deductions claimed by the taxpayer in these appeals.

The taxpayer contends that the payments to Manipa were outgoings incurred in gaining or producing its assessable income or were necessarily incurred in carrying on its business for the purpose of gaining or producing such income: s. 51 (1) of the Act.

The Commissioner contends to the contrary and asserts that the payments are of a capital nature. He does not contend that the agreements under which the payments were made were shams (see Boydell v. James (1936) 36 S.R. (N.S.W.) 620; Perpetual Trustee Co. v. Bligh (1940) 41 S.R. (N.S.W.) 33; Snook v. London and West Riding Investments Limited (1967) 20.B. 786 per Lord Diplock at p. 802; Albion Hotel Pty. Limited v. F. C. of T. 115 C.L.R. 78); or that they were illusory or not designed or intended to operate or that they did not operate according to their tenor (see Allsop v. C. of T. (1964) 113 C.L.R. 341 at p. 351). Nor were the agreements attacked under s. 260.

The present case requires the determination of the true legal character of the two payments made by the taxpayer to Manipa pursuant to the agreements. It is impermissible to answer this question in the field of taxation by having regard to economic equivalance or the end result except as a matter of contractual right: see Europa Oil (N.Z.) Limited (No. 2) v. I.R.C. 1976 1 W.L.R. 464 per Lord Diplock at pp. 471-472 who delivered the majority opinion of the Judicial Committee and per Lord Wilberforce at p. 478; F.C. of T. v. South Australian Battery Makers Pty. Limited (1978) 52 A.L.J.R. 640. In Europa Oil (N.Z.) Limited v. I.R.C. (supra) Lord Diplock said at pp. 471-472: -

"It is not the economic results sought to be obtained by making the expenditure that is determinative of whether the expenditure is deductible or not; it is the legal rights enforceable by the taxpayer that he acquires in return for making it."

The court is entitled to look at the whole of the circumstances to see if the payment answers the description of the relevant provision in the agreement. This is not entering the prohibited field of "taxation by economic equivalence or end result" (per Lord Wilberforce in Europa Oil (No. 2) (supra) at p. 478); but rather enquiring whether the facts establish that the relevant payment in truth falls within the description assigned to it by the parties in the agreement. For example, if parties to an agreement describe a particular payment as a "management fee" the court may examine all the relevant circumstances surrounding the payment to determine if its true legal character accords with that description. This enquiry may be conducted whether or not the Commissioner attacks the agreement by reference to s. 260 or as a sham: See Ridge Securities Limited v. I.R.C. 1964 1 W.L.R. 479; The Federal Coke Company Pty. Limited v. F. C. of T. (1977) 77 A.T.C. 4255 per Bowen C.J. at p. 4262; and Europa Oil (N.Z.) Limited (No. 2) (supra) per Lord Diplock at pp. 471-472 and per Lord Wilberforce at p. 478.

The legal character of a payment made under an agreement for consideration generally will be determined by reference to that consideration, i.e. to the character of the matter in respect of which the payment is made: see Europa Oil (N.Z.) Limited (No. 2) (supra) per Lord Diplock at pp. 471-472; and The Federal Coke Company Pty. Limited v. F. C. of T. (supra) per Brennan J. at p. 4273.

The 1975 agreement provides: -
"(2) In consideration of the sum of $21,040.00 paid by the employer to Manipa, the receipt whereof Manipa does hereby acknowledge, Manipa does hereby promise to indemnify and make payment to the employer as follows: -"

There then follow the provisions of the 1975 agreement that whenever the taxpayer makes payment for or in respect of holiday pay in respect of holidays attributable in whole or in part to the period of employment prior to 1 July 1975, Manipa promises to pay to the taxpayer whichever is the lesser of the amounts set against the name of the employee on the relevant schedule and the amount of holiday pay actually paid to that employee. Similar promises are made in relation to long service leave. The provisions of the 1976 agreement are substantially the same.

In my opinion the character of the payments made by the taxpayer to Manipa are determined by reference to the consideration provided by Manipa, namely its promise "to indemnify and make payment" to the taxpayer of the moneys to which I have referred.

The use of the word "indemnify" is, perhaps, not a strictly accurate use of the word. Manipa does not agree to indemnify the taxpayer to the full extent of its liability to employees for holiday pay and payments in respect of long service leave; but rather to pay the taxpayer predetermined amounts or the equivalent of the amounts paid by the taxpayer to its employees, whichever is the lesser. To the extent that the taxpayer's liability to its employees exceeds the predetermined amounts, there is no "indemnity" for the excess.

Further, the agreements expressly recognise the possibility of the taxpayer transmitting its business to an associated company and the taxpayer's employees ceasing to be employed by it and being employed by the transmittee. It is the transmittee who assumes the liability in due course for holiday pay and amounts payable in respect of long service leave. Yet it is the taxpayer who is entitled to payment from Manipa of the relevant sums notwithstanding that it would have ceased to carry on its business and, for all practical purposes, be under no relevant liability to its employees. In those circumstances, the promise of Manipa is not properly characterised as an indemnity to the taxpayer. This point is not answered by the probability that the price paid by the transmittee to the taxpayer for the purchase of its business would reflect, by way of diminution, the prospective liability of the taxpayer in respect of holiday pay and long service leave.

The Commissioner contends that the payments are not recurrent and that, although the test of recurrence is not decisive, the absence of recurrence points to the conclusion that the payments are capital expenditure. In my opinion, the payments are not recurrent in the sense of meeting a continuous demand: see Ounsworth v. Vickers 1915 3 K.P. 267 at p. 273. Neither agreement was dependant upon the other and each was complete in itself. Each payment by the taxpayer was made once and for all. Manipa's obligation to pay moneys under each agreement was not conditional upon any further payments being made by the taxpayer.

The Commissioner relies upon the fact that the parties did not implement each of the agreements strictly in accordance with its terms. This matter is referred to fully in the judgment of Fisher J. and I need not not say anything about it except that, in my opinion, the parties substantially adhered to the terms of the agreements. I do not regard any departure from the terms of the agreements as having any material bearing on the resolution of the questions before the court.

The tests for determining the deductibility of expenses have been referred to in many of the authorities. I referred to certain of the relevant tests in Total Holdings Limited v. F. C. of T. (1979) 79 A.T.C. 4279 at pp. 4282 and 4283 and need not repeat what I said.

I do not regard the use by the parties to the agreements of the word "indemnify" as critical. What matters is that the taxpayer paid moneys to Manipa under each agreement in consideration of Manipa promising to pay to the taxpayer amounts measured by payments to be made by the taxpayer for holiday pay or in respect of long service leave. It is true that the agreements recognise the possibility of the taxpayer paying more money to its employees than it may recover from Manipa; but the formula evolved by the parties was clearly designed to achieve a close correspondence between the moneys paid by the taxpayer to employees and the moneys payable by Manipa to the taxpayer.

Evidence was given by a Mr. Mayes, a chartered accountant, of the method of calculating the amounts paid by the taxpayer to Manipa under the agreements. The learned trial judge summarised the evidence of Mr. Mayes as follows: -
"In the case of holiday pay the calculation was made on the assumption that the amount paid to Manipa would be available to it for the first eight months of the year based upon a survey of the time at which employees of the "group" ordinarily took their holidays. the short term earning rate was taken to be 12%. Thus over the period for which the money would be available for use by Manipa it would earn 8%. This was reduced to 4% after taking into account "expenses and taxation". The amount paid to Manipa was calculated as the total liability for annual holiday pay shown in the schedule to the agreement reduced by 4%. In effect, this amount represented very close to the present value of the liability for holiday pay payable eight months later, calculated as a rate of 4% over that period. In the case of long service leave a similar kind of calculation was made. The long-term earning rate was taken to be 8% before taking into account expenses and taxation. This was reduced to 4% to take these matters into account. A calculation was then made of the likely year of payment for long service leave for each of the employees and the present value of the liability arrived at by applying a 4% per annum discount rate. In the result, in relation to holiday pay, by making an immediate payment at the date of the agreement the taxpayer obtained a discount of 4% on the amount which it would be liable to pay on an average eight months later, that is a discount of 6% per annum. Put another way, the taxpayer laid out money which, together with interest at 6% per annum would amount to the holiday pay accrued to the date of the agreement payable on an average eight months later . . . Manipa obtained the use of the money paid for an estimate period of eight months for a price of 6% per annum in the expectation that it could earn on it a rate of 12% per annum. The results in relation to long service leave were similar expect that the periods involved were to be much longer and the percentage rates per annum were 8% and 4%."

As there is no suggestion that the agreements were illusory or that they were not designed to operate according to their tenor, I doubt the relevance of this evidence. Even if it is taken into consideration, it would only serve to reinforce the conclusion that there was a financial advantage to the taxpayer in entering into the agreement with Manipa by obtaining a discount of 6% per annum in the case of the provision for holiday pay and 4% per annum in the case of long service leave.

What the taxpayer received as consideration for paying to Manipa the sums of $21,040.00 and $16,371.00 under the two agreements were the promises of Manipa to pay the taxpayer sums directly referable to and measured by the liabilities of the taxpayer that must accrue in the future. On any view of the matter those very liabilities must themselves be incurred in gaining or producing the taxpayer's assessable income or be necessarily incurred in carrying on its business for the purpose of gaining or producing such income.

It may be that, by making the payments to Manipa, the taxpayer gained a fiscal advantage in the form of an accelerated deduction and that the commercial benefit to the taxpayer was not great; but that is not to the point. What matters is that the taxpayer expended its funds in return for a promise that it would be reimbursed for moneys applied by it in satisfaction of its obligations to employees as to holiday pay and long service leave. Unless and until those obligations crystallized and were satisfied by payment there was no right of recoupment. Those obligations and their satisfaction by payment were an integral part of the business and income producing activities of the taxpayer.

The fact that the agreements provide for the possibility that the taxpayer may transfer its business to an associated company as transmittee says nothing significant as to the true character of the payments to Manipa.

Holiday pay was paid to the taxpayer's employees. It is conceded by the taxpayer that the moneys received from Manipa form part of its assessable income. The amounts received were returned by the taxpayer for the 1976 year of income.

In my opinion the payments made by the taxpayer to Manipa were incurred in the course of gaining or producing the assessable income and were incidental and relevant to that end. The expenditure was incurred in relation to the management of the income producing enterprise of the taxpayer.

There is a clear and direct nexus between the payments made by the taxpayer to Manipa and the derivation of the taxpayer's assessable income and the carrying on of its business. The payments fall within each limb of s. 51.

For these reasons I would allow the two appeals.