Riba Foods Pty Ltd v Commissioner of Taxation

[1990] FCA 566

Re: RIBA FOODS PTY LIMITED
And: COMMISSIONER OF TAXATION
No. N G567 of 1989
FED No. 566
Income Tax
21 ATR 960

COURT

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Sheppard J.(1)

CATCHWORDS

Income Tax - payment made to outgoing director of company in consideration of his not being engaged or interested in business similar to that carried on by company - whether payment an outgoing or capital or income.

HEARING

SYDNEY

#DATE 6:8:1990

ORDER

The application be dismissed.

The applicant pay to the respondent his costs of the appeal.

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

JUDGE1

This is an appeal against the disallowance by the Commissioner of Taxation of an objection to an assessment of income tax based upon a claim that a payment of $136,000 made by the applicant in the 1983 year of income was a payment on revenue, rather than on capital, account and thus deductible pursuant to s.51 of the Income Tax Assessment Act 1936. The Commissioner disallowed the payment as a deduction because, in his contention, the payment was of a capital nature. That is the question which has to be determined in this appeal.

1. The payment was made pursuant to a deed which was entered into on 30 June 1983 between the applicant, Riba Foods Pty. Limited, and one Edward Kehl. The deed recited that the company, Riba Foods Pty. Limited, was incorporated on 24 April 1973 and from that date carried on business as fishmongers, dealing in the smoking, processing and marketing of fish, trout, roe, eels, prawns and other sea and freshwater foods, and for such purposes bought its stock of fish and other sea and freshwater foods in the States of New South Wales, Queensland, Victoria and Tasmania and sold the major portion of its products in those States.

2. The deed further recited that Mr. Kehl was a signatory to the company's memorandum and articles of association and, since the date of its incorporation, had been one of the principal shareholders of and a life director of the company and had been fully engaged in the company's business. It was also recited that he was fully conversant with the suppliers from which the company purchased its stock of fish and other seafoods and with the company's methods of smoking and processing and marketing the same, and also with the company's customers.

3. It was then recited that Mr. Kehl had sold his shares and had retired as a director of the company and no longer had any association with it. There followed recital (d) which was as follows:-
   

"The Company has for the purposes of preserving and maintaining the profitability of its said business agreed to pay to Mr. Kehl the sum of One hundred and thirty-six thousand dollars ($136,000.00) as a consideration for his entering into such covenants with the Company as are hereinafter contained."

1. The deed then provided that Mr. Kehl would not by any means howsoever himself use or disclose to any other or others any information concerning the company or its processes and products or its suppliers or customers which might be of a confidential nature and which might have come to his knowledge as a shareholder, director or representative of the company. Mr. Kehl also covenanted that he would not, for a period of six years from the date of the deed, in any of the States mentioned, be in any way howsoever, either directly or indirectly, concerned, engaged or interested, or would assist any person concerned, engaged or interested, in any business of smoking or processing fish and other seafood or in the sale by wholesale of any smoked or processed products.

2. Finally it was provided that Mr. Kehl would not, for a period of six years from the date of the deed, in any of the States mentioned, be in any way, directly or indirectly, concerned, engaged or interested, or assist any person concerned, engaged or interested, in any business of smoking or producing or selling by wholesale or exporting fish or other seafood of a kind used or acquired by the company in its business.

3. For these covenants the deed provided that Mr. Kehl should be paid by the company the sum of $136,000 to which I have referred.

4. The evidence on the part of the taxpayer was given by one Domenico Rolfo who is the present managing director of the company. His evidence was not the subject of any challenge. He said that, from the time the company commenced business until June 1983, the directors were Mr. Kehl and himself and the shareholders were Mr. Rolfo's former wife and Mr. Kehl's wife. Mr. Rolfo subsequently purchased his former wife's share. Mr. Rolfo said that in June 1983 Mr. Kehl and he had had discussions concerning the possible termination of his involvement with Riba Foods. Following those discussions, he considered that they had reached a firm agreement for his retirement from the company and the sale of his shares and those held by his wife to Mr. Rolfo.

5. Some days later, but before 30 June 1983, he had a telephone conversation with an official from the Tea Gardens Fish Co-operative in the course of which he said words to the effect:-
   "Tell Eddy (Mr. Kehl) that next year we can do the same deal
   again. Next year the roe will be available at the same
   price as this current year."
   Mr. Rolfo said that this comment surprised him. The season for roe had finished some weeks earlier and Mr. Kehl had not spoken to him about placing an order for the next season. He concluded from the conversation that Mr. Kehl had been negotiating with the co-operative for the purchase of roe for the next season for himself so that he could deal in roe on his own account after he left the company.

6. Mr. Rolfo said that at that time the co-operative was an important supplier of roe to Riba Foods. It had been supplying about 80 per cent of the company's requirements of roe and Riba Foods had been buying the co-operative's entire catch. He formed the view that, if Mr. Kehl were to buy substantial quantities of it from the co-operative after terminating his involvement with the company, Riba Foods would lose the co-operative as a supplier of roe and this would adversely affect the sales and profits of Riba Foods.

7. Shortly afterwards he had a conversation with Mr. Kehl. He said to him, "What is going on here? You are trying to corner the market for roe for next year. You know I will need that roe to carry on the business." Mr. Kehl said, "Well, why should not I? I have got to make a living." Mr. Rolfo said, "Well, in that case we do not do a deal."

8. The next day they had some further discussions. On 28 June 1983 Mr. Kehl and his wife transferred their shares to Mr. Rolfo in consideration of the sum of $25,000. On the same day Mr. Kehl resigned as a director and employee of Riba Foods and Mr. Rolfo's brother was appointed a director. He continued as a director and became the managing director. On 30 June Mr. Kehl executed the deed dated 30 June 1983 to which I have referred. Paragraph 9 of Mr. Rolfo's affidavit is as follows:-
   

"I caused Riba Foods to pay $136,000.00 to Mr. Kehl as consideration for executing the Deed for the following reason. Mr. Kehl, by virtue of his position as director and employee since 1973, had acquired an intimate knowledge of the way Riba Foods conducted business and the way it went about purchasing stock. If Mr. Kehl were to commence buying roe from the Co-Operative, and processing and selling it on his own account after leaving Riba Foods, the company would find it difficult to obtain an alternative source of supply and this would reduce the sales and profits that Riba Foods would otherwise make. I wanted to ensure, for the benefit of the company, a continuity of supply of roe and I considered it was necessary to keep the Co-Operative as a supplier. I considered that, in the circumstances this could only be achieved by paying Mr. Kehl for his promise to refrain from engaging in the business of dealing in roe or other fish products for a period of some years."

1. Counsel have referred me to the authorities which appear to bear on the matter. The principal Australian case to which reference was made is the decision of the High Court in Broken Hill Theatres Pty. Limited v. Federal Commissioner of Taxation (1952) 85 CLR 423. That case was decided at first instance by Williams J. His decision that the payment in that case was on capital account was upheld on appeal. In the course of his judgment, Williams J. referred to a number of authorities. These included British Insulted and Helsby Cables Limited v. Atherton (1926) AC 205, Associated Portland Cement Manufacturers Limited v. Inland Revenue Commissioners (1946) 1 All ER 68 and Sun Newspapers Limited v. Federal Commissioner of Taxation (1938) 61 CLR 337. Amongst other things Williams J. said (p 429):-
   "Many tests have been propounded, the most favoured being
   that propounded by Viscount Cave L.C. in British Insulated
   and Helsby Cables Ltd. v. Atherton
   (1926) AC 205, at pp 213, 214: 'when an expenditure
   is made, not only once and for all, but with a view to
   bringing into existence an asset or an advantage for
   the enduring benefit of a trade, I think that there
   is very good reason (in the absence of special
   circumstances leading to an opposite conclusion) for
   treating such an expenditure as properly attributable
   not to revenue but to capital."
   Williams J. continued (p 429):-
   

"That test has been used and discussed in many cases, including three cases which closely resemble the present case in that the essential purpose of the expenditure was to prevent the competition of another business with that of the taxpayer."

1. His Honour mentioned in that context the two cases of Associated Portland Cement and Sun Newspapers to which I have referred. He said (p 429) that, "In all these cases the expenditure was held to be of a capital nature." Referring to the Associated Portland Cement case he said (p 430) that no capital assets were acquired. Payments were made to retiring directors simply as consideration for covenants on their part not to engage in activities in competition with the taxpayer. He continued (p 430):-
   

"Lord Greene M.R., referring to the test propounded by Viscount Cave, said (1946) 1 All ER, at p 72 that the test, though not by any means exhaustive, was an extremely useful test and in many cases would give the clue to the right answer. The test was discussed by this Court in the Sun Newspapers' Case. Latham C.J. said:- 'It is true that the payments did not result in obtaining a new capital asset of a material nature, but they did obtain a very real benefit or advantage for the companies, namely, the exclusion of what might have been serious competition. When the words 'permanent' or 'enduring' are used in this connection it is not meant that the advantage which will be obtained will last forever.'"

1. Later Williams J. referred (p 431) to the judgment of Rich J. in the Sun Newspapers case where his Honour, speaking of the payment in that case, said (p 347):-
   

"The purpose was to buy out opposition and secure so far as possible a monopoly. The fact that the benefit was not perpetual does not deprive it of its capital attributes."

Williams J. continued (p 431):-

"Expenditure of this nature is in each case made once and for all to remove a particular threat to the prosperity of the business structure as a whole. The fact that further applications may be made in the future for new licences does not destroy the nature of the advantage to be derived from the defeat of any particular application."

1. It was in these circumstances that Williams J. concluded that the payment in the Broken Hill Theatres case was on capital account. I do not refer to the detail of the judgments delivered on appeal. It is enough to refer to the joint judgment of Dixon C.J. and McTiernan, Fullagar and Kitto JJ. at pp 433-434.

2. Counsel for the applicant in the present case relied specifically upon what had been said by the High Court in the Sun Newspapers case at pp 359 and 363. At the second of those pages Dixon J. (as he then was) said (p 363):-
   

"There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment."

1. Contrary to the submissions made to me by counsel for the applicant, I am of opinion that, if those considerations are applied to the present case, they lead clearly to the conclusion that the payment here in question was on capital account. If one considers the character of the advantage sought, what was sought was a covenant which would restrain Mr. Kehl from engaging in competition with the company and thus possibly doing acts which might damage its business and goodwill. If one considers the manner in which the payment was to be used, it was to secure the advantage to the company to which I have referred, and, so far as the means adopted to obtain it are concerned, one payment was made. There is no question here of any periodicity in the payments. The very decision in Sun Newspapers itself suggests that it, if applied directly to the facts of this case, should lead to the conclusion that this payment was on capital account.

2. For all these reasons, I have reached the clear conclusion that the payment in question in the present case was paid on capital and not on revenue account.

3. The only other matter I wish to mention concerns reference by counsel for the Commissioner to a New Zealand case, Buckley and Young Limited v. Commissioner of Inland Revenue (1978) 2 NZLR 485. There Richardson J., who delivered the judgment of the New Zealand Court of Appeal, referred to the Associated Portland Cement Manufacturers Limited case as well as to a number of other authorities. He drew a distinction (p 489) between a payment made as a matter of commercial necessity or expediency to secure the removal of an unsatisfactory director or employee and a payment made to a retiring director or employee in consideration for a restrictive covenant not to compete. The former payment would usually be on revenue account, whereas the latter would usually be on capital account.

4. I do not, of course, decide any matter concerned with a payment made to a director or employee who has been paid a sum of money simply to remove him from office. It is enough to say that Richardson J.'s judgment in the Buckley and Young case is in accordance, so far as it concerns payments of the kind in question here, with the conventional run of authority.

5. In the result, the application is dismissed.