Rotherwood Pty Ltd v Commissioner of Taxation
[1996] FCA 94
•29 Feb 1996
CATCHWORDS
INCOME TAX - assessable income - corporate trustee of service trust for firm of solicitors held head lease of premises - sub-lease to firm - head lessor anxious that firm remain in premises - head lease had less than four years of initial term unexpired - head lessor paid $6 million to trustee for surrender of head lease - contemporaneous execution of new head lease of same premises with substituted corporate trustee of new service trust - new head lease was for ten years at increased rent - whether $6m received for surrender of head lease was a capital receipt or assessable income - whether income in accordance with ordinary concepts and usages - whether profit-making undertaking or scheme.
Income Tax Assessment Act 1936 ss25A, 160Z, 160ZC, 160ZO; sub-ss25(1), 160M(7), 160ZA(4)
Arrowcrest Group Pty. Ltd. v. Gill (1993) 46 F.C.R. 90
Cliffs International Inc. v. F.C.T. (1979) 142 C.L.R. 140
F.C.T. v. Cooling (1990) 22 F.C.R. 42
F.C.T. v. Hyteco Hiring Pty. Ltd. (1992) 39 F.C.R. 502
F.C.T. v. Myer Emporium Ltd. (1987) 163 C.L.R. 199
Federal Coke Co. Pty. Ltd. v. F.C.T. (1977) 34 F.L.R. 375
Hayes v. F.C.T. (1956) 96 C.L.R. 47
Reuter v. F.C.T. (1993) 93 A.T.C. 5,030
Scott v. F.C.T. (1966) 117 C.L.R. 514
S.P. Investments Pty. Ltd. as trustee for L.M. Brennan Trust v. F.C.T. (1993) 112 A.L.R. 443
ROTHERWOOD PTY. LTD. V. THE FEDERAL COMMISSIONER OF TAXATION
WG99 OF 1994
SPENDER, LEE, O'LOUGHLIN JJ.
PERTH
29 FEBRUARY 1996
IN THE FEDERAL COURT )
OF AUSTRALIA )
WESTERN AUSTRALIA )
DISTRICT REGISTRY )
GENERAL DIVISION ) NO. WG99 OF 1994
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
B E T W E E N: ROTHERWOOD PTY. LTD.
Appellant
and
THE FEDERAL COMMISSIONER
OF TAXATION
Respondent
MINUTE OF ORDER
THE COURT: SPENDER, LEE, O'LOUGHLIN JJ.
DATE OF ORDER: 29 FEBRUARY 1996
WHERE MADE PERTH:
THE COURT ORDERS THAT:
The appeal be dismissed.
The appellant pay the costs of the appeal.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
IN THE FEDERAL COURT OF AUSTRALIA )
WESTERN AUSTRALIA DISTRICT REGISTRY ) No.WG 99 of 1994
GENERAL DIVISION )
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT
OF AUSTRALIA
BETWEEN: ROTHERWOOD PTY LTD
Appellant
AND: THE FEDERAL COMMISSIONER OF TAXATION
Respondent
CORAM: SPENDER, LEE and O'LOUGHLIN JJ
PLACE: 29 February 1996
DATE: PERTH
REASONS FOR JUDGMENT
SPENDER J: I agree with the reasons for judgment of Lee J.
I certify that this is a true copy of the Reasons for Judgment of the Honourable Justice Spender.
Associate
29 February 1996
IN THE FEDERAL COURT )
OF AUSTRALIA )
WESTERN AUSTRALIA )
DISTRICT REGISTRY )
GENERAL DIVISION ) NO. WG99 OF 1994
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
B E T W E E N: ROTHERWOOD PTY. LTD.
Appellant
and
THE FEDERAL COMMISSIONER
OF TAXATION
Respondent
CORAM: SPENDER, LEE, O'LOUGHLIN JJ.
DATE : 29 FEBRUARY 1996
PLACE: PERTH
REASONS FOR JUDGMENT
LEE J:
This is an appeal from orders made by a Judge of this Court (Carr J.) which give effect to decisions made by his Honour on three questions ordered to be tried separately from other questions in an "appeal" by the appellant ("Rotherwood") against a decision of the respondent ("the Commissioner") which disallowed Rotherwood's objection to the inclusion of a sum of $250,317 in Rotherwood's assessable income for the year ended 30 June 1989.
His Honour's orders and decisions on the preliminary questions did not determine finally the rights of the parties and accordingly leave to appeal from an interlocutory judgment was required. (See: Arrowcrest Group Pty. Ltd. v. Gill (1993) 46 F.C.R. 90.) Leave to appeal was granted by the Court at the commencement of the hearing of the appeal.
The facts as found by his Honour were as follows:
"Rotherwood was, at the relevant time, a beneficiary under a discretionary trust for the benefit of the family of a Mr J.R.B. Ley ('Mr Ley'), a partner in the firm of Messrs Freehill Hollingdale & Page ('Freehills' - which, unless otherwise stated may be taken to include a reference to Freehills and its predecessor firms), solicitors. The trustee of that discretionary trust was a company called Eason Pty Ltd ('Eason'). Mr and Mrs Ley are the directors and shareholders of Eason. Eason held units in the unit trust known as the Chancery House Unit Trust, the trustee of which was Chancery Services Pty Ltd ('Chancery Services'). Chancery Services, in its capacity as trustee of the Chancery House Unit Trust (a capacity which, unless otherwise stated, can be taken to have applied to all of its activities described hereunder), provided certain secretarial, administrative and other services to Freehills. Those other services included sub-leasing office premises to Freehills and providing the use of office furniture and equipment to that firm for the purposes of its legal practice.
There were two classes of units in the Chancery House Unit Trust, namely ordinary units and special par units, but for present purposes it is not necessary to distinguish between them.
All but one of the relevant units in the Chancery House Unit Trust were held by nominees of the partners of Freehills from time to time. The remaining unit was held by a partner personally. The Board of Directors of Chancery Services comprised the partners in Freehills from time to time.
On 6 December 1983 Chancery Services (then known as Chancery Nominees Pty Ltd) entered into a lease with Austmark Investments Pty Ltd ('Austmark'), pursuant to an agreement to lease made on 1 November 1982, whereby Chancery Services leased, unfurnished, four floors ('the Premises') of a ten storey building known as 15-17 William Street, Perth for a term of ten years commencing on 1 November 1982 ('the Old Lease'). The Old Lease contained three options for renewal, each for further terms of five years, although Mr Ley in his affidavit referred to only two of those options. Payment of the rent
and performance of Chancery Services' obligations under the Old Lease were guaranteed by the partners of Freehills. Simultaneously, Austmark and Chancery Services entered into a licence ('the Old Licence') whereby Chancery Services was granted the right to use certain car parking bays in the same building as the Premises, for a term which was co-extensive with the term granted by the Old Lease.
Chancery Services borrowed moneys which eventually amounted to a total of approximately $1.5 million which it applied in carpeting the Premises and in furnishing and fitting out those portions of the Premises which were to be occupied by Freehills. Payment of that loan and interest upon it was guaranteed by the then partners of Freehills and their wives. By deeds of charge, Chancery Services charged the partitioning, other fittings, and furniture further to secure payment of those moneys.
Towards the end of November 1982 Chancery Services took possession of the Premises. On 22 November 1982 Freehills took up occupation of two floors of the Premises pursuant to a sub-lease from Chancery Services and at the same time Chancery Services granted to Freehills an oral sub-licence of the parking bays. All or part of the balance of the Premises was sub-let to unrelated parties, until required by Freehills. By 1988 Freehills was occupying the whole of floors 8 and 9 and part of floor 7. Freehills occupied almost one third of the building and was its largest tenant. On 30 October 1984 Austmark (the head lessor) changed its name to Colpenarm Pty Ltd ('Colpenarm'). Colpenarm was a wholly-owned subsidiary of West Australian Trustees Ltd in its capacity as the trustee of the Armstrong Jones Property Fund of which Armstrong Jones Management Ltd ('Armstrong Jones') was the manager.
During 1986 and 1987 the partners in Freehills were concerned about Chancery Services' level of indebtedness in respect of the moneys borrowed to furnish, fit out and carpet the Premises, particularly as the partners and their wives had entered into the guarantee referred to above. In 1986 two former partners in Freehills and all of the partners' wives who had executed that guarantee were released from liability. The concern reached the level of being a major factor in the resignation of five of the six partners in Freehills who resigned in 1987. By early 1988 that concern had spread to the capital gains tax and stamp duty implications, which arose out of the retirement of partners and the admission of new partners in Freehills, of holding units in the Chancery House Unit Trust. Professional advice was sought and received which was to the effect that the Chancery House Unit Trust should be replaced
with a discretionary trust. At about the same time, the company which lent the above moneys to Chancery Services indicated that it would like the loan repaid before its due date (21 October 1989). Freehills' Management Committee considered that the request for early repayment of the loan was a good opportunity to put in place a new structure to replace the Chancery House Unit Trust. Although Chancery Services sought and obtained a number of proposals to refinance its debt, none was thought to be acceptable and on 28 June 1988 Freehills' Management Committee decided to defer the question of such refinancing.
By deed dated 24 May 1988 a new service trust, the 'FHP Service Trust' was created, the trustee of which was FHP Services Pty Ltd ("FHP Services"). When the FHP Service Trust was settled, the Directors of FHP Services were the then partners of Freehills. The FHP Service Trust was a discretionary trust, the beneficiaries of which were the partners of Freehills or their nominees. The trust deed provided that the beneficial interest of a beneficiary could be determined from time to time by a committee known as the 'Partnership Committee' (comprising two senior partners of Freehills) on the basis of a merit system.
By letter dated 10 August 1988 addressed to one of the partners in Freehills, Armstrong Jones offered, on behalf of Colpenarm, to pay Chancery Services $750,000 towards an improved fit-out and refurbishment of the Premises and to contribute up to $250,000 towards replacement of the carpet in the Premises if Chancery Services would then agree to exercise the option to extend the term of the Old Lease for five years from 1 November 1992.
This was not the first time that Chancery Services, as lessee of premises sub-leased to a firm of solicitors, had been pressed by its landlord to exercise an option to renew such lease. In late 1980 Chancery Services was the assignee of a lease of office premises at Law Chambers, Cathedral Square in Perth which it sub-leased to Messrs Muir Williams Nicholson & Co, a predecessor of Freehills. The landlord of those premises pressed Chancery Services to exercise an option to renew the term for five years from 1 December 1980. Chancery Services exercised that option, but there is no evidence of this being other than at or about the time of the expiry of the then current term and certainly no evidence or suggestion of the landlord giving any consideration in return for the exercise of that option. Two years later, when Muir Williams Nicholson (as the firm was then named) moved to the Premises, the Law Chambers lease was assigned to W.A. Bar Chambers Ltd for no consideration other than the future
performance of the lessee's obligations under that lease.
By mid 1988 Freehills was receiving approaches from leasing agents of buildings under construction or to be constructed in the Perth Central Business District, offering the firm various inducements to take leases of premises in those buildings. There is evidence that Armstrong Jones had become aware of these approaches.
At a partners' meeting held on 16 August 1988, the partners of Freehills considered the letter from Armstrong Jones and resolved to obtain advice from a Mr Ian Sanderson, a property consultant, about alternative premises and the likely rental that would be payable in respect of the Premises and other similar premises in Perth in the years to come.
The matter had been considered at a meeting of the Freehills Management Committee earlier that day. The following is an extract from the minutes of that meeting:
'It appeared that the owners were considering selling the building and therefore wanted to get a long term commitment from FHP as the major tenant. There was a premium value to the owners from securing the major tenant on a long term basis and it was agreed that THR [Mr T.H. Reinold, a partner in Freehills] should attempt to get an indication of that value before the Partners' meeting later in the day.'
On or about 22 August 1988 Freehills received a formal offer on behalf of the owners of the building under construction next door to 15-17 William Street to lease office space in that building. That offer included a proposed incentive payment of $1,935,000.
Freehills' Management Committee met on 13 September 1988 and considered Mr Sanderson's letter of advice dated 5 September 1988. The Management Committee decided to seek further advice as to the value to Colpenarm of Chancery Services agreeing, at that time, to exercise the option. That further advice was not obtained in view of the further developments referred to below.
By October 1988 Freehills had not responded to the offer from Armstrong Jones which had neither been withdrawn nor increased. At about that time one of the partners in Freehills, a Mr Bruno Camarri, began to take an interest in the Armstrong Jones offer. Mr Camarri had been a member of the Management Committee from its formation on 1 July 1979 until his resignation from it in February 1987 and until that resignation, had for many years been the de facto managing partner of the firm. Mr Camarri told the Management Committee that he thought Armstrong Jones 'could be persuaded to increase its offer'. He was authorised by Freehills' Management Committee to approach Armstrong Jones, on behalf of Chancery Services, to see if an increased offer could be obtained. Mr Camarri engaged another property consultant, Mr Warren Tucker of Warren Tucker Pty Ltd, to assist him in his negotiations with Armstrong Jones.
By 22 November 1988 those negotiations had proceeded to the extent that a full meeting of the partners was convened at which Mr Camarri tabled particulars of what was described as the 'anticipated offer' in these terms:
'$4 million to $4.5 million, payable $3 million on 1 January 1989 balance in 4 equal 6 monthly instalments on the basis that existing lease is renewed for ten years commencing on 1 January 1988 at rental of $300 m2.'
[I have taken the reference to 1988 in the above passage as being intended as a reference to 1989, although I do not think that anything turns on this].
Mr Camarri's memorandum then set out some figures which showed that if the total payable by the Landlord was $4,500,000 certain loans (which were described as 'Partnership Loans') could be repaid, leaving a balance of $1,685,000 'to be invested'. The partners agreed in principle to accept an offer of $4.0 to $4.5 million, if and when it was made, subject to the receipt of detailed analyses which two of the partners agreed to prepare. The meeting was adjourned to 24 November 1988 at which Mr Camarri was authorised to continue negotiating with Armstrong Jones with a view to obtaining a higher offer.
On 7 December 1988 there was a quarterly meeting of the partners of Freehills. The relevant extract from the minutes of that meeting reads as follows:
'3.Premises
BGC [Mr Camarri] told Partners that, subject to the approval of the Board of Armstrong Jones and the approval of the Trustee of the Armstrong Jones Property Trust, agreement could be reached with the landlord whereby Chancery Services Pty Ltd would surrender its existing lease and FHP Services Pty Ltd would take a new lease for 10 years commencing on the 1st January 1989 at a commencing rental of $300.00 per square metre per annum with rent reviews every 2 years. He also said that Armstrong Jones would be prepared to give us their legal work which could amount to as much as $300,000.00-$500,000.00 in fees per annum.
BGC sought authority to complete the arrangement with Armstrong Jones. It was moved by BRJ and seconded by PJM that such authority be given and that resolution was carried unanimously. BGC said that he would meet with the managing director of Armstrong Jones on 9 December 1988.'
The applicant's evidence was that Mr Camarri mentioned the amount which the landlord was prepared to pay, although this was not minuted. That evidence did not extend to specifying the amount mentioned by Mr Camarri.
On or about 14 December 1988 agreement was reached and, in a letter dated 16 December 1988, Armstrong Jones set out the terms and conditions for the surrender of the Old Lease and the Old Licence and the grant of a new lease and car park licence of the Premises. To indicate their acceptance of those proposals, Chancery Services and FHP Services caused their respective common seals to be affixed to the last page of that letter. The same two directors, Mr Camarri and a Mr John Robert Hayward, also a partner in Freehills, witnessed the fixing of those respective seals. In summary, the matters agreed to (subject to ratification from the Boards of Armstrong Jones and West Australian Trustees Ltd) were as follows:
.Chancery Services was to agree to an early surrender of the Old Lease and the Old Licence on 31 January 1989 in consideration of receiving $6 million from Colpenarm;
.The existing guarantees of the obligations of Chancery Services would be released;
.Stamp duty associated with that surrender would be borne in full by Colpenarm;
.Freehills would be placed on a panel of lawyers to be considered from time to time by Armstrong Jones to carry out Armstrong Jones property-related work throughout Australia;
."In consideration of that appointment and acknowledging the consequential value of the opportunity to do the legal work on behalf of Armstrong Jones, Freehill Hollingdale & Page will through FHP Services Pty Ltd, in its
capacity as trustee of the FHP Services Trust, agree to enter into a new Lease and Carpark Licence in respect of the above premises";
.The new lease was to commence on 1 February 1989 for a term of ten years with two five year options. Initially the annual rent was to be $1,488,000 ($300 per square metre) per annum;
.There was provision for a separate cark park licence;
.Except for changes to reflect the above and certain other stipulated exceptions, the terms and conditions would be identical to the Old Lease and the Old Licence.
By deed of surrender and a surrender of lease, both dated 31 January 1989, made between Colpenarm and Chancery Services, Chancery Services surrendered the Old Lease and the Old Licence in return for the payment of $6,000,000 which was made on or about that date by bank cheque paid to 'Chancery Services Pty Ltd as trustee of the Chancery House Unit Trust.' The deed of surrender attracted liability for Western Australian stamp duty of $250,525.00 which was duly paid.
By deeds, both dated 8 February 1989, Colpenarm as lessor and FHP Services as lessee entered into a lease of the Premises ('the New Lease') and a parking licence ("the New Licence") for a term of ten years commencing on 1 February 1989 with options to renew for two further terms each of five years. The annual rent for the Premises was $300 per square metre reviewable at the expiration of each two years of the term. The terms of those deeds were substantially in accordance with the terms and conditions contained in the letter dated 16 December 1988 referred to immediately above. The partners in Freehills executed the deeds as covenantors, thereby guaranteeing the performance by FHP Services of its obligations under the New Lease and New Licence.
In its report dated 13 January 1989 for the 'National Committee Meeting' of the nationally-organised firm of which Freehills was a part, what was then about to take place was described in the following terms:
'Premises
As the result of the spate of office building construction occurring in Perth at the moment, the Firm had received numerous approaches from developers offering substantial incentives to move to a new building. The Firm had also been offered attractive incentives from the landlords of its existing building to make a commitment to stay. In the result, the Firm accepted the landlord's proposal and, as a consequence, will surrender its existing lease (which was due to expire on 31 October 1992) and enter into a new lease for 10 years on 1 February 1989.'
Chancery Services ceased to operate as a service company to Freehills on 1 February 1989 and from that date those services formerly provided by it to the firm were provided by FHP Services. Numerous leases of office equipment which Chancery Services had been making available, for reward, to Freehills were transferred to FHP Services for the same purpose.
The directors of Chancery Services and FHP Services were the partners for the time being of Freehills. The shareholders of both Chancery Services and FHP Services were at all material times M.W.N. Administration Pty Ltd and Muirwill Nominees Pty Ltd and the directors and shareholders of each of those two companies were the partners for the time being of Freehills. The inescapable conclusion is that Chancery Services and FHP Services were each controlled by the partners from time to time in Freehills.
The sum of $6,000,000 received by Chancery Services was disbursed (in terms of cash movements) in payment of fees to Warren Tucker Pty Ltd ($310,000), repaying the moneys borrowed by Chancery Services and certain moneys borrowed by Freehills. The balance of $3,141,659 was held on deposit pending a decision of the partners as to its disbursement.
On 13 February 1989 the partners of Freehills resolved that the abovementioned balance of $5,690,000 remaining after payment of the fee of $310,000 referred to above should be distributed (in terms of beneficial interest) by Chancery Services equally between the holders of special par units in the Chancery House Unit Trust. There were 22 such unit holders, all except one of whom were nominees of the partners in Freehills. The other was a nominee of a Mr Peter Lark, a director of a company associated with Freehills. The effect of this resolution and a resolution made on 29 June 1989 by the board of directors of Chancery Services was that each such holder would receive a beneficial entitlement in the amount of either $258,636 or $258,637. Eason as trustee of the Ley Family Trust thus became entitled to receive $258,637.
On 29 June 1989 the Board of Directors of Eason resolved that the net income of the Ley Family Trust for the year ending 30 June 1989 be distributed as to $6108 to a named beneficiary and as to the whole of the balance to the applicant. The resolution continued in these terms:
'To the extent that there is an assessable accretion to the Trust fund (arising from the beneficial holding by the Trust of ordinary units in Chancery House Unit Trust) during the Accounting Period ended 30 June, 1989 the Trustee determines in terms of clauses 7 and 8 of the Trust Deed that those accretions be distributed as follows:
a.[to each of four named beneficiaries the sum of $2080]; and
b.the balance to Rotherwood Pty Ltd.'
On 30 June 1989, Eason executed a declaration under seal in similar terms in relation to the net income of the Trust and what was described as any assessable accretion to the Trust Capital.
On 27 April 1990 the Commissioner issued to Rotherwood a notice of assessment of income tax for the year ended 30 June 1989 and on 19 June 1991 issued to Rotherwood notice of an amended assessment of income tax for that year. The amended assessment included the distribution of $250,317 from the Ley Family Trust in Rotherwood's assessable income.
Rotherwood, by notice dated 16 August 1991, objected to that amended assessment. By notice dated 5 August 1992 the Commissioner disallowed that objection."
The following questions were those ordered to be tried separately, and the answers are those provided by his Honour:
Is the sum of $6 million ("the payment") received by Chancery Services Pty. Ltd. from Colpenarm Pty. Ltd., or some lesser amount, assessable income of the Chancery House Unit Trust ("CHUT") pursuant to sections 25(1) or 25A of the Income Tax Assessment Act 1936 ("the Act")?
Answer: Yes, the sum of $6 million is assessable income of the Chancery House Unit Trust pursuant to both section 25(1) and 25A of the Income Tax Assessment Act 1936.
Is the payment assessable income of CHUT pursuant to the operation of sections 160M(7), 160Z, 160ZC and 160ZO of the Act?
Answer: No, because by virtue of the answer to Question 1 above s.160ZA(4) requires the amount of the capital gain to be reduced to nil.
If the answer to questions 1 or 2 above is "yes", is the amount of $250,317 assessable income of the Applicant under section 97 of the Act?
Answer: Yes. A further amount of some $2,212 may also be assessable income of the Applicant depending upon the true construction and the effect in all the circumstances of the resolutions and declarations passed and made by Eason Pty Ltd on 29 June 1989 and 30 June 1989.
Before his Honour the parties agreed that if either question 1 or 2 was answered affirmatively, question 3 was to be answered in the same way. In its appeal Rotherwood contends that his honour erred in failing to answer all questions in the negative. If the appeal fails in respect of the answer to Question 1 it is unnecessary to consider the appeal in respect of the answer to Question 2.
It was not in issue between the parties, and it was accepted by his Honour, that in the latter part of 1988 it was apparent to landlords and tenants, both actual and prospective, that by reason of the number of office buildings then under construction, or about to be constructed, in the central business district of Perth, it was likely that the area of lettable office space available in 1990 would substantially exceed demand. As a result the owners and developers of the new buildings began to offer inducements to prospective tenants to encourage them to agree to take leases of the office space to become available when the buildings were completed. The inducements took the form of cash payments, reduced rentals, rent-free periods, subsidization of fitting-out costs and like benefits.
His Honour accepted the following evidence of Mr Glass, a property consultant employed by Armstrong Jones who had been personally involved in persuading Chancery Services and its sub-tenant, Freehills, to re-negotiate the lease of the space it then occupied:
"...the time seemed opportune to approach Chancery to again attempt to gain extended tenure from them.
...
I was concerned about losing Chancery as anchor tenant and the further risk that the departure of Chancery (and with it FHP) could initiate a domino effect resulting in the loss of more tenants from the building. These losses could have stigmatised the building making it extremely difficult to lease to new tenants resulting in a deterioration of the value of the property.
...
The leasing market at that stage was already showing signs of fiercer competition.
My intent was to extend the existing tenure, but I knew that this would not be considered without something in return.
...
As at December 1988, there were a number of new buildings under construction in the Perth central business district, namely the QV1 building, Central Park and Exchange Plaza. Others had been recently completed...and there were yet others on the drawing board...Competition to attract tenants was becoming fierce, especially to attract tenants of the calibre of FHP. The cost associated with refilling the space left by FHP and others (in particular the loss of rent while waiting to secure other tenants, and the incentive that would have had to have been paid to secure other tenants) would have been substantially greater than the amount offered."
("FHP" referred to Freehills.)
In his evidence Mr Glass stated that the loss of Chancery Services as the "anchor tenant" would have had an immediate and detrimental effect on the value of the William Street building, the prospective fall in value being said to be in excess of $6 million.
In about October 1988 Freehills had been offered an
inducement by the developer of the QV1 building then under construction, to take a lease in that building upon its completion. The offer to Freehills was expressed in the following terms:
".the discharge of Freehills' remaining current debt in relation to the fit-out at 15-17 William Street, estimated at $750,000;
.indemnifying Freehills for the cost of all rentals, outgoings and charges in relation to the Old Lease until 31 October 1992 (being the expiry date of the initial term of the Old Lease) from the date of commencement of the proposed lease at the QVI building; and
.payment to Freehills of the sum of $3 million with a condition expressed in the following terms 'This amount would be negotiated to suit both parties to optimise tax effectiveness and could be taken by you as rent free periods, fit out costs, rental subsidies, etc. etc.'"
His Honour noted that in anticipation of that offer an internal memorandum dated 12 July 1988 prepared by one of the partners of Freehills expected that Freehills would be offered an "arrangement (presumably financial) for what we were stuck with here in terms of the residue of our lease".
His Honour accepted the evidence of a licensed valuer, Mr Burvill, that the lease held by Chancery Services had no marketable value at the time of its surrender. His Honour also accepted Mr Burvill's evidence that the market rent for the premises at the time of the surrender and the grant of the new lease was $265-275 p.s.m. per annum and that the rental payable under the new lease of $300 p.s.m. per annum was significantly higher than the projected market rate for May 1989 the date at which a rent review had been scheduled to be conducted under the surrendered lease. Those findings by his Honour were incidental to but not the foundation for the grounds on which his ultimate answers were based.
How the figure of $6 million was calculated by Colpenarm and the new rental set at $300 p.s.m. per annum is explained in a memorandum prepared by Mr Glass for his superior:
"It is vital to retain Freehills as the major tenant on a longer lease term and, at the same time, set a new rental precedent for the building of $300.00 per square metre per annum exceeding the previous highest full floor rental rate of $270.00 per square metre per annum by $30.00 per square metre per annum which, in turn, off-sets a major portion of the level of inducement. ...
The inducement to secure this commitment from Freehills is a $6 million cash contribution to be paid 1 January 1989. This amount quotes (sic) to $1209 per square metre and is consistent with inducements currently being offered by the developers of QVI and Exchange Plaza."
His Honour found, and it was not in issue in the appeal, that it was the business of Chancery Services to provide services to the legal practice conducted by Freehills and to do so by acquiring, by lease or otherwise, real and personal property; by acquiring personal and other services; by making available that property and those services to Freehills for reward, and by disposing of that property and those services when Freehills no longer required Chancery Services to provide that property or those services to the firm.
His Honour held that in receiving the sum of $6 million from Colpenarm "Chancery Services derived a profit...in a business operation and commercial transaction carrying out a profit-making scheme" and "derived a profit or gain from an extraordinary but profit-making transaction undertaken in the course of its business". Further, his Honour stated that if "Chancery Services had not been carrying on a business then, for the same reasons..., the receipt of this money would have been assessable income in Chancery Services' hands as income according to ordinary usages and concepts". His Honour did not accept that the receipt represented the realization of a capital asset in an enterprising way.
His Honour did not find that the sum had been received in the ordinary course of the business of Chancery Services. After having regard to the decision of this Court in Commissioner of Taxation v. Hyteco Hiring Pty. Ltd. (1992) 39 F.C.R. 502 his Honour was not persuaded that the sum received by Chancery Services for the surrender of the lease was part of a transaction that was an ordinary incident of its business. Although his Honour was satisfied that the "disposal, by surrender, of the leasehold estate was part of a carefully planned business operation carried out in the course of the business of profit-making", his Honour was "not inclined to find that the surrender of the lease...was in the ordinary course of Chancery Services' business".
The appellant contended that on any one of the following grounds the conclusion that the sum received by Chancery Services constituted income was erroneous.
.As stated in the deed of surrender the sum received by Chancery Services was consideration for the surrender of the lease, a capital asset, and, therefore, it was a receipt of a capital nature.
.For the receipt to be characterized as income it had to be related to an income-earning activity.
.The "activity" undertaken by Chancery Services was the mere realisation of an asset which involved negotiating the best price payable for the asset.
.The lease was not an asset acquired by Chancery Services for resale at a profit.
.The disposal of the lease was not the disposal of an asset in the course of the business of Chancery Services but was a disposal effected for the purpose of putting an end to that business.
The appellant's submissions may be dealt with compendiously.
The question whether the sum of $6 million paid to Chancery Services was in the nature of a revenue receipt had to be determined by considering the circumstances relevant to the receipt of that sum by the payee and not by determining the character payment as paid by the payer. (See: Scott v. Commissioner of Taxation (1966) 117 C.L.R. 514 at 526; Hayes v. Federal Commissioner of Taxation (1956) 96 C.L.R. 47 at 55.) Of course, absence of consideration for the payment may make the motive of the payer a fact relevant to the characterisation of the payment received. (Federal Coke Co. Pty. Ltd. v. Federal Commissioner of Taxation (1977) 34 F.L.R. 375 per Brennan J. at p.403.)
Where a sum paid or received is described as the consideration for a contract, the description applied to the sum by the parties to the contract is to be given some weight but it does not follow that the character of the payment as made by the payer, or as received by the payee, is determined by that description. (See: Cliffs International Inc. v. Commissioner of Taxation (1979) 142 C.L.R. 140.) The description of the payment in the contract may be only part of a matrix of facts from which the character of the payment, as paid or received, is to be determined. (See: Reuter v. F.C.T. (1993) 93 A.T.C. 5,030 at 5,036; Commissioner of Taxation v. Cooling (1990) 22 F.C.R. 42 per Hill J. at 53.)
That is not to say that the process of characterization permits documents recording or describing the payment made or received to be disregarded as if the transaction recorded therein were a sham. What is said is that the Court is required to look at the circumstances as a whole and not restrict itself to consideration of the form of a document in which the payment is recorded or the words chosen by the parties to describe the payment. (See: S.P. Investments Pty. Ltd. as trustee for L.M. Brennan Trust v. Federal Commissioner of Taxation (1993) 112 A.L.R 443 per Hill J. at 456.)
There was ample evidence before his Honour to support the finding that Chancery Services, Freehills and F.H.P. participated in a mutual arrangement to organize their affairs to deliver a gain to Chancery Services.
It is plain on the evidence before his Honour that neither the acceptance by Colpenarm of the surrender of the lease by Chancery Services nor the payment of a sum to Chancery Services to obtain that surrender would have occurred unless an arrangement was already in place pursuant to which F.H.P. would take a new lease for an extended term with Freehills as sub-lessee, F.H.P. replacing Chancery Services as lessee and sub-lessor at the request of Freehills.
Chancery Services did not receive the payment for the surrender of the lease as consideration for the disposal of that asset under an independent transaction. The surrender was an integral part of an arrangement under which the payment of the surrender fee operated as an incentive to the parties associated with Chancery Services to enter a new long-term lease at an increased rental with like obligations undertaken by Freehills as sub-lessee.
Chancery Services, Freehills and F.H.P. shared common directors or controllers and may be taken to have operated under a shared motive. (See: Federal Coke at p.402 per Brennan J.)
In that circumstance it was the participation by Chancery Services in the arrangement that secured the payment of the surrender fee. Chancery Services' part in the arrangement was to execute the surrender to obtain the gain on offer by reason of the arrangement.
Given that his Honour was satisfied that it was part of the business of Chancery Services to dispose of property according to its utility as determined by Freehills, it should have followed that the circumstances described above were incidents in the ordinary course of the business of Chancery Services stamping the sum received for the surrender with the character of revenue within the meaning of sub-s.25(1). It was the business of Chancery Services to serve the practice conducted by the Freehills partnership, including negotiating terms of occupancy under which Freehills could be a sub-lessee, and if surrender of the lease under which Chancery Services was Freehills' sub-lessor was necessary to advance the interests of Freehills, it was part of the business of Chancery Services to carry out that step. The fact that the surrender of the lease for that purpose was coincident with the termination of Chancery Services' services to the partnership meant that the surrender could not be isolated and identified as a mere act of disposal of an asset in the winding-up of a business.
Furthermore, upon his Honour being satisfied that the surrender of the lease was a profit-making transaction undertaken in the course of its business, a conclusion open on the facts, the question whether the particular transaction was unusual or extraordinary by reference to transactions in which Chancery Services usually engaged became irrelevant. It was sufficient that it was a profit-making transaction undertaken in the course of its business. (See: Commissioner of Taxation v. Myer Emporium Ltd. (1987) 163 C.L.R. 199 at 215.)
In any event, as found by his Honour, the whole transaction was a business operation to carry out a profit-making scheme and either under the concepts of income according to ordinary usage or the express provisions of s.25A of the Act the receipt was assessable income in the hands of Chancery Services.
In the words used in Myer Emporium at p.216, by no stretch of the imagination is it possible to describe the arrangement, or the surrender of the lease standing on its own, as the mere realisation of a capital asset. The surrender was not unrelated to, and independent of, the other elements of the arrangement involving F.H.P. and Freehills. Chancery Services would not have offered the surrender unless those other elements of the arrangement were in place. The surrender was one step in a set of integrated steps designed by Chancery Services, F.H.P. and Freehills to take advantage of extraordinary market conditions and provide to Chancery a sum described as a fee payable for the surrender of the lease. The sum so generated and received represented a gain to Chancery Services produced by the arrangement not a sum produced by mere realization of a capital asset.
In those circumstances neither the fact that the lease was a capital asset nor the fact that Chancery Services did not acquire the lease for resale at a profit had any bearing on whether the sum received by Chancery Services could be characterised as a revenue receipt.
His Honour found correctly that the surrender fee was a receipt in the nature of income and the affirmative answers to Questions 1 and 3 which followed must stand. As stated earlier, Question 2 does not fall to be considered and his Honour's answer to that question also stands.
I certify that this and the preceding (22) pages are a true copy of the Reasons for Judgment of his Honour Justice Lee.
Associate:
Date:
IN THE FEDERAL COURT OF AUSTRALIA )
)
WESTERN AUSTRALIA DISTRICT REGISTRY )
)
GENERAL DIVISION ) No. WG99 of 1994
ON APPEAL FROM A JUDGE OF THE FEDERAL COURT OF AUSTRALIA
B E T W E E N:
ROTHERWOOD PTY. LTD.
Appellant
- and -
THE FEDERAL COMMISSIONER OF TAXATION
Respondent
REASONS FOR JUDGMENT
CORAM: SPENDER, LEE and O'LOUGHLIN JJ.
DATE : 29 FEBRUARY 1996
PLACE: PERTH
O'Loughlin J: I have had the advantage of reading the Reasons for Judgment of Lee J. I agree with those reasons and have nothing further to add.
I certify that this is a true copy of the Reasons for Judgment of Justice O'Loughlin.
Associate
Dated:
APPEARANCES
Counsel for the Appellant: D.H. Bloom Q.C.
A. Robertson
Solicitors for the Appellant: Freehill Hollingdale & Page
Counsel for the Respondent: S. Owen-Conway Q.C.
P.R. Macliver
Solicitors for the Respondent: Australian Government Solicitor
Dates of Hearing : 20 and 21 March 1995
Date of Judgment : 29 February 1996
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