Pub Charity v Department of Internal Affairs
[2013] NZHC 3311
•12 December 2013
IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY
CIV 2012-485-705 [2013] NZHC 3311
UNDER The Judicature Amendment Act 1972, Part 30 of the High Court Rules, and the Declaratory Judgments Act 1908 IN THE MATTER OF
an application for judicial review and/or for a declaratory judgment
BETWEEN
PUB CHARITY Applicant
AND
DEPARTMENT OF INTERNAL AFFAIRS
Respondent
Hearing: 2 December 2013 Counsel:
F M R Cooke QC and M S Smith for Plaintiff
K M Muller and N C Anderson for DefendantJudgment:
12 December 2013
JUDGMENT OF SIMON FRANCE J
Introduction
[1] These proceedings concern the Gambling Act 2003. Pub Charity is one of the largest participants in the gaming machine industry. It is in dispute with the Department of Internal Affairs as to how the purchase price of gaming machines is to be recognised when calculating the net proceeds of its gaming operation. There are many other areas of dispute between the parties, but this decision relates only to that
narrow issue, the resolution of which will affect all class 4 licence holders.
PUB CHARITY v INTERNAL AFFAIRS [2013] NZHC 3311 [12 December 2013]
[2] It is appropriate first to set out the definition of net proceeds prior to identifying the issues. Net proceeds is defined in s 4 of the Act:
net proceeds, in relation to gambling, means the turnover of the gambling plus interest or other investment return on that turnover plus proceeds from the sale of fittings, chattels, and gambling equipment purchased from that turnover or investment return less—
(a) the actual, reasonable, and necessary costs (including prizes), levies, and taxes incurred in conducting the gambling; and
(b) the actual, reasonable, and necessary costs incurred in complying with whichever of the following apply to the gambling:
(i) this Act or any other relevant Act: (ii) an operator's licence:
(iii) a venue licence
This definition can be partitioned, for analysis purposes, into Part A, being all that precedes the word “less” and which identifies what constitutes the income portion of a gambling operation, and Part B which is the rest. Part B identifies what are permissible costs in running the gambling operation.
[3] The issues initially for resolution were:
(a) whether the purchase price of a gaming machine is an expense that forms part of the net proceeds calculation;
(b)if so, in the year of purchase, is the relevant figure to be expensed the full purchase price of the machine, or is it a lesser sum being a depreciation figure calculated in accordance with conventional accounting practice; and
(c) if it is part of the net proceeds calculation, is the purchase price of a gaming machine an expense that reduces the gross proceeds (Part A) figure, or is it to be treated as a cost of business and considered under Part B of the net proceeds definition.
[4] The first issue is no longer in dispute, it being common ground that the purchase price is a cost that is properly included in the net proceeds assessment.
Issue one – is the whole of the purchase price to be expensed in the year of purchase, or must it be subject to a depreciation regime?
[5] Pub Charity submits that the Act requires that the whole of the purchase price be claimed as a cost in the year of purchase. The Department rejects that, saying a gaming machine is an asset that must be treated in accordance with generally accepted accounting principles. Those principles require the cost of purchase to be depreciated over the life expectancy of the asset.
[6] The correct approach to statutory interpretation issues is not in dispute, with reference typically being made to the observations of Tipping J in Commerce Commission v Fonterra Co-Operative Group Ltd:1
[22] It is necessary to bear in mind that s 5 of the Interpretation Act 1999 makes text and purpose the key drivers of statutory interpretation. The meaning of an enactment must be ascertained from its text and in the light of its purpose. Even if the meaning of the text may appear plain in isolation of purpose, that meaning should always be cross-checked against purpose in order to observe the dual requirements of s 5. In determining purpose the Court must obviously have regard to both the immediate and the general legislative context. Of relevance too may be the social, commercial or other objective of the enactment.
[7] In relation to the present issue I consider it is a significant contextual fact that the method proposed by Pub Charity is not consistent with ordinary accounting standards. The Department filed unchallenged evidence to this effect from Mr Barry Jordan, a partner in the accounting practice, Deloitte. He deposes that both the applicable sets of international accounting standards – GAAP (generally accepted accounting principles) and NZIFRS (New Zealand International Financial Reporting Standards) – require not-for-profit organisations to treat the cost of a capital asset as
an expense over its estimated useful life.
1 Commerce Commission v Fonterra Co-operative Group Ltd [2007] NZSC 36, [2007] 3
NZLR 767 (citations omitted).
[8] This lack of symmetry with normal accounting standards is not fatal to Pub Charity’s case if the Act prescribes a different approach. In this regard Mr Cooke QC points to the actual issue in Commerce Commission v Fonterra Co-Operative Group Ltd. In dispute was the meaning of “cost of capital” in the Dairy Industry Restructuring (Raw Milk) Regulations 2001. There was evidence that accountants would normally see capital, used in such a context, as meaning the “weighted cost of capital”. The Supreme Court emphasised that what was required was an interpretation of the Regulations to ascertain if that was the meaning intended when the word was used. Other meanings were possible and so the exercise was one of correctly discerning the intended meaning. The Supreme Court concluded a meaning other than that which accountants might attribute to the term was the correct interpretation. Mr Cooke contends that similarly here, the fact that depreciation would be the normal way of expensing the purchase price is not conclusive.
[9] I accept that contention. However, that does not detract from it being significant that what Pub Charity proposes is the Act mandating a treatment of assets that is contrary to international standards. Ms Muller submits that this cannot be correct for several reasons. First, under the preceding legislation assets were treated in the normal way and depreciated. This was done by way of Department mandate, through licence conditions, rather than by legislation, but it still means that the 2003
Act would be effecting a significant change. It is submitted there is nothing in the legislative history to suggest this was intended. Second, the Secretary for Internal Affairs is obligated to assess the financial viability of licensees, both at the time of the initial grant, and on renewal. Mr Jordan’s evidence is that a depreciation system provides a better base for such analysis, since it smoothes out fluctuations, and allows for better forecasting. Accordingly, the existing system of depreciation better facilitates the carrying out of the Secretary’s statutory functions. Third, s 108 of the Act requires that financial statements in the annual report be prepared in accordance with generally accepted accounting practice. This is submitted to be a strong indicator that the Act was not mandating a different approach for the calculation of net proceeds.
[10] Pub Charity’s argument is three-fold:
(a) Depreciation is not an “actual” cost within the meaning of the word as used in the definition of net proceeds. It is a notional cost and, therefore, not permitted.
(b)The purpose and scheme of the Act is to move away from the previous approach and focus on tracing the cash, a method that promotes transparency.
(c) The concerns about non-compliance with generally accepted accounting practice are misplaced because the dispute has nothing to do with the preparation of financial statements and the annual report. The calculation of net proceeds in accordance with a statutory formula is a separate exercise.
[11] In support of Pub Charity’s contention that a depreciation is not an actual cost, Mr Cooke refers to another passage from Commerce Commission v Fonterra where Tipping J observes:2
... The concept of a plain and ordinary meaning does not involve the Court having recourse to external sources such as expert evidence and textbooks. If the Court has to do that there can hardly be a plain meaning. If one has to go outside the immediate text in this way, there is no logical reason to stop there. Any suggestion of a plain meaning must then evaporate.
Relying on this it is submitted that a notional cost is not within the plain meaning of
“actual”.
[12] It is further submitted that the Department’s evidence to the opposite effect
misses this point. Mr Jordan in his affidavit states:
Depreciation is an allocation of the actual cost of an asset over its estimated useful life in circumstances where the economic benefits derived from that asset are expected to span greater than one year. The cost of an asset is exactly what has been incurred in purchasing it and selling it into a position where it can be used.
2 At [23].
[13] Pub Charity’s response to that statement is that it does not overcome the reality that in a depreciation regime, in the year of outlay the actual cost was different from that being expensed, and in the subsequent years there is no actual outlay at all.
[14] I do not consider this riposte avoids the fundamental difficulty for Pub Charity that it in no sense strains the language of the Act to regard a depreciation expense as an actual cost within the ordinary meaning of the word. There is an actual outlay of money and in my view the fact that it is only being expensed over say four years does not mean the depreciation figure does not reflect an actual cost. The machine has been purchased. The money has been spent; an actual cost has been incurred. I consider this makes the depreciation cost one that “exists in fact” or
“is real”.3 I consider it too narrow to say that the use of the word actual excludes per
se depreciation costs.
[15] Nor do I accept Mr Cooke’s submission that the whole purchase price and the depreciation figure cannot both be actual costs in relation to the same item. What the Act requires is that a cost be actual, in the sense that it “must be incurred”, and be reasonable and necessary. A depreciation cost represents apportionment of an incurred expenditure and is thereby an actual cost. Just because recognition of the cost is spread over four years does not make it any less of an actual cost that has been incurred.
[16] If this view is correct, the situation is that:
(a) the Act allows depreciation to be claimed as a cost;
(b)depreciation is the internationally approved, and indeed required, method of dealing with such assets; and
(c) depreciation was the method by which these assets were dealt with prior to the present Act.
[17] The second factor advanced by Pub Charity is the proposition that the scheme of the Act supports a narrow reading of “actual”. Mr Cooke first relies on the detailed statutory requirements for dealing with cash proceeds. These provisions require the venue operator to bank proceeds into a dedicated account. Thereafter the money may only be withdrawn to meet approved costs or to be distributed to the community. This detailed control of the actual proceeds leads to the more general point that the Act focuses not on the accounting concept of “profit” but rather on turnover and proceeds. Net proceeds are a product of money actually received less, it is submitted, money actually expended. It is also consistent with the scheme that the required analysis of whether an expense is reasonable and necessary is undertaken at the time of expenditure. (Depreciation does not prevent that; the purchase must still be acknowledged in the year it is made and can be scrutinised.)
[18] Next, Pub Charity submits that the reliance by the Department on the wording of s 108, and its express reference to generally accepted accounting principles, is misplaced. Section 108 is concerned with preparation of the annual report and financial statements. These properly inform the Secretary’s assessment of financial viability but they are not the net proceeds calculation. The financial statements contain the raw data needed for that calculation but do not represent the calculation itself. To illustrate that this is so, reference is made to reg 11 of the Gambling (Class 4 Net Proceeds) Regulations 2004, which allows three months following year end for final distribution of net proceeds from the preceding year. Therefore, to assess what net proceeds have been distributed, and whether the amount required has been met or bettered, a calculation separate from the financial statements is inevitably required.
[19] In terms of the implications of Pub Charity’s interpretation, it is submitted that a depreciation regime inevitably involves subjective judgements about the method to be used, and the life expectancy of the asset. These are decisions that are ill-suited to the type of regime being established by the Act. Pub Charity calls in aid the obiter observations of the Gambling Commission in An Appeal by Constellation
Communities Trust.4 The Commission there noted it had not had the benefit of any
argument on the point but expressed doubt over the correctness of using a depreciation model. It recognised the advantages of depreciation for business efficacy but noted that class 4 gambling businesses are not ordinary businesses. Instead they are constrained by the provisions of the Act. The Commission’s concerns seem based on the proposition that deprecation “is a notional rather than an
actual cost at the time in which provision is made”,5 and therefore not within the
statutory definition.
[20] The Commission is obviously a specialist body but it recognised it had not had argument on the point. For reasons already given I do not consider the focus of the Act on allowing only “actual, reasonable and necessary costs” prevents the application of standard accounting principles, nor was intended to.
[21] As regards the overall statutory scheme, once it is accepted that the use of the word “actual” does not itself rule out a deprecation regime, I do not see anything to suggest that the purpose of the Act was to define the core concept of net proceeds in a way that is contrary to recognised international accounting practice. I agree with the Department’s submission that the requirement in s 108 that financial statements be prepared in accordance with generally accepted accounting principles is significant. It would make it most unexpected to find that elsewhere the Act required proper accounting approaches to be ignored.
[22] In my view once one accepts that a depreciation expense is an actual cost within the meaning of the Act the whole issue really disappears. All one is talking about is how an asset is treated. The prescribed statutory route is the requirement that costs be “reasonable” and I agree with the Department that there is nothing to suggest either that a proper depreciation expense is unreasonable or, that a claim for
100 per cent of an asset, such claim being contrary to generally accepted accounting principles, is reasonable.
[23] This conclusion is reinforced by the advantages of requiring use of a depreciation regime. As the Commission observed, the role of a depreciation regime
is “to smooth reported periodic performance to reflect performance over the longer
5 At [54].
term”.6 The uncontested evidence filed by the Department is that a depreciation regime provides a better basis for the Secretary to carry out his statutory functions, particularly as regards assessing the financial viability of licence holders. This is another factor supporting a requirement to use standard accounting principles.
[24] The evidence has not satisfied me that either method would ultimately make a difference in terms of how much goes back to the community. However, there is a further implication of Pub Charity’s approach which the Department submits tells against its correctness. The Department submits that requiring recognition of the full cost of new gaming machines in the year of purchase will make it prohibitive for new entrants. The Regulations require licence holders to return at least
37.12 per cent of gross proceeds to the community.7 The converse of this is that in
any given year an operator’s costs cannot exceed 62.88 per cent. Achieving these figures will be beyond new entrants if in the first year of operation they must account for the full cost of gaming machines.
[25] Pub Charity responds by submitting that the difficulty for new entrants does not stem from the issue of allowable deduction. In its submission, difficulty only arises because the Department, wrongly, does not insist upon new entrants having appropriate capital backing from which they can purchase gaming machines. The Department submits this is unrealistic, and self serving (my words) because Pub
Charity is one of the few, if not only, operator that owns its machines outright.8
Most borrow and then claim the cost of borrowing as an expense.
[26] I have not found this particular dispute to be of assistance in reaching the correct interpretation. The Department obviously is in the best position to assess the impact of accounting changes on all licence holders, but I am less convinced that preserving the opportunity for new entrants is a discernible policy imperative in an area where the number of machines is capped and new entrants would inevitably be
competing for existing venues or machines.
6 At [54].
7 Glambling (Class 4 Net Proceeds) Regulations 2004, reg 10.
8 The legitimacy of the circumstances in which Pub Charity was able to achieve this situation is the subject of separate dispute. The Department contends, and Pub Charity denies, it is the product of not distributing all net proceeds as required.
[27] In the final outcome I am of the view that the answer can be found in a consideration of the wording and statutory scheme without recourse to other policy debates. For the reasons given I conclude that the purchase price of machines should be dealt with on a depreciation basis in accordance with generally accepted accounting principles.
Issue two – does the purchase price of a machine reduce the gross proceeds figure under Part A, or is it a cost to be assessed under Part B of the net proceeds definition?
[28] Regulation 10 of the Gambling (Class 4 Net Proceeds) Regulations 2004 controls how much money must be returned to the community from these operations. The figure is a minimum requirement and, as noted, is presently 37.12 per cent of the gross proceeds. That means that expenses cannot exceed 62.88 per cent. The fact that this minimum distribution obligation is linked to the gross proceeds makes this issue one of some significance.
[29] The cost of gaming machines is the largest capital investment. If that expenditure reduces the gross proceeds figure, then what must be returned to the community will be a percentage of a greatly reduced figure. Conversely if that expenditure is treated as a cost under the net proceeds calculation, then it is an expense that must be absorbed by the licence holder as part of its maximum of 62.88 per cent cost of running the operation.
[30] Gross proceeds is defined in the Regulations. There is a necessary variation in relation to the treatment of prizes, but for present purposes the definition is the same as Part A of the net proceeds definition, namely:9
... the turnover of the gambling plus interest or other investment return on that turnover plus proceeds from the sale of fittings, chattels, and gambling equipment purchased from that turnover or investment return, [less prizes].
[31] On its face the net proceeds definition in s 4 of the Act seems to establish a relatively simple equation – Part A deals with income, and Part B deals with
permitted expenditure. Within that context one would expect that the cost of
9 Gambling (Class 4 Net Proceeds) Regulations 2004, reg 3(1).
machines would fall to be considered within Part B, being the recognition of a cost that must be actual, reasonable and necessary.
[32] Other parts of the statutory scheme reinforce this. Section 104 mandates that gaming machine profits (turnover less prizes) be directly banked into a dedicated account. Those funds must then be kept in the account and applied only:
(a) to meet the costs of a class 4 gambling operation; or
(b) to distribute the funds to the community.
[33] This appears to posit a situation where once the proceeds are realised, there are only two things that can happen to them – they are expended by way of authorised costs as provided for in Part B of the net proceeds definition, or they are distributed back to the community. Given that, it is difficult to accept that the cost of machines is to be treated differently.
[34] It is, however, the wording of Part A that provides the basis for Pub Charity’s contrary interpretation. Mr Cooke focuses on the fact that the definition of net proceeds makes it plain that gaming machines may be purchased from turnover, and that when resold the proceeds must be factored back into turnover. He submits that this suggests that the treatment of the cost of buying machines lies outside the way in which all other expenditure is treated and is a Part A calculation.
[35] I consider this approach reads too much into that aspect of the definition of net proceeds. The fact that it is recognised that a gaming machine may be purchased from gross proceeds is not a requirement that machines must be bought from turnover. Rather it is recognition that the purchase of machines from turnover can be a reasonable cost. That being so, the Act just makes it plain that if the machine is then resold, the money is to come back into the equation. I also observe that if Pub Charity’s view were correct, then the process of purchasing machines would not appear to be subject to the restraints imposed by Part B of the definition – namely that the expenditure be necessary and reasonable. In an area where all use of gaming money is scrutinised, this seems an unlikely situation.
[36] I am accordingly of the view that the purchase price of a machine is a cost that is to be accounted for under Part B of the net proceeds definition as a cost incurred in conducting the gambling. That is subject, of course, to it being an actual, reasonable and necessary cost.
Conclusion
[37] The purchase price of gaming machines is a cost incurred in the course of conducting gambling. The machine itself is an asset which should be expensed by a depreciation method according to recognised accounting principles. It would not be a reasonable expense to treat the full purchase price as an expense in the one year if the machine has a longer estimated useful life. The Act does not require or provide for an alternative method.
[38] These proceedings were brought as an application for declarations. I do not consider it is necessary or appropriate to make declarations where the wording can become problematic. The import of the ruling is clear.
[39] Underlying the proceedings was a proposed suspension of Pub Charity’s licence. Orders quashing that and remitting it back were sought. Mr Cooke accepted that if I did not agree with Pub Charity’s interpretation, there was no basis for an order quashing the proposal to suspend. The other matters in dispute will need to be pursued with the Department or the Gambling Commission.
[40] The respondent is entitled to costs. Memoranda may be filed if agreement cannot be reached.
Simon France J
Solicitors:
F M R Cooke QC, Wellington
Crown Law, Wellington
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