Commissioner of Taxation v Eastern Nitrogen Ltd B29/2001 [2002] HCATrans 22 (15 February 2002)

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry

Brisbane No B29 of 2001

B e t w e e n -

COMMISSIONER OF TAXATION

Applicant

and

EASTERN NITROGEN LTD

Respondent

Application for special leave to appeal

GAUDRON J

McHUGH J

TRANSCRIPT OF PROCEEDINGS

AT SYDNEY ON FRIDAY, 15 FEBRUARY 2002, AT 10.23 AM

Copyright in the High Court of Australia

MR G.J. DAVIES, QC: If the Court pleases, I appear with my learned friend, MR P.M. FRASER, for the applicant. (instructed by the Australian Government Solicitor)

MR A.H. SLATER, QC: If the Court pleases, I appear for the respondent. (instructed by Minter Ellison)

GAUDRON J: Yes, Mr Davies.

MR DAVIES: Your Honours, this is a small point. It arises out of the decision that the fees incurred for entering into the sale and lease-back transaction were on revenue account, the fees being a fee for a valuation of the plant and a fee that was charged by Macquarie Bank for setting up the transaction.

GAUDRON J: Does that though not necessarily depend on identifying the nature of the transaction?

MR DAVIES: Yes, your Honour, in our submission, it does.

GAUDRON J: And is not that now conclusively dealt with by the decision of the Full Federal Court in respect of which we have just refused special leave to appeal?

MR DAVIES: Yes, your Honour, in our submission, it does.

GAUDRON J: And, therefore, is not the point you raise - - -

MR DAVIES: And, therefore, your Honour, we should be granted special leave.

GAUDRON J: No, no. I am thinking the other way around.

MR DAVIES: Can I explain that, your Honour? It is now conclusively determined that the transaction involved the sale of the plant, a lease-back of the plant and the obtaining by the vendor, the respondent, of the sum of $71.4 million permanently.

GAUDRON J: And you say because it was the sale it is on capital?

MR DAVIES: Yes, your Honour, indisputably.

GAUDRON J: Was the matter put like that in the Federal Court?

MR DAVIES: Yes, it was found to be like that by his Honour Justice Drummond at first instance, your Honour. Your Honour will see at page 18 at paragraph 48 - - -

GAUDRON J: But that finding was premised on it being a sale?

MR DAVIES: Your Honour will see that his Honour found that these fees were on capital account because, in his words, they:

were all incurred by Eastern Nitrogen for the purpose of the sale and lease back transaction, ie, to facilitate, in part at least, the disposal by Eastern Nitrogen of its capital asset.

GAUDRON J: And how was it dealt with in the Full Federal Court?

MR DAVIES: The Full Court deals with it on page 100, your Honour, in paragraphs 124 and 125. In paragraph 124 the court refers to Part IVA and then says that the payment of the fees were not in themselves a "scheme". His Honour then says:

In my view, the proper characterisation of the transaction was that of a financing arrangement. This particular type of financing arrangement was a "one off" in the sense that it was the first time that the appellant had entered into a transaction in this form.

Now, what his Honour then does is to go on and consider the question of deductibility without having regard to the form.

GAUDRON J: Now, even on your argument though, it would not all be on capital account, would it? The valuations might be.

MR DAVIES: Your Honour, in our submission, because the establishment fee was set up for the combined purpose of the sale, the lease-back and the obtaining of the $71.4 million, which does not involve a loan, it would all be on capital account.

GAUDRON J: None referable to the lease component? The valuation I would think not.

MR DAVIES: But, your Honour, the rental payments were made, as the court found, to obtain the periodic use of the lease, not the establishment fee. So that there you have the revenue outgoings, obtaining the use of the plant, and what their Honours fail to do in paragraph 125 is that they fail to consider the rights and obligations created and conferred by the constituent documents and deal with the matter solely as though this was simply a financial arrangement that had been entered into recurrently. Your Honour, we know that this could not have been entered into recurrently. It involved the sale of the ammonia plant.

McHUGH J: I think there is much force in what you say, Mr Davies, but really is not this one of the questions, nevertheless, that should be left in the Full Court of the Federal Court as the final tribunal in most tax cases? What is so special about this that we should take the case up? I mean, I appreciate the force of your argument and, prima facie, it seems to me to have some merit.

MR DAVIES: I understand what your Honour is saying because, on the face of it, it is really quite a small point and was always dealt with as part of the conduct of the cases as one of the small points, but these things arise out of it, your Honour. The first thing we say is that it is plainly and manifestly wrong. The second is, your Honour, that it - - -

GAUDRON J: Well, prima facie, there is an internal inconsistency in the judgment, is there not?

MR DAVIES: I was going to say that. Within the judgment itself, your Honour, there were two questions of characterisation. The first related to these fees and the other related to the characterisation of the rental. Now, in determining the characterisation of the rental fees, their Honours pointed out that what was being paid for was the use of the plant, so that with - - -

GAUDRON J: Yes, I think, Mr Davies, we would like to hear from Mr Slater at this point.

MR DAVIES: Thank you, your Honours.

MR SLATER: If your Honours please. Perhaps I should deal firstly with this suggestion that the matter is one which is apparent or, as my friend would have it, manifestly wrong. That depends on what characterisation one adopts of the outgoings and what role they play in the conduct of the taxpayer's business. The evidence was, quite clearly, that the taxpayer had a need for external finance of different types from time to time and it raised it in different ways from time to time.

The occasion which led to this transaction was the need for finance of a more enduring character for reasons which had to do with the taxpayer's apprehension that if it did not have more enduring finance, it would have a lower credit rating and it might also have difficulty in rolling over the bills that it had previously used, simply because there might not be somebody in the market who would take them up.

McHUGH J: Is this a BP-type case, is it?

MR SLATER: It is a BP-type case, your Honour.

McHUGH J: It may be a one-off transaction but it is just another way of - - -

MR SLATER: It is a one-off transaction if one has regard only to the form of the particular transaction, but in the context of the whole business it was one of a series of activities by which the taxpayer raised debt finance. When one then is dealing with whether this was to stand slightly on one side of the border or slightly on the other, that, in our submission, is purely a question of fact. As Lord Denning said, it is a matter on which different minds may, with equal propriety, come to different conclusions. The speeches in the Privy Council in BP make that very clear indeed. It is not a matter of principle. It is a matter in which, as their Lordships said, one can pick up felicitous phrases from previous decisions on either side of the line and seek to apply them to the instant case in different ways.

GAUDRON J: All that may be true, but ultimately one cannot escape, can one, the fact that there was a sale?

MR SLATER: No, one cannot escape the fact that there was a sale but the question - - -

GAUDRON J: And that this was part of the cost associated with the sale?

MR SLATER: No, your Honour, it was part of the cost associated with the financing transaction which this comprised. It is possible to look at it in different ways. One can look at it by saying the most important connection is between the act of sale and the fees which are paid, or one can look at it by saying the most important connection is between the fees which were paid and the means which were used to raise finance. That is a balancing exercise. It is purely a question of characterisation of the facts for the purpose of the instant transaction and we would respectfully say that - - -

GAUDRON J: Where does this balancing take place in the Full Court?

MR SLATER: In so far as it takes place at all, I might say to your Honours that - - -

GAUDRON J: That seems to be the problem, does it not?

MR SLATER: I might say to your Honours that this issue merited one paragraph in the submissions at first instance, in the written submissions, one paragraph in the submissions in the Court of Appeal on either side.

GAUDRON J: So it will not take long if special leave is granted?

MR SLATER: No, your Honour. If special leave is granted, your Honour is going to hear from me at great length. But it was a vestigial issue below. It was treated, in effect, as just flowing with the rest of the case. Now, the consideration of it - and my learned friend has taken your Honours to it - - -

GAUDRON J: Well, it may have been treated as flowing with the rest of the case but the flow is not necessarily apparent in the decision, is it?

MR SLATER: Only to this extent, your Honour, that in the passage which my learned friend directed the Court's attention to on page 100 of the application book, it is considered by his Honour starting at page 99 where he addresses the sole issue in that appeal and sets out the trial judge's conclusions, sets out the two contentions at the top half of page 100 and his reasoning appears in the bottom half of page 100 under that heading. His Honour Justice Carr, with whom the other members of the court agreed, came to the conclusion that:

the proper characterisation of the transaction was that of a financing arrangement. This particular type of financing arrangement was a "one off" in the sense that it was the first time . . .

However, the evidence was that on a regular annual basis the appellant raised funds for the purposes of its business. Its business was seasonal or cyclical . . . In my view, given this element of regularity and the use made of the finance raised, these fees were allowable deductions because they were either incurred in gaining or producing assessable income, or were necessarily incurred . . . I do not regard any part of the fees as being outgoings of capital or of a capital nature. They were necessarily incurred as part of a fund-raising arrangement which was engaged in recurrently. They were thus on revenue account.

That is his Honour's conclusion on a factual characterisation question. May I remind your Honours that the amounts involved in this application are not the $70 million that is the subject of previous application, but two amounts of $40,000 and $50,000.

McHUGH J: Are there not 247 of these transactions? Is there not an affidavit somewhere I saw?

MR SLATER: There is a tendentious and unsupported affidavit filed on my learned friend's part but no, your Honour, there is no suggestion that there are any other cases similar to this, not on this point certainly.

McHUGH J: What does your submission come to? Is it that it is only a question of fact, that you cannot say as a matter of law this payment must be characterised as a capital payment?

MR SLATER: In essence, that is our submission, your Honour.

McHUGH J: Yes.

MR SLATER: I mean, I heard what fell from your Honour during my friend Mr Durack's address and I think he heard it at length, your Honour, but this, quintessentially, is a question of fact. Its characterisation is just a matter of weighing up all the facts and saying, "Which way does the balance tip?". It would be our respectful submission that that is not the sort of case that this Court is here to hear.

It was in the fifties when such matters came to this Court as of right, and the Court was often troubled with them and cases like Hallstroms v The Commissioner, BP Australia, which was heard in this Court before it went to the Privy Council, and all of those required the Court to exercise the fine balancing of judgment that is required but, in our submission, there is no issue of principle in this. It is, as the presiding Judge said in dismissing the previous application, simply the application of settled principle to particular facts and that, in our submission, is not something which warrants a grant of special leave and I can put it no higher than that, your Honours.

GAUDRON J: Yes, Mr Davies. Now, we cut you short before, so do not feel inhibited in reply.

MR DAVIES: We say, your Honour, that there were two errors, that it is not simply a question of fact, but there are two errors, one of which is apparent from the decision itself. Would your Honours go to page 87. This is coming close to the conclusion that the rental payments are deductible. In paragraph 64 line 16 his Honour says in relation to the rental payments:

The main advantages were the uninterrupted use of the ammonia plant for the appellant's business and the use of the funds representing the proceeds of the sale of that plant, also for the purposes of that business. The rent payments were made recurrently to secure the continued enjoyment of those advantages.

When your Honours go to the dealing with the fees in relation to the same transaction, his Honour does not mention the first of those main advantages in relation to the transaction which is dependent upon there having been a sale of the legal title and the lease-back.

McHUGH J: So, the way the Full Court seems to have looked at it is that, in effect, the fees that were incurred were part of the company's business because from time to time it raised finance and this was just another method of raising finance and, therefore, it was on revenue account just in the same way as in BP the payment of the lump sum for the one brand was regarded as on revenue account, notwithstanding it was quite different from the way that in previous years oil companies had conducted their business.

Can you say that as a matter of law there is only one conclusion open on this and that is that it is on capital account, or is it not a question of looking at all the circumstances of the transaction and the company's business and saying, as a matter of fact, it is one or the other? I mean, if you get special leave you have to be able to say, have you not, that there is a question of law involved here?

MR DAVIES: Well, in our submission, there is a clear question of law and that is that in respect of the characterisation of the rental payments, their Honours took into account the rights and obligations conferred and created by this particular transaction. In dealing with the characterisation of the fees, their Honours did not. A balancing exercise from my learned friends was entered into but there is nothing in the judgment, your Honours, that indicates why in respect of one characterisation the rights and obligations should be taken into account, whereas in relation to the others they should not. Our submission was that they ought to have been taken into account and if one does that in relation to the second set of fees, the valuations, then they are clearly on capital account.

The next matter, your Honours, is that, in our submission, it was a departure from principle simply to have regard to use and recurrence. It is true that recurrence and use are things that ought to be taken into account, but at the end of the day, what the inquiry is with this type of characterisation of this type of expense is to determine whether the raising of the finance takes place in order to finance the business operations, in which case it is on capital account, or whether they actually take place as part of the day-to-day activities of the business.

Your Honours will see in our submissions we have recurred to Avco and Coles Myer Finance. Can I take your Honours very briefly to a decision of the Full Court, which is Federal Commissioner of Taxation v Hunter Douglas.

McHUGH J: Well, the question of law, I suppose, that you seek to raise is that raised in ground 4 of your notice of appeal, is it not, that:

The Court should have held that the characterisation of expenses incurred in raising finance depends on whether the funds raised are capital or trading stock - - -

MR DAVIES: Yes, your Honour. That is so.

GAUDRON J: I do not think you need to - - -

MR DAVIES: Thank you, your Honours.

GAUDRON J: Mr Davies, we propose to grant special leave, but does the draft notice of appeal correctly raise what you want to raise?

MR DAVIES: Yes, paragraphs 4 and 5 I am content with, your Honours.

GAUDRON J: Very well. Thank you. There will be a grant of special leave and despite Mr Slater's assurances to the contrary, I shall assume it is a very short matter.

AT 10.45 AM THE MATTER WAS CONCLUDED