Commissioner of Taxation of the Commonwealth v Citylink Melbourne Ltd [2006] HCATrans 2 (31 January 2006)

--

Commissioner of Taxation of the Commonwealth v Citylink Melbourne Ltd [2006] HCATrans 2 (31 January 2006)

Last Updated: 31 January 2006

[2006] HCATrans 002

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
Melbourne No M49 of 2005

B e t w e e n -

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Appellant

and

CITYLINK MELBOURNE LIMITED (FORMERLY KNOWN AS TRANSURBAN CITY LINK LIMITED)

Respondent

GLEESON CJ
GUMMOW J
KIRBY J
CALLINAN J
HEYDON J
CRENNAN J

TRANSCRIPT OF PROCEEDINGS

AT CANBERRA ON TUESDAY, 31 JANUARY 2006, AT 10.18 AM

Copyright in the High Court of Australia

MR B.J. SHAW, QC: If the Court pleases, I appear with my learned friend, MR I.B. STEWART, for the appellant Commissioner. (instructed by Australian Government Solicitor)

MR A.C. ARCHIBALD, QC: May it please the Court, I appear with my learned friends, MS M.M. GORDON, SC, MR M.N. CONNOCK and MR S.H. STEWARD, for the respondent. (instructed by Freehills)

GLEESON CJ: Yes, Mr Shaw.

MR SHAW: If the Court pleases, the - - -

KIRBY J: How are we going to resolve all these nasty factual arguments? I mean, are you going to take us through all this because they seem to stand at the threshold of this appeal, getting the facts right?

MR SHAW: Well, it is, of course, important to have the facts right.

KIRBY J: They say you got them very wrong, very wrong, and, indeed, that you are acting contrary to concessions and the way the case was argued. It is a bit of a mess. I mean, the concepts are hard enough as it is, but you do not get to them until you have the facts right.

MR SHAW: Your Honour, in relation to some matters there is no dispute and some questions clearly arise in the way that the matter was put below. Other matters there may be some dispute about. But, in our submission, there will not be any difficulty about the facts. Whether there will be a difficulty about the way in which the case was put below, we submit that that really will not matter because the objection taken to our argument seems to be an objection related to our attitude to the base case model and they say we challenge the model and we say we do not. We do not, and in our submission, it is perfectly clear we do not. All we say about the model is it is but a model, but a forecast and it has to be regarded as that rather than a document which produces any binding contractual obligations.

What one has is simply a forecast of what - in the model - about what was expected to happen when the original documents were entered into but it is perfectly clear that the assumptions that were made in forming the model may not be fulfilled and, indeed, the taxpayer called evidence to demonstrate what would happen if they were not fulfilled in some respects in some circumstances, so there is really no dispute about that.

GLEESON CJ: At all events, Mr Shaw, we need to understand the commercial arrangements relevant to this project, including the finance arrangements. I am sure that you were about to explain those to us, anyway.

MR SHAW: Yes. Your Honour, I was about to try.

KIRBY J: What does that mean, that you do not have much confidence that you will succeed to explain it?

MR SHAW: Your Honour, I am confident that I will be able to explain it. My slight doubt is whether I will be able to convince your Honour that I have.

GUMMOW J: Let us give it a go.

MR SHAW: There are two central questions. One is a question about whether under section 51 of the old Act or section 8-1 of the new Act the concession fees are deductible in 1996, 1997 and 1998 at their full face value when they are said to have accrued in those years but payment of them is to become due only when a number of conditions have been satisfied. The conditions were not satisfied in those years and they are not projected to be fulfilled until something like 2013 and when the fees do become payable they are payable without interest. The question which arises there is whether the fees are outgoings incurred in the relevant years within the sections and that includes whether or not they are referable to those years.

GLEESON CJ: As I understand it, these were liabilities that were subordinated to certain other liabilities incurred in favour of the financiers.

MR SHAW: Yes, they were, your Honour.

GLEESON CJ: And that is the reason for their deferral.

MR SHAW: Well, it is not the only reason for their deferral.

GLEESON CJ: It explains their deferral.

MR SHAW: It does not explain it all. One of the reasons they were deferred was that the fees are payable – well, from the beginning of the project and the years that the Court is concerned with were years in which there was no tolling. So although there was some interest income it was the fact that there were not any tolls to pay the fees or to pay any of the other things that had to be paid in due course in these years. The second set of questions which arises is in relation to whether or not the liability is a liability on capital account. I should take the Court to the relevant documents.

KIRBY J: If you win on the first point we are not concerned with the second point.

MR SHAW: That is so, your Honour.

KIRBY J: Is it necessary in order to get to the first point to bypass the second point, in other words, to characterise the matter as falling within section 51 to not to, as it were, exclude the capital account argument?

MR SHAW: Well, your Honour, I suppose one could first go to the capital argument and say it does not matter whether or not they fall within the first part. It is perfectly clear they are excluded by the second part, but the way in which the court has proceeded below is to look first at whether the first part of the sections were satisfied and then to say if they were, what about the capital argument? But one could do it the other way round and say - - -

KIRBY J: I am just thinking whether logically and conceptually you deal first of all by signing into capital account or revenue account?

MR SHAW: No, it is the other way round.

KIRBY J: It is the other way round?

MR SHAW: Yes. The concession deed is in the first volume of the appeal books commencing at page 150.

GUMMOW J: That is one of the instruments, is it, that is ratified and takes effect as if it had been enacted as a law of Victoria by section 14 of the Melbourne City Link Act?

MR SHAW: Yes, your Honour. The deed commences with a number of definitions including a definition of “Concession Notes” which was subsequently amended. That amendment appears in an amendment deed of 20 February 1996 and that is in volume 2 of the appeal book at page 629. That amendment deed had as an exhibit to it a pro forma concession note and that appears at page 636.

GUMMOW J: What is the commercial reason for having these concession notes? They are not promissory notes, so they are not negotiable.

MR SHAW: No, they are not promissory notes. I think they can be transferred, your Honour.

GUMMOW J: By contractual arrangement but not by the law of negotiable instruments.

MR SHAW: No, that is so, your Honour.

CRENNAN J: Are they supported by letters of credit?

MR SHAW: No.

GLEESON CJ: Could there be factoring arrangements in relation to them?

MR SHAW: If your Honour means could they be - - -

GLEESON CJ: Did they provide the State with a means of raising money itself?

MR SHAW: I think the answer to that is yes.

GLEESON CJ: Yes, which is why you would do it, I would have thought.

MR SHAW: Yes. It is difficult to see any other reason for doing it when, amongst other things, all one can say about the concession notes is they are subject to the same conditions as the concession fee was plus some added ones.

KIRBY J: Was it explained why the deed was amended or how that came about it? Is that relevant for us to know that?

MR SHAW: Your Honour, I do not think there is any explanation in the evidence, no. For present purposes of the definitions the most significant one is the definition at page 186 of “Project Debt” and the definition at page 188 of “Project Documents” and project documents, the Court will see, include the concession notes and the master security deed. At page 197 in clause 1.3 it is provided that:

(a) Subject to paragraph (b), if there is any inconsistency between a provision of this Deed and a provision of another Project Document, this Deed shall prevail.

(b) If there is any inconsistency between any provision of any Project Document and the Master Security Deed, the provisions of the Master Security Deed shall prevail.

GLEESON CJ: Is clause 1.4 on page 198 relevant?

MR SHAW: I do not think so, your Honour. At page 209 in clause 2.3 the obligations of the company and the trustee are set out. At page 224 in paragraph 2.8 it is provided that:

Subject to clause 12.3 –

and clause 12.3 is at page 308 which deals with the allocation of risk –

the State grants to the Company the right to:

(i) design;

(ii) construct;

(iii) Commission;

(iv) operate;

(v) impose and collect a toll for the use of Vehicles . . .

(vi) maintain and repair; and

(vii) raise revenues . . . in respect of,

the Link until the end of the Concession Period –

and there is a similar provision in relation to the trust. Then at page 235 in clause 3.1(a)(i) it is provided that:

The Company shall (provided the Concession Period then continues), in consideration of the State granting the concession rights set out in clause 2.8 –

and that is the clause that I was just taking the Court to, that is the right to design, construct, commission, operate, impose and collect the tolls and so on, and link –

pay to the State in the period from the date of the commencement of the Concession Period until the end of the twenty-fifth year after the date which is 6 months earlier than the Link Expected Completion Date an annual concession fee of $95,600,000, payable in equal instalments semi-annually in arrears, on the last Business Day of each June and December in that period and on the date of termination of this Deed (should termination occur in that period) with each such payment being adjusted on a pro rata basis -

Then the further clauses provide for “an annual concession fee of $45,200,000” in respect of the period from the commencement of the twenty-sixth year and the end of the thirty-fourth year, and then after that, in the next clause $1 million dollars a year, and then going over the page, in paragraph (d) “an additional concession fee” which is payable where the aggregate revenue exceeds what is projected in the base case model.

GUMMOW J: It seems to have been the obligation of the company and the trustee to, as between them and the State it was their job to arrange the finance – 2.3.

MR SHAW: Yes, your Honour. If I could then go - - -

GLEESON CJ: Are the provisions that you have just taken us to the provisions that were characterised by Justice Merkel as a profit-sharing arrangement between the State and the taxpayer?

MR SHAW: Yes, your Honour.

KIRBY J: I took that to be the purpose of the Chief Justice’s earlier question about the provision excluding a joint venture.

MR SHAW: Special leave was not given in relation to that question. The master security deed, which the Court will recall is the document which takes precedence, as it were, over the concession deed, appears in the second volume of the appeal books at page 729. It contains a provision at page 737 in clause 1.4 similar to the provision in the concession deed giving priority to the provisions of this deed in the case of any inconsistency between it and any other document including the concession deed.

At page 738, what I might call clause 1.9 appears in its old form, but the form of that clause which is presently relevant appears in an amending deed which commences at page 785 and that clause is at page 786. That provides that:

For so long as any Project Debt is owing and notwithstanding the express terms of any Project Document to the contrary, any payment to be made by the Company or the Trustee to the State under, or for breach of, any Project Document (other than payment of the State’s Priority Amount) –

and the concession fees are not –

(the “State Payment Amount”) shall be owing to the State but shall not be due for payment until sufficient money is available - - -

KIRBY J: Where is that clause, I am sorry.

MR SHAW: It is at page 786, at about point 4, line 22.

KIRBY J: I see, yes.

MR ARCHIBALD: It provides:

For so long as any project Debt is owing and notwithstanding the express terms of any Project Document to the contrary, any payment to be made by the Company or the Trustee to the State under, or for breach of, any project Document . . . shall be owing to the State but shall not be due for payment until sufficient money is available for withdrawal from the Distributions Account (as defined in the Security Trust Deed) to meet that payment in full and each of the Company and the Trustee undertakes not to apply any amounts held in the Distributions Account maintained in its name for any purpose other than payment of that State Payment Amount until the balance of the Distributions Account maintained in its name equals or exceeds that State Payment Amount to the extent that it is not in dispute and all or part of the balance has been applied by it to pay that State Payment Amount in full to the extent that it is not in dispute.”

GLEESON CJ: Where do we most conveniently find a description of the practical operation of that provision? That provision, I take it, subordinates the obligations created by the concession fee, or affecting the concession fee, to the obligations to the lenders but just at the moment it appears to me to involve two rather different concepts. One is the existence of an outstanding obligation to the financiers and also some considerations relating to cash flow.

MR SHAW: It does do that, your Honour, but your Honour asks a question which is difficult to answer and it is difficult to answer for this reason that it was contemplated that concession notes would be issued in relation to all concession fees. The concession notes were subject to clause 1.9 of the master security deed, just as every other document was, because they are project documents and in any case the concession notes contain an express provision which is to the same effect, but not only do the concession notes contain that condition, they contain other conditions which are not present in clause 1.9 which relate to the rate of equity return and to making distributions from the distributions account so that the base case model proceeds on the assumption that the way in which the various obligations will fall to be discharged will be subject to all the conditions which are present in or through the concession notes.

Your Honour has asked me a question about 1.9 by itself, as it were, and 1.9 was not intended to operate by itself, as it happens, so the base case model projects that the payment of the concession notes will commence, according to its projections, in 2013 but that is on the basis of all the obligations or the conditions to which the promissory notes are subject.

GLEESON CJ: Am I right in thinking that one of the reasons Justice Merkel saw this concession fee as a profit-sharing arrangement between the State and Transurban was that the concession fees only became payable after, to put it very broadly, the financiers had been paid out and the project was providing a certain level of return to the operators?

MR SHAW: Yes, your Honour. His Honour took the view that it was, if you like, in the form of some sort of joint venture or profit sharing, or however you might like to describe it, because the arrangements which were made provided that there should be priority given first of all to the repayment of the lenders, if you like, and, in some circumstances at any rate, an equity return would be given to the investors in Transurban before the State became entitled to, leaving out its priority amount, the concession fee.

GLEESON CJ: Another possible point of view might be that that is simply the commercial explanation of the deferral of the liability.

MR SHAW: That is true, your Honour, but for present purposes it does not really matter why. What matters is what was.

GLEESON CJ: Quite. We just have to work out the fiscal consequences of the arrangement, but there is a perfectly obvious commercial explanation of the arrangement.

MR SHAW: Yes, your Honour, there is but, for whatever reason, whatever is the commercial explanation of why the particular provisions were made in relation to payment of the fees or the notes, however one likes to regard it, the fact is that payment of them was made subject to a number of stringent conditions which had the effect that if everything went according to plan, as it were, or according to expectation, perhaps I should say, that there would be no repayment of the concession fees or the notes for something like, if you take it from the beginning, 18 years or 20 years.

What is more – and this is another indicator – the concession fees were payable whenever they became payable as it was expected, 18 years taking the first one on, without interest, which itself suggests that the amount is not owing in the sense of a debt which is due because, if it was regarded once the date fixed by the concession deed had arrived for the next semi-annual payment, if that was truly regarded by the documents as then belonging to the State, one would have expected interest to be payable on the amount, but it was not.

CALLINAN J: Sometimes the interest is capitalised in effect, is it not? How do we know that there is not a component of capitalised interest in the amount?

MR SHAW: Well, your Honour, the Commissioner attempted to make a case based on what the concession fee was for, but there was never an explanation of how that figure was arrived at. One of the experts said it was hard wired, which seems to mean it was just a given, and all that can be said about it is that if the base case financial model turned out actually to be what happens, then there will be sufficient moneys to pay all the people who need to be paid, including the State concession fees.

GLEESON CJ: Mr Shaw, just for our own convenience in writing the description of this, what is the most convenient account to be found in either of the judgments or the evidence of the commercial arrangements with which we are concerned?

MR SHAW: Your Honour, I will ask a junior to give me the pages.

GLEESON CJ: Just some useful description.

MR SHAW: Yes. So what one needs to do is to take clause 3.1 – that is at page 235 in volume 1 – and place it beside clause 1.9 at page 786, and it will be seen that clause 3.1(a) provides that:

The Company shall . . . pay to the State in the [relevant] period . . . an annual concession fee of $95,600,000, payable in equal instalments semi-annually in arrears –

and that is made subject to the provisions in clause 1.9 of the master security deed which provides that so long as any project debt is owing, any payment to be made by the company under the concession deed:

shall be owing to the State but shall not be due for payment until sufficient money is available for withdrawal from the Distributions Account . . . to meet payment in full –

So, in our submission, although the obligation in clause 3.1 is on its face an obligation to make payments every six months, because of the effect of clause 1.9 the obligation to make payment is altered and it is not to be made until the conditions in 1.9 are satisfied.

The answer to your Honour the Chief Justice’s question, I am told, is 1321 to 1331 and 1356 to 1386.

GLEESON CJ: Thank you.

KIRBY J: Is Justice Merkel’s reasons reported anywhere or not?

MR SHAW: Yes, they are, your Honour.

KIRBY J: If you can give us that in due course. That was not in your submission.

MR SHAW: If your Honour pleases. Then if I could take the Court to appeal book 3 at page 1119 running through to page 1187, there are a whole series of concession notes. If I could go to concession note 1, that provides for payment of an amount upon presentation.

GUMMOW J: Part 5 is important, is it not, “This Concession Note is transferable and does not bear interest”, on page 1121?

MR SHAW: Yes, your Honour. Then in Part 3 it is provided that:

The Payment Amount must be paid under this Concession Note notwithstanding paragraphs (b) and (c), on the date which is 33 years and 6 months after the Link Expected Completion Date (“the Expiry Date”) and this Concession Note may be presented for payment to the Company at any time after 32 years and 6 months after the Link Expected Completion Date.

So that the conditions in (b) and (c) only operate for 30 years or so. Then it is said:

If the following conditions have been satisfied at any time prior to the Expiry Date:

(i) the Equity Return . . . must be 10% per annum or more; and

(ii) the payment of the Payment Amount under this Concession Note must not result in the aggregate of the amounts paid by the Company under the Concession Notes, and of the amount payable under this Concession Note, presented in the financial year in which this Concession Note is presented, exceeding 30% of the Distributable Cashflow for the preceding financial year.

If those conditions are satisfied before the expiry date then the concession note can be presented for payment so for early payment if those conditions are satisfied.

KIRBY J: And what if not?

MR SHAW: Then you cannot present them until the expiry date, according to that.

KIRBY J: Is there any provision under the Income Tax Assessment Act in those circumstances to, as it were, gather back the deduction that has been claimed on an assumption that the conditions will be fulfilled?

MR SHAW: Your Honour, those conditions apply only until the expiry date so that at the expiry date, so far as those conditions are concerned, the obligation to pay becomes unconditional but if you go to - - -

KIRBY J: I am talking about in the meantime.

MR SHAW: In the meantime, no, your Honour.

KIRBY J: So the deduction is claimed although in the eventuality and the facts as they may occur - - -

MR SHAW: Not paid for 30 years or something?

KIRBY J: Yes.

MR SHAW: Then no, your Honour, there is not.

KIRBY J: It seems a very odd result. That is the reference to a taxpayer’s heaven.

MR SHAW: Part of the reference to the taxpayer’s heaven, your Honour. Heaven has more than one room.

KIRBY J: There are many mansions.

MR SHAW: Then, if the Court pleases, in Part 4 on page 1120 it says:

Unless clause 1.9 of the Master Security Deed is applicable to this Concession Note –

and clause 1.9 would, one would have thought, be applicable to the concession note because it is a project document –

then for so long as any Project Debt is owing and notwithstanding any express terms of this Concession Note to the contrary any payment to be made by the Company under, or for breach of, this Concession Note shall be owing but shall not be due for payment until sufficient money is available for withdrawal from the Distributions Account . . . to meet that payment in full –

So that in effect the concession note repeats the effect of clause 1.9 of the master security deed expressly, even though by reason of the provisions relating to the priority of the master security deed it would apply anyway, but the effect of that is that if any project debt remains owing then no amount is due for payment until there is enough money in the distributions account to meet the payment in full. So that if for some reason or other the project debt was not repaid, then the concession note would not be payable. That seems to be what it means.

If I could then add to that without going to it that there are some 1998 accounts of the taxpayer or financial statements in the appeal book at pages 1197 and following. The reason they are the 1998 accounts is that, although the question is a question about the allowability of the deductions in 1996, 1997 and 1998, the question arose in relation to an objection to an assessment in the 1998 years where - - -

KIRBY J: That was still a year of no tolling, was it?

MR SHAW: It was still a year of - - -

KIRBY J: So all of the years we are concerned with are years of no tolling?

MR SHAW: No tolling, but in that year there was some interest income. It was still under construction. I do not think it opened until 2000. If I could then point out to the Court that the statements of facts, issues and contentions of the parties - - -

GLEESON CJ: What was it about those accounts you were going to show us?

MR SHAW: I was not going to show you anything in particular, your Honour; I was just telling your Honour that they were there in case your Honour thought for some reason that your Honour wanted to know what the financial statements said there.

GLEESON CJ: Was there any issue in the Federal Court about the proper methods of financial accounting in relation to these concession fees?

MR SHAW: If I could answer the question this way. In the Federal Court there were only three witnesses. One of those witnesses was Mr Hope. He was an officer of Transurban, although he had not been there at the time when the various arrangements were made. His affidavit – I have the wrong name. It is Phillips. His affidavit was an affidavit which merely described the project, that is to say the link, which exhibited the various project documents. He was cross-examined and the cross-examination of all the witnesses was short. His cross-examination is in the first volume of the appeal books at pages 82 to 121.

There was an expert called by the taxpayer. He was Mr Hope, the one I muddled up before. His affidavit is in the second volume of the appeal books at page 863 and he produced a report which I will take the Court to briefly. He was cross-examined at pages 122 to 132. There was an expert called by the Commissioner. His name was Mr Tinsley. His affidavit is at page 895. He produced a number of reports, one of which is at 909 and one of which is at pages 1283 to 1287. His cross-examination commences at page 132 and goes on for about 10 pages.

If I could take the Court first of all to Mr Phillip’s cross-examination which is the most relevant to answer your Honour’s question. First of all at page 96 at line 11 he is being asked about a document – and Mr Phillips was the finance director of Transurban. At line 11 he was asked:

At the top of page 1223 you say “Due to uncertainty in determining when the concession note liability will be paid, it has not been included in the age analysis of the amounts payable detailed above”?---Yes.

. . .

Had you been able to forecast with some degree of confidence when that payment date would come, you would, I take it, have included the concession note liability in the age analysis in the appropriate category?---Yes.

At page 97 he says at line 14 and 15 that if payment of the deduction in respect of the concession note was deferred until the time of payment, the present value of the deduction was “not material”. That is at line 16. At page 100 he says at the bottom of the page that the value of the deductions in those circumstances would have been nil. That is right at the bottom of the page. Then at page 101 at line 21 he is asked:

Under (a) concession fee notes, promissory notes et cetera, the report states or the note states, “Concession fee notes are received by the authority on behalf of the state from Transurban in consideration of Transurban’s obligation to pay concession fees. The notes are accounted for in the manner normally applicable to such financial instruments, namely on a discounted basis to net present value.”

So he gave evidence that the ordinary way of accounting for such notes would be on a discounted base to net present value, but that was in cross-examination. Then at page 102 at line 26:

“Terms and Conditions: concession fee notes have an undetermined life dependent on uncontrollable circumstances.” I take it you’d agree with that description?---Yes, subject to the qualification they must be all repaid by the end of the concession.

KIRBY J: Is that strictly accurate, they must be paid? They must be paid if the conditions fall in?

MR SHAW: I think that is so, your Honour, I think that is not accurate. Then at line 32 his Honour says:

Just one moment, can I just go to page 53, Mr Phillips. When you agreed that notes were accounted for in the manner normally applicable to such financial instruments, namely on a discounted basis to net present value, is that an economic basis rather than an accounting basis or do they both merge?---I think they merge.

Then at 107 to 108 at the bottom of the page at line 43:

MR MAXWELL: The face value of the notes 3.104 - - -

HIS HONOUR: That’s 3 billion.

MR MAXWELL: 3 billion, plus 32 million cash licence payments.

Then a question is asked what the net present value is and it is said to be 233, but that is just an exchange between his Honour and Mr Maxwell. At page 121 at about line 17 Mr Phillips says that the net present value was, “Not nil, but small.”

GLEESON CJ: We happen to be dealing with the first three years of the concession while the project was still under construction.

MR SHAW: Yes.

GLEESON CJ: Is there any suggestion that the result would be different if we were concerned with the year ended 30 June 2005?

MR SHAW: Well, nobody has made that suggestion, your Honour. Everybody has proceeded on the basis that it really does not matter what year you are talking about, unless the conditions are fulfilled.

KIRBY J: It is just that you use the earlier year for forensic force because of the fact that in those years there was no tolling.

GLEESON CJ: What does it get its forensic force from if the result would be no different in the year ended 30 June 2005?

MR SHAW: Well, what I had been going to say, your Honour, was that when one looks at the case of Ash and the case of New Zealand Flax, his Honour Justice Dixon seems to take the view that in order to be properly referrable to a year then, at least in some circumstances, the appropriate thing where one has a business deduction is to look at the year in which the income is to be derived which provides for payment of the liability.

GLEESON CJ: Does that mean that a possible outcome is that our decision will not settle the issue for the years after tolls began to be collected?

MR SHAW: No, your Honour, because it should satisfy the – I am sorry. Your Honours, the Court’s decision should at least be determinative of the years up to 2013 and perhaps longer because on the base case model there was to be no payment of the concession fees until then at earliest.

GLEESON CJ: Exactly, but not because there were no tolls.

MR SHAW: No, not because there was no tolling but because the moneys were to go elsewhere. Project debt was to be repaid, for example. So that the way in which the model saw the concession fees or the notes being paid was out of later revenues because other people had earlier priorities.

GLEESON CJ: Have you given us a reference to where we find that model?

MR SHAW: Your Honour, the model is not in the appeal book. I inquired about that and I was told that you cannot really just look at it and understand it. I took that to be directed to me but I gather there is some difficulty in just being given the model.

GLEESON CJ: Thank you.

KIRBY J: But was it before Justice Merkel?

MR SHAW: It was, yes.

KIRBY J: If it was before Justice Merkel, it is part of the record and we should have it, is that not correct?

MR SHAW: Your Honour, there is a lot of material which was before Justice Merkel which is not - - -

KIRBY J: It is very kind and tender of the parties to try and protect us from irrelevant material but the model does seem to be relevant.

MR SHAW: Your Honour, the contents of the appeal book are affected by the parties’ wishes but ultimately determined by the Registrar.

KIRBY J: Are you saying that our Registrar imperiously refused to allow the model to be received?

MR SHAW: I am saying, your Honour, that if there is any blame, it is to be shared.

KIRBY J: That is generous of you.

CRENNAN J: Mr Shaw, can I ask you this. Does the model show that the concession notes within the framework of the model represent an irrevocable promise to pay having regard to the projected returns?

MR SHAW: Your Honour, I think the answer to that question is no, although I suppose it depends on how one interprets the model, but they do show the concession notes being paid. But your Honour has asked me would they show them being paid because of an irrevocable promise and they are not really directed to that question.

CRENNAN J: No, I was really asking whether the cash flow shown in the model predicts that within a certain period of time the concession notes are likely to be paid.

MR SHAW: Yes, it does. As I have said before, if the assumptions of the model turn out to be correct – and those assumptions are assumptions about traffic flow and all sorts of things like that – then the concession notes are expected to start to be repaid in, say, 2013. If the traffic flows fall off, then the model would say if they fall off by 20 per cent, then they will not start to be repaid until 2034.

CRENNAN J: So the Commissioner is concerned about the contingencies such as the project debt being repaid in relation to the promise which is represented by the concession notes?

MR SHAW: Yes. The problem with the model is that it is a projection for the future based on certain assumptions. Once you change the assumptions you get a different answer.

KIRBY J: There is nothing contingent about the deductions.

MR SHAW: There is nothing contingent about deductions.

KIRBY J: The models are contingent but the deductions are actual.

MR SHAW: The deductions are actual when they are properly to be made but that is the question.

KIRBY J: That is the question, yes. It seems an odd result.

GLEESON CJ: When do you say they are properly to be made, assuming they are on revenue account?

MR SHAW: If one assumes that they on revenue account, your Honour, we would submit that they are properly to be made when the funds become available to pay them.

GLEESON CJ: When the contingencies disappear?

MR SHAW: Yes.

GLEESON CJ: So you do not say they should be made now but on a discounted basis?

MR SHAW: Your Honour, we have, as your Honour will recall, an alternative based on apportionment and that appears in our outline at page - - -

HEYDON J: Pages 9 and 10.

KIRBY J: It is paragraph 31.

MR SHAW: It starts at the bottom of page 9 and then goes on to page 10. In the Full Court the Commissioner put forward the proposition that an appropriate way of dealing with the question would be apportionment on a straight-line basis, ie, as in Coles Myer. In our submissions we have made that submission as an alternative and we have pointed to another alternative which was the alternative suggested by Justice Deane in his agreeing judgment in Coles Myer where he said that what one looked to was net present value.

GLEESON CJ: Are you calling in question the correctness of the decision of the Federal Court in the AGC Debentures Case?

MR SHAW: No, we are not. We say that this is a different case to this. That is a case which concerned a financial institution. It concerned the deduction of interest and there was evidence that in the case of financial institutions it was appropriate to give a correct reflex of income to have the deductions, as it were, upfront. That is not this case. We would submit that this case is different. It is true that in the Full Court at – and if I could just take the Court to the Full Court’s reasons. In volume 3 at page 1416 the Full Court says at paragraph 36, line 25:

The accounting evidence before the learned Primary Judge made it clear that it was not in accordance with sound accounting practice to delay bringing to account as a liability of Transurban the Concession Fees until the year in which payment was made. To do so would massively distort the results of Transurban.

That, your Honour, is first of all not what Justice Merkel said and, secondly, not what the evidence said. The Full Court was mistaken about that, in our submission.

GLEESON CJ: The next two sentences.

MR SHAW:

No doubt it was the case that proper accounting principles would bring to account –

That is true and the next sentence is true.

GLEESON CJ: Then was there a difference between the position the Commissioner took before Justice Merkel and the Full Court?

MR SHAW: Yes. What I have been doing was to take the Court to what the evidence was in order to show, partly to answer the question about what the accounting evidence was and partly to demonstrate that the Full Court was wrong in saying what it said there. If I could then go to Mr Hope, the taxpayer’s witness, in volume 2. His affidavit is at page 863 and he just produces a report. The report follows immediately. He says at page 867:

In preparing this report I have been instructed to run sensitivities on the Transurban Base Case Model . . . and the Westpac Debt Model . . . The sensitivities were to assume reductions in traffic volume for each and every year of the concession by (alternatively) 5%, 10% and 20% compared to a base case scenario –

He goes on in paragraphs 14, 15, 16 and 17 to say that he has not examined the models to see whether they are right or not but he just accepts that they are right.

At pages 873 to 874 are the results of his analysis. On 873 is his analysis of the base case model and on page 874 is his analysis of the lender’s financial model. That is the Westpac model. It will be seen if one goes to page 873 in column 15 that on the assumption that there is a 20 per cent reduction in traffic volumes and the conditions in the concession notes in relation to the 10 per cent equity return and the cash flow from the distributions account are maintained, then the amount of the concession fees outstanding at the end of the concession period is 2.7 billion and about 400 million had been paid. My learned friends have referred in one of their footnotes to columns 13 and 14 but, in our submission, those columns are not helpful because they do not assume the continuance of the conditions in the concession notes because it will be seen that in those columns the post-tax net equity return trigger is zero.

Mr Hope’s cross-examination was at page 122 and at page 128 at line 36 Mr Hope is asked:

No, but you accept the proposition that if the traffic volumes do vary from what is shown in the Base Case model, the actual amounts of the payments of the concession notes to the state in the years in which redemption can occur will differ depending on those traffic volumes?---Yes.

Consequently you cannot predict with certainty what will be the actual amount of concession notes redeemed by the state in any one of those years?---It was outside the scope of my instructions . . .

But even notwithstanding the fact you haven’t been instructed on it, just as a matter of modelling it’s correct, isn’t it, that if there will be variations in traffic volumes you are not able to predict – because you don’t have knowledge of the actual traffic volumes at the time you’re doing your forecasting – you will not be able to predict what will be the actual amount of the concession notes redeemed in any one period?---I don’t like your use of the word “you”. I haven’t forecasted or predicted anything; I’ve taken a financial model.

Well, the model can’t predict that either?---Yes.

And then at page 130 at line 26 he is asked:

In other words, it’s as simple as this: any variation in traffic volumes from the Base Case model will have an impact on both the amounts and the timing of the redemption of the concession notes?---It may have an – I would like to use “it may have” an impact. There may be - - -

It depends on the percentages?---It depends on percentages.

HIS HONOUR: Mr Hope, is the position this: that you’ve locked in certain percentages and if those percentages remain constant throughout the period you’ll get a certain result of how much will be redeemed and when?---Yes.

But if you start to vary those percentages then you have to rework the model and you will get another answer?---The model is structured such that you can change these variables and it will automatically flow through the model and will produce different answers.

Mr Tinsley, the Commissioner’s expert, his affidavit is at page 895 and he has a report at page 909 to neither of which I need go, but I should take the Court to volume 3, page 1283. That is another of Mr Tinsley’s reports. At page 1286 he says, at the top of the page:

There are three key financial components of the MCL project:

1. A given cashflow stream. The cashflows consist mainly of traffic toll revenues for a tollroad project. Tollroad operating costs are often less than 10% of gross revenues;

2. A rate of return . . .

3. The capital construction costs and contraction schedule . . .

With knowledge of any two of these components, it is possible to calculate what figure is required to satisfy third.

. For the MCL project, the projected revenues depend on the traffic forecasts. These forecasts (and by extension the gross toll revenues) remained fairly stable during the Initial Submission, Preferred Tenderer Stage, and up to the final Concession Deed.

Then going down to line 32:

expected, the level of CF is set to match the traffic Base Case projected cash flows exactly. If the traffic reduces . . . the redemption of the PN’s by the State is deferred further, perhaps to the end of the Concession. If the traffic increases above the Base Case, then the Concession Deed, Schedule 4 ACF payments . . . commence to be made.

Then there is a table setting out the concession payments and the base case shows a nominal return of $3.1 billion, a real return, that is a net present value at 10.5 per cent of $157 million and if all the concession fees are paid at the end there is the same nominal return by the real return of only $71 million.

Going to his cross-examination, that is at page 132 in the first volume and at page 136, he is asked at the top of the page:

What you are saying there is, is it not, that if there is a 20 per cent reduction in traffic from the lender’s Base Case, the concession notes will not be paid during the concession period but will be paid at the end of the concession period?---Yes, certainly the models show zero payment during the concession period.

At page 141 at line 36 he is asked:

I’m not sure what the point is that you’re seeking to make there?---We referenced earlier the waterfall of accounts. Some of those items in the waterfall are in fact reserves for things like maintenance, the regular maintenance of the concession. So the concessionaire, Transurban, can’t spend the money. It has to keep some of it aside for future maintenance. That’s the way a reserve works. In fact there are two of them in what’s called the waterfall of accounts. If I could take – I see that has been taken out. I’m sorry, I had it in earlier.

That is a reference to a change in his report.

But in any event, in the waterfall of accounts there are two such reserves; maintenance reserves is the key one but it would be quite common in a project financing to have a reserve set aside to make a future payment. That’s what a reserve is all about. It’s of the nature of a sinking fund, if you like, and it is unusual in this case that there are no reserves allowed for that future payment of the concession notes.

Now, that is what the evidence was.

KIRBY J: What is the significance you seek to get from that last statement:

no reserves allowed for that future payment of the concession notes.

One would, as a layperson, assume that in good accounting if they were intended to be paid there would be a reserve for them.

MR SHAW: Yes, and there is no provision for reserve.

KIRBY J: In government superannuation and pensions there was, until recently, no reserve but that was because we would expect it to come out of consolidated revenue but all of that has been changed, but in a private sector body one would expect that if it was intended to be paid there would have to be a reserve for good accounting purposes and in order to show properly the profit and loss of the company.

MR SHAW: The witness says there is not any provision for reserve in the documents and there was not any evidence that there was a reserve.

CRENNAN J: Were there any covenants that might have somehow secured in relation to the cash flow for these purposes?

MR SHAW: I think the answer is no, your Honour.

GUMMOW J: We do not know very much about the securities taken by the banks, do we?

MR SHAW: Not much, no, your Honour, although there is clearly provision made for the repayment of the project debt before the concession notes were paid - - -

GUMMOW J: Or to be precise over what the banks held security, over what tangibles or intangibles they held security.

MR SHAW: I do not know that there is any evidence about that, your Honour.

CALLINAN J: The accounts should show a true picture of the liabilities under the Corporations Law and the listing rules.

MR SHAW: Your Honour, the accounts, as I told his Honour the Chief Justice - - -

GUMMOW J: We are looking at 1196. What is disclosed is that there seems to have been, to digress for a minute, a request for a binding rule which languished. That appears at 1198. There seems to have been some disputation with the banks at one stage about amendments to the documents. That appears at 1227, in particular at 1228, the amendment to clause 1.9.

MR SHAW: The answer to the question whether the accounts show a reserve to pay for the concession notes is I think no.

GLEESON CJ: Was there evidence as to what the State Treasury did with the concession notes?

MR SHAW: No, I do not think so, your Honour, but Mr Tinsley does say at 1287 that in every case he examined the concession fee was to be paid by way of the concession notes. I suppose it is hardly surprising. That being what the evidence is, it is - - -

KIRBY J: Justice Callinan referred to a provision – is it in the Corporations Act – that says that accounts should - - -

MR SHAW: - - - give a true and fair picture. Yes.

KIRBY J: Would you give us a reference to that in due course.

MR SHAW: If your Honour pleases.

KIRBY J: Unless something can be shown that I am missing, the inference I would draw from that was that it was not intended that the concession notes would be paid ever.

MR SHAW: Your Honour, what was expected was that the concession notes would be paid and it was expected, based on the assumptions made about the traffic volumes, that repayment of them would commence in, say, 2013 and it was expected that the concession notes would be paid.

GLEESON CJ: Is it your submission that it was not intended that the concession notes would be repaid ever?

MR SHAW: No, of course not.

KIRBY J: Why is there not a reserve for whatever is to be paid?

MR SHAW: Your Honour, I cannot give an answer in the sense that – an answer that the evidence shows but - - -

KIRBY J: What is your submission? It is an inference that is derived.

MR SHAW: It would seem to be that it was expected that the concession notes would be repaid and they would be repaid out of later revenues from tolling.

CALLINAN J: In future dollars much diminished in value.

MR SHAW: Yes.

GLEESON CJ: The chief financial officer of Transurban was a witness in the case, was he not?

MR SHAW: Yes, he was. That was Phillips.

GLEESON CJ: What was put to him about the fact that there was no reserve?

MR SHAW: Nothing. It is submitted that the evidence being as I have described it, what the Full Court said at page 1416 in paragraph 36 is in the first part of the paragraph just wrong. What Justice Merkel had said which appears in his judgment at page 1346 is this at line 31:

In the present case there was evidence, to which I later refer, that normal accounting practice would bring to account the net present value, rather than the nominal value, of the amounts due under the Concession Notes in the year of income.

That is what Phillips had said.

However, no expert accounting evidence was adduced to the effect that to bring the relevant amounts, whatever they may be, to account in the year in which liability was incurred would not give a fair view of Transurban’s operations, nor was there evidence that sound accounting practice required that the liability in respect of the concession fees should only be brought to account in the year in which payment is made.

So there was not any evidence one way or the other.

Further, as was observed by Toohey J in Australian Guarantee Corporation (at 493) the fact that it is not known when the interest payment will be made is an “insufficient objection” to the payment being treated as referable to the year of income in which the liability for the interest accrued.

The absence of accounting evidence in the present case to the effect that the amounts due should be brought to account in the year of payment is not surprising. Assuming, as I have on this aspect of the case, that the Commissioner’s submissions on the other aspects of the case have not been made out and that consequently the concession fees are on revenue account, it is difficult to perceive of any proper basis for concluding that they are not referable or attributable to the year in which the liability is incurred. On the basis of that assumption the liability for the fees arises semi-annually as the consideration for Transurban’s entitlement to establish and operate City Link, and thereby derive its assessable income, during those semi-annual periods . . .

The correctness of this approach is easily demonstrated. The terms of payment of the concession fees and of the amounts due under the Concession Notes issued in respect of the relevant years of income are the same. The amounts due will not fall due for payment prior to 2034 unless the requisite financial conditions enabling earlier payment have been satisfied. If the Notes were treated as referable to the year or years of income in which payment is made that would lead to a distortion of Transurban’s operations on revenue account in that year or those years because, as was the case with the example given in the joint judgment at 66 in Coles Myer Finance, that “would open the way to inflating very considerably the amount of allowable deductions under s 51 for that year –

So what his Honour was saying was, really, the only evidence he had was the evidence of Phillips given in cross-examination that normal accounting practice would take into account the net present value and apart from that he was speculating.

KIRBY J: So that I will get it clear in my mind, is my understanding correct that your submission is not that the concession notes were never to be paid but that they were to be paid at some future time, say, 2013, or thereabouts, and that will be time good enough in which to be seeking the deductions that are now sought by the respondent?

MR SHAW: What we say, your Honour, is that if one looks at the terms of the concession notes, reading them strictly it is possible that they might never be paid – legally become payable. That, however, was not the intention of the parties. The intention of the parties was that they would be paid and they thought they would be paid, as your Honour had said, but they accepted, and indeed the taxpayer led evidence, that if the traffic volumes fell off by 20 per cent then what was projected would not happen but the concession notes would be paid later.

KIRBY J: Can I add, and it would be at that time that one would expect, in accordance with the Corporations Act and proper accounting practice, that the accounts of the respondent would demonstrate a reserve and that that would, as it were, tend to confirm that it was not intended, nor did the deed provide, that as at the year in which the deductions had been sought that any moneys would be paid.

MR SHAW: I do not know, your Honour, whether you would expect a reserve at that stage, but if - - -

KIRBY J: I would have thought in my simple naïve and ignorant way that one would expect that if it was to be paid, if it was truly expected that it would be paid, then doing the best they could with their estimates and fore-estimates and calculations and projections and models and computers that they would start laying down a reserve from the day one, but they did not do that, we know that and therefore the question is what inference is to be derived from that fact.

MR SHAW: Your Honour, it is submitted that is not necessarily so and it is not necessarily so for this reason, that if what was in mind was that what was desired was to ensure that the project lenders would be repaid and that the tolls would go first of all to them and that the equity investors should receive an adequate return and that would be looked after, and that so long as that was provided for, payment of the concession notes would begin and what was projected was that the income from tolling was going to be sufficient at that stage to set out to pay the concession notes from the income as it came in once these other liabilities had been met, then there is no need for a reserve because what is projected to occur is that there will be income sufficient to pay for the concession notes in the manner contemplated in the years which we have projected.

KIRBY J: Ie, about 2013 or thereabouts.

MR SHAW: Yes, or starting there and going through to 2034 or whatever, yes.

KIRBY J: .....corporation has been established on hope and expectation and prudence normally dictates that possibilities adverse should be taken into account in establishing the reserves, but it was not done here.

CALLINAN J: Mr Shaw, can you assist me, please. Is it at page 1195 that the last set of financial accounts of the respondent before the Court - - -

MR SHAW: I am sorry, your Honour?

CALLINAN J: Do the last set of financial accounts, financial documents of the respondent, begin at page 1195? That is for the 1998 year I think.

MR SHAW: Yes, it is and it is not the last set.

CALLINAN J: No, the last set before the Court.

MR SHAW: The last set before the Court I think, your Honour, and the reason that the 1998 year is there is because it was in relation to the – an objection in relation to the 1998 assessment.

CALLINAN J: It is 1996, 1997 and 1998, is it not?

MR SHAW: Yes.

CALLINAN J: They are the years we are concerned with?

MR SHAW: They are the years, yes.

CALLINAN J: Mr Shaw, is there any treatment in those accounts at all of the liabilities arising under the concession notes?

MR SHAW: Yes, there is, your Honour.

CALLINAN J: Whereabouts is that, please?

MR SHAW: If I could just take your Honour first of all to page 1198 at about line 37 or something, there is a paragraph - - -

CALLINAN J: Reference to the taxation ruling, yes.

MR SHAW: Yes, and to the basis on which the accounts had been prepared, namely that the deduction was immediately available. If I could then take your Honour to page 1207 at, say, line 43 or something:

k) Non Interest Bearing Long Term Debt

Non interest bearing long term debt represented by the Concession Notes has been included in the financial statements at the present value of expected future repayments. The present value of expected future repayments is determined using a discount rate applicable to the Company’s other borrowing arrangements. The present value of expected future repayments will be reassessed periodically.

CALLINAN J: Where does the number appear, Mr Shaw?

MR SHAW: I am coming there, your Honour. What I am trying to do is go through and pick up the references as I go through.

CALLINAN J: You do it your way.

MR SHAW: At page 1209 there is again another description of the treatment of the tax losses and the way in which they had been treated. If one then goes to page 1213 there is a description at line 25 and following of the various financing arrangements. That goes over onto the next page. If I might go back to that page – I am sorry, I have gone too fast. If you go to the top of the page at, say, line 13 where it says:

12. BORROWINGS – NON CURRENT

Equity Infrastructure Bonds
Concession Note

Your Honour will see 60 million and 32 million.

GUMMOW J: Do we know anything about the prospectus mentioned at 1209, line 32?

MR SHAW: I do not know the answer to that, your Honour.

GUMMOW J: It is just that one is left with a very incomplete picture of the whole of this structure.

MR SHAW: Then if one goes over to 1214 at line 36 it says:

The Company has entered into a Concession Deed with the State. annual concession fees under the Concession Deed will be $95.6 million per annum during the Construction Phase and for the first 25 years after the expected completion date . . . $45.2 million per annum for years 26 to 34 and $1 million thereafter if the concession continues beyond year 34. Until a certain threshold return is achieved, payments under the Concession Deed will be satisfied by means of the issue of non-interest bearing Concession Notes to the State.

CALLINAN J: Mr Shaw, I am sorry, if I could go back to 1213, the concession note for 1998 is said to have a value of what, 60 million, is that correct?

MR SHAW: Your Honour, I think not. I think that is cumulative.

GLEESON CJ: Mr Shaw, is not the answer that - Justice Callinan asked you when you referred to page 1207, line 45 where that was included in the financial statements. Is not the answer that it is included on page 1204, line 31 in the figure 515,672, as is explained on page 1213, lines 15 to 20?

MR SHAW: Which figure was that you referred to on page 1205, your Honour?

GLEESON CJ: “Borrowings” under the heading “NON-CURRENT LIABILITIES” on page 1204.

MR SHAW: I am sorry, I am looking at the wrong page.

GLEESON CJ: It is in that figure of 515,672.

MR SHAW: Yes, I think your Honour is right.

GLEESON CJ: The makeup of that figure of 515,672 appears on page 1213.

MR SHAW: Yes, it does.

GLEESON CJ: What I am interested to know is: if you included it in your balance sheet as at 30 June 1998 under the heading “NON-CURRENT LIABILITIES” how any question would arise of making a provision. It is in there as a non-current liability.

MR SHAW: At a certain value, yes.

GLEESON CJ: Quite. So what does provision have to do with it?

MR SHAW: One might, your Honour, set aside certain amounts in order to provide against future payment and that does not seem to have been done.

GLEESON CJ: But the liability is taken into account at - - -

MR SHAW: Yes, your Honour, but not at face value.

GLEESON CJ: At what is said to be the value of the liability.

MR SHAW: Yes, your Honour.

GLEESON CJ: What if you then made a provision what would be the amount of the provision?

MR SHAW: Presumably, your Honour, setting aside such amounts as would, if the provision continued to be made, provide sufficient funds when the matter became payable to pay.

CALLINAN J: Mr Shaw, does the inclusion of the amount at its present value represent to that extent an admission against interest by the taxpayer that at the most that is the liability for that year?

MR SHAW: Your Honour, Mr Phillips seemed to say in his cross-examination that the proper way to treat the amount was to – from an accounting point of view he was only speaking of course – that from an accounting point of view the proper way to treat it was to include it in the accounts of its net present value and that seems to be - - -

CALLINAN J: That is what the accounts purport to do. Why is that not an admission against interest that that is its maximum value as a liability, assuming it is an outgoing liability by way of an outgoing?

MR SHAW: Your Honour, it is an admission against interest but it is an admission which relates to accounting principle, if you like, as opposed to tax principle.

CALLINAN J: I do not know. As a matter of law the accounts must present a true picture, a true picture in the opinion of the taxpayer and ultimately, objectively, to satisfy all relevant regulatory authorities.

MR SHAW: Yes, your Honour, but as we understand the taxpayer’s submission, it is that the effect of section 51 is that one ignores economic reality and one looks at simply nominal values.

CALLINAN J: I understand that but that is not a mere matter of economic reality. It may be a matter of legal reality.

MR SHAW: It might be. The view your Honour is putting to me is, in effect, what Justice Deane said in his agreeing judgment in Coles Myer.

CRENNAN J: That is the third possibility.

MR SHAW: As a possibility, yes.

GLEESON CJ: These accounts deal with the amount we are looking at on capital account. We are looking at the balance sheet on page 1204.

MR SHAW: Yes.

GLEESON CJ: We do not have any accounts, do we – do we have any accounts for a year later than 30 June 1988?

MR SHAW: Certainly not in the appeal book, your Honour. I think not at all.

GLEESON CJ: I presume, consistently with this accounting treatment, that that amount of borrowings under non-current liabilities would keep increasing from year to year thereafter.

MR SHAW: Yes, I assume that is so.

GLEESON CJ: And it would include the amount of 60883. For the year ended 30 June 1999 that amount would be 60883 plus whatever was the net present value of the concession notes issued during the year ended 30 June 1999.

MR SHAW: And maybe, your Honour, as well, any increase in the net present value of the concession notes already issued.

GLEESON CJ: Yes, but all of that is a statement on capital account of the liabilities or the present value of the liabilities of the company.

MR SHAW: That is true, your Honour.

KIRBY J: Is that relevant to your second and alternative argument?

MR SHAW: It is, your Honour.

KIRBY J: Well, no doubt you will come back to that. May I just mention that I noticed on page 1201 that one of the directors of the respondent is Professor J.G.A. Davis who is a close and long-term personal friend of mine. I do not feel embarrassed by it but I just put it on the record.

MR SHAW: If your Honour pleases. If I might then merely refer to the fact that the statements of facts, issues and contentions of the parties appear in volume 1 and the Commissioner’s commence at page 40 and the taxpayer’s commence at page 53. If I could draw specific attention to our statements of facts, issues and contentions, at page 44 in paragraph 20 it is said:

As at the date of the Concession Deed (29 October 1995), it was uncertain whether or when the conditions for payment would be satisfied.

Not just “when” but “whether or when”. In paragraph 24 it says:

If, contrary to the respondent’s submission, any part of the Concession Fee is a deductible outgoing, such outgoing is properly referable to the year of income in which the payment is made, rather than the year in which the obligation to make the payment is incurred.

If I might then go to the judgments, first of all, they are in volume 3. Justice Merkel’s judgment begins at 1318. He deals with “incurred” at page 1331 and the following pages. At page 1337 he says at line 20:

59 Part 4(b) of the Concession Notes appears to have been inserted out of an abundance of caution . . .

60 As explained above, payments of amounts due in respect of the concession fees payable under the Concession Notes were expected to commence between 2013 and 2017. However, that expectation was based on assumptions and estimates that may, or may not, prove to be accurate . . .

62 By reason of cl 1.9 of the Master Security Deed, the concession fees that fell due under cl 3.1 of the Concession Deed in respect of that portion of the Concession period which commenced on 4 March 1996 and concluded on 30 June 1998, were not required to be paid because Project Debt had not been paid and the funds in Transurban’s Distributions Account were not sufficient to pay the amount of the concession fee that was due. Thus, although Transurban fell under an obligation to pay the concession fees payable during the relevant years of income the date for payment of the amount due was deferred until Project Debt had been paid or there was sufficient money in the Distributions Account to pay the full amount due to the State.

Then at line 29 he says:

The most that can be said about the expected date for payment is that when the Concession Notes were issued, payments were likely to commence at some time between 2013 and 2017 but it may have been later depending on whether the assumptions and estimates made in the Base Case Model or the financiers’ Financial Model proved to be correct. Subject to the cl 1.9 contingencies, which were expected to apply to 2023, the latest date for payment is 14 February 2034.

Going to paragraph 66:

The initial question is whether, in the circumstances outlined above, Transurban incurred the losses and outgoings it claimed in respect of the concession fees that it became obliged to pay, but did not pay, in the relevant years of income.

Then he cites a number of authorities including AGC. At page 1344 at line 15, paragraph 75:

In my view it is clear that, on the proper construction of the Concession Deed, the Master Security Deed and the Concession Notes issued during the relevant years of income, Transurban completely subjected and definitively committed itself to paying the amounts due in respect of the concession fees . . . Further, Transurban’s liability to eventually pay the amounts due was not subject to any contingency other than the “theoretical contingency” that the requirements of cl 1.9 of the Master Security Deed would not be satisfied.

The Full Court deals with the question of incurred at 1412 - - -

GLEESON CJ: Where did Justice Merkel deal with the question of what was incurred, in other words, the net present value argument?

MR SHAW: He really deals with that, your Honour, in relation to “referable”. I stopped reading before I got to “referable”.

GLEESON CJ: Because you are coming back to that?

MR SHAW: Yes, your Honour, yes. The Full Court dealt with incurred at – commences at page 1412 at about line 40 and at page 1414 at about line 38. They say:

We agree with the learned Primary Judge that Transurban completely subjected and definitively committed itself to paying the amount of the Concession Fees which accrued in each of the relevant years of income. There is no suggestion that the amount in question was defeasible. It was subject to no contingency other than the requirements of clause 1.9 of the Master Security Deed that there be adequate funds in the Distributions Account.

Then in the following two paragraphs they go on to say that in any case it does not matter because the concession fees were satisfied by the issue of the concession notes.

GLEESON CJ: Mr Shaw, can I just raise with you a question of principle unrelated to the particular facts of this case. There is nothing at all uncommon about a taxpayer incurring in year one a liability that is not to be discharged until a future year.

MR SHAW: Yes, true.

GLEESON CJ: And, as a matter of principle, it does not make a difference whether the future year is year two or year 10 or year 20, and also, whether the future year is year two or year 10 or year 20, the net present value of the liability in year one will almost inevitably be less than the amount of the liability.

MR SHAW: Yes.

GLEESON CJ: Yes. It really does not matter as a matter of principle whether it is a lot less than the amount of the liability or only a little bit less than the amount of liability. If it is different, then the net present value of the liability incurred in year one will always, except in times of deflation, be less than the amount of the liability. Why in those circumstances would it not always be the case that where there is a liability incurred in year one that has to be discharged in a future year, whatever future year, what should be the allowable deduction is the net present value of the liability?

MR SHAW: Part of your Honour’s question involves the referable question. If I could put that to one side - - -

GLEESON CJ: I am assuming that against you.

MR SHAW: If I could put that to one side for the minute, what we say here is that you have to have a liability which is due before it can be deductible. Our submission is that the way in which the Court dealt with the question in Nilsen means that here there is nothing which is due in the relevant years. The reason there is nothing that is due is that your Honour will recall that the facts in Nilsen were that it was a question about long service leave, liabilities for long service leave and annual leave. It was not the case in the circumstances of that case that the relevant liabilities were liabilities which were accruing in the sense that not enough time had been served to - - -

GLEESON CJ: - - - be entitled to long service leave.

MR SHAW: Yes.

GLEESON CJ: I was intending to raise a different point of principle. I want you to assume a case where a liability is incurred in year one within the meaning of section 51 and where the liability is not payable until a future year, whether the future year be year two or year 10 or year 20. In any such case the net present value of the liability in year one otherwise assuming it to have been incurred and to be referable to year one will be less than the face value of the liability.

MR SHAW: Yes.

GLEESON CJ: Why is it not always the case then that under section 51 what you deduct is the net present value of the liability?

MR SHAW: Your Honour, the answer to that, in our submission, turns on the referable point because what one has to ask oneself is in effect whether the deduction of the whole of the amount, in the year in which it was incurred on your Honour’s assumption, will give a true reflex of the taxpayer’s income.

GLEESON CJ: But that cannot turn, can it, upon whether the net present value is a lot less than the face value of the liability or only a little bit less than the face value?

MR SHAW: I suppose it might because the difference might be - - -

GLEESON CJ: You could have de minimis.

MR SHAW: Yes, you could. It just might not matter.

KIRBY J: But I thought the question assumes that second arrow in your quiver against you and asks assuming that against you, what follows from that in respect of the year in which the deduction is sought?

MR SHAW: His Honour may have assumed that but if his Honour’s question assumes both incurred and referable, I am left without a raft.

GLEESON CJ: What I am putting to you is that the accounts of taxpayers all over the place are full of claims for allowable deductions in respect of amounts that will not be payable for some future time and therefore in every such case the net present value of the amount in the year of the return is less than the face value of the liability. As a matter of principle, why is not the net present value of the liability the amount for which the taxpayer gets an allowable deduction? I am not saying it is but I would like to understand why it is not.

MR SHAW: Your Honour, if I might take the Court to Coles Myer [1993] HCA 29; 176 CLR 640, and at page 661 the majority starts off its examination of section 51 by referring to what Justice Dixon said in Ash. There his Honour said:

“Where the reason for allowing a deduction is that it is a normal or recurrent expenditure or an expenditure which is fairly incident to the carrying on of the business, it is evident that it can seldom be associated with any particular item on the revenue side against which to set it, and, as the ground of its allowance is that it is an incident or accident, something concomitant to the conduct of the business, it follows that to deduct it in the year when it falls to be met is consistent with the reason for deducting it and conforms with business principles. Thus, in [Nevill], where, although the matter was not argued, the court found it necessary to say whether the payments . . . should be deducted in the period when they were agreed upon or that in which they were made, it was considered that the deductions should be made from the assessable income of the periods of account in which the payments were made.”

Your Honour will recall that Nevill was a case in which a managing director or some such officer of a company had agreed to retire in return for the payment of, I think it was £2,500 and some of the amount was paid in cash and some of the amount was paid by the issue of promissory notes. The promissory notes were payable monthly and some of the months in which they fell due were not in the income year that was the subject of objection but the subsequent year. The question was when were the later ones deductible and, as Justice Dixon says there, all the members of the Court said that deduction was available in the second year. Then, if one goes over to - - -

KIRBY J: Could I ask you just to pause for a moment? The reference to the reason for deducting it and “conforms with business principles” is taken from Ash and at the end of that passage where Justice Dixon refers to that looking, as it were, for guidance that would deliver a resolution in a particular case that is consistent with the reason for deducting it is not the reason that the deduction is allowed, speaking globally, because of the fact that the taxpayer not having the benefit of the income makes it appropriate to deduct it because the taxpayer does not have the full amount to play with. If that is so, does that not lead to the search for the net present value, as distinct from just a nominal value, because that is what the taxpayer, at least notionally, is deprived of?

MR SHAW: What the Court said is that to be allowable as a deduction a liability must be incurred and they treat as part of the occurrence a requirement that it be properly - - -

KIRBY J: But that looks to what is actually incurred, what is truly incurred. It is not looking to some notional incurring; it is looking to what is – after all, this is just another federal statute and we are trying to look at what the legislature in providing for tax on incomes and then providing for these deductions is getting at, and Justice Dixon said the guiding star was what is the reason for deducting it that conforms with ordinary business principles. I think that is a very intriguing statement, what is the reason for deducting it.

MR SHAW: He says that - - -

KIRBY J: I suspect we have got a bit away from that.

MR SHAW: Well, Coles Myer - - -

KIRBY J: Speaking globally, and I realise that there are myriad of cases, but speaking globally, the reason for deducting it is because the taxpayer does not have it to play with and therefore, it would be unfair to burden the taxpayer with paying income tax on it when the taxpayer does not have it.

MR SHAW: Well, it is because he has outlaid it in a permissible way, your Honour.

KIRBY J: Yes.

MR SHAW: But, with respect, your Honour is not correct.

KIRBY J: Either actually or notionally.

MR SHAW: Yes, your Honour. Coles Myer was decided in 1993 and the majority commences the examination of the section 51 question with this citation from Ash. Not only do they do that, but going over to 663 their Honours say at about point 4:

But it is not enough to establish the existence of a loss or outgoing actually incurred. It must be a loss or outgoing of a revenue character and it must be properly referable to the year of income in question. So it was that in New Zealand Flax the taxpayer was not entitled to deduct all payments of interest in future years notwithstanding that it had incurred a liability to pay them in the accounting period under assessment.

Now, New Zealand Flax is not usually cited for that proposition. It is in 61 CLR and at page 207, at the top of the page, there is a passage which is constantly cited about the meaning of “incurred”. But his Honour goes on to say after that description of what “incurred” means:

In the present case I regard the obligation to p ay interest to bondholders who, within the four years from the date of issue, paid up the amount of the bonds, as a definite liability contingent only on the bondholders meeting their instalments, that is, in the case of bonds subscribed for in or before the respective accounting periods the subject of assessment. There is no reason why the future lability should not be treated as incurred, if otherwise it were proper to throw it against the revenue items, as it would clearly have been if the full face value of the bonds were included in the assessable income . . . There is, I think, no objection to the commissioner’s taking into consideration the actual events of the subsequent years in order to see whether, under a method of accounting by which only actual receipts from the bonds are included, the liability for interest would naturally be provided out of revenue from that source accruing in the year when the liability would be met, or whether safe or proper practice required for the purpose an appropriation and retention of part of the sums received in the accounting periods under assessment.

So it is hardly surprising that his Honour should have said the same thing in Ash as he said in New Zealand Flax because they seem to have been decided within a month of one another. But it is perfectly clear that in Coles Myer the majority were relying on Ash and New Zealand Flax as establishing the principle which they actually did apply in that case, although in a slightly different way because the circumstances were different.

KIRBY J: How do you encapsulate that principle relevant to this case?

MR SHAW: Relevantly to this case that the appropriate time for allowing the deduction in respect of the concession fees, assuming it not to be on capital account, is when the income is derived out of which they would naturally be paid. That seems to be his Honour’s principle.

GLEESON CJ: That would seem to be a fourth alternative in the present case.

MR SHAW: Your Honour, the question in this case is: is it allowable now? We say that our conclusion - - -

KIRBY J: That is the only legal question now, is it not, whether it is allowable now?

MR SHAW: Is it allowable now? The answer is no.

GLEESON CJ: The answer “No” to that question is very different from the answer “Yes, but at its net present value”.

MR SHAW: Your Honour, I absolutely accept that. That is certainly true but you only get to net present value if you get to “incurred”, which we say you do not, and you not only get - - -

KIRBY J: You put two barriers in the way, “incurred” and “referable to the year” and if you get through those you have a third barrier.

MR SHAW: And it is referable to the year, so we would submit.

GLEESON CJ: But what I am concerned about is the principle according to which once you find that a liability has been incurred in the year and that it is referable to the year, what is the principle according to which in some cases you take the net present value of the liability and in some cases you take the full face value of the liability as an allowable deduction?

MR SHAW: The principle is you must, assuming a deduction to be allowable, the deduction which is allowable is that which gives a proper reflex of the taxpayer’s income.

GLEESON CJ: Why does it not always give a proper reflex of the taxpayer’s income to take the net present value?

MR SHAW: To take the AGC Case, because there you have a continuing business in which interest is coming in and going out all the time and in that sort of case you look at it on a day-to-day basis or a year-by-year basis and it is appropriate to treat the matter in the way that deals with it at the time it is first incurred. But here you have a very different situation. Here you have a situation in which a new business is being set up which involves the building and construction of the freeways or the link and its operation and we are talking about the deductibility of fees which are said to have been incurred in relation to a year in which functionally there was no income.

GLEESON CJ: That seems to make the outcome of this case not determinative of any of the years after about 1998. That sounds to me like a matter that might have been of interest on the special leave application.

MR SHAW: Your Honour, if it were so limited it is true, but our submission is that when one looks at the model, treating it just as a model, it is perfectly clear that no deductions should be available up until 2013.

KIRBY J: If your argument on the second issue, that is to say capital account, is upheld, what effect does that have to deductions after 1998?

MR SHAW: No deductions will be available at all.

KIRBY J: Ever?

MR SHAW: Ever.

KIRBY J: So that is, as it were, the first gateway logically. If you do not get through that, go away. Do not trouble us with the other three gateways.

MR SHAW: If I could go back to “incurred”. If I could just take the Court to Nilsen [1981] HCA 6; 144 CLR 616.

GUMMOW J: I think an understanding of Nilsen is assisted by a consideration of what Justice Deane said in the Federal Court in that case.

MR SHAW: Your Honour, I had not looked at that.

GUMMOW J: He then came back to it in Coles Myer you will remember?

MR SHAW: If I could take the Court to 623, and what one needs to remember when reading this is what one is talking about is a liability for long service leave where the persons have served sufficient time to be absolutely entitled to their long service leave and the only reason that it was held that the employer was not entitled to a deduction was that the employees had not actually begun to take long service leave. It was said that that meant there was not any pecuniary liability for the - - -

KIRBY J: So, like the concession notes, this was something contingent that might and probably would fall in at some future time - - -

MR SHAW: Well, it in Nilsen it was certain - - -

KIRBY J: Unless they died it will fall in.

MR SHAW: It was certain. Even if they died he had to pay.

KIRBY J: Well, I do not know about that.

MR SHAW: Well, I think so. I think that - - -

KIRBY J: What? Under the agreement with Mr Nilsen?

MR SHAW: Under the award, your Honour.

KIRBY J: Under the award?

MR SHAW: I think that is what Justice Gibbs said, but - - -

KIRBY J: I thought long service leave died with the worker but I may be wrong.

CALLINAN J: I do not think so. They get it. They must get it.

MR SHAW: I thought they got it. My understanding was different from your Honour’s.

KIRBY J: It does not matter.

CALLINAN J: I am sure they do. I think you are right.

KIRBY J: In the normal case it would be payable certainly at a future time when the conditions were - - -

MR SHAW: So that here is something which is certain but no deduction was allowed, and what his Honour Chief Justice Barwick said at about point 8 on the page is:

Granted that exhaustive definition of what may be denoted by the word “incurred” in s 51(1) may not be possible, there can be no warrant for treating a liability which has not “come home” in the year of income –

“come home” is from Justice Dixon in Carden’s - - -

GUMMOW J: We are adrift in a world of metaphors in these cases. What does “come home” mean?

KIRBY J: What is wrong with that? It helps to explain things.

GUMMOW J: It does not help to explain things.

MR SHAW: Your Honour, we are in a world of metaphors, but not adrift.

GUMMOW J: I hope you are right. Like this notion of jurisprudential analysis, what does that mean?

MR SHAW: In the sense of a pecuniary obligation which has become due as having been incurred, Sir John Latham’s language in Emu Bay:

clearly enough indicates that to satisfy the word “incurred” . . . the liability must be “presently incurred and due though not yet discharged”. The “liability” of which Sir John speaks is of necessity a pecuniary liability and the word “presently” refers to the year of income in respect of which a deduction is claimed. It may not disqualify the liability as a deduction that, though due, it may be paid in a later year. That part of Sir Own Dixon’s statement in New Zealand Flax Investments Ltd v Federal Commissioner of Taxation which presently needs emphasis is that the word “incurred” . . . “does not include a loss or expenditure which is no more than pending, threatened or expected”: and I would for myself add “no matter how certain it is in the year of income that that loss of expenditure will occur in the future”.

KIRBY J: This is Chief Justice Barwick speaking here.

MR SHAW: Yes. At page 628, Justice Gibbs, on the top line, says:

The employees were entitled to leave, but they were not entitled to payment. The entitlement to payment would not arise until the employees took leave (or died or left the employment).

GLEESON CJ: Nilsen is a clear example, is it not, of the discrepancy between accounting practice and fiscal accounting because under ordinary accounting, proper commercial practice, ordinary accounting practice which showed a true and fair view, you would bring these things to account as they were accruing.

MR SHAW: Yes, it is true, your Honour, but the case seems to say you must have a liability to make payment otherwise it is not incurred.

KIRBY J: Why have we taken this discordant approach in Australia? I mean, it is not, as I understand it, the approach in the United States. Has any application ever been made in recent years to re-examine this disparity between proper accounting practice that is done by all the business people and everyone else in the society and what the cases say?

MR SHAW: No, I think, your Honour, it has been accepted that what has been called the jurisprudential approach to deductions is so firmly established in the jurisprudence that that is that.

KIRBY J: Maybe in the tax reform statutes they will change all this if ever they get around to it.

GLEESON CJ: It was explained by Justice Deane in Nilsen itself in the Federal Court.

GUMMOW J: And again in Coles Myer.

MR SHAW: Our submission is that the liability here is neither an outgoing incurred nor referable to the year of income or the years of income. I should refer the Court also back to Coles Myer to what was said by his Honour Justice Deane at pages 670 to 673.

GUMMOW J: You will see at the bottom of page 670, the third-last line:

It is whether the taxpayer is, as a practical matter –

the bottom of page 670 of 176 CLR.

MR SHAW: But then he goes on in the middle of page 672 at about point 5:

If, to take an extreme example, a taxpayer were to acquire a valuable item of stock-in-trade in exchange for a binding promise to pay $1 million on 1 July 2005 if, but only if, the population of Australia exceeded two thousand persons on that day, the fact that the obligation to make the future payment was theoretically contingent could not prevent the conclusion that the taxpayer had “incurred” it for all practical purposes.

There are two things to take from that. One is in relation to the theoretically contingent point. If the conditions here were only theoretical, why have the parties put them in? There is surely no case for saying these conditions are theoretical. Here are two sets of what one has to assume are sensible parties, the State and Transurban. They have made the provisions which they have made in order to make the payment of the notes conditional.

GLEESON CJ: They have put them in, have they not, to ensure an agreed commercial order of priority as between financiers, equity investors and the State?

MR SHAW: Yes.

GLEESON CJ: This, again, is related to Justice Merkel’s conclusion that this was in fact a profit-sharing arrangement between the State and Transurban, but the deferral, if I can use that word, of the concession fee entitlements was, as I understand the substance of the transaction, intended to produce the consequence that the State did not get its cut until after the financiers had been satisfied and the equity investors had been satisfied to a certain level.

MR SHAW: Yes.

KIRBY J: But this was by a bootstraps arrangement whereby the Commonwealth makes a generous contribution by the provision of a deduction.

MR SHAW: Yes, so the taxpayer would say, your Honour.

KIRBY J: Was the Commonwealth a party to these arrangements?

MR SHAW: No, it was not.

GLEESON CJ: Nobody would enter into a major commercial enterprise without having an opinion, hoped to be correct, about the fiscal consequences of it.

MR SHAW: Of course not.

GLEESON CJ: You would be a raving lunatic to do otherwise.

MR SHAW: Yes, and we are not for a minute saying that concession fees were not intended and meant to be paid. All we are saying is in order to achieve the commercial results they wanted, they imposed conditions on payment which takes them outside of deductibility. That is all.

CALLINAN J: Mr Shaw, it is interesting that when Sir Owen Dixon refers to ordinary business practice in Ash, he is talking in the context of 10 years of deflation – a highly different commercial context from anything that has happened since the war.

MR SHAW: Your Honour, one does not know where his Honour’s understanding of business practice came from.

CALLINAN J: He has a view about ordinary business practice in 1938. I might have an entirely different view about it in 2006.

MR SHAW: Your Honour, that is certainly so, and business practice obviously does change.

CALLINAN J: And practice changes according to the financial climate.

MR SHAW: And all sorts of other things as well; that is certainly true. If I could just finish the reference to Coles Myer by going to 673, at the top of the page his Honour says:

If, for example, interest at a commercial rate is payable in respect of the period up until the time of payment, the quantum of the loss or outgoing “incurred” at the end of a particular tax year is likely to correspond with the amount which must eventually be paid. On the other hand, if no such interest is payable, the circumstances may well be such that the amount or “value” of the loss or outgoing “incurred” at the end of the relevant tax year is clearly less than the full amount of the ultimate liability. Thus, in the example given above, the liability to pay $1 million on 1 July 2005 could not properly be treated, for the purposes of the tax year ending 30 June 1993, as a loss or outgoing, of $1 million. For the purposes of that tax year, the amount of the liability would be the amount which represented the appropriate valuation of the liability as at 30 June 1993. Necessarily, that amount would reflect the fact that no interest was payable –

If I might now pass to the argument that the issue of the concession notes satisfied the liability to pay the concession fee so that the concession fee should be treated as paid and so that even if it were not an outgoing incurred because a liability was created it was an outgoing incurred because it was paid.

GLEESON CJ: Did this argument succeed anywhere in the Federal Court?

MR SHAW: It succeeded, yes, it did, your Honour.

GLEESON CJ: In the Full Court?

MR SHAW: It succeeded in the Full Court and it sort of succeeded before Justice Merkel.

GLEESON CJ: Where can we find the Full Court putting it? This is an argument you are setting out to answer.

MR SHAW: Yes, it is. Your Honour, in the Full Court at page 1415 at the top of the page their Honours say:

Even if it were the case that either because the amounts in question were payable far into the future or because payment would depend then upon there being funds in the Distribution Account the Concession Fees would, on the facts of the present case have been incurred by Transurban. This comes about because the Concession Notes operated to “satisfy” the underlying liability (that is to say the yearly Concession Fees) and thus brought about the result that the holder of the notes, that is to say, at least initially, the State of Victoria became entitled to sue upon the notes themselves rather than upon the Concession Agreement which created the obligation to pay the Concession Fees.

It is trite law that a bill or promissory note operates as a conditional payment of the underlying liability. Hence the holder of a note will be obliged to sue on the note, rather than to sue for the original debt which the note satisfied unless there is default in payment of the note. However, it is clear that the Concession Notes, although in form promises to pay a sum of money are not within the definition of “promissory notes” in the Bills of Exchange Act 1909 (Cth). To be a promissory note there must be an unconditional promise engaging to pay a sum certain and the engagement must be either to pay on demand or at a fixed or determinable future time. Not only may it be said that the present notes are conditional and thus not promissory notes but also there is an uncertainty as to the actual date for payment and for this reason also the notes would not be promissory notes in the defined sense. However, although the notes would not therefore be negotiable, it is clear from the terms of the Concession Notes, that once they are issued they would operate in satisfaction (or in other words, discharge) of the liability which they replaced. This being the case, there was in the year of income both the undertaking of a liability created by the Concession Deed pursuant to which the Concession Fees became owing and the discharge of that presently existing debt by the issue to the State of Victoria of the Concession Notes. On any view of the matter it would follow that the obligation to pay the Concession Fee was incurred in the year of income.

GUMMOW J: In that connection, can we just go back to page 1214, which is the accounts, line 38, the sentence there:

Until a certain threshold return is achieved, payments under the Concession Deed will be satisfied by means of the issue of non-interest bearing Concession Notes to the State.

Which the State can then go off and market.

MR SHAW: Yes, and the argument seems to be that if I promise to pay an amount which is deductible and then I say, “Well, I will make you another promise to pay the same amount subject to the same conditions”, the second promise may discharge the first and the result is that the first promise becomes a promise in respect of a liability which has been discharged and is deductible even although there remains outstanding a promise by the same party on the same terms to pay the same sum.

GLEESON CJ: I am just not sure at the moment why you are not embracing this argument but perhaps we can come back after lunch to look at that.

MR SHAW: I was certainly not endeavouring to embrace it.

GLEESON CJ: I understand you were not.

MR SHAW: I was endeavouring to escape from its embrace.

GLEESON CJ: I wondered whether a possible point of view would be that it would be the value of the notes that would represent the liability that was incurred.

MR SHAW: Yes, it might be.

GLEESON CJ: That is a different approach.

MR SHAW: Your Honour, the point about the notes is that not only are the notes subject to the same conditions as the fees, that is to say the 1.9 conditions, but they are subject to the further conditions about equity return and proportion of distributable amount. So the second promise is much less valuable than the first.

GLEESON CJ: Is that a convenient time, Mr Shaw?

MR SHAW: If your Honour pleases.

GLEESON CJ: We will resume at 2.15 pm.

AT 12.47 PM LUNCHEON ADJOURNMENT

UPON RESUMING AT 2.17 PM:

GLEESON CJ: Yes, Mr Shaw.

MR SHAW: Justice Kirby, the judgment of Justice Merkel is reported at [2004] FCA 40; (2004) 135 FCR 356.

KIRBY J: Thank you.

MR SHAW: Your Honour the Chief Justice asked me a question this morning to which I now offer an improved answer. If I could take your Honour to the third appeal book at 1204. Your Honour asked me why there was any need for a reserve when the liability was taken into account in the liabilities of the company and the answer is this. There might be a liability for a reserve because the liabilities nearly balance, if you like, almost balance, the assets. The assets are described on the left-hand page - amongst the non-current assets there is 1.3 billion in property, plant and equipment.

The property, plant and equipment is described on page 1211 and the CityLink fixed assets of $1.286 billion plus some slight additions and the lease improvements are then described at about line 30. They include balance and construction costs and, oddly enough, concession fee, although that is reduced by revaluation further down. But the point about the assets is that on expiry of the concession period, whenever that may be, the CityLink is bound by clause 3.4 of the concession deed, which is at page 239, in substance to transfer the link and all associated assets to the State. In other words, those assets are not available to pay the notes.

GLEESON CJ: Mr Shaw, what is the reason for the difference between the figure of 95,600,000 on page 1211 at line 35 and the figure of 60,833,000 at line 15 on page 1213?

MR SHAW: Your Honour, I think I said to your Honour when your Honour asked me about the 60 million what that represented and I said I thought it represented a cumulative figure. In other words, it is not just the concession notes for that year, but for the preceding years as well.

GLEESON CJ: But is there some gap, some time gap between the incurring of a concession fee and the issuing of a concession notice?

MR SHAW: No, there is not because the provision about the issue of the concession note is that it has to be issued before or on the date when the concession fee would otherwise fall due.

GLEESON CJ: Then why would the concession fee be larger than the concession note?

MR SHAW: You have on page 1211 a concession fee at 95.6 million and right at the bottom, “Revaluation of Concession Note”, it says, at 67 million. So presumably they are to be set against one another and the amount would be the difference which is approximately 30 million. I think the reason for the difference between 30 million and the 60 million is that when it says “Concession Note” on page 1213 it means not just the 1998 concession note but that concession note and the prior ones.

GLEESON CJ: I have to admit I have not followed that but perhaps you could put in a note about that at some later stage.

MR SHAW: Yes, certainly. If it turns out that is wrong because I have just made it up, I will correct it.

GLEESON CJ: What is the deduction claimed for the year ended 30 June 1998?

MR SHAW: I will have to find out what the answer is.

GLEESON CJ: Thank you, Mr Shaw.

MR SHAW: If I might go to the question about the issue of the notes and whether that satisfies the fee. First of all, it is submitted that it would be an odd conclusion if a promise by the same party to pay the same amount on the same conditions meant that another promise, an earlier promise of the same kind with the same conditions was satisfied so as to produce a deduction which otherwise would not be allowable. In our submission, that conclusion is supported by The Midland Railway Case in [1952] HCA 5; 85 CLR 306. If I might first go to the headnote because the facts are rather surprising although no doubt the Court is acquainted with them:

The tax-payer company was incorporated in England and was carrying on business in Western Australia. In 1902 the company issued certain cumulative income debenture stock which stock entitled the holders thereof to interest at the rate of six per cent per annum from 30^th June 1898, payable only out of the surplus revenue of the company. The company, in fact, did not have any surplus revenue at any time during the twelve years ending 30^th June 1910, and interest for that period amounted to £701,080. In the year 1910 the company reduced its share capital and re-organized its share and loan capital, and the arrears of interest up to 30^th June 1910 were covered by issuing to the holders –

that is the holders of the debenture stock -

reversionary certificates to the total value of –

the unpaid interest -

These certificates were issued on conditions which provided that one-third (later reduced to one-sixth) of the net profits of the company which from time to time the directors should determine to divide should be applied in their redemption. In the year ending 30^th June 1943 the company set aside a certain sum out of profits for that year as a provision for redemption of reversionary certificates and the money was, in fact, spent for that purpose in the ensuing year. The company claimed a deduction of the amount expended in the redemption of the certificates under s 51(1). . . and the claim was disallowed by the commissioner.

So it was a claim for a deduction of an amount paid in redemption of the reversionary certificates which had earlier been issued as representing the interest which had been incurred on the stock which had earlier been issued but the interest had been unpaid. The question was whether the money paid in redemption of the reversionary certificates which had been issued to the holders of the debenture stock was deductible. So it is not the question which arises in this case, but at page 313 in the second complete paragraph his Honour Justice Dixon says:

The third consideration is that if a liability of a revenue nature is incurred, subsequent changes in the legal form of the liability, in the identity of the creditor or in the circumstances or contingencies in which it is to become immediately due or in the specification of the sources of payment do not matter, so long as the liability is not capitalized –

Then going over to page 315, his Honour says:

The commissioner however says that reversionary certificates were accepted in satisfaction of the old liability; that the holders of the £973,723 six per cent cumulative income debenture stock on which the interest had accrued accepted in satisfaction of all their rights as stockholders (1) the second mortgage debenture stock, (2) the unified ordinary shares in stock, and (3) the new reversionary certificates. He says that the £701,080 then lost its legal character as a contingent debt for interest and took on a new character, namely a liability upon the special terms governing the so-called reversionary certificates under the plan of arrangement.

All that I readily accept.

So his Honour accepts that the certificates were accepted in satisfaction of the liability for the interest. And he says:

But it does not seem to me to matter. It would of course matter if the special terms governing the new liability were incompatible with the fulfilment of the conditions upon which the allowability of a deduction depends, as for instance if the contingent debts were transformed in some way into a liability of a capital nature. But that is not because the contingent debt has been satisfied by the acceptance of a new obligation, not because it has ceased, as between the obligor and the obligee, to wear the legal complexion of a debt for interest, contingently payable. It would be wholly because of the particular character of the new contingent liability. It will be necessary to consider whether the terms governing the company’s liability in respect of reversionary certificates are inconsistent with the conditions of deductibility. But apart from that possibility why should the substitution of a new liability matter?

Now, if it were the correct position that the satisfaction of the liability for interest by the issue of the reversionary certificates satisfied the debt for interest, then a deduction ought to have been allowable, not when the reversionary certificates were redeemed, but when they were issued, and that is not what happened.

So, in our submission, this case supports our proposition that where you have a mere change in the character of the liability of someone who is liable for an amount which is deductible makes another promise of the same character, what one is left with is an end deductibility when the second liability is satisfied and its character is the same as the character of the liability which was satisfied. So that in our submission - - -

GUMMOW J: The primary judge in Midland Railway [1950] HCA 49; 81 CLR 384 was Justice Kitto. He is more given to succinct expression than some of the judges in the Full Court. At 392 to 393 he says:

the issue of the reversionary certificates to those holders did not operate as a payment or satisfaction of their unpaid interest. Its operation, in my opinion, was to alter the method by which that interest was to be paid.

MR SHAW: In our submission, that is all this is.

GUMMOW J: That is the question, I guess.

MR SHAW: Then if I might go to the capital question, on this question Justice Merkel and the Full Court differed. Justice Merkel - - -

GUMMOW J: Just before you do that, Mr Shaw, the deduction claimed in the 1998 year was concession fee of 95.6. That appears from page 36 which is to be read then with page 1211. It was the concession fee.

MR SHAW: At page 1320 that seems to be what his Honour Justice Merkel says. Justice Merkel deals with this matter at 1380 and 1387. That first passage is bound up with a discussion of some of the matters going to the question of whether or not there was a joint venture or a profit-sharing arrangement. His Honour comes to the conclusion at the bottom of page 1381:

In summary, the matters described above, which are set out in the City Link Act and the Concession Deed, are the advantages which enabled the State to grant the concession rights described in cl 2.8 and are, in truth and substance, the advantages for which the concession fees are really paid. In my view, they are to be regarded as the State’s contributions to the Project as they were necessary preconditions that had to be met if the Concession in cl 2.8 was to be granted. They are properly characterised as advantages enuring to capital.

Then on 1387 his Honour says at line 11:

Alternatively, for the following reasons I have concluded that, when the matters stated by Dixon J in Sun Newspapers are 363 are considered, the concession fees are of a capital nature. The advantages sought by the payment of the concession fees are to be characterised by reference to the services, facilities and entitlements contributed by the State. Those contributions, which have been described in detail above, have lasting qualities, are of enduring benefit, are of a “once and for all” nature and form part of the profit yielding structure of City Link.

He goes on to conclude they are of a capital nature. The Full Court deals with the matter commencing at page 1428. At 1429 at line 16 the court says in paragraph 4:

As noted earlier the Concession Fee is said, by clause 3.1(a) to be payable in consideration of the State granting the concession rights set out in clause 2.8. Clause 2.8 is expressed to be the grant by the State to Transurban of rights, being rights to:

“(i) design
(ii) construct
(iii) Commission
(iv) Operate
(v) Impose and collect a toll for . . .
(vi) Maintain and repair; and
(vii) Raise revenues from other lawful uses of the Link . . .

These “rights” are granted subject to the terms of the deed, that is to say, inter alia, to compliance by Transurban of its obligations which include payment of the Concession Fee.

It might be said that the “rights” to design, construct and commission are more aptly described as obligations than rights, although no doubt the fact that construction takes place on land owned or acquired by the State would require permission on the part of the State. It may also be said that these rights to the extent that the Concession Fee is paid for them may be seen to confer an advantage of an enduring kind and therefore be capital. If this were right there would be a need for an apportionment of the Concession Fee or perhaps to treat the Concession Fee as not deductible during the construction phase and until commissioning. It is, however, not necessary for this matter to be considered as the Commissioner eschewed any possibility of apportionment and the case was argued upon the basis that either the whole Concession Fee was on capital account and thus non deductible, or alternatively the whole Concession Fee was on revenue account and thus wholly deductible.

And then their Honours said - - -

GLEESON CJ: Just pausing there, that is different from the approach that was taken by the Commissioner in the Full Court in the Federal Court, is it?

MR SHAW: No, I do not think so. I will check that, your Honour. I did not think it was.

GLEESON CJ: When you say alternatively or when it said:

alternatively the whole Concession Fee was on revenue account and thus wholly deductible -

does the expression “whole Concession Fee” mean the face value of the concession fee?

MR SHAW: I thought it did, your Honour, yes, but I will just have my junior check what the position was below. In paragraph 66 the Court goes on:

The Concession Fee can thus be seen to be paid for the right to operate the ring road system to be constructed by Transurban and to impose and collect tolls for the use of the system by motorists in accordance with a toll schedule.

There is a danger in arguing by way of analogy if only because analogies are not perfect and may ignore matters which require the analogy to be distinguished. However, during the course of argument it was put to Senior Counsel for the Commissioner that the situation was not really distinguishable from the grant by the State of a right to conduct a parking station after it had been constructed on land owned by the State and to charge motorists for parking there . . .

68 The learned Primary Judge saw the concession Fees as being expenditure directed at establishing and maintaining the business entity or structure and thus expenditure of a capital nature. That seems, with respect, to concentrate on the initial “rights” to design and construct and to ignore the right for which the Concession Fee is ultimately payable, namely the right to operate the road system.

Then down at line 43 or so the Court says:

In essence the Concession Fee was no different from the rental that would be payable for the parking station lease to which reference was made. To say that if that lease continued the rental was a lump sum because (unless there were rental escalations) it would be possible to calculate the total amount payable does not convert periodic rental to a single lump sum amount having the character of capital.

In our submission, what one needs to do is first of all look at the terms pursuant to which the concession fee was to be paid.

GUMMOW J: Perhaps before we do that, when we embarked on this branch of section 51 we are told in Hallstroms Case, are we not, that we have to look at practical and business matters, not juristic classifications?

MR SHAW: Yes, that is true, but that is not to say that juristic classification is irrelevant.

GUMMOW J: I just wonder how Sir Owen Dixon got from juristic classification for incurred to business practicalities for capital revenue account.

MR SHAW: I imagine, your Honour, one has to look at everything and try and work out what impression one gets but if you look at clause 3 of the concession deed which is at page 235 in volume 1 of the appeal book, it says:

The Company shall (provided the Concession Period then continues), in consideration of the State granting the concession rights set out in clause 2.8, pay to the State in the . . . Concession Period . . . $95,600,000 –

annually. The right is the right which is set out in the Full Court’s judgment, namely, the right to design, construct, commission, operate and so on. It is submitted that first of all there can be no doubt that - - -

GUMMOW J: It is not really a licence. A licence is a permission to do something that otherwise invades the legal rights of the licensor. It is very much a sui generis creation, I think.

MR SHAW: It is not just that, your Honour, it is this that the State creates the right which - - -

GUMMOW J: By statute.

MR SHAW: Which enables the taxpayer, amongst other things, to charge a toll and when the concession period comes to an end the various assets over which the taxpayer has had temporary dominion are transferred to the State and the whole structure, the whole - - -

GUMMOW J: They are all fixtures, anyway, are they not?

MR SHAW: Not the right to charge tolls, that is not - - -

GUMMOW J: No, quite.

MR SHAW: But that right disappears. It has gone.

GUMMOW J: Yes.

CALLINAN J: It is like a lease of land in a way, you sublease it.

MR SHAW: No, your Honour.

CALLINAN J: Then the reversion. There is reversion to - - -

MR SHAW: Yes, but what I was just pointing out to Justice Gummow, I hope correctly, was that certainly the most valuable thing, namely, the right to toll is (a) not a right which the State had. It created the right as it could do by legislation. When the concession period comes to an end the right to toll goes, disappears. It does not revert to the State. It just comes to an end. In our submission, it is impossible not to regard - - -

GUMMOW J: Is it any different from a patent licence?

MR SHAW: Most things are, your Honour.

GUMMOW J: An exclusive patent licence. It expires, it has gone, like the right to toll.

CRENNAN J: And the licensing fees would be on the income account and the royalties would be on the capital account.

MR SHAW: Yes, but here there are no royalties. In Cliffs International, which was a case about the sale of shares in a company which had rights to mine, there was a promise to pay 200,000 – I have forgotten whether it was pounds or dollars – and to pay an amount of 15 cents per ton if the right to mine was exercised and the iron ore was taken off the land over which the company in which the shares had been issued was taken out. It was held that those payments of the 15 cents per ton were not on capital account, they were on revenue account. Here one has the grant of one right to do all these things. It is a right pursuant to which the concession fees from time to time become payable but they are not paid. What there is is simply the right. It becomes an obligation from time to time, assuming that there is a liability, to pay the concession fee but the concession fee is agreed to be paid in return for really obtaining the business.

CRENNAN J: But is it not like a patent licence fee imposed annually on an annual basis, the payment of which is postponed until the licensee’s business is up and running? In that case it would be characterised as an income expense.

MR SHAW: In our submission, it is not. If I might take the Court to Colonial Mutual [1953] HCA 68; 89 CLR 428, if I might first of all go to the headnote:

J Brothers agreed to transfer to a life assurance company a piece of land adjoining land owned by the company, in consideration of a promise by the company to pay to them, for a period of fifty years, an amount equal to ninety per cent of all rents, as and when received, from lessees or tenants of three shops and a basement in a new building to be erected on both the blocks of land. The building having been erected, ninety-three per cent of it was let to tenants and the remaining seven per cent was occupied by the company itself. In the accounting period ended 31^st December 1942, the rents received by the company in respect of the three shops and basement amounted to £1,314 and the company duly paid to J Brothers ninety per cent of this sum, viz, £1,183. In its income tax return for the year ended 31^st December 1942 the company included the sum of £1,314 in its assessable income, and claimed as an allowable deduction . . . ninety-three per cent of that sum of £1,183, viz, £1,100.

It was held that the 1100 pounds was of a capital nature. At page 454 Justice Fullagar, who was in the majority – the Court seems to have been unanimous – said this at about point 4:

It is, however, the second aspect of the transaction of 1934 that is material for present purposes, and the present question is whether the monthly payments to Just Brothers are allowable deductions from the assessable income of the company. Considerations which are relevant on the other aspect of the transaction appear to me to be irrelevant here. For it is incontestable here that the moneys are paid in order to acquire a capital asset. The documents make it quite clear that these payments constitute the price payable on the purchase of land and that appears to me to be the end of the matter. It does not matter how they are calculated, or how they are payable, or when they are payable, or whether they may for a period cease to be payable. If they are paid as parts of the purchase price of an asset forming part of the fixed capital of a company, they are outgoings of capital or of a capital nature.

CALLINAN J: But, Mr Shaw, that is an outright transfer. There is no reversion. There is a reversion here. The State gets back the land and the road. Is that not right?

MR SHAW: Yes, it does, but it does not get back the right which it granted.

GUMMOW J: It does not need to.

CALLINAN J: It does not need to. It could impose tolls itself. It does not give any assurance that it will not.

MR SHAW: No, that is true, but it has no power to impose tolls unless it enacts a new statute, no doubt, but it does not get back the right which it has created in Citylink. What happens to that right is that it simply disappears.

CALLINAN J: Well, if the land was simply made available to the conglomerate that is building the road, for the purposes of building the road, does the State need to enact anything to entitle the conglomerate to charge tolls? It may be there for better assurance but if they own the land or they have exclusive possession of the land for the purpose of the road - - -

MR SHAW: They do not have exclusive possession of the land.

CALLINAN J: Well, they do, do they not, in substance and then they make it available for use by users?

MR SHAW: That is true, they do, yes, but - - -

CALLINAN J: All I am really wondering is whether, if you are going to talk about analogies, an analogy with a lease may not be inappropriate. It is not a lease, I know, but it has some features in common with it. It begins to look like rent.

CRENNAN J: Or a licence of a monopoly which reverts.

MR SHAW: Well, it is true that is has some of the characters which one might say are appropriate to a lease or whatever, but there is no doubt, it is submitted, that on the terms of the document the promise to pay the concession fee is a promise given in order to acquire the profit-earning structure.

CALLINAN J: It is just I do not think this case assists. The Colonial Mutual Case does not seem to me to assist really, because it is an outright transfer.

MR SHAW: It is an outright transfer - - -

CALLINAN J: There was no other purchase price, was there? I mean, there is no other way of identifying the purchase price.

MR SHAW: No, there is not. It is the same here though. I mean, if there was a purchase price, it was a promise to pay the concession fee and it is true in some - - -

CALLINAN J: Except there is no outright transfer. They do not end up with the fee simple in the land occupied by the road.

MR SHAW: It is true there is no outright transfer but Citylink does acquire rights which did not previously exist and which will expire on the expiry of the concession period. So it is really just a matter of characterising and, as the Chief Justice pointed out this morning, the company in its accounts seems to be treating the indebtedness in respect of the concession notes or concession fees as on capital account. In that respect we would say they were right. For those reasons, if the Court pleases - - -

GLEESON CJ: Mr Shaw, just before you finish, was it one of your submissions this morning that assuming this is on revenue account the amount claimable as an allowable deduction is the net present value of the concession fee in the year in which it is incurred?

MR SHAW: Yes.

GLEESON CJ: Which ground of appeal covers that? I am looking at pages 1436 and 1437.

MR SHAW: Your Honour, I would have to say 5 and 6.

GLEESON CJ: Then I need to understand the apportionment better than I do at the moment. The apportionment referred to in 5, as I understand it, is worked out by apportioning the concession fee over the whole of the period.
That is different from working out the net present value, is it not? The net present value of an amount of money payable in 20 years time is something that you work out by reference to interest rates.

MR SHAW: Well, your Honour, you do.

GLEESON CJ: This apportionment that you are proposing in ground 4 and ground 5, as I understood it, perhaps incorrectly, was this, that if a fee was incurred in year one but not payable until year 20, the amount of the deduction you get in year one is one-twentieth of the fee.

MR SHAW: Yes, that is so.

GLEESON CJ: That is different, is it not, from working out the net present value of the amount that is payable in 20 years time?

MR SHAW: It is, it is submitted, different, but merely a different way of apportioning.

GLEESON CJ: It is very substantially different, is it not? It would depend on interest rates, economic forecasts and the like.

MR SHAW: It is true, your Honour, it is a different way, I accept that.

GLEESON CJ: How is that alternative submission covered by the grounds of appeal?

MR SHAW: Well, your Honour, it depends on whether or not one can properly say it is a method of apportioning. If your Honour thinks it is not, then I would have to seek leave to amend the grounds of appeal.

GLEESON CJ: Maybe you would like to think about that.

MR SHAW: If your Honour pleases.

GLEESON CJ: Yes, Mr Archibald.

MR ARCHIBALD: If the Court please, in relation to that last point, the Commissioner sought leave before the Full Federal Court to argue for what was effectively straight line apportionment for that had not been raised at all below at first instance. The Full Court in its reasons at paragraph 38, page 1417 in volume 3 referred to the fact that the Commissioner had sought leave, observed at line 12 that:

There may be some unfairness now to give leave to the Commissioner to so argue when the submission was not made below, as it may be that evidence could have been called by Transurban which might have been relevant to negating such an approach.

That is certainly true of straight line apportionment and, a fortiori, true of the lately conceived argument about net present value. As your Honour the Chief Justice observed, there would likely to be all sorts of evidence led as to the availability and appropriateness of apportionment and matters that might affect it. None of that evidence was led or addressed at trial in this matter. At page 1416, to make the position clear, the Court observed in paragraph 36 that there would be distortions if matters were brought to account only in final years. In the penultimate sentence of that paragraph the Court said:

No doubt it was the case that proper accounting principles –

distinguished from fiscal principles –

would bring to account the net present value of the debt for the Concession Fees as a liability each year. That was not the view which the Commissioner took before his Honour as representing the true income tax position.

So it was the case that the Commissioner adopted a stance which was inconsistent with an MPV outcome.

CALLINAN J: Mr Archibald, you will not find a word, I do not think, in the Tax Act about anything other than nominal dollars.

MR ARCHIBALD: Exactly so.

CALLINAN J: The only exception is perhaps those provisions of the capital gains tax legislation, now repealed, which indexed up actual nominal dollars paid.

MR ARCHIBALD: Yes.

CALLINAN J: But, otherwise, the whole of the Act has always been nominal dollars.

MR ARCHIBALD: The fundamental scheme of the Act is derived as to income incurred as to liabilities not paid and received, as we have mentioned in our outline. A concomitant of that approach is that one addresses nominal values and historical cost and it is antithetical to those central tenets of the legislation to seek to address matters by reference to economic or accounting concepts such as might attract considerations involving net present value.

CALLINAN J: Yes, I might have sent that hare running, I think.

GLEESON CJ: Is what you have just been saying related to what appears on page 1429 at line 40?

MR ARCHIBALD: Yes, your Honour. Yes, it is. It was either yes or no.

GLEESON CJ: Insofar as there was a difference between the argument presented for the Commissioner in the Full Court of the Federal Court and the argument presented at first instance is it the case that the Commissioner was not given leave to make the change?

MR ARCHIBALD: The Full Court left it in the position that I identified at paragraph 38 observing that there would be unfairness involved but resolving against the availability, in any event, of such an approach by reason of the considerations to which the Court there referred, so there was, so to speak, not a formal refusal of leave, a recognition that the grant of leave might have involved other considerations but a rejection of the notion, in any event, by reference to the circumstances which were explored before the Court. One might observe, therefore, leave was never granted in the Full Federal Court and has not been sought here.

GLEESON CJ: If you were going to apportion the 1998 concession fee over the remainder or the whole of the period between 1998 and say 2013, if that was when it looked as though it would become payable, why would you do that apportionment by dividing the amount in 1998 by 15?

MR ARCHIBALD: If it were otherwise considered to be an appropriate and an available approach one would do it, no doubt, because there was, so to speak, constant accrual of advantage throughout that period to the taxpayer in respect of the subject matter of a fee in a particular year. It would really reflect that the incurring of that liability was not uniquely yoked to an advantage in the year of income but had some enduring advantage that the liability in year one secured advantages in years two, three, four, five, six, et cetera, and because of that circumstance, presumably, one might seek to fasten upon an allocation evenly, in nominal terms, throughout that period. We would say there are all sorts of reasons to reject that approach but presumably that is the foundation of the Commissioner’s contention in that respect.

Under the exposure draft for the new TOFA legislation, the taxation of financial arrangements, there are provisions being considered which would address ways in which one might account over a period of time for gains and losses under financial arrangements. What is interesting to observe in respect of that exposure draft is that there is no fastening upon some notion of straight line accounting either for gains or losses over the whole of those periods, nor of fastening uniquely upon net present value concepts. I think there are five alternatives that are being considered, each of which no doubt would have their own appropriateness in particular cases, but those five approaches would be available to be selected under the exposure draft at the option of the taxpayer involved. That circumstance tends to show that there is no unique virtue in straight line apportionment, no unique virtue in net present value. There are a variety of ways in which one might seek to cater for the achievement of gains or losses under financial arrangements which extend over a number of years.

CALLINAN J: You get the same problem with depreciation. On one basis it would be much fairer if you could get depreciation on current replacement cost, and of course you do not under the Tax Act; you get it on the nominal dollars spent in the past.

MR ARCHIBALD: Yes. Another feature which is very important to bear steadily in mind when one is considering arguments that outgoings should be assessed on some basis of net present value is that there should no doubt be parity of consideration and one would need to address what happens on the income derivation side. If it were considered to be appropriate to treat the outgoing on some net present value basis, by parity of reasoning one would likely encounter the proposition that there should be some adoption of a net present value system on the income side. So, instead of having to account for income derived in year one at the nominal value, one would seek again to embark upon some exercise of departing from face value and adopting some other measure, and that would have equal difficulties.

GLEESON CJ: This is just a consequence of accrual accounting, but once you got into the area of seeking a true reflex through some system of apportionment, then presumably the competing possibilities, as you say, would be numerous and selecting the one that is appropriate might well depend upon expert evidence.

MR ARCHIBALD: Yes, and really is a choice which resides not in fundamental principle for this Court but is a choice that is available for the legislature in particular cases to select. Historically that is what has happened. Where there have been considerations which have commended themselves to the legislature, the legislature has stepped in, enacted specific and usually very complicated legislation to deal with the particular phenomenon and select a particular legislative solution, not always selecting the same solution in different cases. We have identified some of those legislative initiatives in our written summary.

GLEESON CJ: Presumably one possibility if you wanted to look at apportionment in this case would be related to your estimates of future toll receipts and you would not necessarily apportion on the basis that toll receipts over the next 15 years would be the same year by year.

MR ARCHIBALD: No, they would very unlikely be constant in nominal terms and equally unlikely to be constant in 2006 dollar terms. They would vary in a number of ways. So that there is no single solution identifiable as a matter of principle or concept even if the legislation, the current legislation enabled some departure from historical cost, accrual systems, nominal and face value concepts.

GLEESON CJ: Where would we most conveniently find this exposure draft?

MR ARCHIBALD: Probably by our being able to hand up some copies of it tomorrow if we are not able to do it instantly.

GLEESON CJ: Thank you.

MR ARCHIBALD: I am sorry, I have half made an assumption about tomorrow in answering your Honour’s question.

GLEESON CJ: No, it is a reasonable assumption.

MR ARCHIBALD: If we are unable to finish the oral argument today, would the Court be continuing this matter tomorrow morning?

GLEESON CJ: Yes.

MR ARCHIBALD: Thank you, your Honour. Might I then address submissions to the Court in relation to the question as to whether the concession fees are incurred in the years of income in question? One starts, in our submission, with clause 3.1(a) of the concession deed. The terms of that clause, in our submission, unequivocally and immediately establish a present liability subject to one and one only contingency. The clause is at page 235 in volume 1 of the appeal papers. The contingency is the provision or the requirement that the concession period then be continuing. So if one takes the 1998 year, the last of the three years with which this appeal is concerned, one asks the question, was the concession period continuing within that year? The answer to that on the evidence is yes. That being so, the contingency is satisfied and one is left in the relevant year of income with a present liability to which the taxpayer is definitively committed.

Under clause 3.1(a)(i) that liability was an annual liability payable semi-annually in arrears. If the matter rested there, there would, in our submission, be no room for argument that the liability was incurred in the year of income. The contention of the Commissioner is that that outcome is displaced by other circumstances and provisions. The Commissioner points to and relies upon the provisions within the concession note mechanism and points to and relies upon the provisions in clause 1.9 of the master security deed.

Now, one observes that the concession deed was entered into between the State and the project vehicles, the company and the trustee. It was entered into on, I think, 20 October 1996. Ten days later the master security deed was executed. The parties to that deed include the State and the project vehicles, but also include the senior lenders to the project and their agents and the trustees. The existence of the master security deed is really explained because of the involvement of those financiers in the project and the requirements which they had in relation to the debt that would be owed to them and the accommodation of the different interests of the multiplicity of creditors in light of those lending arrangements.

The substantive work which the master security deed effected was to ordain the priorities between those secured lenders, the State, on the one hand, having a deed of charge, fixed and floating, and the lenders, on the other hand, with their various securities.

GUMMOW J: Do you know any more about this fixed and floating charge?

MR ARCHIBALD: The State charge?

GUMMOW J: No, the lenders.

MR ARCHIBALD: No, I am sorry. We know clearly that the State charge which is in the appeal papers in volume 2 at page 463 was fixed and floating. We know from the provisions of the master security deed that the lenders naturally had securities and we know that they were charges in character. We do not have the charges themselves. One might infer that they were usual charges, probably both fixed and floating.

GUMMOW J: Over this income stream?

MR ARCHIBALD: Over everything.

GUMMOW J: Yes, but including the income stream, surely?

MR ARCHIBALD: Yes, including the income stream. The priority regime under clause 3.1 at page 739 was that the State ranked first, ahead of everything else, the certain obligations owed to it called in the master security deed “the State’s Priority Amount”. Then the senior lenders came second. The State came third for non-priority amount items, which included concession fees and concession notes, and then there were some further priority provisions identified.

GLEESON CJ: Where did the equity investors come? Before the concession fee?

MR ARCHIBALD: No. There was an ability, of course, to distribute but they were not inevitably postponed. In a winding-up, of course, the secured creditors would rank first, then unsecured and, of course, equity would follow after that. Plainly, by reason of the multiplicity of lenders and the requirements they had negotiated with the project vehicles, there was a need to accommodate between the State, on the one hand, and the project lenders, on the other hand, their various entitlements. That was achieved by the substantive priority arrangements that I have indicated.

A concomitant of that was that there was provision for concession notes. The concession note provision was introduced by and is found only in the master security deed. That provision, which I think my friend may not have taken the Court to, is at page 777 in volume 2 under clause 18.5. My friend indicates that he did mention it to the Court. Under clause 18.5(a) the company is able to elect to adopt the concession note mechanism and the clause provides:

The obligation of the Company to pay an amount payable by it under paragraph 3.1(a) of the Concession Deed –

the concession fee –

may (at the election of the Company) be satisfied by the Company issuing to the State . . . Concession Notes –

Then there is provision as to face value and one sees that the State has the ability to designate the particular face value of a concession note. Some of the notes that were issued during this period that are in volume 3 are for nominal amounts of $5 million and so on and it seems that the State was making requests so that if it was wishing to transfer.....there were separate notes that would reflect amounts of money in which interested acquirers might achieve their desired end.

So that the very concept of concession notes which are attended by deferral of the time for payment that would otherwise attend the concession fees emerges through the provisions of the master security deed. So that was one of the matters introduced in order to achieve the harmonious subordination arrangements which emerge from the master security deed. The second provision which is of the same character, in our contention, is clause 1.9 to which the Court has been taken. If a concession note election was made, as on the evidence it was, then by the express provision of clause 18.5 the issue of the concession note satisfied - whatever that may be taken to mean in these circumstances - the concession fee and thereafter the obligations of the company, the taxpayer, were to be found within the concession note.

Might I take the Court to the first concession note which is in volume 3 at page 1119? Part 3(a) of the note provides that:

The Payment Amount must be paid -

on the expiry date. Then Part 3(b) and Part 3(c) provide that in certain circumstances acceleration of the ultimate payment date may occur.

GLEESON CJ: Were there circumstances under which the concession might come to an end prematurely, as it were?

MR ARCHIBALD: Yes, the circumstance under Part 3(c) was indeed available only in the event that the concession period ended early and Part 3(c)(1) shows that that early payment provision would be available where the concession period ended due to the operation of paragraph (a) of the concession period and paragraph (a) of the definition appears at page 165 in volume 1. One sees from that paragraph that the earlier expiration may occur if the State gives notice of such termination where equity returns have exceeded 17.5 per cent and all project debt has been paid out. So where there are hugely advantageous outcomes under the concession and all the debt has gone the State had the ability to bring the concession to an end.

GLEESON CJ: Presumably, there could also be termination for default.

MR ARCHIBALD: Yes, there is certainly that possibility and that is provided for - - -

GLEESON CJ: And if that happened then under Part 3(c) the concession note would be payable.

MR ARCHIBALD: Yes.

GLEESON CJ: Within 30 days.

MR ARCHIBALD: Yes, so those provisions cater for termination in those circumstances and paragraph (b) provides for earlier payment where the specified equity return hurdle of 10 per cent has been cleared and payment would not draw on more than 30 per cent of distributable cash flow. Now, those criteria are criteria which attend possible acceleration of a payment date, but they do not, in our submission, on their face entail the imposition of any condition upon or contingency in relation to the existence of the liability. They can only affect the time for payment because it is bringing forward, if certain provisions are met, the time which would otherwise be ordained for payment of the note. But all of that reflects the way in which the interests of the senior lenders are accommodated and adjustments that follow in relation to dates for payment of what is otherwise a liability to which the taxpayer is definitively committed.

GLEESON CJ: What did the State’s fixed and floating charge secure?

MR ARCHIBALD: All of its entitlements, all of the obligations owed by CityLink to it including, therefore, not only concession fee and concession note liabilities, but also liabilities for breach of CityLink’s obligations under the concession deed to maintain, to operate a range of matters.

GUMMOW J: There is a definition of “Obligations” at page 471.

MR ARCHIBALD: Yes, that is so, your Honour, and “Secured Money” at 472 is defined to mean:

all money the payment or repayment of which then forms part of the Obligations - - -

GLEESON CJ: But to the extent to which the State had a first charge, that has to be understood against the nature of the obligations which in relation to the concession fee were subordinate to the obligations to the lenders.

MR ARCHIBALD: Yes, so that where the State had first ranking priority there was a carve-out of the concession note and concession fee liability and that came in after the senior lenders’ entitlements. Now, it is also important to understand what it is that clause 1.9 of the master security deed was doing. Clause 1.9 is relevantly in the form at page 786 in volume 2. Its language is temporal in character:

For so long as any Project Debt is owing . . . any payment to be made by the Company or the Trustee to the State . . . shall be owing to the State but shall not be due for payment until –

the relevant criterion is satisfied.

So it is not introducing any contingency as to liability. It expressly and specifically confirms the existence of liability, “shall be owing” but it alters, so as to accommodate the substantive subordination arrangements made in clause 3, the likely sequence in which payments would be made and therefore impacts upon the timing of payments.

GLEESON CJ: Could we just take a moment over this?

MR ARCHIBALD: Yes.

GLEESON CJ: The project debt is presumably payable according to the terms of the lending agreement?

MR ARCHIBALD: Yes. There were three elements of project debt.

GUMMOW J: Yes. We had better see that definition, I think.

MR ARCHIBALD: “Project Debt” is at 186 in volume 1. It is the money in respect of which liability exists under the lending documents and the lending documents are listed at 181 to 182. One sees the very large number of them. In essence there was a tranche, tranche A which was repayable in 2013, a tranche, tranche B repayable in 2015 and the CPI bonds to which reference is made at 181 were long term CPI adjusted bonds repayable in 2023.

GLEESON CJ: Then, so long as there is any money owing to Westpac, for example, the concession fee is not due for payment until sufficient money is available for withdrawal from the distributions account to meet the payment for the concession fee.

MR ARCHIBALD: Yes.

GLEESON CJ: What protection does that give the lender, the financier?

MR ARCHIBALD: It has the consequence that unless funds have flowed through to that account no payment will be made by the company to the State. I will take the Court to this in a moment. The funds will not reach that account unless and until the entitlements of the senior lenders have been met in the meantime.

GLEESON CJ: Including future entitlements?

MR ARCHIBALD: No, current entitlements.

GLEESON CJ: What is to stop them paying the concession fee to the State although there remain moneys owing to the financiers?

MR ARCHIBALD: The provisions of the security trust deed, which I wish to go to in a moment, provide that the – in the way that project lenders do – that all the revenues of the project, all the equity inflows and all the loan draw downs have to go into a system of accounts controlled by the agent for the lenders and may be only dealt with under that system of accounts in specified ways, so there is no opportunity for moneys that are available to the project, whether it be revenue or from any other source such as draw downs or equity raisings, otherwise than in conformity with the system of accounts and that ensures that the priorities agreed in the master security deed are observed.

GLEESON CJ: That is the way somebody works out that it is not until 2013 that it is likely that there will be concession fees payable?

MR ARCHIBALD: Yes. All of this could be done no doubt by the company itself carefully observing all of the provisions to which it has subjected itself and observing the subordination arrangements, but the lenders here may be seen to have insisted upon and achieved agreement in respect of the controlled system of accounts in respect of which their agent serving their interests has the whip hand. Through that mechanism there is a greater assurance to the senior lenders that their interests will be protected, their interests will be observed and payments would not be made in disconformity with the priorities agreed in the security deed. That is why clause 1.9 operates only while project debt remains outstanding. The moment project debt has gone, clause 1.9 ceases to operate. So its purpose and function can be seen to be protecting the interests of the senior lenders and their securities.

GUMMOW J: Am I right in thinking that – just looking at 1.9 – the payment that would be made would be payment made by the company out of funds which in its hands were already charged to the financiers anyway? So they would be in breach of the security.

MR ARCHIBALD: Not the floating aspect because - - -

GUMMOW J: That is what I am wondering. Would it crystallise? Would this sort of misconduct, to use that expression, crystallise any secured rights on notice of which the other party would - - -

MR ARCHIBALD: But that is exactly why, in our contention, one has the provision stipulating that the due date for payment in respect of the concession fees will not arrive until there are moneys in those accounts, otherwise the company may be thrown into inappropriate default vis-à-vis the State by observing the priority requirements ordained by the secured lenders. This clause achieves harmony between the interests of the various creditors without precipitating an inappropriate default. That explains, in our contention, why there is a deferral of the due date for payment until the moneys are available or the moneys will be available immediately upon satisfaction of the higher priority entitlements.

GLEESON CJ: Is default under the lending arrangements one of the grounds of termination of the concession?

MR ARCHIBALD: Not under the lending arrangements, no. It is default under the concession deed. We do not have all of the lending documents but it may well be that a breach of the deed would also trigger entitlements of the secured lenders but would not allow them pursuing their own rights to bring the concession period to an end.

So that to understand what clause 1.9 is doing when it speaks of the amount of the concession fee being owing but not due for payment until moneys are in the distributions account, one needs to understand the distributions account. The distributions account is part of the system established by the security trust deed. The security trust deed is to be found in volume 3 starting at page 912.

Under the security trust deed the agent for the lenders has certain entitlements and the company and the trustee, the other project vehicle, have obligations to establish special purpose accounts. The provision in relation to special purpose accounts is clause 15 starting at page 1024. By clause 15.1 the borrower is to establish and maintain certain bank accounts and is obliged to operate those accounts -

until the Secured Money has been fully and finally paid or repaid –

So again it is tied to the interest of the secured creditors.

GUMMOW J: I am sorry; could you explain that again, Mr Archibald?

MR ARCHIBALD: Yes.

GUMMOW J: I am looking at 15.1.

MR ARCHIBALD: Yes. The obligation to open and to maintain these special accounts incepts at “Financial Closing” - that is at line 28 on page 1024 - - -

GUMMOW J: Yes.

MR ARCHIBALD: And continues:

until the Secured Money has been fully and finally paid or repaid -

So it only exists while the project debt is outstanding. A similar obligation is imposed under 15.1(b) upon the trustee who is called the guarantor in this document. 15.2 deals with the terms of the accounts and importantly 15.2(b) contains a grant by both the company and the trustee to the agent of the secured lenders to make all transfers and withdrawals from any special purpose account so the agent has complete control.

GUMMOW J: This is secured creditors’ heaven.

MR ARCHIBALD: Yes, the agent being the agent of the secured creditors.

GUMMOW J: ANZ Bank.

MR ARCHIBALD: Yes, if you want to borrow money there are some it seems you would have to tolerate, particularly in major project finance. One sees what happens in these accounts. 15.7 deals with the clearing account. It is at page 1032, line 22:

The Borrower shall ensure that all of the following is deposited into the Borrower’s Clearing Account, promptly after receipt -

and what goes into that includes virtually everything.

(i) Project Revenue -

line 24, various other items but importantly (vi) at line 45 –

(vi) Equity Proceeds -

and at the top of page 1033, (viii), proceeds of other loans. So what goes into the account are all your earnings, all of your equity, and all of your borrowings. So these accounts are dealing with cash flow. Commissioner’s submissions have been predicated upon payment of the concession fees out of revenue or assessable income of future years but the distributions account will contain what is a mix of equity, borrowings and revenue. Even before the link was completely constructed and tolling commenced, plainly there were very large inflows into this set of accounts.

GUMMOW J: Yes, from the moneys coming under the prospectus.

MR ARCHIBALD: Yes, billions of dollars, billions of dollars coming into these accounts. But for the subordination arrangements and other security requirements, if there was a need to pay out $95.6 million, cash was there from a variety of sources no doubt. But the subordination arrangements and the project structure required that those funds be held for other immediate purposes, priority purposes, and that the payment of the fees be deferred in point of time while the liability remained. So that is the clearing account. That is where it comes in.

Clause 15.8 deals with withdrawals from that account and one sees in 15.8(e) at page 1037 priority withdrawals include “(A) (Funding Costs)”, which are essentially interest and matters of that kind to the creditors – that is defined at page 929 in volume 3 – and “(B) (Mandatory Repayments), which I think are essentially repayments of principal, defined at page 935 in volume 3. So out of the clearing account the secured creditors get much of their entitlement.

There is an operating account for ordinary outgoings, day-to-day outgoings and then there is the distributions account, which is the concept addressed by clause 1.9. That is dealt with in clause 15.14 at page 1049. Section 15.14(a) controls what may go into that account and only two inflows are allowed. Under 15.8(l) there can be an inflow. Clause 15.8(l) is at page 1040 and those are essentially moneys which relate to the State priority amounts, the very first ranking entitlement. So first ranking entitlements can go into that account.

The other inflow is 15.12(b)(iii). One sees that at 1047. That relates to what is standing to the credit of the excess cash flow account. The Court will see at 1047 that that can flow out to the distributions account but only if certain ratios are met, these being secured lender ratio requirements. So again it is allowing the requirements of the priority secured creditors to control this cash flow. There are various ratios, but if all of those ratios are met, then funds flow out of the excess cash flow account into the distributions account. Once they are in the distributions account, 15.14(b) deals with permitted withdrawals, and the withdrawals may be made “in payment of amounts then owing and due for payment by it to the State” and then otherwise to holders of other concession notes or other purposes.

So that moneys arrive in the distributions account when the priority requirements of the secured lenders have been met and eo instanti the time ordained by clause 1.9 for payment to the State of the concession fee will be satisfied. Then 15.14(c) restricts withdrawals from the distributions account so again as to ensure conformity with these arrangements. The payment may be made to the State pursuant to paragraph (c):

if an amount . . . is owing to the State by the Borrower or the Guarantor under any Project Document and would be due for payment but for the operation of clause 1.9 of the Master Security Deed - - -

GUMMOW J: I am sorry, what clause are you reading from, Mr Archibald?

MR ARCHIBALD: Clause 15.14(c) at page 1049. So that:

if an amount . . . is owing . . . and would be due for payment but for the operation of clause 1.9 . . . it undertakes not to apply any amounts held in the Distributions Account . . . for any purpose other than payment of the State Payment Amount until the balance . . . equals or exceeds that State Payment Amount –

So again it controls other outflows.

Although somewhat elaborate and complicated, one can see, in our contention, when one understands the function and role of the distributions account in the overall system, the waterfall of accounts, as it has been called, is to secure no more than conformity with the subordination arrangements, the avoidance of any inappropriate breach to the State by reason of the company observing its obligations to the secured creditors and achieving payment to the State when the funds flow through the system. The flow of funds through the waterfall of accounts reflects, in our submission, the priority arrangements and therefore the two harmonise. None of that process, in our submission, in any way disturbs the existence of the present liability which otherwise obtains by reason of clause 3.1 of the concession.

GUMMOW J: It assumes it really.

MR ARCHIBALD: Yes, it assumes, it confirms, and if that were not what it was doing, it actually establishes or ordains that that is the position because there are express stipulations that those amounts are owing. They do it explicitly and plainly deliberately in order to recognise that there is no interference with the integrity of the present liability which was otherwise established. The reason and the only reason for these steps being taken, one can discern from the documents, is to meet and satisfy the requirements of the secured lenders.

So that our contention is that an agreement of the kind that one sees in the master security deed between creditors as to priority will not of itself affect the liability which one creditor may enjoy from the project vehicle and elevation up or relegation down the line of priorities leaves intact the particular liability wherever it is ultimately located along the line of priorities. If it is relegated, then there may be some attenuation of the creditor’s rights to enjoy discharge of the liability but the liability itself will not be affected.

The problem that we are addressing here is really a problem that is necessarily encountered in project finance wherever a multiplicity of creditors is involved, as is commonly the case. It is not as though, in our submission, any eccentricity is to be found in the drafting of clause 1.9 which produces a problem that is unique to this case. It is inevitably the position with a multiplicity of lenders that they need to adjust priorities inter se and it is the existence of the need for and the achievement of those priorities that yields the provision in clause 1.9 and the parallel provision in Part 4(b) of the concession note regime. It is not the case and could not be the case in our contention that one would encounter in every project financing regime a situation where only the very top priority creditor had entitlements which reflected existing liabilities rather than an absence of liabilities or contingent liabilities. Every other creditor in the project, including secured creditors, had nothing more than, depending how the Commissioner’s argument is put, an expectancy of a liability coming to existence at a future date or had some liability which was contingent in a way which deprived that liability of features which would completely subject the project party to that liability.

So we make those submissions. The circumstance that these arrangements come to an end when project debt is paid out confirms, in our contention, that they are referable to and explicable by reference to the need, requirements and insistence of the bank lenders and we observe that both clause 1.9 in its own language confirms that the liabilities remain owing. I have not drawn the Court’s attention to that provision in the concession notes but looking at concession note 1 in volume 3 at page 1119 one sees the parallel provision in Part 4(b) at page 1120, line 43: “shall be owing but shall not be due for payment”. So each provision goes out of its way to confirm the continued existence of a present liability in respect of these items.

There is also, one might observe, in the security trust deed in volume 3 at page 1055 an “Overriding provision” which stipulates that:

Nothing in this Clause 15 –

the waterfall of accounts system –

limits the obligation of each Relevant Party –

an expression defined at page 944 to include the borrower, the borrowing company –

to make due and punctual payment of each payment due from it under or in respect of any Operative Document.

“Operative Document” is defined at page 940 to include “Project Document” and “Project Document” includes “Concession Deed” and includes concession notes. So, again, there is a confirmation of a more general kind that obligations that would otherwise exist are not intruded upon or interfered with or derogated from by reason of these arrangements.

It follows, in our contention, from that analysis that there is and remains a present liability in respect of the concession fee and equally in respect of the concession note that is not interrupted or disturbed by the provisions to which we have drawn the Court’s attention. Those provisions do no more than fix the time for discharge of that liability by reference to and in consequence of the existence of the priority entitlements of the secured creditors.

If what the parties had done was not to incorporate clause 1.9 in the master security deed but had simply been content to exact from the company, the taxpayer, a covenant to pay its obligations conformably with the priority arrangements between the secured creditors, such a provision could not, in our contention, yield a conclusion that the liability of the company to the State had become contingent or had been eliminated. Such a provision would do the same work in a different fashion as is done by clause 1.9 and the parallel provision in Part 4(b) of the concession notes.

Because the company is definitively committed to the secured lenders and definitively committed to the State, its promise to pay them, but in sequence, does not, in our contention, interfere with the commitment to either of them. It simply yields a sequence and therefore a time or likely time of payment. To agree to preferentially discharge liabilities to the secured creditors does not mean that the liability to the State thereby becomes contingent in any relevant sense. Were it otherwise, then, as we have indicated, there would be fragility, necessary fragility, in project financing arrangements, for liabilities could not be created other than of a contingent kind below the most senior ranking level and attendant difficulties would follow.

Were it to be the case, for example, that the project did falter and the project vehicle encountered insolvency of one kind or another, if one were to envisage that kind of outcome, the creditors would not be able to prove for liabilities as debts. The most that they could do if they had a contingent liability would be to seek to prove the value of that contingent liability, and if there were no liability, if there were only an expectation of a liability, they could not prove at all. It is improbable, in our submission, that parties of the kind involved in project finance would enter into arrangements which would produce those outcomes.

We mention that in particular only because it was the observation of Justice Beaumont in the AGC Case at page 506 between point 5 and point 6 on the page that such an outcome would be an improbable arrangement between parties.

GUMMOW J: This is 2 FCR?

MR ARCHIBALD: Yes, your Honour, at 506:

It would be a feature of such a contract that, if it did not run its full term, because, say, insolvency or even voluntary liquidation intervened before the due date (time would be of the essence), the lender would have no entitlement to interest as such. At best, the lender would be able to claim for general damages on the footing that a valuation of his . . . interest accrued due at that point of time. Unattractive features of this kind suggest that a special agreement along these lines is unlikely to be made, at least between parties at arms’ length.

A fortiori, in our submission, in sophisticated major project finance structures.

GLEESON CJ: To what extent did the decision in that case turn on the fact, or the holding, that interest accrues from day to day?

MR ARCHIBALD: Not at all, in our submission. All that that circumstance reflected was stronger confirmation, in our contention, of the incurring within the year of income of a liability that reflected the features attending the earning of assessable income within that year. The important circumstance is that the deferral of the date for payment until some unknown future time did not derogate from the circumstance that the liability was incurred within that period.

So that cases upon which the Commissioner relies, such as Nilsen, in our submission, are cases involving circumstances of a different kind from the instant case. In Nilsen there was no liability of any kind until – this was the consequence of the award – leave was taken. Before that time commercially there was an appreciation of a likelihood, if not a near certainty, that such a liability would arise at a future point of time.

GLEESON CJ: Well, Nilsen was a good example of a disconformity between the fiscal regime and the commercial regime and the directors would be likely to end up in gaol if they were not acknowledging these accruing liabilities in their accounts.

MR ARCHIBALD: That is why they made provision. They made provision meeting the accounting principles, properly apprehending that at a future point of time what was in year one a mere spes or expectancy would in year two, or year three, be a liability, and the apprehension that that would occur made it appropriate to make provision in their accounts for it but the making of a provision by reference to estimates and the like did not bespeak the existence at that moment in that within that year of some feature which reflected a present liability it was only the apprehension of an entirely future liability that led to that course being adopted.

GLEESON CJ: With a sufficiently large organisation it would be statistically almost a certainty.

MR ARCHIBALD: Yes. Yes, indeed, but the circumstance that there was good and sound reason from the point of view of accounting principles and observances of proper corporate governance principles to make a provision of that kind did not entail that there was a circumstance which allowed fiscal deductibility. There was no liability, nothing incurred.

CALLINAN J: It is a curious disconformity, is it not, when under other sections of the Tax Act you have to apply strict legal principles derived often from enactment, but here, in this sort of area you do not?

MR ARCHIBALD: We do not. We might argue in another location that a regime of this kind ought no longer persist and that measures should be taken by the legislation to alter it and the TOFA exposure draft shows addressing the issue in a particular area but so long as we have the central regime under this legislation which - - -

CALLINAN J: But it really eliminates any legal effect to be given to admissions against interest which may appear in the accounts.

MR ARCHIBALD: But accounts are prepared by reference to principles and considerations which are divorced from and, as one observes here, different from matters that arise under the taxation legislation. The proper recognition according to accounting principles of features of liability which would make it appropriate to bring liability to account according to the then net present value of a liability will reflect not so much an admission in respect of that matter but proper observance of those considerations and criteria, but it tells you nothing about what the outcome under the taxation legislation will be so far as deductibility is concerned.

GLEESON CJ: I suppose one of the problems politically is that once you disturb the existing fiscal regime, there is no guarantee that the net result will be favourable to the revenue.

MR ARCHIBALD: That is so. As we have observed, it is artificial to consider these issues only from the point of view of the deduction side. One would consider what happens on the income side. Here the particular circumstance is that the party with whom the taxpayer dealt was the State, the Crown in right of Victoria, a non-taxpayer. Had the party with whom the company dealt been a private sector participant, the corollary of the deductibility of the concession fee in 1996, 1997 and 1998 would be the derivation of income by the party with whom we dealt in each of those years and the tax outcome would be entirely satisfied for there would be brought to account on both sides both the deductibility so far as the project vehicle is concerned and the advantage accruing, the income derived by the other party, would be brought to account in its returns of income for each of those years and the tax system would be satisfied. The observation one makes here is that the reason that outcome has not occurred is only because the State is exempt from paying income tax.

CALLINAN J: I suspect the Federal Treasurer might have some regard to it though when the funds are allocated.

MR ARCHIBALD: Maybe under various regimes there may be – there is more than one way to deal with a problem.

GLEESON CJ: It is probably all taken into account in the Grants Commission. That is what they used to tell me.

MR ARCHIBALD: Yes, somewhere but not within the tax system.

GLEESON CJ: It is impossible to think that the expected fiscal outcome would not have been a factor entering into the negotiations about the concession fee between the State and Transurban.

MR ARCHIBALD: Likely so, one might speculate. It might be taken into account in relation to whether or not there would be an ability to accommodate the requirements of the secured lenders. At every point, in seeking to make the project work, there would be consideration of the interests of each party, the demands of each party and the fiscal outcomes. Where one has, as one had here, the State Government, the Government in right of the Crown in Victoria, participating, it, of course, was in a position where it might, for its own reasons, be prepared to enter into arrangements on particular terms.

Take the interest free feature here, the point which has been mentioned on behalf of the Commissioner. One might think that a private sector party might not take that step and had the party been a private sector party it may not have occurred. What impact it would have had upon the project arrangements one cannot know, but governments are habitually engaged in making arrangements which will assist or allow projects seen to be for the advantage of the community to proceed and governments make interest free loans or they make low interest loans, regional grants. They may take a step beyond a low interest loan or an interest free loan and they may make a positive grant in order to see that a project will take place.

Here, the State has been in a position where it can make its own decision as to whether, when the deferral arrangements needed to be put in place to meet the requirements of the secured lenders, the State would be prepared to allow financial accommodation to the project vehicle or not. So, again, it is not an untoward or a particularly unusual outcome where a State Government is involved in a project to see that a project will proceed to the advantage of the community.

Could I make a few brief observations on the question of satisfaction. As I drew the Court’s attention to, the provisions of the master security deed, clause 18.5, expressly provide that the issue of the concession note will operate so as to discharge the concession fee. Clause 18.5 at page 777 in volume 2 says as much. So that the view about satisfaction is not really based upon any analogy with promissory notes or their ilk but is fastening on an express provision of the agreement made between the parties.

The point about satisfaction was not one that we had urged at first instance, nor one that we had urged before the Full Court; rather, the point emerged, proffered by the Court, as a matter to be taken into account and to which some attention was given by the parties in the course of argument before the Full Court.

We, for our part, rather see the satisfaction point as confirming the primary argument, namely, that if one is satisfying an obligation to pay an amount, one is indicating that there exists something in the nature of an obligation that is susceptible of being satisfied. So that the provisions of clause 18.5 serve to confirm, in our submission, the primary conclusion to be derived from clause 3.1(a) in light of clause 1.9. Put differently, it is improbable that the parties would be speaking in terms of satisfying obligations unless it was their intention and it was their provision that there be such an obligation capable of being satisfied.

Further, the provision in relation to satisfaction provides some assistance, auxiliary assistance, in our contention, for the conclusion that the liability in respect of a concession fee is referable to the year of income in which the concession fee arises. For again, there is happening within the year of income the satisfaction that flows form the exercise by the party of its election to issue the concession note in satisfaction of the fee. Whether more would follow upon particular analysis of the position of the liability in
relation to the concession fee or concession note is another matter and we, for our part, would not wish to develop arguments beyond those that we have otherwise addressed.

GLEESON CJ: Is that a convenient time, Mr Archibald?

MR ARCHIBALD: Yes, that would be a convenient time, if the Court pleases.

GLEESON CJ: How long do you think you will require?

MR ARCHIBALD: I would hope an hour, your Honour

GLEESON CJ: Mr Shaw?

MR SHAW: Half an hour perhaps, your Honour.

GLEESON CJ: We will say the next case will be not before 11.30 and we will adjourn until 10.15.

AT 4.15 PM THE MATTER WAS ADJOURNED
UNTIL WEDNESDAY, 1 FEBRUARY 2006