1997] NZCA 466 [1997] NZCA 331 (27 November 1997)

Last Updated: 24 February 2019

IN THE COURT OF APPEAL OF NEW ZEALAND C.A. 185/96

BETWEEN THE COMMISSIONER OF INLAND REVENUE

Appellant

AND LYTTELTON PORT COMPANY LIMITED

Respondent

Coram: Gault J Henry J Cartwright J

Hearing: 28 May 1997

Counsel: J H Coleman for Appellant A C Shaw for Respondent

Judgment: 25 June 1997

JUDGMENT OF THE COURT DELIVERED BY CARTWRIGHT J

Introduction

In 1988, as a consequence of the decision by Government to restructure ports nationwide, the Port Companies Act was passed. As part of the process, the Act provided for an establishment unit to negotiate a Port Company plan with each affected Harbour Board. Subject to Ministerial approval, the commercial undertakings of each port were ultimately to be transferred from the Harbour Board to a Port Company. As from 1 October 1988 the respondent in this appeal, the Lyttelton Port Company Limited, took possession of the assets of the former Lyttelton Harbour Board. Ministerial approval was ultimately given following negotiations over the value of Harbour Board assets and liabilities. There was no negotiation between the old Harbour Board and the respondent over the extent of assets to be acquired. The respondent was obliged to acquire certain buildings, regardless of whether they held any commercial value for the newly formed Port
Company. According to the evidence before the Judge in the High Court, the respondent did not want the buildings, and while there might have been some temporary use for them a decision was made to demolish them. The tender for the demolition work included the work necessary for the land under the buildings to be brought up to the operational standard of a Category 1 highway. The respondent claimed (inter alia) a deduction against taxation payable for the costs of demolition of the buildings, a total of $13,500.

In a written judgment delivered on 17 May 1996 covering a wide range of issues stated in a case pursuant to s 33 of the Income Tax Act 1976, Hansen J determined that the cost of demolishing the buildings was a necessary item of expenditure incurred in the carrying on of the taxpayer’s business and should properly be allowed as a deduction. This determination is the only aspect of the judgment challenged on appeal.

The Issue

The sole issue for the Court’s determination is whether the demolition costs of
$13,500 are capital in nature and therefore non-deductible by virtue of s 106(1)(a) of the Income Tax Act 1976.

The appellant acknowledges that the sum involved is relatively insignificant. There is, however, no other New Zealand case addressing the deductibility of demolition costs. Prior to the judgment in the High Court, the appellant (following Australian authorities and in particular Mount Isa Mines Ltd v Federal Commissioner of Taxation [1992] HCA 62; (1992) 24 ATR 261 and Commissioner of Taxation of the Commonwealth of Australia v Broken Hill Pty Co Ltd [1968] HCA 16; (1967) 120 CLR 240) had treated demolition costs as capital in nature. The appellant therefore considers, in view of the High Court decision, that it is essential that the status of demolition costs be clarified.

The Income Tax Act 1976

Except as provided by the Act, s 101 expressly prohibits deductions being made in respect of any expenditure or loss. Section 104 provides for the deduction of expenditure as follows:

104 In calculating the assessable income of any taxpayer, any expenditure or loss to the extent to which it -

(a) Is incurred in gaining or producing the assessable income for any income year; or

(b) Is necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income for any income year -

may, except as otherwise provided in this Act, be deducted from the total income derived by the taxpayer in the income year in which the expenditure or loss is incurred.

Notwithstanding anything in s 104 however, s 106 of the Act provides that in calculating the assessable income of any person no deduction should be made in respect of certain matters, which include (s 106(1)(a)):

Investment, expenditure, loss, or withdrawal of capital; money used or intended to be used as capital; money used in the improvement of premises occupied; interest which might have been made on any such capital or money if laid out at interest; the acquisition price of any financial arrangement (as defined in section 64B(1) of this Act) to which sections 64B to 64M of this Act applies:

It is the appellant’s contention that the expenditure is capital in nature and that this is an issue which will have continuing relevance, given the fact that ss BB7 and BB8 of the 1994 Income Tax Act are of similar effect to ss 104 and 106.

The Judgment in the High Court

On the evidence before him the Judge found that the buildings had been demolished because the respondent had no use for them. He also found that it was a condition of the tender for the demolition that the land was to be left to the operational standard of a Category 1 highway. Having considered the judgment in Mount Isa Mines Ltd v Federal Commissioner of Taxation, he distinguished it from the present instance for the following reasons: The respondent could not be expected to leave the buildings deteriorating, having regard to the dangers associated with abandoned buildings of vandalism, arson and the like. Any benefits gained by the respondent were incidental to the demolition of the building, as was the advantage of a greater usable portion of the wharf area sealed to a
high standard. These benefits were not the primary motivation in carrying out the demolition.

The Appellant’s Argument

The appellant submitted that this is a case which falls within the principles enunciated in Mount Isa Mines Ltd and in BP Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia [1966] AC 224 (PC). In the Commissioner’s submission, the Judge did not apply the correct test, placed reliance on the intention underlying the expenditure rather than its effect, and further erred by ruling that factors were revenue-suggestive when in fact they were capital-suggestive. No deduction ought to have been permitted.

The Respondent’s Argument

The respondent emphasised that the focus of the enquiry ought to be on the expenditure and what it is intended to secure to the business rather than on the character (as revenue or capital) of the object demolished (see Mount Isa Mines Ltd at p 265). In the respondent’s submission the demolition of the buildings was the sole motive for the expenditure, attended only incidentally by the removal of obsolete buildings, the provision of greater uncluttered wharfage area and the removal of potentially dangerous buildings. As the buildings did not play a part in the operation of the respondent’s business and as the respondent had been obliged to acquire them by reason of the Port Companies legislation, the expenditure incurred in their demolition is revenue in nature. Alternatively, the expenditure was incurred as part of the maintenance and upkeep of the respondent’s assets, or there are analogies with the acquisition of an asset for the purposes of its consumption as, say, in a mining operation. In the present instance, the respondent submits, the expenditure on the demolition of the buildings has resulted in the buildings all but disappearing.

The Australian Authorities

Mount Isa Mines Ltd v Federal Commissioner of Taxation, a decision of the full Court of the High Court of Australia, is very similar factually to the present appeal. The

taxpayer was a mining company which, following a review of its plant at Mount Isa, decided to demolish two structures which had been erected for purposes associated with its mining operations. It claimed the costs of demolition as deductions under the relevant Australian legislation. Both in the full Court of the Federal Court and in the High Court, the judgment at first instance, that the expenditure incurred in the demolition of the structures was capital in nature, was upheld. The Court held (at p 266):

Expenditure on repairs to structures and plant for the purpose of maintenance only is classified as expenditure on maintenance or upkeep and is chargeable to revenue account. But expenditure which goes beyond repair and results in the improvement of structure or plant and makes it more advantageous is capital expenditure. Likewise, as in the case of expenditure on the improvement of an asset, expenditure on the acquisition of an asset or on the removal of a disadvantageous asset, generally speaking, will constitute capital expenditure. On the other hand, it may be that, in some circumstances, expenditure on land, even the acquisition of land, for example, where it is acquired as a consumable, will constitute an operating expense. So, in Johns-Manville Canada Inc v R (1985) 21 DLR (4th) 210, the Supreme Court of Canada held that the cost of acquiring land adjacent to an open pit mine for the purpose of enlarging the sloping sides of the pit as it became deeper in the course of the taxpayer’s mining operations was an operating and not a capital expense. Similarly, where demolition is undertaken in the course of the day-to-day conduct of a business, the cost of it will be a revenue expense.

However, expenditure incurred for the purpose of improving land as the site for the carrying on of a business must be regarded as a capital item provided that the money is not spent merely on maintenance or upkeep. Thus, in the BHP case, once Kitto J found that the expenditure related to the improvement of the site on which the business was conducted and the improvement was of an enduring and not a transient character, he was correct in regarding these matters as having decisive weight in tipping the scales in favour of the expenditure being of a capital nature. It was not to the point that the taxpayer did not acquire a tangible asset; it was enough that the taxpayer obtained an enduring advantage in the form of the improvement just described.

The Court relied on Tucker (Inspector of Taxes) v Granada Motorway Services Ltd [1979] 2 All ER 801 (HL), a case in which the Lords held that a payment made to reduce the rent payable under a lease was capital in nature and not therefore deductible against taxable income. In his speech at p 804 Lord Wilberforce said:

I think that the key to the present case is to be found in those cases which have sought to identify an asset. In them it seems reasonably logical to start with the assumption that money spent on the acquisition of the asset should be regarded as capital expenditure. Extensions from this are, first, to regard money spent on getting rid of a disadvantageous asset as capital expenditure and, secondly, to

regard money spent on improving the asset, or making it more advantageous, as capital expenditure. In the latter type of case it will have to be considered whether the expenditure has the result stated or whether it should be regarded as expenditure on maintenance or upkeep, and some cases may pose difficult problems.

Bearing in mind the need for care in applying principles or “felicitous phrases from earlier judgments”¹, the identifiable asset test is one which has relevance to the present case. The respondent obtained a long-term benefit as the result of clearing the area of an unwanted building and improving the standard and extent of the wharf area. This benefit can only be characterised as an improvement in a capital asset.

Although not determinative, the cost of demolition was a one-off expenditure which in itself helps distinguish the acquisition of an asset from revenue-related payments made on a regular basis. The “once and for all” payment must of necessity bring into existence an asset or advantage for the enduring benefit of a trade². It is also of assistance to determine objectively the effect of the expenditure; to do otherwise might be to allow as determinative a test based on the taxpayer’s stated intention.

The foregoing factors have been summarised by Dixon J in Sun Newspapers Ltd v Federal Commissioner of Taxation [1938] HCA 73; (1938) 61 CLR 337, where the nature of certain sums spent in buying up the competition of a rival were discussed (at p 363):

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

And (at p 362):

... the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant

1. BP Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia (supra) at 265, per Lord Pearce.

² British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205, 213, [1925] All ER Rep

623, 629, per Viscount Cave LC, adopted in Tucker and BP Australia Ltd.

demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely.

Summary

The present instance falls squarely within these principles and is particularly analogous to the judgment in Mount Isa Mines Ltd. Buildings which were not required for the purposes of the ongoing business were demolished in a “once and for all” expenditure. Effectively this was the disposition of a disadvantageous asset. Moreover, the demolition improved the respondent’s capital asset by providing an upgraded and additional uncluttered wharf area. The fact that the buildings were effectively compulsorily acquired in the first instance is irrelevant: they were part of the asset acquired by the respondent and their removal was seen as advantageous to its future business. The fact that the purpose or intention of the demolition of the buildings might have been to improve the company’s revenue and share of profits equally is immaterial. The effect of the demolition was to enhance the assets deployed by the respondent in the production of revenue.

The demolition of the buildings as an isolated incident of the respondent’s operations cannot be characterised as maintenance or upkeep and nor is there any analogy with the acquisition of land or other assets as a consumable. From a practical and business point of view the demolition was calculated to secure a better asset structure for the business of the company. The enduring advantages achieved by the demolition cannot be separated from the purpose of the expenditure and relegated to a category of incidental consequences. The expenditure was capital in nature. That conclusion is dictated not only by the Australian demolition cases referred to but also by a straightforward application of the well-known test of Dixon J in Hallstroms Pty Ltd v Federal Commissioner of Taxation [1946] HCA 34; (1946) 72 CLR 634, 648, which has been consistently applied in this Court.³

3. Commissioner of Inland Revenue v Rangatira Ltd [1995] NZCA 330; (1995) 17 NZTC 12,182, 12,191, per McKay J; Commissioner of Inland Revenue v Inglis [1992] NZCA 262; [1993] 2 NZLR 29, 33, per Cooke P; Commissioner of Inland Revenue v McKenzies (NZ) Ltd [1988] 2 NZLR 736, 740, per Richardson P.

For these reasons we conclude that the cost of demolition was characteristic of capital expenditure and the appeal must be allowed.

Costs

We understand no issue as to costs arises but if that is incorrect, memoranda may be filed.














Solicitors:
J H Coleman, Crown Law Office, DX SP 20208, Wellington, for Appellant
A C Shaw, Lane Neave Ronaldson, DX WP 21008, Christchurch, for Respondent