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Court of Appeal of New Zealand |
Last Updated: 1 December 2011
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IN THE COURT OF APPEAL OF NEW ZEALAND
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CA112/98
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BETWEEN
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HAWKE'S BAY POWER DISTRIBUTION LIMITED
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Appellant
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AND
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THE COMMISSIONER OF INLAND REVENUE
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Respondent
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Hearing:
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18 May 1999
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Coram:
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Richardson P
Gault J Blanchard J |
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Appearances:
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D E McLay and F J Heiford for Appellant
B A Corbett and L A Herbert for Respondent |
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Judgment:
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21 May 1999
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JUDGMENT OF THE COURT DELIVERED BY RICHARDSON P
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[1] This appeal is from the decision of Goddard J in the High Court at Wellington reported at (1998) 18 NZTC 13,685. The question it raises is whether electricity supplied by Hawke's Bay Power to consumers up to the end of the income year but not yet billed to consumers is to be accounted for by Hawke's Bay Power as income derived by the company (then the Hawke's Bay Electric Power Board) in that year. It relates to the income years ending 31 March 1988 to 31 March 1991 inclusive.
The factual background
[2] The Electric Power Board Accounting Regulations 1977 prescribed how the financial accounts of electricity supply authorities were to be prepared. Note 1 to Part C of the First Schedule stated "Sales of electricity - This item consists of actual sales as billed and minimum guarantee deficiencies". Regulation 3(2) required accounts to be set out in the form prescribed in the First Schedule but subject to the proviso that "those accounts may be so varied as may from time to time be authorised by the Audit Office".
[3] For the financial years down to 31 March 1986 the Board prepared its accounts on that billed sales basis and did not bring to account on an accruals basis electricity supplied to consumers between the last billing dates and the end of the income year. In 1986 it then moved to an accruals regime. It had been billing on a two-monthly basis and in its financial statements for the year ended 31 March 1987 it estimated its unbilled sales to 31 March 1987 by reference to the April and May 1986 invoiced consumption and current tariff. The Chief Executive's evidence was that the electricity industry is a very stable industry so that the prior year provided a good basis of estimation. Essentially the accrual was made by taking one half of the April and May billings for the previous year.
[4] The same accrual approach was adopted for financial reporting purposes for the year to 31 March 1988. In August 1988 the Board moved to monthly billing so that in accruing to 31 March 1989 it focussed on the April 1988 billings and the accrual as at 31 March 1989 was one half of that April month's billing. The same approach was adopted for the 1990 and 1991 years. And to avoid double counting the accrual for the previous year was deducted (from April billings) in arriving at the income for the past year.
[5] There was no evidence of a formal authorisation by the Audit Office under reg 3(2) in respect of the adoption of the accruals basis for accounting electricity sales but the Audit Office approved for audit purposes the financial statements for the four income years in question which accrued unbilled sales of electricity at balance date. And the Electricity Supply Association - Code of Accounting Practice (1C-3) issued in 1989 recommended the accrual of unbilled electricity sales to balance date.
[6] Prior to 1 April 1987 Power Boards were exempt from income tax. As from that date the Board's status was changed by legislation and it became a taxpaying entity subject in the ordinary way to tax on its business profits. It was advised by its accountants that it was not required for taxation purposes to accrue sales of electricity unbilled at balance date. The estimated unbilled sales as recorded for financial reporting purposes for the four years 1988 to 1991 were: $2,702,257 -1988, $1,453,056 - 1989, $1,456,307 - 1990, and $1,483,236 - 1991. There was a like add-back in the next year's accounts to recognise income being derived for tax purposes when billing occurred.
[7] The essential issue in the present case is the timing question. Is revenue from sales to be accrued as the Commissioner contends or to be recognised for tax purposes only when billed as the company contends? The first and crucial step is to consider the terms and conditions of the contract under which the electricity was supplied.
Terms and conditions of contract
[8] By reg 17(6) of the Electrical Supply Regulations 1984 the standard terms and conditions for the supply of electricity issued by the Electrical Supply Authority provided the terms of payment to apply to any service. The terms and conditions for the supply of electricity adopted by the Board in 1984, subject to minor amendment in 1988, relevantly provided:
- Responsibility for Energy Consumed
Every consumer will be held responsible for the energy consumption registered on the Board's meters in the premises until written notice is received by the Board requesting that the supply be disconnected or advising that the premises have been vacated. A minimum of 48 hours notice is required.
10.1 Reading Frequency
The Power Board shall read meters and render reading-based accounts at such intervals as it shall from time to time determine, but reserves the right to read meters at any time.
Where the period between two consecutive readings is greater than one month the charges which are set out on a monthly basis shall be adjusted accordingly.
10.2 Electricity Accounts
Accounts for the supply of electrical energy will be delivered or posted to the address given by the consumer. Accounts posted to the latest supplied address shall be deemed to have been delivered in the ordinary course of the mail.
10.4 Interim Accounts
The Board may render interim accounts at such intervals between actual readings of the meter as may be expedient. Such accounts shall be calculated on the basis of either -
(a) The units sold during the corresponding reading period of the previous calendar year assessed according to the current schedule of electricity charges and related to the appropriate interval, or
(b) In the case of new connections or damage of consumer an assessment in whole dollars based upon the type and extent of the installation. Such assessment may continue until the conditions of (a) above apply.
(c) Interim accounts are subject to payment on the same basis as reading accounts.
10.10 Liability and Terms of Payment
All accounts rendered under the schedule of electricity charges are due and payable when rendered and if not paid within seven days thereof the Board, having served written notice of intent, may disconnect the installation concerned. ...
[9] The evidence of the Chief Executive was that meters were generally read every second month and that every month for which the reading was not obtained a computer generated an estimated reading. It follows that every second bill reflected an estimate rather than an actual reading. For sensible administrative reasons reading of meters and billing by the Board was carried out on a rolling basis over the period but the Board was entitled in terms of cl 10.1 to read meters at any time and so to read all meters on balance date. It seems it read all industrial meters on 31 March 1991 so that no accrual was required for those consumers. It was also entitled to render accounts based on estimated usage of electricity. Finally, the consumer has access to and may read the meter at any time.
Accountancy principles and practices
[10] There are numerous statements in the cases testifying to the importance of applying generally accepted accounting principles and ordinary commercial practice in the computation of business income so far as the statutory language permits (see the discussion in Commissioner of Inland Revenue v Farmers' Trading Co Ltd [1982] 1 NZLR 449, 454-455).
[11] During the period in question the relevant statements of accounting principles and practices were the Statements of Standard Accounting Practice (SSAP) issued by the New Zealand Society of Accountants and International Accounting Standards (IAS) issued by the International Accounting Standards Committee. SSAP 1, issued December 1983, identified the measurement base and the matching of expenses and revenues as the general accounting policies underlying the preparation of financial statements and in common use and, as to the latter, stated:
Matching of expenses and revenues
Under accrual accounting, expenses and revenues are recognised as they are incurred or earned (rather than as money is paid or received) and recorded in the financial statements of the period to which they relate. Results for the period are determined by matching expenses with the related revenues.
That reflects the classic statement of Viscount Simonds in Whitworth Park Coal Co Ltd (In Liquidation) v Inland Revenue Commissioners [1961] AC 31, 62:
The price of goods sold or services rendered is included in the year's profit and loss account although that price has not yet been paid. One reason may be that the price has already been earned and that it would give a false picture to put the cost of producing the goods or rendering the services into his accounts as an outgoing but to put nothing against that until the price has been paid. Good accounting practice may require some exceptions, I do not know, but the general principle has long been recognised.
And SSAP9 requires assets that are expected to be realised in cash or sold or consumed within one year of balance date to be included as a "current asset" within a balance sheet.
[12] IAS18 entitled Revenue Recognition, issued in 1982, states:
Sale of Goods
A key criterion for determining when to recognise revenue from a transaction involving the sale of goods is that the seller has transferred to the buyer the significant risks and rewards of ownership of the asset sold. If the seller retains significant risks of ownership, it is normally inappropriate to recognise the transaction as a sale. ...
Assessing when the risks and rewards of ownership are transferred to the buyer with sufficient certainty requires an examination of the circumstances of the transaction. In most cases, transfer of the legal title either results in or coincides with the passing of possession or the transfer of the risks and rewards of ownership to the buyer, such as in the case of most retail sales. In other cases the passing of legal title may occur at a different time from the passing of possession or of the risks and rewards of ownership.
The following considerations are relevant in deciding whether significant risks and rewards of ownership have been transferred to the buyer:
(a) Whether any significant acts of performance remain to be completed;
(b) Whether the seller retains any continuing managerial involvement in, or effective control of, the goods transferred to a degree usually associated with ownership. ...
[13] The evidence of Mr Frankham, a very experienced chartered accountant called by the Commissioner, was that the SSAPs and IAS required that income be recognised when the following tests are satisfied: (a) that the income earning process is complete; (b) the amount of income can be reasonably calculated; and (c) there is a reasonable expectation that the supplier will be paid for the goods or services provided.
The tax issue
[14] Section 38(2) of the Income Tax Act 1976 provided:
Subject to this Act, income tax shall be payable by every person on all income derived by him during the year for which the tax is payable.
The legislation is thus specifically directed to "income derived" by the taxpayer during the income year and, in relation to business income, to "profits or gains derived" from any business (s65(2)(a)). The expression "derived" is not defined. It means flowing, springing, or emanating from and is synonymous with the English tax expression "arising or accruing" (Commissioner of Inland Revenue v Farmers' Trading Co Ltd at 457; Egmont Co-operative Dairies Ltd (In Liquidation) v Commissioner of Inland Revenue (1996) 17 NZTC 12,536, 12,541). In Egmont Co-operative Dairies the court went on to say:
Putting to one side the special statutory accruals regime which was enacted subsequent to the income years in question, the foundation of the accrual system is the view that accounts should show at once the liabilities incurred and the revenue earned, independently of the date when payment is made or becomes due (Commissioner of Taxes (South Australia) v Executor Trustee & Agency Co of South Australia Ltd [1938] HCA 69; (1938) 63 CLR 108 at 157 per Dixon J).
The judgment of Goddard J
[15] Goddard J concluded that the Commissioner had acted correctly in making assessments of the company's income for each year in question on the accruals basis. The issue was whether or not income had been derived by the company from supplying electricity before it was billed. The Judge concluded that based on its Terms and Conditions of Supply (which had regulatory force), Hawke's Bay Power was entitled to be remunerated for the electricity it had supplied at the point of supply; and that entitlement was not delayed until the consumer's meter was read or an invoice sent. Good accounting practice required its income entitlement to be assessed, matched against its costs in supplying the electricity and returned as income for taxation purposes. In summary, she said, she was satisfied:
That electricity supplied by Hawke's Bay Power but not metered nor invoiced at balance date constitutes income "derived" by it for income purposes in terms of s38(2) and s65(2)(a) of the Act, and is therefore assessable for the following reasons:
Discussion
[16] The crux of the argument for the appellant company is the proposition that income is not derived in respect of electricity supplied until a debt has arisen and that in the present case the Board's entitlement at balance date was a right to account which had not matured into a debt by the rendering of a bill. Mr McLay accepted that a debt may exist before an invoice is issued but he submitted that the terms of contract in this case did not give rise to a debt until the consumer was billed. In his submission, "responsibility"and "liability" were different concepts and cl 8 conferred only an entitlement to render an invoice.
[17] The short answer is that in terms of the contractual arrangements between the Board and consumer electricity was sold to consumers as and when drawn by the consumer and the Board had a contractual entitlement to read each meter or estimate usage (and bill the consumer) at the end of the income year. The income-earning process was complete on supply and sale of the electricity to the consumer.
[18] To elaborate. By cl 8 every consumer is "held responsible for the energy consumption registered on the Board's meters in the premises" until written notice is received by the Board. In that context "responsible" has its standard meaning of "Answerable, accountable (to another for something); liable to be called to account" (Oxford English Dictionary, 2nd ed); and "Liable; legally accountable or answerable" (Black's Law Dictionary 5th ed). Clause 10.1 provides for the Board to read meters and render reading-based accounts at such intervals as the Board shall from time to time determine. Importantly, the Board "reserves the right to read meters at any time" - and to bill the consumer accordingly. Further, by cl 10.4 the Board may render interim accounts on an estimated usage basis by reference to the corresponding period for the previous year - as for most of the four years in question it did every second month. In short, the Board was contractually entitled on balance date to actually read each meter or to estimate the units sold and to render accounts accordingly.
[19] On this analysis the terms of contract are a complete answer. That conclusion is also in harmony with the application of accrual rules under generally accepted accounting principles and practices.
Case law
[20] Counsel canvassed a considerable number of authorities from various jurisdictions but, as we said in Egmont Co-operative Dairies at 12,542, referring to Federal Commissioner of Taxation v Australian Gas Light Co (1983) 83 ATC 4800, many tests have been propounded and many expressions adopted by the courts in attempting to state when income is derived; and, helpful as they may be as signposts, each has been conceived in different circumstances and applied to determine different facts.
[21] It is sufficient for present purposes to refer to four cases on which Mr McLay for the company particularly relied in oral argument. The first is the Australian Gas Light case which, as it happens, was the authority on which the company's accountants relied in advising that accruing unbilled sales was not necessary for tax purposes. The gas industry there was price controlled and heavily regulated. The sale price for gas supplied was fixed on a graduated scale according to the quantity used in a quarterly period. The gas companies were required to make quarterly readings of the meters. They were not entitled except as exceptionally allowed by regulation to render an account not based on an actual reading. They were not entitled to make demand for payment until the account had been rendered bearing the actual readings of the meter on the first and last days.
[22] Lusher J concluded that there was no sale of unbilled gas up to balance date during the relevant quarter and that the unbilled gas supplied to balance date did not result in income being derived during the year within the relevant tax provisions; and further, that the (non-accrual) procedures adopted were in accordance with proper and acceptable accounting standards. Dismissing the appeal the Federal Court of Australia (Bowen CJ, Fisher and Lockhart JJ) emphasised the exceptional features of the case and concluded (at 4806):
It is true that the taxpayers could physically read all meters within their respective districts on 30 June; but, apart from the obvious commercial impracticability of such a course, there are legal restraints imposed on them from demanding payment for gas consumed up to that date. First, the taxpayers are obliged to supply for a quarterly period. The relationship between each taxpayer and its domestic customers is governed by statute and regulation which, in the light of the tariff, obliges it to supply for a quarterly period. Second, the circumstances to which we have referred as exceptional in our opinion dictate the manner in which the taxpayers bring their revenue to account namely, by not including an estimate of anticipated revenue from unbilled gas supplied after the last bills were rendered in the particular year and before 30 June in that year.
The consequence of the exceptional manner in which the taxpayers operate is that as at 30 June in each year their claims against customers for current liabilities for gas supplied had not matured into recoverable debts. The method of accounting adopted by the taxpayers was in our opinion dictated by obligations imposed upon them, both in their dealings with customers and with the Board which fixed their tariff or rates for domestic consumers. The taxpayers are bound to deal with their customers on a quarterly basis. The obligation to supply is for a period of three months, rates for gas supplied are fixed on a quarterly basis and amounts consumed are calculated for that period. Furthermore, payment cannot be required of customers until their meters have been read and accounts rendered. Thus the taxpayers contend that they cannot regard the amounts for which customers are contingently liable on 30 June each year as recoverable debts. Their method of accounting is in accord with this conclusion.
[23] The second case is Farnsworth v Federal Commissioner of Taxation [1949] HCA 27; (1949) 78 CLR 504. The taxpayer, a fruit grower, supplied fruit to be processed and sold in accordance with the rules of a marketing association. The fruit, when intermingled with other growers' fruit, lost its identity as the taxpayer's fruit. The rules of the association provided for distribution of the net proceeds of sale of the fruit among the suppliers rateably according to parity in respect of the grade, description and quantity of the fruit supplied. The High Court of Australia held that the estimate of the grower's share of the estimated proceeds from post-balance date sales of the fruit in the pool was not part of the taxpayer's assessable income for the preceding year to balance date. Following supply to the marketing association the fruit was no longer trading stock of the taxpayer and her claim at balance date was only to receive payment in due course of her share in the proceeds as eventually determined under the rules. In short, there was no present derivation, the amount not being ascertained or ascertainable at balance date.
[24] The third case is Gasparin v Federal Commissioner of Taxation (1994) 94 ATC 4,280. The contracts of sale of land held as trading stock became unconditional in one year and were for settlement in the next year. The Federal Court of Australia held that income from sale was not derived until settlement when a debt accrued due from the purchaser. The court applied the standard principle governing contracts for the sale of land stated by Salmond J in Ruddenklau v Charlesworth [1925] NZLR 161 that it is only where the contract has been completed by the execution and acceptance of a conveyance that unpaid purchase money may become a debt and be recovered accordingly. Up to then the vendor may sue for specific performance or for damages for breach.
[25] The fourth case is Henderson v Federal Commissioner of Taxation (1970) 70 ATC 4,016. The High Court of Australia held that the earnings basis was appropriate for returning the income of a large professional partnership and that in ascertaining net earnings only accrued fees, fees which had matured into recoverable debts, were to be included. But, as Barwick CJ went on to say at 4,020: "When the service is so far performed that according to the agreement of the parties or in default thereof according to the general law, a fee or fees have been earned, then it or they will be income derived in the period of time in which it or they have become recoverable". That is the position here. The consumers drew and used electricity to balance date having contractually accepted responsibility to pay for it. Their liability to pay arose when they consumed electricity. For its part, the company supplied and sold that electricity and was contractually entitled to read the meter or estimate the usage and render a bill on balance date.
Result
[26] For these reasons, which are essentially those given by Goddard J, the appeal is dismissed with costs to the Commissioner of $5,000 plus reasonable disbursements as fixed if necessary by the Registrar.
Solicitors
Bell Gully Buddle Weir, Wellington, for
appellant
Crown Law Office, Wellington, for respondent
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