FEDERAL COURT OF AUSTRALIA INCOME TAX - appeal from Administrative Appeals Tribunal - investment allowance - lease by leasing company to taxpayer and sub-lease to related company - whether sub-lease pursuant to contract or arrangement with related company made while lease was in force Income Tax Assessment Act 1936 (Cth) s 82AG(3)(d) Newton v Federal Commissioner of Taxation (1958) 98 CLR 1 Dithelm Manufacturing Pty Ltd v Commissioner of Taxation (1993) 44 FCR 450 Hope v Bathurst City Council (1980) 144 CLR 1 BERKELEY COMMERCIAL CO PTY LTD v THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA NO'S VG 626, 627 and 628 of 1996 HEEREY J MELBOURNE 8 AUGUST 1997 IN THE FEDERAL COURT OF AUSTRALIA ) ) VICTORIA DISTRICT REGISTRY ) Nos VG 626, 627 and 628 of 1996 ) GENERAL DIVISION ) ON APPEAL FROM THE TAXATION APPEALS DIVISION OF THE ADMINISTRATIVE APPEALS TRIBUNAL CONSTITUTED BY DEPUTY PRESIDENT G L McDONALD, MR B H PASCOE, SENIOR MEMBER AND MR W L McLEAN, MEMBER BETWEEN: BERKELEY COMMERCIAL CO PTY LTD Applicant AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: HEEREY J PLACE: MELBOURNE DATE: 8 AUGUST 1997 MINUTES OF ORDER THE COURT ORDERS THAT: 1. Appeal allowed. 2. Decision of the Administrative Appeals Tribunal dated 12 December 1996 insofar as it concerns the matters the subject of this appeal be set aside. 3. Direct the matters the subject of this appeal be remitted to the Tribunal for determination in accordance with these reasons. 4. Respondent pay the applicant's costs to be taxed, including reserved costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA ) ) VICTORIA DISTRICT REGISTRY ) Nos VG 626, 627 and 628 of 1996 ) GENERAL DIVISION ) ON APPEAL FROM THE TAXATION APPEALS DIVISION OF THE ADMINISTRATIVE APPEALS TRIBUNAL CONSTITUTED BY DEPUTY PRESIDENT G L McDONALD, MR B H PASCOE, SENIOR MEMBER AND MR W L McLEAN, MEMBER BETWEEN: BERKELEY COMMERCIAL CO PTY LTD Applicant AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: HEEREY J PLACE: MELBOURNE DATE: 8 AUGUST 1997 REASONS FOR JUDGMENT The applicant Berkeley Commercial Co Pty Ltd (formerly Berkeley Cleaning Co Pty Ltd) appeals from a decision of the Administrative Appeals Tribunal, Taxation Appeals Division, made on 12 December 1996. The only live issues on the appeal concern the Tribunal's affirmation of the Commissioner's disallowance of deductions for investment allowances under Subdiv B of Pt III Div 3 of the Income Tax Assessment Act 1936 (Cth) (the Act). The tax years in question were those ending on 30 June 1977, 1978 and 1979. Neither counsel were able to give any explanation for this extraordinary delay. The allowances claimed were in respect of plant and equipment leased by the applicant from various financiers. The applicant in turn sub-leased the property to other companies within its group. The Commissioner considered that s 82AG(3)(d) made Subdiv B inapplicable because, before the expiration of twelve months after the relevant property was first used, the applicant:: while the lease was in force... entered into a contract or arrangement with another person for the use of the property by that other person. The case of the applicant was that the "contract or arrangement" with the other companies in the group was not made while the lease was in force but at an earlier point in time. The Legislation To encourage investment in plant and equipment Parliament provided a generous deduction of, in broad terms, 40 per cent of the cost of eligible property. This allowance was in addition to the ordinary depreciation provisions and thus provided a strong incentive for industry to invest in plant and equipment and thereby increase prosperity and job opportunity. Since plant and equipment in modern times are often acquired by lease or hire purchase rather than purchase, s 82AA(b) made Subdiv B applicable where a leasing company leased eligible property to another person under a long term leasing agreement for use by that other person in Australia for producing assessable income. Under s 82AD a leasing company could transfer the benefit of the investment allowance deduction to the lessee. The object of the scheme would obviously be defeated if taxpayers acquired, or leased, eligible property and claimed the investment allowance deduction without retaining the property for productive use. Section 82AG therefore provided that Subdiv B would not apply to property disposed of within twelve months after installation. Subs (1) dealt with the case of property acquired by a taxpayer who was not a leasing company. It provided that the subdivision would not apply and be deemed never to have applied in relation to such property if within twelve months after the property was first used or installed ready for use by the taxpayer the taxpayer disposed of the property, or the property was lost or destroyed, or the taxpayer leased the property or let it on hire-purchase or otherwise granted the right to another person to use it, or the taxpayer used the property outside Australia or for a purpose other than the purpose of producing assessable income. Section 82AG(2) dealt with the situation where the taxpayer disposed of part of an interest. Section 82AG(3), with which the present case is concerned, was as follows: (3) This Subdivision does not apply, and shall be deemed never to have applied, in relation to property leased by a leasing company to another person (in this sub-section referred to as the "lessee") if, before the expiration of 12 months after the property was first used, or installed ready for use, by the lessee- (a) the property was disposed of by the leasing company to a person other than the lessee or was lost or destroyed; (b) the lessee used the property outside Australia or for a purpose other than the purpose of producing assessable income: (c) the lease was terminated otherwise than by the acquisition of the property by the lessee; (d) while the lease was in force the lessee entered into a contract or arrangement with another person for the use of the property by that other person; or (e) the lessee acquired the property and disposed of it. Evidence Before the Tribunal The applicant was incorporated in 1959 and thereafter carried on business as a commercial cleaning contractor. From 1 July 1976 the goodwill of the cleaning business carried on by the applicant in all the mainland States, including the benefit of cleaning contracts, was sold to Berkeley Cleaning Co (Management) Pty Ltd (Berkeley Management) in its capacity as trustee of the Berkeley Cleaning Trust. The plant and equipment owned by the applicant were retained by it and no leases of equipment were assigned. Also with effect from 1 July 1976 Berkeley Management engaged two other associated companies, Berkeley Cleaning (Australia) Pty Ltd (Berkeley Australia) and Berkeley Cleaning (William) Pty Ltd (Berkeley William), as managers for various partnerships to provide cleaning services as sub-contractor to Berkeley Management. The applicant then entered into an arrangement under which it agreed to lease to the various partnerships of which Berkeley Australia and Berkeley William were managers, the plant and equipment required by them. This arrangement was documented by minutes of the directors meeting of each of the three companies on 28 October 1976. The minute of the applicant in relation to Berkeley Australia was in these terms: Sub-lease: Resolved and hereby approved that the Company lease to the various partnerships of which Berkeley Cleaning (Australia) Pty Ltd is a member, motor vehicles, plant and equipment as needed, at a price to be agreed upon. If no agreement, then it is to be determined by Mr Donald Minett, a member of the firm of C F King and T J Whittle Proprietary. There was an identical minute in relation to Berkeley William. The minute of Berkeley Australia was in the following terms: Sub-lease: Resolved and hereby approved that the Company as Manager of the various partnerships lease from Berkeley Cleaning Co Pty Ltd motor vehicles, plant and equipment as needed, at a price to be agreed upon. If no agreement, then it is to be determined by Mr Donald Minett, member of the firm of C F King and T J Whittle Proprietary. There was a minute of Berkeley William in like terms. This arrangement changed in June 1978, when Berkeley Management ceased employing Berkeley Australia and Berkeley William as sub-contractors in all States, except Western Australia, and took over the obligations of the hiring of equipment. In May 1980 Western Australia came back under the direct responsibility of Berkeley Management. Also in June 1978 Berkeley Management entered into a sub-contracting agreement with C J Consultants Pty Ltd in relation to the cleaning business throughout Australia. Under the terms of this agreement, C K Consultants agreed to do all things necessary to perform the obligations of Berkeley Management under the cleaning contracts held by it. This included the promise to provide "men together with all materials, equipment and plant necessary to be used". Notwithstanding this requirement, the accounts of Berkeley Management produced in evidence showed that that company paid significant sums to the applicant for plant hire in addition to sub-contractors fees. At all times the applicant, Berkeley Management, Berkeley Australia, Berkeley William and C K Consultants were related companies and not at arm's length from each other. The evidence of Mr Geoffrey Fitzsimmons, the Financial Controller and company Secretary of the applicant as to the operation of the arrangement was as follows. The actual acquisition of plant and equipment was initiated by the branch managers who would decide what equipment was needed. The branch manager would seek approval by the head office of the Berkeley Group. When that approval was received (in the early years often orally) the branch manager would place the order for the equipment. In his witness statement Mr Fitzsimmons said: In theory, the branch manager or the vendor of the equipment was then supposed to contact me and for me to advise them which leasing company would acquire the plant and lease it to the applicant. However, in practice, the invoices were often addressed directly to the applicant rather than a leasing company. In these circumstances, I would contact the vendor and have the invoice readdressed. I would then contact the leasing company being used at the time and arrange for the paper work to be completed pursuant to the line of credit. The leasing company would prepare the documents and send them to me for signing. They would be signed and returned to the leasing company together with a cheque for the first lease payment; the leasing company would pay the supplier who would then deliver the goods to the branch manager. Over the years the above process was modified. The main change was the abolition of the oral approval of the acquisition of equipment. The rule was implemented across the company that only if approval was received from the Managing Director or Mr Miller (after he commenced with the company) could equipment be acquired. When approval was received, I would keep a register of the approval for internal purposes. In cross-examination Mr Fitzsimmons agreed that the people who made the decision whether to take on lease from financiers plant and equipment were people acting as officers of the applicant and that "from time to time they said yes and from time to time they said no". The items of plant and equipment leased under the foregoing arrangement varied in value from a little over $1000 to as much as $30,000. The deductions at issue for the tax years in question are as follows: 1977 $122,000 1978 $439,000 1979 $19,000 The Tribunal's Decision The Tribunal said (emphasis added): 9. There was a twofold argument for the applicant that the arrangement for use of the equipment by another person was entered into prior to the loan being in force. Firstly, it was said that an agreement was entered into on 28 October 1976, and evidenced by minute of the applicant, B.A. Pty Ltd and B.W. Pty Ltd, for the applicant to provide all equipment required and that agreement covered all future requirements and was, therefore, an agreement prior to any subsequent lease being entered into. Secondly, it was said that the evidence of Mr F demonstrated that the procedure adopted within the group was for the operator (B.A. Pty Ltd or B.M. Pty Ltd) to decide when a new item of equipment was needed. It then sought approval for the acquisition from the applicant who, if the acquisition was approved, would then arrange to purchase or lease the required item. It was admitted that, at times, the procedure was not properly followed and orders were placed with suppliers without prior reference to the applicant. These arrangements, it was said, further demonstrated that the agreement to provide the equipment to the other company was made prior to the lease coming into force. After June 1978, it was said that the same arrangements continued with B.M. Pty Ltd, when the company adopted the 28 October 1976 agreement. However, no minutes or other evidence of any such agreement with B.M. Pty Ltd were provided. 10. Dealing with the first contention based on the 28 October 1976 minutes, the Tribunal has some difficulty accepting that this alleged agreement removes the exclusion produced by section 82AG(3)(d). At best, the minutes evidenced an intention of the applicant, and B.A. Pty Ltd and B.M. Pty Ltd, for current and future equipment to be leased by the applicant to the two companies "as needed" at "a price to be agreed upon". Whilst there would be no doubt that the applicant would not have acquired or leased an item of equipment without the clear understanding that it would be provided for the use of one of the other companies, the Tribunal is unable to accept that the 1976 minutes constitute an agreement to lease that specific item of equipment prior to the applicant entering into the lease with the finance company. Where, as in the majority of cases, the equipment was leased by the applicant, it would have been necessary for the applicant to initially determine whether it was financially viable to acquire the equipment, whether finance was available and the ultimate location and price to be charged to the other company. Only after the lease was in force with the finance company could it be said that the applicant entered into a specific contract or arrangement with the other company in relation to that specific item of equipment. In any event, there is no evidence that equipment provided to B.M. Pty Ltd was provided pursuant to the 1976 minutes. No evidence of any such arrangement with B.M. Pty Ltd was provided or even indicated as having ever existed other than that, from June 1978, B.M. Pty Ltd paid amounts for plant hire to the applicant. The argument based on the procedure said to be in place is equally difficult to accept as a reason why the section 82AG(3)(d) exclusion should not apply. At best, it could be said that the applicant had a proper expectation that any equipment leased from a finance company would be provided to a third party, but, on the balance of probabilities, the Tribunal is not satisfied that these procedures demonstrate that a contract or agreement, in relation to each specific item of equipment, was entered into prior to the lease being in force. It should be said that the only evidence of these procedures was revealed in the evidence of Mr F who was required to remember facts of some 17 years earlier and, not surprisingly, was somewhat vague in his recollections. Conclusion In my respectful opinion, the Tribunal's reasons disclose error in a number of respects. First, the Tribunal substituted for the statutory criterion in s 82AG(3)(d) of "contract or arrangement" that of "agreement". In par 10 already quoted the Tribunal first speaks of "alleged agreement" and an "agreement" then of "contract or arrangement" (but in this instance not referring to the 1976 arrangement) and finally of "contract or agreement". In Newton v Federal Commissioner of Taxation (1958) 98 CLR 1 at 7 the Judicial Committee said: Their Lordships are of opinion that the word "arrangement" is apt to describe something less than a binding contract or agreement, something in the nature of an understanding between two or more persons - a plan arranged between them which may not be enforceable at law. In my opinion "arrangement" in s 82AG(3)(d) bears the same meaning. Although the Tribunal used the correct term on one occasion in par 10 of its reasons, it concluded the relevant passage by referring again to "contract or agreement". A fair reading of the reasons indicates that the Tribunal wrongly adopted the more rigorous standard of contract or agreement and thus deprived the applicant of having its entitlement to deduction determined according to the test which the Act laid down. . Further, it is apparent from the passage quoted that the Tribunal considered that the arrangement relied on by the applicant, being an arrangement made before the lease for a particular item of property came into force, was not an arrangement in relation to "that specific item of equipment". But there is no warrant in the statute for this requirement of specificity. Assume X agrees with Y (for good consideration in a formal contract and not merely as an arrangement) that X will from time to time, if requested by Y, lease motor vehicles and sub-lease such vehicles to Y for use in Y's business. This would be a contract outside s 82AG(3)(d), notwithstanding that the motor vehicles the subject of the contract were unascertained or future goods. Whenever Y made a request of X to lease a particular vehicle, the contract would oblige X to lease that vehicle and sub-lease it to Y. It would be immaterial that the vehicle was not specified, or even in existence, at the time the contract was made. The only difference in the present case is that what took place between the applicant and its related companies in October 1976 was sufficiently informal to be an arrangement rather than a contract. But the principle remains the same. Parties can make legally binding contracts - or non-binding arrangements - for the disposition of unascertained or future goods. In similar vein, counsel for the Commissioner stressed that the 1976 arrangement recorded in the minutes and the subsequent dealings were not between parties at arm's length. That is quite true, but in my opinion not relevant. The statute does not require parties to be at arm's length. More precisely, the pre-lease contract or arrangement which will protect an investment allowance from the operation of s 82AG(3)(d) does not have to be between parties at arm's length. (Conversely, a contract or arrangement made while the lease is in force does not cease to be such if not made between parties at arm's length.) It was not suggested before the Tribunal, or in this Court, that the arrangement was a sham. No reliance was placed on s 260. In this regard I would refer to what was said by French J in Dithelm Manufacturing Pty Ltd v Commissioner of Taxation (1993) 44 FCR 450 at 457: As a general proposition the taxpayer claiming the benefit of an exemption from the imposition of a tax has the burden of proving the facts necessary to fall within that exemption: Cumming Smith & Co Pty Ltd v Melbourne Harbour Trust Commissioners (1905) 2 CLR 735 at 742; Jackett v Deputy Federal Commissioner of Taxation [1932] SASR 405 at 407. On the other hand an exemption which exists for the purpose of encouraging, rewarding or protecting some class of activity is not to be given a narrow application. See also Collector of Customs v Cliffs Robe River Iron Associates (1985) 7 FCR 271 at 275. It is perhaps worth mentioning again in this context that the obvious purpose of s 82AG(3) is to prevent abuse of the investment allowance deduction by taxpayers turning over plant and equipment simply to get the tax deduction rather than using it for productive purposes. There is no hint in this case that the Berkeley Group did not use the relevant items of property for producing assessable income in the way the statute contemplated. The question whether facts fully found fall within the provisions of a statutory enactment properly construed is a question of law: Hope v Bathurst City Council (1980) 144 CLR 1 at 7. In this regard I do not read the comment of the Tribunal that the evidence of Mr Fitzsimmons was "not surprisingly, ... somewhat vague" as a rejection of the evidence which he gave seventeen years after the events. The comment is no more than an obtrusion of the obvious. True it is, Mr Fitzsimmons' evidence indicates that the arrangement of October 1976 subsequently operated in a loose and informal way, but that is characteristic of the performance of something which is less than a binding contract. The fact that, for example, on occasions the applicant might have declined a request for the ordering of some plant or equipment does not mean that the October 1976 arrangement never existed or was not put into effect on many other occasions. Read as a whole, the Tribunal's reasons do not indicate that its conclusion turned on a resolution of disputed questions of fact. I conclude that on the facts as found the Tribunal erred in law in finding that there was no contract or arrangement within the meaning of s 82AG(3)(d) prior to the leases of the relevant items of eligible property coming into force. An alternative argument of the applicant was that as plant or equipment can only be used after it is provided, any specific contract or arrangement must in fact have been entered into before the property was first used and hence "before the expiration of twelve months after the property was first used, or installed ready for use". But I agree with counsel for the Commissioner that par (d) does not require the arrangement be entered into after the property was first used by the lessee or another person. Rather, this has to occur while the lease is in force and before a date fixed by the expression "the expiration of twelve months after the property was first used". Orders I was told that in the event of the appeal being allowed there are some loose ends to be tied up in connection with proof of some financiers making requisite declarations. Accordingly the appeal will be allowed, the decision of the Tribunal set aside and the matter remitted to the Tribunal for determination in accordance with these reasons. The respondent will pay the applicant's costs to be taxed, including reserved costs. I certify that this and the preceding seven (7) pages are a true copy of the Reasons for Judgment herein of the Honourable Justice Heerey Associate: Dated: 8 August 1997 Counsel for the Applicant: J W de Wijn Solicitor for the Applicant: Arnold Bloch Leibler Counsel for the Respondent: B Walker QC Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 18 July 1997 Date of Judgment: 8 August 1997