FEDERAL COURT OF AUSTRALIA Pontifex Jewellers (Wholesale) Pty Ltd v Commissioner of Taxation [1999] FCA 1822 SALES TAX – meaning of "non-arm's length transaction" in s 94 – meaning of "it would have been the case (or could reasonably be expected to have been the case)" in s 94 – effect of the section – effect of related parties selecting a wholesale price of goods discounted as unsold, after being delivered on consignment, by consulting a valuer who decided figures according to the category of goods and the length of time an item had failed to sell – whether proceeding should be dismissed summarily. PRACTICE & PROCEDURE – summary dismissal – whether, on the affidavit evidence filed, the applicant must fail. Sales Tax Assessment Act 1992, s 94 Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 75 ALR 287 referred to Australian Trade Commission v Richard Shrapnel Consulting Services Pty Ltd (1988) 85 ALR 287 referred to Granby Pty Ltd v F C of T (1995) 95 ATC 4240 followed The Trustee for the Estate of the late A W Furse No. 5 Will Trust v F C of T (1990) 91 ATC 4007 followed Barnsdall v Federal Commissioner of Taxation (1988)88 ATC 4565 followed Copperart Pty Ltd v F C of T (1993) 93 ATC 4779 referred to Collis v Commissioner of Taxation of the Commonwealth of Australia (Jenkinson J, unreported, 30 May 1996) referred to Castle Bacon Pty Ltd v Comptroller-General of Customs (1995) 38 ALD 230 referred to Malec v J C Hutton Pty Ltd (1990) 169 CLR 638 applied Sellars v Adelaide Petroleum NL (1994) 179 CLR 332 applied Alec Finlayson Pty Ltd v Armidale City Council (1997) 98 LGERA119 referred to Webster v Lampard (1993) 177 CLR 598 applied Lonrho Plc v Fayed [1992] 1 AC 448 applied PONTIFEX JEWELLERS (WHOLESALE) PTY LIMITED v COMMISSIONER OF TAXATION NG 516 of 1998 NG 517 of 1998 BURCHETT J 23 DECEMBER 1999 SYDNEY IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY NG 516 of 1998 BETWEEN: PONTIFEX JEWELLERS (WHOLESALE) PTY LIMITED Applicant AND: COMMISSIONER OF TAXATION Respondent JUDGE: BURCHETT J DATE OF ORDER: 23 DECEMBER 1999 WHERE MADE: SYDNEY THE COURT ORDERS THAT: The motion be dismissed with costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY NG 517 of 1998 BETWEEN: SILROX PTY LIMITED Applicant AND: COMMISSIONER OF TAXATION Respondent JUDGE: BURCHETT J DATE OF ORDER: 23 DECEMBER 1999 WHERE MADE: SYDNEY THE COURT ORDERS THAT: The motion be dismissed with costs. Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules. IN THE FEDERAL COURT OF AUSTRALIA NEW SOUTH WALES DISTRICT REGISTRY NG 516 of 1998 NG 517 of 1998 BETWEEN: PONTIFEX JEWELLERS (WHOLESALE) PTY LIMITED Applicant AND: COMMISSIONER OF TAXATION AND BETWEEN: Respondent AND: SILROX PTY LIMITED Applicant COMMISSIONER OF TAXATION Respondent JUDGE: BURCHETT J DATE: 23 DECEMBER 1999 PLACE: SYDNEY REASONS FOR JUDGMENT 1 In each of these matters, the applicant seeks declaratory relief in respect of the taxable value of particular assessable dealings, falling within the terms of the Sales Tax Assessment Act 1992, relating to items of jewellery, watches etc. Each sells stock at wholesale to a retail company which is under the same management, the wholesale transaction taking place immediately before a sale to a customer at retail. Until then, the stock is placed with the retailer on consignment. This case is concerned with the sales tax consequences of a particular practice followed by each of the applicants in respect of the disposal of old stock. It is not suggested that any difference of principle can be discerned in relation to the application of this practice between the two cases, although the retail company to which sales are made by Pontifex (as I shall call the first applicant) has only one store, while the retailer in the other matter has four. 2 The practice in question may be conveniently explained by reference to Pontifex, which carries on business as a wholesaler of jewellery, watches, clocks and other items in a shopping centre at Sylvania, a suburb of Sydney, consigning its stock to Pontifex Jewellers Pty Limited (which I shall call "the Pontifex retailer"), the proprietor of a retail business at the same address. The Pontifex retailer conducts three sales each year at which stock is offered for sale at significant discounts, one in February or early March, a second in June, and a third at the end of October. The affidavit evidence filed on behalf of Pontifex supports the proposition that the discount sales are required to clear old stock in which capital is tied up, so as to enable new stock to be acquired. The retail price of old stock is initially discounted at these sales by 50%, and items not sold are subsequently further discounted. Diamond rings, if unsold after several discount sales, may be sent to a jeweller to be remade in a different setting, the gold then being sold as scrap. Watches more than one year old and other stock more than two years old are treated by the Pontifex retailer as old stock, being identified from computer records showing the date of purchase by Pontifex. The evidence is that the retail price which can be obtained for jewellery more than two years old and watches more than one year old declines significantly because of changes in style and fashion, and that these items can generally be sold only at a discount. 3 In respect of the relevant items, amongst many others, both the applicants consulted one Terence Mitchell, who is a valuer of jewellery and precious stones. Mr Mitchell's affidavit evidences his impressive qualifications and experience in relation to the valuation of jewellery, both for wholesale and for retail purposes. He perused documents identifying the classes of stock by categories, and the date when each item was acquired. He then determined an appropriate discount on which he based his valuation. In doing so, he proceeded on the footing that a reasonable period, which he put at eighteen months, should be allowed for the sale of jewellery before the application of any discount, but in the case of watches, which he says "are currently being manufactured and sold as fashion accessories as much as timepieces", and involve frequent changes to accommodate change in fashion and style, thus becoming "outdated very quickly", he considers that period should be reduced to between twelve and eighteen months. Other factors tending, in his opinion, to reduce the value of old stock, are referred to in his affidavit. He expresses the view that the wholesale value of a watch which is not sold within twelve months of being offered for sale "is significantly less than the wholesale value of a watch which has been on hand for less than that time", and that the same applies to jewellery remaining unsold after eighteen months. 4 The applicants' cases are that the wholesale price of each of the items referred to in the two applications was included, in respect of that item, in the valuation furnished by Mr Mitchell, and represented its wholesale value at the relevant time. 5 According to Mr Mitchell, other than the allowance of the discounts he fixed, the alternatives open to the retail jeweller would be to offer the items for sale to another retail jeweller, or auction the items, or remodel items being jewellery by breaking them down and re-setting them. Each of these would involve a greater reduction in the price obtainable. 6 It is apparent that the approach adopted by Mr Mitchell, in accordance with which each applicant set the discount price of the various items involved in these cases, dispensed with any individual assessment of any one item as a unique watch or piece of jewellery. But there is no suggestion in the evidence that one or more of these items displayed some unique characteristic. The evidence filed on behalf of the applicants could support the conclusion that the general considerations summarised by Mr Mitchell provided a sufficient basis for the making of a fair assessment. It is also the evidence that an individualised valuation done by scrutinising each item would be impractical. In the case of Pontifex, a director, Mrs E R Pontifex, has sworn: "The use of a system like this is a commercial necessity in the Applicant's business. It is not practical for my husband or me to conduct a valuation of each item of old Stock before each discount sale occurs as the Applicant carries approximately 800 items of old Stock at any one time. As there are three discount sales a year, it is not practical for the Applicant to set a wholesale price of old Stock in any other way." 7 What is before me, in each case, is a motion taken out by the Commissioner of Taxation for summary dismissal on the ground that the proceeding is frivolous or vexatious. There is no challenge to the availability of the declaratory relief sought by each applicant, although at the outset of the argument counsel used language suggesting there would be; the basis of the motions is the breadth of Mr Mitchell's approach to valuation, said by the Commissioner to be inconsistent with the Act, and in particular with s 94 to which I shall come. According to the Commissioner, a separate and individual examination of each item would be required to comply with the legislation. 8 The key provisions of the statute, for these cases, are s 16, with which must be read Part A of Table 1 of Schedule 1, the second item of which, AD1b, refers to a case of a "wholesale sale by a person who is not the manufacturer of the goods". By that provision, it is specified that the "normal taxable value" is "the price (excluding sales tax) for which the goods were sold". But this is subject to s 94, on which the Commissioner relies. Section 94 provides as follows: "(1) This section applies to a taxpayer if: (a) the taxpayer (or an associate) has been a party to a non-arm's length transaction; and (b) if the transaction had instead been an arm's length transaction, it would have been the case (or could reasonably be expected to have been the case) that: (i) the liability of the taxpayer to tax on the non-arm's length transaction, or any other transaction, would have been increased; or (ii) the entitlement of the taxpayer to a credit in connection with the non-arm's length transaction, or any other transaction, would have been reduced. (2) The liability or credit is taken always to have been the amount that it would have been (or could reasonably be expected to have been) if it had been based on an arm's length transaction instead of on the non-arm's length transaction." It is the Commissioner's argument that s 94 makes the applicants' cases untenable. 9 The first thing to observe about s 94 is that the section only applies where both of two conditions are fulfilled: the presence of "a non-arm's length transaction" (subs (1)(a)); and the availability of the conclusion - in the sense that this conclusion is drawn - that the liability of the taxpayer "would have been increased" in an arm's length transaction (subs (1)(b) – subject to the construction of the words "could reasonably be expected", a question to which I shall return). Even if each of the relevant sales, in the present case, involved "a non-arm's length transaction", it would still be necessary, for the operation of s 16 and Table 1 to be displaced, to draw the further conclusion set out in s 94(1)(b). It would then be necessary also to apply s 94(2). Before proceeding to analyse the section in detail, I should indicate that I have difficulty in understanding why the evidence of the applicants to which I have referred should not be regarded as enabling a conclusion to be drawn in their favour on the issue raised by s 94(1)(b). I do not say that such a conclusion must be drawn; this is only an application for summary judgment, not a full hearing. But if it is not practical to look at each one of hundreds of items of this kind individually, and if, upon a more general approach, the propositions advanced by Mr Mitchell are justified, it is difficult to see why a court should not be able to infer that an arm's length transaction could reasonably be expected to have taken place at the same price. Then how could it be said the liability to tax would have been increased by such a transaction? However, before coming to a determination in each of these matters, I shall proceed to a somewhat more minute examination of the terms of s 94. 10 The section begins by postulating "a non-arm's length transaction". This expression is not only inelegant; it masks an ambiguity. Does it refer to a transaction between parties who are not at arm's length? Or does it refer to a transaction which is not conducted at arm's length, whether or not the parties themselves would be described as at arm's length from each other? The case law shows that similar, if not identical, expressions have been construed in each of these ways, and that the difference between the two constructions has been emphasised. One approach is exemplified by Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 75 ALR 287, where a Full Court (Beaumont, Wilcox and Burchett JJ) was concerned with the meaning of the expression "any person determined by the Board to be a person not at arm's length with the claimant or the association", an expression appearing in s 4(8) of the Export Market Development Grants Act 1974. Having drawn attention to the fact that the phrase "not at arm's length" is often found in revenue statutes, the joint judgment of the Court (at 291) took the "ordinary meaning of the phrase" to be that explained in Osborn's Concise Law Dictionary, 6th ed, 32: "the relationship which exists between parties who are strangers to each other, and who bear no special duty, obligation, or relation to each other, eg vendor and the purchaser". The Court commented: "[T]he context of s 4 is consistent with the disqualification of expenditure by one party in favour of another where one of them has the ability to exert personal influence or control over the other." This decision was followed in Australian Trade Commission v Richard Shrapnel Consulting Services Pty Ltd (1988) 85 ALR 287, where (in a judgment with which Northrop and Keely JJ agreed) I said (at 289): "[T]he statute is concerned with a relationship, the nature of which may affect the amount of the expenditure involved. The test is not whether the amount was affected; what is in issue is the relationship. Accidentally or by design, parties who are not independent of each other may contract at a proper price, but Parliament has not put on the administrator the burden of sifting through cases of that kind. It has made them ineligible for the purposes of the particular provision here in question." (Emphases original.) 11 But in Granby Pty Ltd v F C of T (1995) 95 ATC 4240, where the expression "dealing with each other at arm's length" in s 160ZH of the Income Tax Assessment Act 1936 was in question, Lee J said (at 4243): "The expression 'dealing with each other at arm's length' involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs. Of course, it is relevant to that enquiry to determine the nature of the relationship between the parties, for if the parties are not parties at arm's length the inference may be drawn that they did not deal with each other at arm's length." His Honour referred to The Trustee for the Estate of the late A W Furse No. 5 Will Trust v F C of T (1990) 91 ATC 4007 at 4014-4015; Barnsdall v Federal Commissioner of Taxation (1988) 88 ATC 4565 at 4568; and Australian Trade Commission v WA Meat Exports Pty Ltd, and cited a passage from the judgment of Hill J, in the first of these cases (at 4014-4015), in which that learned Judge said: "The emphasis [in the particular provision there under consideration] is rather upon whether those parties, in relation to the agreement, dealt with each other at arm's length. The fact that the parties are themselves not at arm's length does not mean that they may not, in respect of a particular dealing, deal with each other at arm's length. This is not to say that the relationship between the parties is irrelevant to the issue to be determined under the subsection." (Emphasis original.) For himself, Lee J added (again at 4243): "Whether parties not at arm's length have dealt with each other at arm's length will be a matter of fact." 12 The same point was also made by Hill J in Copperart Pty Ltd v F C of T (1993) 93 ATC 4779 at 4798-4799, where he said: "However, it must be said that in a particular fact situation related parties may deal with each other at arm's length in relation to a transaction and unrelated parties may deal with each [other] not at arm's length in relation to a particular transaction. … In that case [the A W Furse case] I expressed the view that what was required was a determination whether, in respect of a particular dealing, the parties were dealing with each other as arm's length parties would normally do, so that the outcome of their dealing was a matter of real bargaining." (In the present case, it may be noted here, the applicants say that they dealt "as arm's length parties would normally do" in obtaining an independent valuation by the method adopted by Mr Mitchell, since other courses would have been less appropriate from a practical and commercial point of view.) In Collis v Commissioner of Taxation of the Commonwealth of Australia (Jenkinson J, unreported, 30 May 1996), the views expressed by Lee J and Hill J were followed in relation to s 26AAA of the Income Tax Assessment Act 1936. Finally, I should note that, in Castle Bacon Pty Ltd v Comptroller-General of Customs (1995) 38 ALD 230 at 236, Lockhart J, who was not dealing with taxation legislation, distinguished between "arm's length transactions" and "transactions between parties at arm's length", commenting: "The relevant factor in considering whether there is an arm's length transaction is, of course, whether the parties are at arm's length. But merely because parties are themselves not at arm's length does not support the conclusion that they may not be engaged in transactions at arm's length." Referring to Copperart, his Honour noted (ibid) that the reversal of this decision on appeal did not concern the present point. 13 The ambiguity of s 94 is hardly relieved by this brief survey of authority. The situation is the more curious, since the draftsman of the Act had a clear model to follow in s 4A(5)(b) of the Sales Tax Assessment Act (No. 6) 1930, where the expression is "the importer and the purchaser were not dealing with each other at arm's length in relation to the transaction". The use of this expression would, as the authorities show, have removed all difficulty. However, I think the better view of s 94 is that it does not refer to the relationship between the parties to a transaction, but to the manner of their dealing, although any relationship will obviously be important for the inferences it may raise. In other words, I think the reasoning of Lee J and Hill J in the cases to which I have referred is applicable to s 94. 14 The next question relates to the meaning of the expression "if the transaction had instead been an arm's length transaction, it would have been the case (or could reasonably be expected to have been the case) that …". It seems to me that, in this part of the section, the words in brackets express the draftsman's recognition of the difficulty of showing what would have been the case in a hypothetical event. The point has been made in a number of cases dealing, particularly, with the issue of damages. For instance, in a passage in Sellars v Adelaide Petroleum NL (1994) 179 CLR 332 at 355, Mason CJ, Dawson, Toohey and Gaudron JJ referred to "the peculiar difficulties associated with the proof and evaluation of future possibilities and past hypothetical fact situations". And in Malec v J C Hutton Pty Ltd (1990) 169 CLR 638 at 642-643, Deane, Gaudron and McHugh JJ said: "If the law is to take account of future or hypothetical events in assessing damages, it can only do so in terms of the degree of probability of those events occurring." I referred to a number of the cases in this area in Alec Finlayson Pty Ltd v Armidale City Council (1997) 98 LGERA119 at 124-126. In the hypothetical situation contemplated by s 94(1)(b), it is impossible to say what would have happened, but it is possible to say whether it could reasonably be expected to have been the case that the taxpayer's liability would have been increased, or whether that could not reasonably be expected to have been the case. Since the hypothetical event is ultimately unknowable, I think the draftsman inserted the words "or could reasonably be expected to have been the case" as explanatory of the concept intended to be conveyed by the expression "would have been the case". That is why the words are in brackets – there would have been no reason for brackets had they expressed a true alternative. To use "or" as a conjunction in this way is in accordance with one of the usages given in The New Shorter Oxford English Dictionary (1993), that of employing it to serve the function of "[c]onnecting two words denoting the same thing, or introducing an explanation of a preceding word etc". Were the parenthetical words in s 94 to be construed as really expressing an alternative, they would swallow up the primary statement, for if something "would have been the case", of course it "could reasonably be expected" to have been so. Furthermore, subs (2) reinforces the point, since there can only be one amount which can be determined. 15 It follows that the section poses hypothetically the question, what would have been the case, as a question to be answered in accordance with what could reasonably be expected. It does not pose two alternative questions. 16 On these views of the meaning of s 94, it could only apply if two broad issues were determined against the applicants. The first issue is whether they had been parties to non-arm's length transactions in the sense I have explained; and the second issue, which does not arise unless they had been, is whether, if the transaction had been an arm's length transaction, it could reasonably be expected to have been the case that their liability to tax on that transaction would have been increased. Each of these questions is put in issue by the applicants' evidence. They claim to have appointed an independent valuer to determine on a practical and commercial basis the appropriate discount to allow in a situation where discounting was required, and thus to have dealt as parties at arm's length would have dealt. They also claim that the amounts so fixed were in fact calculated on a practical and commercial basis, and were appropriate amounts, so that there is no reason to say it could reasonably be expected to have been the case that their liability would have been increased if it had been based on an arm's length transaction. 17 As the matter has been argued on a motion, in each case, for summary dismissal, and not after a full hearing, the test is not what ultimate conclusion I should draw; it is whether the Commissioner has shown that the applicants' cases "must fail", so that they "should not be permitted to go to trial in the ordinary way": Webster v Lampard (1993) 177 CLR 598 at 602. As has been pointed out on many occasions, a decision of the kind sought by the Commissioner should only be made in an absolutely clear case. A plaintiff is generally entitled to a full hearing in the normal way, and should not be "driven from the judgment seat unless the case is unarguable": Lonrho Plc v Fayed [1992] 1 AC 448 at 469. In my opinion, the present case does not nearly approach the requirements for summary dismissal, and the motions should be dismissed with costs. I certify that the preceding seventeen (17) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Burchett. Associate: Dated: 23 December 1999 Counsel for the Applicants: Mr P Fraser Solicitors for the Applicants: Holman Webb Counsel for the Respondent: Mr T Murphy Solicitor for the Respondent: Australian Government Solicitor Date of Hearing: 23 February 1999 Date of Judgment: 23 December 1999