Tax Brief
4 October 2006
High Court Confirms Deductibility of
Concession Fees – FCT v CityLink
Melbourne Limited (Transurban)
Introduction
In FCT v CityLink Melbourne Ltd the High Court held that annual concession fees
payable by CityLink to the State government are deductible as they accrue.
Crennan J wrote the lead judgment with Gleeson CJ and Gummow, Callinan and
Heydon JJ agreeing. Justice Kirby dissented.
Although the contractual arrangements surrounding the CityLink project are
complicated, the tax law involved appears comparatively straightforward. The
case involved only one section of the tax legislation: the general deduction
provision in section 8-1 (and its predecessor, section 51(1) ).
The decision essentially concerns the correct timing of CityLink’s deductions.
The number of previous decisions in this area reflects the inherent challenge of
allocating deductions to arbitrary divisions of time (ie. income years), particularly
where a transaction spans more than one period. Of course, the same challenge
arises in relation to ‘income’ -cases such as Arthur Murray and J Rowe & Son
deal with the question of when income should be recognised for tax.
The decision represents an important contribution to the resolution of this issue.
As well as confirming well established principles (that a loss or outgoing may be
incurred and deductible before it is paid), the decision clarifies a number of points
left unclear by the previous authorities. In particular, the decision:
(a) indicates that a practical approach should be taken to the question of whether
a loss or outgoing has been incurred rather than the strict jurisprudential analysis;
and
(b) confirms that the referable principle applies in circumstances other than
financial transactions.
Summary of the Decision
Facts
In 1995, a consortium comprising Transfield Holdings Pty Ltd and Obayashi
Corporation successfully bid to undertake the $2 billion Melbourne City Link
Project in conjunction with the State of Victoria. The project involved the
expansion and linking of a number of Melbourne freeways. CityLink was
incorporated to act as the project vehicle for the development.
CityLink, the State and other parties entered into a Concession Deed, which
provided for the grant of certain rights during the concession period which
commenced on 4 March 1996 and continued until 33 years and 6 months after
the expected completion date of construction (which was 14 July 2000). More
specifically, the State granted CityLink the right to design, construct, commission,
operate, maintain, repair and impose tolls for the use of City Link in exchange for
the payment of “Concession Fees”.
The Concession Deed gives CityLink the option to satisfy its obligations to pay
the concession fees by issuing Concession Notes to the State (effectively IOUs).
CityLink issued Concession Notes to the State for the 1996, 1997 and 1998
income years. All Concession Notes are payable at the end of the concession
period (ie as late as 2034). However, in certain circumstances the date for
payment can be brought forward and at commencement of the Melbourne
CityLink Project it was anticipated that redemption of the Concession Notes would
commence in 2013.
By agreement with CityLink and its lenders, the payment of the Concession Notes
was subordinated to the payment of senior debt. This subordination was achieved
by providing that repayment of Concession Notes could only be made from
CityLink’s “distributions account”. The operation of a ‘waterfall’ controlled deposits
to the distributions account. Hence CityLink’s senior creditors have an assurance
that repayment of Concession Notes will not jeopardise CityLink’s ability to repay
senior debt.
CityLink claimed a tax deduction for the Concession Fees satisfied by the issue of
Concession Notes for the 1996, 1997 and 1998 income years.
At first instance, Merkel J in the Federal Court held that the Concession Fees
were of a capital nature and were not allowable deductions. He did, however, find
that the amounts were outgoings incurred in the relevant income years, and were
properly referable to the respective periods. On that basis, His Honour would
have allowed the deductions if he had been satisfied that the outgoings were on
revenue account. In upholding CityLink’s appeal, the Full Federal Court agreed
that the amounts were outgoings incurred and properly referable in each year and
held that they were on revenue rather than capital account. The Commissioner
appealed to the High Court.
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The Decision
(a) Concession fees were incurred in the years of income
The majority agreed with the Full Federal Court that the Concession Fees were
outgoings incurred in the relevant years of income because CityLink was
“subjected to a contractual liability to pay the concession fees”, which arose when
the Concession Notes became due. CityLink was “definitely committed and had
completely subjected itself” to liability under the Concession Notes. Moreover,
neither the subordination of the Concession Notes to senior debt nor the
commercial operating risks of the project amounted to a contingency that
prevented the outgoings being incurred in each year. Crennan J explained that:
The only sense in which it could be said that the liability on the Concession Notes
is contingent is in the abstract sense that all events in the future are conditional or
contingent (para 44).
(b) Concession fees were referable to the years of income
The Commissioner contended that the Concession Fees were not properly
referable to the relevant income years because payment was going to be made
out of future assessable income and that the correct approach is to match
expenses and revenues. However, the Court held that the amounts were properly
referable to the income years and confirmed that the criterion of referability is the
advantage secured by the liability in question. The liability under each
Concession Note was undertaken in exchange for the State granting the right to
establish and operate the road systems to CityLink in the relevant income years.
Implications
An Outgoing May be Incurred But Not Discharged
It is well established that an outgoing or loss may be incurred, and therefore
deductible under section 8-1, before it is paid. Just as income may be assessable
under section 6-5 before it is actually received. This was made clear by Latham
CJ in W Nevill & Co:
It is only the incurring of the outgoing that must be actual; the section does not
say in terms that there must be an actual outgoing – a payment out.
And in James Flood the Court wrote:
The word ‘outgoing’ might suggest that there must be an actual disbursement.
But partly because such an interpretation would produce very strange and
anomalous results, and partly because of the use of the word ‘incurred’, the
provision has been interpreted to cover outgoings to which the taxpayer is
definitively committed in the year of income although there has been no actual
disbursement.
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This approach may be described as simply a consequence of our tax system’s
adoption of accruals based accounting or as ‘a statutory recognition and
application of … the matching principle’.
The High Court’s decision therefore provides a worthwhile confirmation of these
principles and shows that they are not affected by the time expected to pass
between incurrence of the loss or outgoing and payment. For example, in Coles
Myer the liabilities were payable in the following income year. In AGC the
deferred interest bonds had a life of up to 20 years. In contrast, the Concession
Fees might not be paid by CityLink until the end of the concession period in 2034
(or even later if the period is extended). On this point Crennan J concluded:
Here the liability comes into existence in the year of income. The deferral of the
time for its discharge cannot alter this conclusion, nor can the length of time of the
deferral.
Jurisprudential or Practical Analysis?
The decisions in Nilsen and even James Flood perhaps suggest that a strict
jurisprudential analysis may be required in determining whether a loss or outgoing
has been incurred. In James Flood the Court wrote:
But it is certainly true that it is not a matter depending upon ‘proper commercial
and accountancy practice rather than jurisprudence’. Commercial and
accountancy practice may assist in ascertaining the true nature and incidence of
the item as a step towards determining whether it answers the test laid down by
s51(1) but it cannot be substituted for the test.
Thus any legally contingent liabilities arguably may not give rise to a loss or
outgoing incurred regardless of how likely (or certain) it is that the contingency will
be satisfied. This approach dominates Barwick CJ’s decision in Nilsen, a case
that involved a claim for deductions for accrued annual and long service leave.
The chief justice recognised that it was certain that, one way or another, the
taxpayer would become liable to pay its employees their accrued leave
entitlements. Nevertheless, as a matter of jurisprudential analysis no liability had
yet arisen because the relevant award expressly provided that the liability to pay
only arose when the employee took leave (or left employment or died). His
Honour said:
That part of Sir Owen Dixon's statement in New Zealand Flax Investments Ltd v
Federal Commissioner of Taxation which presently needs emphasis is that the
word "incurred" in s 51(1) "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 or expenditure will
occur in the future".
However, in many ways Nilsen represents the height of the courts’ acceptance of
the jurisprudential approach. Since then a number of lower court decisions have
signalled a departure from the strict approach and instead allowed a more
practical or commercial analysis. For example in Commercial Union Newton J
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recognised that there was a legal contingency to the liability arising. There an
insurer sought a deduction for provisions it made for future claims. Many of the
claims were technically unrecoverable because the insured had not given the
insurer notice within the requisite period. However, the evidence was that the
insurer never relied on non-compliance with the notice period to resist a claim (to
do so would have been uncommercial and lead to a loss of business) and His
Honour held that the outgoing was incurred on the basis that:
payment was a matter of commercial certainty, and was not subject to any
contingency which would be regarded as such in the world of ordinary business
affairs.
Similar observations can be made of RACV Insurance.
In Coles Myer both Deane and McHugh JJ indicated that they would have been
willing to move away from the strict jurisprudential approach. That was, however,
unnecessary because all members of the Court held that a liability to pay the
discount on the notes arose upon issue. Their comments are therefore strictly
obiter. Deane J said that:
the critical question is not whether, as a matter of legal analysis, the liability is
theoretically contingent or defeasible. It is whether the taxpayer is, as a practical
matter, ‘definitively committed’ or ‘completely subjected’ to the obligation to make
the payment in the future even though it has not come under ‘an immediate
obligation enforceable at law’ to do so.
Justice McHugh criticised the jurisprudential approach as follows:
No doubt the jurisprudential analysis of s 51(1) is the natural result of the doctrine
of legal formalism which dominated Anglo-Australian legal thought for much of
this century and which has been rejected by this Court only in recent years. As
has so often been said, legal formalism represents the triumph of form over
substance.
His Honour then went on to note that neither party had sought to question the
correctness of the jurisprudential approach and concluded that ‘the present case
is not one which calls for a re-evaluation of the principles concerning the
allowance of deductions under s 51(1)’.
The decisions in the insurance cases mentioned above together with Deane and
McHugh JJ’s comments in Coles Myer Finance led the Privy Council to remark
that:
this construction involves taking what the Australian Courts have called a
jurisprudential rather than a commercial view of the meaning of ‘incurred’. This is
an unusual approach to a taxing statute and Their Lordships detect in the
Australian cases some degree of tension between loyalty to formal legal doctrine
and reluctance to accept a computation of taxable profits which is wholly divorced
from commercial reality.
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Justice Crennan seems to have been satisfied that the Concession Fees were not
subject any legal contingency so that they were incurred, even on a
jurisprudential analysis:
The only sense in which it could be said the liability on the Concession Notes is
contingent is in the abstract sense that all events in the future are conditional or
contingent.
Therefore it may have been strictly unnecessary for her to resolve the tension
between the jurisprudential analysis and a more practical approach. However, in
her analysis, Crennan J adopted Deane J’s comments extracted above, and
seems to have accepted that a more practical approach should be taken. It
remains to be seen whether the CityLink decision will be taken as authority for a
more practical approach, or whether the courts will revert to the strict
jurisprudential analysis applied in the earlier cases.
Referability
Although section 8-1 does not explicitly require that the amounts claimed as
deductions be referable to the year of income, the majority judgment in Coles
Myer recognised that:
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.
Allowing a deduction in the year in which a loss or outgoing is incurred without
reference to the period to which it is referable may lead ‘to a distortion of
CityLink’s operations on revenue account’ by recognising the deduction too early.
By only allowing the deduction in the year in which the taxpayer puts the product
of the loss or outgoing ‘to profitable advantage’ the correct reflex of the
taxpayer’s operations on revenue account is achieved.
Perhaps because of the difficulty in finding authority for the referable principle in
the words of the legislation there have been suggestions that the application of
the principle should be restricted to the facts of Coles Myer Finance. Thus, in FCT
v Woolcombers the Full Federal Court did not apply the referable principle and
distinguished Coles Myer Finance on the basis that it involved a financing
transaction:
In Coles Myer, because of the special nature of the financing transaction, it was
held, by the majority, that apportionment was appropriate. Likewise, in the
financial arrangements considered in Australian Guarantee, apportionment of the
total sum of the interest was proper. But there are no similar features in the
present matter, which concerns a relatively simple forward contract for sale
without any financing aspect; no question of arises here of a liability accruing
daily, as interest does, or otherwise accruing periodically.
Similarly, in FCT v Mercantile Mutual Insurance CityLink submitted that the
referable principle should be confined to deductions of losses rather than
6High Court Confirms Deductibility of Concession Fees – FCT v CityLink Melbourne Limited (
outgoings. Justice Hill could not see any difference in principle between a loss
and an outgoing and held that the test of referability was applicable to both losses
and outgoings. In doing so his Honour expressed some scepticism regarding the
correctness of the approach taken by the Court in Woolcombers.
By clearly applying the referable principle to the Concession Fees in CityLink
Crennan J has confirmed that it applies in circumstances much wider that those in
Coles Myer Finance. In particular it applies in situations other than financing
transactions and to outgoings as well as losses. The Concession Fees were
outgoings, not losses. The gross amount of each payment was deductible, not
some net amount. So the Woolcombers decision should perhaps now be
questioned.
Footnotes
1 The income years in question were those ended 30 June 1996, 1997 and 1998.
Section 51(1) applied to the 1996 and 1997 years while section 8-1 applied to the
1998 year.
2 Although the Court also rejected the Commissioner’s argument that the
concession fees were expenditure on capital account and not deductible.
3 FCT v Mercantile Mutual Insurance (Workers’ Compensation) Ltd (1999) 87
FCR 536, [1]; New Zealand Flax v FCT (1938) 61 CLR 179, 199.
4 Arthur Murray, J Rowe & Son.
5 (1937) 56 CLR 290, 302.
6 (1953) 88 CLR 492, 506 (emphasis added).
7 RACV Insurance v FCT [1975] VR 1, 14; Coles Myer Finance v FCT (1983) 176
CLR 640, 665-6.
8 (1984) 2 FCR 483.
9 [2006] HCA 35, [134].
10 (1953) 88 CLR 492, 506-7.
11 (1993) 47 FCR 561, 575.
12 [1975] VR 1, 12.
13 (1993) 176 CLR 640, 670-1.
14 (1993) 176 CLR 640, 676 (footnote omitted).
15 Ibid.
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16 CIR v Mitsubishi Motors New Zealand Ltd (1995) 3 NZLR 513, 517 (emphasis
added).
17 [2006] HCA 35, [137] (footnote omitted).
18 Coles Myer Finance (1993) 176 CLR 640, 666.
19 Ibid, 665.
20 (1993) 47 FCR 561, 575-6.
21 (1999) 87 FCR 536, [61].
22 (1999) 87 FCR 536, [69].
23 (1999) 87 FCR 536, [69].
Greenwoods & Freehills and Freehills acted for CityLink Melbourne Limited
in relation to the Melbourne City Link Project and subsequent tax litigation.
This article was written by Raghu ram Mohan, Tax Consultant and Andrew de
Wijn, Solicitor from Greenwoods & Freehills.
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For further information, please contact
Melbourne
Adrian O’Shannessy
Adrian.O’Shannessy@gf.com.au
+61 3 9288 1723
Alan Mitchell
Alan.Mitchell@gf.com.au
+61 3 9288 1401
Paul Wenk
Paul.Wenk@gf.com.au
+61 3 9288 1704
G&F document ID 510039501_15.docx
These notes are in summary form designed to alert clients to tax developments of general
interest. They are not comprehensive, they are not offered as advice and should not be
used to formulate business or other fiscal decisions.
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