are lease incentives taxable? - a trans

________________________________________________________________________________

ARE LEASE INCENTIVES TAXABLE? - A TRANS-TASMAN

COMPARISON

By Andrew Maples

The characterisation of receipts or payments as either on capital or on revenue account is often a complex and uncertain exercise.

The taxation of lease incentives is an illustration of both the complexity and uncertainty in this area. In 1990, and contrary to established principles, the Australian Full Federal Court in FC of T v Cooling held that a lease inducement was assessable to the recipient.

There have been a number of decisions since that time dealing with this same issue, some of which have distinguished the decision in Cooling. A decade on, the author examines and contrasts the two most recent and significant cases on the taxation of lease incentives: C of IR v Wattie (Privy Council–appeal from New Zealand) and FC of T v Montgomery (High Court of Australia). While the cases have not dissimilar facts, they have produced completely different results and indicate a difference in approach between the Australian and New Zealand (and arguably the United Kingdom) courts in the area of the taxation of singular receipts such as lease incentives

1. INTRODUCTION

"No part of our law of taxation presents such almost insoluble conundrums as the decision whether a receipt or outgoing is capital or income

1 for tax purposes..."

This statement is true of the tax treatment of lease incentives in recent years. The "traditional" view of such incentives, prior to the Australian decision of FC of T v Cooling ,

2

was that they were on capital account.

3

This was on the basis that generally such payments are made "once and for all"

4

and "with a view to bringing into existence an asset or advantage [the lease] for the enduring benefit of trade".

5

A lease is part of the lessee's profit-making structure and a capital asset.

6

The acquisition, or disposal, of a lease is an integral activity associated with that business structure.

Accordingly, payments in respect of acquiring or disposing of that lease are also on capital account.

7

In 1990, however, the Australian Full Federal

Court in Cooling held that a lump sum cash incentive payment to partners of a law firm to enter a lease was assessable. This was on the basis that the receipt constituted income according to ordinary concepts. The decision followed the

High Court decision of FC of T v The Myer

Emporium.

8

Both decisions were extremely significant, representing "a substantial shift in the construction of s 25 and a novel enlargement of the concept of income."

9

1

Regent Oil Co Ltd v Strick; Regent Oil Co Ltd v IRC [1966] AC 295, 343 (per Lord Upjohn) ("Regent Oil").

2

90 ATC 4472 ("Cooling").

3

J Dabner, "Lease Incentives and The Gain Theory of Income" (1998) 1 Journal of Australian Taxation 136, 138-139: in Australia

"...apart from the possibility of the reimbursement provisions applying, then later possibly Pt IVA of the ITAA36 [Income Tax

Assessment Act 1936 (Cth)], there appeared to be little risk of the lease inducement being assessable. Even with the introduction of Pt

IIIA of the ITAA36 in 1985, it remained inconceivable that an inducement could be assessable in the absence of the disposal of an

4 asset by the lessee..."

5

Vallambrosa Rubber Co Ltd v Farmer (Surveyor of Taxes) (1910) 5 TC 529.

British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205, 213; Sun Newspapers Ltd v FC of T (1938) 61 CLR 337, 359

6

( "Sun Newspapers" )

See, for example, C of IR v McKenzies (NZ) Ltd (1988) 10 NZTC 5233 ( " McKenzies" ) .

The Court of Appeal in McKenzies held

7 that a lump sum payment by the lessee to the lessor to secure the termination of a long and onerous lease was on capital account.

For a discussion on characterising a receipt as capital or income see M Flynn, "Distinguishing Between Income and Capital

8

Receipts - a Search for Principle" (1999) 3 Journal of Australian Taxation 155.

87 ATC 4363 ( "Myer" ). The case involved the sale by the taxpayer of an income stream for a lump sum amount. The High Court of

Australia held the receipt constituted income on the basis that the taxpayer's intention was to convert a future income stream into a

9 current lump sum (capital) receipt.

ICF Spry, "New Directions for Section 25: The Significance of Cooling's Case" (1990) 19 Australian Tax Review 158.

208 JOURNAL OF AUSTRALIAN TAXATION

LEASE INCENTIVES: TRANS-TASMAN COMPARISON

________________________________________________________________________________

As a result of Cooling "there was a scramble by lessees to distance the receipt of lease inducements from the facts of Cooling and to identify what tax effective forms of lease inducements remained."

10

The effect of Cooling was formalised into the Australian Tax Office's administrative practice in Income Tax Ruling IT

2631, which dealt with the tax treatment of various types of lease incentives.

11

Cooling is briefly reviewed in Part 2 of this article.

It has been a decade since Cooling was decided. Since that time a number of cases dealing with the tax treatment of lease incentives have been decided.

12

These decisions highlight the inherent complexity of distinguishing between capital and revenue receipts. The two most significant recent decisions are the New Zealand appeal to the Privy Council in Wattie

13

and the decision of the High Court of Australia in

14

Montgomery.

Wattie is the first decision on the taxation of lease incentive payments in New Zealand. The outcome of the appeal to the Privy Council was keenly awaited. It is estimated that there were about 200 cases awaiting that outcome.

15

Their

Lordships (along with the majority of the New

Zealand Court of Appeal) found the lease incentive in that case was on capital account.

Prior to the High Court finding in

Montgomery , the authority of Cooling in Australia had received a setback in a number of subsequent decisions in which lease incentive payments were held to be capital in nature.

16

The majority of the

High Court in Montgomery, contrary to the findings in these earlier cases, held that the lease incentive under consideration was on revenue account and taxable.

In Parts 3 and 4 respectively, the Wattie and

Montgomery decisions are reviewed and contrasted. Part 5 concludes the discussion on the two cases. In Part 6, the likely future treatment of lease inducements is briefly reviewed.

2. COOLING REVISITED

This case concerned a firm of Brisbane solicitors who, in 1985, received an offer from the

AMP Society ("AMP") to relocate its practice to a new office block owned by AMP. As an incentive to move, AMP offered the firm either a rent holiday or a cash incentive. After protracted negotiations the firm agreed to move in return for a cash payment of $162,000, which was paid directly to the partners. Although not required to, the partners applied the proceeds of the cash payment to the fit-out expenses. Once the fit-out was complete it was sold to a financier on a sale and leaseback arrangement. The proceeds of the sale and lease back were paid to the partners. The documentation between the solicitors and AMP described the payment as an incentive for procuring the solicitors' service company to enter the lease and for the partners agreeing to guarantee the service company's performance of its obligations under the lease.

The taxpayer disclosed his share of the incentive in his 1986 tax return but stated that it was not assessable. The Federal Commissioner of

Taxation ("Co mmissioner") disagreed and

10

Dabner, above n 3, 140.

11

For further discussion on the impact of recent cases on the ruling see N Bellamy and S Barkoczy, "When Will Lease Incentives be of an Income Nature?" (1998) 1 Journal of Australian Taxation 14, 28.

12

Case 22/95 95 ATC 243, Rotherwood Pty Ltd v FC of T 96 ATC 4203, Lees & Leech Pty Ltd v FC of T 97 ATC 4407 ( "Lees &

Leech" ) , Selleck v FC of T 97 ATC 4856 ( "Selleck" ) , C of IR v Wattie (1998) 18 NZTC 13991( "Wattie" ) , FC of T v Montgomery 99

ATC 4749 ( "Montgomery" ).

13

14

(1998) 18 NZTC 13991.

15

99 ATC 4749.

16

R Inder, "Managers deny cash payments" (13 Nov 1998) The National Business Review, 58.

Lees & Leech, Selleck and Montgomery v FC of T 98 ATC 4120 (Full Federal Court). These decisions also cast doubt on the accuracy of Income Tax Ruling IT 2631, para 8 which stated that in "view of the decisions in Myer and Cooling, where a business taxpayer is given a cash incentive to enter into a lease of premises, the incentive is income of the taxpayer." The capital gains tax aspects of such payments in Australia are outside the scope of this article. For a discussion on this see H Ashiabor, "Lease Incentive

Payments and Capital Gains Tax Provisions" (1999) 2 Journal of Australian Taxation 102.

MAY/JUNE 2000 209

A MAPLES

________________________________________________________________________________ ultimately the case was appealed to the Full

Federal Court. The Court found in favour of the

Commissioner. assessable.

In a controversial finding, Hill J (Lockhart and

Gummow JJ concurring) concluded that the payment constituted income according to ordinary concepts assessable under former s 25(1) of the

ITAA36.

In his judgment, Hill J stated:

Where a taxpayer operates from leased premises, the move from one premises to another and the leasing of premises occupied are acts of the taxpayer in the course of its business activity just as much as the trading activities that give rise more directly to the taxpayer's assessable income. Once this is accepted, the evidence established in

Queensland in 1985 it was an ordinary incident of leasing premises in a new city building ... to receive incentive payments of the kind in question. Why then should a profit received during the course of business where the making of such a profit was an ordinary incident of part of the business activity of the firm not be seen to be income in ordinary concepts?

17

(emphasis added)

The Court also held that the first strand of

Myer

18

applied to the facts before their Honours.

The transaction entered into by the firm was a commercial transaction. A "not insignificant purpose"

19

of the transaction was to obtain a commercial profit by way of the incentive p ay me n t . Ac c o r d i n g ly , t h e p ay me n t w a s

The taxpayer submitted that the amount received was analogous to "key money" or a lease premium paid by a tenant to secure the lease of premises, such payments being prima facie on capital account: Regent Oil

20

and Kosciusko

Thredbo Pty Ltd v FC of T

21

.

Hill J distinguished the two types of payments on the basis that a payment of a lease premium is a sum paid to the lessor in return for the grant to the lessee of the leasehold estate. The lease incentive, by way of contrast, is not received by the lessee in return for parting with an estate in land. Therefore, no analogy could be drawn.

3. C OF IR V WATTIE

3.1 The Facts

As a result of a depressed economy, there was an unprecedented level of vacant space in the

Auckland central business district in 1991.

Owners and developers of buildings were anxious to secure major tenants for their developments and were therefore prepared to negotiate substantial deals to attract key tenants. Among such developments was a 32-level office block owned by Pacific Tower Limited ("Pacific"), which was entirely untenanted.

At this time, international accountancy firm

Coopers & Lybrand ("C&L"), now part of

PricewaterhouseCoopers, decided to move into new premises. C&L were well aware that a major tenant such as itself was attractive to building owners. They knew that they had considerable bargaining strength and could expect to be offered

17

Cooling 90 ATC 4472, 4484. Bellamy and Barkoczy, above n 11, 18 discuss this passage and have developed two interpretations of it, in particular the emphasised phrase, referred to as the "ordinary incident of the business activity" principle ("a distinct jurisprudential principle") and the "business income principle". In respect of the first principle, Bellamy and Barkoczy state, on that view, that "...Hill J was stating that a gain may be of an income nature if it arises outside the ordinary course of carrying on a taxpayer's business, so long as it is an ordinary incident of the business activity of the taxpayer." Under the second principle, the passage can be seen as stating that the solicitors' business involved not only the provision of legal services but also leasing premises.

As the receipt of the lease incentive was an ordinary incident of the second of these activities, it should be assessable. On this interpretation "Hill J was merely adopting a broad factual view of what fell within the ordinary course of carrying on the firm's business...".

18

See Myer 87 ATC 4363, 4366-4367: "...a receipt may constitute income, if it arises from an isolated business operation or commercial transaction entered into otherwise than in the ordinary course of the carrying on of the taxpayer's business, so long as the taxpayer entered into the transaction with the intention or purpose of making a relevant profit or gain from the transaction."

19

Cooling 90 ATC 4472, 4484.

20

[1966] AC 295.

21

84 ATC 4043.



________________________________________________________________________________ substantial inducements in return for entering a lease. two leases were re-negotiated each year.

23

After negotiations with Pacific, they entered into a 12 year non-assignable lease of six floors of

Pacific's office block. They signed a collateral deed at the same time. The collateral deed provided C&L with a number of incentives totalling $NZ15.08 million. Based on the agreement to lease, the rent for the premises for the first six years was $NZ349.83 per square metre. The rent, however, when the various incentives were taken into account was effectively

$NZ18.97 per square metre. While there was to be a rent review after the first six years, the resulting rent, however, was not to be less than $NZ20 per square foot.

His Honour, however, found in favour of the

NZ Commissioner on the basis of his second submission – that the inducement payment was a type of rent subsidy and therefore assessable. In so finding, Fisher J focussed on the substance of the transaction rather than its legal form.

3.3 Court of Appeal

24

On appeal, C&L submitted that the inducement was related to a capital asset (the lease) and accordingly was part of the structure of their business. The payment represented a negative premium paid in return for C&L accepting the burden of a 12 year non-assignable lease.

The incentives included a monthly rent subsidy of $NZ94,008 and a one-off $NZ5 million payment described in the collateral deed as a "Cash Inducement Sum". There was no restriction on how C&L chose to apply the latter sum. C&L treated the rent subsidy as assessable income and the inducement payment as a capital receipt. The inducement payment was paid into a suspense account. After allowance for losses and costs associated with the move, the balance was paid out to the partners. The Commissioner of

Inland Revenue ("NZ Commissioner") argued that the incentive was on revenue account.

3.2 New Zealand High Court

22

The NZ Commissioner contended that the inducement was received in the course of the current operations of the firm's business or, alternatively, it was assessable as a rent subsidy.

The NZ Commissioner argued that the lease inducement payment was taxable on any of the following grounds:

as a rent subsidy derived from C&L's business;

as a gain in the ordinary course of, or ordinary incident of, C&L's business, applying Cooling ; or

 as income according to ordinary concepts, as decided in Myer.

The majority of the Court of Appeal

(Richardson P, Gault, Henry and Blanchard JJ,

Thomas J dissenting) decided the inducement was a capital receipt. The majority decision was delivered by Blanchard J.

3.3.1 A Rent Subsidy?

Fisher J rejected the NZ Commissioner's first contention, notwithstanding that C&L leased fifteen premises in New Zealand and that one to

After "examining the bargain made and recorded by the parties in its factual setting"

25 the majority found that the payment was not a rent

22

Wattie v C of IR (1996) 17 NZTC 12712.

23

Ibid 12718. In an implied rejection of Cooling, his Honour stated "I am satisfied that in the present case the firm's ordinary business operations did not include the acquisition or disposition of leases. Because of its many branches it was inevitable that from time to time the firm would be involved in the acquisition, disposition or surrender of leases. It had to have offices in which to conduct its profession. But the lease transactions occurred infrequently and on an ad hoc basis. They were merely an incident of the need to maintain a permanent structure in which to conduct the business. It did not form part of the current operations of the business itself."

24

25

Wattie v C of IR (1997) 18 NZTC 13297.

Ibid 13304-13305.

MAY/JUNE 2000 211

A MAPLES

________________________________________________________________________________ modify leases fairly frequently...

28

(emphasis added) subsidy. Applying the test in Hallstroms Pty Ltd v

FC of T

26

, their Honours accepted that from a practical and business point of view, a substantial incentive was necessary for C&L to forgo its freedom to enter a lease elsewhere and to accept the burden of a non-assignable lease.

According to the majority the inducement payment was correctly categorised as a negative premium. The payment was:

In this statement, the majority have not adopted the "ordinary incident of the business activity" principle outlined by Bellamy and

Barkoczy,

29

rather have taken a narrow

(compared to Hill J's broad) factual view of what falls within the ordinary course of C&L's business.

...a capital item in the same way as in

McKenzies the payment by a lessee to obtain surrender of its lease was a capital item. It is the mirror image. This lessor was asking Coopers and Lybrand to relieve it of untenanted premises by taking a burdensome lease. In McKenzies it was the lessee asking the lessor to relieve it of its unwanted lease by accepting a surrender and consequently untenanted premises.

27

3.3.2 Part of its Ordinary Business?

Despite the similarity in facts to Cooling , the majority of the Court of Appeal clearly rejected the NZ Commissioner's second argument based on Cooling . Their Honours stated:

The majority's conclusion may have been different if it were shown that the firm had on several occasions sought to capture inducement payments. There was no suggestion that C&L had ever received a similar payment. This was a unique event for the firm, which arose out of unusual circumstances from which it was able to extract an advantage in return for acceptance of a considerable burden. The fact that other prospective tenants at the time were able to obtain similar inducements in the Auckland market was beside the point. C&L's success in this matter did not create an extension of their business operations.

The majority also disagreed with Hill J's distinction between a lease premium and a lease inducement: With due respect to the contrary view taken in

Cooling , the business of a professional firm, conducted along normal lines, does not include its dealings with its lessor which are necessary if the firm is to be suitably housed. The business of a firm of accountants is accountancy ... but it cannot sensibly be said to be in the business of dealing with leaseholds because it is obliged to have rental accommodation.

Nor can it influence the characterisation of its leasing transactions that the firm may have many offices and must perforce acquire, dispose of or

Another difficulty we have with the reasoning in

Cooling is that we cannot accept that an inducement to take a lease is distinguishable from a receipt of a premium by a lessor simply because in the former case there is no disposition of an estate in land by the recipient of the payment.

There is of course an acquisition of a leasehold estate. We do not understand how a distinction can be drawn between acquisition and disposition.

30

(emphasis added)

26

(1946) 72 CLR 634, 648 ( "Hallstroms" ). Dixon J stated the approach to be adopted in considering the character of expenditure depends on the answer to the question as to " what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process."

27

Wattie (1997) 18 NZTC 13297, 13305 (per Richardson P, Gault, Henry and Blanchard JJ).

28

Ibid 13308.

29

Bellamy and Barkoczy, above n 11, 18.

30

Wattie (1997) 18 NZTC 13297, 13308. This approach is consistent with that adopted by Beaumont J in Selleck 97 ATC 4856,

4877. In that case his Honour stated that a lease incentive payment should prima facie, be treated as being on capital account "as a payment made, in the nature of a premium, in consideration of a prospective lessee agreeing to accept the burdens (along with the benefits) of the proposed lease.

"



________________________________________________________________________________

In an emphatic rejection of the application of

Cooling in New Zealand, the majority concluded that "the decision in Cooling should not be followed in New Zealand."

31

3.3.3 Application of Myer

The majority of the Court of Appeal also rejected the NZ Commissioner's third contention based on the first strand of the judgment in Myer .

The application of the decision has caused problems in subsequent cases. Drummond J in the

Federal Court in Selleck commented that there has been debate about the scope of the ratio decidendi

32 in Myer .

The Court of Appeal was content to read the decision as simply describing an adventure in the nature of trade:

A gain from such an adventure deliberately entered into with a view to the profit, though perhaps unprecedented for the taxpayer, will constitute income. It is a profit making scheme.

The profit is income in accordance with ordinary concepts.

33

Blanchard J later in the judgment of the majority further stated:

... it does not follow because a gain is made by a taxpayer which has a business that the gain is to be regarded as a receipt of income by that business. The Court in Myer plainly recognised that not every receipt from an extraordinary business event will give rise to a liability for taxation.

34

In the majority's view, the facts before them did not fit the concept of an adventure in the nature of trade, a fact that counsel for the NZ

Commissioner had to concede. The firm was left with a burdensome lease. While the partners received some of the cash inducement, the value of their business assets may have actually diminished. There was no obvious gain to C&L.

However, their Honours stated if their view of

Myer was incorrect and that case should be construed as having created in Australia some extension to the taxation of receipts, then it did not apply to the present facts.

As far as the majority of the Court of Appeal is concerned, Myer in New Zealand at least, has not expanded the concept of income beyond ordinary parameters.

35

3.3.4 Thomas J

Thomas J dissented, believing the link between the inducement payment and the rent was too close for the inducement to be isolated. The sum was paid to C&L to procure its agreement to pay rent at a figure that was substantially in excess of the market rental.

As the firm did not dispose of any capital asset in consideration for the receipt, his Honour believed any analogy between the receipt and a negative premium was ill-founded.

3.4 Privy Council

In an emphatic 16 page judgment delivered by

Lord Nolan, the Privy Council rejected the NZ

Commissioner's appeal.

The NZ Commissioner argued that the inducement:

represented a rent subsidy or offset against the

(above market) rent payable by C&L, and, therefore was assessable as business income; or

31

Wattie (1997) 18 NZTC 13297, 13308.

32

Selleck v FC of T 96 ATC 4903, 4910. His Honour noted that not all decisions in which Myer has been applied are easy to reconcile. One such example of the difficulties in applying the case could be, does Myer extend the boundaries of the concept of income to include all profits that arise from the operation of a business?

33

Wattie (1997) 18 NZTC 13297, 13306.

34

Ibid 13309.

35

The Privy Council decision in Rangatira Ltd v C of IR (1996) 17 NZTC 12777, dealing with the taxation of share profits in New

Zealand, was to the same effect.

MAY/JUNE 2000 213

A MAPLES

________________________________________________________________________________

was, in the alternative, assessable as a gain arising from a venture entered into in part for the purpose of making a profit, based on

Myer .

36

In a significant move at the Privy Council hearing, the NZ Commissioner abandoned his argument that the inducement was a receipt arising from the ordinary course of C&L's business or as an ordinary incident of their business.

37

As a result Cooling was not argued at the Privy

Council hearing. This was a major concession by the NZ Commissioner and an acknowledgment that the principle in Cooling should not be applied in New Zealand. On this apparent change in focus by the NZ Commissioner, John Shewan, a tax partner of PricewaterhouseCoopers (incorporating

Coopers & Lybrand) and an observer at the Privy

Council hearing comments:

Sitting in the Court in London, I could not help but muse over the fact that here I was 7 years after the debacle started with the Commissioner categorically stating that he was not arguing the very point which was the focus of 90% of our debate with him when the technical issues were first debated.

38

C&L submitted that the inducement was of the same nature as a lease premium except, in this case paid by the landlord rather than the tenant and, therefore, it was a capital receipt.

3.4.1 A Rent Subsidy or Negative Premium?

As the Court of Appeal had before it, the Privy

Council followed the approach outlined by Dixon

J in Hallstroms case. Lord Nolan, noting that

Dixon J was speaking in terms of expenditure

(rather than receipts), commented "but it is familiar law that within the context of the same business, similar principles will apply to p ay me n t s and receipts."

39

Their Lordships stated what the inducement was calculated to effect, from a practical and business point of view, was to be determined from the particular facts of the case. In an attempt to have the Privy Council look beyond the form of the transaction to its economic substance, the NZ

Commissioner submitted that such an enquiry:

... inevitably involved a review of the factual context in which the payment was made. That review could not properly be precluded by what he [counsel for the NZ Commissioner] described as the 'economic equivalence prohibition', even if the review had regard to the economic or financial impact of the inducement payment upon levels of rental nominally paid.

40

(emphasis added)

C&L accepted that the inducement was linked

"commercially, financially and mathematically"

41 to the lease payments made by them. This, they submitted, would "normally be true of the ordinary premium payable by a lessee to a lessor

36

As an aside, given the NZ Commissioner's preoccupation with arguing the inducement was a rent subsidy, one wonders why he did not seek to limit the deduction allowed for the rent paid. This point did not escape the Privy Council. Their Lordships ( Wattie

(1998) 18 NZTC 13991, 13997) noted that the NZ Commissioner did not at any stage seek to challenge the deductibility of the above-market rental payable under the lease as an expense for the purpose of calculating C&L's taxable profit under the business provision - Income Tax Act 1976, s 65(2) (a) (now Income Tax Act 1994, s CD 3).

37

Wattie (1998) 18 NZTC 13991, 13996-13997. Lord Nolan commented "[a]lthough the argument before their Lordships covered a wide range of decided cases there was much common ground between the parties, and the issue raised by the first of the

Commissioner's submissions became clear and relatively narrow. Thus, it was common ground before their Lordships that the

$5[NZ] million was not a receipt arising from C&L's ordinary business operations which consist, of course, in the practice of the accountancy profession. Nor, as Fisher J had found, could it be regarded as arising from an ordinary incident of that business, and thus liable to tax... by reference to the principle applied by the Australian High Court in Commissioner of Taxation v

Cooling ...The majority of the Court of Appeal upheld the decision of Fisher J on this point and expressed the view that the decision in Cooling should not be followed in New Zealand. The Commissioner has not sought to argue to the contrary before their Lordships' Board."

38

J Shewan, " C of IR v Wattie , An Inside View" (7 Oct 1998) PricewaterhouseCoopers National Tax Conference, Wairakei

Resort. Used with kind permission.

39

Wattie (1998) 18 NZTC 13991, 13997.

40

Ibid 13998.

41

Ibid 13999.



________________________________________________________________________________ upon the grant of a lease."

42

In response to the NZ Commissioner's submission, their Lordships believed the reasoning of Lord Wilberforce in Regent Oil was applicable. In that case, the taxpayer had submitted "that their Lordships must look through the transparent form of the lease-sublease to some underlying commercial reality"

43

and view the payments as "merely part of Regent's normal marketing operations or, alternatively, that the payments were nothing but disguised rebates"

44 and accordingly were deductible. Lord

Wilberforce, in Regent Oil , declined to adopt this approach. Rather, he noted, that the lump sum nature of the payments, the nature of the advantages obtained and the substantial period involved "more than adequately established the expenditure as made for the acquisition of capital

45 assets."

Their Lordships believed that the same reasoning applied in the case before them. This approach can be contrasted to that adopted by Hill

J in Cooling ,

46

in which his Honour appeared to suggest that economic equivalence was relevant to characterising the payment before him. Hill J commented in Cooling that, as the firm also had the option of paying a lower rent and thus obtaining a lower tax deduction, an incentive payment compensating for higher rent (and thus a larger tax deduction) should fall within assessable income. The Privy Council in Wattie firmly rejected any such approach.

47

In what is the main thrust of their decision, their Lordships noted that in both New Zealand and the United Kingdom, where there is no specific legislation dealing with the matter, that a premium has always been viewed by the courts as a capital rather than a revenue receipt. This is on the basis that such payments are made "not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade".

48

Applying these principles, the Privy Council agreed with the majority of the Court of Appeal.

The payment before it was a "negative premium" paid to C&L in return for them entering into an onerous lease for a substantial period. It was "the mirror image" of the termination payment in

McKenzies case. Accordingly the payment was on capital account.

3.4.2 A Profit Seeking Purpose?

In another significant concession, the NZ

Commissioner accepted the Court of Appeal's interpretation of Myer as contemplating a profit arising from an adventure in the nature of trade of the type illustrated in Californian Copper

Syndicate (Limited and Reduced) v Harris .

49

The NZ Commissioner also accepted that

C&L's dominant purpose in entering the transaction was to acquire new office space. He, however, contended that there was also a purpose of securing a profit of $NZ5 million without which, C&L would not have entered the lease.

The majority of the Court of Appeal rejected this submission. The Privy Council concurred with their finding. In their Lordship's view, the inducement could only be regarded as a profit "if it constituted a benefit or bonus accruing to

Coopers & Lybrand quite independently of the other terms of the bargain between the parties."

50

42

Ibid.

43

Regent Oil [1966] AC 295, 351.

44 Ibid.

45

Ibid 354.

46

Cooling 90 ATC 4472, 4484-4485.

47

This aspect of Cooling did not arise for consideration in Montgomery, as no such option was presented to the firm. Such a choice was, however, present in Selleck 97 ATC 4856. There was no suggestion by the Full Federal Court in that case that this element should result in the sum being taxable as ordinary income.

48

British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205, 213 (per Viscount Cave LC).

49

(1904) 5 TC 159 (" Californian Copper ").

50

Wattie (1998) 18 NZTC 13991, 14000.

MAY/JUNE 2000 215

A MAPLES

________________________________________________________________________________

The above view would, in the opinion of their

Lordships, be an erroneous one. This view would also contradict the first contention raised by the

NZ Commissioner, namely "...that the $[NZ]5 million was inextricably linked to the payment by

Coopers and Lybrand of the above-market

51 rental." In their Lordships' opinion, such reliance was not consistent with the proposition of an element of profit or gain in the inducement payment. They observed that the $NZ5 million may be described as the price C&L received in return for undertaking to make the rental payments. On that basis, according to the evidence as "the undertaking was equal in value to the price then there could be no profit element in the latter."

52

The Privy Council decision in Wattie therefore confirmed not only that the payment to C&L was an item of capital, but that a payment that is made as an incentive to enter into a lease (unless it is a sham) will normally be on capital account in the recipients hands.

4. MONTGOMERY V FC OF T

4.1 The Facts

Freehill, Hollingdale and Page ("Freehills") are a firm of solicitors who conduct their business in Melbourne. In 1987/1988 the firm spent $3.8 million undertaking a total refurbishment of the premises it was leasing (BHP House). The firm intended to remain in occupation of the premises, which met all its requirements, at least until 1994.

The leases for the floors occupied were due to expire in 1993 and 1994 respectively. In

September 1988 the building owner, AMP, informed Freehills that all levels of the building were to be gutted and cleansed of asbestos. In

March 1989, AMP advised the tenants that work on the building would commence in September

1989 and that it was anticipated to take three or more years. Work on the floors occupied by

Freehills would commence in 1991. AMP offered to relocate the tenants within the building while the work was carried out.

The firm was concerned about the disruption that the refurbishment would have on its business as well as the potential dangers posed by the asbestos dust. The firm considered several options. In the words of Jenkinson J at first instance,

53

Freehills "did not think themselves devoid of choice... between staying in BHP

House and leaving it." They were offered (and ultimately accepted) the opportunity to take a lease in a building nearing completion at 101

Collins Street. The firm's service company entered a 12 year lease of the Collins Street premises on behalf of the partners.

At the same time as the lease was entered, the partners' service company also entered into an agreement for the payment of an inducement amount. The amount finally paid, under this agreement, to the firm over a three year period totalled $29.35 million. Freehills were entitled to draw down on the incentive payment for specific expenditure including fit-out costs. The termination of the lease at BHP House and the move to new premises involved the firm in substantial costs, most of which were on capital account. Jenkinson J found that the actual expense of moving and the high rental that the firm was committed to resulted in a low profit for the partners in the initial years after the move. The rent at the Collins Street premises was considerably higher than that charged in their old premises.

In Melbourne, (as in Auckland) at the time of the move, it was common practice for large incentive payments to be offered to lessees contemplating moving to new premises. Lessors were concerned at maintaining the capital value of their building by fixing high levels of 'face' rental, ie the rental specified in the lease as distinct from the 'effective' rental.

54

Accordingly, the rent lessor's charge was often non-negotiable; rather it was the incentive itself that was subject to negotiation.

51

Ibid.

52 Ibid.

53

Montgomery 97 ATC 4287, 4296.

54

This is the 'face' rental less the value of the incentive paid.



________________________________________________________________________________

The taxpayer, who was a partner in Freehills, received a share of the incentive payment which was treated as being assessable by the

Commissioner. The taxpayer appealed to the

Federal Court.

4.2 Federal Court

55

Jenkinson J held that the payment was assessable income for two reasons. First, the incentive payment paid to the firm was in consideration for the firm committing itself to the lease of the Collins Street premises. While the receipt could not easily be expressed as a "profit", it was rightly described as a "gain" arising in the course of the firm's business. One substantial purpose of Freehills entering into the transaction was to secure this gain. This brought the case within the ambit of the principles espoused in

Cooling and the first strand of Myer . His Honour was not convinced that the principal reason for the move was that BHP House was to be gutted and refurbished. Secondly, the payment was received by Freehills in the course of carrying on its business.

4.3 Full Federal Court

56

The Full Federal Court (Heerey, Davies and

Lockhart JJ) in separate judgments unanimously allowed the taxpayer's appeal, finding that the payments did not constitute ordinary business income. The taxpayer submitted that it was not an ordinary incidence of the firm's business to receive lease incentives and that the only intention in entering the lease was to obtain suitable premises from which to conduct its practice.

4.3.1 Heerey J

His Honour commented as follows:

(i) Premises from which a solicitor's practice are conducted from are part of its profit earning structure irrespective of whether those premises are owned or leased:

This is none the less so if the firm from time to time, and for various reasons, moves its premises, just as other capital items like computer equipment and furniture are replaced from time to time.

57

A solicitor's practice does not usually include trading in leasehold or freehold premises.

58

(ii) As far as Cooling was concerned "[i]n my respectful opinion, the interests of clarity and predictability...require one to grapple with the issue whether Cooling should be followed or not."

59

Lease premiums are generally on capital account.

60

While, depending on the state of the commercial property market, sometimes they may be paid by the lessor and sometimes the lessee, the essential capital nature of the payment remains.

(iv) The first strand of Myer did not apply as there was no profit or gain. In determining whether a profit or gain exists all outgoings must be taken into account, that is, one must look at the net result of the whole scheme.

61

55

Montgomery 97 ATC 4287.

56

Montgomery 98 ATC 4120.

57

Ibid 4121.

58

Bellamy and Barkoczy, above n 11, 18. His Honour declined to follow the "ordinary incident of the business activity" principle outlined earlier.

59


60

His Honour referred to Beaumont J in Selleck 97 ATC 4856, 4877 and the majority decision of the Court of Appeal in Wattie

(1997) 18 NZTC 13297, 13308.

61

The move cost Freehills $6.2 million in respect of obligations under its old lease, $12.9 million to fit-out the new premises and an annual rent of $8.47 million. There was no gain derived by Freehills to which any profit making purpose could attach. His

Honour adopted the approach of Beaumont J in Selleck 97 ATC 4856, 4873. This approach is similar to that adopted by the Court of Appeal (1997) 18 NZTC 13297, 13308 and Privy Council in Wattie (1998) 18 NZTC 13991, 14000. It also accords with the approach of Hill J in Lees & Leech, where it was unclear whether the first strand of Myer applied because it was unclear whether the taxpayer had made a gain looking at the whole arrangement.

MAY/JUNE 2000 217

A MAPLES

________________________________________________________________________________

Finally, his Honour concurred with the majority in the Court of Appeal in Wattie ,

62

and rejected the distinction made by Hill J between a lease premium and a lease inducement.

4.3.2 Davies J

According to his Honour, if a traditional approach to determining the character of a receipt were adopted, the inducement would be regarded as a capital receipt, as it arose out of a transaction of a capital nature. The payment did not arise from the firm's ordinary revenue earning activities or from a profit making scheme or venture. It was not the result of the exploitation of an asset owned by the partners nor a reward for services. "The transaction of obtaining a new lease, in this case for 12 years with an option of another 6 years, was in its essence a capital transaction."

63

In support of this conclusion his Honour referred to the Court of Appeal decision in Wattie and the Full Federal Court decision in Selleck .

More generally, Davies J also drew support from the oft-cited statement of Dixon J in Sun

Newspapers

64

concerning the distinction between the business entity or structure and the business process.

In Montgomery , entering a lease was an activity that concerned the structure of the business. In the words of Viscount Cave LC in

British Insulated and Helsby Cables Ltd v

Atherton , the lease was "an asset or an advantage for the enduring benefit of a trade".

65

The lease incentive was a once and for all sum that arose from the capital transaction involving the lease.

His Honour, however, recognised that traditional views of capital and revenue are

"undergoing change as more sophisticated techniques are being developed for the determination of matters such as profit and income. This development was given recognition in the law in [the Myer case]..."

66

Davies J went on to distinguish the approach and facts in Myer . On the facts before him there was no evidence of a scheme to make a profit or a gain. Freehills had to move premises. They were not offered the opportunity to take a reduced rent with a reduced, or nil, incentive. The transaction was not a profit making one. When regard was had to the obligations under the old lease, costs of fit-out, relocation expenses and the higher rental obligations under the new lease, the firm did not make a profit. The first strand of Myer did not therefore apply. Support for this approach was again drawn from Wattie (Court of Appeal) and

Dickenson v FC of T .

67

His Honour also distinguished Myer on the basis that, unlike Myer , the sum before him was not a profit or a gain made by the firm from the use of its capital, ie the provision of services or the exploitation of its assets. Rather, the incentive was a gain arising from a capital transaction, the undertaking of a new lease. The incentive derived its character from that transaction.

4.3.3 Lockhart J

While considering "the ordinary incident of the business activity" principle from Cooling was a distinct jurisprudential principle,

68

Lockhart J went on to distinguish Cooling on the facts. The lease incentive was not derived in the ordinary course of the firm's business nor did it arise from a transaction that was an ordinary incident of

Freehills business activities. Rather, as his Honour had also found in Selleck ;

69

62

(1997) 18 NZTC 13297, 13308.

63


64 (1938) 61 CLR 337, 359.

65

[1926] AC 205, 213. See also McKenzies, where the Court of Appeal also held that a lease is a capital item.

66

Montgomery 98 ATC 4120, 4127-4128.

67

(1958) 98 CLR 460 (" Dickenson ").

68

Bellamy and Barkoczy, above n 11, 25.

69

97 ATC 4856.



________________________________________________________________________________

The circumstances which required the firm

[Freehills] to look at options for alternative premises...were extraordinary and directly flowed from the statement by AMP in

September 1988 that all floors in BHP House were to be gutted and cleansed of asbestos.

70

(emphasis added)

The firm had no alternative but to move, which it did after weighing up all the alternatives.

Obviously it must be expected by a firm of solicitors [who rent premises] that it may have to move premises from time to time consistent with the lessor's requirements, the expansion or retraction of the solicitors' practice, the rental charged and matters of this kind. But this was not a move to premises made in the ordinary course of carrying on the practice of a firm of solicitors.

71

As far as Lockhart J was concerned, the real question was, if there was a profit or gain, whether the relevant profit making intention was present ie did the first strand of Myer apply to the arrangements.

Based on the evidence, the firm's purpose in entering into the lease of the 101 Collins Street premises was to secure prestigious premises from which it could conduct its practice at the lowest possible cost.

The evidence [was] not consistent...with a finding that the making of a profit or gain was a significant element in entering into the transaction...Naturally the Firm wished the inducement payment to be as large as possible, but it does not follow that the acquisition of an incentive payment was the object of the transaction. The purpose or object of entering into the transaction to lease the Collins Street premises and to receive the inducement payment w a s t o s e c u r e p r e m i s e s f o r t h e l o n g term future of the Firm, not to obtain a payment by way of inducement ...

72

Cooling was distinguished on the basis that, unlike the case before his Honour the move was not initiated by the solicitors in Cooling but by

AMP.

4.4 High Court of Australia

The High Court of Australia, by a 4 to 3 majority, found the inducement to be assessable.

The Commissioner submitted that the inducement was income as:

the receipts were an incident of a transaction that occurred in the course of the taxpayers business activity (even though it was not in the ordinary course of that business);

the receipts were a gain from a profit-making undertaking or scheme and that a significant purpose of Freehills in entering the transaction was to derive a gain;

it was an amount, received in business, as an incentive to pay greater (deductible) rental payments than the taxpayer would have been prepared to pay. The incentive was negotiated in the normal course of carrying on their business.

4.4.1 The Majority

The decision of the majority (Gaudron,

Gummow, Kirby and Hayne JJ) is outlined in the following.

The Tree and the Fruit

At the outset of its judgment, and before examining the Commissioner's contentions, the majority referred to well established case law on the meaning of income including Pitney J's analogy of the tree (capital) and fruit (income) in

70


71

Ibid.

72

Ibid 4141.

MAY/JUNE 2000 219

A MAPLES

________________________________________________________________________________

Eisner v Macomber .

73

In respect of Pitney J's observations, the majority concluded that income is often, but not always, the product of exploiting capital.

74

Their Honours' noted that attempts to classify a particular receipt often proceeded by drawing analogies with decided cases.

75

While recognising this approach was often helpful, in their Honours' view it "should not be permitted to obscure the essential nature of the inquiry which is to determine whether 'in ordinary parlance' the receipt in question is to be treated as income."

76

Rather, "it is necessary to make both a wide survey and an exact scrutiny of the taxpayer's

77 activities".

This approach set the scene for the rest of their

Honours' judgment, one which contained minimal analysis of prior Australian lease inducement cases.

78

It is interesting to reflect on why the majority did not analyse the various Australian lease inducement decisions. Perhaps, while concurring with the outcome in Cooling , the majority were uncomfortable with basing the taxation of lease inducements solely on the grounds outlined in that case. Cooling has come under some criticism both in subsequent cases

79

and by commentators.

80

In addition, the courts in subsequent decisions have resorted to fine distinctions in order to distinguish

Cooling:

Whilst Cooling was initially viewed as ending tax effective incentive payments, the simple expedient of connecting the incentive payment with an anticipated outgoing of the lessee has caused the courts to retreat from the proposition that all incentives are assessable. Although the decisions subsequent to Cooling have struggled to identify rational points of distinction, the essential difference between the cases is that in

Cooling the partners effectively claimed a tax deduction for expenditure for which they had been reimbursed whereas in Lees & Leech,

Selleck and Montgomery the lessees were careful not to have it both ways."

81

The decisions subsequent to Cooling , by finding that the lease incentives were inherently capital, "exposed the narrow base on which the assessability of lease incentives were founded.

The potential tax planning opportunities presented by this vulnerability in the tax law cannot be underestimated."

82

The majority of the High Court, while endorsing Cooling , have chosen to confirm the principle in Australia that lease incentives are taxable, but based on more general capitalrevenue principles.

73

(1920) 252 US 189, 206-207 - "The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time..." Their Honours' also referred to Jordan

CJ's comments in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215, 219: "The word 'income' is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind..."

74

It would be incorrect, however, to infer from these comments that all receipts that arise from exploiting capital are on revenue account. A capital receipt can also be derived from exploiting the capital of a business.

75

Van den Berghs Ltd v Clark [1935] AC 431, 438-439 (per Lord Macmillan).

76

These comments echo those made by Lord Pearce in BP Australia Ltd v C of T [1966] AC 244, 265 - "As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken."

77 Western Goldmines NL v C of T (WA) (1938) 59 CLR 729, 740 (per Dixon and Evatt JJ).

78

For example, the Full Federal Court decision in Selleck is not mentioned. There is little discussion of the lower (Full Federal) court's decision in Montgomery.

Even Cooling, in which it was first held that lease incentives constituted income in Australia, only receives brief mention. The New Zealand Court of Appeal and Privy Council decisions of Wattie were, however, discussed and criticised by the majority.

79

The strongest criticism has been from Heerey J in the Full Federal Court in Montgomery 98 ATC 4120, 4125 and the Court of

Appeal in Wattie (1997) 18 NZTC 13297, 13308.

80

See for example, Bellamy and Barkoczy, above n 11.

81

Dabner, above n 3, 146.

82

Ashiabor, above n 16, 104.



________________________________________________________________________________

An Incentive to Pay Greater Rent?

The majority dismissed the Commissioner's third argument. As already noted, lessors would not negotiate on the level of rent, only the level of the inducement. Accordingly, their Honour's stated that it was inaccurate to speak of a market rent, calculated by reducing the rent charged by the value of the incentive, as the 'true' rent. That argument was based on an artificial assumption.

As a result of market circumstances, the market produced a more complicated agreement

(including an agreement to provide an incentive) than the simple agreement to lease premises. Both the lease agreement and collateral incentive agreement were the result of arm's length bargaining which represented what each party thought was an acceptable set of terms.

83

The Privy Council in Wattie rejected similar submissions made by the NZ Commissioner in respect of the inducement in that case being a rent subsidy. The NZ Commissioner had argued that

"the economic and financial impact of the inducement payment"

84

upon the rent levels should be considered in determining the character of the receipt.

It is therefore clear that neither jurisdiction will accept such arguments of economic equivalence. These decisions reaffirm the principle in tax cases that (except in the case of a sham or tax avoidance) the terms of a specific contract determine what a particular payment is for. Those terms are to be construed by reference to the surrounding circumstances. Whether the parties to an arrangement could have entered into a different set of legal arrangements (or would have, if given the opportunity) is irrelevant.

85

Characterisation of the Receipts - a Capital

Occasion?

The taxpayer submitted that the incentive was for Freehills to take a long term lease. As the lease was part of the profit-yielding structure, the inducement payment brought into existence an asset or advantage for Freehills enduring benefit and, therefore, was also on capital account.

While acknowledging that the lease of premises was part of Freehills profit-yielding structure, their Honour's stated that it did not follow that:

... any and every aspect of the several transactions associated with the obtaining of the lease [an asset] is necessarily a transaction on capital rather than revenue account. To take the most obvious example, it is beyond question that rent paid under the lease would be a deductible outgoing.

86

Two comments can be made concerning this passage. First, while the first part of the statement by the majority may be correct, examples of expenditure outlaid to acquire an asset being on revenue account would be the exception rather than the rule. It is well established that "if an asset which is acquired is in its intrinsic nature a capital asset, then any sum paid to acquire it must surely be a capital outlay".

87

This principle was extended to include expenses on getting rid of a disadvantageous asset and expenditure on improving, or making an asset more advantageous in Tucker v Granada Motorway Services Ltd.

88

83 The majority stated "[i]t is not useful to note that one party to the bargain would have preferred to undertake some less onerous obligation. Almost every party to a commercial transaction would prefer to have less onerous obligations. But in the absence of some choice about what level of rent would be paid, it cannot be said that the sums paid under the inducement agreement were received in return for an agreement to pay a higher rent." - Montgomery 99 ATC 4749, 4764-4765.

84

Wattie (1998) 18 NZTC 13991, 13998.

85

IRC v Church Commissioners for England [1977] AC 329, Buckley & Young Ltd v C of IR [1978] 2 NZLR 485, Marac Life

Assurance Ltd v C of IR [1986] 1 NZLR 694, AA Finance Ltd v C of IR (1994) 16 NZTC 11383.

86


87

Regent Oil [1966] AC 295.

88

(1979) 53 TC 92.

MAY/JUNE 2000 221

A MAPLES

________________________________________________________________________________

Secondly, rent is not an example of this exception to the general principle. The majority in the above passage refer to "transactions associated with the obtaining of the lease..."

89

(emphasis added) not necessarily being on capital account. Clearly rent is not an item "associated with ...obtaining the lease"; rather it is a

(recurring) consequence of a lease being successfully entered into.

The majority correctly observed that the receipts in question in the present case were associated with the acquisition of part of the profit-yielding structure rather than its disposition, the latter being the situation in other decided cases. In addition, their Honours' observed the present case concerned receipts connected with the acquisition of part of the firms capital structure rather than payments, as in other cases.

Having noted the difference in the factual situation between this and other cases, their

Honours' concluded under this head by stating:

The analogies which the taxpayer sought to draw with payments to acquire part of a taxpayer's capital structure or receipts on disposition of part of a taxpayer's capital structure are at best imperfect and may mislead.

In particular, the reliance on an analogy with lease premium payments is misplaced.

90

Analogous to a Premium Account?

Not surprisingly, given the preceding comments, the majority disagreed with the view, adopted by the Privy Council (and New Zealand

Court of Appeal) in Wattie , that the inducement was 'a negative premium'.

Rather, the majority noted that the character of an expenditure is generally determined by reference to the nature of the asset acquired or the liability discharged by the expenditure being made: Sun Newspapers .

91

In that case, Dixon J referred to three matters to be considered in determining the character of expenditure.

92

Of these three matters, the critical factor is the character of the advantage sought.

Their Honours' then made several observations:

(i) For a lessee who pays a premium for a lease, they obtain the advantage of the lease. The lease may form part of the profit-yielding structure of the lessee's business and the premium accordingly will be on capital account. The amount that a lessee receives on agreeing to take a lease is not necessarily of the same character even if, as with the lease premium, the lease is a part of the profityielding structure of the business. [While this is correct, the same is also true in respect of lease premiums. The character of a lease premium paid by one lessee will not necessarily be the same as a similar premium paid by another lessee.]

(ii) In this regard, the quality of the receipt in the hands of the recipient is crucial to determining its character: Scott v FC of T .

93

(iii) Applying the above principle, a receipt may be taxable to the recipient irrespective of whether or not it is capital expenditure by the payer. The majority stated that it was wrong to assume exact congruence between the character of a sum as a receipt and as expenditure.

(iv) It was also wrong to assume exact congruence between the characterisation of a sum received or paid by one taxpayer and its character when received or paid by another.

The majority concluded:

89


90

Ibid 4765-4766.

91

(1938) 61 CLR 337, 363 (per Dixon J).

92

These factors are: the character of the advantage sought; the manner in which the advantage is to be used, relied upon or enjoyed; and the means adopted to obtain it.

93

(1966) 117 CLR 514, 526 (" Scott ").



________________________________________________________________________________

And reduced to its essentials the argument seeking to compare, if not equate, this

[inducement] receipt with a premium paid by a taxpayer for a lease... [and was] founded on an assertion of congruence or symmetry between whether a payment is deductible and whether a receipt is on capital account.

94

This assertion had been rejected in FC of T v

Rowe .

95

Accordingly, the majority were unable to accept the reasoning in Wattie.

The majority are correct. The tax treatment of

96 payments and receipts is rarely symmetrical.

The majority judgment, however, proceeds

(incorrectly) on the view that the Privy Council and Court of Appeal judgments in Wattie are based on, or endorsed, "symmetry".

97

Harley

98

in respect of the majority's approach in Montgomery to Wattie and to the above sentence cited from Montgomery comments:

Curiously, the High Court [of Australia] majority confused itself with what was meant by the expression "negative premium" and it being the "mirror image" of the payment in

McKenzies case in the context of a payment or receipt in the same business . By misapplying that language - and contrary to how it was used in Wattie - the High Court [of Australia] majority fell into a basic error...

In respect of the aforementioned sentence from

Montgomery, Harley continues:

The sentence is nonsensical, for two reasons.

First, what their Honours really mean is that there is an assertion of symmetry between a claimed deductible payment (of a premium) by the tenant and the characterisation of the amount as a receipt in the hands of the landlord, as being necessarily capital. This is not a function of deductibility at all. The payment is not deductible (statutory provisions to one side).

It is generally a payment by the tenant (and as distinct from a land development business) of capital. Second, the Privy Council (and Court of

Appeal) certainly did not accept symmetry in the way the High Court [of Australia] majority assumed. In Wattie the payment was made by the developer, and so formed part of the cost of the building. That was the [NZ]

Commissioner's reason for supporting the assessment in Wattie.

That cannot determine its character, as a receipt in the hands of the lessee.

The vital part of Lord Nolan's approach [in

Wattie ] is overlooked. After referring to Dixon

J's approach in Hallstrom the Privy Council said [p13997]:

Dixon J was speaking in terms of expenditure but it is familiar law that within the context of the same business, similar principles will apply to payments and receipts.

99

(emphasis added by Harley)

Harley

100

further notes that this last point

(concerning acquisitions and dispositions in the same business ) was not addressed by the majority in Montgomery . It was expressly recognised, however, by the minority in Montgomery .

101

Lord Nolan, in the passage in Wattie , was not endorsing "symmetry" at all. The passage does say that the acquisition and disposition of an asset by the same business will receive the same

94


95

97 ATC 4317.

96

See for example, Regent Oil [1966] AC 295, 333-334; Tasman Forestry Ltd v C of IR (1999) 19 NZTC 15147, 15154.

97

"In Wattie the submissions for the taxpayer firmly rejected the symmetry that the [NZ] Commissioner sought to argue for, in that case, based on the deduction taken by the building owner." G Harley, "The Capital - Income Boundary; Not Again. Instead

Selected Further Musings on the Law of 'Form and Substance' in Taxation", The 1999 Tax Conference, Institute of Chartered

Accountants, 18. Geoff Harley is a partner for Russell McVeagh McKenzie Bartleet & Co, Banisters and Solicitors and represented the taxpayer in the Wattie case along with Richard Green, Barrister (and formerly also a partner in Russell McVeagh

McKenzie Bartleet & Co).

98

Ibid.

99

Ibid.

100

Ibid 19.

101


MAY/JUNE 2000 223

A MAPLES

________________________________________________________________________________ treatment. This principle does not apply to payments and receipts between different businesses.

When endorsing the "negative premium" language, the Privy Council was (like the Court of Appeal) focusing on acquisitions or dispositions by Coopers & Lybrand. Because of that misunderstanding, the High Court majority equally missed the point as to the authority of

Regent Oil, and its own much earlier decision

(led by Sir Owen Dixon CJ) in Dickenson v

FCT (1958) 98 CLR 460 (the first being a disposition (payments) case and the second the

"mirror image" on the facts, being an acquisition (receipts) case).

102

Before leaving this part of the judgment of the majority, two final points should be made. Firstly, it is unfortunate that as a result of their Honours' confusion, that the majority in Montgomery did not mention or analyse the reasoning of the Privy

Council in supporting the approach of the Court of Appeal in Wattie.

Given the support that the approach has had, not only in New Zealand in

103

Wattie but also in Australia, one would have hoped that there would be some discussion by the majority on this point.

104

Secondly, it is interesting to note that the

United Kingdom Inland Revenue recognise lease inducements as a negative premium, referring to them as 'reverse premiums'.

105

Receipts for Modification of the Capital

Structure

The majority also rejected the analogy with cases involving payments received by a taxpayer on agreeing to give up part of its profit-earning structure (eg 'trade-tie' cases).

106

In particular

Dickenson was cited. The majority stated that such analogies with these cases were misleading because in these cases there was an element of exchange that was absent in Montgomery . In those cases the taxpayer gives up, or gives up the use of, a capital asset in return for a receipt. The taxpayer in Dickenson "agreed to give up or sterilise part of his profit-yielding structure."

107

In contrast, in the present case, Freehills gave up no part of its capital structure in return for the payment, rather it added to its capital structure by acquiring the lease.

The majority stated that the firm did not agree that it would not take other premises and:

... thereafter conduct its practice only from 101

Collins Street; it did not oblige itself to give up its premises in BHP House or its premises in

Nauru House. So far as concerned the taxpayer's legal obligations it would have been entirely consistent with the agreements made in relation to 101 Collins Street for the firm to continue its practice from those other premises, or, indeed, from any other premises... [the payments were] not in return for any disposal of part of the firm's capital structure.

108

(emphasis in original judgment)

Harley

109

comments:

This approach simply missed the point. There was, of course, an acquisition by the firm. It was obtaining a capital asset and being paid to do so, because the asset otherwise had negative value. No reference is made to the burden of a long term lease, nor to why there is no basis for asserting that any "profit" arises, by the High

Court [of Australia] majority, both of which are discussed in the Wattie decisions of the Court of

Appeal and Privy Council.

102

Harley, above n 97, 19.

103

Selleck 97 ATC 4856, 4877 (per Beaumont J) and in Full Federal Court in Montgomery 98 ATC 4120, 4126 (per Heerey J).

104

The majority of the High Court of Australia also omitted to discuss the decision in Regent Oil, a decision which on its facts, is also a negative premium case.

105

IRC, "Taxation of Reverse Premiums", REV32: Inland Revenue Budget Press Release.

106

In Selleck 97 ATC 4856, Beaumont J held that the receipt of a lease incentive payment was analogous to a sum received by a trader in consideration of a trading restriction.

107


108

Ibid 4766-4767.

109




________________________________________________________________________________

In practical, if not in legal terms, as C&L had in Wattie , Freehills had sacrificed the ability to stay in their existing premises or move elsewhere.

Legally they were now committed to a 12 year lease, with an option for another 6 years. This commitment and the costs of relocating meant at the time of entering the lease, any relocation within the 12 year period was unlikely. The taxpayer had also committed itself to a lease with a higher rental than it was paying in its existing premises. The payment was therefore, compensation for the firm agreeing to restrict itself concerning where it would conduct its

110 practice and for entering an onerous lease.

As such, the payment did relate to Freehills profityielding structure.

111

In the Ordinary Course of Freehills Ordinary

Business?

The taxpayer contended that the receipts were on capital account on the basis that the lease transaction, which gave rise to the receipts, was not a transaction in the ordinary course of the ordinary business of Freehills. The majority agreed with this submission.

112

In reaching this conclusion, the majority looked at the leases and subleases the firm's service company had in respect of BHP House.

There was no evidence that any inducements had been paid to the firm to enter any of those leases or subleases. For such a receipt to constitute part of the taxpayer's business it appears, from the majority's finding, that there needs to be some regularity or recurrence concerning the receipt.

113

In determining what fell within the ordinary course of the solicitors' business, the majority have taken a narrower view than that adopted in

Cooling.

114

In Cooling, moving from one set of premises to another was just as much a part of a solicitors' business activity as its trading activities.

115

Yet there was no evidence of the firm in Cooling, in its fifty year existence, ever receiving an incentive before. There appears, on the facts, to be little to distinguish between the two cases. In each case, at the time, the provision of lease incentives was common practice. If the majority of the High Court of Australia are stating that some form of regularity is necessary for an incentive to constitute part of the ordinary business of the taxpayer, this factor was absent in

Cooling . The main factual difference between the two cases appears to be that the firm in Cooling , unlike that in Montgomery , did not initiate the move, that was done by AMP. This point, however, relates to the application of the first strand in Myer (profit-making purpose), and not to what constitutes the business of the taxpayer.

Their Honours concluded at this point by stating that the singularity of the inducement did not, however, mean that the amounts were on capital account.

110

Similar observations were made by the majority of the New Zealand Court of Appeal in Wattie (1997) 18 NZTC 13297,

13305.

111

Alternatively, it could be argued that the firm received the payment in consideration of its agreement to deal with a particular landlord ie AMP. In this sense there is also an element of exchange.

112

The Court of Appeal reached a similar conclusion in Wattie (1997) 18 NZTC 13297, 13308. The inducement was not received in the course of C&L's business. "It might be different if it were shown that the firm had on several occasions sought to capture inducement payments but there is no suggestion in the evidence that Coopers & Lybrand had ever received a similar payment or has since done so. It was for the firm a unique event ..."

113

If this is the case, the question then becomes what degree of regularity is required for such a receipt to be received in the ordinary course of the taxpayer's business activity. Drummond J in the Federal Court in Selleck 96 ATC 4903, 4912-4913 dismissed arguments by the Commissioner that because the merged firm moved six years later and received a lease incentive at that time also, that made the original move the first of a number of recurring activities. The six years was seen as "quite a long period". The Court of Appeal in Wattie (1997) 18 NZTC 13297, 13308 stated that C&L "cannot be said to be in the business of dealing with leaseholds because it is obliged to have rental accommodation." This was the case even though C&L had a total of fifteen leases and every year was renegotiating one or two.

114

In so concluding, for the reasons outlined in the next section, the author believes that the High Court have adopted the

"business income principle".

115 Cooling 90 ATC 4472, 4484.

MAY/JUNE 2000 225

A MAPLES

________________________________________________________________________________

Characterisation of a Singular Transaction

In respect of his first two contentions, the

Commissioner placed great emphasis on the Myer decision.

The majority referred to the first strand in

Myer . Their Honours commented that the fact that a gain is from an isolated or singular transaction could suggest that the gain is from the mere realisation of a capital asset or a change in investment rather than from a transaction on revenue account. In deciding issues, the purpose of profit-making is therefore an important consideration. "But, as Myer demonstrates, a singular transaction, in business, even if unusual or extraordinary when judged by reference to the transactions in which the taxpayer usually engages, can generate a revenue receipt."

116

In the majority's only specific discussion of

Cooling, their Honours endorsed the case stating:

And this is why, in [ Cooling ], the Full Court of the Federal Court rightly emphasised the fact that, in that case, the receipt was an ordinary incident of part (albeit an extraordinary and unusual part) of the firm's business activity.

117

(emphasis added)

As already mentioned, the author believes that the High Court applied the "business income principle" to the facts in Montgomery and in interpreting Cooling.

In the above statement, the use of the word "part" seems to indicate the majority were of the opinion that Hill J viewed the business activity of the solicitors in Cooling as constituting two parts ie the provision of legal services and also the leasing of premises. The lease incentive was an ordinary incident of the second of those activities. On this view, the fact that this was the first incentive the firm in Cooling had received (ie, there was no regularity as indicated as being necessary in Montgomery ) was, therefore, not relevant.

118

The Conclusion of the Majority

The High Court majority, returning to principles outlined at the start of its judgment, found that the receipts were assessable. In their view, the inducement amounts did not add to

Freehills profit-yielding structure. The lease was acquired as part of their business structure, while the inducement amounts were not.

The inducement amounts were, in the words of

Pitney J in Eisner v Macomber,

119

"a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed..."

Their Honours' continued:

To put the matter another way, the firm used or exploited its capital ... to obtain the inducement amounts. As the papers presented to the firm in

August 1989 [containing evaluations of two leasing offers made] said, the firm was 'then of a size which makes it a particularly attractive tenancy target'... [thus] it was suggested in those papers that the firm should receive a good inducement offer to take premises. The firm used or exploited its capital in the course of carrying on its business, albeit in a transaction properly regarded as singular or extraordinary.

And the sums it received from the transaction were not as some growth or increment of value in its profit-yielding structure - the receipts came in or were derived for the separate use, benefit and disposal of the firm and its members as they saw fit.

120

The following points can be made concerning the majority's conclusion:

116


117

Ibid.

118

It is, however, possible to argue that by using the word "activity" in its singular form, rather than in the plural form

"activities", that the majority adopted "the ordinary incident of the business activity" principle. A discussion on this issue is beyond the scope of this article.

119

Eisner v Macomber (1920) 252 US 189, 207.

120

Montgomery 99 ATC 4749, 4769-4770.



________________________________________________________________________________

(i) To try to distinguish between the lease agreement itself and the inducement payment, especially when it was not possible to negotiate a lower rent (thus necessitating an incentive), is artificial. It is incorrect to state that, in terms of its derivation, the incentive amounts were "severed from the capital".

Such a view involves focussing on the inducement agreement as separate to the lease agreement and the leasing transaction as a whole. Rather than being separate, the inducement agreement and the lease agreement, which were executed simultaneously, were inextricably connected.

The receipt of the inducement amounts were, after all consideration for agreeing to enter the lease agreement itself- had there not been agreement concerning leasing the premises, no lease agreement would have been entered and no inducement payment would have been necessary. In addition, the lease agreement would not have been entered, at the rental levels agreed, unless the lease incentive was provided. The incentive was "a 'price' for the grant of the lease".

121

(ii) The majority's approach can be contrasted to that adopted by the Privy Council in Wattie . At the outset of their judgment, their Lordships' stated "It was common ground that, for the purpose of determining the true character of the $5[NZ] million payment, the collateral deed and the agreement for the lease... should be read as one."

122

As in Montgomery, the lease agreement and the inducement agreement were executed simultaneously. The

Privy Council rejected the NZ

Commissioner's argument that C&L had a purpose of securing a profit in entering into the lease. The inducement could only be regarded as a profit if it accrued to C&L quite independently of the other agreed terms of the bargain between the parties. Such a view would have been erroneous.

123

(iii) In Wattie, C&L were also aware of the considerable bargaining strength they had and that they could expect substantial inducements. This was discounted by the

Court of Appeal

124

and was not discussed by their Lordships in the Privy Council.

(iv) Neither the New Zealand Court of Appeal nor the Privy Council in Wattie attributed any significance to the fact that the inducement paid to C&L, after allowance for losses and relocation costs, was paid out to the partners.

Indeed, it seems irrelevant whether Freehills and its partners were free to use the proceeds of the inducement amounts as they saw fit.

Proceeds from the sale of a capital asset, forming part of the profit-yielding structure, are no less a capital receipt because they are distributed to the owners of a business rather than retained in the business or applied to acquire a new asset.

4.4.2 The View of the Minority

The minority (Gleeson, McHugh and Callinan

JJ) also held the Commissioner's characterisation of the payments, as an inducement to pay an inflated rent, was not correct. Unlike Cooling , the taxpayer had no choice of paying less rent.

The minority had no difficulty with the Court of Appeal's judgment for the taxpayer in Wattie, and simply applied the Privy Council's approach, endorsing the outcome. In the minority's opinion,

Wattie "was stronger in favour of the revenue authorities than the present case. There an inducement payment...was accepted to have been made to offset above-market rental."

125

The minority agreed with both the New Zealand Court of Appeal and Privy Council in Wattie , Beaumont

J in Selleck ,

126

and Heerey J

127

in the Full Federal

Court, that it was impossible to distinguish between a lease premium and an inducement.

121

Selleck 97 ATC 4856, 4877.

122

Wattie (1998) 18 NZTC 13991, 13996.

123

Ibid 14000.

124

Wattie (1997) 18 NZTC 13297, 13308.

125


126

Selleck 97 ATC 4856, 4877.

127


MAY/JUNE 2000 227

A MAPLES

________________________________________________________________________________

The amounts received did not represent a profit or gain when the whole transaction was considered. They were not received in the ordinary course of the firm's business. The inducement was paid for agreeing to enter into, and undertake the obligations in, a long term lease. The lease was to form part of the structure within which Freehills conducted its business.

The inducement payment was a singular transaction not part of the regular means by which the firm's income was derived.

The relocation by Freehills did not have a purpose of obtaining the inducement. The payment was but one aspect of a wider transaction, a transaction which was a practical necessity.

Finally, the minority were unable to accept that the payments could properly be characterised as proceeding from the firm's use or exploitation of its capital. Such a characterisation disregarded the entire transaction, focussing only on part of it.

5. CONCLUSION

Two courts, two cases and two completely different decisions. These decisions illustrate the conundrum referred to by Lord Upjohn in Regent

Oil

128

in deciding whether, in this instance, a receipt is capital or income for tax purposes. Both the cases were based on, or referred to 'classic' tax cases and principles on the capital-revenue distinction, yet arrived at completely different results.

The different approach to the taxation of lease incentives between Australia and New Zealand may have wider ramifications, potentially even influencing the decision as to whether to lease premises in Australia or New Zealand. Further a field, the decision could cause uncertainty in other jurisdictions, for example in Singapore, which has no special provisions dealing with the receipt of lease inducements.

129

There is some agreement in the findings of the two cases. Both cases agree that the acquisition of leaseholds was not part of the ordinary course of the respective taxpayers' business and indicate that some degree of regularity of the receipt (of inducements) would be necessary before this would be the position. This is arguably a step away from the position in Cooling, ie that the moving from one set of premises to another was just as much a part of the taxpayer's activity as its trading activities.

The Australian High Court (including the minority) and the Privy Council also appear to have rejected arguments of taxation on the basis of economic equivalence, an approach generally restricted to transactions which are a sham.

130

There are, however, significant differences in the ultimate conclusion between the two cases, indicating a difference in approach to the issue between the courts in the two countries (and also the United Kingdom). In Wattie , the Privy Council has reaffirmed what could be labelled the

'traditional approach' to distinguishing between receipts of a capital and revenue nature noted at the outset of this article. In contrast, in Australia both Myer and Cooling, have expanded the concept of income.

131

The decision of the majority in Montgomery has endorsed the approach in those cases in respect of singular receipts.

Their Lordships (and the New Zealand Court

128

[1966] AC 295, 343.

129

See "The Characterisation of Lease Incentives from the Recipient's Perspective- CIR v Wattie & Lawrence" (March/April

1999) Singapore Accountant 42, 44 - "...a Singapore court dealing with the taxability of a leasehold inducement receipt will have to determine whether the receipt is revenue or capital in nature. Traditionally, the local courts tend to place heavier reliance on

British and Australian tax cases compared to Canadian tax cases... the line of reasoning to be followed by the courts in the

Singapore context remains to be seen." This may cause a dilemma for the Singapore courts - which approach should they adopt

(the UK or the Australian approach)?

130

See IRC v Duke of Westminster [1936] AC 1 for the discussion on the House of Lords approach to shams.

131

Spry, above n 9.



________________________________________________________________________________ of Appeal) in Wattie accepted that an inducement is a negative premium and on capital account, the inducement being made "not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade".

132

The fact that their Lordships' decision is both succinct and unanimous is a clear endorsement of this more traditional approach to determining capital-revenue issues. It is likely that this will be the most enduring implication of the decision in New Zealand, especially, as is suggested in the next section of this article, legislation is likely to be introduced in

New Zealand to tax such incentives.

The majority in the High Court of Australia in

Montgomery emphatically rejected the analogy between lease inducements and lease premiums.

Rather, in their view the inducement was the product of the exploitation of capital by the solicitors' in the course of carrying on their business.

The Wattie decision has confirmed "...that the decision in Cooling should not be followed in

New Zealand."

133

In contrast "the High Court of

Australia majority really revived Cooling , as being correctly decided."

134

The New Zealand Court of Appeal in Wattie were content to read Myer as simply describing an adventure in the nature of trade. The NZ

Commissioner conceded this on appeal to the

Privy Council. In contrast, the principles in Myer were adopted in Montgomery to assess a 'one-off' receipt received by the taxpayer as part of a larger business activity.

As a result:

[t]axpayers should be on notice that unusual or irregular receipts may not escape assessability following the Myer, Cooling and Montgomery trio of cases... So long as the taxpayer has a profit motive (and it would be difficult to argue otherwise where an amount is received as part of an enterprise which has profitability as its underlying motive), the taxpayer will be assessed on any amount received in the course of carrying on that enterprise.

135

The decision of the majority may mean that both Myer and Cooling will in the future be given wider application in Australia.

136

Finally, in Wattie, the lease agreement and the inducement agreement were read as one. Based on this approach, the Privy Council found that there was no profit to tax. The majority in Montgomery, on the other hand, viewed the inducement agreement as quite separate, and accordingly the entire inducement was taxable.

6. THE FUTURE

As both decisions are from the ultimate court in each jurisdiction, the cases are probably the last word from the courts on the matter.

137

The author suggests, however, in both countries that these decisions will not be the end of the matter (from a legislative perspective.)

In Australia, as a result of the outcome of

Montgomery, it would appear extremely unlikely that any legislation will be introduced in respect of the tax treatment of lease incentives. There may

132 British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205, 213 (per Viscount Cave LC).

133

Wattie (1997) 18 NZTC 13297, 13308.

134


135

A Carey, "Lease incentives: The unholy trinity of Myer, Cooling and Montgomery " (1999) 34 Taxation in Australia 198, 200.

136

See Deloitte Touche Tohmatsu, "High Court Decides Lease Incentive Payment Assessable" (1999) 31 Taxing Times 1

(http://www.deloitte.com.au/Library/969.asp): "The majority judgement has taken a wide view of the concept of income, suggesting that all business receipts will be assessable income unless in exchange for a capital asset or capital injection."

137

See Deloitte Touche Tohmatsu, "Australia says no to Wattie " (September 1999) Tax Alert

(http://www.deloitte.co.nz/site/site_2.cfm?nc=y&id=5481) - "The fact that the High Court does not agree to hear many tax cases, coupled with the fact that a bench of seven judges heard the appeal, suggests that the Montgomery decision has settled the point once and for all in Australia".

MAY/JUNE 2000 229

A MAPLES

________________________________________________________________________________ be a restructuring of lease arrangements in an attempt to ensure that individual incentives are not assessable.

Of more potential fundamental significance in

Australia are recommendations from the report of the Review of Business Taxation chaired by Mr

John Ralph ( A Tax System Redesigned ), which may result in a change in the concept of income:

In particular, it is anticipated that the recommendations of the Review of Business

Taxation may include a fundamental change in the calculation of taxable income; one that would bring the calculation closer to the concept of accounting profit with less emphasis upon the income/capital distinction.

138

The Wattie decision will have significant ramifications for the revenue in New Zealand, both for objections and challenges that were waiting the outcome of the appeal and for the future structuring of property leases. In respect of the first point, the Director of Litigation for the

Inland Revenue Department, Mr Mike Lennard, was reported as saying there were about 200 cases that would have been prosecuted had the Privy

Council ruled in the NZ Commissioner's favour.

Now, however, the "majority of those cases would probably ... be abandoned."

139

On the second point, the decision poses a potential risk to the revenue if lease packages offered by lessors are structured to take advantage of the decision.

140

Prior to the decision, incentives provided by lessors were more in the nature of free fit-outs or rent holidays.

141

This may change with the Wattie decision. The decision potentially opens the door to taxpayer's documenting leases with excessive rent levels with the compensating inducement being on capital account, a fact that has already been noted by the IRD.

142

In both the 1998 and 1999 New Zealand

Budget, the Government identified the tax treatment of lease incentives as a fiscal risk to the revenue and indicated that such receipts should be taxable. Now that the decision has been delivered in the taxpayer's favour, some legislative action making lease inducements taxable is likely. At the time the Privy Council decision in Wattie was delivered, it was reported that both the Nationalled Government and Labour Opposition were committed to taxing cash incentives.

143

This commitment has not changed with the election in

November 1999 of a Labour-led coalition to the

Treasury benches.

144

Further impetus for legislative change has come from the report of the Committee of Experts on Tax Compliance ("the Committee")

145 released in late February 1999. In its report to the

Government, the Committee noted the tax treatment of lease incentives as a risk to the New

Zealand revenue base

146

and recommended the government consider legislation to make lease

138

Ibid.

139

Inder, above n 15, 58.

140

It is reported that "[1]ease inducements are becoming prevalent again in the depressed property market, particularly from developers chasing tenant pre-commitment to get bank funding." - F Rotherham,"Gov't to trump Privy Council" (1998) 7 The

Independent 3.

141

Ibid.

142

Ibid - Mr Robin Oliver, IRD General Manager Policy Advice, is reported as saying: "In the light of the ruling we have to look at how much of the tax base could be exposed. We're concerned people could take normal income and turn it into lease inducements".

143

Anon, "Lease Inducements Face Tax", The National Business Review, 13 November 1998, 1.

144

The Labour-led coalition government, in its 2000 NZ Budget (delivered 15 June 2000), stated that work continues on expanding gross income to include lease inducement (and restrictive covenant) payments. Since the Budget, an Issues Paper has been released on the proposed tax treatment of restrictive covenants.

145

Committee of Experts on Tax Compliance, Tax Compliance, Report to the Treasurer and Minister of Revenue (Dec 1998).

146

Ibid 77 - "Accepting that lease inducement payments would be deductible to a commercial lessor, as in Wattie, there is an incentive for parties to leasing contracts to arbitrage the tax cash value of non-assessable but deductible lease inducement payments. This arbitrage opportunity means that the apportionment of receipts between different but readily substitutable elements, for example, between inducement payment and rent, can be highly sensitive to tax considerations."



________________________________________________________________________________ inducement payments taxable.

147

On this point it is interesting to note that the United Kingdom

Government moved swiftly to protect its revenue base following the Privy Council decision of

Wattie .

148

A further issue for a government, if any legislation is enacted in New Zealand, is whether to make it prospective only or also retrospective in application.

In conclusion, this article began with a quotation from Lord Upjohn in Regent Oil noting the insoluble conundrum in determining capital- revenue issues. Having illustrated by comparing these two cases that the conundrum is alive and well, it is also pertinent to close with a quotation:

The [ Montgomery ] case is a useful reminder that the law in general, and tax law in particular, is not a precise science. Eleven judges were involved in the Montgomery case at three levels.

Six of those judges thought the payment was on capital account, while five thought it was taxable as income. Unfortunately for the taxpayer, four of those five judges made up the majority in the High Court.

149

147

The Committee considered that the legislation in Canada may provide a worthwhile model for such legislation. Further investigation of the Canadian model's implications is beyond the scope of this article.

148

The United Kingdom Government announced in its 1999 Budget that legislation would be enacted to make lease inducements

(referred to as 'reverse premiums') subject to tax, with the change to apply to all such premiums payable under agreements made on or after 9 March 1999 (Budget day). See Inland Revenue, Budget Press Release (Rev 32), above n 105, which commented that the Inland Revenue's view was that, depending on the circumstances, the recipient of any such inducement may have been taxable.

The Privy Council decision of Wattie had (now) cast doubt on the UK Revenue's ability to tax reverse premiums under the UK law which, as was pointed out by the Privy Council in Wattie, was the same as the New Zealand law. The Press Release stated legislation would accordingly be introduced to clarify the issue.

149

Deloitte Touche Tohmatsu, above n 137.

Andrew J Maples is a Lecturer in Taxation and Business Law with the Department of Accountancy, Finance and Information

Systems, University of Canterbury, Christchurch, New Zealand. He was formerly an Assistant Tax Manager in the Christchurch office of Price Waterhouse (now Pricewater-houseCoopers).

MAY/JUNE 2000 231

are lease incentives taxable? - a trans

ARE LEASE INCENTIVES TAXABLE? - A TRANS-TASMAN

COMPARISON

Related documents

Products

Support

are lease incentives taxable? - a trans

ARE LEASE INCENTIVES TAXABLE? - A TRANS-TASMAN

COMPARISON

Related documents

Add this document to collection(s)

Add this document to saved

Suggest us how to improve StudyLib