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Critical Case Study - Citylink

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Critical Case Analysis

Case: "City Link Melbourne vs Commissioner of Taxation of the Commonwealth of Australia",

July 2006


Case Background

The City Link Melbourne Company formerly known as the 'Transurburban City Link Limited', was a roads and infrastructure development corporation. It was contracted by the Victorian government, through a competitive bid, to develop a system of roads to connect Melbourne's freeway system in 1995. Specific contractual documents of particular relevance to this 'project' were the 'Concession Deeds', which outlined their rights to design, construct, commission and operate a tollway (para 100), along with other contractual stipulations. The deeds outlined that a 'Concessionary' payment was agreed upon, payable in arrears of at least $95.6million from 1996-2034, $45.2m for the subsequent nine years, and $1million for the remainder of the contractual period. At the end of this period, full ownership of the toll would be given to the government. This concessionary payment was consideration for government approval to develop infrastructure, utilise the land necessary to develop the tollway, and to operate the profit-making entity; raising issues concerning the capital or revenue nature of these payments.

In consideration for this liability, the company issued a series of 'concession notes', long-term bills which entitled payment to the government under specific stipulations. These included City Link meeting specific financial objectives such as achieving equity returns of over 10%, and no payment necessary until the company achieves revenue objectives (para 109). These financial stipulations in effect entitled the company not to pay the government any of the accrued liabilities till 2034, also leading to the valuation of the concession notes at nil. City-Link thus incorporated these accrued concessionary costs as being incurred for the periods between 1996-8, thus reducing the assessable income under S51(1) of ITAA 1936 and S8-1 ITAA 1997.

The company derived nil tax balances for those relevant years. City link was subsequently denied by the commissioner on the grounds that these costs were considered capital costs, and were deemed not to have been incurred during the relevant time periods.

A number of key ratios and obiter were established in the preliminary hearings with the Primary Judge Merkel J and at the Full Court level.

Preceding Courts Outcome Overview

At the preliminary hearing with Merkel J, it was determined that the concession fees were a liability that arose unconditionally, and that the 'concession notes' were appropriate consideration for the accrued costs. However, it was also established that the concessionary payment made was similar to that of a share in profits and/or dividend payment made to the government, in return for its operation of its profit making initiative. This payment was thus seen as a capital payment, for the right to operate the business structure, and not part of the profit making process of the company. This was appealed by City Link.

The Full Court then contrasted the preliminary hearings reasoning concerning the concession fees as being a cost of acquiring a profit-making enterprise, but rather, as a cost for the right to conduct the project. Under this reasoning, it was determined that the concessionary payment was on revenue account, and that the payments were (as per the preliminary hearing), relating to the relevant incurred periods. This was appealed by the Commissioner.

High Court Decision

The High Court decision was in favour 5:1 to City-Link, with Justice Crennan & Kirby discussing a number of broad issues in deciding the nature of the Concessionary payments per para 92 of the High Court Ruling ;

1. Whether the costs were 'incurred' ordinary expenses per s8-1(a), and the concessionary payments were incurred and referred to 1996-8

2. Whether the face value or present value of the liability should be deducted on an apportioned basis (para 95)

3. And whether or not the actual payment was capital in nature.

It was determined that the concessionary payments were incurred and referrable to the same period, and that the value of the concessionary payment need not be apportioned, but treated at it's nominal value per period. It was also determined that the actual payment was on revenue account, rather than capital, and thus satisfies the 'Deductibility' test per s8-1 (a) and (b) of the ITAA 1997. Below is an analysis of the case ratios used to derive the above conclusions.

Key Ratio & Obiter Analysis

1. The costs were 'incurred' ordinary expenses per s8-1(a), and the concessionary payments were incurred and referred to 1996-8

The first issue concerning this payment was whether or not the amount accrued and subsequently not paid, had actually been incurred in the relevant years from 1996 through to 1998, and whether or not the 'Concession Notes' are adequate consideration for incurrence. It involved the assessment of s8-1's requirement concerning the incurrence of the relevant loss or outgoing in the relevant year. The Concessionary payment itself was discussed in Para 79 by Crennan J, as an agreement where 'a government, seeking to minimise public sector debt, retains private sector interest to build new infrastructure'. The payment is accrued semi-annually, but per the conditions stipulated in the Concessionary Deeds, the payment may only arise contingent on the achievement of certain conditions. Crennan J followed the Ratio per 'Coles Myer Finance Ltd v Federal Commissioner ' defining an outgoing as being incurred even if 'payment is due in future, and subject to theoretical contingency'. This ratio was distinguished with the 'New Zealand Flax ' case which deemed that 'incurred' cannot include a 'loss or expenditure which is no more than impending, threatened, or expected', which was the ratio assumed by J Kirby. The Coles Myer ratio supports the accruals method of accounting, as costs are deemed incurred even without physical settlement. The facts of



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