Deductibility of concession and related fees
On 20 July 2006, The Full High Court handed down its decision in Commissioner of Taxation v Citylink Melbourne Ltd (2006) HCA 35. This case deals with concession fees payable under the Concession Agreement between State of Victoria (State) and the Concessionaire, Citylink Melbourne Ltd., for the Melbourne Citylink Project, a major toll road.
The Full Court held that the concession fees payable under the Concession Agreement were incurred in each of the relevant years of income (1996 to 1998) and thus were allowable deductions at their full face value.
This decision has important commercial implications: it highlights that taxpayers need to consider and deal with several important issues in the early transaction negotiation phase when entering into ‘concession type’ arrangements, including potential service and licence arrangements.
The Concessionaire contracted with the State to design, construct and maintain a major network of roads (the Melbourne toll road) and to operate the toll road for a period of 331/2 years following completion of construction. The toll road and all other rights including intellectual property rights would revert to the State at the expiry of the concession period.
In return for the right to establish and operate the Melbourne toll road, the Concessionaire was liable to pay the State an annual concession fee (payable semi-annually in arrears in June and December), although actual payment was not required until the year 2034 or upon certain financial conditions being met, eg available cash flow.
The Concessionaire claimed deductions for concession fees in the amount of $31.25m in the year ended 30 June 1996, and in the amount of $95.6m in each of the years ended 30 June 1997 and 1998. The Commissioner of Taxation appealed from a unanimous decision of the Full Federal Court in favour of the Concessionaire on this issue.
The key issues raised before the High Court on the deductibility of the concession fees were as follows:
- Were the concession fees ‘incurred’ in the relevant years of income?
- Were the concession fees ‘referable’ to each of the 1996, 1997 and 1998 income tax years
- If the concession fees were regarded as otherwise deductible, should the nominal amount (or face value) in each year be deductible only on a straight line apportionment basis over the total concession period?
Or, should the deductible amount be based on the net present value of the liability to pay?
Or, should the full face value of each annual fee be deductible each year?
- Were the concession fees on capital account, rather than revenue account and thus non-deductible?
Full High Court decision
The Full High Court held by a majority of 5 to 1(Kirby, J dissenting) that the concession fees payable under the Concession Agreement were incurred in each of the relevant years of income (1996 to 1998) and thus were allowable deductions at their full face value under respectively section 51(1) of the Income Tax Assessment Act 1936 (1936 Act) and Section 8-1of the Income Tax Assessment Act 1997 (1997 Act).
Crennan, J with whom Gleeson CJ, Gummow J, Callinan J, and Heydon J agreed, delivered the majority judgment and held with respect to the key issues as follows:
1 The concession fees were incurred in the relevant years of income as there was a contractual liability to pay the concession fees on a semi-annual basis - each liability arose as each concession fee became due. Although the State’s entitlement to demand payment of the concession fees depended on traffic levels, revenue and available cash flow, these matters went to the timing of discharge of the liability and not to the existence of the liability. The Concession Notes that had been issued semi-annually supported the existence of the liability to the State. Crennan J rejected arguments by the Commissioner that the liability for the concession fees were contingent (or conditional) based on the matters raised above.
Crennan J attributed much importance to the key terms of the Concession Deed (clause 3.1), the Master Security Deed (clause 1.9) and the Concession Notes themselves.
Accordingly, at paragraph 136, Crennan J stated:
‘The respondent’s [concessionaire’s] obligation to discharge the debt is not conditional on the commercial operating risks of the project. These risks can do no more than affect the date on which the discharge of the liability begins and the speed with which it is discharged.’
Further at Paragraph 137, Her Honour stated:
‘In the relevant years of income, the respondent [concessionaire] was definitely committed and had completely subjected itself to the losses or outgoings which the concession fees represent.’
2 The concession fees were held to be directly referable to the relevant years of income. Pursuant to paragraph 143, Crennan J stated:
‘They [the Concession Agreements] are essentially licence agreements to use capital assets for the limited period of the Concession.’
Further at paragraph 141:
‘The amount of the liability for concession fees corresponds precisely to the period for which the concession fee relates.’
Thus, as each concession fee is an annual liability they are totally referable to that year of income.
Crennan J rejected the two submissions by the Commissioner, arguing that:
- the concession fees represented a future expense to be met out of future assessable income; and
- the criteria of referability is the advantage secured by the liability in question, not the source of funds from which the liability will be discharged.
Again, the fact that the Concession Deed stipulates that each concession fee is an annual liability was a significant issue in determining that the concession fees were referable to a particular year of income.
3 Crennan J also rejected any claim for apportionment of the amount of the annual concession fees over more than one tax year, either on a straight line apportionment basis or for deductions only at their discounted present value, ie the net present value of the liability to pay the concession fees.
As each concession fee was payable for its period, the Court held that the full face value of the loss or outgoing (ie annual concession fees) should be claimable in each tax year.
4 Finally, Crennan J also rejected the Commissioner’s argument that the concession fees were of a capital nature on the basis of securing any enduring asset or to establish a profit yielding structure (ie toll road).
Although less discussion of this capital nature argument was provided for in the majority judgment than in the Full Federal Court decision in Citylink Melbourne Limited, Crennan J stated firmly as follows at paragraph 154:
‘Unlike periodic payments on the purchase price of a capital asset, the concession fees are periodic licence fees in respect of the Link Infrastructure Assets, from which the Respondent [Concessionaire] derives its income, but which are ultimately "surrendered back" to the State. Accordingly, they are on revenue account.’
It is noteworthy that there was limited or no reference by Crennan J to arguments raised by the Commissioner in the Federal Court decisions dealing with purported profit sharing with or dividends paid to the State, monopoly rights or other anti-competitive rights secured.
The majority decision of the Full High Court was that the concession fees satisfy the test for deductibility at their full face value in respect of the each of the income years in which these deductions were claimed.
There are several important considerations for taxpayers when entering into ‘concession type’ arrangements, including potential service and licence arrangements. These considerations, should be highlighted and dealt with early in the transaction negotiation phase. These considerations include:
1 Care must be taken in documenting concession and related arrangements to ensure that the creation or existence of the liability for the relevant concession fee is not conditional or contingent on any particular event or factor — as distinct from the discharge of the liability. The Full High Court attributed significant importance to the specific terms of the key documents including the Concession Deed, Master Security Deed, Security Trust Deed and the Concession Notes.
2 Crennan J could not be more explicit in stating at paragraph 98 that:
‘The result in this matter is ‘peculiarly dependent upon the particular facts and circumstances’ of the Concession Agreement. Brief reference to certain project documents must be made to understand the context and the commercial and legal features of the concession fees.’
3 Concession type fees should not, where possible, be linked to profits or the profitability of the concession vehicle. Further, any indication of a partnership relationship for tax purposes between the Concessionaire and the State (or equivalent) should be avoided.
4 It is important to distinguish the nature of any proposed payments from the ‘capital type’ payment to secure the lasting advantage of exclusivity and/or freedom from competition — as per Jupiters Limited v DFC of T (2002) ATC 4566 and United Energy Limited v FC of T (1997) ATC4796.
5 Finally, it is important to note the potential and currently uncertain impact of the proposed new Taxation of Financial Arrangements Bill released as an Exposure Draft in December 2005. It is unclear at this time whether concession and related fees may in certain circumstances be regarded as ‘financial arrangements’ for the purposes of the proposed new Bill.
However, the timing of recognition of deductible expenditure (and assessable income) may change in the foreseeable future for concession and related fees, if these were regarded as ‘financial arrangements’. Whether or not this will change depends, amongst other things, on the timing of the Financial Arrangements Reforms and any transitional provisions contained in them.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.