Energy sector license and consent charges: capital or revenue?

Recently two interesting cases were reported in New Zealand and Australia. The cases related to whether certain expenses incurred by taxpayers in the energy sector were deductible for purposes of income tax. In those countries – like in South Africa – taxpayers may generally not deduct costs of a capital nature for purposes of income tax.

In the case of Commissioner of Inland Revenue v Trustpower Ltd [2015] NZCA 253 the taxpayer (Trustpower) generated and sold electricity. The taxpayer was developing new projects. In that process it incurred expenses in applying for and obtaining consents under the Resource Management Act 1991. The consents related to land use, water and discharge.

Under New Zealand tax legislation a person “is denied a deduction for an amount of expenditure or loss to the extent to which it is of a capital nature”.

The court considered a number of cases and held that the expenditure was of a capital nature and hence not deductible by the taxpayer. Among other reasons for that conclusion, the court found that the costs were incurred to enable the taxpayer to extend or expand its electricity generation business. The court said: “From a practical and business point of view, the expenditure was calculated to effect the extension or expansion of Trustpower’s business structure.”

The court also found that the expenses were not incurred in carrying on Trustpower’s business or in earning the income of the existing business or in performing the income-earning operations of the existing business.

In the High Court of Australia case of AusNet Transmission Group Pty Ltd v The Commissioner of Taxation of the Commonwealth of Australia [2015] HCA 25 the facts were the following. In 1997 a State-owned electricity transmission company sold its assets to the taxpayer (AusNet). One of the assets was a transmission licence. Under the sale agreement AusNet also undertook to pay certain statutory charges pertaining to that licence.

Australian tax law does not allow a taxpayer to deduct an outgoing of capital, or of a capital nature. The court carefully considered previous court judgments, the legislative framework behind the licence charges, and the sale agreement. The court found that the assumption by AusNet of the liability to pay the charges by operation of law on the transfer of the licence to it, and the contractual promise to pay the charges was an integral part of the consideration it had to provide to acquire the assets of the transmission business. The finding was made despite the fact that the purchase price in the sale agreement did not include the charges, and despite the fact that the charges were recurrent.

The court also held that AusNet paid the charges to secure the rights and to carry on the business of the distribution and transmission of electricity.

It was found that the licence charges were of a capital nature and hence not deductible for purposes of the taxpayer’s income tax.

In South Africa, generally speaking, a once-off licence fee is seen as an expense of a capital nature, while a recurring licence fee is of a revenue nature. For example, in ITC 1726 64 SATC 236 the taxpayer paid an initial fee for a licence to conduct a cellular service, which was paid before its commercial operations started, and an ongoing annual licence. The court held that the initial payment was an expense of a capital nature as it was incurred for a right that gave the taxpayer an enduring benefit, and as it was more closely connected with the income-earning structure of the appellant than its income-earning operations. However, the court found that the ongoing annual licence fee was recurrent expenditure paid to maintain the advantage acquired by the initial payment and, accordingly, was of a revenue nature.

Similarly the cost of obtaining State consents for undertaking an electricity generating plant (as in the Trustpower case) would be seen to be of a capital nature. See for example ITC 1241 37 SATC 300 (C) where a court held that expenditure incurred by the taxpayer in attempting to persuade the State to rezone land was expenditure of a capital nature, because the purpose of that expenditure was to obtain a permanent right to use the land for scrap-yard purposes.

One very interesting aspect of the AusNet case was the following. Under the sale agreement the taxpayer agreed to assume liabilities of the seller to certain creditors. The obligations thus assumed were stated to be contingent liabilities. The court held that, despite the fact that the price did not include the charges, the charges –

“were a significant part of the consideration moving from AusNet for the acquisition of the Assets. The designation of an amount as the Total Purchase Price to be paid to [the seller], as distinct from the licence charges to be paid to the State does not relegate the payment of those charges to some lesser, incidental purpose. From the perspective of AusNet, ‘from a practical and business point of view’, they were part of the consideration moving from it for the acquisition of the Assets”.

In South Africa there still exists uncertainty as to the tax treatment of the assumption of contingent liabilities in the hands of a buyer of business assets. Put simply the question is whether the liabilities so assumed are deductible by the taxpayer when they arise (assuming they are of a revenue nature) or whether they form part of the consideration for the acquisition of the assets, in which case they may not be deductible for income tax purposes. The preliminary view of the South African Revenue Service (SARS) is that the liabilities are not deductible and form part of the price (see the SARS publication Discussion Paper on the Tax Implications for the Seller and Purchaser in relation to the Assumption of Contingent Liabilities in Part Settlement of the Purchase Price of Assets Acquired as part of a Going Concern). The judgment in AusNet appears to provide some support for that view.