28 October 2020

Major tax success for utilities: appeal judgment handed down in Victoria Power Networks

This article was written by Frankie Barbour.

The Full Federal Court handed down its decision in Victoria Power Networks Pty Ltd v Commissioner of Taxation on 21 October 2020,[1] with a unanimous decision to partially overturn the first instance decision of Moshinsky J. 

The decision concerned the taxation treatment of certain assets (known as “gifted assets”) and cash contributions received by electricity distributors CitiPower and Powercor as part of the connection of new customers to their network.  The Court held that gifted assets are non-cash business benefits under section 21A of the Income Tax Assessment Act 1936 (Cth) with a value equal to the Rebate, and cash contributions are income under ordinary concepts assessable under section 6-5 of the Income Tax Assessment Act 1997 (Cth).

The Court’s decision with respect to gifted assets is contrary to the Commissioner’s position in the 2017 draft Privatisation and Infrastructure – Australian Federal Tax Framework paper (“Infrastructure Paper”) that the arm’s length value of gifted assets under section 21A is their actual or estimated cost of construction.  The Commissioner’s response awaits to be seen, however he has 28 days to seek leave to appeal to the High Court.

Factual background

The activities of electricity distributors are highly regulated to ensure access to the network to all who request it and to control prices in the context of a natural monopoly. 

Where a new customer requests a connection to the network, depending on the type of works required, the regulatory regime may allow that customer the choice to either build the necessary infrastructure themselves and transfer it to the distributor or to ask the distributor to build it. 

A given connection may be classed as “economic” or “uneconomic”, depending on whether the connection is predicted to generate more in tariffs over a specified period (incremental revenue, or “IR”) than it costs to build (incremental cost, or “IC”), or vice-versa.

Four situations can therefore arise, with the outcome of each situation under the regulatory regime being:

Uneconomic connection, customer builds

The connection assets are transferred to the distributor

The customer is paid the Rebate, calculated as the estimated cost of constructing the connection assets less the difference between IC and IR

Uneconomic connection, distributor builds

The customer pays a cash contribution equal to the difference between IC and IR

Economic connection, customer builds

The connection assets are transferred to the distributor

The customer is paid the Rebate, calculated as the estimated cost of constructing the connection assets

Economic connection, distributor builds

The customer pays nothing


Tariffs charged by the distributors are capped and are calculated using a “building block” model.  The model functions effectively as a reverse P&L, under which the permitted return on, and return of, the distribution network asset base (known as the “regulatory asset base” or “RAB”) is added to other specified costs such as estimated maintenance and operational expenditure, and the total is divided by estimated usage.  

Notably, only costs actually borne by a distributor go into the RAB.  To the extent a newly connecting customer bears the cost of a connection, it does not form part of the RAB.

The key questions to the dispute were:

  1. What is the value of the gifted assets in the hands of the Distributor?
  2. What is the appropriate taxation treatment for the cash contributions?

There was no dispute about the appropriate taxation treatment of economic connections. 

Cash contributions

VPN put forward the argument that the cash contributions were received by way of a gift or subsidy to augment the Distributor’s capital, or as a recoupment of the Distributor’s capital expenditure.  This position rested heavily on an argument about the application of GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124.

The Commissioner successfully argued that the cash was received in the ordinary course of the Distributors’ businesses as part of the consideration for providing a distribution service and was therefore assessable under section 6-5.  

All three judgments held that the scope of the Distributors’ business included connecting new customers. Justice Logan noted that it was relevant that the amount received was undissected, and that only a portion of it was intended to compensate the Distributor for expenditure on the new plant and equipment.[2]  Justice Colvin took a slightly different approach, noting that the shortfall was not a reimbursement, but was to cover the deficiency in revenue over capital.[3]

On this point, the judgment of Moshinsky J was not overturned.

Gifted assets

The Commissioner put two alternative arguments in relation to gifted assets:

  1. the connecting customer had an obligation to pay the Distributor the difference between IC and IR. This was offset against the value of the gifted assets (which they claimed to be the estimated cost of construction), with the Rebate being a “balancing figure”; or
  2. the arm’s length value of the gifted assets was their estimated cost of construction.

VPN argued that section 21A must consider the position of the actual recipient in their actual regulatory situation.  As the Rebate was equal to the projected incremental revenues arising from the connection, and because only the amount of the Rebate was included in the RAB (and therefore used in calculating future tariffs), the Distributors would not have paid any more for the gifted assets than the Rebate. 

The Commissioner’s first argument was rejected by Moshinsky J, who determined at trial that the arm’s length value of the gifted assets was the estimated cost of construction.  The Commissioner continued to promulgate the first argument in the appeal by means of a Notice of Contention.  Interestingly, the first argument is not in accordance with the Commissioner’s own position in his Infrastructure Paper, which uses the simpler second argument. 

On appeal, both of the Commissioner’s arguments were rejected by the Court.  As regards the Commissioner’s first argument, Colvin J noted that the facts did not support this contention, and that there was no commitment by the customer to make a payment in the amount of the shortfall.[4]

In considering the arm’s length value of the gifted assets, while section 21A is an objective test, all three judgments stress the importance of considering “the character or status of the actual parties and to the market in which such parties must deal,”[5] including by reference to the applicable regulations.  As the Distributor and a given customer actually deal with each other at arm’s length, it was noted that the price actually paid was the best evidence on which to base a reasonable expectation of the objective parties’ behaviour.[6]

As the value of the gifted assets is equal to the Rebate (being a recipient’s contribution under section 21A(2)(a) and 21A(5)), no amount of assessable income arises to the Distributor.

General comments

Increasingly, formerly State-owned utilities around Australia are becoming privatised and formerly non-taxable transfers of cash and assets are coming into the Federal tax net.  The dollar figures involved are significant.  As one of the first major decisions in determining the appropriate taxation treatment of highly regulated transactions, Victoria Power Networks has been the subject of much scrutiny. 

At least with respect to gifted assets, the judgment represents a positive step towards aligning the taxation outcomes with the economic effect of the regulations.  Consideration of Moshinsky J’s first instance judgment makes clear the significance of economics experts in shaping the arguments made by the taxpayer.  Given the gifted assets only contribute to the RAB to the extent of the Rebate, there is no value received by the Distributor beyond that amount, regardless of their cost of construction. This economic “value gap” is noted by Colvin J, who states at [105] that:

In effect, the customer valued the connection assets at their full cost but the distributor valued them at the amount of the rebate.

It awaits to be seen whether the Commissioner will seek special leave to appeal to the High Court, and if so, what arguments he will seek to make.

However, it is certain that a large number of utilities businesses operating within similar regulatory regimes will be reviewing this judgment carefully to see how it may affect the taxation of their transactions.  


[1] Victoria Power Networks v Commissioner of Taxation [2020] FCAFC 169.

[2] Per Logan J at [19].

[3] Per Colvin J at [81].

[4] Per Colvin J at [93].

[5] Per Logan J at [31].

[6] Per Logan J at [35].

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