Customs loses the latest case in a 5 year long TCO battle
In 2012, Vesta – Australia Wind Technology Pty Ltd applied for a tariff concession order (TCO) covering certain gear boxes for wind turbines. The matter has gone from the Administrative Appeals Tribunal (AAT) to the Full Federal Court and back to the AAT, which recently found that the TCO should be made.
The decision is important in respect of many aspects of applying for a TCO, including the test of substitutable goods, and will be of particular interest in respect of made to order capital equipment.
The facts
Vesta is part of a corporate group that supplies wind turbines. A component of a wind turbine is a gearbox. Vesta has overseas suppliers produce the gearboxes and in 2012 it applied for a TCO to allow the duty free import of the gearboxes. The initial application did not make it past the screening stage. That decision was overturned by the AAT and the TCO application was published and so open to objection. Hofmann Engineering objected to the TCO and Customs ultimately came to the decision that the TCO should not be made.
Customs formed the view that while Hofmann Engineering had not produced substitutable goods, the TCO goods were "made to order capital equipment" and Hofmann Engineering could have produced substitutable goods using existing facilities.
This decision was appealed to the AAT which ordered that the TCO should be made, on the basis of an unexpected interpretation by the AAT of the "made to order capital equipment" provisions. That interpretation was overturned by the Full Federal Court. Vesta tried to appeal to the High Court, but the Court would not allow the appeal. The matter was returned to the AAT which had to reconsider the facts in light of the Full Federal Court interpretation of the requirements of the Customs Act.
Relevant issues for the AAT included:
what goods were substitutable goods?
in 2012, could Hofmann Engineering have produced substitutable goods using existing facilities?
would those goods have been made to order capital equipment?
would the goods have been manufactured in Australia?
would the 25% local content test have been met in respect of those goods?
Substitutable goods
A crucial issue was determining what goods were substitutable for the goods described in the TCO. The TCO described a gear box for a wind turbine and required it to meet certain standards that apply only to gearboxes for wind turbines. The long line of case law on substitutable goods was repeated, including the position that issues such as quality, cost and how a good performs a particular use are irrelevant.
We know that the test of substitutability is very strict and it may be thought that one large gearbox will be substitutable for another. However, the AAT found a very specific "use" of the TCO goods which limited the range of goods which could be substitutable for the TCO goods.
Customs argued that the use of the TCO goods was "conversion of high torque to low torque for use by generators to produce a power output of 3MW". If this use was accepted, any 3 megawatt gearbox could be substitutable, regardless of whether that gearbox could be used in a wind turbine.
The AAT however took a more narrow view of the use of the TCO goods. It held that the use of the goods was "converting high torque from low turbine blade rotations to higher rotation low torque revolutions for use by a wind turbine generator to produce a power output of 3MW".
The finding of this narrow use was crucial in this case and for future TCO applications. Effectively the AAT found a use for the TCO goods that was a sub-set of the broad category of use put forward by Customs. The AAT held that the relevant use must be identified with some degree of specificity. The AAT considered relevant, when comparing goods with the same broad use, whether those goods could be put to the same specific use in a common set of circumstances.
Future TCO applicants should keep this in mind and where possible, articulate the stated use of the TCO goods as narrowly as possible. Allowing narrow expressions of stated use of TCO goods will often be the best way to combat the commercially unrealistic test of substitutable goods.
Production in 2012 of substitutable goods with existing facilities
While Hofmann Engineering had produced many types of large gearboxes, it had not produced a gearbox that could be used in a wind turbine. This heavily impacted on the finding as to whether it could have produced substitutable goods with its existing facilities.
The AAT ultimately found that Hofmann Engineering could not, with its facilities existing in 2012, have produced gearboxes for a wind turbine. This was based on findings that Hofmann Engineering had not designed and manufactured such a product before and did not have the facilities to test the operation of such a gearbox.
While it was found that Hofmann Engineering's skills from producing other gearboxes may have been transferrable, this was not enough to satisfy the test.
Future TCO applicants for "made to order capital equipment" will be well served to examine whether the alleged local manufacturer has made goods that require the same skills as the TCO goods or whether the local manufacturer would be making the TCO goods for the first time. It seems that the AAT will not require importers to be the guinea pig for an untested Australian industry.
Would the goods have been manufactured in Australia?
The AAT had to consider whether the hypothetical goods if made, would have satisfied the test that they were wholly or partly manufactured in Australia. This requires that at least one substantive process in the manufacture of the goods be carried on in Australia. Amazingly, the AAT was not satisfied of this issue. It stated it had no evidence as to what components would be imported and whether components made in Australia would be substantive in the context of the entire good. Further, the AAT did not have evidence that the production of the goods would not be mere simple assembly.
It seems that Customs took the satisfaction of this test for granted and failed to put the required evidence before the AAT.
Was the 25% local content requirement satisfied?
It was necessary to demonstrate that 25% of the costs of the hypothetical goods would have been incurred in Australia. Surprisingly the Australian manufacturer failed to satisfy the AAT that it would satisfy this low threshold. This was largely due to a lack of evidence addressing the costs that would have been incurred in Australia in producing the hypothetical goods.
Recently the Federal Government amended the Customs Act to remove the 25% local content requirement on the basis that it was redundant. It was argued that local producers will always be able to satisfy the test. This case shows that this view may have been formed as Customs required less evidence than what was required to satisfy the AAT.
What is made to order capital equipment?
Customs were arguing that the substitutable goods test could be based on hypothetical production as the goods were "made to order capital equipment". If this was the case the local manufacturer did not have to show actual production of substitutable goods, but only that it could produce substitutable goods with its existing facilities.
Made to order capital equipment is defined in the legislation as made in Australia on a one-off basis to meet a specific order rather than being the subject of regular or intermittent production and that is not produced in quantities indicative of a production run.
In assessing this question the AAT looked not at past production, but rather what would have happened had an order for the gearboxes been placed. The AAT found that if Hofmann Engineering had accepted an order, it would have made 1 – 10 gearboxes annually. This would not have been "one off" production but would have been production on an intermittent or regular basis.
As such, while the goods would have been capital goods, they would not have been made to order capital equipment.
This seems to be a very strict interpretation of the requirement and one that will mean that orders for bespoke goods in sufficient quantities will never be eligible for classification as made to order capital equipment.
Appeal or refunds
Customs will have the option of appealing the decision to the Federal Court. The difficulty for Customs is that it lost on many key factual issues. It may nevertheless appeal aspects of the decision to avoid ongoing impact for future TCO applications.
If the decision stands the TCO will be made and importers of goods that fit within the terms of the TCO will have 12 months to seek a refund of that duty.
Please feel free to contact us if you need help with applying for a TCO or disputing a decision by Customs regarding a TCO application.