FC of T v JONES
Judges:Beaumont J
Finn J
Sundberg J
Court:
Full Federal Court
MEDIA NEUTRAL CITATION:
[2002] FCA 204
Beaumont, Finn and Sundberg JJ
Introduction
1. The issue on this appeal is whether the respondent taxpayer is entitled to interest deductions pursuant to s 51(1) of the Income Tax Assessment Act 1936 for the years ended 30 June 1993 to 30 June 1997 and pursuant to s 8-1 of the Income Tax Assessment Act 1997 for the year ended 30 June 1998. Sections 51(1) and 8-1 are to the same effect. The primary judge held that the taxpayer was entitled to the deductions in all years [reported at 2001 ATC 4607].
Facts
2. The taxpayer carried on business in partnership with her husband from 1967 until his death on 30 December 1992. On 30 May 1990 they borrowed $70,000 from the ANZ Bank for the purposes of the business. The Bank also provided them with a $20,000 overdraft facility for the purpose of the business. The loan and the overdraft were secured against the family home. The term of the loan was nominally for ten years but was repayable at any time. If repaid within two years, a penalty was payable, but not thereafter. In September 1992, by which time the husband was very ill, the partners began to sell partnership assets in order to clear as much debt and overhead as possible. The partnership was allowed deductions for the interest expenses in the years in which the business operated. The business ceased during the year ended 30 June 1993. At that time the loan balance outstanding was about $100,000. It was reduced to $80,000 shortly thereafter, with the proceeds of the deceased husband's superannuation policy. After her husband's death the taxpayer continued to make loan repayments and claimed deductions for the interest expenses. More than half her wages as a nurse were used to make the repayments. On 22 May 1996 the taxpayer borrowed $74,000 from RAMS. This was the amount then outstanding on the ANZ loan, and was used to repay that loan. The taxpayer refinanced the loan because she was able to obtain a lower rate of interest through RAMS. RAMS took security over the taxpayer's house. The taxpayer paid interest to RAMS and claimed deductions therefor.
3. The Commissioner disallowed the deductions for the period after the partnership business ceased. The taxpayer's objections were disallowed. On review, the Administrative Appeals Tribunal varied the objection decisions by determining that for the years ended 30 June 1993 to 1996 the interest was deductible, but for the later years it was not [reported at 2000 ATC 2103]. In addition to the facts set out in paragraph 2, the Tribunal found that after the termination of the partnership on 30 December 1992, the taxpayer did not make ``a voluntary decision not to repay the loan and to continue to pay interest instalments''. She did not have the financial capacity to repay. The context shows that although the Tribunal spoke of ``the loan'', its reference to the taxpayer's inability to repay was directed to both the ANZ loan and the RAMS loan. The primary judge dismissed the Commissioner's appeal in relation to the years 1993 to 1996 and allowed the taxpayer's cross-
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appeal in relation to the other years. The result was that the taxpayer was held entitled to the deductions in all years.Primary judge's reasons
4. After reviewing earlier decisions on the deductibility of interest payments the primary judge said [at 4613-4614]:
``... The appellant points to nothing other than the cessation of the partnership business as justifying the assertion that such payments were thereafter not deductible. It is said that the cessation of business resulted in a break in the relevant nexus, but the cases seem to suggest otherwise. The obligation undertaken whilst carrying on the business was to repay principal and interest. That obligation having been undertaken in the course of earning assessable income and for that purpose, it seems to follow that the interest payments on such borrowings continued to be outgoings incurred as contemplated in subs 51(1) until some event or circumstance arose to break the necessary nexus, cessation of the business of the partnership not necessarily being sufficient for such purpose.
As is observed in some of the cases, the passage of a substantial period of time after the cessation of business may be relevant to the question but not necessarily conclusive. In such cases passage of time may lead to the inference that the taxpayer has kept the loan on foot for reasons unassociated with the former business. Similarly, where a conscious decision is made to extend the loan in the way contemplated in [
FC of T v Brown 99 ATC 4600; (1999) 43 ATR 1], it will often be clear that there is an ongoing commercial advantage to be derived from such extension which should be seen as unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred. These are not the circumstances of the present case. It is clear from the findings of the Tribunal, and it is consistent with the way in which the case has been conducted that the respondent has not been in a position to repay the loan, although she has been attempting to do so as best she can from the resources available to her. This demonstrates that the failure to repay the loan over the quite lengthy period since her husband's death is attributable to her financial position and not to any decision to keep the loan on foot for other reasons.''
His Honour concluded that the interest payments made to the ANZ Bank after the cessation of the partnership business were occasioned by the loan effected for the purpose of earning assessable income. Neither the cessation of business nor the passage of time thereafter until 22 May 1996, when the ANZ loan was repaid, broke the nexus between the payments and the obligations incurred while the partnership was trading.
5. The primary judge took the same view of the payments made after 22 May 1996 when the RAMS refinancing occurred. He said that although the refinancing was a relevant factor in determining whether the relevant nexus had been broken, it did not have that effect in this case [at 4614]:
``... The RAMS re-financing did not in any way detract from the fact that the borrowing represented by the loan was incurred in connection with the earning of assessable income. Until that borrowing is repaid, the respondent will be liable to pay interest on it as a direct consequence of the borrowing. That the identity of the lender has changed and the rate of interest has been reduced appear to me to be irrelevant circumstances in the present case.''
Submissions on appeal
6. The Commissioner took issue with the primary judge's statement (recorded in par 4 above) that the ``obligation undertaken whilst carrying on the business was to repay principal and interest''. It was said that the taxpayer did not, when the ANZ loan was taken out in May 1990, assume an obligation to pay interest for the years ended 30 June 1993 to 30 June 1998. The loan was repayable at will and, from 30 May 1992, without penalty. It was submitted that the primary judge failed to appreciate that the taxpayer did not come under any contractual obligation to pay interest in respect of the years in question when she took out the loan. The obligation to pay interest only came into existence in the relevant years on a periodical basis, namely when she ``chose to not repay the principal sum''. Reliance was placed on
Norman v FC of T (1963) 13 ATD 13 at 16; (1963) 109 CLR 9 at 16 for the proposition that when the loan was taken out, the payment of interest for the years 1993 to 1998 was ``the merest expectancy or possibility, having no
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existence in contemplation of law''. By way of contrast, it was said that an obligation to pay interest for a fixed period is a chose in action:FC of T v The Myer Emporium Ltd 87 ATC 4363 at 4371; (1986-1987) 163 CLR 199 at 217-218.
7. The Commissioner submitted that the payments of interest under the loan were no different from payments of rent for premises under a tenancy at will. While a business is carried on at the premises the rent is deductible. But if, after the business ceases, the tenant chooses to remain in the premises, the rent will not be deductible even though the tenancy commenced while the business was being carried on. The circumstances prevailing when the further rent is paid provide the occasion for determining whether a deduction is allowable. That occasion is not the assumption of an obligation when the tenancy was created, but the decision by the tenant to continue the tenancy notwithstanding the absence of an antecedent obligation to do so. Reliance was placed on the observations of Dixon J in
FC of T v The Midland Railway Co of WA Ltd (1952) 9 ATD 372 at 377-378; (1952) 85 CLR 306 at 313-314.
8. The Commissioner submitted that if he was successful in relation to the earlier years, he must also succeed in relation to the interest payments after 22 May 1996 when the RAMS financing was effected.
Reasoning on the appeal
9. Whether the occasion for a loss or outgoing lies in business operations so as to be deductible under s 51 or s 8-1 requires a judgment about the nexus between the loss or outgoing and the business operations; there must be ``sufficient proximity'' between the loss or outgoing and the business operations:
FC of T v Brown 99 ATC 4600 at 4608; (1999) 43 ATR 1 at 9. We do not accept the Commissioner's submission that the primary judge's decision is predicated upon the ``misconception'' that the taxpayer undertook an obligation to pay interest for the years 1993 to 1998 when the ANZ loan was taken out on 30 May 1990. What his Honour said was that the ``obligation undertaken whilst carrying on the business was to repay principal and interest'', by which we understand him to mean that the obligation then undertaken was to pay interest until the principal was repaid. There is no misconception here. When the partners took out the loan they agreed to pay interest until the principal was repaid. During the course of the loan they periodically became liable to pay various amounts of interest.
10. Nor do we accept the Commissioner's submission that the taxpayer only became obliged to pay interest in the years in question on each occasion when ``she chose to not repay the principal sum''; that what provided the occasion for the interest outgoing was ``each periodic decision to keep the ANZ loan on foot''. These characterisations of the taxpayer's situation are unsound for two reasons. The first is that they fail accurately to reflect the nature of the loan. It was a loan for a fixed term, and unless the taxpayer defaulted it would continue for that term unless she decided to repay it early. The loan's continuance was not dependent on periodic decisions on her part to keep it alive. The second reason lies in the Tribunal's finding of fact that [at 2105]:
``There is no question of Mrs Jones making a voluntary decision not to repay the loan and to continue to pay interest instalments. She is attempting to repay a commercial loan on a non-commercial income. Whether or not Mrs Jones had an entitlement to repay the loan, immediately after cessation of business, without penalty, is not relevant in her case because she simply did not have the financial capacity to do so.''
That finding also answers the Commissioner's related submission that after 30 May 1992 the parties' rights and obligations in relation to interest were dependent entirely on the taxpayer's decision whether or not to repay the principal. The Commissioner's selection of 30 May 1992 as the date after which the taxpayer ``had the capacity'' to repay the principal is curious. No formal ANZ loan documents were in evidence. However it was common ground that the loan could be repaid at any time, but that a penalty was applicable if it was repaid within the first two years. The penalty had no relevance to the legal capacity to repay. The partners were able to repay the loan at any time.
11. The Commissioner's argument by analogy with rent payments under a tenancy at will is inapposite. First, while the tenant at will has a free choice whether to remain in possession after the cessation of the business, the taxpayer had no free choice whether to continue with the loan, as the Tribunal's finding
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makes clear. Secondly, in the case of the tenancy, there is a change in the use of the premises from business to private. There was no such change in the present case. The borrowed funds and the interest on them were always referable to the former business.12. The Commissioner claimed support from
FC of T v Riverside Road Pty Ltd (in liq) 90 ATC 4567; (1990) 23 FCR 305 and
FC of T v Brown 99 ATC 4600 for his submission that interest on a business loan ceases to be deductible after the cessation of a business where a taxpayer has a legal capacity or legal right to repay the loan immediately. Put another way, the submission was that the cessation of business is fatal to deductibility unless, during the time the business was being carried on, the taxpayer assumed a liability that locked him into paying interest after the cessation of business. In Riverside Road the taxpayer borrowed money in order to purchase land, erect a motel on it, and provide plant and equipment and working capital. Some of the borrowings were for a fixed period. Later the taxpayer sold these assets and leased them back from the purchaser. The Commissioner disallowed the deduction for the portion of the loan interest relating to the land and buildings that the taxpayer continued to incur after the sale. A Full Court (Northrop, Wilcox and Hill JJ) rejected the taxpayer's argument that the interest payments made after the sale remained deductible because it had to pay the interest in order to retain the use of the land upon which it conducted the motel business. The Court observed that the fact that income from the running of the motel would cease unless the interest was paid was not determinative. What was decisive was whether the essential character of the interest after the sale and lease back was such that it could be said that those outgoings were incurred in the course of the gaining or production of assessable income or, having regard to the business then carried on by it, that they were necessarily incurred in carrying on that business. The Court said (at ATC 4576; FCR 315):
``Once this is appreciated, it is apparent that at some point of time at least the interest outgoings ceased to have this character or to be, in the sense used by the cases, relevant and incidental to the business activities engaged upon by the respondent after 1 February 1979 [the date of the sale and lease back]. They had no real connection at all with the business of running a rented motel.''
13. The Court then considered the date from which the interest outgoings ceased to have the necessary character of incidental and relevant outgoings [at 4576]:
``... As at 1 February 1979 the loan to Perpetual Trustees was repayable on 1 May 1979. It was in fact repaid on that date. The remaining interest was incurred pursuant to the terms of a new borrowing entered into after the restructuring. It seems to us that it does not follow from De Bavay's case, particularly if regard be had to the comments of Mason J in AGC (Advances) Ltd to which we have referred, that the mere fact that the land and buildings were sold necessarily results in the conclusion that as and from the date of sale the whole of the interest incurred was not deductible. The respondent, pursuant to the contractual arrangements it had entered into, was obliged when it was an owner/operator to continue to pay interest until 1 May 1979 . Had it sought to discharge its obligation to the mortgagee, it could have been required to pay interest to this date. In the circumstances of the present case, therefore, it cannot be said that the change in character of the business activity of the respondent immediately excluded the interest payable by it to the mortgagee from deductibility. Rather, it seems to us that the respondent was entitled to a deduction of such part of the disallowed interest as related to the borrowing of moneys reflected in the Perpetual Trustees' mortgage until 1 May 1979 and as related to the land and buildings upon which the motel was situated.''
(Emphasis added)
The Court's reference to
Amalgamated Zinc (De Bavay's) Ltd v FC of T (1935) 3 ATD 288; (1935) 54 CLR 295 was for the proposition that an outgoing may be precluded from deductibility if it is incurred after the business or activity has ceased, as in that case, at least where a considerable time has passed and the taxpayer had given up all thought of mining (at ATC 4575; FCR 313-314). Their Honours went on (at ATC 4575-4576; FCR 314):
``... However, the subsequent case of [
AGC (Advances) Ltd v FC of T 75 ATC 4057; (1974-1975) 132 CLR 175] while not a case
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where the business had wholly ceased, although operations had been suspended, suggests that there should be some qualification to the absolute principle suggested in De Bavay's case. Mason J in AGC (Advances) Ltd at ATC p 4072; CLR p 197-198, discussing a loss incurred by writing off a debt after a company had ceased to carry on as a going concern the business in which the debt was created, remarked that:
- `even in such a case it may be correct to speak of the loss as having been incurred in the carrying on of the business. This is because the occasion for the loss is to be found in a transaction entered into in the carrying on of the business for the purpose of producing assessable income....'''
14. The Commissioner stresses that the fact that the taxpayer was legally obliged to pay interest until 1 May 1979 (see the emphasised sentence in par 13) was the determinative factor in Riverside Road. From the time the interest expenses became a legal choice of the taxpayer, no deductions were allowed because the business had ceased and no antecedent obligation referable to the business existed. In our view Riverside Road does not establish that a taxpayer who has a legal right to repay a business loan after the cessation of business can never thereafter deduct interest payable on the loan. All it decided is that, in the circumstances of that case, which involved a distinct change in business activity during the currency of the loan, interest continued to be deductible after the cessation of the business for which the loan was incurred because the taxpayer was contractually bound to pay interest until the loan was repaid.
15. In FC of T v Brown the taxpayer and his wife traded together in partnership. In 1988 they borrowed money to finance the purchase of a business. The terms of the loan required them to make 120 monthly repayments comprising both principal and interest. The interest components of payments made in the years ending 30 June 1989 and 1990 were allowed. The business was sold in March 1990 but the proceeds of sale were insufficient to discharge the loan. The partners continued to pay interest on the remaining balance until the loan was repaid in July 1995. The taxpayer's claim to deduct interest payments in the years ended 30 June 1993 and 1994 was disallowed by the Commissioner. The primary judge allowed the taxpayer's appeal, and the Full Court (Lee, Nicholson and Merkel JJ) dismissed the Commissioner's appeal. Their Honours said (at 4608):
``We can find no error in his Honour's approach. It accords with, and is fully supported by, the approach to deductibility of interest under s 51(1) (albeit the first limb) in [
Steele v DFC of T 99 ATC 4242; (1999) 197 CLR 459]. In particular his Honour, in determining that the occasion for the loss or outgoing in question was the payment of interest which the taxpayer was obliged to pay under the Bank loan contract, was applying the principles established in AGC, [
Placer Pacific Management Pty Ltd v FC of T 95 ATC 4459] and Riverside Road to the undisputed facts of the present case.''(Emphasis in original)
The Court went on to say that there may come a period of time between the cessation of business and the payment of interest which is such that, in all the circumstances, the payment is no longer sufficiently proximate to the activities of the business to be deductible under s 51(1), with the consequence that those activities no longer provide the occasion for the outgoing. Their Honours concluded that the evidence did not establish that that point had been reached during the 1993 and 1994 financial years. They added (at 4608):
``Accordingly, the present case was determined against the Commissioner because the cessation of business did not have the consequence that the `occasion' for the liability to pay interest no longer remained the original liability to pay that interest under the Bank loan.''
16. The Court rejected the Commissioner's contention that the matter should have been dealt with on the basis that the partners would have been able to pay out the loan early (at 4608):
``... The fact that the Bank might, as a matter of practicability rather than legal obligation, allow early repayment does not alter the analysis in the present case. In our view his Honour was correct in characterising the occasion for the liability in such circumstances as depending upon the terms of the contract rather than upon whether or not the partners might or might not have
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availed themselves of an opportunity to repay the loan on a particular day because of an indulgence shown by the lender on that occasion. In that regard, it is significant that the partners did apply the net proceeds of sale in repayment of the loan and his Honour did not appear to be prepared to find that the taxpayer and his wife had any other partnership assets which were available, had the Bank agreed, to discharge the loan when, or even after, the partnership business ceased.''
Then follow some obiter remarks upon which, at least in his written submissions, the Commissioner particularly relied [at 4608]:
``Had the loan agreement in question been a `roll over' business loan facility which entitled the taxpayer conducting the business, on the date of each monthly payment, to elect to repay the principal and thereby avoid incurring liability for interest or to `roll over' the loan and continue to be liable for interest, that may have been a different situation. In that circumstance there may be considerable force in a contention that the occasion of the liability was the election to `roll over' the loan on each monthly payment date, rather than any liability arising under the terms of the original loan agreement establishing the terms of the `roll over' facility. In such a case the cessation of the business or sale of the income-producing asset acquired with the borrowed funds might properly be regarded as breaking the nexus in much the same way as certain post cessation interest payments were not allowed as deductions in Riverside Road.''
17. The facts found by the Tribunal and the nature of the ANZ loan show that the notion of an election ``to repay the principal and thereby avoid incurring liability for interest'' does not reflect the position in the present case. The taxpayer had no free choice between continuing the loan and repaying it. In our view the obiter dictum in Brown deals with the case of a true election - where the borrower has the resources to pay out the loan but decides not to and rolls the loan over instead. In any event, as we have indicated (pars 9 and 10), the loan in the present case was not a ``rollover'' business loan facility, but one that would run for the agreed term unless the taxpayer decided to repay early. The Commissioner derives no assistance from the Full Court's reference (see par 15) to ``interest the taxpayer was obliged to pay under the Bank loan contract''. First, as with Riverside, the fact that in a particular case interest continues to be deductible after the cessation of business because of a continuing obligation to pay interest until a particular date does not establish any general proposition that interest can never be deductible after the cessation of business where the borrower has the legal right to pay out the loan early. Secondly, as we have said, until such time as she decided to repay the loan, the taxpayer was obliged to pay interest.
RAMS interest
18. We agree with his Honour that the refinancing in May 1996 did not break the nexus between the interest expense and the business. It is well established that when an original borrowing is refinanced, the new financing takes on the same character as the original borrowing. The character of the loan is not changed. See
FC of T v JD Roberts; FC of T v Smith 92 ATC 4380 at 4388; (1992) 37 FCR 246 at 257 and
FC of T v The Midland Railway Co (WA) Ltd (1952) 9 ATD 372 at 377; (1951-1952) 85 CLR 306 at 313. All that happened in the present case was that the identity of the borrower changed and the rate of interest was lower. The taxpayer was financially unable to repay the ANZ loan without taking out another, and this she did in order to obtain a more favourable rate of interest. In all respects the new borrowing with referable to the same ``occasion'' as its predecessor. The Commissioner's reliance on Riverside Road in this connection is misplaced. The loan refinanced there was repayable on the date upon which it was refinanced. The connection with the initial loan was bound to end on that date.
Conclusion
19. The appeal must be dismissed.
THE COURT ORDERS THAT
1. The appeal be dismissed.
2. The appellant pay the respondent's costs of the appeal.
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