Thiess Toyota Pty. Ltd. v. Federal Commissioner of Taxation.

Judges:
Meares J

Court:
Supreme Court of New South Wales

Judgment date: Judgment handed down 25 August 1978.

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Meares J.: Since the year 1959 the appellant has held the sole Australian franchise from Toyota Motor Sales Co. Ltd. Japan for the Toyota range of commercial vehicles.

The appellant's paid-up capital was never adequate to enable it to pay the Japanese company for vehicles imported in accordance with the terms of the various franchise agreements entered into between the parties from time to time and since April, 1966, the financing of the importation of these vehicles has been effected through the Bank of New South Wales.

Under the terms of the franchise agreement in force for the financial year ending 30th June, 1968, payment for vehicles shipped by the Japanese company to the appellant was made by letter of credit issued by the taxpayer's bank, the Bank of New South Wales in Sydney in favour of the Japanese company. Upon the vehicles being loaded on to a ship in Japan, the Japanese company drew a draft for the sterling value of the shipment at ninety days sight on the London branch of the bank. Thereupon, the bank's agent in Japan paid the Japanese company, in the currency demanded by it, the equivalent of the then subsisting

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exchange rate of the full amount in sterling due to it by the taxpayer. The London branch of the bank on being satisfied that its agent bank in Japan had made payment to the Japanese company in accordance with the requirements of the letter of credit then paid to its agent bank in Japan the amount of sterling set forth in the claim. Thereafter the London branch of the bank discounted the draft on the banking market without any reference to the appellant. By virtue of an arrangement with the Bank of New South Wales, the appellant then had ninety days from the date on which the London branch of that bank reimbursed its agent bank in Japan in sterling to pay to the bank the value of the draft together with certain discounts and other sundry charges. These credit arrangements which the appellant had made with the Bank of New South Wales were guaranteed by Tozer, Kemsley & Millbourn (A'asia) Pty. Limited.

In November, 1967, sterling was devalued. As a consequence the appellant had to spend $304,645 fewer Australian dollars to purchase the pounds sterling after the devaluation than it would have had to spend before for the purpose of meeting its liability to the bank.

The Commissioner included the exchange gain in the taxpayer's assessable income for the year ending 30th June, 1968, to which the taxpayer objected. Since it was not suggested that any of the special provisions of the Income Tax Assessment Act justified the assessments, the sole question was as to whether exchange gains should be included for the purpose of arriving at the gross income derived by the appellant within the meaning of sec. 25(1) of the Income Tax Assessment Act, which provides:

``The assessable income of a taxpayer shall include -

• (a) where the taxpayer is a resident - the gross income derived directly or indirectly from all sources whether in or out of Australia; and
• (b) where the taxpayer is a non-resident - the gross income derived directly or indirectly from all sources in Australia,

which is not exempt income.''

This is an appeal from a majority decision of the Board of Review which held that the exchange gain was properly attributable to the discharge of a liability which arose out of the taxpayer's purchases of trading stock. The transaction which gave rise to the exchange gain was, it held, on revenue account and the gain was assessable income pursuant to the terms of sec. 25(1).

The hearing of the appeal was adjourned for the purpose of awaiting two decisions of the High Court, namely,
Commercial and General Acceptance Limited v. F.C. of T. 77 ATC 4375 and
International Nickel Australia Limited v. F.C. of T. 77 ATC 4383 and since the date of the Board's decision the decision of Wilson J. of the Supreme Court of New Zealand in
Nissan Motors Distributors (N.Z.) Ltd. v. Commr. of I.R. (N.Z.) 6 A.T.R. 158; 1 T.R.N.Z. 463 was reported but it is only the last-mentioned authority which is directly in point.

Mr. Bainton Q.C. for the taxpayer submitted that the effect of these arrangements simply was that the taxpayer borrowed money from its bank and used the borrowed money to purchase its trading stock, that it subsequently repaid its bank but because the borrowing was in sterling and sterling was revalued, it cost less in Australian dollars than it expected had to be laid out. In these circumstances, he submitted that this was a gain on capital account.

Mr. Priestley Q.C. for the Commissioner submitted, on the other hand, that the gain was on revenue account and that the method by which the taxpayer financed its purchase of trading stock through the Bank of New South Wales was an integral part of its trading transactions.

In the CAGA case, the Commissioner assessed the taxpayer on the amount of an exchange gain which arose on the repayment of a loan made by the Bank of America to the taxpayer but in that case it was held that the principal purpose of the borrowing was to strengthen ``the business entity, structure, or organization set up or established for the earning of profit''; it was not part of the process by which the organization operated to obtain regular returns, this being the distinction drawn by Dixon J. in
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337, at p. 359, in elaborating the difference between expenditure and

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outgoings on revenue account and on capital account. For this reason the case was distinguished from cases in which a manufacturer or trader buys or sells stock-in-trade for a price payable in a foreign currency which appreciates or depreciates before payment is made. Then, it was held, there is a case for saying that the exchange gain or loss forms part of the taxpayer's assessable income.
Texas Co. (Australasia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382;
Armco (Australia) Pty. Ltd. v. F.C. of T. (1948) 76 C.L.R. 584;
Caltex Limited v. F.C. of T. (1960) 106 C.L.R. 205.

Mr. Priestley relied upon a short passage in the CAGA case from the judgment of Barwick C.J. at pp. 4376-7 and that passage from the judgment of Gibbs J. at p. 4377 in which he stated: ``I incline to think that an exchange gain or loss on the repayment of moneys lent will always be a capital gain or loss, and can never be taken into account in the assessment of income.'' But the learned Judge, after referring to the fact that that seemed to be the view of Latham C.J. in Texas Co. (Australasia) Ltd. v. F.C. of T. (supra) at p. 428 added ``But if that be too extreme a view, I agree with Mason J. that the repayment of the borrowing in the present case was an expenditure on the capital account, within the principles stated in the leading case, Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (supra) at pp. 359-363,'' and both Barwick C.J. and Gibbs J. as did Jacobs J. agreed with the judgment of Mason J. as and for the reasons for that judgment.

Mason J. in his judgment, clearly distinguished the purpose of the borrowing in that case from borrowing by which the organization operated to obtain regular returns and held that the gain was in essence a windfall advantage stemming from a reduction in liability to repay a borrowing of capital.

In the International Nickel case the question was as to whether an exchange variation resulting in an exchange gain was assessable income within the meaning of sec. 25(1) where the taxpayer purchased nickel products from two companies in England which it marketed in Australia. It was held that the exchange gains were made for the purpose of discharging liability on revenue or income account and were plainly not of a capital nature and
Eli Lilly & Co. (Canada) Ltd. v. Minister of National Revenue 4 D.L.R. 561, in which the facts were similar to those in International Nickel, was relied upon.

In
Davies (H.M. Inspector of Taxes) v. The Shell Company of China Ltd. (1951) 32 T.C. 133, the respondent was a British company which sold and distributed petroleum products in China. It made a practice of requiring its agents in China to deposit with it a sum of money usually in Chinese dollars which was repayable when the agency came to an end. Owing to a depreciation of the Chinese dollar with respect to sterling the amounts eventually required to repay agency deposits in Chinese currency were much less than when the deposits were made and, as a result, a substantial profit accrued to the company. It was held that the exchange profit was a capital profit not subject to income tax.

At p. 151, Jenkins L.J., with whose judgment the other members of the Court agreed said: -

``As regards the law to be applied there is a considerable measure of agreement between the parties. Mr. Grant for the Company does not dispute that where a British company in the course of its trade engages in a trading transaction such as the purchase of goods abroad, which involves, as a necessary incident of the transaction itself, the purchase of currency of the foreign country concerned, then any profit resulting from an appreciation or loss resulting from a depreciation of the foreign currency embarked in the transaction as compared with sterling will prima facie be a trading profit or a trading loss for Income Tax purposes as an integral part of the trading transaction. That concession or admission by Mr. Grant is amply justified by the cases to which we have been referred.''

True it is that the English Act substantially taxes profits whereas the Australian Act taxes income but that passage nevertheless was cited by Gibbs J. in the International Nickel case as being relevant in a determination in that case of the question as to whether trading stock purchased by an Australian company from U.K. companies resulting in an exchange gain was assessable

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within the meaning of sec. 25(1) and see also per Mason J. at p. 4394. The passage from the judgment of Jenkins L.J. to which I have referred is, accordingly, in my opinion, in point.

The facts and the issue in the Nissan Motors Distributors case was substantially the same as in the present case except that in the former case the borrowing for the purpose of purchasing stock comprising motor vehicles from the Nissan Motor Company Limited of Japan by the taxpayer, Nissan Motors Distributors (N.Z.) Limited was not from a bank but from a finance company. The Commissioner, in that case, contended that, as the loan was raised for the specific purpose of paying for the motor vehicles, it must be treated as part and parcel of the purchase thereof and that this justified the Commissioner's assessment, but Wilson J. upheld the appellant's submission that, in effect, the facts of the case disclosed two transactions - one of purchase from the Nissan Motor Company Limited and the other of borrowing from the finance company - and that, though related, they were quite separate and distinct and the purchase transaction was the only one of those relevant to the objector's trading produce which produced assessable income; that the price of the motor vehicles to the objector was ascertained and fixed at the time when it was paid; that the price expressed in its New Zealand currency equivalent as at that time, was the true cost of vehicles to the objector, and had been correctly shown in its return of income.

But in
Tip Top Tailors Ltd. v. Minister of National Revenue 11 D.L.R. 289, the Supreme Court of Canada, (Cartwright J. dissenting) took a somewhat different view. In that case a Canadian company, Tip Top Tailors Limited, which purchased large quantities of cloth in the United Kingdom arranged for a large sterling overdraft with a London bank and for the bank and not the company to pay the vendors for the cloth. The purpose of the borrowing was because the company foresaw the likelihood of a devaluation of sterling. It was held that the profit in question was taxable as income, that the gain did not occur from a temporary capital investment in foreign currency or an isolated transaction of a capital dealing but that it was merged in the business of the appellant as the creation of the overdraft was merely a substitution of the bank as appellant's creditor in place of the original vendors and that the overdraft consisted of an accumulated debt made up exclusively of payments made in the course of trade. In reaching the conclusion that the gain did not result from an isolated transaction in a capital dealing and that it was connected with the business of the appellant, Rand J. said, at p. 292: -

``The loan produced working capital used in the course of the company's business; the loan was effected as each payment was made to a seller; but in substance the creation of debt in a bank was merely a substitution of creditor for the actual transactions.''

And, later at p. 293: -

``What was intended and done was the creation of indebtedness to the bank arising directly out of the business and we cannot distort that into a purchase from the bank and a payment, as a matter of choice, by the company to the supplier.''

And see also Locke J. at p. 298, in which he stated that the borrowings of sterling from the bank were made for the purpose of transactions on revenue account and nothing else.

I am unable to accept the view of Wilson J. in the Nissan case and respectfully adopt the reasoning of the majority of the Supreme Court of Canada in Tip Top Tailors Ltd.

In considering the nature of the transaction, one is entitled, in my opinion, to look to its substance and reality, see per Fullagar J. in Caltex Limited v. F.C. of T. (supra) at p. 227. It is unreal, as I see the appellant's dealings with the bank, in regard to the acquisition of the vehicles to consider them as involving two separate and discrete transactions. The appellant's arrangements with the bank were, in my opinion, all part of a transaction relating directly to and having the purpose of the purchase of trading stock and the exchange gains were, in reality, not on capital but on revenue account. For these reasons, the appeal is dismissed. The appellant will pay the respondent's costs.