Case L3

Judges:
AM Donovan Ch
LC Voumard M
G Thompson M

Court:
No. 2 Board of Review

Judgment date: 14 February 1979.

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A.M. Donovan (Chairman); L.C. Voumard and G. Thompson (Members): The question involved in this reference is whether an amount paid by the taxpayer to honour a guarantee given by him of a bank overdraft is an allowable deduction under sec. 51(1) of the Income Tax Assessment Act.

2. The taxpayer was a shareholder in, and a director and employee of two companies from their incorporation until each ceased trading and went into liquidation in 1974. Between 1972 and the early part of 1974, he and his fellow directors were required to give the companies' bank a number of personal guarantees,

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expressed to be joint and several, in respect of each company's overdraft. After liquidation, the bank recovered judgment against the guarantors for the amount owing to the bank including, perhaps, interest and costs. During the year ended 30 June 1976, the taxpayer discharged part of his liability by paying the bank $7,500. The Commissioner disallowed the claim, made in the taxpayer's return, to deduct this amount under sec. 51(1), and treated the subsequent objection similarly. Further payments were made by the taxpayer in the two succeeding years, but the only year before us is that ended 30 June 1976.

3. As well as giving the guarantees mentioned, the taxpayer had also (again with some of his fellow directors) guaranteed the performance by each company of its obligations under a number of equipment leasing contracts the companies had entered into. But no other guarantees had been given by the taxpayer, nor had either company paid him, or undertaken to pay him, any consideration for accepting his liabilities as a guarantor.

4. Section 51(1) provides that, to the extent to which the loss or outgoing of $7,500 ``was incurred in gaining or producing the assessable income'', or was ``necessarily incurred in carrying on a business for the purpose of gaining or producing such income'', it is an allowable deduction, provided that it does not fall within the section's excepting words, as being an outgoing of capital or of a capital nature.

5. The taxpayer did not incur the loss or outgoing of $7,500 in carrying on a business; there was no suggestion that at any relevant time he carried on a business involving or including the giving of guarantees. However, he sought to bring his claim within the first limb of sec. 51(1) on the basis, as his return put it, that ``the guarantee was supplied to allow the company to obtain funds for trading expenses including travelling, wages, consumable stores etc. and a proportion of the expenditure was received back by the taxpayer in the form of wages, directors' fees etc.... whilst the balance was an outgoing in the form of normal trading expenses of the company''. But the guarantee was given gratuitously, and did not bear any direct relationship to the salary, dividends, directors' fees, or entertainment allowance that he derived from the companies. There may have been an indirect relationship in the sense that without the guarantees the bank would not have provided funds for payment of the items mentioned or other purposes, but such nexus as that provides between the outgoing and the taxpayer's income is too remote to allow it to be said that the former was incurred in gaining or producing the latter. The payment made by the taxpayer as guarantor did not have the character of a working expense; the guarantees given by him seem to have been no more than one step in a procedure designed to provide the companies, or to ensure that the bank provided them, with working capital.

6. The taxpayer's claim, therefore, does not fall within either positive limb of sec. 51(1). But even if it could be said that the outgoing was incurred in gaining or producing the assessable income, the claim would still fail on the ground that the relevant outgoing was one of capital, or of a capital nature, and as such expressly excluded from deductibility under the section.

7. There have been many decisions establishing that outgoings such as that here in question are of capital or of a capital nature. Many of them are referred to and discussed in two decisions of the No. 3 Board of Review - see Case B3,
70 ATC 10 and Case C34,
71 ATC 149 - and it is unnecessary to refer to them again in these reasons. It is enough to say that in the present case the payment made by the taxpayer can be likened to the situation that would have arisen had he chosen, not to give a guarantee, but rather to put either company in funds by making a loan to it or by subscribing additional share capital to it. On the failure of either company with a loss of those amounts, it could not be doubted that the amounts lost by the taxpayer were losses of capital. In 1948, Mr. R.R. Gibson, Chairman of Board of Review No. 1, said (Case 22,
13 C.T.B.R. 156 at pp. 161-2): ``If what is risked is the capital of'' the taxpayer ``(as it must be in the case of a guarantee or loan given or made by a person otherwise than in the course or for the purpose of carrying on his business) the loss or liability, if it materialises, is necessarily of a capital nature.'' This principle seems to us to govern the present case precisely, and its application here means that the present taxpayer's claim must fail.

8. The point was not argued, and in any case the evidence was uncertain, but it may be that the payment made by the taxpayer included some amount by way of interest due to the bank. The non-deductibility of any such amount rests on the same footing as the principal sum, as the terms of the guarantee extended to interest as well. Accordingly, to the extent the taxpayer's claim included any amount paid as interest it must also be held to be one to deduct an outgoing of capital or of a capital nature, and therefore to fail.

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9. For the reasons given, the Commissioner's decision on the objection should be upheld and the assessment confirmed.

Claim disallowed