Federal Commissioner of Taxation v. Cadbury-Fry Pascall (Australia) Ltd.
Judges:Jenkinson J
Court:
Supreme Court of Victoria
Jenkinson J.: Appeals by the Commissioner of Taxation from decisions of a Board of Review upon two references in respect of amended assessments to income tax.
In respect of each of two accounting periods, ending on 31 December 1968 and 31 December 1969 respectively, adopted by the taxpayer with the leave of the Commissioner, the Board of Review directed deduction from the respondent's assessable income of an amount referable to exchange gains by the respondent which the Commissioner had brought into assessable income in the making of his amended assessment.
The respondent was at relevant times carrying on the business of manufacturing confectionery for sale. It was the Australian subsidiary of an English company, Cadbury Brothers Ltd., other subsidiaries of which carried on similar businesses in a number of countries. Cadbury Brothers Ltd. itself carried on such a business in England. Two of the materials which the parent company and the respondent required for the manufacture of confectionery were cocoa beans and cocoa butter, which the respondent purchased from vendors in Ghana and other West African countries. Employees of Cadbury Brothers Ltd. who were authorised in that behalf by the respondent negotiated and signed on the respondent's behalf contracts for the purchase and shipment to Australia of those materials. Although the respondent as purchaser and the West African supplier as vendor were the only parties to those contracts, the supplier's invoice was sent, not to the respondent, but to Cadbury Brothers Ltd. in England, and the latter company made payment of the price of the goods, pursuant to an arrangement of long standing between the parent and its Australian subsidiary.
The arrangement had been established before the commencement in 1955 of employment by the respondent of the only witness whose testimony was placed before the court on the hearing of these appeals. A search had been unsuccessfully made for documentary record of the making and of the terms of the arrangement. At the time when he gave evidence before the Board of Review the witness was the chief accountant of a company which had in 1971 acquired all the assets of the respondent in consequence of mergers of the respondent's parent company with another English company and of the respondent with that other company's Australian subsidiary. The witness was not aware of any formal agreement concerning the payments which Cadbury Brothers Ltd. made on behalf of the respondent and his testimony was in substance an account of what had in fact happened from 1955 until after 1969. That account is supplemented by information in the file of documents submitted by the Commissioner to the Board of Review and tendered in evidence on the hearing of the appeals.
From these sources I derive certain findings concerning the dealings between
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Cadbury Brothers Ltd., and the respondent. The parent paid not only for the cocoa beans and cocoa butter which the respondent bought in West Africa, but also for other raw materials and some items of plant purchased abroad by the respondent. Regular statements of the payments made by Cadbury Brothers Ltd. on the respondent's behalf were sent to the respondent. The statements recorded not only such payments, but also the prices of materials sold by Cadbury Brothers Ltd. to the respondent for use by the latter company in the manufacture of confectionery. All these items the respondent included in an account which it designated as a loan account and the balance of which appeared in its annual balance sheets as ``Unsecured Loan - Cadbury Brothers Ltd. Current Account''.The balance of that account bore interest at 6 per centum per annum, but each year the respondent applied to Cadbury Brothers Ltd. for what was described as a rebate of interest and usually the parent forgave all interest except an amount equal to one per centum per annum of the balance.
Payments by the respondent in reduction of the balance owing in the account were made chiefly in the latter half of the calendar year. The greatest increases in that balance occurred during the first five months of the year when payments for cocoa beans were being made on the respondent's behalf by Cadbury Brothers Ltd. The following amounts were owing on balance of the account:
31 December 1965 $3,446,015
28 June 1966 $4,173,519
31 December 1966 $150,393
31 December 1967 $1,909,433
31 December 1968 $2,326,757
31 December 1969 $2,342,731
During the period relevant to these appeals the chief accountant of the respondent and the witness, who was then assistant to the chief accountant, decided when and in what sums payments should be made in reduction of the balance owing, according to the evidence of the witness. The witness swore: ``We'd have a look at our situation as it was and as we expected over the next few periods. We used to pay as we could, as we saw the situation. We didn't want to leave ourselves short but, you know, we played the game fairly well with them and paid as we could.'' Later he was asked: ``How was a decision made from time to time how much of this money should be repaid?'' He testified: ``Well, we used to prepare cash flows fairly regularly, that's, you know, your funds in and your funds out for the future and as we could see it as being able to repay it we would do so. As I indicated to Mr. Forsyth earlier, we didn't have to play the game with them, we could have sort of kept the funds here but we would repay as we could.'' The witness was not cross-examined on these assertions, but they are no doubt to be understood as a description of what he and the chief accountant did under the surveillance of the directors of the debtor and the creditor.
amount or the usual amount of the balance of the account, except the evidence of the six balances stated above. Evidence was adduced to explain the substantial increase in the balance owing to Cadbury Brothers Ltd. between December 1966 and December 1967. During that period the respondent acquired the issued capital of another confectionery manufacturer and required in consequence very substantial funds. Funds aggregating almost $21,000,000 became available to the respondent during the period and its liabilities increased by more than $6,000,000. But the witness denied any allocation, of the increase in funds which was reflected by the increase in the loan account balance, for a particular purpose; and he pointed out that during that year the respondent had borrowed $3,500,000 on the security of debentures. The respondent's indebtedness on bank overdraft increased by more than $1,230,000 during the year.
The monthly statements by Cadbury Brothers Ltd. to the respondent of the items which were to be credited in the loan account and debited in various accounts were expressed in English currency, Each item was taken into the respondent's books of account in Australian dollars calculated at the rate of exchange prevailing at the time the statement was received. In November 1967 the currency of the United Kingdom was devalued. Immediately before the devaluation the respondent's indebtedness in the loan account was $1,738,337. Almost nine-tenths of that amount was attributable to payments made by Cadbury Brothers Ltd. in respect of
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sales of raw materials by foreign suppliers to the respondent, and prices on sales of raw materials by Cadbury Brothers Ltd. to the respondent had aggregated more than $130,000 of that amount. The remainder reflected payments made by the English company for plant purchased abroad by the respondent (about $44,000) and what were described as ``service charges'' made by the parent company (about $4,700).Upon devaluation of the English currency the respondent recalculated the indebtedness recorded in the loan account, for it was an indebtedness to be discharged in the currency of the United Kingdom. The indebtedness was then recorded in the respondent's loan account in the sum of $1,489,273. The decrease was recorded in the respondent's balance sheet at 31 December 1967 as ``Exchange Devaluation Reserve - $249,065''.
No payment in reduction of the loan account indebtedness was made by the respondent after the devaluation until September 1968. The payments made in reduction of the balance owing during the year ended 31 December 1968 required an expenditure of Australian dollars by the respondent which was less by $212,804 than the expenditure of Australian dollars which would have been required before the devaluation. From that sum of $212,804 the Commissioner deducted $5,396 as attributable to amounts due by the respondent in respect of purchases of plant, and he contends that the remainder of the sum formed part of the assessable income of the respondent derived during the year of income ended 31 December 1968. The respondent conceded that so much of that sum of $212,804 as was attributable to amounts due by the respondent for raw materials bought from Cadbury Brothers Ltd. and in respect of ``service charges'' was part of its assessable income, and the decision of the Board of Review gave effect to that concession. (See
International Nickel Aust. Ltd. v. F.C. of T. 77 ATC 4383; (1977) 137 C.L.R. 347; 51 A.L.J.R. 782). The amount about which the parties are in dispute in relation to that year of income is so much of the sum of $212,804 as is attributable to amounts due by the respondent in respect of raw materials which were bought by the respondent from suppliers other than Cadbury Brothers Ltd. and for which payment had been made by the English company. The parties were in agreement that the amount in dispute is $190,720. Similar calculations and concessions have been made with respect to the payments by which the respondent's indebtedness at the time of devaluation was wholly extinguished during the year of income ended 31 December 1969, and the amount in dispute in respect of that year is agreed to be $32,497. Each of those two sums was directed by the Board of Review to be excised from the respondent's assessable income of the year of income ended 31 December 1968 and 31 December 1969 respectively.
In the making of calculations of the two sums the parties no doubt followed what the witness said was his practice in casting the respondent's accounts ``...you attributed the payments you made from time to time to the U.K. company as wiping out the earliest debit entries in the account? - That's correct, yes, certainly''. (Cf.
Texas Co. (A'asia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382 at p. 467).
The cost of raw cocoa used as an ingredient in manufacture by the respondent during each of the years ended 31 December 1966 and 31 December 1967 was just below $2.4 million, and that cost was in each year more than one-tenth of all the expenses disclosed in the respondent's trading account. It seems, likely, from the less detailed information in the respondent's returns for 1968 and 1969 that a cost of similar amount and proportion was incurred in those years in respect of cocoa used in manufacture.
Counsel for the respondent sought to characterise the arrangement between Cadbury Brothers Ltd. and the respondent for delay in payment on account of moneys expended by the parent as a credit facility of such a kind that it constituted part of ``the business entity, structure or organisation set up or established for the earning of profit'', so that the payments made on that account were seen to be on capital account. (Cf.
Sun Newspapers Ltd. & Anor. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 359;
Commercial and General Acceptance Ltd. v. F.C. of T. 77 ATC 4375 at pp. 4377, 4381; (1977) 137 C.L.R. 373 at pp. 377, 384; 51 A.L.J.R. 842 at pp. 843-844, 846).
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The evidence upon which that submission is based seems to me unsatisfactory. It consists of a synthesis of the experiences and beliefs of a former employee of the respondent (whose veracity and reliability as a witness I have, I hasten to say, no reason to doubt), some accounting records of the respondent's activities and, perhaps, written assertions such as those on folio 38 of the Commissioner's file (exhibit ``A''). It is difficult to discern in the evidence any clear indication as to whether the facility was available to the respondent in respect of any foreign purchasing transaction into which the respondent should choose to enter, or only in respect of certain classes of transaction. And, notwithstanding the testimony of the witness which I have already quoted, the terms of payment by the respondent and the monetary limit of credit available under the arrangement are not explicitly disclosed by the evidence. Although the arrangement was shown to have been on foot for many years, there was no evidence as to how, or upon what period of notice, it might have been terminated by either of the parties to it.
I find that the credit facility was principally for payment of liabilities in respect of the purchase by the respondent of raw materials, that the purchases of such materials in respect of which the facility was available were those only in which the parent company was involved, either as the vendor or as the payer of the price to the vendor, that the terms of payment by the respondent under the arrangement were such that, except in unusual circumstances, the respondent's liability in respect of each purchase was discharged within about six months of the time when it was incurred, and that in the only unusual circumstance of which the evidence provided information that period extended to about eighteen months.
Whenever credit was allowed under the arrangement in respect of a purchase of raw material from a vendor other than Cadbury Brothers Ltd., there was a simultaneous discharge of the respondent's liability to the vendor, recently incurred on revenue account in the course of its trade, and an incurring of liability to its parent in a like amount, which the parent's discharge of the previous liability occasioned. Having regard to the findings I have stated, I think the incurring of the latter liability and its subsequent discharge by payment, no less than the incurring of the previous liability to the vendor, to be a step in ``the process by which... (the respondent)... operates to obtain regular returns by means of regular outlay.'' But the view was taken in the Board of Review, and advanced in argument on behalf of the respondent before me, that upon discharge by its parent's payment of the respondent's liability to its supplier (a liability undoubtedly on revenue account) a liability to the parent arose which was on capital account: a borrowing of the amount paid by the parent. The payment later made by the respondent in discharge of the latter liability was therefore a capital payment, it was said, and the exchange gains derived in the course of discharging such liabilities were therefore capital profits.
If attention is confined either to each separate transaction considered in isolation, or to the circumstance that one consequence of the maintenance in operation of the arrangement between the respondent and its parent was that the respondent had the benefit of advances aggregating a large sum of money, the analysis proposed on the respondent's behalf is not easily to be denied the acceptance which a similar analysis received in Nissan Motor Distributors
(N.Z.) Ltd. v. Commr. of I.R. (1976) 2 NZTC 61089. (Cf.
Thiess Toyota Pty. Ltd. v. F.C. of T. 78 ATC 4463;
Tip Top Tailors Ltd. v. M.N.R. (1957) 11 D.L.R. 289).
The purpose and effect of the arrangement is to be considered, in my opinion, in the application of the principles stated in Sun Newspapers Ltd. & Anor. v. F.C. of T. (supra). If the assertions are ignored which are made on the respondent's behalf - explicitly in letters written on its behalf which are in the Commissioner's file (exhibit ``A'') and implicitly in the description given to the balance owing to Cadbury Brothers Ltd. in the respondent's balance sheets - the evidence does not in my opinion justify a finding that the making of the arrangement between parent and subsidiary, or the maintenance of the arrangement on foot, was for the purpose of securing for the respondent a provision of loan funds. It appears that one effect, and it may have been also a purpose, of the arrangement for substitution of Cadbury Brothers Ltd. for
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the supplier as creditor was to extend the period within which payment was to be made for cocoa purchases and to allow the respondent to determine, within limits, what from time to time the period should be. I am disinclined to give unquestioning credence to any of the assertions in the letter which commences at folio 37 of exhibit ``A'', for one of those assertions - ``interest is paid on the outstanding balance of the loan at normal market rates'' - is contradicted by the sworn testimony. I am not persuaded of the correctness of the assertion on folio 38 of exhibit ``A'' that, if the account designated by the respondent as a loan account ``had not been utilised to operate as a loan account in its strict meaning, there would have been a need for further capital''. It is for the respondent to prove that the assessment is excessive:McCormack v. F.C. of T. 79 ATC 4111;
Macmine Pty. Ltd. v. F.C. of T. 79 ATC 4133. I do not find that the arrangement was kept on foot by the respondent for the purpose of having the benefit of an advance of funds. What purposes the arrangement had, for the respondent or for its parent, could be answered by speculation, if speculation were permissible, more easily than by reference to the evidence. It appears from the last sentence on folio 70 of exhibit ``A'' that other subsidiaries of Cadbury Brothers Ltd. had similar arrangements with the parent company, a circumstance unlikely to have weakened the standing of any of the subsidiaries or of the parent in the cocoa market, where the parent was also a buyer for its own requirements as a confectionery manufacturer.
But even if what was done is regarded as having been done with the purpose of assuring to the respondent ``an identifiable increase in credit capable of use in supporting specific expenditure'', further consideration of that expenditure is required. ``For income tax purposes the narrower legal conception is seldom important. We are here considering a commercial operation and the character of an expenditure arising from it.'' ``What is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.'' (See
Armco (Aust.) Pty. Ltd. v. F.C. of T. (1948) 76 C.L.R. 584 at pp. 620-621, and
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634 at p. 648, per Dixon J.).
I think that the expenditure here in question - the payments in reduction of the loan account - was in substance part of the regular outlay of the respondent for raw materials regularly acquired by it for manufacture. The substitution of Cadbury Brothers Ltd. for the supplier as creditor ought in my opinion to be regarded as an incident of the commercial operation by which the materials were acquired. It is true that what was done to achieve the substitution was neither in form nor in legal effect a novation of the contract for sale of the materials or an assignment of the debt owed by the respondent to the vendor. (Cf.
Caltex (Aust.) Ltd. v. F.C. of T. (1960) 106 C.L.R. 205 at pp. 220, 227, 231). But that circumstance does not, in my opinion, contradict a conclusion which I think that regard to the substance and reality of the transactions compels. The payments in question were not in my opinion repayment of loan funds forming part of the profit-yielding subject, but part of the continual flow of working expenses, and made on revenue account.
If that be the correct view of the transactions, nothing will turn, for present purposes, on the circumstance that the amount of the respondent's liability to the vendor of the materials became ``fixed and incapable of subsequent variation'' upon discharge of that liability by the payment made by its parent. (See Armco (Aust.) Pty. Ltd. v. F.C. of T. (1948) 76 C.L.R. 584 at 618). Speaking of an exchange loss, Latham C.J. observed in Texas Co. (A'asia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382 at 427 that ``the increased outlay required in a subsequent year to discharge the constant (in this case, dollar) debt is regarded not necessarily as payment of the price of the goods, but as a necessary outgoing made in the normal course of the continuance and maintenance of the business as an enterprise conducted for the purpose of profit''; and the reasoning of Fullagar J. in Caltex Ltd. v. F.C. of T. (1960) 106 C.L.R. 205 at pp. 226-227 treats that conception of the exchange loss as applicable to an exchange gain,
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conceiving the gain to be income derived in the period when the taxpayer makes payment in the foreign currency.In my opinion the amounts directed by the Board of Review to be excised from the respondent's assessable income were shown by the evidence to be gains forming part of assessable income.
The orders disposing of the appeals are:
1. That the appeals be consolidated.
2. That the appeals be allowed.
3. That the orders of the Board of Review with respect to assessment of the amount of taxable income of each of the years ended 31 December 1968 and 31 December 1969 be set aside and that assessment be made in conformity with the reasons for judgment herein.
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