Lombard Australia Limited v. Federal Commissioner of Taxation.
Judges:Powell J
Court:
Supreme Court of New South Wales
Powell J.
This is an appeal, pursuant to the provisions of sec. 187(b) of the Income Tax Assessment Act 1936, against an Amended Assessment for income tax issued by the Commissioner in respect of the appellant taxpayer's ``income tax year'' ended 31 December 1975. The appeal arises by reason of the disallowance by the Commissioner of two sums claimed by the taxpayer to be losses or outgoings within the meaning of sec. 51(1) of the Act and, thus, allowable deductions for the purposes of sec. 48 and 51(1) of the Act. The two sums are shortly described as:
- a. realised exchange losses of $3,271,475.00; and
- b. the provision in the taxpayer's books in respect of long service leave of $194,001.00.
While the appeal in respect of the latter sum is pressed, counsel for the taxpayer accepts that, unless and until it be overruled, I am bound by the decision of the Federal Court
ATC 4153
ofAustralia F.C. of T. v. Nilsen Development Laboratories Pty. Limited (79 ATC 4520); however, as special leave to appeal to the High Court from the decision of the Federal Court has been granted, the taxpayer, naturally enough, wishes to preserve its position by having its submission recorded and any relevant facts found. In the result, therefore, by far the greater part of the evidence, and virtually the whole of counsel's submissions were directed towards the question of the deductibility of the exchange losses.
The taxpayer was incorporated as long ago as 1935 under the name of Producers and General Finance Corporation Limited; later its name was changed to Consolidated Finance Corporation Limited, and, later still, in March 1959 it adopted its present name of Lombard Australia Limited. It would seem that, if not at all times, then, at least, for some time, prior to June 1962, the ordinary shares in the capital of the taxpayer were listed for quotation on the Australian Associated Stock Exchanges. However, in June 1962 - no doubt as the result of a takeover offer - the taxpayer became a wholly-owned subsidiary of a company, then known as Lombard Banking Limited, but later to change its name to Lombard North Central Limited (``North Central''), a company incorporated and carrying on business in the United Kingdom. In about January 1970, the whole of the issued ordinary shares in the capital of North Central was acquired by National Westminster Bank Limited (``National'') a company carrying on business as a banker in the United Kingdom and elsewhere. Since 1962, in the case of the taxpayer, and since 1970, in the case of North Central, there has been no change in the ownership of the ordinary shares in the capital of either company.
Although, during the period with which I am concerned there has been no change in the ownership of the ordinary shares in the capital of the taxpayer there have been variations in the authorized capital of the taxpayer and the number of the shares in the capital which have been issued. These variations are reflected in the following table [reproduced at p. 4,154].
The taxpayer carries on and, at all material times since its incorporation has carried on business as a general financier. As at 31 December 1975 the taxpayer had the following subsidiaries:
NAME NATURE OF BUSINESS
Wholly Owned Subsidiaries
Consolidated Finance Corporation Pty. Housing loans to Lombard staff.
Limited Property development.
Lombank Finance Pty. Limited Motor wholesale financing.
Lombard Properties Pty. Limited
Lomman Pty. Limited Property development.
Bardess Pty. Limited
Lombard Holdings Australia Pty.
Limited Property investment.
Lombank Insurance Limited
Lombank Investments Pty. Limited
Manoora Pty. Limited
Chandson Pty. Limited Inactive.
Australian Motor Finance Pty. Limited
Heathorn Finance Proprietary Limited
Partly Owned Subsidiaries
Westgate Property Investment Pty.
Limited Property development
Booker Industries Pty.
ATC 4155
During the period with which I am primarily concerned the taxpayer's business has been the making of loans, both secured and unsecured, the supplying of goods by way of credit sale, hire purchase, lease, and otherwise, the provision of guarantees, bonds and indemnities, the provision of bill acceptance, endorsement and discounting facilities, and the carrying out, as financier and principal, either directly or through wholly owned subsidiaries, of the development of real estate. The extent to which the taxpayer has in the years ended 30 September 1974, 1975 and 1976 (those being the only years for which a more detailed breakdown is available) dealt in these various categories of business is shown by the following table:
Y.E. Y.E. Y.E.
30.9.74 30.9.75 30.9.76
$m % $m % $m %
Instalment Credit
Receivables 146.6 53.1 140.1 49.2 180.3 54.4
Real Estate Bridging and
Development
Receivables 69.1 25.0 59.1 20.8 55.3 16.7
Dealer Wholesale
Facilities 17.5 6.3 24.5 8.6 29.1 8.8
Real Estate Projects and
Joint Ventures 17.3 6.3 26.0 9.1 29.6 8.9
Other Fixed and Current Assets
(e.g. Money Market
Deposits) 25.6 9.3 35.1 12.3 37.0 11.2
----- ----- ----- ----- ----- -----
276.1 100 284.8 100 331.3 100
----- ----- ----- ----- ----- -----
As will be abundantly obvious on a comparison of this table with the table which I have set out above the sums committed by the taxpayer to its business far exceeded the issued and paid up capital of the taxpayer (the ratio being, in each of the years end 30 September 1974, 1975 and 1976, in excess of 10:1), the difference between, on the one hand, shareholders' funds (capital, reserves, unappropriated profits) and lendings being made up by borrowings from both Australian and overseas sources - both institutional and by way of public issue of debenture stock and unsecured notes. Between 1962 and January 1970, a substantial proportion of the taxpayer's borrowings were provided, or arranged, by North Central; the material before me discloses that the percentage of overseas borrowings to total borrowings of the taxpayer for the years ended 31 December 1968 and 1969 was respectively 54.2% and 62.0%. In September 1969, apparently in an endeavour to encourage the offer, by foreign-owned companies to Australian investors, of equity participation or greater equity participation, the then Liberal administration of Prime Minister Gorton imposed restrictions upon the extent to which foreign-owned companies, such as the taxpayer, could raise money by way of fixed interest borrowings on the Australian market. Thus, the result was that foreign owned companies, such as the taxpayer, which wished to expand their activities in Australia, were obliged to raise overseas a greater proportion than before of the necessary borrowings.
It would seem that, prior to September 1969 the senior officers of North Central and of the taxpayer had formed the view - fortuitously, in the circumstances - that if, during the then ensuing period of 5 years, the taxpayer were to be in a position to take advantage of any opportunities to expand its activities which might arise, the taxpayer would need to have access to significant funds beyond those which could be raised on the Australian market or provided by North Central; the view which, so it seems, was reached was that, for all practical purposes, what is known as ``the Euro-dollar market'' was the only likely source of those funds. This view having been formed, a Mr. Hawkins, the Director of North Central responsible for its overseas subsidiaries, and, as well, a Director of the taxpayer was authorised to negotiate Euro-dollar loan facilities on behalf of the taxpayer as and when such facilities were required by the taxpayer for the general purposes of its business.
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In pursuance of that authority, Mr. Hawkins, between 1969 and 1974 negotiated, on behalf of the taxpayer, three Euro-dollar loan facilities, they being:
- 1. from Burston & Texas Commerce Bank Limited of London (``Burston & Texas'') a loan facility of $US5,000,000 or equivalent in Deutschmarks, Swiss Francs or other agreed currency for a period of five years;
- 2. from International Commercial Bank Limited of London (``International Commercial'') a loan facility of $US5,612,000 (the then equivalent of \ca\5,000,000 or equivalent in Deutschmarks, Swiss Francs or other agreed currency for a period of five years;
- 3. from National, through its wholly owned subsidiary International Westminster Bank Limited, a series of loan facilities, the first being for the foreign currency equivalent of \ca\10,000,000 for five years. The first facility was subsequently extended to the foreign currency equivalent of \ca\25,000,000. Later, two further facilities, for the foreign currency equivalent of \ca\3,000,000 and \ca\5,000,000 were established. Later, again, the existing facilities were consolidated and varied and new facilities granted so that, by the end of 1974, the facilities represented the foreign currency equivalent of \ca\48,500,000 and a further $US40,000,000 for periods expiring as to part in July 1976, part in October 1977 and part in September 1979.
The Burston & Texas loan facility was drawn down by a single loan on 1 October 1969. Initially, the loan was taken down in Dutch Guilders. After six months, the loan was ``rolled over'', again, in Dutch Guilders. In October 1970, the loan was again ``rolled over'', but, on this occasion, in United States dollars. The loan continued to be ``rolled over'' in United States dollars until April 1972, when it was converted into Swiss Francs. Thereafter, the loan continued to be ``rolled over'' at six-monthly intervals until April 1974, when it was ``rolled over'' for three months. In July 1974 the loan was again ``rolled over'' for a final three months. On 30 September 1974 the loan was paid out, partly by National (the amount in question being treated as a drawing by the taxpayer under the National facility), and, as to the balance, by a remittance from the general funds of the taxpayer to Burston & Texas in London (Transcript p. 61). Although there appears to have been a foreign exchange loss sustained by the taxpayer that loss was not the subject of any claim in the proceedings before me.
The International Commercial loan facility, too, was drawn down, on 11 May 1970, as a single loan. Initially, the loan was drawn down in United States dollars. Thereafter, the loan was ``rolled over'', still in United States dollars, until May 1972 when, on being again ``rolled over'', it was converted to Swiss Francs. The consequence of the conversion of the loan to Swiss Francs and the then foreign exchange rate was that there was ``thrown up'' a ``notional profit'' in favour of the taxpayer. Thereafter the loan continued to be ``rolled over'', still in Swiss Francs, at six monthly intervals until it was paid out, on maturity, on 9 May 1975. By that time, partly in consequence of the devaluation of the Australian dollar in September 1974, and partly by reason of the severing of the link, for foreign exchange purposes, between the United States dollar and the Australian dollar, the foreign exchange rate had run heavily against the taxpayer; the result being that, on repayment, the taxpayer sustained, on this transaction, a realized foreign exchange loss of \ca\1,483,840. This loss is the subject of a claim before me.
The permutations of the various National facilities, and the manner in which, and the times at which, those facilities were drawn down are such that they are most readily described by the table which I set out below:
NOTES 1.
Repayable on 31 December 1975. 2.
Repayable 5 years after drawdown. 3.
Lines 1 and 2 repayable on 31 July 1976, Line 3 repayable on 31 December 1976. 4.
Repayable on 31 July 1976 subject to option for a further 5 years. 5.
Repayable on 30 September 1979. 6.
This loan represents the transfer to National Westminster Bank Limited of the Burston & Texas Commerce Bank Limited loan of $US5 million which yielded \ca\3.5 million at drawdown. $US5 million at 30 September 1974 would have yielded \ca\3,781,513. 7.
Repayable on 8 October 1977.
* These loans were repaid in the year ending 31 December 1975
As will be seen from the table, eight loans, Loans 8, 9, 11, 12, 16, 17, 18, and 20 were repaid during the year ended 31 December 1975. In respect of each such loan, the taxpayer sustained a foreign exchange loss, the loss in each case (\ca\543,820, \ca\543,444, \ca\217,320, \ca\49,089, \ca\88,549, \ca\216,324, \ca\123,949 and \ca\108,162) being the subject of a claim before me.
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The manner in which these various loans were dealt with may be shortly recorded as follows:
- 1. Loans 8 and 9 each for the then equivalent of \ca\4,000,000 were drawn down in February 1971, initially in United States dollars. When, at the end of March 1972 each loan was ``rolled over'', it was converted to Swiss Francs - on this occasion a ``notional profit'' was ``thrown up''. Each loan was again ``rolled over'', still in Swiss Francs, at the end of September 1972. When in December 1972, the loans were again ``rolled over'' they were again converted to United States dollars - on this occasion, a further ``notional profit'' was ``thrown up''. The loans were again ``rolled over'' at the beginning of January 1974 and, as a consequence of their having again been further converted to Swiss Francs, yet another ``notional profit'' was ``thrown up''. The loans were paid out in December 1975 - that is, before the expiry of the period for which the facility was to remain open - the taxpayer, in each case, sustaining a realized foreign exchange loss;
- 2. Loan 11, for the then equivalent of \ca\2,000,000 was drawn down in United States dollars on 30 June 1971. Thereafter, it was ``rolled over'', still in United States dollars, initially for six months, and then at twelve-monthly intervals until the beginning of January 1974, when it was, on being ``rolled over'' for a period of 24 months, converted into Swiss Francs - on this occasion, a ``notional profit'' was ``thrown up''. The loan was repaid, before maturity and before the expiration of the facility in December 1975, there being a loss realized on repayment;
- 3. Loan 12, for the then equivalent of \ca\1,000,000, was drawn down in United States dollars on 30 July 1971 being ``rolled over'', at twelve-monthly intervals still in United States dollars. In October 1973 the loan was ``rolled over'' again, but, on this occasion converted to Swiss Francs - again, on this occasion a ``notional profit'' was ``thrown up''. The loan was repaid on 31 October 1975, upon its maturity but before the expiration of the period of the facility, the taxpayer again sustaining a realized exchange loss on repayment;
- 4. Loan 16, for the then equivalent of \ca\1,000,000, was drawn down in United States dollars on 1 November 1971, being ``rolled over'', but still in United States dollars, 12 months later. In November 1973 the loan was again ``rolled over'', but, on this occasion, in Swiss Francs, a ``notional profit'' being again ``thrown up''. This loan was, in its turn, repaid in November 1975, the taxpayer sustaining still yet another realized exchange loss on repayment;
- 5. Loan 17, for the then equivalent of \ca\2,000,000 was drawn down on 31 July 1972 in United States dollars, being ``rolled over'' 12 months later in the same currency. In October 1973 the loan was ``rolled over'' again but converted to Swiss Francs - again, a ``notional profit'' was ``thrown up'' on conversion. However, when the loan was repaid in October 1975 the taxpayer sustained a further realized exchange loss:
- 6. Loan 18, for the then equivalent of \ca\2,000,000 was drawn down in United States dollars on 31 August 1972. However, when it, in its turn, was ``rolled over'' in August 1973, it was converted into Swiss Francs, a ``notional profit'' being ``thrown up''. On it being repaid in August 1975 the taxpayer sustained yet another realized exchange loss on this loan;
- 7. Loan 20, for the then equivalent of \ca\1,000,000 was drawn down on 31 October 1972 in United States dollars, being ``rolled over'' 12 months later in Swiss Francs - again, a ``notional profit'' was ``thrown up'' on the conversion. However, when the loan was repaid in October 1975 the taxpayer sustained a further realized exchange loss.
As can be seen from the table [``National Westminster Bank Loans''] which I have earlier set out and from this short history of each relevant loan, there were many options open to, and exercised by, the taxpayer in respect of each of the Burston & Texas, International Commercial and National, facilities, those options being:
- 1. whether each facility should be drawn down in one, or more than one, loan;
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- 2. in the event of more than one loan, the amounts in which, and the times at which, each such loan should be drawn down;
- 3. in relation to any loan, the currency in which, and the period for which, the loan should initially be drawn down;
- 4. whether, upon maturity, any loan should be repaid or ``rolled over'';
- 5. if ``rolled over'', in what currency, and for what period, should any such loan be ``rolled over''.
The evidence establishes quite clearly that the decisions, from time to time taken, as to which of the various options open to the taxpayer should be exercised and the manner of any particular exercise were anything but intuitive. On the contrary, it is clear that decisions as to when, and in what amounts, and for what periods, loans should be drawn down, were affected, in part, by the forecast future needs of the taxpayer not only to have a regular cash flow but also to take advantage of any opportunities to expand its business which might present themselves to the taxpayer. So, too, decisions as to the period of any loan or ``roll-over'' were affected by the varying rates of interest applying to loans of varying duration. Finally decisions as to the currency in which a loan was initially drawn down, or into which, on a ``roll-over'' it was converted, were affected not only by the actual rates of interest offered but also by the possible advantage to be obtained from a likely depreciation of a particular currency, or the possible disadvantage to be suffered from a likely appreciation of a particular currency, against the Australian dollar. It is, I think, clear that, whether or not their view be regarded as legally sound - this is the question which ultimately I have to determine - the officers of National and of North Central whose advice as to the correct decision to take in any particular case was regularly sought by Lombard took the view that the ``cost'' to the taxpayer of any particular loan was to be determined, not merely by reference to the amount of interest payable over the term of the loan, but also by reference to the difference between the amount required in Australian dollars to repay the loan and the amount which the loan yielded in Australian dollars at the date of draw down. Finally it is clear that it was the devaluation of the Australian dollar, the severing of the link with the United States dollar and the continuing tendency of European currencies, particularly of the Swiss Franc, to appreciate as against the Australian dollar which led to the taxpayer's decision - reflected in the repayment of the various loans referred to above - gradually, as the cash flow of the taxpayer permitted it, to ``disengage'' from its Euro-currency borrowings; the process of ``disengagement'' was in fact completed when the balance of the loans drawn down under the National facility was repaid during 1976 - by the end of 1976, out of total borrowings by the taxpayer of the equivalent of \ca\284,734,000, overseas borrowings totalled the equivalent of \ca\38,126,000 (13.4%), of which the equivalent of \ca\9,225,000 (3.24%) represented borrowings in foreign currency, and \ca\28,901,000 (10.16%) represented borrowings in Australian currency.
Although, during the period from 1969 to 1975 the taxpayer had raised significant funds abroad, it did not do so to the exclusion of loans raised either from institutional lenders or from the public - although, for a time, overseas borrowings represented more than half of its borrowings. The manner in which the taxpayer's borrowings increased and varied as between overseas and local borrowings during the period 31 December 1968 to 31 December 1976 can be seen from the following table:
Percentage of
Total Overseas
Overseas Borrowings Borrowings to
At 31 Foreign Australian Total Australian Total Total
December Currency Currency Borrowings Borrowings Borrowings
$A $A $A $A $A %
1968 23,327,000 10,000,000 33,327,000 27,929,000 61,256,000 54.2
1969 27,819,000 10,000,000 37,819,000 23,174,000 60,993,000 62.0
1970 38,786,000 10,000,000 48,786,000 30,696,000 79,482,000 61.4
1971 56,880,000 10,000,000 66,880,000 35,232,000
As was the case with the facilities made available, and the loans made, to the taxpayer by Burston & Texas, International Commercial and National, the facilities made available, and the loans made to the taxpayer, during the period with which I am concerned, took a variety of forms. The following are given by way of example:
1. Lender The National Bank of Australasia Limited
Amount $A 3,000,000 Bill acceptance/endorsement
Commencement 6 June 1973
Period Three (3) years;
2. Lender Hill Samuel Australia Limited, Australian European
Finance Corporation Limited, and MBC International
Limited
Amount $A 5,000,000 loan facility
Commencement 8 August 1973
Period Eighteen (18) months
Interest Rate Average of Lender's buying rates for bills of
exchange, accepted or endorsed by a Bank plus 1.8%
calculated half yearly;
3. Lender International Pacific Corporation Limited,
Euro-Pacific Finance Corporation Limited
Amount $A 5,000,000 loan facility
Commencement 31 August 1973 and 1, 2 and 3 May 1974
Period Eighteen (18) months from 24 August 1973
Interest Rate Average of Lender's buying rates for bills of
exchange accepted or endorsed by a Bank plus 1.8%
calculated half yearly;
4. Lender The Commercial Banking Company of Sydney Limited
Amount $A 5,000,000 bill acceptance/endorsement facility
Commencement 11 September 1973
Period Year to year;
5. Lender Commonwealth Trading Bank of Australia
Amount $A 10,000,000 bill acceptance/endorsement facility
Commencement 23 April 1974
Period Three (3) years.
The moneys raised by the taxpayer from the public during the period with which I am concerned took a variety of forms. Thus, on one occasion (July 1971 - Exhibit ``3''), the relevant Prospectus invited subscriptions for Debenture Stock (for varying terms at varying rates of interest) and Unsecured Deposit Notes (likewise for varying terms at varying rates of interest); on another occasion (March 1974 - Exhibit ``8'') the relevant Prospectus invited subscriptions for Debenture Stock (for varying terms at varying rates of interest) and for Second Ranking Debenture Stock (for varying short terms at varying rates of interest, which rates were higher than those offered for Debenture Stock); and on other occasions (August 1975 and February 1976 - Exhibits ``11'' and ``12'') the relevant Prospectus invited subscriptions for Debenture Stock maturing
ATC 4162
in three years but repayable at the investor's option on three months' written notice after 18 months.This pattern of raising money from a variety of sources - overseas, local institutional, and public subscription - upon a variety of forms of security and by means of differing types of facility, and for differing terms was not only the usual method adopted by the taxpayer at the time, but was, so it seems (Transcript pp. 52-3) the norm, at the time, for all companies engaged in the finance industry in Australia.
Before turning from the question of the moneys raised by the taxpayer from the public, it should be recorded - since the Commissioner seeks to rely upon it - that, in each of the Prospectuses issued by the taxpayer during the relevant period, there appears a reference to ``Parent Company Support and Facilities'' - no such reference appears in Prospectuses issued after February 1977 (by which time the National loans were all repaid) although, sometimes under the title ``Parent Company'' and sometimes under the title ``National Westminster Bank Limited'', later Prospectuses all contain a reference to the fact that National is the ultimate holding company of the taxpayer and, further, to the financial position of National. Although the material from time to time included in Prospectuses under the title ``Parent Company Support and Facilities'' varied, the following, which appeared in the Prospectus issued in February 1972 (Exhibit ``4'') is sufficient to indicate the general nature of the material from time to time included:
``Parent Company Support and Facilities Lombard North Central Limited grants overdraft facilities to Lombard Australia Limited without security. Part of the money so advanced amounting to $16,428,700 has been made the subject of unsecured sub-ordinated notes as follows:
Date Interest of Notes Amounts Rate 10/1/68 $10,000,000 71/2% p.a. 22/6/70 2,142,900 * 71/2% p.a. 4/1/71 4,285,800 * 71/2% p.a. ----------- $16,428,700 -----------* Being £Stg.1 million and £Stg.2 million respectively converted at \ca\2.1429 equals £Stg.1.
The repayment of these notes is due on 31st December, 1980, and is sub-ordinated to the other borrowings and liabilities of the Company and its subsidiaries if the event described in the extract of the note quoted on pages 22 and 23 hereof occurs during the currency of these notes.
As at 30th September, 1971, a further $16,749,740 was owing to Lombard North Central Limited on overdraft account and $500,000 on an unsecured note maturing 31st March, 1972.
In addition, unsecured loan facilities established in December, 1970 and July, 1971 for $25,000,000 and $3,000,000 respectively are currently available to the Company from National Westminster Bank Limited through its wholly-owned subsidiary Westminster Foreign Bank Limited. These facilities were being utilised as at 30th September, 1971 to the extent of $25,000,000 by way of loan from Westminster Foreign Bank Limited of which $3,000,000 had been lent by the Company to a wholly-owned subsidiary in Australia of Lombard North Central Limited. Moneys borrowed or reborrowed under the $25,000,000 facility are repayable at the option of the Company at the expiration of six or twelve month periods from the date of borrowing or reborrowing and moneys borrowed under either facility are repayable not later than 31st July, 1976. National Westminster Bank Limited has informed the Company of its willingness to renew the $25,000,000 facility for a further period of five years from 31st July, 1976 on terms to be mutually agreed.
The amount that would have been required to repay that portion of the above facilities which was being utilised at 30th September, 1971, based on exchange rates ruling at that date, was $24,455,013.
A stand-by facility for a further $5,000,000 established in January, 1972 is also currently available to the Company from National Westminster Bank Limited and any moneys borrowed under this stand-by facility are repayable not later than 31st December, 1976.''
The inclusion of such material in the Prospectuses was, so it seems, the result of a
ATC 4163
conscious decision on the part of the officers of the taxpayer, the ``sales ploy'' being that ``(the taxpayer offered) a margin of security in terms of the value of (its) assets but it (was) just as important from (its) point of view to demonstrate that (it had) the cash flow to repay (its) obligations as they (fell) due... (the taxpayer placed) as much importance on that'' (Transcript p. 21).Finally, before turning from the facts relating to this aspect of the appeal before me I should record how the taxpayer dealt, in its financial records and statements, with the effects, from time to time, on outstanding overseas loans, of currency fluctuations in the period 1969 to 1975.
Although it is not the subject of any dispute before me, it is necessary first to record a piece of history - since that piece of history appears to have set the pattern for the taxpayer's later treatment in its financial records and statements of the effect of currency fluctuations. During the period 1962 to 1967 a substantial part of the taxpayer's overall funding was provided by North Central. In 1967 there was a major realignment of currencies which resulted in a significant devaluation of Sterling currency as against the Australian dollar; there was thus ``thrown up'' a ``notional profit'' in favour of the taxpayer in its dealings with North Central. Part of that ``notional profit'' was realized by the taxpayer when portion of its Sterling debt to North Central was converted into an Australian dollar debt, being later converted into a subordinated loan (see Exhibit ``B(i)'' p. 13). The ``realized profit'' was then carried, in the books of the taxpayer, into an ``Exchange fluctuation reserve''. The Commissioner having, later, sought to assess the taxpayer for income tax on the ``realized profit'', the taxpayer appealed. During the pendency of the appeal, the taxpayer charged against the ``Exchange fluctuation reserve'' the amount of tax claimed by the Commissioner (see, for example, Exhibits ``B(iii)'' p. 13, ``B(iv)'' p. 13), the amount of the provision being later ``written back'' when the disputed assessment was withdrawn (see Exhibit ``B(v)'' pp. 3, 15).
The question of the manner of recording the effect of currency fluctuations on the loans with which I am concerned appears first to have arisen in the year ending 30 September 1972. It will be recalled that when, in April 1972, loans 8 and 9 drawn under the National facility, and, in May 1972, the Intercontinental Commercial loan, were and was ``rolled over'', each loan was converted into Swiss Francs and a ``notional profit'' was ``thrown up''. The Annual Report and financial statements of the taxpayer for the year ended 30 September 1972 (Exhibit ``B(v)'') record the position in the following way:
1. In the Directors' Report the following (inter alia) appears:
``Exchange Fluctuation Reserve
Liabilities to repay overseas borrowings were converted at the relevant rates of exchange ruling at 30th September, 1972. The following movements took place in the Exchange Fluctuation Reserve Account during the year:
Balance at 30th September, 1971 ............................... 5,651,000 Add: Gains during the year .............. 1,532,000 1967 and 1968 Income Tax provisions no longer required ........................... 672,000 --------- 7,855,000 Deduct: Provision for contingencies relating to exchange fluctuations ....................... 700,000 ---------- Balance at 30th September, 1972 .................... $7,155,000 ----------The Income Tax Assessments, referred to in previous Directors' Reports, which were received in relation to those portions of the Exchange Fluctuation Reserve realised in 1967 and 1968 and which were the subject of an appeal by the Group, were withdrawn during the year.;''
2. In both the Consolidated Balance Sheet and the Balance Sheet of the taxpayer the following entries appear on the debit side:
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``1971 Reserves
Capital
40,913 Capital profits 103,831
746,132 Share premium 746,132
Fixed asset revaluation 1,100,000
5,651,034 Exchange fluctuation 7,154,753
301,500 Revenue - general 301,500
5,281,718 Unappropriated profit 7,150,083
---------- ----------
12,021,297 16,556,299
Current Liabilities
Bank overdrafts - Lombard
16,749,740 North Central Limited 10,970,149
Creditors and accrued
2,805,186 charges 2,205,229
Provision for income
3,075,996 tax 3,784,279
302,661 Owing to subsidiaries 309,088
Provision for contingencies
relating to exchange
fluctuations 700,000
---------- ----------
22,933,583 17,968,745''
3. In the Notes to the Accounts the following appears:
Lombard Australia Lombard Australia
Limited and its
Limited subsidiary companies
1971 1972 1971 1972
1. The matters relating to surpluses on
foreign exchange which are described in
Note 2 below have not been dealt with in
the accompanying statements of Profit and
Loss. The Directors recognise that this
treatment does not accord with that
recommended by the Institute of Chartered
Accountants in Australia but are of the
opinion that the treatment adopted is the
most appropriate in the circumstances.
2. Exchange fluctuation reserve
Balance 30 September 1971
4,567,153 5,651,034 4,567,153 5,651,034
Add Net surplus on valuation
of overseas borrowings at
30 September
1,083,881 1,531,539 1,083,881 1,531,539
Refund of income tax 672,180 672,180
--------- --------- --------- ---------
5,651,034 7,854,753 5,651,034 7,854,753
Deduct Transfer to provision
for contingencies relating to
exchange fluctuation 700,000 700,000
---------- ---------- ---------- ----------
Balance 30 September 1972
$5,651,034 $7,154,753 $5,651,034 $7,154,753
---------- ---------- ---------- ----------
4. Funds repayable in overseas currencies have been converted at the following rates of exchange at 30 September 1972:
Pound Stg1 = $A 2.0397
$US1.1886 = $A 1
Swiss Francs 4.493 = $A 1
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(In relation to Note 1 to the Accounts it should be recorded that the statement that the ``treatment'' of the effect of currency fluctuations adopted ``does not accord with that recommended by the Institute of Chartered Accountants in Australia'' may not be completely accurate, for it would seem (Exhibit ``J'') that, although, at the time, the Institute had ``an exposure draft currently on issue'' it had not, at that time adopted, as a standard, a practice of ``applying balance date (closing) exchange rates to all foreign currency assets, liabilities and income and expense items taken through the profit and loss account''.)
The practice reflected in the various entries which I have just set out was followed in subsequent years (see Exhibits ``B(vi)'' and ``B(vii)''). The accounts and financial statements for the income year ended 30 September 1975 (not the income tax year ending 30 September 1975) (see Exhibit ``B(viii)'') contain the following notes and entries:
1. In the Director's Report the following appears:
``Exchange Fluctuation Reserve
Foreign exchange fluctuations during the year resulted in a $6,053,000 increase in Group liabilities to repay foreign currencies borrowed. This reduced the balance of exchange fluctuation reserve account at 30th September, 1975 to $1,518,000. Subsequent movements in foreign exchange rates have resulted in a further depreciation of the Australian dollar and should this trend continue deficiencies in excess of $1,518,000 will be charged against future trading results.;''
2. In the Balance Sheet of the taxpayer there appears, on the debit side, the following:
``Reserves 1975 1974
Capital
Capital profits 103,831 103,831
Share premium 746,132 746,132
Fixed asset revaluation 1,100,000 1,100,000
Exchange fluctuation 1,417,675 7,471,035
Revenue - general 301,500 301,500
Unappropriated profit 13,482,239 10,754,481
---------- ----------
17,151,377 20,476,979;''
3. In the Notes to the accounts the following appear:
``Fluctuations in foreign exchange
Liabilities to repay borrowings in overseas currencies are valued at the rates of exchange ruling at balance date and net surpluses or deficiencies are transferred to exchange fluctuation reserve account.
4. Exchange Fluctuation Reserve Lombard Australia Limited 1975 1974 $ $ Balance 30 September 1974 7,471,035 14,009,207 Net deficiency on valuation of overseas borrowings at 30 September 1975 6,053,360 7,838,172 --------- --------- Transfer from provision for 1,417,675 6,171,035 contingencies relating to exchange fluctuations 1,300,000 --------- --------- Balance 30 September 1975 1,417,675 7,471,035 --------- ---------(a) The foreign exchange fluctuations during the year have resulted, as shown above, in a $6,053,360 increase in group liabilities to repay foreign currencies borrowed. Subsequent movements in foreign exchange rates have resulted in a further depreciation of the Australian dollar, and should this trend continue
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deficiencies in excess of the balance above of $1,517,785 will be charged against future trading results.(b) The matters relating to surpluses and deficiencies on foreign exchange which are described above have not been dealt with in the accompanying statements of profit and loss. The directors recognize that this treatment does not accord with that recommended by the Institute of Chartered Accountants in Australia but are of the opinion that the treatment adopted is the most appropriate in the circumstances.''
In relation to the following income year, ending 30 September 1976 (during which period the eight loans, drawn down under the National facility, to which I have earlier referred, were repaid) the treatment adopted in the accounts and financial statements (Exhibit ``B(ix)'') varied a little from that reflected in the earlier entries which I have recorded above. Thus:
1. In the Directors' Report the following appears:
``Foreign Exchange Fluctuations
The Company has accounted for gains and losses on overseas borrowings up to 30th September, 1975, through the Exchange Fluctuation Reserve Account so that such gains and losses were not taken into account in arriving at the operating profit. Exchange losses this year have extinguished the balance of $1,418,000 standing to the credit of the Reserve at 30th September, 1975, and leave an amount totalling $3,461,000 to be charged against the Profit and Loss Account for the year as an extraordinary item.
The Directors believe there is a strong case for claiming tax deductibility for exchange losses on certain of the Company's overseas borrowings. Because of uncertainties in the tax law pending decisions in a number of test cases, in the interest of prudence the accounts have been drawn up on the basis that the losses are not allowable as income tax deductions.
......
Local Borrowings
In line with Group policy of disengagement from foreign currency borrowings, the Company reduced its foreign currency liabilities by $48.4 million during the September half-year, making a total repayment of $68 million for the year. The Company's exposure to exchange fluctuations has been reduced to a $US10 million subordinated unsecured loan from its Parent Company, Lombard North Central Limited. The replacement of these foreign currency borrowings during the year demonstrates the underlying strength of the Group, which is strongly supported by its Parent, the National Westminster Bank Group in the United Kingdom.
Due to the Government's economic policy for reducing inflation, competition for local funds remained strong and interest rates had a tendency to increase during the year. Despite this, the Company was able to raise sufficient local funds to service its growth.;''
2. In the Balance Sheet of the taxpayer there appears, on the debit side, the following:
``1976 1975
"Reserves $ $
Capital
Capital profits 220,995 103,831
Share premium 746,132 746,132
Fixed asset revaluation 1,100,000 1,100,000
Exchange fluctuation Note 5 - 1,417,675
Revenue - general 301,500 301,500
Unappropriated profit 10,481,412 13,482,239
---------- ----------
12,850,039 17,151,377";''
3. The ``Statement of Profit and Loss'' of the taxpayer was as follows:
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``Notes 1976 1975
$ $
Operating profit before income tax 2 2,023,322 3,409,027
Income tax expense applicable
thereto 3 776,390 1,290,987
--------- ---------
Operating profit before
extraordinary items 1,246,932 2,118,040
--------- ---------
Extraordinary items
Extraordinary income tax credit
resulting from a retrospective
adjustment to income tax rates 307,515
Capital profit on sale of freehold
property 117,164
Losses and deficiencies on valuation
of foreign currency loans 5 (3,460,922)
Provision for diminution in value of
shares in subsidiary (255,153) (313,115)
----------- ----------
(3,598,911) (5,600)
----------- ----------
Operating profit/(loss) and
extraordinary items (2,351,979) 2,112,440
Unappropriated profit at 30
September 1975 13,482,239 10,754,481
Adjustment relating to the
introduction of tax effect
accounting (171,184) 975,818
----------- ----------
10,959,076 13,842,739
Transfer to capital Profits reserve (117,164)
Preference dividends paid (360,500) (360,500)
----------- -----------
UNAPPROPRIATED PROFIT AT
30 SEPTEMBER 1976 10,481,412 13,482,239;
---------- -----------''
4. Note 5 to the Accounts was as follows:
``5. Exchange Fluctuation Reserve 1976 1975 $ $ Balance at 30 September 1975 1,417,675 7,471,035 ----------- ----------- Exchange profits/(losses) during the year Realized (4,890,420) Nil Unrealized 11,823 (6,053,360) ----------- ----------- (4,878,597) (6,053,360) ----------- ----------- (3,460,922) 1,417,675 Amount charged to statement of profit and loss 3,460,922 Nil ----------- ----------- BALANCE AT 30 SEPTEMBER 1976 Nil 1,417,675 ----------- -----------The company has accounted for gains and losses on overseas borrowings up to 30 September 1975 through the exchange fluctuation reserve account so that such gains and losses have not been taken into account in arriving at the operating profit. Realized exchange losses for the year ended 30 September
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1976 have extinguished the balance of $1,417,675 standing to the credit of the reserve at 30 September 1975 and leave an amount totalling $3,460,922 in respect of realized losses to be charged to the statement of profit and loss for the year as an extraordinary item.The directors recognise that to the extent that the deficiency has been absorbed against the exchange fluctuation reserve this treatment does not accord with that recommended by the Institute of Chartered Accountants in Australia but are of the opinion that the treatment adopted is the most appropriate in the circumstances.''
Having recorded so much of the history as relates to the claim for realized currency losses, I turn, now, to record - but briefly - the facts relating to the claim for the deductibility of the provision made for Long Service Leave.
The taxpayer carries on its business as a financier in each of the States of Australia, and in the Australian Capital Territory; in each such State, and in the Australian Capital Territory the taxpayer maintains an office, or a number of offices and, of course, employs clerical and other staff. At all material times, the employees of the taxpayer have been entitled to the benefits provided for by either a local statute, ordinance, industrial award, or by way of federal award made by the Australian Conciliation and Arbitration Commission. The following is a summary of the relevant source documents operating in the taxpayer's income tax year ending 31 December 1975:
1. New South Wales
- a. employees generally - Long Service Leave Act 1955 (N.S.W.);
- b. clerical employees
- (i) until 1 July 1975 - Clerks (State) Award cl. 14;
- (ii) from 2 July 1975 - Long Service Leave Act 1955 (N.S.W.) (the Clerks (Finance Companies) Award 1975 (Cth.) which effectively ``replaced'' the Clerks (State) Award made no provision for long service leave);
2. Victoria
- a. employees generally - Labour and Industry Act 1958 (Vic.) Pt. VIII Div. 4;
- b. clerical employees -
- (i) to 1 July 1975 - Wages Board Determination and Commercial Clerks Award No. 7, 1974 (?);
- (ii) from 2 July 1975 - Labour and Industry Act 1958 (Vic.) Pt. VIII Div. 4 (as to the effect of Clerks (Finance Companies) Award 1975 (Cth.), see 1(b)(ii) (above));
3. Queensland
- a. employees generally - The Industrial Conciliation and Arbitration Act 1961 (Qld.) sec. 17, 19;
- b. clerical employees -
- (i) to 1 July 1975 - Clerical Officers of Finance Companies Award - State cl. 14;
- (ii) from 2 July 1975 - The Industrial Conciliation and Arbitration Act 1961 (Qld.) sec. 17, 19 (as to the effect of Clerks (Finance Companies) Award 1975 (Cth.), see 1(b)(ii) (above));
4. South Australia
- employees generally - Long Service Leave Act 1967 (S.A.) (the Clerks Award (State) does not appear to have made any provision for long service leave; the Clerks (Finance Companies) Award 1975 (Cth.) did not make any provision for long service leave);
5. Western Australia
- a. employees generally - Long Service Leave Act 1958 (W.A.);
- b. clerical employees
- (i) to 1 July 1975 - Clerks (Credit and Finance Establishments) Award cl. 26;
- (ii) from 2 July 1975 - Long Service Leave Act 1958 (W.A.) (as to the effect of the Clerks (Finance Companies) Award 1975 (Cth.) see 1(b)(ii)(above));
6. Tasmania
- employees generally - Long Service Leave Act 1956 (as amended) (Tas.) (the relevant State Clerks Award does not appear to have made any provision for
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long service leave; the Clerks (Finance Companies) Award 1975 (Cth.) did not make any provision for long service leave);
7. Australian Capital Territory
- a. employees generally - Quaere whether prior to the making of the Long Service Leave Ordinance there was any general entitlement to long service leave;
- b. clerical employees - Quaere whether the Clerks (Long Service Leave A.C.T.) Award was made a ``common rule'' pursuant to the provisions of sec. 49 of the Conciliation and Arbitration Act 1904 (Cth.) (see notes to sec. 49 in Mills & Sorrell: Federal Industrial Law 5th ed. 219).
Although the language in which the various provisions are couched varies, it is, I think correct to say that the primary entitlement of an employee under each of the relevant provisions is, upon the expiry of the relevant qualifying period, to a period of paid leave, payment being made at the time when the employee enters upon the relevant period of leave. It is, I think, also correct to say that the secondary entitlement of an employee, that is, to receive a sum of money in lieu of paid leave, arises only on the determination of the employment in the circumstances contemplated by each of the relevant provisions. It follows, in my view, that while a period of continuous employment is a necessary qualification for entitlement to either of the alternative benefits provided for by the relevant provisions, there does not accrue to any particular employee, on a daily, weekly or other periodic basis, an absolute right to payment of any particular sum of money (see, for example,
Stein v. Saywell (1969) 121 C.L.R. 529; 43 A.L.J.R. 183; (1969) A.L.R. 481).
It would seem that the taxpayer's practice in dealing with the question of long service leave was, at the end of each ``income tax year'', to calculate, in respect of each employee who, at that time, had been in its service for at least five years, the amount which would have been payable to her or him upon the assumption that his services had been terminated in circumstances entitling her or him to payment in lieu of long service leave; the difference between that sum and the sum (if any) calculated as at the end of the previous ``income tax year'' was then charged against the taxpayer's profits as returned for the then just completed income tax year. Although the evidence does not, in express terms, disclose the practice to be so, I would infer from the evidence, that as and when an employee actually took long service leave, or, on the termination of her or his employment, received a payment in lieu of leave, the relevant amount paid was charged in the taxpayer's books, not against the profits of the relevant year but against ``the provision'' earlier raised as the result of any prior annual calculation. The amount of the additional ``provision'' made in relation to the ``income tax year'' with which I am concerned appears to have been $55,000; later and more detailed calculations would seem to demonstrate that if such a provision may, for income tax purposes, properly be charged against income, the correct amount chargeable is of the order of $43-44,000.
So much, then, for the factual background against which the matters debated before me are to be viewed.
On the hearing before me, Mr. A.M. Gleeson Q.C. and Mr. Graham Hill appeared for the taxpayer, while Mr. L.J. Priestley Q.C. and Ms. G.M. Kinnane appeared for the Commissioner.
Mr. Gleeson submitted:
- 1. that the evidence established the following general propositions of fact -
- a. that, at all material times the taxpayer was carrying on business as a financier;
- b. that it is of the essence of the business of a financier that the financier applies the funds available to it by lending them at interest;
- c. that borrowing money and relending it at interest is an integral part of the business of a financier;
- d. that even prior to 1969 the taxpayer had had a history of both overseas and local borrowings;
- e. that borrowing overseas was not the taxpayer's preferred method of raising finance but was a course of action forced on the taxpayer by the actions of the Australian Government;
ATC 4170
- f. that the various ``draw downs'' were always regarded and referred to as a substitute for funds which would or might otherwise have been raised on the Australian short term market;
- g. that the purpose of each and every one of the loans was to provide the taxpayer with funds to be dealt with in the ordinary course of the taxpayer's business - to be lent, to honour existing commitments to borrowers, to fund new business, or to repay existing borrowings;
- h. none of the relevant loans was earmarked for any special purpose;
- j. from the outset of the creation of the various facilities the possible effect of future currency fluctuations was an important part of the decision-making process, whether on ``draw down'' or ``roll-over'';
- k. from the outset, the possible effect of future currency fluctuations was always regarded by those involved in decision-making process as part of the cost of borrowing;
- l. the taxpayer's ``disengagement'' from Euro-currency loans was dictated not by the major devaluation of the Australian dollar in 1975 but by the continuing movement of the relevant European currencies against the Australian dollar and the taxpayer's wish to obtain a more balanced ``spread of currencies'';
- 2. in the circumstances -
- a. the realized exchange losses were losses or outgoings incurred in the normal course of the business of the taxpayer;
- b. that those losses were losses or outgoings necessarily incurred in carrying on business for the purpose of gaining or producing assessable income (he referred to
The Texas Company (Australasia) Limited v. F.C. of T. (1939-1940) 63 C.L.R. 382 at pp. 426-7 per Latham C.J.); - c. the critical question - which question was a mixed question of fact and law - was whether the losses were losses or outgoings on capital, or on revenue, account (he referred to
Sun Newspapers Limited v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-63 per Dixon J. (as he then was);
B.P. Australia Limited v. C. of T. (1966) A.C. 224); - d. in the case of companies or persons carrying on the business of banking or carrying on business as financiers the moneys with which such companies or persons deal in the ordinary course of business are part of the ``circulating capital'' and are thus to be dealt with on revenue account (he referred to
Farmer v. Scottish North American Trust Limited (1912) A.C. 118 at pp. 124 et seq. per Lord Atkinson;
Tip Top Tailors Limited v. Minister of National Revenue (1958) 11 D.L.R. (2d) 289 at pp. 291-2;
Thiess Toyota Pty. Limited v. F.C. of T. 78 ATC 4463; (1978) 1 N.S.W.L.R. 723;
Davies v. The Shell Company of China Limited (1950-51) 32 T.C. 133); - e. despite the tentative view - ``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'' - expressed by Gibbs J. in
Commercial and General Acceptance Limited v. F.C. of T. (77 ATC 4375 at p. 4377; (1977) 137 C.L.R. 373 at p. 377) the views of Mason J. (supra at ATC p. 4381 and C.L.R. pp. 383-4) (with whom Barwick C.J. and Jacobs J. concurred) and of Murphy J. support the view that where the principal purpose of the borrowings is to arm a taxpayer with more funds to lend or apply in the ordinary course of business the borrowings are part of the process whereby the borrower operates to obtain regular returns and thus any associated expenditure is an expenditure on revenue account (he referred to AVCO
Financial Services Limited v. F.C. of T. 79 ATC 4560; see also
F.C. of T. v. Total Holdings (Australia) Limited 79 ATC 4279;
F.C. of T. v. Cadbury-Fry Pascall (Australia) Limited 79 ATC 4346); - f. it followed that, to the extent to which the appeal related to the realized exchange losses, the appeal should be upheld;
ATC 4171
- g. the decision of the Federal Court of Australia in
F.C. of T. v. Nilsen Development Laboratories Pty. Limited (79 ATC 4520) as to the basis upon which, for income tax purposes, provisions for long service leave should be treated was wrong and should not be followed; - h. contrary to the views of Brennan and Deane JJ., the pecuniary liability associated with the obligation ultimately to grant long service leave accrues de die in diem;
- j. the liability which the provision for long service leave reflected was thus a liability incurred in the relevant year of income;
- k. therefore, to the extent to which it related to the provision for long service leave, the appeal should be upheld.
For his part, Mr. Priestley submitted:
- 1. an exchange gain or loss must necessarily be a capital gain or loss (he referred to the tentative view of Gibbs J. in Commercial and General Acceptance Limited v. F.C. of T. (supra) which I have set out above);
- 2. alternatively, the only circumstances in which an exchange gain or loss on a borrowing may result in assessable income or a permitted deduction are those cases in which the subject borrowing is directly related to identified expenditure of a revenue nature, as, for example, the purchase of stock-in-trade (he referred to F.C. of T. v. Cadbury-Fry Pascall (Australia) Limited (supra));
- 3. further, alternatively, even if it be otherwise, the true view of the evidence was that the subject borrowings were directed towards maintaining or expanding ``the profit-yielding subject'' rather than ``the process of operation'' and were thus of a capital nature;
- 4. care must be taken against an overready reliance upon the English cases for:
- a. the subject matter of the English legislation is ``profit'' or ``gain'' made in the course of trade;
- b. ``profit'' or ``gain'' takes into account all relevant receipts or outgoings;
- c. there is a fundamental distinction between the English and Australian legislation for -
- (i) sec. 51(1) excludes losses or outgoings of capital or of a capital nature;
- (ii) sec. 51(2) provides that expenditure incurred in relation to stock or trading stock is not to be regarded as being an expenditure of capital or of a capital nature
(he referred to and contrasted
Southern v. Borax Consolidated Limited (1941) 1 K.B. 111; (1940) 23 T.C. 597 and
John Fairfax and Sons Pty. Limited v. F.C. of T. (1958-59) 101 C.L.R. 30);
- 5. insofar as it related to the realized exchange losses, the appeal should be dismissed;
- 6. the decision of the Federal Court of Australia in F.C. of T. v. Nilsen Development Laboratories Pty. Limited (supra) was correct;
- 7. in any event, having regard to the scheme of appeals provided for by sec. 196, I was bound by the decision of the Federal Court of Australia;
- 8. it followed that insofar as concerned the amount claimed for long service leave the appeal should be dismissed.
With that preface, I turn to deal first with that part of the appeal which concerns the realized exchange losses. In doing so I propose to consider the question in the order suggested by Mr. Priestley's three alternative submissions.
Mr. Priestley's first submission is, as I have previously recorded, based upon the tentative view - set out above - expressed by Gibbs J. in Commercial and General Acceptance Limited v. F.C. of T. (supra). Notwithstanding the great respect which one is accustomed to attribute to the views - even if they be tentative - of Gibbs J., I find it difficult to accept that there is so fixed and immutable a rule as his Honour has suggested in the passage upon which Mr. Priestley so strongly relies. The existence of such a fixed and immutable rule would, so it seems to me, have rendered it unnecessary for Mason J. (with whom Barwick C.J. and Jacobs J. concurred) to adopt the approach
ATC 4172
which he did in denying that the exchange gain then in question should be brought to charge. In expressing this view, I do not overlook the fact that, at one stage of his judgment Mason J. said (supra at ATC p. 4380 and C.L.R. p. 383):``The exchange gain was in reality a saving or reduction in the amount of Australian currency equivalent which the taxpayer required to repay its indebtedness. In essence it was a windfall advantage stemming from a reduction in a liability to repay a borrowing of capital.''
However, it does not seem to me that his Honour was, in this passage asserting that the subject matter of every loan must have the character of capital, but, rather, that the subject loan had the character of capital. So much, so it seems to me, follows from the following passage in his Honour's judgment (supra at ATC p. 4381 and C.L.R. pp. 383-4):
``The evidence accepted by his Honour established that the principal purpose of the borrowing was not to arm the taxpayer with more funds to lend or apply in the ordinary course of its finance business - 35 per cent only of the loan could be so applied - but rather to provide a base of additional assets which would generally strengthen the taxpayer's financial standing and enable it the more readily to borrow moneys from the public by demonstrating that it was free of liquidity problems.
Indeed, the evidence shows that by reason of the condition contained in cl. 6.6 of the loan agreement, that 65 per cent of the amount of the loan should be kept in cash and money market instruments, it was inevitable that the interest payable under the loan would exceed the income to be derived from it. This was because the interest charges payable to the Bank of America were those appropriate to a long-term loan, whereas the interest payable on money market securities was at a lower rate appropriate to short-term securities. No doubt the effect of the loan was to enable the taxpayer to divert other funds into the more profitable channels of its finance business, but this does not affect the character of the loan transaction itself.
In these circumstances 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. (supra) in elaborating the difference between expenditure and outgoings on revenue account and on capital account. In truth the transaction was designed to strengthen the framework within which the taxpayer intended to carry on business - see
C. of T. v. Nchanga Consolidated Copper Mines Ltd. ((1964) A.C. 948, at p. 959); B.P. Australia Ltd. v. F.C. of T. (supra).''
It is, I think, implicit in what his Honour has said in this passage that, if the principal purpose of the borrowing was part of the process of operation of the then taxpayer, by means of which process it obtained regular returns, then the disputed exchange gain ought to have been brought to charge.
A similar view, so it seems to me, appears in the judgment of Menzies J. in
Caltex Limited v. F.C. of T. ((1959-60) 106 C.L.R. 205 at p. 251) where his Honour says:
``The purchase of pounds to repay the dollar loan that was obtained from the new supplier could not affect revenue account unless the borrowing of the money was itself part of the taxpayer's trading activity. Borrowing money to carry on business or to pay liabilities incurred in carrying on business is prima facie to increase the capital employed in the business, and there is not sufficient here to give the taxpayer's borrowing any different character. What occurred, therefore, was the discharge of a revenue liability owing to the old supplier with dollars borrowed upon capital account from the new supplier, and at the point of discharge it is necessary to decide whether the taxpayer was worse off in terms of Australian currency than it was when it incurred the original liability. I think it was and that the difference does represent part of the cost in pounds of carrying on business to produce assessable income.''
I conclude, therefore, that while, prima facie, borrowing money to carry on business
ATC 4173
or to pay liabilities is prima facie ``an affair of capital'' - so that any exchange gain or loss arising in relation to the borrowed funds is irrelevant for income tax purposes - there is not such fixed or immutable rule such as is suggested by Gibbs J. in the passage upon which Mr. Priestley relies (see also Davies v. The Shell Company of China Limited (supra at p. 157 per Jenkins L.J.); Tip Top Tailors Limited v. Minister of National Revenue (supra); AVCO Financial Services Limited v. F.C. of T. (supra)). I therefore reject Mr. Priestley's first submission.What, then, of Mr. Priestley's alternative submission, that is, that the only circumstances in which an exchange gain or loss on a borrowing may result in assessable income or a permitted deduction are those cases in which the subject borrowing is directly related to identified expenditure of a revenue nature, as, for example, the purchase of stock in trade?
It is, of course, well established that if a taxpayer purchases goods at a price payable in a foreign currency at a future time and, in consequence of a currency movement prior to the time for payment, is obliged to spend a lesser or greater sum in Australian dollars in discharging his liability for the price that variation must be reflected in the taxpayer's return of income; and, if the payment is made in a subsequent ``income tax year'', the ``exchange gain'' must be brought to charge or the ``exchange loss'' allowed as a deduction (The Texas Co. (Australasia) Limited v. F.C. of T. (supra); Armco (Australia) Pty. Limited v. F.C. of T. (1948) 76 C.L.R. 584; Caltex Limited v. F.C. of T. (supra):
International Nickel Australia v. F.C. of T. 77 ATC 4383; (1976-7) 137 C.L.R. 347; Thiess Toyota Pty. Limited v. F.C. of T. (supra)). This being so, it would seem to follow, as a matter of logic, that if, in any given case, goods had been acquired by means of an overseas loan, repayable in a foreign currency, any exchange gain or exchange loss arising on the repayment of the loan ought either to be brought to charge or allowed as a deduction in the taxpayer's return of income, for the loan was, in reality ``an affair of revenue'' - this, indeed, seems to have been a view which commended itself to Jenkinson J. in F.C. of T. v. Cadbury-Fry Pascall (Australia) Limited (supra). But if, as I conceive to be the true position, the obtaining of a loan may, in an appropriate case, be ``an affair of revenue'' (see, for example, F.C. of T. v. Total Holdings (Australia) Limited (supra)) then there seems to me that there is no reason in logic why, in such case, the principle reflected in F.C. of T. v. Cadbury-Fry Pascall (Australia) Limited (supra) should be limited to loans associated with the purchase of stock rather than be regarded as extending to embrace loans related to any ``affair of revenue''. I accordingly reject Mr. Priestley's alternative submission.
I turn, then, to the third of Mr. Priestley's submissions, that is, that the true view of the evidence was that the subject borrowings were directed towards maintaining or expanding ``the profit-yielding subject'' rather than ``the process of operation'' and they were ``an affair of capital''.
With regard to this submission, Mr. Priestley submitted that the evidence demonstrated the following:
- 1. that the business of the taxpayer was that of a money lender;
- 2. that trading in foreign currency was not, at any time, a part of the taxpayer's business;
- 3. that each of the International Commercial facility and the National facility was of extended duration, the former for 5 years; and the latter, as ultimately varied, for 10 years;
- 4. that each of the facilities, and, in particular the latter, thus became part of the structure of the business of the taxpayer;
- 5. that, in its Prospectuses, the taxpayer put forward the National facility for the purpose of demonstrating the size and stability of its financial structure;
- 6. any borrowings made pursuant to either facility were thus ``coloured'' by the standing contractual arrangements pursuant to which they were made;
- 7. the loans thus drawn down or ``rolled over'' were, in substance, no different from moneys which the taxpayer might have obtained by the issue of redeemable preference shares - that is, they were, in substance, part of the capital of the company;
ATC 4174
- 8. this view is strengthened by the fact that the borrowings from time to time made pursuant to the various facilities were, apparently, applied for the general purposes of the taxpayer, and were not integrated with, or linked to, any particular loan or loans, or classes of loan, made by the taxpayer;
- 9. further support for this view in the manner in which the unrealized gains were treated in the financial records of the taxpayer; that is, as shareholders' funds or capital, rather than passed through the Profit and Loss Account;
- 10. the discharge of the subject loans in 1975 was not part of the ordinary business of the taxpayer - it was part of a process of ``disengagement'' from foreign currency borrowings;
- 11. the purpose of the process of ``disengagement'' was to protect, or to preserve, the capital of the taxpayer from loss or from further loss;
- 12. the process of ``disengagement'' had nothing to do with the trading or revenue activities of the taxpayer.
It is, in this situation, necessary, in my view, to go further than labelling the taxpayer a ``financier'', ``money lender'' or ``currency trader''; what one must do, in my opinion, is to determine how this particular taxpayer carried on its business. It is clear, at the outset, that substantial though the subscribed capital and shareholders' funds of the taxpayer may have been, they, at no relevant time, were sufficient to enable the taxpayer to carry on business on the scale which it did; it was, at all relevant times essential for the taxpayer's business that it have access to substantial borrowed funds to on-lend to its customers. It is also clear that, at all relevant times, the taxpayer obtained its borrowed funds from a variety of sources, overseas institutions, local institutions and local public subscriptions. Finally, it is clear that the funds which were borrowed by the taxpayer for the purposes of its business were, at all relevant times, borrowed pursuant to a variety of contractual arrangements, and for varying periods, the object, as I understand it, being to permit the taxpayer to on-lend to its customers by way not only of short-term, but, also, of medium-term and long-term, loans (see Transcript p. 53). It follows, in my view, that while it is correct to say, as Mr. Priestley has submitted, that the taxpayer's business was not that of a dealer in foreign currency, it is, nonetheless true to say that the taxpayer's business was that of a dealer in credit, its profit being derived from the margin between, on the one hand, the cost to it of obtaining, ``holding'', ``selling'', ``protecting'' and collecting the funds (or credit) which it had or which it borrowed, and, on the other, the interest charged to, and received from, its customers.
If this be so, then, so it seems to me, the application by the taxpayer of the funds from time to time borrowed by it cannot be described as expenditure on the structure within which profits were to be earned; rather, the application of those funds by onlending them was an integral part of the process by which the taxpayer earned its income. It follows, in my view, that the borrowed funds of the taxpayer, wherever borrowed, so applied by the taxpayer ought to be categorized as circulating capital.
The question thus is, whether the ``foreign exchange losses'' can properly be described as ``losses or outgoings... necessarily incurred for the purposes of gaining or producing (assessable) income''. While I am by no means persuaded that the phrase ``foreign exchange loss'' is an entirely appropriate description of what is involved - I prefer to think of the additional cost of repayment of the relevant loans as an additional cost of borrowing - I am satisfied that the ``losses'' ought properly to be treated as losses or outgoings necessarily incurred in the income earning process. The evidence would seem to demonstrate that, at all relevant times, borrowing overseas was an integral part of the process by which not only the taxpayer but most, if not all, major financiers in Australia funded their lending activities; so too the evidence would seem to demonstrate that, at all relevant times, fluctuations in the value of currencies were an established feature of the worldwide monetary scene. This being so it seems to me that the ``losses'' in question ``represent that kind of casualty, mischance or misfortune which is a natural or recognized incident of (the) particular trade or business the profits of which are in question (and that they were) characteristic incidents of the systematic
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exercise of a trade or the pursuit of a vocation'' (C. of T. (N.S.W.) v. Ash (1938) 61 C.L.R. 263 at p. 277 per Rich J.; see also
Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at pp. 56-7;
Charles Moore & Co. (W.A.) Pty. Limited v. F.C. of T. (1956) 95 C.L.R. 344 at pp. 350-1).
It follows, in my view, that, to the extent to which ``the realized foreign exchange losses'' sustained by the taxpayer represent ``losses'' on funds borrowed by the taxpayer and applied by the taxpayer for the ordinary purposes of its business they are to be allowed as a deduction pursuant to the provisions of sec. 51(1) of the Act.
I turn, then, but, in the circumstances, briefly, to the question of the deduction claimed for the increased provision for long service leave. Quite untutored by authority I would have thought that, while there was much to be said for the view which commended itself to Murphy J., at first instance, in
Nilsen Development Laboratories Pty. Limited v. F.C. of T. (78 ATC 4335), namely, that in respect of those employees of the taxpayer who had completed the appropriate period of service which would qualify them for long service leave, it could be said that a pecuniary liability had accrued, it was, nonetheless, difficult to treat the value then assigned to that liability as an ``outgoing'' necessarily incurred in the relevant year of income. This, so it seems to me, would flow from the facts, firstly, that an employee's primary entitlement is to paid leave, and, secondly, that the payment to which an employee, entering upon leave, is entitled, is payment calculated at his then ordinary rate of pay - which may not be the same as the rate of pay to which he was entitled at the time of the accrual of his entitlement to leave - it following, that one could not accurately quantify the extent of the relevant liability until any particular employee entered upon his leave or until that employee's service was terminated. The inability to quantify, accurately, the extent of the pecuniary liability until the happening of either of the events to which I have referred would, in my view, lead one to the conclusion that, until the liability was quantified by payment, it was not, for income tax purposes, ``incurred''. I am, however, relieved of the necessity of considering the matter further for, quite apart from other authorities which might lead one to a similar conclusion (see
F.C. of T. v. James Flood Pty. Limited (1953) 88 C.L.R. 492;
F.C. of T. v. The Northern Timber & Hardware Co. Pty. Limited (1960) 103 C.L.R. 650), I regard myself as bound by the decision of the Federal Court of Australia in F.C. of T. v. Nilsen Development Laboratories Pty. Limited (79 ATC 4520) which decision would deny deductibility to the increase in the provision for long service leave in the year of income with which I am concerned.
This leaves only the question of the costs of the appeal. Although the taxpayer has not been completely successful upon the appeal, the time devoted, during the course of the hearing, to the question of long service leave, was insignificant in the extreme - it consisted of little more than the time involved in reading the Affidavit of Mr. Wright, the former Secretary of the taxpayer, and the time occupied - but 13 minutes - with the oral evidence of Mr. Stewart, the present Secretary of the taxpayer, who identified the relevant statutes, awards and Wages Board determinations relating to long service leave, and who explained the procedure adopted in calculating the relevant provision for long service leave. In the light of the fact that the appeal, as a whole, occupied some 4½ days, it seems to me that the appropriate order for costs is that the Commissioner pay the taxpayer's costs of the appeal except to the extent to which those costs relate to the preparation of Mr. Wright's Affidavit or to the oral evidence of Mr. Stewart.
For these reasons, I make the following formal Orders:
1. ORDER that -
- a. to the extent to which it relates to the disallowance of the deduction claimed for realized exchange losses, the appeal be upheld;
- b. to the extent to which it relates to the disallowance of the deduction claimed in respect of the provision for long service leave, the appeal be dismissed;
2. ORDER
that the Amended Assessment issued to the taxpayer in respect of the taxpayer's income tax year ended 31
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December 1975 be remitted to the Commissioner for amendment in accordance with these reasons;3. ORDER
that the Commissioner pay the taxpayer's costs of this appeal except to the extent to which those costs relate to the Affidavit sworn herein on the 15th day of February by Eric Stanly Wright or to the oral evidence given on the hearing of the appeal by Jack Caldwell Stewart;
4. ORDER
that, unless, within 28 days, an Appeal is lodged, Exhibits may be returned; in the event of an Appeal being lodged Exhibits to be retained until the disposition of the appeal.
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