Hunter Douglas Limited v. Federal Commissioner of Taxation.
Judges:Rogers J
Court:
Supreme Court of New South Wales
Rogers J.
The taxpayer has appealed against the disallowance by the Commissioner of Taxation of two objections to refusals by the Commissioner to allow, as deductions against the taxpayer's income, currency exchange losses suffered by the taxpayer in the years ended 30th June, 1977 and 1978. By consent, the two appeals were heard together.
The facts founding the taxpayer's claim are not in dispute. The taxpayer was at all relevant times well established in the business of the development, manufacture and marketing of window covering, home improvement, casual living, architectural and building products. In 1971, according to Mr. Barlow, who was then Group Accountant of the taxpayer, it was determined that the budgets and cash forecasts prepared for the taxpayer necessitated the obtaining of additional finance required to be expended by the taxpayer in the day-to-day running of its business. At all times relevant to these appeals the taxpayer had credit facilities with its Australian bankers. It would seem that the taxpayer made some informal approaches to its bankers in Australia for additional finance, but was unsuccessful in obtaining the requisite accommodation.
The taxpayer had the advantage that its majority shareholder is a company resident in the Netherlands. That company made approaches to two banks, the Banque Europeene de Credit a Moyen Terne, S.A., a Belgian organisation, and the Amsterdam-Rotterdam Bank N.V. of the Netherlands. Negotiations resulted in an agreement executed by the taxpayer on 1st February, 1972 for the provision by the two banks of standby facilities in an amount of US$2m.
In the evidence the participation of the Dutch bank has been disregarded and the transaction has conveniently been described as being with ``B.E.C.'', an appellation which I will utilise.
Article 3 of the loan agreement afforded the taxpayer the opportunity of drawing on the standby facility between 1st February, 1972 and 1st February, 1975, in multiples of US$100,000, with a minimum of US$200,000 to be drawn either in United States currency or its equivalent in another currency, chosen ``in consultation between the borrower and B.E.C.''. The taxpayer was entitled to repay amounts drawn down on five days notice. The facility was available for a period of seven years, which was subsequently extended to ten years.
Article 5 provided for the payment of interest calculated ``on the basis of the offered quotation to first class banks for deposits in the appropriate currency for a period in accordance with the previous paragraph, plus one per cent per annum''.
Article 6 gave the option to the taxpayer to switch the currency in which the loan was drawn, in accordance with the procedures prescribed.
The taxpayer drew on the facility thus provided in Swiss francs on 9th July and 9th November, 1973, and in United States dollars on 19th July, 1st August and 19th August, 1974. The first of the drawings was converted to Dutch guilders on 10th January, 1977, and the drawing on 9th November was partly converted to Dutch guilders on 26th January. The amounts drawn and the dates of repayment and the amounts repaid are conveniently set out in a schedule which has been provided to me and which I reproduce.
ATC 4553
``Banque Europeene De Credit
Drawn 9.7.73 Swiss francs 1,150,000 Australian dollars 288,220 10.1.77 Converted to Dutch guilders 1,149,080 Repaid 11.7.78 456,255 ---------- Exchange loss 168,035 Drawn 9.11.73 Swiss francs 1,500,000 Australian dollars 321,130 Repaid 25.1.77 Swiss francs 388,869 143,056 ---------- Exchange loss 59,804 26.1.77 Converted balance to Dutch guilders 1,115,408.85 Repaid 27.6.78 439,310 ---------- Exchange loss 201,432 Drawn 10.7.74 U.S. dollars 300,000 Australian dollars 201,342 Repaid 20.7.78 262,192 ---------- Exchange loss 60,850 Drawn 1.8.74 U.S. dollars 200,000 Australian dollars 134,228 Repaid 30.8.78 174,049 Exchange loss 39,821 Drawn 19.8.74 U.S. dollars 600,000 Australian dollars 402,766 Repaid 28.7.78 523,789 ---------- Exchange loss 121,023''
It will be seen from that table that universally the Australian dollar suffered against the currencies in which the loans were denominated and that, in the repayments which were effected, a larger number of Australian dollars was called upon to be provided than was thrown up by the original drawing.
The taxpayer's officers considered that further credit facilities were required for the purpose of providing working capital, based on the taxpayer's budgets and cash forecasts produced in the middle of 1973. Once again the Australian credit facilities were explored, with unsatisfactory results. In July 1974 the Dutch parent entered into a loan agreement, bearing date 3rd July, 1974, with Orion Term Bank Limited of the United Kingdom, which in turn has been conveniently referred to as ``Orion''. A feature of the loan agreement was that the facility provided thereunder could be drawn on by a subsidiary of the borrower in the event that certain requirements were satisfied. Those requirements were satisfied in respect of the taxpayer in October 1974, and it thereupon became entitled to draw on the facilities provided by Orion. The total amount of the standby facility was $4m, which could be drawn against by a qualified subsidiary either in United States dollars or any other freely convertible ``Eurocurrency'' (see para. 2.3). Repayment was to be in the same currency
ATC 4554
(see para. 2.5). Subclause 3 of para. 2.5 permitted an alteration of the currency in which the borrowing was denominated. Clause 3.5.2 made specific provision for the consequences of exchange rate fluctuations. I have also noted para. 4.1, which again fixes the interest payable by reference to the denomination in which the borrowing was drawn down. As it happens in the case of this loan, all drawdowns were in United States dollars and again by reason of the movement by the United States currency against the Australian dollar in the relevant period, in each instance an exchange loss was suffered. The relevant transactions between the borrower and Orion are also set out in the schedule the relevant portion of which I reproduce.``Orion Bank Limited, London:
$ $ Drawn 4.12.74 U.S. dollars 1,000,000 Australian dollars 759,301 Repaid 30.8.78 869,565 --------- Exchange loss 110,264 Drawn 13.12.74 U.S. dollars 500,000 Australian dollars 378,530 Repaid 14.12.77 442,752 --------- Exchange loss 64,222 Drawn 22.8.75 U.S. dollars 1,000,000 Australian dollars 779,606 Repaid 27.9.78 867,679 --------- Exchange loss 88,073''
In the result, in respect of these transactions the taxpayer suffered a detriment, in the sense that the Australian dollars required to repay in the appropriate currencies the loans provided by B.E.C. and Orion totalled $913,524, more than the total of the original drawdowns.
Mr. Barlow, in his affidavit, deposed to the purpose of these drawdowns and to the use to which they were put. He said in para. 36 and 37 of his affidavit:
``36. All drawdowns of the B.E.C. loan and the Orion loan referred to above were made on the basis of the budget projections prepared by the Company during the period in which the drawdowns were made as part of its usual financial planning. At the end of each month these six-monthly projections were prepared using the annual Budget adjusted to current and projected trends showing the anticipated cash position of the Company for a period of six months ahead. Drawdowns on the credit facilities provided by B.E.C. and Orion were made where these projections showed a cash deficiency and other local finance was not available.
37. All drawdowns of the B.E.C. loan and the Orion loan were used by the Company for the purpose of providing funds for the day-to-day running expenses of the Company's business in respect of the itemised expenses in the Schedules annexed hereto. Some of these payments may have been non-deductible to the Company but the greater balance of payments consisted of the payment of amounts which were deductible to the Company in determining its assessable income.''
The appellant's submissions may be encapsulated in the following propositions: if a borrowed fund is used for the purpose of gaining or producing assessable income or in the course of carrying on a business for that purpose, then all the costs involved are prima facie deductible. If one of the costs is of the
ATC 4555
kind generally referred to as an exchange loss, that cost is deductible unless it is an outgoing of capital or of a capital nature. By reason of the to which the moneys borrowed were put, the loss was not of a capital or of a capital nature.The principles against which these submissions have to be measured have been substantially settled by recent decisions of the High Court. The primary principle with which to commence an examination of the topic is set out in the judgment of the Chief Justice in
AVCO Financial Services Limited v. F.C. of T. 82 ATC 4246; (1982) 56 A.L.J.R. 668. The taxpayer there was a finance company. For the purpose of enabling it to provide finance to its customers it borrowed moneys, inter alia, in the United States. In the tax years in question, in some years it incurred exchange losses, in some years it made exchange gains in effecting repayments of moneys borrowed. In that setting, the Chief Justice at ATC p. 4249; A.L.J.R. p. 670 said:
``The gains which resulted from variations in the rate of exchange will be assessable if they can be regarded as income in accordance with ordinary usages and concepts and so within sec. 25(1) of the Income Tax Assessment Act 1936 (Cth.), as amended (`the Act'). The losses will be deductible if they fall within sec. 51(1) of the Act, i.e. if they were losses or outgoings incurred in gaining or producing the assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income, and if they were not losses of a capital nature. Where, as a result of variations in the rate of exchange, a taxpayer, in the course of carrying on a continuing business, makes gains or incurs losses of a revenue and not of a capital nature, the gains are assessable income in the year in which they are realised and the losses are allowable deductions in the year in which they are incurred. This is settled by a line of authorities in this Court (
Texas Co. (Australasia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382;
Armco (Australia) Pty. Ltd. v. F.C. of T. (1948) 76 C.L.R. 584;
Caltex Ltd. v. F.C. of T. (1960) 106 C.L.R. 205;
International Nickel Australia Ltd. v. F.C. of T. 77 ATC 4383; (1977) 137 C.L.R. 347) and is not now in dispute. The principle has been fully discussed and explained in the cases to which I have referred and does not require elaboration. The sole question in the present case is whether the gains and losses were of a revenue or of a capital nature.''
In attempting to arrive at a conclusion on the sole question thus posited by his Honour, whether losses are of a revenue or of a capital nature, there are no absolutes, but guidance is provided by both the High Court and the Federal Court. Thus, in general terms, if the principal amount is payable on a revenue account, then generally speaking, losses or gains occasioned by a variation in the rate of exchange will similarly be on a revenue account. Equally, however, the decisions show that expenditures to secure capital may in appropriate cases throw up revenue expenditures, in respect of which variations in exchange rates may increase or decrease the quantum of deduction.
The foregoing is but an inadequate attempt at reflecting what fell from the Chief Justice in another passage in AVCO at ATC pp. 4249-4250; A.L.J.R. p. 671, where his Honour says:
``It does seem true to say, at least in general, that if an amount payable by a taxpayer is allowable as a deduction, then any increase or decrease in that amount caused by a variation in the rate of exchange is to be taken into account as an allowable deduction or as assessable income as the case may be: see the second of Murphy J.'s propositions in
Commercial and General Acceptance Ltd. v. F.C. of T., at ATC p. 4382; C.L.R. p. 386. In such a case, ex hypothesi the amount originally payable will not be of a capital nature. For example, there is no doubt that where the payment in connexion with which the gain or loss is made is the price of goods used by the appellant as trading stock the gain or loss will be of a revenue nature: see Texas Co. (Australasia) Ltd. v. F.C. of T. and International Nickel Australia Ltd. v. F.C. of T. However, expenditure may be deductible in some cases even if it is designed to secure an advantage of a capital nature.''
ATC 4556
Counsel for the Commissioner has rightly submitted that in arriving at a conclusion in the present case I must have regard to principles of general application enunciated in the joint judgment of Mason, Aickin and Wilson JJ. This of course I intend to seek to do. The general principles to which attention has thus been drawn are firstly that a loan and the repayment of a loan are generally an affair of capital (ATC p. 4255; A.L.J.R. p. 675C).
Secondly, their Honours approved the statement of Menzies J. in Caltex Limited v. F.C. of T. (1960) 106 C.L.R. 205 at p. 251, that:
``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''
(ATC p. 4255; A.L.J.R. p. 675D).
Thirdly, their Honours referred to the dissenting judgment of Cartwright J. in
Tip Top Tailors Ltd. v. Minister of National Revenue (1958) 11 D.L.R. (2d) 289, where at p. 300 his Honour said:
``... in the case of a taxpayer carrying on a commercial undertaking such as that of the appellant, whose business is not that of dealing in foreign exchange or borrowing and lending money, a gain or loss related to dealings between borrower and lender is prima facie one of capital and not of income''
(ATC p. 4256; A.L.J.R. p. 675G).
The general propositions thus enunciated are, I venture to think, based on the general notion which finds expression at ATC p. 4256; A.L.J.R. p. 675 of the joint judgment where their Honours say:
``On the other hand, borrowing by a manufacturing or trading company is often undertaken to strengthen the capital or profit-earning structure of the company. A finance company usually borrows in order to increase its working capital which is then turned over at a profit; the manufacturing or trading company frequently borrows to strengthen its permanent capital.''
I have ventured to lend emphasis to the words which, in my respectful view, make clear that their Honours were directing their minds to what might be called a customary situation, and were not intending to delimit in absolute terms the occasions when invariably borrowings are to be termed capital or revenue borrowings, as the case may be.
The decision in AVCO is but the latest in a line of decisions wherein the Courts have sought to work out the limits within which fluctuations in rates of currency exchange resulting in gains and/or losses will sound in assessable income or deductions, as the case may be, as distinct from those occasions when such amounts must rank as capital transactions. In the forefront of instances where the fluctuations in question have been held to be of a revenue nature are instances where goods were purchased outside Australia with the purchase price in other than Australian currency, and prior to payment there were movements in the currency one way or the other when measured against Australian currency. In such circumstances, even if payment was delayed for some time and the unpaid purchase price utilised by the taxpayer as part of its working capital, the transaction did not lose its revenue or income nature, and the resultant movement in exchange rates resulted in either assessable income or an appropriate deduction.
In so saying, I have attempted to summarise what I understand to be the effect of the decision of the High Court in
Texas Co. (Australasia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382. There the taxpayer incurred debts overseas for trading stock, plant and equipment and other capital items, and also advances made to it. The items sold and the advances made were denominated in United States currency at a time when the rate of exchange between that currency and the Australian pound was close to par. By the time of payment, the rate had moved against the Australian pound. The taxpayer did not pay the purchase price for the goods at the time when it would have been ordinarily payable.
It may be noted that according to the reported argument, and indeed as is made clear in the judgment of Sir John Latham (pp. 424 and 429), the Commissioner was prepared to allow the taxpayer the cost of the
ATC 4557
additional Australian pounds required to discharge the liability in respect of the purchase of goods at the time when the purchase price would have been ordinarily payable. However, payment was withheld with the consent of the supplier, producing at least a two-year lag between invoicing and payment made.On behalf of the Commissioner it was argued that any increased cost due to this further delay in payment occasioned by the taxpayer's need for capital was to be regarded as an outgoing of capital and not allowable as a deduction because ``it was really incurred by reason of the necessity of obtaining more capital for the company'' (see p. 429).
The Court rejected that submission, the Chief Justice saying at p. 430:
``It was further objected on behalf of the Commissioner that the exchange in question was not an allowable deduction because it did not constitute a payment or any part of a payment for goods. I have already incidentally dealt with this objection. In my opinion, the payment may be described as a payment of the price of goods, but it may also be described as an ordinary outgoing not in the nature of capital, because it was an outgoing for the purpose of carrying on a business as a going concern and a necessary outgoing for that purpose. Accordingly, the amount can be deducted under sec. 23(1)(a). Therefore, even if the view be taken that the expenditure of the moneys paid to obtain the American dollars cannot be regarded as being simply and only a payment of the price of goods, still the payment can be deducted as an outgoing under sec. 23(1)(a).''
(I have ventured to lend emphasis to part of his Honour's judgment because it is of crucial relevance in the conclusion to be arrived at in the present case.)
I should mention in parenthesis that statements such as appear in the last full paragraph on p. 428 and in the paragraph following that from which I have quoted at p. 430 are explicable in the light of the concession made by counsel for the taxpayer in reply (see p. 421).
Dixon J., whose judgment obtained the approval of Rich and McTiernan JJ., rejected the generalised submission that because the increase in expenditure arose from a delay in payment designed to create a fund for working capital, it followed that it was a capital outgoing. His Honour explained the reasons for this view at p. 468 when he said:
``Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant. No doubt the difficulty of assigning an outgoing to capital or income is often very great. This Court has dealt with aspects of the problem in
Egerton-Warburton v. D.F.C. of T. (1934) 51 C.L.R. 568, cf. at pp. 575-576;
Ash v. F.C. of T. (1938) 61 C.L.R. 263; and
Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337. Here I think that there are factors which place the expenditure in the category of an outgoing on account of revenue, so far as it is not referable to capital liabilities. First among these factors is that the circumstances that the liability discharged is ex hypothesi of an income nature. Next the chance of loss or gain in the expenditure required to discharge it, owing to variations in exchange, is a matter attendant upon the use of funds transferable from one country to another, which is continual, recurrent and not independent of judgment and policy on the part of those managing a business of which such funds form a part. It is a loss or gain ordinarily regarded in business as detachable from the fund, and susceptible of treatment as a trading profit or loss.The delay increased the chances of a loss expressed in pounds, but the fact that the reason for the delay related to capital does not make the outgoing a capital loss. It is rather a standing contingency representing the recurrent expenditure which must be incurred to obtain the use of the money and is much more like annual outgoings to obtain the use of capital assets, such as rent, hire or interest.''
ATC 4558
Commercial reality and business efficacy dictated that the boundaries for deduction or assessment delimited by the decision be extended to circumstances where a bank or financier is substituted as the creditor for the original vendor, that extension was affected by the decision of Meares J. in
Thiess Toyota Pty. Limited v. F.C. of T. 78 ATC 4463, and received the approval of the High Court in AVCO. The taxpayer there obtained delivery of its stock in trade, motor cars, by means of letters of credit which, by arrangement with its bankers, it was not required to discharge for some 90 days. Payment by the bankers to the Japanese supplier was made in sterling in London, and the devaluation of sterling intervened between payment to the Japanese supplier and discharge by the taxpayer of its liability under the letter of credit. At p. 4467 his Honour explained his reason for holding the transaction to be one of an income nature, when he said:
``It is unreal, as I see the appellant's dealings with the bank, in regard to the acquisition of the vehicles to consider them as involving two separate and discrete transactions. The appellant's arrangements with the bank were, in my opinion, all part of a transaction relating directly to and having the purpose of the purchase of trading stock and the exchange gains were, in reality, not on capital but on revenue account.''
I do not wish to encumber a judgment which is already too long, and which will be of only passing interest, as this matter travels along the appellate path, by further citations, and I merely acknowledge my indebtedness to the exposition to be found in the judgment of Jenkinson J. in
F.C. of T. v. Cadbury-Fry Pascall (Australia) Ltd. 79 ATC 4346 at p. 4351.
Before the decision of the High Court in AVCO, it was apparently the view of the Commissioner that the principle laid down in the Texas case and applied in subsequent decisions of the High Court and of inferior courts was restricted to instances where the liability for principal arose from the purchase of goods or supply of services. Indeed, that appears to have been a submission put in terms to the Judge of first instance in AVCO, Kearney J. (79 ATC 4560 at p. 4565). His Honour rejected this submission (p. 4567).
The matters to which regard should be had are stated by his Honour in the following terms:
``It is the nature of these borrowing transactions, which includes reference to their purpose which determines the issue between the parties.
The ultimate object of the taxpayer's enterprise was to make profits out of the making of the consumer loans. It is clear that in order to provide funds to this end it made borrowings, inter alia, in foreign currency.''
Once the requisite nature and purpose is found, it matters not whether the original transaction was one for the purchase of goods or supply of services: nor, in my view, is it accurate to say, as was submitted on behalf of the Commissioner, that exchange losses or gains on borrowed funds for on-lending, as happened in AVCO, constitute but an exception to the general principle which would work to reject claims for exchange fluctuations to be of an income or revenue nature in the absence of a sale of goods or supply of services. In my respectful view, what fell from Mason J. in
Commercial and General Acceptance Limited v. F.C. of T. 77 ATC 4375 at p. 4381; (1977) 137 C.L.R. 373 at p. 384 is also inconsistent with the soundness of the submission.
It may be useful to round off the survey of relevant principle by referring to the summary made by Dixon J. himself of the Texas case in his subsequent judgment in Armco (Australia) Pty. Limited v. F.C. of T. (1948) 76 C.L.R. 584 at p. 621. There his Honour said:
``There the purpose of allowing a fund to accumulate, representing, among other things, unpaid purchase of stock, was that it should be employed in trading, not taken out of the business and invested. The use of the money as trading capital was not considered to exclude the view that variations in the exchange rate might result in gains or losses on revenue account.''
ATC 4559
In my view the true approach which is required is that embraced by Kearney J. in AVCO, and that is to test the nature of the outgoing, conformably to the principles enunciated by Dixon J. in Sun Newspapers Limited v. F.C. of T. (1938) 61 C.L.R. 337 at pp. 359-363, in the light of the comments made by the Privy Council in
B.P. Australia Limited v. F.C. of T. (1965) 112 C.L.R. 386.
The two loan agreements to which I have referred are important as providing the context in which the actual drawdowns occurred. However, the drawdowns themselves are the primary transactions on which attention should be focused. They were of a recurring nature and, most importantly, were required to be made so that proceeds could be and were devoted in the satisfaction either mediately or immediately of outgoings of the taxpayer's business of a clearly revenue nature. The payment of wages, the payment of payroll tax, the payment for stock in trade, are but examples of the kind of expenditure to which the funds in question were devoted. The moneys obtained from B.E.C. and Orion were utilised as working capital used in the course of the taxpayer's business (Tip Top Tailors supra at p. 292). It was utilised in the activities by which the taxpayer earned its income.
Applying as best I can the principles I have mentioned to the purpose and nature of the transaction, I am of the view that the borrowings in question were just as clearly required for application in the taxpayer's business of satisfying day-to-day outgoings as was the utilisation of borrowed funds in AVCO. True it is the moneys themselves were not paid out as loans, but they were utilised in enabling the profits of the taxpayer to be earned.
I come to this conclusion the more easily because in my view the losses in question should, in current economic circumstances, be perceived to be in essence in the nature of interest. This is an aspect of exchange fluctuations which has not heretofore enjoyed which was examination of the Courts. That is partly because it is only within the last decade or so that there came into common commercial usage means of exchange such as Eurocurrency, that we have become accustomed to violent fluctuations in interest rates, and in currency adjustments. A fair indicia of this fact is that it is only within that period that there have come into common usage in the commercial world hedging contracts to guard against the effects of interest and currency fluctuations. The very terms of the borrowing agreements with B.E.C. and Orion make clear the importance the parties attached to the currency in which they wished to deal.
Mr. Mortimer's evidence in this case makes it clear, to my mind at least, that in circumstances such as the present, where a borrower enjoys the privilege of nominating the currency in which a loan is to be extended, he takes into account, in determining the appropriateness of interest and the appropriateness of the currency to be chosen, what his expectation is of currency movements. In other words, the compensation for a lower rate of interest may well be a loan in a currency in which fluctuation is expected. In those circumstances, to pay the result of such currency fluctuation must in a very real commercial sense be perceived to be nothing more nor less than the equivalent of the payment of interest in any guise. The fact that the rate of interest depends on the currency in which the loan may after given time be denominated requires recognition. It is, however, unnecessary to pursue this aspect of the matter which is, if at all, deserving of examination at hands other than mine, who may be in a position to arrive at an authoritative conclusion.
However, what I have said with respect to the nature of the outgoings or loss is sufficient to determine the fate of the appeals. The appeals will be allowed. I order that the assessments be remitted to the Commissioner for amendment, and I order the respondent to pay the appellant's costs. Exhibits may be retained for 28 days, thereafter to be dealt with in accordance with the rules of Court.
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