Case Q39

Judges:
KP Brady Ch
JE Stewart M
DJ Trowse M

Court:
No. 2 Board of Review

Judgment date: 13 May 1983.

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K.P. Brady (Chairman), J.E. Stewart and D.J. Trowse (Members)

The question involved in this reference is whether an amount paid by the taxpayer, a practising chartered accountant, during the 1980 financial year to honour a guarantee given by him and others to a trading bank is an allowable deduction under sec. 51 of the Income Tax Assessment Act.

2. The taxpayer, who commenced private practice in 1975, provided on a number of occasions guarantees to a bank for the benefit of various companies associated with the real estate industry. The stated purpose of these actions was to assist with the further promotion of his practice. The taxpayer added that this course of action might be considered unusual as compared with the more normal behaviour whereby a chartered accountant purchases either a group of clients or an interest in an existing partnership. But he contended that the giving of guarantees was a normal incident of his particular business and that any resultant outgoings were deductible in terms of sec. 51.

3. A nominee company was incorporated in May 1976 for the purpose of holding various blocks of land in trust for nominated beneficiaries, one of them being the wife of the taxpayer who was to receive a share of

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the profits earned from the development project. The taxpayer was the accountant for the nominee company and the trust, and in that capacity received fees for work undertaken. He was also a director and shareholder of the nominee company. The acquisition and further development of the property were funded by way of mortgage loans advanced from an investment company and a trading bank. Both lenders sought and received personal guarantees as additional security, with one of the guarantors being the taxpayer. The documents were prepared on the basis of each guarantor being jointly and severally liable.

4. During the 1980 year, the trust was not able to meet its commitments on moneys borrowed, and action was instigated by the holder of the first mortgage, i.e. the investment company, to realise upon its security. The property was sold in January 1980 at a mortgagee auction and the resultant proceeds were insufficient to cover repayments in full to the lenders. The shortfall to the bank was an amount of $20,916, and the taxpayer was called upon to pay same in terms of the guarantee. The co-guarantors were the taxpayer's wife and a third party referred to as X. It appears that X had left the area and had been or was in the process of being declared a bankrupt. Payment of the sum of $20,916 was made by the taxpayer on 7th March 1980 and the amount was claimed as a deduction in his 1980 income tax return.

5. A guarantee fee of $1,000 was paid by the nominee company on behalf of the trust to the taxpayer on 30th November 1979. The taxpayer brought this receipt to account as assessable income in his 1980 return. No such similar fees were paid to the other co-guarantors.

6. The Commissioner in raising the 1980 assessment, issue date being 11th May 1981, disallowed the claim of the amount paid to the bank and, by way of explanation, stated that he considered the outgoing to be related to the income production of the nominee company rather than to the income of the taxpayer. The taxpayer in his objection, dated 2nd July 1981, claimed that the amount of $20,916 was deductible pursuant to provisions contained in sec. 51 of the Act. The objection was disallowed and notice of the decision was forwarded on 2nd October 1981. The taxpayer being dissatisfied with the Commissioner's ruling requested, on 5th October 1981, that the matter be referred to a Board of Review for review. On 9th October 1981 the Commissioner issued an amended assessment, having formed the view somewhat belatedly that the guarantee fee of $1,000 was not assessable income. The accompanying adjustment sheet further indicated that the loss on guarantee was considered to be a loss of capital or of a capital nature. The statement required in accordance with reg. 35(1) revealed the Commissioner's reasons for disallowing the taxpayer's claim to be:

• (1) the amount of $20,916 paid to discharge a liability under a guarantee is not an allowable deduction pursuant to sec. 51(1);
• (2) the amount of $1,000 received as a fee in respect of the provision of the guarantee does not constitute assessable income under sec. 25 or any other provision of the Act.

7. At the hearing, the Commissioner's representative appeared to take the view that the $1,000 fee was not a question in issue in this reference. We are uncertain whether that is the correct position but, because the matter was not argued before us, we think it proper not to take the matter further.

8. Section 51(1) provides that, to the extent to which the loss or outgoing of $20,916 was incurred in gaining or producing the assessable income or was necessarily incurred in carrying on a business for the purpose of gaining or producing such income, it is an allowable deduction, providing that it does not fall within the section's excluding words as being an outgoing of capital or of a capital nature.

9. Let us now consider the taxpayer's statement that the granting of guarantees was incidental to the carrying on of the accountancy business for the purpose of gaining assessable income. In determining this issue, reference was made to the number of times the taxpayer acted as a guarantor. Evidence was produced supporting the fact that he had on four occasions, including the present matter, given written guarantees. The circumstances and facts pertaining to the

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other three were similar to those recited in this issue. Nominee companies had been incorporated to hold real estate in trust for various beneficiaries. In all instances, either the spouse of the taxpayer or his family trust were involved as beneficiaries. The taxpayer said that a further written guarantee had been given to a life assurance company, but no documentation was produced nor were particulars of the transaction submitted to us for consideration. It appears as if the taxpayer had on five other instances organised bank overdraft facilities for prospective and existing clients, and that in the event of default he would make good any loss. Two of these occurred after 30th June 1980, i.e. the year of income in issue. The arrangements were handled by making telephone calls to bank managers with no formal documentation being deemed necessary.

10. The taxpayer's representative referred us to the English case
Jennings v. Barfield & Barfield (1962) 2 All E.R. 957; 40 T.C. 365 in support of his client's contention that the loss arising from the payout was an allowable deduction. In that case the respondents, a firm of solicitors, were called upon to make payment under a guarantee provided for a client. They successfully argued that the practice of acting as guarantor was so commonplace that it was to be regarded as part of the usual business of a practising solicitor and that the outgoing was, on ordinary principles of accounting, a revenue payment wholly and exclusively expended for the purpose of their profession. The legal firm had been in operation for a period of 30 years and had often given guarantees on behalf of clients. The respondents' case was considerably assisted by evidence forthcoming from independent solicitors which suggested that the giving of guarantees in certain situations was commonplace and formed a general or ordinary activity of a solicitor's practice.

11. However, in the present case, we conclude that the provision of guarantees was not incidental to the carrying on of the accountancy business, and in arriving at this opinion we have taken into consideration:

• (a) the minimal number of occasions when guarantees were granted in transactions at arm's length; and
• (b) the act of guaranteeing is not commonly undertaken by chartered accountants.

For the sake of completeness, let us assume that our finding had been otherwise, i.e. the giving of guarantees was incidental to the conduct of the accountancy business. There is then another aspect which would indicate that losses arising therefrom were of a capital nature. The purpose of furnishing guarantees was to establish a clientele and from such to secure a source of income. Any payment made under the guarantee would be associated with the acquisition of a position from which income is to be yielded rather than with the day to day revenue costs of deriving income. In
John Fairfax & Sons Ltd. v. F.C. of T. (1959) 101 C.L.R. 30, Menzies J. stated at p. 48:

``To make a payment to acquire or to defend the acquisition of a favourable position from which to earn income or to enter into arrangements that will yield income is not in general an outlay incurred either in gaining or in carrying on business for the purpose of gaining assessable income.''

12. The provisions of the first limb of sec. 51(1) are now examined. Is it possible to conclude that the outgoing of $20,916 is an allowable deduction because it was incurred in the production of the guarantee fee of $1,000, remembering that items of expenditure of a capital nature are excluded? We think not. The claim fails on the grounds that the relevant outgoing was one of capital or of a capital nature.

13. Claims of this type have been considered by Boards on several previous occasions, and the decisions reached establish that payments under guarantee are capital - see Case 22
(1946) 13 C.T.B.R. (O.S.) 156; Case 28
(1946) 13 C.T.B.R. (O.S.) 223; Case B3,
70 ATC 10; Case C34,
71 ATC 149 and Case L3,
79 ATC 14. A statement made by Mr. R.R. Gibson, a former Chairman of Board of Review No. 1, in Case 28 at p. 238, is set out hereunder as in our opinion it clearly summarises the position:

``Payment under Guarantee... I prefer to hold that this payment was a loss or outgoing of a capital nature and therefore

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that the deduction claimed is forbidden by sec. 51(1) - the only provision which can reasonably be said to be applicable to the payment (which for convenience I shall refer to as a loss). The guarantee was not given by the taxpayer solely for the purpose of obtaining income, but for the sake of discussion I shall assume that it was. The position then is that, as my colleagues aptly state, the taxpayer risked his capital in order to earn an annual fee. The taxpayer could have risked his capital by lending it to `D' Ltd. with a view to obtaining an equivalent return by way of interest. If he had done so and had eventually incurred an equivalent loss, the character of the loss, in relation to his income and capital, would in my opinion be the same as that of the loss under the guarantee. In the actual as in the supposed case the loss could, I think, be properly said to have been incurred in gaining the income. If in order to get, for the time being, a return or returns of the nature of income a person embarks on some transaction, act or operation which inherently involves the risk of incurring a monetary loss or liability at some future time, the relevance of any loss or liability so incurred to the purpose of producing income is to be gathered from the purpose of the antecedent transaction, act or operation, this being ex hypothesi an income-producing purpose. That I think is the principle which emerges from the decision in the
Herald and Weekly Times case (1932) 48 C.L.R. 113. But if what is risked is the capital of that person (as it must be in the case of a guarantee or loan given or made by a person otherwise than in the course or for the purpose of carrying on his business) the loss or liability, if it materializes, is necessarily of a capital nature.''

14. For the reasons detailed above, we consider that the outgoing of $20,916 was of a capital nature and precluded from deduction under sec. 51. Accordingly, we uphold the Commissioner's decision on the objection and confirm the assessment in issue.

Claim disallowed