Australian Guarantee Corporation Ltd. v. Federal Commissioner of Taxation.
Judges:Lee J
Court:
Supreme Court of New South Wales
Lee J.
This is an appeal against the disallowance by the Commissioner of a deduction of $2,808 made in the company's return of income in respect of interest referable to deferred interest debentures issued by the company in the year of income ending 30 September 1978. Section 51(1) of the Income Tax Assessment Act 1936, as amended, which permits deductions from assessable income, provides as follows:
``All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a
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business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.''
The company carries on business as a financier in all States and Territories of Australia. It makes advances, both secured and unsecured, and provides financial accommodation to its customers. In order to be in a position to provide funds to its customers the company borrows funds in a number of ways, including the issue of debentures to members of the public or to investors sought privately. During the relevant year of income the company borrowed funds and issued debentures. Included in the funds borrowed was the sum of $80,500 in respect of Deferred Interest First Charge Debenture Stock which amount was used in the ordinary business of the company in that year.
The evidence shows that between 10 May 1978 and 25 September 1978 the company issued twenty-two certificates of Deferred Interest First Charge Debenture Stock to various investors at rates of interest therein specified and all maturing at specified times between 21 November 1997 and 25 September 1998. Redemption in whole or in part was open to an investor after six years. A bonus was payable on redemption after six years. During the year of income 30 September 1978 the company adopted the following accounting procedure in respect of the interest which would ultimately become payable for the Deferred Interest First Charge Debenture Stock: the aggregate amount of interest liability accrued for all investors applicable to each calendar quarter was calculated at 11% and the amount of that calculation for the quarters ending 31 March 1978, 30 June 1978 and 30 September 1978 respectively, were advised in writing to the company's accounts department. Upon receipt of these written advices the accounts department passed General Journal entries debiting interest on debentures account and crediting accrued interest on deferred debentures account with the respective amounts appearing in those advices. These General Journal entries were ``posted'' to the General Journal to the applicable accounts and became listed in the trial balance which was the cumulative record during the financial year of entries to all general ledger accounts prepared as at the end of each calendar month. Debit entries to interest on debentures accounts constituted an expense and were reflected in the company's Profit and Loss Account. Credit entries to accrued interest on deferred debentures accounts were treated as an accrued liability until disbursed in cash and were reflected in the company's balance sheet. The accrued liability on Deferred Interest First Charge Debenture Stock was included in the balance sheet in the company's published annual report under the item ``Public Borrowings; Debenture Stock - Secured''. The amount of $2,808 claimed as a deduction represented interest at 11% on the amount of the debentures issued during the year of income ending 30 September 1978.
The evidence shows that in all years since the company has issued Deferred Interest First Charge Debenture Stock it has accrued in its accounts as a liability that interest, calculated on a daily basis on the principal sum lent on such debentures, which has accrued as at 30 September, notwithstanding that such interest has not been paid.
Evidence has been given before me by Mr. J.N. Miles, chartered accountant, in regard to accounting practice in respect of the ``liabilities'' of a company which fall to be discharged in the future. Mr. Miles holds the degree of Bachelor of Economics, Sydney University and has been a Fellow of the Institute of Chartered Accountants in Australia since 1961. He is a partner in the firm of Messrs. Cooper and Lybrand, Chartered Accountants, Sydney, and a member of the Accounting Standards Board of the Australian Accounting Research Foundation. He pointed out that general accounting principles require that all costs incurred during a financial accounting period which are attributable to the operations of that period should be accrued (the ``accrual basis'') and matched with the revenue earned during the period: that is, such costs should be taken up as a charge in the accounts irrespective of whether they have actually been paid out during the period or not. In the context of a finance company this means that the ongoing liability for interest costs on borrowed funds should be accrued and matched against the interest received from lending out those funds. Proper matching in those circumstances is usually applied on a progressive basis. The
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objective of the use of such principles in the accounts is to ensure that the accounts ``best portray economic reality''.Mr. Miles went on to say that just as labour costs incurred in producing a saleable product are matched against the proceeds receivable from the sales (even though the cash received from sales and the cash paid as wages may occur in different time periods or years), so in the finance context, interest costs incurred in borrowing funds are matched on a progressive basis against the proceeds receivable from their on-lending (that is, interest received). He went on to explain that in terms of accounting concepts the ``accrual basis'' properly reflects the other side of the relevant transaction being the liability undertaken pursuant to the relevant agreement or contract which gives rise to it. Expenses are accrued because a liability for payment of such expenses exists and, pursuant to the Australian Statement of Accounting Practice Dl. 1 - Presentation of Balance Sheet (para. 3) liabilities should be included in the balance sheet. Mr. Miles pointed out that if the practice to which he has referred was not followed in company accounts then that fact should be stated in the accounts, and he said that he had examined the accounts of all finance companies listed on the Australian Stock Exchange and had not observed that any of those accounts signalled a departure from the accrual basis. It was his knowledge that finance companies overseas adopted the same accounting practice. His evidence showed that the accrual basis was recognised by the International Accounting Standards Committee (I.A.S.C.) as one of three fundamental accounting assumptions (International Accounting Standard - Disclosure of Accounting Policies (para. 7) the other two being going concern and consistency).
Mr. Miles, in his evidence, pointed out that deferred interest debenture stock was, as far as he knew, issued only by the appellant and two other companies in Australia but that the ``accrual basis'' was applied by those other two companies in their accounts. He went on to say that if the accounting practice under consideration had not been followed by the appellant in its accounts, that is if the Company had not taken up as a charge in its annual accounts the interest payments accruing on a day-to-day basis on all its issued debenture stock, he, if auditor, would have been concerned. I am satisfied that the practice is a well-established practice observed by accountants in all commercial accounting.
In the present case the deduction of $2,808 interest being a proportion of the interest at 11% payable under the whole of the debentures is justified if it can be regarded as a ``loss or outgoing'' ``incurred'' in gaining or producing assessable income of the company within sec. 51(1) of the Act.
In
Alliance Holdings Ltd. v. F.C. of T. (81 ATC 4637) Woodward J. considered the question of deduction under sec. 51(1) of interest in respect of deferred interest debenture stock, and held that the finance company in that case was entitled in the year of income to deduct a portion of the total interest in accordance with the accounting principle to which reference has been made. The Commissioner contends that that case is distinguishable on the facts from the present case but that, in any event, the case was wrongly decided. In order to deal with this submission, it is necessary to understand the basis upon which Woodward J. rested his conclusion and that may be stated shortly; his Honour concluded that the case was one in which, during the year of income the finance company had come under a present liability to pay interest in the future, and that that being the case, proper accounting practice then required the application of the ``accrual basis'' referred to earlier. Accordingly, the amount of interest appropriated to the year of income was to be regarded as ``a loss or outgoing incurred'' in that year. His Honour in his judgment did not expressly deal with the relationship between the ``present liability'' to which he found the company had become subject in the year of income, and the word ``incurred'' in sec. 51(1), but it is implicit in his conclusion, it seems to me, that the existence of a ``present liability'' (in the sense in which he used that expression) to pay interest at a future time, means that the amount of interest that accrues each year in the meantime can be said to be ``incurred'' each year within sec. 51(1). I should mention here that in Alliance Holdings Ltd. v. F.C. of T. (supra) counsel for the Commissioner had conceded that if there was a present liability undertaken in the year of income to pay the interest at a future date, then the taxpayer should succeed. Counsel for the Commissioner in the present case makes plain that that concession is not made in the present case, and, accordingly, in order to determine if Alliance Holdings Ltd. v. F.C. of T. was properly decided, it is
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necessary to consider the matter afresh and that requires a determination, firstly, of the nature of the ``liability'' to pay a total amount of interest in the future which results in that liability being a ``present liability'' - was there such a liability in Alliance Holdings Ltd. v. F.C. of T. and is there such a liability in the present case? Secondly, if there is such a liability, can the accrual basis of accounting be resorted to to justify a deduction in the year of income (and in subsequent years) of part of the total interest liability, i.e. of the amount of interest which accrues during the year.Before dealing with the first question, it is therefore necessary to examine the nature of the contractual obligation to pay interest undertaken by Alliance Holdings Pty. Limited and by the company in the present case. Mr. Conti Q.C. for the Commissioner submits that even if there was ``a present liability'' to pay the interest in the future in the Alliance case, that feature is lacking in the present case.
The deferred interest debentures issued by Alliance Holdings Pty. Limited provided for interest in 13.5% for from three to ten years. The maturity date of the loan appeared on the face of the debenture certificate. Interest was accrued from day to day but no interest was payable or credited prior to maturity. Provision was made for early redemption by the company and the investor and for withdrawals by the investor of his funds in case of hardship. Upon death of an investor, the amount of the loan was to be repaid without any adjustment to the rate of interest.
I now set out more fully the circumstances in regard to the debentures issued by A.G.C. in the present case. The evidence shows that the debentures were issued to lenders who had first received an application form, and what has been called an ``information sheet'' explaining the terms upon which the debentures were issued. The debenture certificate which was subsequently issued itself listed a number of conditions which accorded with the information given in the ``information sheet''. The contractual obligations of the company can be determined by reference to the information sheet and the conditions set out on the back of the debenture certificate, but for present purposes it will suffice to set out the conditions on the back of the debenture certificate and a portion of what is in the information sheet. It is unnecessary to refer to the trust deed securing the issue.
The special conditions endorsed on the back of the debenture certificate are as follows:
``The Stock comprised in this Certificate will earn and be credited with interest at redemption, which interest will then be calculated from the original date of investment viz. 8th March, 1978, through to date of redemption of a simple interest basis; no interest will be paid or credited prior to maturity.
The interest rate to be applied in respect of the first part of the term will be 11% per annum. This rate will apply through to 31st December, in the fifth year following the year of investment.
In respect of the year 1st January to 31st December which is the sixth year following the year of investment (`year 6') and in respect of each succeeding year the simple interest rate to be applied will be the maximum interest rate being offered by Australian Guarantee Corporation Limited (`A.G.C.') for `fixed term' first charge debenture stock in the A.G.C. prospectus current on the first day of such year and if there be no such prospectus it will be the rate applied in respect of the last preceding period.
In addition to the simple interest specified above, a bonus will be paid on redemption in respect of the period from the original date of investment to the date of redemption. This bonus will apply only to redemptions occurring after 1st January in the sixth year following the year of investment (`year 6') and will be calculated as a simple rate per cent per annum on the principal amount of the Stock. The rate will be determined by the year in which the redemption date falls in accordance with the following table:
Redemption date occurring
From 1st To 31st Bonus % per January December annum of in year in year principal 6 8 3 8 11 5 12 14 6 15 17 8 18 20 10The said Stock is redeemable at par on 8th March, 1998 (`the maturing date') but -
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- (a) the holder may require redemption of the said Stock in full, or in part in multiples of one hundred dollars, any time after 1st January in year six by giving to A.G.C. not less than two months' prior written notice to that effect; and
- (b) upon the death of a sole holder his executors or administrators may, upon fulfilment of any requirement of State or Federal legislation relating to death or succession duties, require redemption of the said Stock in full or as to a part thereof being a multiple of one hundred dollars at any time thereafter; and
- (c) A.G.C. reserves the right to redeem at any time at par all or any part of the said Stock upon giving three (3) months' notice in writing to the Holder. In the event of A.G.C. exercising this right interest and bonus will not be calculated past the expiry of the three months' notice but on expiry of such notice A.G.C. will pay the Holder not only interest and a bonus to that date at the rate or rates provided above but also additional interest calculated at the rate of.25 per cent per annum for the period commencing from the date of expiry of the three months' notice until the maturity date.''
(The date specified is from one of the relevant debenture certificates.)
The following (inter alia) is contained in the information sheet:
``Bonus payments.
In addition to the simple interest specified above, a bonus will be paid on redemption in respect of the period from the original date of investment to the date of redemption. This bonus will apply only to redemptions occurring after 1st January in the sixth year following the year of investment (year 6), and will be calculated at a simple rate per cent per annum on the principal sum. The rate will be determined by the year in which the redemption date falls in accordance with the following table:
Example:
- On an investment of $1,000 made on 1st April, 1978, and redeemed after due notice on 31st December, 1985, the total amount payable (in addition to repayment of principal) would be calculated as follows:
Simple interest at fixed rate 11% per annum: $ 5 3/4 years to 31st December, 1983 632.50 Simple interest at varying rates being maximum rate offered for `fixed term' debentures at the time (rates assumed for purposes of illustration only) year ending 31st December, 1984 - say 10% 100.00 year ending 31st December, 1985 - say 9% 90.00 -------- Total simple interest 822.50 Bonus at 3% per annum for 7 3/4 years 232.50 -------- Total income on $1,000 investment 1,055.00 -------- Total income expressed as a simple interest rate 13.61% per annumFor how long must I invest?
- The term of investment is twenty years from the date your application money is received by A.G.C. or Bank of New South Wales, but you may redeem your holding in full, or in part in multiples of $100, any time after 1st January in the sixth year following the year of investment subject to two months' prior written notice to A.G.C.
- The investor should notify A.G.C. of any change of address.
- When is tax payable?
- The company has been advised that under the provisions of current income tax legislation the interest and bonus payment on deferred interest debenture stock will not normally become assessable income until the year in which it is received.
- Can I redeem before five years?
- A.G.C. will be pleased to consider requests by stockholders who through unforeseen or exceptional circumstances request repayment of their investment before maturity. Agreement by the
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company to such requests and the conditions applicable will depend upon the circumstances involved.- Upon the death of a sole investor A.G.C. will, if requested, pay his executors or administrators the amount invested upon fulfilment of any requirements of State or Federal legislation relating to death or succession duties.''
It was submitted by Mr. Conti of Queen's Counsel for the Commissioner that the terms and conditions of the debenture stock presently under consideration differ from those dealt with in Alliance Holdings Ltd. v. F.C. of T. (supra) in the following three respects: (1) that in the present case the term of investment is twenty years with a right to redeem any time after 1st January in the sixth year with provision for varying interest rates and a bonus at a rate of interest depending upon the date of redemption, whereas in the Alliance case the rate of interest was the same for the whole period until maturity. (2) That in the Alliance case it was a term of the contract that ``interest accrues from day to day but no interest is payable or credited prior to maturity at which time the principal and interest is paid in full'', whereas in the present case, although the debenture certificates expressly stated that no interest would be paid or credited prior to maturity, there was no reference to interest accruing from day to day. (3) That in the present case the provision referable to death of an investor is not to be found in the debentures under consideration in the Alliance case: in that case interest was payable on death of an investor. (There was, however, as in the present case provision enabling an investor to negotiate for withdrawal prior to the due date.)
It will be necessary to refer again to those differences a little later, after considering the decision in Alliance Holdings Ltd. v. F.C. of T., in order to determine whether those differences or any of them should produce a different conclusion from that arrived at in that case. Let me then go now to Alliance Holdings Ltd. v. F.C. of T.
In Alliance Holdings Ltd. v. F.C. of T. (supra), Woodward J. considered the cases,
F.C. of T. v. James Flood Pty. Ltd. (1953) 10 A.T.D. 240; (1953) 88 C.L.R. 492;
Nilsen Development Laboratories Pty. Ltd. & Ors. v. F.C. of T. 81 ATC 4031; (1981) 33 A.L.R. 161;
New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 5 A.T.D. 36; (1938) 61 C.L.R. 179 and
Emu Bay Railway Co. Ltd. v. F.C. of T. (1944) 7 A.T.D. 455; (1944) 71 C.L.R. 596, amongst other authorities, and those same cases have been referred to me.
In Nilsen Development Laboratories Pty. Ltd. & Ors. v. F.C. of T. 81 ATC 4031; (1981) 55 A.L.J.R. 97 the question arose as to the liability of an employer to make payments in future years in respect of long service and annual leave to which employees were indefeasibly entitled. Accounting principles applied in commercial accounts were put forward as a justification for the method used by the taxpayer of providing for portion of the liability to be attributed to each year beforehand. The Court on the facts there held that such amounts could not be deducted. The mere fact that ``prudence and commercial propriety'' (per Barwick C.J. at ATC pp. 4035-4036; A.L.J.R. p. 100) dictated that provision be made in the accounts for such liabilities in the future provided no justification for holding that any part of the liability had been ``incurred'' within the meaning of sec. 51(1). But that case was different from the present case because there, there was in the year of income no liability in law upon the employer to make any payment at all. It was certain or almost certain that there would be a liability but it had not yet come into existence. Gibbs J., as he then was, summed up the matter at ATC pp. 4036-4038; A.L.J.R. p. 101. After referring to the taxpayers' argument that it was appropriate to attribute to the year of income, as an outgoing incurred in the year of income within sec. 51(1), a portion of the liability expected to be met at a future date said:
``But what is clearly necessary is that there should be a presently existing liability. In F.C. of T. v. James Flood Pty. Ltd. at p. 506, this was expressed by saying that the provisions of sec. 51(1) cover `outgoings to which the taxpayer is definitively committed in the year of income although there has been no actual disbursement', and that those provisions `do not admit of the deduction of charges unless... the taxpayer has completely subjected himself to them'. In other words, sec. 51(1) does not cover `a loss or expenditure which is no more than impending, threatened or expected': New Zealand Flax Investments Ltd. v. F.C. of T., at p. 207.
If these principles are applied to the present case, the question is whether the taxpayer
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was under a present liability to make a payment to its employees in respect of leave. The answer is that it was not. The employees were entitled to leave, but they were not entitled to payment. The entitlement to payment would not arise until the employees took leave (or died or left the employment). The event on which the entitlement of the employees to payment depended had not occurred. There was a certainty that a liability to make payments in respect of leave would arise in the future, but it had not arisen. The present is not a case in which there was an immediate obligation to make payment in the future, or a defeasible obligation to pay, or a present obligation which as a matter of law was unenforceable - there was no accrued obligation to make any payment at all. There was no loss or outgoing `incurred' within sec. 51(1).''
Emu Bay Railway Co. Ltd. v. F.C. of T. (1944) 7 A.T.D. 455; (1944) 71 C.L.R. 596 was referred to by Gibbs J. and was relied upon by counsel for the Commissioner here, but there is nothing in that case which in any way throws doubt upon the proposition that a presently existing liability, to be discharged in the future, can lead to part of that liability being regarded as ``incurred'' in the year of income within sec. 51(1). The difference of opinion in that case related, not to the principle to be applied, but to the view of the facts taken by the different Judges. Latham C.J. at A.T.D. pp. 460-461; C.L.R. p. 606 said:
``The words `outgoings incurred' should not be limited to expenditure actually made. They include a liability presently incurred and due though not yet discharged -
Jolly v. F.C. of T. (1934) 2 A.T.D. 434; (1934) 50 C.L.R. 131 at p. 137;
W. Nevill & Co. Ltd. v. F.C. of T. (1937) 4 A.T.D. 187; (1937) 56 C.L.R. 290 - cases on a provision not quite identical with sec. 51 of the present Act, but which does not differ in any particular which is material for present purposes. It may be argued that the words include a liability which falls within the description debitum in praesenti, solvendum in futuro. But the alleged liability in the present case does not even answer this description.''
Williams J. (dissenting, but on the facts) said at A.T.D. pp. 469-470; C.L.R. pp. 620-621:
``The second contention is that, even if the appellant incurred a liability of £13,333 thirteen shillings and sixpence in the accounting period, it did not discharge any part of that liability and the outgoings that can be deducted under the section are liabilities that have been actually discharged during the accounting period. I cannot agree with the second contention. Outgoings, which is a word of the widest import, must include debts. A taxpayer incurs a debt when it becomes due and owing although it may not be immediately payable, so that debts incurred during the year of income are outgoings incurred in that year within the meaning of the section whether they are paid or payable in that period or not:
Westham Corporation v. Grant (1888) 58 L.J. Ch. 121.As Luxmoore L.J. said in
Absalom v. Talbot (1943) 1 All E.R. 589 at p. 600:
- `In ordinary parlance debt is the proper description to be applied to money which is owing and remains unpaid, whether the due date of payment has arrived or not, as witness the well-worn phrase `debitum in praesenti, solvendum in futuro'.'''
F.C. of T. v. James Flood Pty. Ltd. (1953) 10 A.T.D. 240; (1953) 88 C.L.R. 492 raised the question whether an amount set aside by the taxpayer against a ``liability'' for annual leave payments to his employees in the future were deductible under sec. 51(1). Again it was held that there was no present liability to make such payments.
``There was not an accrued obligation, whether absolute or defeasible. There was at best an inchoate liability in process of accrual but subject to a variety of contingencies. It may be true, that regarding the labour employed as a whole, the accrual of an amount of the order claimed had, by 30th June 1947, become predictable with certainty. But that is not the test.''
Per Dixon C.J., Webb J., Fullagar J., Kitto J., Taylor J. at A.T.D. pp. 244-245; C.L.R. pp. 507-508. A little earlier in the judgment the Court dealt with sec. 51(1) and said at A.T.D. p. 244; C.L.R. p. 507:
```Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a concept intended to have such a various or multifarious application. But it does not
ATC 4031
include a loss or expenditure which is no more than impending, threatened, or expected:
New Zealand Flax Investments Ltd. v. Federal Commissioner of Taxation (1938) 5 A.T.D. 36; (1938) 61 C.L.R. 179 at p. 270. Nothing that was decided in
W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation (1937) 4 A.T.D. 187; (1937) 56 C.L.R. 290, was intended to imply that a liability to pay an ascertained sum is never incurred until the sum becomes due and payable.''
The cases, it will be seen, use the expressions ``immediate obligations'', ``present liability'', ``accrued obligation'', ``debts'' and they contrast such a state of affairs with expenditures which are but ``impending, threatened or expected'' or ``inchoate'' liabilities. The distinction being made is between an ``obligation'' or ``liability'' which has, in the eyes of the law, crystallised into an enforceable obligation, albeit payment is to wait, and an ``obligation'' or ``liability'' which is discernible in the sense that it will or probably will come into existence, but which must await a further passage of time before the law accepts it as enforceable. The case of
Norman v. F.C. of T. (1963) 13 A.T.D. 13; (1963) 109 C.L.R. 9 (especially the judgment of Windeyer J. at A.T.D. pp. 21-29; C.L.R. pp. 26-37) although not dealing with sec. 51(1) of the Act, illustrates, in my view, the general concept expressed in the words ``present liability'' when used in regard to a ``liability'' or ``obligation'' in the field of contract, and as the cases just cited show, such a liability must be shown to exist, in the case of a payment to be made in the future, before any part of the amount payable can be said to be an ``outgoing'' incurred in the year of income within sec. 51(1). In Norman v. F.C. of T. a taxpayer by deed purported to assign to his wife by way of gift the interest derived during the year of income ending 30th June 1958 from a sum of £3,000 being part of a sum deposited by him on loan with a firm. The loan was for no fixed term and the firm was at liberty to repay it or any part of it at any time without notice. During the year of income ending 30th June 1958 £450 was paid by way of interest on the sum of £3,000 and the Commissioner claimed that this was income derived by the taxpayer in the year of income. The taxpayer relied on the deed. Sir Owen Dixon at A.T.D. pp. 15-16; C.L.R. p. 16 said:
``As to the question of the alleged assignment of the interest, I have had the advantage of reading the discussion contained in the judgment of Windeyer J. of the whole subject of voluntary equitable assignments and I do not know that there is anything contained in it with which I am disposed to disagree. In the conclusion, however, that in this case there was an effectual equitable assignment of the future interest I cannot agree. I think that such a conclusion must be reached in order to support an answer favourable to the taxpayer of so much of the question in the case stated as relates to the sum of £450 (sc. interest). It appears to me that the future interest was the merest expectancy or possibility, having no existence in contemplation of law.''
(The emphasis is mine.)
The discussion to which the Chief Justice referred is to be found at A.T.D. p. 20; C.L.R. p. 24 and ends at A.T.D. p. 29; C.L.R. p. 38. At A.T.D. p. 22; C.L.R. p. 26 Windeyer J. said:
``The distinction between a chose in action, which is an existing legal right, and a mere expectancy or possibility of a future right is of cardinal importance in this case, as will appear. It does not, in my view, depend on whether or not there is a debt presently recoverable by action because presently due and payable. A legal right to be paid money at a future date is, I consider, a present chose in action, at all events when it depends upon an existing contract on the repudiation of which an action could be brought for anticipatory breach.''
His Honour went on at A.T.D. pp. 28-29; C.L.R. pp. 37-38:
``But a contract to pay a sum of money on a future day, call it interest or what you will, calculable in amount according to conditions presently agreed, is in my view a presently existing chose in action. As between the parties to a contract of money lent at interest the borrower is simply a debtor who must pay a sum or sums (called interest) that he has, for good consideration (the forbearance of the creditor) contracted to pay to his creditor at the time or times stipulated. Why should not the creditor before the date when this debt becomes due and payable, assign his right to receive payment on the due date? He could assign the whole under the statute:
ATC 4032
Walker v. Bradford Old Bank Ltd. (1884) 12 Q.B.D. 511. Why not part in equity? What he assigns is not, it seems to me, a right to arise in the future but a present contractual right to be paid at a future date a sum of money, to be calculated in the agreed manner: cf.
Lett v. Morris (1831) 4 Sim. 607. In
Brice v. Bannister (1878) 3 Q.B.D. 569 [at p. 573] Lord Coleridge, C.J., said `that a debt to become due is a chose in action is clear'. Interest on money lent is recovered by action at law as a debt separate from the principal, as the common indebitatus count for interest shews: see Halsbury 3rd ed., Vol. 27, p. 12.''(The emphasis is mine.)
The above citation of authority leads me to conclude that in the case of a loan at interest to be paid at a fixed time in the future beyond the present year of income, there will be a ``present liability'' in respect of that interest in that year of income and in future years of income, if during that year or those years there is an existing contractual obligation to pay the interest at that future date; and further, that when there is such a liability, part of the total amount of that liability may be within the expression ``outgoings... incurred'' within sec. 51(1). I shall deal with this latter aspect shortly.
The liability to pay interest under consideration in both Alliance Holdings Ltd. v. F.C. of T. (supra) and in the present case, is in nature, a present liability. In each instance, the company was, when the debenture was issued, immediately under a contractual obligation to pay interest in accordance with the terms of the debenture. In each instance the borrowers had remedies at law and in equity that were enforceable, if the company at any time thereafter repudiated the terms of the agreement so far as the payment of interest was concerned. In each instance the borrowers had rights under the contract in regard to the interest payable, that were assignable either at law or in equity. In the case of the Alliance Holdings debentures, the obligation to pay interest remained, even when the investor died before maturity, and in my respectful view Woodward J. was correct in holding that there was a ``presently existing liability'' in the company in the year of income to pay the future interest.
But the terms of the A.G.C. debentures differ from those of Alliance Holdings, and the Commissioner claims that this takes the obligation to pay interest out of that concept of ``present liability'' which can give rise to part of the interest being an ``outgoing incurred'' under sec. 51(1). The differences have already been referred to and I repeat them shortly here.
- (i) The Alliance Holdings debentures offered interest at the same rate up to redemption, whereas the A.G.C. debentures provide for interest at 11 per cent for six years and at variable interest plus a bonus thereafter till redemption.
- (ii) The Alliance Holdings debentures stated that interest ``accrued from day to day but no interest is payable or credited prior to maturity'', whereas the A.G.C. debentures made no reference to the interest accruing from day to day - the provision it made was simply ``The stock comprised in the certificate will earn and be credited with interest at redemption, which will be the calculation from the original date of investment viz. (date) through the date of redemption on a simple interest basis; no interest will be paid or credited prior to maturity''.
- (iii) That Alliance Holdings debentures provided that on death of a debenture holder the company would on three months' notice repay the moneys lent with full interest whereas the A.G.C. debentures provided that the company would if requested repay the loan - but without interest.
So far as (i) above is concerned I am unable to see that the fact that the interest rate was variable after six years has any bearing upon whether the liability to pay interest was presently existing in the year of income or that it results in that liability being different in law from that found in the Alliance Holdings case. The company was obliged at the time the debenture certificate was issued to pay interest as provided in the debenture, and plainly in my view, that was a presently existing liability as far as the year of income was concerned.
Nor am I able to see why the fact that the Alliance Holdings debenture expressly provided that interest would accrue from day to day whereas there was no such stipulation in the A.G.C. debenture should bear upon the question whether there was a present liability of the kind which the authorities in the High Court speak of in the year of income to pay the interest in the future. The fact that the Alliance debenture provided for interest ``to accrue from day to day'' conferred no contractual benefit on
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the debenture holder. He was not entitled to be paid or credited with any interest until maturity. Whether the interest was expressed to accrue from day to day or not, in no way altered the nature of the liability which the company in either case was then undertaking in regard to the payment of interest in the future, or has any significance as to whether or not that liability is or is not to be regarded in it as a then existing liability. (At Common Law interest accrues from day to day even if payable at intervals. Halsbury 4th ed. vol. 32 para. 106; Halsbury 4th ed. vol. 16 para. 1250.) Nor, I would add (because it was mentioned in argument) does the fact that the debenture holder does not have any contractual right to interest until maturity have any bearing upon whether the company, in the year of income, was under a legal liability to pay interest at the future date. It is equally irrelevant that this may mean that the debenture holder only, becomes liable to pay tax on the interest, when in fact it becomes payable to him.That leaves for consideration the third difference, which relates to the provision for payment on death of an investor. The contention, as I understand it, is that because death of an investor may bring about the situation that the company will refund the amount borrowed without interest this bears upon the question whether the liability to pay interest can be said to be ``presently existing'' in the relevant sense when the debenture certificate is issued. But I cannot see why it should mean that the undoubted present legal liability to pay the interest in the future should thereby cease to be that ``present liability'' to which the High Court cases cited, were referring. The obligation of the company undertaken on the issue of the debenture certificate is an existing obligation to pay interest in accordance with the conditions of the certificate and that obligation does not cease to be a presently existing obligation to pay interest in accordance with the conditions of the certificate and that obligation does not cease to be a presently existing obligation to pay, merely because the contract stipulated a circumstance, under the control of the investor's legal representative, in which interest may not have to be paid by the company. The existence of such a stipulation does not in any way cut down the obligation of the company to pay interest, although it confers a right on the legal representative of the investor to receive back without interest the money loaned. The interest remains payable unless the company is requested to refund the moneys loaned in whole or in part. A liability is in law a presently existing liability even though the other party may, in accordance with the terms of the contract, have the option of relieving the company of such liability. The cases in the High Court cited do not suggest otherwise. In my opinion, the liability to pay interest under the A.G.C. debenture was as much a presently existing liability immediately the debenture certificate was issued as was the liability in the Alliance Holdings debenture.
Given then, that there was both in this case and in Alliance Holdings a presently existing liability to pay interest in the future, on what basis in law can part of that interest each year be regarded as an ``outgoing... incurred'' within sec. 51(1), in the year of income.
I have already referred to the observations of Barwick C.J. in Nilsen Development Laboratories v. F.C. of T. 81 ATC 4031; (1981) 55 A.L.J.R. 97 that accounting principles cannot be a determinant as to when an outgoing is ``incurred''. An observation to the same effect was made in F.C. of T. v. James Flood Pty. Ltd. (1953) 10 A.T.D. 240; (1953) 88 C.L.R. 492 at A.T.D. p. 244; C.L.R. pp. 506-507 in the joint judgment of Dixon C.J.; Webb, Fullagar, Kitto and Taylor JJ. where their Honours said:
``Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by sec. 51(1) but it cannot be substituted for the test.''
But a conclusion that, where there is a presently existing liability to pay interest in the future, the amount of interest accruing each year, up to the date of maturity, is ``incurred'' during the respective years, does not mean that accounting practice is being used as a substitute for the true meaning of ``incurred'' in sec. 51(1). All it means is that accounting practice is identifying in respect of that liability, which is a present liability to pay the whole of the interest at a future time, the amount which is to be treated as an outgoing ``incurred'' during each year of income. Section 51(1) does not define ``losses or outgoings'' or ``incurred'', nor does it spell out the means of dealing with liabilities present and existing during a year of income but not to be discharged until a later year. But accounting practice does in commercial accounting deal with the manner in which such liabilities should be dealt with. In this situation it seems to me that accounting practice can be resorted to to identify the extent to which a presently existing
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liability to be discharged in another year, should be treated as an ``outgoing incurred'' in the year of income. Accounting practice accepts that a present liability to pay the total amount at a future date is to be regarded as an entire liability incurred and existing throughout the period up to redemption and then defines how much of that liability is, according to proper accounting principles, to be regarded as ``incurred'' within each year of income. The accrual basis of accounting is as Mr. Miles' evidence shows, used generally in regard to future liabilities, and it has the consequence that part of the interest of a total future interest payment is from the year in which the liability arose, treated as an expense and charged to revenue in the accounts of the company. The accrual basis (like sec. 144 of the Conveyancing Act, 1919) acknowledges that interest accrues from day to day, and it proceeds upon the footing that where the money borrowed is, from the time of the borrowing, used to earn interest - and that was the case in Alliance Holdings, and is the case with A.G.C. - the interest, accruing throughout the year should be treated in the same way as any other costs incurred by the company in that year. In the present case, the application of accounting practice shows that $2,808 should be treated as an expense in the company's accounts, and therefore be regarded as an outgoing ``incurred'' within sec. 51(1) in the year of income. This approach to the use of accounting principles in the field of taxation law was made by the Court (Barwick C.J., Kitto and Taylor JJ.) inArthur Murray (N.S.W.) Pty. Ltd. v. F.C. of T. (1965) 14 A.T.D. 98; (1965) 114 C.L.R. 314 where the question arose as to whether amounts received in advance of services to be rendered in the future were income under the Act. They were not so treated according to accounting and commercial principles. At A.T.D. p. 101; C.L.R. p. 320 their Honours said:
``In so far as the Act lays down a test for the inclusion of particular kinds of receipts in assessable income it is likewise true that commercial and accountancy practice cannot be substituted for the test. But the Act lays down no test for such a case as the present. The word `income', being used without relevant definition, is left to be understood in the sense which it has in the vocabulary of business affairs. To apply the concept which the word in that sense expresses is not to substitute some other test for the one prescribed in the Act; it is to give effect to the Act as it stands. Nothing in the Act is contradicted or ignored when a receipt of money as a prepayment under a contract for future services is said not to constitute by itself a derivation of assessable income. On the contrary, if the statement accords with ordinary business concepts in the community - and we are bound by the case stated to accept that it does - it applies the provisions of the Act according to their true meaning.''
In the present case accountancy practice looks to the existing liability to pay the whole of the interest in the future, and shows the manner in which part of that liability may be appropriately treated as an expense ``incurred'' during each year of income.
Counsel for the Commissioner criticised the application of the accrual basis of accounting to the present debentures. He acknowledged that, provided a loan was repayable within a reasonable period in the future, it was not difficult to accept that the accrual basis of accounting did give economic reality and honesty to the accounts of a company but he contends that when one is dealing with a loan that does not mature for twenty years, the accounting practice under consideration does not introduce economic reality into the accounts but rather the reverse. For myself, I do not find that this contention affords any basis upon which to decide the application of sec. 51(1) otherwise than has been done in the present case. One is dealing with money and the turnover of money, the use of money loaned to earn interest, and the payment of interest in the future as the price of having that money. The money advanced is, each year, theoretically available to earn interest until it is repaid when the loan matures. Mr. Miles' evidence, in my view, shows that the accrual basis properly applies just as much in the circumstances of a loan of short duration as it does in the case of a long-term loan, notwithstanding fluctuations in the value of money, and that it can adequately cope from an accounting point of view with variation of rates of interest under a debenture or possible withdrawal of funds on death or for other reasons before maturity. The accrual basis of accounting is used in commercial accounting, as his evidence shows, in circumstances where the payment to be met in the future may not fall within the class of ``present'' liabilities so as to win deductibility under sec. 51(1)(i) (e.g. long service leave payments), but that merely demonstrates further that the purpose of the
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accrual basis is to introduce reality, honesty and fairness into accounting irrespective of taxation considerations. Section 51(1) is intended to apply to multifarious circumstances, and in the particular case of interest on a loan payable at a future date where the money borrowed is itself loaned out at interest, I cannot see any basis for rejecting an accepted accounting principle which treats as an ``outgoing incurred'' each year, a portion of the interest ultimately to be paid. The order made in New Zealand Flax Investments Ltd. v. F.C. of T. A.T.D. p. 50; C.L.R. p. 208 appears to support the propriety of the accrual basis as a means of determining the extent of an outgoing in such circumstances. In that case the Court remitted the matter to the Commissioner,``so as to enable him to include only bond moneys received in the accounting periods and to allow whatever part, if any, of the deductions claimed for future interest and deferred commission as appears referable to the accounting periods under assessment.''
(The emphasis is mine.)
It follows, in my view, that the amount of $2,808 representing accrued interest was deductible under sec. 51(1) and that the Commissioner was in error in disallowing the objection lodged by the taxpayer in regard to that amount.
Before concluding I should mention that Mr. Conti Q.C. for the Commissioner requested that I state a case for the Federal Court on this matter, but I have declined to take that course because it seems desirable that, if the matter does go on appeal, the Court should have the whole of the evidence that has been placed before me rather than that I, in association with the parties, make a selection from that evidence.
The order of the Court is that the appeal is allowed. The assessment of the Commissioner issued on 26 March 1979 is varied by reducing the taxable income therein stated by the sum of $2,808 and the matter is remitted to the Commissioner so that the amount of tax payable may be assessed. The respondent is to pay the appellant's costs.
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