Gwynvill Properties Pty. Limited v. Federal Commissioner of Taxation.
Judges:David Hunt J
Court:
Supreme Court of New South Wales
David Hunt J.
The taxpayer, Gwynvill Properties Pty. Limited, appeals against the Commissioner's tax assessments for the years ended 31 July 1978 and 1979. The taxpayer claimed as a deduction payments of interest in the 1978 year of income totalling $1,569,271, of which $1.5m. was a prepayment of interest which would otherwise have been payable over a five-year period. (The prepayment was made prior to 19 April 1978, and thus was not caught by sec. 82KJ or any other provision of Subdiv. D of Div. 3 (``Deductions'') of the Income Tax Assessment Act 1936.) The taxpayer alternatively claimed a deduction equivalent to one-fifth of the amount of the prepayment in each of the 1978 and 1979 years. Both the initial claim and the alternative claim were disallowed, as was a claim for the taxpayer's legal expenses concerning the loan in relation to which the interest was payable. The Commissioner also imposed an additional tax, pursuant to sec. 226(2), amounting to 150% of the primary tax payable as a result of the disallowance of the taxpayer's claim. The deduction had been claimed pursuant to sec. 51(1), and alternatively pursuant to sec. 67.
The taxpayer was one of a number of companies, known as the Franklins Group, which were connected by common shareholdings. Others in the Franklins Group were:
- Franklins Stores Pty. Limited, which conducted the well-known retail grocery supermarket business of that name in some 80 different locations.
- Franklins Selfserve Pty. Limited, which held the leases of the premises in which that business was conducted when not owned within the Franklins Group.
- F.G. Finances Pty. Limited, which acted as banker and financier to the Franklins Group.
The taxpayer itself was primarily a substantial investor in real estate and shares. In July 1979, the supermarket business conducted by Franklins Stores and the shares in Franklins Selfserve were sold. A fifth company, Gwynvill Securities Pty. Limited, was a dormant member of the Franklins Group at the relevant time, but in 1979 it was resurrected to take over from Franklins Selfserve certain obligations undertaken by that company in the transaction in question in these appeals, after the sale of the shares in that company when the supermarket business was sold.
An important matter in relation to the manner in which the members of the Franklins Group carried on business, prior to the sale of the
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supermarket business in 1979, was the banking procedure which they adopted. Large sums of money were daily paid in and out of the general bank accounts which the various members of the Franklins Group (other than Franklins Selfserve) held with the National Bank of Australia (as it was then known). Franklins Selfserve did not have a general bank account. At the end of each day, by arrangement with the Bank, any funds in credit above $500 held by a member of the Franklins Group were automatically transferred by the Bank to the account of F.G. Finances. The amount so transferred would be a multiple of $500, so that the balance would be an odd sum not exceeding $500. Similarly, where any member of the Franklins Group was in overdraft to an extent of more than $500, funds were automatically transferred by the Bank from F.G. Finances to reduce that overdraft to approximately that sum. Again, the amount transferred would be a multiple of $500, so that the balance would be an odd sum not exceeding $500. As a matter of convenience, the bank statements would show these transfers as having taken place at the commencement of the following day. F.G. Finances in 1978 had an overdraft limit of some $200,000. In addition to that overdraft (and a generous tolerance on the part of the Bank), that company together with the taxpayer and Franklins Selfserve also had substantial funds available to them on the money market. Moreover, Franklins Stores was given substantial credit by its suppliers, exceeding $8m. Mr Ross Carnell, the Franklins Group's finance director, made daily decisions (in consultation with the manager of the Bank) as to whether to put money out with, or to bring it back from, the money market.At that time and for some years earlier, the taxpayer carried on a substantial business as an investor, property owner and developer, and share trader. Its gross income for the 1978 year of income was just over $3m. and its operating profit before tax was just below $300,000. By 1981, these figures had risen to just over $7m. and $1m., respectively. The largest portion of that income came from rent. The bulk of the remainder was income from share trading. Prior to the events which I am about to relate, the taxpayer borrowed the funds for its investments principally from Franklins Selfserve. The amount of its indebtedness to that company varied, but it was always substantial. Up to this time, the taxpayer had been involved mainly with projects associated with stores operated as Franklins Supermarkets.
Late in 1977, the taxpayer began to look for funds from outside. This followed the taxpayer's policy decision to increase its investments in real estate in order to produce growth in its income from rents. The circumstances in which this policy was formulated will be referred to later. Pursuant to this new direction in policy, the taxpayer purchased a number of income-producing properties, in particular the Westleigh Shopping Centre for over $1.1m., in August 1977, and a commercial office building in Crows Nest for nearly $0.9m., the following month. I will have to consider later whether the search for funds outside the Franklins Group was directly related to these purchases or the change in policy.
What was sought by the taxpayer was a loan in which a substantial amount of interest could be prepaid and which would itself be sold at a discount price. Such a loan was discussed with Herunda Finance Corporation Pty. Ltd., a company not associated with the Franklins Group. In the course of these discussions, it was suggested by Mr Carnell that Franklins Selfserve would be interested in purchasing the loan if it were to be sold after the prepayment of the interest. Negotiations with Herunda took place over a period of about a month.
On 3 February 1978, the taxpayer entered into such a loan with Herunda. The amount of the loan was $2.4m. It was expressed to be for a period, in effect, of 25 years at two rates of interest: 12.25% for the period to 1 May 1978, and thereafter to maturity at 12.5%, the interest being payable quarterly and at the commencement of the period to which the interest related. The loan agreement made the usual provisions for repayment of the loan upon default or financial disaster on the part of the taxpayer. By cl. 7, the agreement also gave to Herunda the right to require the taxpayer, by notice in writing given prior to 1 May, to pay (in one amount) interest at 12.5% on the sum lent for the period of five years from 1 May. The taxpayer became contractually obliged to pay such amount of interest immediately upon receipt of that notice, notwithstanding anything else contained in the agreement. If this event occurred, the interest payable for the balance of the term of the loan was reduced (by cl. 8) from 12.5% to 7.75%. Clause 18 gave to Herunda
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the right at any time to assign the benefits which it was to receive under or in consequence of the agreement.The $2.4m. was paid to the taxpayer and deposited by it the same day (3 February) in a special bank account opened for that purpose. On the same day, the taxpayer withdrew the whole of that sum and invested it with three finance companies in the short-term money market, where it remained for seven days. Also on the same day, the taxpayer paid to Herunda an amount of $69,271.23, being the interest payable in advance for the period to 1 May. This was paid by the taxpayer from its general bank account, and is part of the claim disallowed by the Commissioner.
3 February was a Friday. On Monday, 6 February, Herunda gave notice in writing to the taxpayer of its requirement, in accordance with cl. 7 of the loan agreement, that it pay in one sum the interest for the period of five years from 1 May. The taxpayer paid such interest, amounting to $1.5m., the same day. It was paid from the taxpayer's general bank account, leaving at the end of the day an overdraft of just under $1.5m., which overdraft was reduced automatically to approximately $500 that evening by a transfer from F.G. Finances. On the same day, Herunda offered to assign its benefits under the loan agreement to Franklins Selfserve for $916,729, and such assignment took place later that day with a payment by that company to Herunda of that sum, which it paid out of a special account which had been opened the previous Friday with a deposit of $1m. That amount of $1m. had come from F.G. Finances.
On 10 February, the $2.4m. put out with the short-term money market was repaid to the taxpayer (with interest) and banked in its general bank account, leaving at the end of the day a credit balance of just over $2.2m. which was reduced automatically to approximately $200 by a transfer to F.G. Finances. The amount of the transfer was $2,215,000. I shall have to refer later in this judgment to the effect of this transfer upon the financial relationship between the taxpayer and F.G. Finances.
Subsequently, in 1979, because of the impending sale of the shares in Franklins Selfserve (together with the business of Franklins Stores), the benefits in favour of the loan given by the loan agreement were assigned once more by that company to Gwynvill Securities, the previously dormant member of the Franklins Group, for the same price originally paid to Herunda. Nothing now turns upon this fact.
It is conceded that, notwithstanding the absence of any legal obligation upon Herunda to do so, the taxpayer at all times expected and anticipated that Herunda would in fact decide to give the notice requiring prepayment of interest relevant to the period of five years and that Herunda would also in fact thereafter assign its benefits under the loan to Franklins Selfserve.
The taxpayer claims the deductions for $69,271 and $1.5m. primarily as outgoings necessarily incurred in the carrying on of its business for the purpose of gaining or producing assessable income, not being losses or outgoings of capital or of a capital nature. This is what is known as the ``second limb'' of sec. 51(1). The taxpayer says that both payments were made to satisfy its obligations to pay interest upon the loan of $2.4m. which it obtained from Herunda for the purpose of gaining or producing assessable income.
I am satisfied that the payments of $69,271 and $1.5m. were in fact disbursed and thus were outgoings incurred by the taxpayer. The Commissioner has not alleged that either the loan agreement with Herunda or the payments made thereunder were a sham, and I am satisfied that they were not. In order to obtain a deduction pursuant to sec. 51(1), a taxpayer is not obliged to show that the payment was indispensable or unavoidable for the purpose of gaining or producing income. But he must show that the payment was ``clearly appropriate'' to that purpose: the authorities are collected in
Swinford v. F.C. of T. 84 ATC 4803 at p. 4807. Within reason, it is for the taxpayer to be the judge of what outgoings are so appropriate:
F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431 at p. 444. The outgoings or expenditure must properly be regarded as ``incidental or relevant'' to the derivation of assessable income; that must be the essential characteristic of the expenditure itself:
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at pp. 496-497. Payment of interest upon money borrowed for the purpose of gaining or producing assessable income is deductible:
The Texas Co. (A/sia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382 at p. 468.
The principal issue in this appeal is whether the ``essential character'' of the payments of $69,271 and $1.5m. by the taxpayer was in fact
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within the terms of sec. 51(1). The taxpayer's purpose for incurring the expenditure may in some cases constitute an element of its essential characteristic:Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 at p. 4547. Where the expenditure is incurred solely in acquiring an asset or a legal right under the contract or in discharging some antecedent legal liability, the particular result which the taxpayer sought to achieve by making the expenditure does not determine whether that expenditure is deductible or not: ibid. at pp. 4547, 4558-4559. Where the expenditure is not incurred solely for these purposes, the taxpayer's purpose is relevant in determining whether there is a sufficient connection between the expenditure and the taxpayer's business: ibid. at pp. 4548, 4559. The essential character of that expenditure may be identified by an analysis of the taxpayer's objective purpose:
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at pp. 4419-4420, 4421, 4424-4425; (1978) 140 C.L.R. 645 at pp. 659-660, 662, 667-668. Such objective purpose is ascertained from the circumstances of the transaction itself, not from the result which the taxpayer sought subjectively to achieve: Magna Alloys' case at p. 4544. What must be considered are the character of the taxpayer's business and the relationship of the expenditure to the carrying on of that business:
F.C. of T. v. Midland Railway Co. of W.A. Ltd. (1952) 85 C.L.R. 306 at p. 313. In considering those factors, however, the taxpayer's subjective purpose may become relevant. For example, what the taxpayer's intentions were in relation to the character and scope of his business is relevant to that issue: F.C. of T. v. Snowden & Willson Pty. Ltd. (supra) at p. 444; Magna Alloys' case (supra) at p. 4558. In the latter case, at p. 4559, the joint judgment of Deane and Fisher JJ., summed up the position in these words:
``The controlling factor is that, viewed objectively, the outgoing must, in the circumstances, be reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose or earning assessable income. Provided it comes within that wide ambit, it will, for the purposes of sec. 51(1), be necessarily incurred in carrying on that business if those responsible for carrying on the business so saw it.''
The same formulation is repeated by their Honours at pp. 4560-4561.
The Commissioner has contended that the essential characteristic of the payments of $69,271 and $1.5m. was not, as the taxpayer contends, interest upon a loan. He says that the sole or predominant purpose of the transaction must be seen as one to obtain a tax advantage. This, he says, is demonstrated by any one of a number of factors either alone or in combination. He submits that:
- (1) The transaction with Herunda was not one made in the ordinary course of the taxpayer's business, and it would not have been entered into by the taxpayer had it not been for the tax advantage gained.
- (2) The whole transaction was pre-ordained, and the taxpayer's purpose was in reality only to obtain the tax benefit which flowed from the prepayment of interest which all parties envisaged would be made.
- (3) When the position of the Franklins Group as a whole is examined, the end result of the transaction was that, for the payment of a promoter's fee of approximately $86,000, the overall assets and liabilities of the Group were unchanged but the taxpayer obtained a tax benefit in relation to the prepayment of the $1.5m. ``interest'' amounting to a saving of $690,000 in the 1978 year of income.
Alternatively, the Commissioner contends that the payments were in reality repayments of capital, or payments of a capital nature, since they operated in effect to reduce the principal sum by reducing the present value of the loan to $916,729.
I propose to deal separately with each of these arguments, bearing in mind of course that the onus lies upon the taxpayer to persuade me that the Commissioner's assessment was excessive: sec. 190.
There is little doubt that the transaction in question was different to any which the taxpayer had previously undertaken. The most important departure was that the taxpayer had not previously borrowed from outside the Franklins Group. Its principal lender had been Franklins Selfserve. It had also used funds supplied by F.G. Finances. In relation to both of those companies, the financial arrangement
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was that the taxpayer paid a commercial rate of interest to the lender based upon the balance owing at the commencement of each financial year, it being agreed that the amount of such interest would not exceed the net income of the taxpayer, and that the interest would be paid before the end of that financial year.I have earlier referred to the fact that, up until this time, the taxpayer's investments had been involved mainly with projects associated with stores operated as Franklins Supermarkets by Franklins Stores. The following findings are based upon Mr Carnell's evidence, which I accept. I found him to be a very careful and an honest witness who was telling the truth. In 1977, the directors of the taxpayer carried out an examination of the future of investment in Australia. They formed the preliminary view (subsequently confirmed by investigation in the United States) that inflation would continue at a high level and that interest rates would continue to rise. This led to the policy decision being taken by the taxpayer to increase its investments in real estate in order to produce growth in its income from rents, and to purchase a number of income-producing properties - including the Westleigh Shopping Centre and the office building in Crows Nest, to which reference was made earlier.
When the taxpayer came to purchase these properties, the funds for the purchase were expected initially to come from a number of sources: the taxpayer's own trading profits, the proceeds of the sale of other assets during the year, an additional borrowing from Franklins Selfserve, and funds which F.G. Finances had invested on the short-term money market (exceeding $20m.), subject to any requirements of Franklins Stores to meet its very high commitments to its suppliers.
The need for an outside loan was seen at the time of settlement of these purchases. The amount owing by the taxpayer to F.G. Finances and to Franklins Selfserve was such that, at the end of the financial year when that amount crystallized (as earlier outlined), either an outside loan or a substantial sale of assets by the taxpayer was seen to be desirable, in the light of the changed investment policy of the taxpayer to move away from projects associated with stores operated as Franklins Supermarkets and to move more heavily into the investment market.
The nature and the source of the outside loan eventually obtained were originally suggested by Mr Robin Speed, a director of the taxpayer and its solicitor. As stated earlier, what was sought by the taxpayer was a loan in which a substantial amount of interest could be prepaid and which would itself be sold at a discount price. This was at Mr Speed's suggestion. A major concern of the taxpayer was the tax deductibility of the payment of interest. To that particular concern I will turn later. The taxpayer was also concerned with a possible liability for an ad valorem stamp duty imposed upon the prepaid interest, a concern which was just at that time being proved to be groundless:
Baystone Investments Pty. Ltd. v. Commr. of Stamp Duties (N.S.W.) 78 ATC 4439 at p. 4444; (1977) 2 N.S.W.L.R. 709 at p. 714; on appeal: 78 ATC 4448; (1978) 1 N.S.W.L.R. 441. Prior to the suggestion by Mr Speed that Herunda would be willing to make such a loan, Mr Carnell approached a number of finance companies with which the Franklins Group had previously done business, apparently without success. During the negotiations with Herunda, the liability for stamp duty played a prominent part, no doubt in continued ignorance of the decision in the Baystone Investments case (supra). Eventually, Herunda accepted responsibility for any liability for stamp duty (cl. 17).
The Commissioner has pointed to a number of factors which, he submits, emphasise the fact that this transaction was out of the taxpayer's ordinary course of business.
The Commissioner relies upon the fact that the taxpayer had not previously invested in the short-term money market, so that the initial investment of the $2.4m. loan for 7 days was out of the ordinary and no more than ``a token gesture'' and ``mere camouflage''. But that investment was never intended to be regarded as part of the taxpayer's ordinary course of business; it was clearly enough intended to isolate the amount of the loan so as to be able later to demonstrate (to the Commissioner) that funds for the prepayment of interest came from another source and not from the loan itself.
The Commissioner also relies upon the absence of any inquiries made by the taxpayer as to the financial standing or reputation of Herunda, with which the taxpayer had had no previous dealings. But the taxpayer did insist upon a certificate from that company's Bank
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that the funds were available. What more was necessary in the circumstances? If the money was there, it was not suggested that the taxpayer could be put at any other risk. I have already accepted that the transaction was different to any which the taxpayer had previously undertaken.The Commissioner says that the amount of the borrowing was simply what Herunda had available and was not related to any need by the taxpayer for that particular amount. I do not agree. Herunda said that it had $2.5m. available. The taxpayer took almost as much as it could. I will deal with the taxpayer's ``need'' in a moment. At worst, this evidence as to the fixing of the amount of the loan may be equivocal, but I am not prepared to infer the worst from it; the Commissioner's invitation to do so brings to mind the couplet from Alexander Pope's ``Essay on Criticism'' (1711):
``All seems infected that the infected spy, As all looks yellow to the jaundiced eye.''
The Commissioner also asserts that the decision to borrow the funds externally did not arise from any commercial need on the part of the taxpayer to do so. I agree that it is necessary to look at the circumstances of the loan itself, and not merely at the circumstances in which the payments were made thereunder. But the Commissioner's assertion misstates the issue which I have to decide, which is whether the loan and the payments made thereunder were ``reasonably capable of being seen (and were in fact seen) as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income'': Magna Alloys' case (supra) at p. 4559. It is initially an objective test. In the light of the taxpayer's investment policy, I see nothing suspicious in the perceived need for an outside loan, and I accept that such a loan was capable of being seen as both desirable and appropriate. I accept Mr Carnell's evidence that it was in fact seen as such by the taxpayer. The effect of the loan to the taxpayer was to reduce immediately the amount of the taxpayer's borrowing from F.G. Finances by $2,215,000, and consequently also the amount of those borrowings at the commencement of the next financial year (upon which amount interest was calculated) by the same sum. The loan enabled the taxpayer to continue with its changed policy of investing in projects unconnected with Franklins Stores, and to redevelop existing property. Substantial sums were in fact spent in those directions after the loan was made.
I do not accept the Commissioner's contention that the transaction in question is outside the terms of sec. 51(1) because it was not made in the ordinary course of the taxpayer's business. That contention completely ignores the taxpayer's changed policy which immediately preceded the loan, and the continuation of that changed policy for the period following that loan. I am satisfied that the decision to move away from projects associated with stores operated as Franklins Supermarkets and to move more heavily into the investments market was in fact translated into action so that the taxpayer's ordinary course of business changed in accordance with that change in policy. The borrowing from Herunda was therefore made in the course of the taxpayer's business. Indeed, the pattern of interest payments by the taxpayer over the years since 1975 (see Annexure ``A'' to Mr Carnell's affidavit) was not significantly disturbed in its steady growth, in association with its income, by the prepayment of interest upon this occasion.
The second limb of the Commissioner's first contention was that the taxpayer would not have entered into the loan agreement with Herunda had it not been for the tax advantage to be gained. Expressed in that somewhat simplistic way, I would not understand the taxpayer really to deny what the Commissioner says. The taxpayer did, in accordance with its commercial responsibilities, give consideration to the consequences of the proposed transaction should Herunda not give notice that it required the prepayment of interest, and the taxpayer was satisfied that it was nevertheless a good commercial proposition even then. That Herunda would not give that notice in fact was, however, never really contemplated. If the situation were that the taxpayer would not have sought to borrow from outside the Franklins Group except in order to obtain a tax advantage, that would be one thing. Even in that situation, the taxpayer would seem not to be denied the benefits of sec. 51(1): the authorities are referred to in the next paragraph of this judgment. But that was not the situation in this case; I am satisfied that the taxpayer decided to borrow from outside the Franklins
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Group as a consequence of its changed investment policy, and that, having made that decision, the taxpayer determined to go about obtaining that loan in a way which would best give to it a tax advantage. That is quite a different thing. In short, the need for an outside loan was perceived and the decision to obtain it was made independently of the wish to obtain a tax deduction; the form of the loan (and consequently the identity of the lender) were, however, undoubtedly chosen by the taxpayer because of the tax advantages seen. Of that there could be no doubt whatever. At the same time, it should perhaps be pointed out that the tax advantage which the taxpayer sought by the prepayment of interest in this case was not of particularly great consequence. Actually, the prepayment of $1.5m. worked out as costing the taxpayer more (by almost $29,000) than the then present value of five annual payments of $300,000 each. All that the taxpayer would have received (if its claim had been allowed) was the benefit of the accelerated deduction (worth $690,000) in that particular year of income, instead of deductions over five years. Moreover, if the loan had never been made, by reason of the financial arrangements to which reference had already been made, the taxpayer would by the end of the 1978 year of income have been obliged to pay to Franklins Selfserve by way of interest an additional sum of $1,240,000 - $1,860,000 (because of the taxpayer's higher income) in lieu of the $620,000 in fact paid. I referred earlier to the agreement between the two companies that the amount of interest payable by the taxpayer would not exceed its net income.A decision by a taxpayer to adopt a particular means of carrying out a specific transaction in order to obtain a tax advantage which would not have been obtained if the transaction had been carried out in a different way does not deny to that taxpayer the benefit of sec. 51(1), subject only to the possible application of sec. 260 (an issue about which there remains some dispute, a dispute which does not need to be resolved in this case). The authorities for that statement are legion: see, for example,
Mullens & Ors v. F.C. of T. 76 ATC 4288 at pp. 4292, 4303; (1976) 135 C.L.R. 290 at pp. 298 and 318;
Patcorp Investments Ltd. & Ors v. F.C. of T. 76 ATC 4225 at pp. 4233, 4243-4244; (1977) 140 C.L.R. 247 at pp. 252-253, 292, 311-312;
Slutzkin & Ors v. F.C. of T. 77 ATC 4076 at pp. 4079-4080, 4083-4084; (1977) 140 C.L.R. 314 at pp. 319-321, 326-327;
Cridland v. F.C. of T. 77 ATC 4538 at pp. 4541-4542; (1977) 140 C.L.R. 330 at p. 339. See also
Cecil Bros. Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430 at pp. 438, 441. The Commissioner submitted that
Deane v. F.C. of T. 82 ATC 4112 at p. 4120, was an authority to the contrary. I do not read the judgment in that case necessarily as such (because of the finding by Rogers J., that there was no relevant business being carried on at the relevant time) but, if I am wrong in my own interpretation of that judgment, then (notwithstanding ``the constitution of the Court'' in that case: see 82 ATC at p. 4122) I must with respect disagree with such views, which clearly conflict with what was said by the High Court in the cases which I have earlier cited in this paragraph. (The Commissioner submitted that sec. 260 applied to the transaction in question, but this submission was expressed to be a formal one only in order to preserve the Commissioner's position should the climate concerning sec. 260 radically change before the time has arrived when he has exhausted his avenue of appeal. It would need to change radically for sec. 260 to be applied to the present case, but I say no more because the matter was not argued before me.)
The Commissioner pressed upon me the decision of the Federal Court in
F.C. of T. v. Ilbery 81 ATC 4661, in which the factual situation bears some resemblance to the present case. That resemblance is, however, superficial only. That was a case in which the taxpayer relied solely upon the first limb of sec. 51(1). It was held by Toohey J. (with whose reasons Northrop and Sheppard JJ. completely agreed), at p. 4669, that the prepayment of interest was made by the taxpayer in that case at a time when no relevant income-producing activity had begun and that it was not made for any purpose connected with such an activity; it was not outlaid to gain income and it was not incidental or relevant to the gaining of income. That was the ratio of the decision. The prepayment of interest in that case was made at the taxpayer's own option, and it was held (at p. 4668) that he chose to exercise that option and to make the payment solely for the purpose of securing a tax advantage. So understood, Ilbery's case is substantially different to the present case. Insofar as Toohey J. is to be understood as saying that an intention on the part of a taxpayer to gain a tax advantage by the
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particular manner by which he effects the transaction in question will deny to him the benefits given by the Tax Assessment Act, that statement was obiter (in the light of the ratio expressed at p. 4669) and, with all due respect to the very illustrious members of that Full Court, such a proposition is quite inconsistent with what was said in the Patcorp case (supra) to which I have already referred (but to which no reference was made in his Honour's judgment), and with the other authorities to which I referred in the previous paragraph of this judgment.I do not overlook the evidence that two other companies in the Franklins Group also obtained loans from Herunda upon similar terms, and had claims for deductions in respect of similar prepayments of interest disallowed by the Commissioner. That evidence, which was led by the Commissioner in cross-examination of Mr Carnell, did no more than establish those facts. In answer to my inquiry at the time, counsel for the Commissioner informed me that it was a deliberate decision on the part of his client not to pursue that subject any further. That, of course, was the Commissioner's right: he bears no onus of proof; his obligation is merely to advance a particular matter in the evidence, thereby (if it be relevant) requiring the taxpayer to deal with the issue so raised in the discharge of his overall burden of proof: see, for example,
Casuarina Pty. Ltd. v. F.C. of T. 70 ATC 4069 at p. 4076; (1971) 127 C.L.R. 62 at p. 72. The position is akin to the evidential burden placed upon an accused in a criminal trial who seeks to raise the issue of self-defence which the Crown must disprove: the authorities are collected, and one is quoted, in
Spautz v. Williams (1983) 2 N.S.W.L.R. 506 at pp. 532-533. But the Commissioner must be careful that he does indeed raise the issue which he wishes to, so that the taxpayer is obliged to deal with it. In the present case, all that I derive from this evidence which was given is that the subjective purpose of the taxpayer was to derive a tax benefit. I really have no idea of the context in which the loans were obtained by the other companies in the Franklins Group. Their appeals are not before me. The fact that this was a device adopted by the taxpayer in common with those other companies certainly did make me look more carefully at Mr Carnell's evidence that this taxpayer's need for an outside loan was seen to be desirable in the light of the changed investment policy of the taxpayer. That evidence, of course, is vital to the taxpayer's appeal. But, notwithstanding the brief glimpse which the Commissioner allowed me of what may have been the devious machinations of other members of the Franklins Group, I adhered then and I still adhere to my acceptance of Mr Carnell as a witness of truth - an acceptance based to a substantial extent, I should say, upon his demeanour over the long period during which he gave evidence. And, having done so, that (as I see it) is the end of any relevance of this particular evidence, which has no independent existence or value of its own: see
Coppleson v. F.C. of T. 81 ATC 4019 at p. 4022; (1981) 34 A.L.R. 377 at p. 382;
Allied Pastoral Holdings Pty. Ltd. v. F.C. of T. 83 ATC 4015 at pp. 4021-4022; (1983) 1 N.S.W.L.R. 1 at p. 11; (1982-83) 44 A.L.R. 607 at pp. 615-616.
The authorities referred to in the paragraph before last also dispose of the Commissioner's second contention, which was that the whole transaction had been pre-ordained, and that the taxpayer's purpose was in reality only to obtain the tax benefit which flowed from the prepayment of interest which all parties envisaged would be made. It is conceded by the taxpayer that the whole transaction had been pre-ordained, as part of the tax benefit which it sought, and I have already attempted to show where the Commissioner has erred in the second limb of that contention.
The Commissioner's purpose in the formulation of this contention was, however, a wider one than appears at first sight. The key lies in his use of the word ``pre-ordained''. What the Commissioner seeks to invoke is the doctrine of ``fiscal nullity'' recently introduced by judicial decision in England:
W.T. Ramsay Ltd. v. I.R. Commrs. (1982) A.C. 300;
I.R. Commrs. v. Burmah Oil Co. Ltd. (1982) 54 T.C. 200;
Furniss v. Dawson (1984) A.C. 474. As expounded by Lord Brightman in the third of these cases, at p. 527, this doctrine involves two findings of fact:
``First, there must be a preordained series of transactions, or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (i.e. business) end... Second, there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax - not `no business
ATC 4055
effect'. If those two ingredients exist, the inserted steps are to be disregarded for fiscal purposes. The court must then look at the end result.''
This principle, the Commissioner has argued, is part of the common law of Australia and should be applied in the interpretation of the Income Tax Assessment Act.
The argument is not new. It first found favour with Northrop and Sheppard JJ., in Ilbery's case (supra), but only as an obiter dictum - as the High Court held when refusing special leave to appeal from the Federal Court, upon that basis (5 March 1982, unreported). Those views were adhered to, but still as obiter dicta, by Sheppard J. in
F.C. of T. v. Werchon & Anor 82 ATC 4332 at pp. 4348-4349; (1982) 42 A.L.R. 425 at p. 447, and in
F.C. of T. v. Kelly Ford Pty. Ltd. & Ors 84 ATC 4205 at pp. 4228-4229; (1984) 52 A.L.R. 535 at pp. 569-570, and by Smith J., in
Spencer v. Commr. of State Taxation (W.A.) 84 ATC 4901 at p. 4907. However, in
Lau v. F.C. of T. 84 ATC 4618 at pp. 4624-4625; (1984) 54 A.L.R. 167 at pp. 177-178, Connolly J., held that the Ramsay principle was inapplicable to the Income Tax Assessment Act in Australia. The same conclusion has now been reached by a unanimous decision of the Full Court of the Federal Court:
Oakey Abattoir Pty. Ltd. v. F.C. of T. 84 ATC 4718 at pp. 4724-4726, in which the Ramsay principle is conclusively (and convincingly) rejected. In particular, it was pointed out that the ``economic equivalence'' doctrine upon which the House of Lords relied has already been ``emphatically rejected'' by the High Court: see Mullens v. F.C. of T. 76 ATC 4288 at pp. 4294-4295; (1975-1976) 135 C.L.R. at p. 301; and that, the scheme of the English legislation being so very different to that existing here in Australia (especially with the presence of sec. 260), it is impossible to place upon the various sections of the Income Tax Assessment Act a qualification that they are inapplicable where - sec. 260 and express provisions aside - the taxpayer has engaged in a device in order to secure a fiscal advantage: Patcorp case 76 ATC at p. 4233; 140 C.L.R. at p. 292. The Ramsay principle has also been rejected in Canada, upon much the same basis:
Stubart Investments Ltd. v. R. (1984) 15 A.T.R. 942 at p. 962.
In the light of the decision of the Federal Court in the Oakey Abattoir case (supra), the Commissioner did not press his argument during the appeal in
F.C. of T. v. Lau 84 ATC 4929 at pp. 4936-4937. I reject that argument in this case also. In any event, I have some difficulty in the present case (which was not removed during the argument when I sought assistance upon this point) in identifying precisely the step which had been ``inserted'' and which had ``no commercial (business) purpose apart from the avoidance of a liability to tax''. If the Commissioner means the whole loan transaction (and he did not say that he did), then that was hardly a step which was inserted; it was the whole transaction. If the Commissioner means the prepayment of interest (and he said that he did), how was that prepayment something which was inserted? There was only one transaction, and not a series of transactions or even a ``composite'' transaction. In the English cases, the House of Lords held that it was able to look behind the form to see the substance of the transactions which, if they had been formulated as one transaction instead of a series of transactions or as a composite transaction, would have been altogether a different transaction to that which appeared from their form. The present case involved only the one transaction and, had I not rejected the Ramsay principle itself, I would have held that it was inapplicable.
The Commissioner submitted that the Ramsay principle applied in the present case because, when the position of the Franklins Group as a whole is examined, the end result of the transaction was that, for the payment only of a promoter's fee of approximately $86,000, the overall assets and liabilities of the Group were unchanged but the taxpayer obtained a tax benefit in relation to the prepayment of the $1.5m. ``interest'', amounting to a saving of $690,000 in the 1978 year of income. This was also the Commissioner's third contention as to why sec. 51(1) was not applicable.
The Commissioner's argument requires me to look at the Franklins Group as one entity and to ignore all internal transfers (and different sources of funds). Looked at in this way, the position may be represented by the following table:
The Commissioner says that Herunda, which was out of its funds for only one working day, received $86,000.23 as interest and as a promoter's fee; the taxpayer received the tax benefit inherent in the prepayment. Otherwise, there was no change in the position of the Franklins Group before and after this particular transaction.
Like statistics, almost anything can be proved in this way. The Commissioner also made a number of attempts (all of them ultimately unsuccessful) to produce a diagram in circular form in order to establish the usual ``Round Robin'' argument.
The Commissioner's submission was that, in determining what is the initial character of the payments in question, it is necessary for me to consider the fact that the taxpayer is a member of the Franklins Group of which each member operated so as to complement the activities of the other members rather than to act in competition with them. It would be ``artificial, inappropriate and unrealistic'', the Commissioner said, to approach the question to be determined as if the taxpayer were not the member of such a group.
In this country, contrary to the Ramsay principle applicable in England, it remains necessary to consider and to respect the legal form of the transaction in question (provided, of course, it is the actual transaction between the parties and not a sham); it is not legitimate to disregard the separate corporate entities or the nature of the contracts made; and there is no room in this connection for taxation by end result or economic equivalence:
Commr. of I.R. v. Europa Oil (N.Z.) Ltd. (No. 1) (70 ATC 6012); (1971) A.C. 760 at pp. 771-772; Mullens v. F.C. of T. 76 ATC 4288 at pp. 4292, 4294-4295; 135 C.L.R. at pp. 298, 301-302; Slutzkin & Ors v. F.C. of T. 77 ATC 4076 at pp. 4079-4081, 4083-4084; 140 C.L.R. at pp. 319-321, 326-327; F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at pp. 4417-4420; (1978) 140 C.L.R. 645 at pp. 655-660. The Commissioner's submission is rejected.
Finally, the Commissioner contends (alternatively) that the payments in question were in reality payments of capital, or payments of a capital nature, since they operated in effect to reduce the principal sum owing by reducing the present value of the loan to $916,729. That was the sum paid by Franklins Selfserve for the assignment to it of the lender's benefits under the loan.
But, the amounts paid were characterized by the parties as interest, and further payments of such interest remained to be made after the five-year period had expired. The two payments in question did not reduce the amount of the capital indebtedness. The fact that, actually, the present value of the loan was (as the evidence showed) somewhere in the vicinity of the price paid for the assignment does not affect the position. The Commissioner's argument is fundamentally inconsistent with the two decisions in Baystone Investments Pty. Ltd. v. Commr. of Stamp Duties (N.S.W.) 78 ATC 4439 at p. 4444; (1977) 2 N.S.W.L.R. 709 at p. 714; on appeal: 78 ATC 4448 at p. 4451; (1978) 1 N.S.W.L.R. 441 at p. 445. It is also inconsistent with F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at pp. 4419-4420; 140 C.L.R. at pp. 659-660. This last contention of the Commissioner is also rejected.
I am satisfied, in accordance with the test laid down in the Magna Alloys' case (supra), at p. 4559, which I quoted earlier, that the two payments in question in this appeal (of $69,271 and $1.5m.) bore the essential characteristic of interest payable upon a loan, being outgoings necessarily incurred in the carrying on of the taxpayer's business for the purpose of gaining or producing assessable income, and thus within the terms of sec. 51(1). I am satisfied
ATC 4057
that they were not losses or outgoings of capital or of a capital nature. The appeal from the Commissioner's disallowance of the deduction for the 1978 year must therefore be allowed. In these circumstances, the appeal from the Commissioner's disallowance of the taxpayer's alternative claim made in the 1979 year for a deduction of one-fifth of the prepayment does not arise, and the appeal in relation to that year will be dismissed, although in the circumstances I propose to order the Commissioner to pay the taxpayer's costs of that appeal.The taxpayer put an alternative argument to uphold the deductions for the payment and the prepayment of interest pursuant to sec. 67 if the claims pursuant to sec. 51(1) failed because they were held to be payments of capital or of a capital nature. In the light of the conclusions to which I have already come, it is unnecessary for me to deal with this alternative argument.
Both parties agreed that the taxpayer's claim for legal expenses concerning the loan in relation to which the interest was payable stood or fell with the claim under sec. 51(1). The taxpayer's appeal in relation to those legal expenses must therefore be allowed also.
Finally, the additional tax imposed by the Commissioner pursuant to sec. 226(2) must fall with the taxpayer's success upon the merits of the appeal. In these circumstances, it is unnecessary for me to discuss the various submissions made by both parties concerning the decision of the Federal Court in
F.C. of T. v. Rabinov & Anor 83 ATC 4437, and, although the arguments were interesting, it would be pointless for me to determine those submissions.
Even if the taxpayer had failed in his argument that F.C. of T. v. Rabinov denied the Commissioner's right to impose any additional tax where the payment had in fact been made, I am satisfied that I would in any event have determined to set aside the Commissioner's decision to impose the penalty and to remit it for reconsideration in the light of the evidence of Mr Vincent Smith, the Assistant Deputy Commissioner (Investigations) responsible for making that decision, who was obliged to admit that a ``most important'' factor in his decision to impose the penalty - that a false statement of fact had been made by the taxpayer in its return - was completely wrong.
There was also a deal of evidence from Mr Smith which demonstrated clearly that he also took into account in deciding to impose the penalty the previous successes by the taxpayer and others in the Franklins Group in so ordering their affairs as to be able to avoid the liability for taxation. Notwithstanding the faint submission by the Commissioner to the contrary, I regard it as a gross error on his part to take into account and therefore to penalize the previous success in tax avoidance on the part of either the taxpayer or some associated person. In my view, it is contrary to every principle of justice that anyone should be so treated.
ORDERS:
(1) In relation to the Appeal No. 722 of 1982, I uphold the taxpayer's appeal. I remit the assessment to the Commissioner to be amended, in accordance with the terms of my judgment, to allow pursuant to sec. 51(1) the claims for deductions totalling $1,569,271 for interest and $3,702 for legal expenses paid by the taxpayer. I set aside the additional tax imposed pursuant to sec. 226(2). I order the Commissioner to pay the taxpayer's costs. I direct the entry of judgment accordingly.
(2) In relation to the Appeal No. 618 of 1984, I dismiss the appeal but I order the Commissioner to pay the taxpayer's costs. I direct the entry of judgment accordingly.
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