Case S83

Members: HP Stevens Ch
TJ McCarthy M

PM Roach M

Tribunal:
No. 1 Board of Review

Decision date: 27 September 1985.

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P.M. Roach (Member)

A and B, who were husband and wife respectively, incurred liability to interest as detailed in the reasons for decision of my colleague, Mr McCarthy.

2. I agree with his findings of fact and his conclusions relating to the claim for a deduction in respect of interest on moneys borrowed to purchase the income-producing flats. (I would only add that it is singularly unfortunate that the purpose of the borrowing

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ATC 617

was not disclosed to the Commissioner prior to the hearing. One wonders what might have resulted if counsel for the Commissioner had sought an adjournment on the grounds of ``surprise''.)

3. I now turn to consider the claim to a deduction in respect of the taxpayer's share of bank charges and interest paid to the Commonwealth Bank amounting in all to $2,514. The taxpayer and his wife, a fully qualified nursing sister, decided to invest in a nursing home as a profit-making venture. The nursing home chosen was controlled by a company. That being so, it was arranged that the taxpayer and his wife would purchase a 50% interest in the company and it happened that contemporaneously the other-half interest was purchased by a medical practitioner (``M''). The contract providing for the purchase provided that the purchasers were to pay $55,944 for 18 ``B'' class shares of $1 each and 9 ``C'' class shares of $1 each being one-half of the total issued shares in the capital of the company and it also required that the vendors [ sic ] would effect the repayment of shareholders' loan funds. To effect the purchase A and B borrowed $45,000 by way of a fully drawn loan from the Commonwealth Bank. They paid the purchase price of $55,944. Notwithstanding the terms of the agreement, it somehow resulted that without A and B introducing any additional amount to the venture they not only came to hold a 50% interest in the company as shareholders but they also became creditors on loan account in the sum of $31,000. How this was achieved was unexplained.

4. At the outset M acquired the other half of the share capital and also came to maintain a loan account with the company in the same sum. There was no evidence of any arrangement between the shareholders, or between the shareholders and the company as to how overall their respective interests were to benefit from the operations of the company. However, what did appear was that the taxpayer's wife became matron of the nursing home and in that capacity derived a salary. Further, the taxpayer was provided with part-time employment by the company which in the year of income in question resulted in a salary to him of $6,236. Further, the taxpayer and his wife resided at the premises. There was no evidence suggesting that their fellow shareholder made any comparable contribution or received any compensating benefit if any were appropriate, although at a later date M did increase the amount on deposit on loan account with the company without there being any comparable increase on the part of the taxpayer and his wife. In those circumstances I am satisfied that the taxpayer is entitled to a deduction pursuant to sec. 51 of the Act in relation to his share of the sum of $2,514 paid by way of interest and bank charges. However, as it will appear from what follows, I hold that that entitlement rests on a broader basis than only the expectation of future dividends.

5. The third claim to be considered is in respect of the sum of $2,438 paid by A and B as interest in respect of a loan of $12,000 borrowed from Citicorp and ``on-lent'' to the company. (The original claim to $3,900 was reduced.) No similar loan was made by their fellow shareholder at that time. The loan was made by A and B because at that time the company was experiencing liquidity problems and the advance enabled the company to pay some of its expenses and reduce its overdraft. Neither the taxpayer nor his wife had any expectation that the income they would derive from the company would be increased in any way by reason of the making of that loan. Their concern was, as I so find, that their income would continue.

6. The company survived its liquidity problems with the result that A and B continued to derive income from employment with the company; the prospect remained that the company might resolve to pay interest to its members on all or some of their loan accounts; and the taxpayers continued to have the prospect of deriving dividend income from the company. Those three prospects of income benefit were interrelated in that to increase salary and wages would reduce the capacity of the company to pay interest and dividends. Further, payment of interest would reduce the capacity to pay dividends whereas on the other hand, to never pay interest on the loan accounts would increase the level of possible dividends. For those reasons I have already concluded that the taxpayer is entitled to a deduction in respect of interest paid on moneys borrowed to finance the initial purchase. The further question which arises in considering the claim I am now addressing is whether the circumstance that there was no expectation of either any

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ATC 618

particular interest return or any increased interest return or any other increase in earnings from the company by reason of this further advance operates to deny the taxpayer an entitlement to a deduction. In my view it does not. An entitlement to a deduction for interest in respect of moneys borrowed which are ``on-lent'' to a third party is not conditional upon a specific entitlement to derive income by way of interest from that third party. In
F.C. of T. v. Total Holdings (Aust.) Pty. Ltd. 79 ATC 4279 Lockhart J., with whom Northrop and Fisher JJ. agreed, said (p. 4283):

``If a taxpayer with a continuing business incurs a liability for interest being incidental to or connected with the operations or activities regularly carried on for the production of income, the interest is an allowable deduction. The circumstance that each item of expenditure cannot be traced to a particular item of income does not prevent the deduction of the expenditure...

In my opinion if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under sec. 51.''

In my view those principles apply in the instant case. The taxpayers were in a position similar to that of a lessor of rented premises let long-term at a fixed rent. If he incurred substantial expense in the ``repair'' (in the revenue sense) of the premises in order to ensure the continuity of income without any prospect of increased income the expenditure would be deductible. If to effect those repairs the lessor had had to borrow moneys, in my view the interest on moneys borrowed would be an allowable deduction. I would therefore allow a deduction under this head for $1,257.

7. That being so I would allow the objection of the taxpayer in the sum of $5,684.

Claims allowed in part