Case S83
Judges: HP Stevens ChTJ McCarthy M
PM Roach M
Court:
No. 1 Board of Review
T.J. McCarthy (Member)
In his return of income for the year ended 30 June 1982 the taxpayer, A, claimed deductions amounting to $6,415, being one-half of the sum of $12,831 which was said to be interest and bank charges jointly paid by the taxpayer and his wife, B, in relation to moneys borrowed by them for income-producing purposes. In the return the calculation of the amount of $12,831 was shown as follows:
Bank charges and interest paid $
to Commonwealth Bank 2,514
Interest paid to Z 6,417
Interest paid to Citicorp 3,900
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$12,831
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The Commissioner disallowed the taxpayer's claim in full and also his subsequent objection. So far as quantum is concerned, counsel for the taxpayer conceded at the hearing that the amount of interest shown as paid to Citicorp had been incorrectly calculated and that the correct amount was not $3,900 but $2,438, being 20.31% of $12,000 plus additional interest of $7.35 in relation to late payment. In the light of the evidence, the taxpayer's modified claim, which was not challenged as to quantum by the Commissioner, may be conveniently summarised as follows:
Joint Borrowings by A and B $
Bank charges and interest paid to
Commonwealth Bank in respect of
a sum of $45,000 advanced to A
and B in July 1978 by way of
fully drawn loan account and used
by them to finance the joint
purchase of shares representing
one-half of the issued share capital
in N Pty. Ltd. which owned and
operated a 54-bed convalescent
home 2,514
Interest paid to Z in respect of a
sum of $40,000 lent to A and B in
October 1980 and used by them in
connection with the purchase of
income-producing flats by A, B,
C and D
The amount now claimed by A is therefore $5,684.
2. The evidence in relation to the loan of $40,000 made by X to A and B was as follows. A and B agreed to a suggestion from their friends, C and D, that the four of them should together purchase a block of income-producing flats on the Central Coast. To finance their share of the purchase, C and D sold a home unit, whereas A and B needed to borrow and did so from X. A sum of $40,000 was advanced to A and B by X in October 1980. The sum was secured by mortgage over the property, C and D consenting thereto in return for being indemnified by A and B against all claims and expenses in relation to the mortgage. A deed of indemnity dated 17 October 1980 was tendered in evidence. The period of the loan was one year and the interest rate was 20% per annum, reducing to 14% per annum where payment was made within the time specified. The loan was renewed on 17 October 1981 at a higher interest rate (25% per annum reducing to 16%). The block of flats was acquired by A, B, C and D in October 1980, rent was obtained from tenants, and the property was sold in 1983. During the year ended 30 June 1982 A and B paid Z interest amounting to $6,417, which presumably included some additional interest for late payment. The taxpayer's claim in relation to this item was ultimately not challenged by counsel for the Commissioner, although I note in passing that the purchase price of the flats, as shown in the deed of indemnity, was $72,350, which suggests that the sum of $40,000 was used in part for purposes other than the actual purchase of the property, though if challenged, A and B may simply have replied that the balance was also used in connection with this investment. The partnership return for A, B, C and D was not tendered in evidence, but I note that in his return A claimed a deduction of $198 in respect of his share of the partnership loss.
3. In the circumstances A is entitled to a deduction of $3,208 under sec. 51(1). Counsel for the Commissioner did not suggest otherwise. In fairness to the Commissioner it should be mentioned that in response to a query from the Taxation Office the taxpayer's accountant advised the Commissioner by letter dated 8 June 1983 that the sum of $40,000 was applied by A and B for a purpose other than the purchase of Central Coast property.
4. Interest and bank charges amounting to $2,415 were paid by A and B to the Commonwealth Bank in respect of a sum of $45,000 advanced to A and B in July 1978 by way of fully drawn loan account. This sum was then applied by A and B, together with other moneys, in purchasing for a total sum of $55,944 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 N Pty. Ltd., which owned and operated a 54-bed convalescent home. In the purchase agreement the purchase price of the shares was shown as $55,944 and the vendors convenanted to effect the repayment by the company of their loans to the company. Although the company's accountant, in a letter dated 9 April 1981 to a statutory body, allocated part of the consideration to acquiring the previous shareholders' loans to the company (which totalled $62,000) it may well be that those loans were subsequently assigned by the previous shareholders to the new shareholders, without any separate consideration for those assignments, but as valid assignments pursuant to sec. 12 of the Conveyancing Act. I also note that some interest was subsequently credited to A and B on these loans. In any event, I do not propose to go behind the purchase agreement. I accept that the sum of $45,000 was used by A and B to purchase their shares in N Pty. Ltd. Although no dividends have yet been paid by the company to A and B - losses were made by the company in every year except the year ended 30 June 1982 when the company made a small profit - the shares, once acquired, had the character of an income-producing asset because the entitlement to any dividends subsequently paid to A and B would have its origin in the articles of association of the company. (The different classes of shares related to the appointment of directors and not to dividend rights.) Accordingly, the amount of $2,514 (which was not disputed as to quantum by the Commissioner) has the character of an outgoing incurred in gaining assessable income
ATC 616
(seeF.C. of T. v. D.P. Smith 81 ATC 4114 at p. 4117 ).
5. The final claim to be considered is interest of $2,438 incurred by A and B in respect of a loan of $12,000 made by Citicorp to A and B in August 1980 which sum A and B on-lent to N Pty. Ltd., interest free, so that N Pty. Ltd., which was in financial difficulties at the time, could pay some of its expenses and reduce its overdraft. These moneys were deposited by B in the company's bank account, and interest on these moneys was never obtained nor sought by A and B, nor did A and B have any entitlement to interest. Whilst there was some attempt by counsel for the taxpayer to relate the interest paid on the Citicorp loan to the dividends expected to be paid, and reliance was placed upon some observations of the Federal Court in F.C. of T. v. Total Holdings (Aust.) Pty. Ltd. 79 ATC 4279, I am of the opinion that no deduction is allowable under sec. 51 for any part of that interest. This case is not like Total Holdings where the carrying on of a relevant business by the taxpayer enabled various activities to be linked and considered together, under the umbrella of one income-producing activity, such that in all the circumstances the outgoing could be said to have the requisite connection with the operations which more directly gain or produce the assessable income. Where a taxpayer is not carrying on a relevant business, it may not be possible in the particular circumstances to link one activity with another in this way. Take the following example: X borrows $40,000 and on-lends that sum to Y at a commercial interest; subsequently Y is in financial difficulties and is struggling to pay interest to X on this loan; X then decides to borrow a further sum of $10,000 which he on-lends to Y, interest-free, in the hope that Y's financial position will improve so that Y can pay interest to X on the loan of $40,000. In that commercially artificial situation, I think it is clear that, although X is entitled to a deduction for interest incurred by him on the loan of $40,000, X is not entitled to a deduction for interest incurred by him on the moneys of $10,000 borrowed by him and lent to Y. In truth, there are two separate loans by X, without any contractual link, and X's motive is not enough to enable the two loans to be grouped together as one income-producing activity. Another example is where an employee borrows moneys at interest and lends those moneys, interest-free, to his employer who is in financial difficulties. In the present case, even if it be assumed that the motive of A and B in making the interest-free loan was solely directed to the ultimate receipt of dividends, that would not be enough, in my view, to qualify the interest which A and B paid to Citicorp as allowable within sec. 51. But no doubt there were other purposes which led A and B to protect the company's financial position: A and B lived in the nursing home; B was the matron and A did odd jobs, for which both were paid. Nevertheless, becoming shareholders was one income-producing activity; performing work as employees was another income-producing activity; and lending moneys interest free to N Pty. Ltd. was not a relevant incident of either activity and was not itself an income-producing activity. Accordingly, in my view, no part of the interest paid to Citicorp qualifies as an allowable deduction within sec. 51. Of course, if I thought that the Federal Court intended to suggest otherwise, I would gratefully accept the guidance of the Federal Court, but when the reasoning in Total Holdings is read in its context, I do not believe that it provides any assistance to the taxpayer here.
6. I therefore conclude that one-half of the amount of interest (and other charges) jointly incurred by A and B (with each contributing to the payment thereof) in respect of the relevant borrowings from the Commonwealth Bank and from X, is deductible under sec. 51 in determining A's taxable income. Thus A is entitled to additional deductions amounting to $4,465.
7. For these reasons I consider that the taxpayer's objection against his assessment for the year ended 30 June 1982 should be upheld in part, his taxable income as previously assessed should be reduced by $4,465, and his assessment should be amended accordingly.
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