Marshall and Brougham Pty. Ltd. v. Federal Commissioner of Taxation.
Judges:Jacobs J
Court:
Supreme Court of South Australia
Jacobs J.
The appellant taxpayer Marshall and Brougham Pty. Ltd. (``the taxpayer'' or ``the taxpayer company'') claims to deduct from its assessable income for the year ended 30 June 1979 a sum of $500,000 written off before the end of that financial year as a bad debt. The debt represented the ``running balance'' owing to the taxpayer as at 8 February 1979, of moneys that had been more or less regularly deposited by the taxpayer with Associated Securities Ltd. (``A.S.L.''), and repaid by that company, as interest bearing loans on short term or ``at call'' during the period from about the middle of June 1977 until the end of December 1978. On 8 February 1979, however, A.S.L. was placed in receivership and subsequently into liquidation. It is common ground that the balance of moneys then owing to the taxpayer, as an unsecured creditor, is irrecoverable.
The taxpayer claimed the deduction under sec. 63(1)(b) and (or alternatively) sec. 51(1) of the Income Tax Assessment Act 1936 as amended. Those sections provide:
``63(1) Debts which are bad debts and are written off as such during the year of income, and -
- (a)...
- (b) are in respect of money lent in the ordinary course of the business of the lending of money by a taxpayer who carries on that business,
shall be allowable deductions.''
``51(1) 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 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 claim was disallowed by the Commissioner and his decision was confirmed by a Board of Review [reported as Case S66,
85 ATC 473]. In substance it has held (1) that the taxpayer, whose principal business is that of a large-scale master builder, does not carry on business as a money-lender and therefore cannot claim the deduction under sec. 63(1)(b); and (2) that the loss was a loss of capital or of a capital nature and therefore not deductible under sec. 51(1). The taxpayer challenges both these conclusions, and those are the issues to be decided on this appeal.
It is unnecessary in this judgment to spend time on the formalities which were canvassed in the course of argument. The appeal comes to this Court pursuant to sec. 196(1) of the Act, and it is not disputed that it involves questions of law - the construction of the statute and its application to the particular facts of the case. Those facts are to be found in the oral evidence and the documents admitted in evidence before the Board of Review. The evidence then called by the taxpayer is not itself under challenge, but I am invited by both parties to draw my own conclusions of fact from that evidence, as on a re-hearing. Before the Board the taxpayer called as witnesses Mr S.J. Marshall, a director and officer of the taxpayer, and Mr J.E. Hansen, a senior executive of another large building company; and the documentary evidence, for the most part, dealt with the taxpayer's transactions on the ``short term'' money market, not only with A.S.L., but for a longer and partly concurrent period with another merchant banker, Australian International Finance Corporation Limited (``A.I.F.C.'').
The evidence discloses that the business of the taxpayer company began in a small way as a partnership business in the building and construction industry in 1948. The taxpayer company was formed in 1954 to acquire the business of the partnership and the business thereafter prospered and expanded. Over the years it assumed a different structure in legal and financial terms, so that by 1974 the business was being carried on by a group of companies. The taxpayer company was the management company within the group. It entered into building contracts and engaged subcontractors. It employed or engaged estimators or quantity surveyors for the purpose of preparing and submitting tenders for construction projects, and carried the overhead costs of the group. It charged management fees to other companies in the group. They were identified as (1) Marshall and Brougham Joiners Pty. Ltd. which specialised in joinery work, and subcontracted to the taxpayer company as well as to other builders outside the group; (2) Marshall and Brougham
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Constructions Pty. Ltd. which employed the building construction workforce used by the group and appears to have been ``the construction company'' used in the performance of head contracts entered into by the taxpayer; (3) Marshall and Brougham Homes Pty. Ltd. was, as its name indicated, a home building company within the group engaged in building project homes, i.e. not custom built, for sale as a ``package'', home building being but one facet of the group's business which, by this stage, also embraced the construction of large public and commercial buildings in the city and suburbs; (4) Maisbury Plumbers Pty. Ltd. was a plumbing subcontractor to the group, as well as to other builders; (5) the remaining effective company in the group - there was one other formed for a specific project which never became operative - was Builders Supplies Pty. Ltd. The evidence about that company is sparse but its name implies that it was the purchaser and supplier of building materials used by the group companies in their various building projects.In 1974 Mr Stewart Marshall, a son of one of the founders of the group, was appointed to the position of corporate accountant for the group. He was a qualified accountant with a university degree in economics and working experience in the building industry. One of his first tasks was to reorganise and improve the group's cash flow by a more prompt and regular procedure for charging work in progress and collecting progress payments. The form of head contract in use entitled the taxpayer to make a claim for progress payments at specified stages and, under Mr Marshall's management, progress payments under the head contract were often received in advance of the time at which payments had to be made, whether to subcontractors engaged to carry out the work, many of whom were outside the taxpayer's own group of companies, or to discharge other trading debts. This time lag meant that the taxpayer had liquid cash resources, earmarked or destined for payment to subcontractors or to discharge other current liabilities within the group. Rather than hold these moneys in the taxpayer's bank account, Mr Marshall, who had later become finance director of the taxpayer company and the group as a whole, placed the funds on short-term loan with approved financial institutions for periods as short as one or two days or as long as several weeks, depending upon when the subcontractors or suppliers of goods had to be paid. One of the institutions approved by the board of directors of the taxpayer company with which money could be so placed by way of deposit on loan, with a limit of $500,000, was Associated Securities Ltd. (A.S.L.).
There was undisputed evidence from Mr Hansen, the financial controller of another large consortium of building contractors, the Fricker Carrington Group, that the way in which the taxpayer managed its funds was common practice in the industry, and that indeed some contractors went so far as to allow for an estimated return on funds so deposited by way of short-term loan in assessing or calculating their profit margin before submitting a tender.
It is part of the taxpayer's case that these funds were received as the taxpayer's revenue, that they never assumed the character of capital, but were simply moneys in transit, the balance of which, after payment in due course to subcontractors or other creditors, would be accounted for in the gross profit of the group companies other than the taxpayer itself. That is because the taxpayer, in addition to or as part of its role as the management company, was also the ``banker'' to the group. It maintained the only creditors' ledger, paid all accounts, and received all progress payments, and, although the building or head contract was in the name of the taxpayer, the contract was in fact carried out by Constructions who used other subcontractors in the group, or outside subcontractors, or its own workforce. Payments made or moneys received on behalf of a group company such as ``Plumbers'' or ``Joiners'', are debited or credited to the loan account of that company with the taxpayer, but the profit or loss on any head contract was brought to account in Constructions and would be reflected in the loan account of Constructions with the taxpayer. Thus progress payments on a head contract received by the taxpayer would be credited in the group accounts to Constructions which would in turn be debited with payments, e.g. to subcontractors (including other group subcontractors) or suppliers of materials, and the balance, whether a credit or debit balance, was reflected in Constructions' loan account with the taxpayer. At the close of the financial year in question, Constructions' loan account with the taxpayer was in credit in an amount of $1,176,199; the accounts of the other group
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companies were all in debit to the taxpayer in a total amount of $951,130. So far as the taxpayer was concerned its own profit was derived not from the building contract into which it enters, but from management and related charges and interest received from moneys which passed through its hands as ``bankers'' for the group.The practice of placing current cash balances on short-term loan or ``on call'' was initiated by Mr Marshall in June 1975. At first he appears to have dealt only with Australian International Finance Corporation Ltd. (A.I.F.C.). In the two year period between June 1975 and May 1977 there were some 165 separate transactions with an average of about seven transactions in each month, the highest number of such transactions in any one month during that period being 12. The lowest individual deposit was $25,000 and the highest $425,000, and almost half were in individual amounts of $100,000 or more. If not at call, the repayment date was generally measured in days although occasionally in weeks. From June 1977 until January 1979 deposit transactions with A.I.F.C. followed the same general pattern but were reduced in number because in the middle of 1977 - so far as the documentary evidence goes, although Mr Marshall thought it was a little earlier - the taxpayer began to make similar deposits on loan from its current cash receipts with Associated Securities Ltd. (A.S.L.) which, for the most part, offered interest rates that were marginally higher than those obtained from A.I.F.C. From June 1977 until January 1979 there were some 35 separate transactions with A.S.L. spread over the period at an average of about two per month. About two-thirds of them were for amounts in excess of $100,000, the highest amount being $300,000 and the lowest $50,000. Again, most of the deposits were at call, or for periods measured in days rather than in weeks. In the period from 1 July 1978 to 31 December 1978, there were some 16 deposits and 17 repayments, the current balance fluctuating from time to time between zero and $450,000 (exhibit G). There is no reason to doubt that the pattern of transactions, in and out, as shown by this exhibit, is typical of the way in which the taxpayer used both A.I.F.C. and A.S.L. in dealing with its current cash resources.
Unfortunately for the taxpayer A.S.L. was placed in receivership on or about 8 February 1979. It is common ground that at that date the taxpayer had $500,000 on ``loan'' to A.S.L. for the repayment of which it ranked as an unsecured creditor. The amount was never repaid, and on 29 June 1979, i.e. shortly before the close of the financial year in which the loss had been incurred, the amount of $500,000 was ``written-off'' as a bad debt. Although it does not clearly show in the accounts which were tendered in evidence, the undisputed evidence of Mr Marshall is that the balance on deposit by way of short-term loan of current cash balances was shown in the annual accounts as ``cash at bank'', the actual amount shown in that item at the end of the financial year being the balance struck after ``marrying'' current accounts with the bank (whether in credit or debit) with the amounts payable to the taxpayer on its short-term loans. Because such loans were invariably available at call - even those on short fixed terms by sacrificing interest - they were treated in the accounts as ``cash at bank''.
The ``loss'' of $500,000 was written off in the ``Profit and Loss Statement'' of the taxpayer for the relevant accounting period. It converted a ``net profit before extraordinary item'' of $70,319.82 into a net loss of $429,680.18, which was carried to a profit and loss appropriation account as follows:
The amount by which this account is now ``overdrawn'' ($369,592.86) is carried to the balance sheet as a ``contra'' against shareholders' funds. Had the loss not been incurred, the figure in the balance sheet shown under ``Current Assets'' as cash at bank would have been augmented by $500,000, and the shareholders' funds would have been augmented by unappropriated profits of $130,407.14 instead of showing the ``contra'' entry of $369,592.86.
Section 63(1)
There is no doubt on the facts as recited that the loss in question was a debt which was a bad debt written off as such during the year of income. Nor is there any doubt that the bad debt so written off was in respect of money lent in the ordinary course of business of the taxpayer; but in order to bring its claimed deduction within the ambit of the section it must also be shown that the taxpayer was carrying on the business of the lending of money, i.e. that the taxpayer was carrying on the business of a money-lender. It is not enough, in my opinion, to show that it regularly ``lent'' money, in a commercial and businesslike way in the ordinary course of its business as a building contractor, but that, as it seems to me, is as far as the evidence goes; the statute, however, requires that the business carried on by the taxpayer should be able to be characterised as the business of money-lending.
Whether or not a person is, in the eyes of the law, ``carrying on'' the business of a money-lender does not seem to be the subject of any precise test. Some of the cases, all of which turn on their own facts, are collected and discussed in
Swayne v. Palm (1970) S.A.S.R. 158, but it must be remembered that many of the cases are concerned with statutory definitions, and are coloured by the penal and sometimes draconian consequences imposed on those who carry on the business of money-lending in contravention of the licensing or other provisions of a statute. It is one thing to say that ``the business of money lending imports the notion of system, repetition, and continuity''... and "more than occasional and disconnected loans (per McCardie J in
Edgelow v. MacElwee (1918) 1 K.B. 205, or to say that ``speaking generally, the phrase `to carry on business' means to conduct some form of commercial enterprise, systematically and regularly, with a view to profit and implicit in this idea are the features of continuity and system'' (
Hyde v. Sullivan and Ors (1956) S.R. (N.S.W.) 113 at p. 119). If that is all that is required, the taxpayer's activities in ``lending'' its money may well pass the tests in sec. 63(1) of the Act. It seems to me, however, that any one who claims to be carrying on the business of money-lending must at the very least hold himself out as willing to lend money on his own terms. As Farwell J. said in
Lutchfield v. Dreyfus (1906) 1 K.B. 584, ``speaking generally, a man who carries on a money-lending business is one who is ready and willing to lend to all and sundry provided they are from his point of view eligible''.
It is to be observed how often such judicial dicta are introduced by the words ``speaking generally'', for in truth each case requires the Court to give the words of the statute their ordinary meaning, giving effect to their commercial usage where they have a commercial meaning, and then apply such meaning to the facts.
Viewed in that way, but not ignoring the quoted dicta, it is in my opinion quite
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impossible to say that this taxpayer, although ``lending'' money in the course of its business, was itself ``carrying on the business of lending money''. The use of the short-term ``money market'' has become a very common commercial activity, not merely by traders, corporate and otherwise, but by institutions, charitable and otherwise, and by individuals. It is used by them selectively, according to their own commercial convenience, and in many cases frequently and systematically, but to describe them as carrying on the business of a money-lender is an affront to ordinary commercial usage. No one, I venture to think, would suggest that they were ``carrying on the business of a money-lender'' if they deposited their money regularly in an interest bearing current account with a bank, but that is precisely how the taxpayer viewed its own transactions with A.S.L. and A.I.F.C. - as a supplementary or complementary banking facility - even to the extent of recording the balance on deposit, in its own books, as ``cash at bank''.The taxpayer sought to derive some assistance, on this aspect of the case from cases such as
Reid's Brewery Co. v. Male (1891) 2 Q.B. 1 in which the lending of money, on the lenders own terms, to its clients or customers, was indeed an integral part of the business carried on by the taxpayer. it was accepted in that case that ``it was the custom, habit, and usual practice of manufacturing brewers, at any rate in London, to carry on the business of bankers and money-lenders as a branch or adjunct of their brewing business, such business being strictly carried on with the customers and connections of the brewery and the losses were sustained on loans advanced by the taxpayer, on the security of public houses with which their business was largely connected, to their customers (that is, persons who dealt or had agreed to deal with the company)''. That enabled Charles J. to say that ``the appellants carry on one business... (they) carry on the brewing business with the business of money lending as a branch or adjunct to it'' (the emphasis is mine); but it is not correct to say by analogy, in the present case that the ``loan'' transactions of the taxpayer with A.S.L. and A.F.I.C., in the ordinary course of the taxpayer's business as a builder, are such as to characterise the business carried on by the taxpayer as the business of money-lending. Lending money in the course of carrying on business as a builder is not the same as carrying on the business of money-lending as a ``branch or adjunct'' of the building business. The case of Reid's Brewery Co. v. Male (supra) may well be relevant to questions arising under sec. 51(1) because the Court in that case (Baron, Pollock and Charles JJ.) held that the loss on the loan was not a loss of capital, but for the reasons stated the taxpayer is not in my judgment entitled to claim the loss as an allowable deduction from its assessable income under sec. 63(1)(b).
Section 51(1)
It is now well settled that a loss being a bad debt which may not be an allowable deduction under sec. 63(1) may nevertheless be an allowable deduction under sec. 51(1),
Fairway Estates Pty. Ltd. v. F.C. of T. 70 ATC 4061 per Barwick C.J. at p. 4066. There are, for present purposes, two limbs to this section. The allowable deductions for which it provides are all losses and outgoings to the extent to which they are (1) incurred in gaining or producing the assessable income or (2) necessarily incurred in carrying on a business for the purpose of gaining or producing such income - provided, of course, for present purposes, that they are not losses or outgoings of ``capital or of a capital nature''.
The taxpayer company claims the disputed deduction under both limbs. It says that the loss was incurred in gaining or producing the assessable income, because it was incurred in the course of its financial management of the group companies for which it was paid the management fees which are the principal component of the earnings that produce its assessable income. It says, in addition, that the loss was ``necessarily incurred in carrying on a business for the purpose of gaining or producing such income''. No argument was addressed on behalf of the respondent Commissioner in denial of these propositions, although the concept of a loss ``necessarily'' incurred is somewhat puzzling. One can readily understand the concept of outgoings that are necessarily incurred in carrying on a business, but it is less easy to comprehend a loss that is necessarily incurred, unless it is a loss of a capital nature, for example, a wasting asset. In
Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344, which will be referred to in more detail a little later, it was
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suggested (arguendo) that ``necessarily'' means no more than that the loss was suffered in carrying on business in the way in which it was carried on by the taxpayer. In the context of the present case, it may be that the word ``necessarily'' means only that the loss must arise in the reasonable and proper course of prudent management, in the sense that it was incurred in the ``necessary'' course of carrying on business; or it may be that the section, with some straining of the syntax, ought to be construed to bring only ``outgoings'' within the second limb. There is, however, in this case no need to resolve these difficulties of characterisation of a loss which is conceded to fall within one or other of the two limbs of the section, if it is not a ``loss of capital or of a capital nature''. It is of interest that in the case of Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (supra) upon which the taxpayer heavily relies, the loss, although apparently incurred in the ``necessary'' course of carrying on business, was allowed under the first limb of the section.Was then the loss of $500,000 which is the subject of the present claim a loss of capital or of a capital nature? In order to answer this difficult question, it is necessary to look again at those critical features of the taxpayer's business activities that provide the setting for the loss, and in particular the nature and source of the funds that were lost. It was the taxpayer to whom progress payments under head contracts were due, even though they were accounted for by appropriate journal entries, in the accounts of group subsidiaries; it was the taxpayer who maintained the creditors' ledger for the group and paid all outgoings; it was the taxpayer which got in or collected progress payments owing to it or to group companies. There can be no doubt upon the evidence that the cash flow which generated the funds placed with A.S.L. and A.I.F.C. on call or very short call was generated by progress payments from building owners received in advance of payments due by the taxpayer, whether to subcontractors outside the group, or for labour and materials expended or other costs incurred on building contracts within the group. The moneys were trading revenues or receipts, and instead of being banked to meet the payments which the taxpayer was obliged to make, they were placed with A.S.L. and A.F.I.C. - which the taxpayer treated as its bank - until they were actually required. The funds on deposit were trade receipts, earmarked for the payment of trade debts. Whatever element of profit there may have been in the funds, it was not at that stage realised profit, and was not in any event the profit of the taxpayer. To assert that these moneys represented a ``capital fund'' which earned interest brought to account as part of the taxpayer's assessable income, appears to me to be an over-simplification; they were moneys received as revenue and earmarked for expenditure as revenue, to the extent that may be necessary - and it is of interest to note that from time to time there was a ``zero'' balance on deposit with the merchant banks. At the time they were lost, the moneys on ``loan'' could not in my opinion be identified in whole or in part as ``capital'' or ``of a capital nature''.
So far as the decided cases are of assistance in resolving the question, very few of them deal with ``losses'' as distinct from ``outgoings'', but the conclusion at which I have arrived appears to be justified by the approach adopted in such cases as
C. of T. (N.S.W.) v. Ash (1939) 61 C.L.R. 263, Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (supra) and Reid's Brewery Co. v. Male (supra).
The first of these cases is clearly distinguishable on the facts, and the loss incurred by a solicitor in settling claims arising out of the fraud of a former partner were held to be not allowable deductions; but the critical question was whether the payments were in the nature of a loss or outgoing of capital. Latham C.J. said (at p. 273) that ``An expenditure which is directly associated with the daily requirements or exigencies of a business will be an allowable deduction.'' but immediately qualified that statement by observing that it ``cannot be regarded as exhaustive'' and ``the line is sometimes difficult to draw''. He went on to give examples of allowable deductions by way of payments that are ``regular and almost unavoidable incidents of the business'', or losses that ``may be shown to be incidental to, and perhaps inevitable, in the operations which produce income''. Rich J., however, stated the principle in terms which are now directly relevant to the present case when he said (at p. 277):
``There is no difficulty in understanding the view that losses or outgoings incurred as an expedient aid to the more satisfactory working of an undertaking over a
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considerable interval of time should be allowed as deductions notwithstanding that no immediate, direct or tangible result can be reflected in revenue. This court has more than once acted upon such a view. There is no difficulty in understanding the view that involuntary outgoings and unforeseen or unavoidable losses should be allowed as deductions when they represent that kind of casualty, mischance or misfortune which is a natural or recognized incident of a particular trade or business the profits of which are in question. These are characteristic incidents of the systematic exercise of a trade or the pursuit of a vocation.''
That passage was cited with approval by a unanimous Court, and was the basis of the decision, in Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (supra), the case which, of all those referred to in the course of argument, appears to be closest to the present case on the facts. In that case a cashier employed by the taxpayer was robbed on his way to the bank of a bag containing a substantial amount of money in bank notes, being part of the taxpayer's previous day's cash receipts in the ordinary course of business. The loss was held to be deductible, and a fortiori not ``a loss of capital or of a capital nature''. The Court said (at p. 350):
``Banking the takings is a necessary part of the operations that are directed to the gaining or producing day by day of what will form at the end of the accounting period the assessable income. Without this, or some equivalent financial procedure, hitherto undevised, the replenishment of stock in trade and the payment of wages and other essential outgoings would stop and that would mean that the gaining or producing of the assessable income would be suspended.''
Then, after referring to the statement of Rich J. in Ash's case (supra) it continued (at p. 351):
``Even if armed robbery of employees carrying money through the streets had become an anachronism which we no longer knew, these words would apply. For it would remain a risk to which of its very nature the procedure gives rise. But unfortunately it is still a familiar and recognised hazard and there could be little doubt that if it had been insured against the premium would have formed an allowable deduction. Phrases like the foregoing or the phrase `incidental and relevant' when used in relation to the allowability of losses as deductions do not refer to the frequency, expectedness or likelihood of their occurrence or the antecedent risk of their being incurred, but to their nature or character. What matters is their connection with the operations which more directly gain or produce the assessable income.
It was argued for the commissioner that even conceding the foregoing the loss was of a capital nature. This argument depends upon the view that before the money was stolen it had come home to the taxpayer so as to form part of its capital resources. But that is not a tenable view of the matter.... For the purposes of this case it is enough... to point out that we are here dealing with a loss incurred in an operation of business concerned with the regular inflow of revenue, not with a loss of or concerning part of the `profit yielding subject' the phrase in which Lord Blackburn in
United Collieries Ltd. v. Inland Revenue Commissioners (1930) S.C. 215, at p. 220; (1929) 12 Tax. Cas. 1248, at p. 1254 summarised the characteristics of a business undertaking or enterprise considered as an affair of a capital nature.''
The primary argument for the respondent to the present appeal was that the money lost had ``come home to the taxpayer so as to form part of its capital resources'', but that argument appears to me to overlook the critical facts in the case - that the taxpayer in its role of financial management of the group was the debtor company to which progress payments were made and from which group creditors were paid. the moneys lost were received on revenue account and ``banked'' on a temporary basis as a source of payment for current outgoings; and those were the very activities which sustained and justified the management fees charged by the taxpayer as its own principal source of income.
Lastly, in Reid's Brewery Co. v. Male (supra), the losses incurred by the taxpayer on money lent in the ordinary course of its business - and it is immaterial on this aspect of the present case whether or not the ``business'' was that of a money-lender or
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brewer, or whether, as the Court held, the business of lending money was an integral part of the business of brewing - were held not to be losses of capital. The loans which proved to be bad debts were treated not as an investment of capital, but rather as money being ``rolled over'' in the ordinary course of the taxpayer's business. InF.C. of T. v. Hunter Douglas Ltd. 83 ATC 4562; 78 F.L.R. 182, the question whether foreign exchange gains or losses made in repaying loans are capital or revenue items fell to be determined with reference to the purpose of the borrowing which supports them. So here, the character of the losses falls to be determined by reference to the nature and source of the moneys lost, and the reason for their temporary deposit by way of ``loan''.
The case is not an easy one, but I have come to the conclusion that the appeal should be allowed, and that the taxpayer is entitled pursuant to sec. 51(1) of the Act, to deduct the sum of $500,000 from its assessable income, for the financial year ended 30 June 1979. The assessment should be amended accordingly, with such other consequential relief to which the taxpayer may be entitled by law.
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