Riverside Road Pty. Ltd. (in liquidation) formerly Captain Fremantle Motor Lodge Pty. Ltd. v. Federal Commissioner of Taxation
Judges:French J
Court:
Federal Court
French J.
Introduction
The Captain Fremantle Motor Lodge was built in 1970 and operated until 1984 by a company formed for that purpose using largely borrowed money. As part of a restructuring in 1979, the company sold the land and buildings to a related corporate trustee under a lease-back arrangement. Neither purchase price nor title changed hands until 1984 when the land was on-sold to a third party. In the meantime the company continued to run the motel business. Interest paid under the original borrowings and refinancing arrangements was claimed as a deduction from the assessable income of the company as were rental payments made to the corporate trustee. The trustee paid no interest on the outstanding purchase price.
In amended assessments issued on 21 April 1986, the Commissioner disallowed a proportion of interest claimed in the years 1979/1980 to 1983/1984 which related to the original purchase of the land and the construction of the motel buildings. A similar disallowance was made in the assessment issued for 1984/1985. Liquidator's fees claimed for 1984/1985 following the voluntary winding up of the company were also disallowed.
The assessments are challenged on the basis that all the interest claimed and the liquidator's fees are deductible outgoings under subsec. 51(1) of the Income Tax Assessment Act 1936. The operation of that subsection thus falls for consideration. And if the interest payments be deductible, the Commissioner asserts in the alternative that the sale and leasehold arrangements are void against him by virtue of sec. 260 of the Income Tax Assessment Act. On that basis it is contended that if the interest payments were deductible, the lease rentals were not. And if either the interest or rental payments were not deductible, then the amended assessments are said to have been authorised under sec. 170 by reason of the failure of the company to make a full and true disclosure of all material facts in its returns for the year in question. Alternatively, the Commissioner contends that if there were a full and true disclosure the original assessments issued as the result of a mistake of fact or calculation on his part and amended assessments are authorised on that ground.
Factual background
The motel known as the Captain Fremantle Motor Lodge has operated under that name on land at 6 Canning Highway, East Fremantle for nearly 20 years. Its history begins with the incorporation of the applicant in 1969 under the name ``Captain Fremantle Motor Lodge Pty. Ltd.'' and its purchase of part of the land designated Lot 2 in September of that year. The land was bought from a company called Robincor Pty. Ltd. under a contract of sale for $102,000.
Tenders were called by the applicant for the construction of a motel on the site and on 7 October 1969 the directors resolved to accept that of Civil and Civic Pty. Ltd. for $199,100. Construction proceeded and in 1970 the applicant commenced trading as the Captain Fremantle Motor Lodge. $36,100 was expended on plant and equipment. On 18 March 1971 Robincor Pty. Ltd. accepted the applicant's offer of $45,000 for land adjacent to the western boundary of Lot 2 and located on the corner of East Street and Riverside Road. This land was evidently purchased under contract of sale for no transfer was registered until October 1972. In July 1976 the applicant's board of directors decided to construct extensions to the motel building and approved expenditure of $245,000 for that purpose. $192,000 of that sum related to the building, with the balance being associated expenses including furniture and fittings.
As appears from the evidence of Mr J.F. Walker, a chartered accountant who was
ATC 4033
company secretary and a member of the board of the applicant from 1969 until December 1984, the cost of the land and buildings and associated expenses was met out of share capital, unsecured loans from shareholders and loans secured by mortgage over the land.In February 1970, $200,000 by way of bridging finance was obtained from Town and Country Building Society, secured by a first mortgage over Lot 2. It was repaid in December of that year and $200,000 borrowed from Messrs Mauger, Peek and McCall for a three year term at an effective rate of 9% per annum. That loan was extended until August 1976 and repaid following a further borrowing, in May 1976, of $350,000 from the Perpetual Executors Trustees and Agency Company Limited. That advance was for three years at 12.5% per annum and was secured by first mortgage over both lots. It was repaid on 1 May 1979, a loan of $350,000 for a term of five years at 12.5% then having been secured from the Motor Vehicle Insurance Trust. This borrowing was increased to $485,000 in December 1981, the interest rate being maintained at the same level. It too was secured by first mortgage over the land. With the exception of progress payments advanced by Perpetual Trustees, any amounts borrowed whether unsecured shareholders' loans or otherwise were paid into a common fund drawn upon as required to finance the applicant's projects.
In mid-1978 Walker formed the view that it would be in the interests of the shareholders to transfer the ownership of the land and buildings to a company other than the applicant. His purpose, as he explained it in evidence, was to protect the real property against liabilities incurred in the conduct of the business. He took legal advice, and with the approval of the directors, a circular was sent to shareholders on 1 November 1978 setting out certain restructuring proposals. The circular described the proposed ownership arrangements as follows:
``1. Introduction
The object of the restructuring is to transfer ownership of the land and building to a separate entity so that the same can be leased to Captain Fremantle Motor Lodge Pty. Ltd. Captain Fremantle Motor Lodge Pty. Ltd. will pay to this separate entity a rental which will be an expense to the Company. In turn, this expense will reduce the taxable profit the Captain Fremantle Motor Lodge Pty. Ltd.''
The steps necessary to effect the proposals were set out. In summary they were:
- 1. The establishment of a unit trust with units to be held by shareholders in proportion to the number of their shares. The directors of the corporate trustee of the unit trust to be the directors of the applicant.
- 2. Following incorporation of the trustee company and establishment of the unit trust the land and buildings to be sold to the trustee at market value. The purchase price was to be payable free of interest and on demand.
- 3. Upon execution of the contract of sale the trustee would lease back the land and building to the company for a rental of $90,000 per annum subject to annual reviews. The lease was to be for a term of one year with five consecutive options to renew for like terms.
The applicant would continue to operate the motel business and the rental would be ``a properly deductible expense within the provisions of the Income Tax Assessment Act''. Taxable income would reduce by an amount approximately equal to the rental paid to the unit trust. As the trust would not be liable for company tax, the net income received by it would be available for distribution to unit holders.
At an extraordinary general meeting held on 6 December 1978 the shareholders resolved to accept the directors' proposals. A valuation of the land was obtained which indicated that as at 24 January 1979 it was worth $900,000 as unencumbered freehold. A corporate trustee was established under the name ``East Street Nominees Pty. Ltd.'' and the trust was designated the ``Challenger Unit Trust''. On 30 January 1979 the applicant agreed to sell the land and buildings to the trustee for $900,000 payable free of interest on demand with possession of the land to be given on or about 1 February 1979. That handing over is best characterised as a notional event unmarked by external observance. The trustee agreed to lease the land back for a term of one year commencing 1 February 1979 with options for
ATC 4034
renewal and a rental of $95,000 per annum subject to periodic review. The rent was to be payable in advance in quarterly instalments of $23,750, the first being due and paid by 1 February.Legal title was not transferred and the mortgage in favour of Perpetual Trustees remained in place. On 18 April 1979 Walker in his capacity as secretary of the applicant, sent a letter to himself as secretary of the trustee requesting its permission to replace the Perpetual Trustee mortgage with a mortgage in favour of the Motor Vehicle Insurance Trust. Permission was given promptly on the following day and a formal consent executed on 30 April. The rental was reviewed upwards from time to time.
On 4 December 1981 the trustee acquired a further piece of land on the corner of East Street and Canning Highway and adjoining the land on which the existing motel building stood. It became the registered proprietor of that land on 4 December 1981. The purchase was financed in part out of the extra sum of $135,000 borrowed by the applicant from the Motor Vehicle Insurance Trust.
The lease-back arrangement continued until 6 December 1984 when the land was sold to a company called Tartaire Pty. Ltd. and the business, including leasehold rights, to Girdis Management Pty. Ltd. At that time all outstanding loans owed to shareholders and others were repaid. And on 1 February 1985 an extraordinary general meeting of the shareholders passed a special resolution that the company be wound up. It was further resolved that Walker be appointed as liquidator and that his fees be paid at the usual rate prescribed by the Insolvency Practitioners Association.
After disposal of the land and business and repayment of debts there was a surplus of $419,000 invested on the short-term money market. The applicant earned about $21,550 in the financial year ended 30 June 1985 from investments made by Walker following his appointment as liquidator. He rendered fees of $5,678 for his services for the period from his appointment to 30 June 1985. They were claimed as a deduction in the applicant's return for that year but in the course of the hearing it was concluded that no more than $3,091 related to management of the investments. The balance was incurred in processing an interim distribution of capital, realisation of assets and incidental activities. The number of hours spent on the applicant's investments was said in a letter from Walker's office, although not prepared by him, to be 69.4. He was unable to personally vouch for its accuracy.
The applicant's returns
It is common ground that in its six returns for the several years ended 30 June 1979 to 30 June 1984 inclusive the applicant claimed interest paid on its borrowings, both secured and unsecured, as expenses necessarily incurred in carrying on its business. And it is not disputed that those expenses were initially allowed as deductions. Two returns were filed for the year ended 30 June 1985, the first covering the period 1 July 1984 to 31 January 1985 and the second from the date of the winding up resolution, 1 February 1985, to 30 June 1985.
In each of the returns filed the profit and loss accounts under the heading Financial Expenses described a number of items including the following:
``Interest on Mortgage Loans Interest on Unsecured Loans Lease Rents''
The amounts so claimed in each return and the total interest payments were as follows:
-------------------------------------------------------------------------------
Year Interest on mortgage loan Interest on unsecured loans Lease rents
-------------------------------------------------------------------------------
$ $ $
1978/1979 43,749 35,447 39,583
1979/1980 45,505 35,447 95,000
1980/1981 43,750 35,448 100,000
1981/1982 43,750 35,447 105,000
1982/1983 43,765 35,447
In addition to the ``lease rents'' item in the financial expenses section of the profit and loss account, there was an item described as ``lease payments'' in the accounts for 1978/1979 and 1980/1981 and as ``leasing charges'' thereafter. The returns did not expand upon the designation ``lease rents'', nor was there indication of the recipient of the rents or its relationship to the applicant.
The list of current assets in the 1978/1979 balance sheet attached to that year's return, included an item designated ``Loan - At Call... $903,447''. A note to that entry said:
``The debt of $903,447 arising in the sale of the land and buildings shown in the balance sheet under the heading of Current Assets, is secured by contract of sale, and the debt is repayable at call, and is interest free.''
In the 1979/1980 return the debt figure was shown as $858,447 and the note was in similar terms. In 1980/1981 it was $850,447, in 1981/1982 $864,047 and in 1982/1983 $870,047. In 1983/1984 the designation of this item was changed to ``Mortgage - Challenger Unit Trust'' and was shown as $900,000. The note to this entry was in the same terms as its predecessor's save for an unelaborated reference to the Challenger Unit Trust. In the return for the period from 1 July 1984 to 31 January 1985 the ``Mortgage - Challenger Unit Trust'' and was shown as $900,000. The note to this entry was in the same terms as its predecessor's save for an unelaborated reference to the Challenger Unit Trust. In the return for the period from 1 July 1984 to 31 January 1985 the ``Mortgage - Challenger Unit Trust'' item was shown as nil and the accompanying note under the reference ``LOAN AT CALL'' said ``This was paid out on the sale of the Captain Fremantle Motor Lodge''. The differences in the debt amounts in each successive year were not explained.
The respondent contended among other things that the returns lodged by the applicant for the years 1978/1979 to 1983/1984 and for the period 1 July 1984 to 31 January 1985 did not make full disclosure of material facts relating to the sale and lease agreement with East Street Nominees. Broadly stated, it was the respondent's complaint that assessors processing the applicant's returns could not have known, on the information provided, that a significant proportion of the interest payments on the secured and unsecured loans and the lease rents related to the same land and a landlord not at arm's length from the applicant tenant. In ignorance of those facts, it was said, the assessors allowed both the interest payments and the lease rents as deductions.
In support of the applicant's contention that all relevant information had been furnished, affidavit evidence was given by Geoffrey Taylor, the senior partner of the firm of accountants, Wilson O'Keefe and Walker. His firm, of which Mr Walker was also a member, was responsible, in the relevant years of income, for the preparation and lodgment of the applicant's returns and those of the trust estate, Challenger Unit Trust and its corporate trustee, East Street Nominees Pty. Ltd. It was their practice to lodge such returns together and he believed that for the years in question that practice was adhered to. In answer to the respondent's contention that there was no disclosure that the applicant's shareholders were the same as the unit holders in the trust, he pointed out that the list of shareholders annexed to the applicant's return was in each case the same as the list of unit holders annexed to the trust return, save for one shareholder who had not taken an allotment of units. Further, the two lists showed that the unit holders held the units in the same proportions as their shares. Taylor was called by the applicant and made available for cross-examination on his affidavit, but no questions were put to him. So far as his evidence goes, it is uncontradicted and I accept it.
Evidence was also led from officers of the respondent relating to the assessment process.
ATC 4036
Peter Robinson, an administrative service officer attached to the Appeals and Review Group of the Australian Taxation Office in Western Australia has worked in that office since March 1987. He said that upon lodgment taxation returns are sorted into different classes such as company, trust and salary and wages returns. During the relevant years of income it was the office practice that they would be forwarded in their bundles to what was called the Returns Examination Area for examination. Trust returns were not examined by the same personnel who examined company returns. Prior to the introduction of the so called ``self assessment'' procedures in 1986, the only returns which remained together if lodged together were partnership returns with those of individual partners and trust returns with those of their beneficiaries.Assessors who had processed the applicant's returns for 1981/1982, 1983/1984 and 1 July 1984 to 31 January 1985 gave evidence on affidavit and were cross-examined. Not surprisingly, none of them had any independent recollection of the returns. All generally testified to the effect that had they been aware that the interest payments and lease rents related to the same properties they would have made further enquiries to determine whether both sets of outgoings were properly deductible. The applicant's counsel sought to establish in cross-examination of Robinson, whether the assessors processing the applicant's returns also dealt with or had access to those of the trust estate and trustee. This exercise was not a rewarding one. The officers who assessed the 1979/1980 and 1981/1982 returns filed by the applicant also appear to have assessed the returns for East Street Nominees in those years. But the first was not called to give evidence, and the second, Mr Shain, had no recollection of the fact.
The amended assessments
On 21 April 1986 amended assessments issued in respect of the 1978/1979 to 1983/1984 income years. For each of those years a proportion of the interest on secured and unsecured loans previously allowed was disallowed. The assessment for the 1984/1985 year issued on the same date disallowed not only a proportion of the interest payments, but also liquidator's fees of $5,678. Additional tax was levied for each year under sec. 226 on the basis that the applicant had claimed deductions for expenditure in excess of expenditure actually incurred and was therefore liable to pay an amount equal to double the tax avoided. At the hearing of the appeals however it was conceded that the additional tax for the years 1978/1979 to 1983/1984 could not be justified. No concession was made in respect of liquidator's fees. The amounts disallowed and additional tax levied in respect of each of the years were as follows:
-------------------------------------------------------------------------------
Year Interest disallowed Additional tax Tax payable
-------------------------------------------------------------------------------
$ $ $
1978/1979 31,612 18,390 32,939.52
1979/1980 77,552 41,392 77,065.92
1980/1981 75,872 37,770 72,671.12
1981/1982 75,871 32,931 67,831.66
1982/1983 75,885 25,210 60,117.10
1983/1984 77,465 19,428 55,061.90
1984/1985 48,665plus 12,990 37,840.58
liquidator's fees of
5,678
-------------------------------------------------------------------------------
The assessment issued for 1984/1985 was not an amended assessment, being the first in respect of the two returns filed for that year which covered the periods 1 July 1984 to 31 January 1985 and 1 February 1985 to 30 June 1985. The accumulated total of tax payable as shown in the assessment for 1984/1985 was $406,560.30.
The respondent also issued assessments under Div. 7 of Pt III of the Income Tax
ATC 4037
-------------------------------------------------------------------------------
Year Income before Income after Undistributed Additional tax
disallowance disallowance amount
-------------------------------------------------------------------------------
$ $ $ $
1979/1980 1,842 79,394 50 25
1982/1983 9,835 85,706 287 143.50
1982/1983 7,975 83,860 2,440 1,020
1983/1984 7,993 77,465 3,288 1,644
-------------------------------------------------------------------------------
Objections to the amended assessments, the 1984/1985 assessment and the Div. 7 assessments were lodged on or about 19 June 1986. Advices of disallowance issued on 23 April 1987 and a letter requesting reference of all objections to this Court was sent on 20 May 1987. The matters were referred to this Court on 14 March 1988.
The contentions
By its grounds of appeal the applicant sets out the factual background to which reference has already been made and contends that the amounts claimed as interest were expenses necessarily incurred in carrying on a business in the various years of income. It further says that it made true and full disclosure of all material facts and in particular in the 1978/1979 return disclosed:
- (a) That the land and buildings had been sold and that the purchase price was payable on demand and was interest free.
- (b) That the borrowings had not been reduced.
- (c) That the land and buildings were leased back to the applicant by the trustee.
In relation to the years 1979/1980 to 1983/1984 it is also contended that:
- 1. By its return for each year and the previous years back to 1978/1979 it made true and full disclosure.
- 2. So far as may be relevant the respondent did not by the amended assessments correct or purport to correct any mistake of fact or error in calculation.
On these grounds, it says the respondent was not authorised by sec. 170 of the Income Tax Assessment Act to issue any amended assessment for the years.
By its amended response, the respondent says that the interest payments claimed:
- 1. Did not constitute a loss or outgoing incurred in gaining or producing assessable income.
- 2. Were not necessarily incurred in carrying on the applicant's business for the purpose of gaining or producing such income.
- 3. Were not able to be claimed as deductions under sec. 51(1) of the Income Tax Assessment Act.
The respondent says that it has determined the amount of interest disallowed by calculating the percentage obtained from dividing the total of secured and unsecured loans outstanding at the end of the 1979 year of income into a proportion of the loans applied to finance the cost of the motel land and buildings. The percentage so obtained was applied to the interest claimed after excluding the sale of the motel land and buildings.
In relation to the 1978/1979 return, it is alleged there was a failure to make full and true disclosure by failing to state the following facts:
- 1. That the company purchasing the land and buildings, East Street Nominees Pty. Ltd. as trustee of the Challenger Unit Trust and the applicant had directors in common and further that units in the trust were held by shareholders of the applicant or their nominee in the same proportion as shares held in the applicant.
- 2. The circumstances surrounding the consent by East Street Nominees as trustee
ATC 4038
for the trust to the mortgage over the motel land and buildings by the applicant with the Perpetual Executors Trustees and Agency Company Limited and the replacement of that mortgage with a mortgage in favour of the Motor Vehicle Insurance Trust after the sale of the motel land and buildings. - 3. That the contract between the applicant and the company as trustee for the trust for the sale of the motel land and buildings was not executed in Western Australia and the transfer was not registered so that the registered proprietor of the motel property after its sale was still the applicant.
- 4. That the amount of lease rents of $39,583 claimed as a deduction in the return of the applicant for the 1979 year of income was paid pursuant to an agreement with the company as trustee of the trust.
- 5. That some of the amounts of interest claimed as a deduction in the income tax return of the applicant for the 1979 year of income included interest relating to the period after the sale of the motel land and buildings by the applicant to the company as trustee for the trust.
- 6. That moneys or some of the moneys from the mortgage and shareholders' loans were utilised for the purpose of acquiring the motel land and the building of the improvements thereon.
- 7. That the leased rents disclosed as financial expenses related to the motel land and buildings which had been sold by the applicant.
- 8. That the sole reason for the formation of the trust, the taking up of units in the trust by the shareholders of the applicant or their nominee and the contract to sell the land to the company as trustee for the trust was to reduce the incidence of taxation so far as the applicant and its shareholders were concerned.
In relation to the 1980/1984 years of income, the respondent asserts non-disclosure of items 1, 2, 3, 6, 7 and 8 and the following additional matters:
- 1. That the amounts of lease rents of $95,000, $100,000, $105,000, $110,000 and $137,500 claimed as deductions in the returns of the applicant for the 1980/1984 years of income were paid pursuant to an agreement with the company as trustee for the trust.
- 2. That the amounts of interest claimed as deductions in the returns of the applicant for 1980/1984 years of income related to moneys borrowed to finance the cost of the motel land and buildings which property had been sold by the applicant.
And alternatively, for the 1982/1985 years of income, if the applicant had made full and true disclosure the amended assessments were made to correct a mistake and were authorised by subsec. 170(3) of the Act as it then stood.
The liquidator's fees were said not to amount to a sec. 51(1) deduction for 1984/1985 and the respondent claimed to be entitled to levy additional tax for that year under sec. 223(1) and that it had granted sufficient remission under sec. 227(3).
In relation to the 1980/1984 years of income, the respondent says the applicant, not having made a sufficient distribution under sec. 105A was liable to additional tax under subsec. 104(1).
Finally the respondent invokes sec. 260:
``The Applicant's Appeal should be disallowed for the reasons stated herein and further or alternatively the Respondent says that by virtue of Section 260 of the Act, as part of a contract, arrangement or understanding between the Applicant and the Company as Trustee for the Trust, the parties entered into a contract of sale and lease agreement which are absolutely void as against the Commissioner.''
The sec. 260 point is relied upon in the alternative to support a disallowance of the lease payments on the basis that the sale and lease-back agreements were void against the Commissioner. On this basis it is contended that the lease rents would be treated as income of the applicant for the years in question. Presumably the Commissioner grounds his authority to issue the amended assessments in that event on the same failure to make true and full disclosure and alternatively on the same mistakes of fact as arise on his primary case that the interest payments were not deductible.
Deductibility of losses and outgoings
The question whether the interest payments claimed were deductible in their entirety
ATC 4039
depends upon the application of subsec. 51(1) of the Income Tax Assessment Act which at all relevant times provided:``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 section has been subjected to considerable judicial exposition and it is unnecessary to do more than consider some relevant features. Not material for present purposes are principles governing the identification of capital, private or domestic losses or outgoings. The deductibility of the payments, the subject of these appeals, depends upon their connection with the gaining of income or the carrying on of the business of the motel.
The immediate statutory predecessor of subsec. 51(1) was to be found in para. 23(1)(a) of the Income Tax Assessment Act 1922 which provided that in the collection of taxable income there should be deducted from total income:
``(a) All losses and outgoings (not being in the nature of losses and outgoings of capital) including commission, discount, travelling expenses, interest and expenses actually incurred in gaining or producing the assessable income;...''
That exemption was subject to para. 25(e) which excluded from the class of deductible expenses:
``(e) Money not wholly and exclusively laid out or expended for the production of assessable income.''
Save for the exclusion of capital losses and the deletion of a requirement that the outgoings be incurred in Australia, these provisions reflected those of para. 18(a) and 20(e) of the Income Tax Assessment Act 1915 which were in turn modelled on the British Income Tax Acts and similar sections in the income tax laws of the various States.
The inclusion in the 1936 Act of the alternative basis for deductibility reflected in the second limb of subsec. 51(1) and the non-inclusion of a disallowance principle along the lines of para. 25(e) of the 1922 Act had been foreshadowed in the Third Report of the Royal Commission on Taxation 1934. The two Commissioners, Ferguson J. of the Supreme Court of New South Wales and Edwin B. Nixon, chartered accountant, identified the object of a general deductibility provision at para. 554:
``554. The problem, therefore, is to draft Sections relating both to the allowance and disallowance of deductions which will make it clear that the taxpayer is entitled to claim any expenditure properly incurred by him in the production of his income, whether derived from a trade or otherwise, without at the same time opening the door so wide as to permit the allowance of deductions for which there is no justification. This might, perhaps, be accomplished by means of a Section under which the taxpayer would be allowed as deductions all losses and outgoings incurred in gaining or producing the assessable income, or in carrying on a business for the purpose of gaining or producing such income; with a proviso or limiting Section excluding the right to deduct any losses or outgoings of capital, or losses or outgoings incurred in relation to the gaining or production of income exempt from tax.''
Specifically referring to para. 25(e) they noted the rejection by the High Court in
F.C. of T. v. Gordon (1930) 43 C.L.R. 456 of the ``very narrow and unworkable view of sec. 25(e) of the (Commonwealth) Income Tax Assessment Act 1922-1927-1928, which disqualifies an expenditure which produces or aids in the production of assessable income, i.e., revenue, because incidentally and accidentally it may aid in the curtailment of expenditure'' (per Rich J. at p. 469). That view had at one time been elevated by the Commissioner to the status of an administrative rule of practice - Ratcliffe and McGrath - The Law of Income Tax (1938) p. 348. And although the High Court in
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 47 refrained from express reference to the report, it noted the repeated contentions by the Commissioner under the former provisions that an expenditure directed to avoid or reduce expenditure was not deductible and observed that (at p. 55):
ATC 4040
``No such contention could be sustained in a case falling under the alternative head of deduction of s. 51(1) and that may be one reason why the alternative was introduced.''
Having regard to the attitude taken by the Court the deletion of para. 25(e) effected no great practical change for it appears that as a matter of experience deductions refused under that provision failed to satisfy the positive requirements of para. 23(1)(a) in any event - Hannan - Principles of Income Taxation (1946) p. 294.
Paragraph 25(e) had, however, imported one significant condition of deductibility not to be found in para. 23(1)(a) nor in subsec. 51(1) and that was a requirement that the losses or outgoings claimed should have been laid out or expended ``for'' in the sense of ``for the purpose of'' the production of income -
Herald and Weekly Times Ltd. v. F.C. of T. (1932) 48 C.L.R. 113 at p. 118 (Gavan Duffy C.J. and Dixon J.), p. 122 (Starke J.), p. 123 (Evatt J.);
Amalgamated Zinc (De Bavay's) Limited v. F.C. of T. (1935) 54 C.L.R. 295 at p. 309 (Dixon J.);
W. Nevill and Co. Ltd. v. F.C. of T. (1937) 56 C.L.R. 290 at p. 307 (Dixon J.). Upon the enactment of the 1936 Act this principle was abandoned and in the words of Brennan J. in
Magna Alloys and Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 at p. 4547; (1980) 33 A.L.R. 213 at p. 218:
``it became necessary to consider, according to the circumstances of each case, whether and to what extent reference to purpose is required or appropriate to determine deductibility under the first limb of sec. 51(1).''
The effect of the motive and purpose for a given expenditure claimed as a deduction is better appreciated in the light of a more general consideration of para. 23(1)(a) of the 1922 Act and its carry over into the construction of the first limb of subsec. 51(1). Although the logic of the words ``incurred in'' might be taken to imply a causal or purposive relationship, the regulation of human, commercial affairs by strict logical criteria happily remains an Orwellian fantasy. So much was accepted even within the confines of the English inspired terminology of para. 25(e). It sufficed for the purposes of that provision that the claimed deduction had been expended ``not of necessity and with a view to direct and immediate benefit to trade but voluntarily and on grounds of commercial expediency to facilitate the carrying on of business'' -
British Insulated and Helsby Cables Ltd. v. Atherton (1926) A.C. 205 at p. 212 (Viscount Cave L.C.);
Maryborough Newspaper Co. Ltd. v. F.C. of T. (1929) 43 C.L.R. 450 at p. 452 (Rich J.);
F.C. of T. v. Gordon (1930) 43 C.L.R. 456 at p. 462 (Dixon J.), at p. 470 (Starke J.); W. Nevill and Co. Ltd. v. F.C. of T. (supra) at p. 300 (Latham C.J.);
Sun Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337 at p. 352 (Latham C.J.).
The wide range of connection between expenditure and income sufficient to satisfy para. 23(1)(a) and 25(e) was emphasised in Amalgamated Zinc by the equation between ``losses and outgoings incurred in'' and ``losses and outgoings incurred in the course of'' gaining or producing income. A taxpayer, it was said, might deduct non-capital expenditure in the year of assessment ``incidental to or connected with his operations or earnings of that year''. He was not required to track each item of expenditure and allocate it to some item of income - per Starke J. at p. 307. In W. Nevill and Co. Ltd. v. F.C. of T. (supra) Dixon J. (at p. 305) summarised the effect of the Amalgamated Zinc judgments when he said of para. 23(1)(a):
``The condition the provision expresses is satisfied if the expenditure was made in the given year or accounting period and is incidental and relevant to the operations or activities regularly carried on for the production of income.''
The same construction has been applied to the first limb of subsec. 51(1) - Ronpibon Tin N.L. v. F.C. of T. (supra) at pp. 56-57;
Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344 at pp. 349 and 350;
F.C. of T. v. Green (1950) 81 C.L.R. 313 at p. 317;
F.C. of T. v. Snowden and Willson Pty. Ltd. (1958) 99 C.L.R. 431 at p. 443 (Fullagar J., Williams J. agreeing). And consistently with this approach, Brennan J. said in Magna Alloys and Research Pty. Ltd. (supra) at ATC p. 4547; A.L.R. p. 219 that the dicta of the Judicial Committee of the Privy Council requiring ``rigorous and objective'' examination of losses and outgoings and a demonstration that some asset or legal right has been acquired or legal obligation discharged, may not always be an adequate guide to the question of deductibility
ATC 4041
- cf.Commr of I.R. (N.Z.) v. Europa Oil (N.Z.) Ltd. (1971) A.C. 760;
Europa Oil (N.Z.) Ltd. v. Commr of I.R. (N.Z.) 76 ATC 6001; (1976) 1 W.L.R. 464.
The phrase ``incidental and relevant'' was developed as an expression of the primary construction of para. 23(1)(a) that to be deductible losses and outgoings had to be incurred ``in the course of'' producing income. It is a phrase which identifies a necessary condition of deductibility going to the essential character of the expenditure rather than its purpose -
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at pp. 496-497 (Williams, Kitto and Taylor JJ.). And although neither motive nor purpose is now a criterion of deductibility these factors may have evidentiary significance and in some cases determine the characterisation of the expenditure - Magna Alloys (supra) at ATC pp. 4549-4550; A.L.R. p. 222 (Brennan J.), ATC pp. 4551-4552; A.L.R. pp. 234-235 (Deane and Fisher JJ.). The purpose of incurring an expenditure may stamp it as an expenditure of a business or income earning kind or as one having no relevant connection with the gaining or producing of assessable income -
F.C. of T. v. Ilbery 81 ATC 4661 at pp. 4667-4668; (1981) 38 A.L.R. 172 at p. 180 (Toohey J., Northrop and Sheppard JJ. agreeing). That observation was referred to with apparent approval in
John v. F.C. of T. 89 ATC 4101 at p. 4105; (1989) 166 C.L.R. 417 at p. 426 (Mason C.J., Wilson, Dawson, Toohey and Gaudron JJ.), but with the rider that:
``It is readily understandable that, if no income has been gained or produced and a question arises as to whether the occasion would be expected to produce assessable income, consideration of the purpose for which the expenditure was outlaid might not be wholly irrelevant. It may be too that even where income is produced the purpose for which the advantage occasioning the loss or outgoing is sought may evidence a sufficient relationship with the income-earning process.
Handley v. F.C. of T. 81 ATC 4165; (1981) 148 C.L.R. 182, per Stephen J. at ATC pp. 4168-4169; C.L.R. pp. 189-190. But the cost of a step taken in the process of gaining or producing income must be regarded as an outgoing or taken into account in calculating the loss (if any) incurred, whatever purpose or motive may have attended all or any of the steps involved.''
And as purpose may have evidentiary relevance, it may require a consideration of the reasonableness and taxation implications of the expenditure in question. An outgoing whether incurred voluntarily or under some legal obligation, that is out of all proportion to the value of any benefit to be derived from it, such as an excessive payment for the services of a director, may not be deductible under either subsec. 51(1) or its predecessors and statutory relatives. Examples of this approach to the 1922 Act are found in
Aspro Limited v. Commissioner of Taxes (N.Z.) (1932) A.C. 683 (P.C.) and
Robert G. Nall Ltd. v. F.C. of T. (1937) 57 C.L.R. 695 at pp. 699-700 (Rich J.), pp. 708-709 (Starke J.), p. 711 (Dixon J.). The judgment in the latter case, adverse to the taxpayer which had maintained a high salary for its governing director after its principal business had wound down, was nevertheless consistent with a broad range of deductible outgoings. After pointing out that the relationship between outgoings and income in para. 25(e) was vaguely stated by the word ``for'' commonly paraphrased by words of purpose, Dixon J. said at p. 712:
``when it is said that gaining or producing assessable income must be the purpose of the expenditure if its deduction is to be allowed, no more can be meant than that the circumstances of the transaction must give it the complexion of money laid out in furtherance of a purpose of gaining income. If in the common course of affairs the expenditure is considered to conduce to or to be required by the purpose, to be referable or attributable to it, the condition prescribed by sec. 25(e) will be presumptively satisfied.''
As is apparent from the judgments in the Aspro and Nall cases, the non-deductibility of a grossly excessive expenditure followed not from any legislative policy in favour of thrift but from its failure to answer the statutory description of a deductible outgoing. The fact that a payment accords with commercial rates may be evidence in favour of the view that it is a business outgoing. If excessive, it may raise the presumption that it is at least partly for some other purpose -
F.C. of T. v. Phillips 78 ATC 4361 at p. 4368; (1978) 20 A.L.R. 607 at
ATC 4042
p. 617 (Fisher J.). Evidentiary implications apart there is no statutory requirement that to be deductible under subsec. 51(1) an outgoing must be ``reasonable''. Hence the oft quoted passage from the Ronpibon judgment at p. 60:``It is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent:''
See also
Cecil Bros Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430 at p. 434 (Owen J.), p. 441 (Menzies J.); Commr of I.R. (N.Z.) v. Europa Oil (N.Z.) Ltd. (No. 1) (1971) A.C. 760 at p. 772;
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at pp. 4416-4417; (1978) 140 C.L.R. 645 at p. 654 (Gibbs A.C.J., Stephen and Aickin JJ. agreeing) and the foreshadowing of that principle in
Tooheys Limited v. F.C. of T. (1922) 22 S.R. (N.S.W.) 432 at pp. 438-441 (Ferguson J.). But the inferences to be drawn from an unreasonable level of expenditure are not to be restricted by application of that dictum. As Toohey J. (with whom Northrop and Sheppard JJ. agreed) said in F.C. of T. v. Ilbery (supra) at ATC p. 4668; A.L.R. p. 181:
``While it may not be for the Commissioner to tell a taxpayer how much he should spend on outgoings in the course of gaining an assessable income or whether he should incur those outgoings in one or more than one tax years, a question may still arise whether, in respect of a particular year, an outgoing incurred by a taxpayer can truly be said to have been incurred in gaining or producing the assessable income.''
The circumstance that payments are made under arrangements intended to give rise to tax benefits falls into the same general category. In South Australian Battery Makers Gibbs A.C.J. said (at ATC p. 4420; C.L.R. p. 660) that the fact that a transaction at first sight ``appears to have the flavour of a scheme or device to reduce taxation'' does not, absent the application of sec. 260 and any suggestion that it is a sham, affect the characterisation of payments made under it. Beyond appearance and flavour to substance, the Full Federal Court has held that, assuming no sec. 260 question, the characterisation of a payment as deductible does not depend as a matter of law on the question whether it is made as part of an overall arrangement entered into with taxation and estate planning considerations in view - F.C. of T. v. Phillips (supra) at ATC pp. 4326-4327; A.L.R. p. 609 (Bowen C.J. and Deane J.), ATC p. 4369; A.L.R. p. 618 (Fisher J.). As with the question whether the outgoing is reasonable however, there may be evidentiary implications going to its proper characterisation in the light of the motive or purpose with which it is made - Magna Alloys and Research Pty. Ltd. v. F.C. of T. (supra) at ATC pp. 4549-4551; A.L.R. pp. 222-224 (Brennan J.), at ATC pp. 4558-4559; A.L.R. p. 234 (Deane and Fisher JJ.);
Ure v. F.C. of T. 81 ATC 4100 at pp. 4109-4110; (1981) 34 A.L.R. 237 at p. 249-250 (Deane and Sheppard JJ.); F.C. of t. v. Ilbery (supra) at ATC pp. 4667-4668; A.L.R. 180 (Toohey J., Northrop and Sheppard JJ. agreeing). And in the latter case, which involved pre-payment of interest on moneys borrowed to acquire income producing assets, the finding that the pre-payment was made solely to secure a tax advantage was critical to the Court's view that it was not incurred in gaining or producing assessable income. On the other hand a transaction structured to offer tax advantages to participants can also be a real business transaction underpinned by genuine commercial considerations and involving losses or outgoings which are deductible under subsec. 51(1) -
F.C. of T. v. Lau 84 ATC 4929 at p. 4942; (1984) 57 A.L.R. 107 at p. 123 (Beaumont J., Jenkinson J. agreeing).
It is a corollary of the broad approach to the connection between losses and outgoings and the gaining of income that expenditure may be a deduction though only related to income generated in years other than that in which it is incurred. The proposition is supported in relation to the 1922 Act by
Ward and Co. Ltd. v. Commissioner of Taxes (N.Z.) (1923) A.C. 145 at p. 148 (P.C.); Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (supra) at p. 303 (Latham C.J.), p. 307 (Starke J.), p. 309 (Dixon J.) and W. Nevill & Co. Ltd. v. F.C. of T. (supra) at p. 306 (Dixon J.), p. 308 (McTiernan J.). Although subsec. 51(1) addresses losses or outgoings incurred in gaining or producing ``the assessable income'', the use of the word ``in'' prevents a reading of that phrase which would limit deductibility to expenditure producing income in the year in which it is incurred. As Dixon J. said in
F.C. of T. v. Finn (1961) 106 C.L.R. 60 at p. 68:
ATC 4043
``s. 51 as now drawn does not in either limb require a rigid restriction to the gaining or production of assessable income of the current year.''
To like effect are Ronpibon Tin N.L. v. F.C. of T. (supra) at p. 56: F.C. of T. v. Snowden and Willson Pty. Ltd. (supra) at p. 436 (Dixon C.J.) and
John Fairfax & Sons Ltd. v. F.C. of T. (1959) 101 C.L.R. 30 at p. 35 (Dixon C.J., Kitto J. agreeing), p. 46 (Menzies J.).
The same general principle applied under the 1922 Act to outgoings generated in connection with the income earning activities of earlier years - Herald and Weekly Times Limited v. F.C. of T. (supra) at p. 118 (Gavan Duffy C.J. and Dixon J.), p. 127 (McTiernan J.); Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (supra) at p. 309 (Dixon J.);
Texas Co. (Australasia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382 at p. 427 (Latham C.J.). A fortiori it applies to subsec. 51(1) -
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057 at pp. 4063-4064; (1975) 132 C.L.R. 175 at p. 185 (Barwick C.J.), ATC p. 4068; C.L.R. p. 192 (Gibbs J.), ATC p. 4071; C.L.R. p. 197 (Mason J.).
The words ``to the extent to which'' appearing in subsec. 51(1) qualify the deductibility of losses and outgoings not wholly incurred in gaining assessable income or carrying on a business and constitute a statement of a principle of apportionment not expressed in the earlier legislation. At one time, under the 1922 Act, the Commissioner had promulgated an administrative rule that wherever an expenditure was incurred in part, otherwise than for the production of assessable income, none of it was deductible - Ratcliffe and McGrath - The Law of Income Tax (1938) p. 348. In practice, the rule was not generally applied and in
Victoria Park Racing and Recreation Grounds Co. Ltd. v. F.C. of T. (1934) 52 C.L.R. 9 at p. 24 Dixon J. accepted that apportionment was necessary for items of expenditure not by their very nature connected with income. The operation of the words ``to the extent to which'' as a rule of apportionment was accepted in Ronpibon Tin N.L. v. F.C. of T. (supra) at p. 55; and John Fairfax & Sons Ltd. v. F.C. of T. (supra) at p. 35 (Dixon C.J.). Ronpibon contemplated two kinds of apportionment. The first arises when an undivided item of expenditure relates to things or services only some of which are devoted to producing assessable income. The second is necessary when a single outlay serves both income and non-income producing objects indifferently:
``With the latter kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income.''
(p. 59)
The Commissioner's apportionment of interest payments in the present case appears to fall into the second category.
On the question of deductibility generally, it is necessary also to consider the application of the second limb of subsec. 51(1). At its inception in 1936 it was a part of the legislation whose function and proper construction were uncertain. The Royal Commission report offered little guidance on the point. Commonwealth authorities offered early assurances that the word ``necessarily'' was inserted to protect the revenue from claims for deductions which were not bona fide business expenses but of a private or domestic nature. But as the authors of Ratcliffe and McGrath - The Law of Income Tax (1938) were quick to point out, private or domestic expenses were already expressly excluded by the same subsection (p. 362). Another writer relied upon the extended definition of ``business'' which includes ``any profession, trade, employment, variation or calling but... not... occupation as an employee''. It was suggested, although the suggestion has not stood the test of time, that the second limb was intended ``to offer professional and other taxpayers (not carrying on a business in its ordinary sense) a benefit which would not otherwise be obtainable'' - Hannan - Principles of Income Taxation (1946).
Judicial pronouncements on the second limb have generally avoided any restrictive construction. More importantly, it has not been used as a basis for limiting the range of deductible losses and outgoings covered by the first. The earliest reported dictum in the judgment of McTiernan J. in
F.C. of T. v. Robinson and Mitchell Pty. Ltd. (1941) 64 C.L.R. 612 equated ``necessarily'' to ``ex necessitate the business'', suggestive of an objective test. A broader approach was propounded in Ronpibon (supra) at p. 56:
ATC 4044
``The word `necessarily' no doubt limits the operation of the alternative, but probably it is intended to mean no more than `clearly appropriate or adapted for': cf. per Higgins J. in
Commonwealth v. Progress Advertising and Press Agency Co. Pty. Ltd. (1910) 10 C.L.R. 457, at p. 469.''
In practical operation, it was said, the second limb adds little to the first:
``No doubt the expression `in carrying on a business for the purpose of gaining or producing' lays down a test that is different from that implied by the words `in gaining or producing'. But these latter words have a very wide operation and will cover almost all the ground occupied by the alternative.''
The limiting function of the word ``necessarily'' was expressly addressed in F.C. of T. v. Snowden and Willson Pty. Ltd. (supra). It was seen by Dixon C.J. as a qualification on the range of connections between the claimed expenditure and the relevant business and otherwise expressed as a requirement that ``the expenditure must be dictated by the business ends to which it is directed, those ends forming part of or being truly incidental to the business'' (p. 437). Logical necessity was eschewed as ``not a thing to be predicated of business expenditure''. Fullagar J. (with whom Williams J. agreed) accepted the Ronpibon approach and the proposition advanced in Hannan - Principles of Income Taxation (1946) that the meaning of ``necessarily'' is not limited to compulsion in a legal sense and extends to business expenditure arising out of exigencies created by unusual or difficult circumstances. This view of the interpretation of the word meant, he said, that for practical purposes and within the limits of reasonable human conduct, the person carrying on the business must be the judge of what is necessary. The logical sequence of that argument may not readily be appreciated. But at the heart of the necessity contemplated by the second limb is the concept of ``need''. That is a term which has been satirically, but not entirely inappropriately, defined as ``a more emphatic form of want''. It is not readily susceptible of purely objective assessment. On the other hand a totally subjective construction would tie the operation of the law to the taxpayer's opinion. Consistently with authority an expenditure is not ``necessarily incurred in carrying on a business'' if it is not capable on reasonable grounds of being judged necessary. Within those bounds the judgment is that of the taxpayer. In Magna Alloys and Research Pty. Ltd. v. F.C. of T. (supra), Deane and Fisher JJ. at ATC p. 4559; C.L.R. p. 235 said:
``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 the view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income.''
Deductibility of interest payments
The argument advanced by counsel for the Commissioner in relation to the deductibility of the interest payments, focused on the second limb of subsec. 51(1). It was not disputed that the applicant was carrying on the business of a motel for the purpose of gaining or producing assessable income. Prior to 1979 when the land was sold to East Street Nominees, the interest payments secured its use for the business and to generate income. After the sale, it was submitted, the payment of the lease rentals fulfilled that function. It is the lease rentals which were deductible, according to the Commissioner. As soon as the land was disposed of, it was said, the interest payments, at least so far as they were attributable to its cost and that of the buildings, no longer related in any way to the business. The relationship between them did not answer the statutory description of a deductible outgoing. Reference was made to a Taxation Board of Review decision, Case R65 reported at 84 ATC 468. That was a case in which a taxpayer claimed as deductions interest payments made in respect of a bank loan taken out to purchase a business which he had since ceased to operate. The claim was disallowed on the basis that the borrowings were of a capital nature and it was only the conduct of the business or use of the asset for income producing purposes that enabled the interest to qualify as a deduction. And reference was there made to
Inglis v. F.C. of T. 80 ATC 4001; (1979) 28 A.L.R. 425, a decision of the Full Federal Court disallowing claims for outgoings associated with the maintenance of a pastrol property on which the taxpayer had for the time being ceased to carry on the pastoral business. Brennan J.
ATC 4045
characterised the claimed expenditure as incidental or relevant to the preservation of the property. Expenditure in preserving an asset until it could be used for the production of income was of a capital nature and not deductible.But the present case is in a sense the factual obverse of Inglis and quite unlike Case R65. The applicant, during the relevant years, continued to carry on the motel business. It was engaged in gaining or producing assessable income within the meaning of the first limb of subsec. 51(1) and was carrying on a business for that purpose within the meaning of the second. The question to be addressed is whether or not the interest payments made by the applicant in those years had the requisite connection with its income earning activities.
It is a corollary of the general principles governing deductibility of outgoings that where interest is paid on moneys borrowed to secure capital or working capital with which to gain or produce assessable income or for a business, it is deductible - Texas Co. (Australasia) Ltd. v. F.C. of T. (supra) at p. 468 (Dixon J.),
F.C. of T. v. Total Holdings (Australia) Pty. Ltd. 79 ATC 4279 at p. 4283; (1979) 24 A.L.R. 401 at p. 406 (Lockhart J.) and the authorities there collected. And in the present case there is rightly no dispute about the deductibility of interest paid by the applicant prior to 1979 on loans raised for the purchase of land, the construction of buildings and the installation of plant and furniture. The payments made satisfied both limbs of subsec. 51(1). There is, of course, no rule in relation to such payments that once a deduction they are always a deduction. The legal source of a liability to pay interest may remain unchanged, but altered circumstances may sever any connection between such expenditure and the production of income in the carrying on of a business that would bring it within the statutory definition of a deductible outgoing. One factor that may effect such a severance is cessation of the business. But notwithstanding Case R65, it is doubtful that cessation of a business would immediately exclude from the scope of subsec. 51(1) interest liabilities incurred in carrying it on. The persistence of the relevant connection may involve questions of degree having regard to other factors such as the period over which interest continues to be paid after cessation and the nature of the arrangements that have given rise to that liability. The mere fact that a business has ceased will not render losses or outgoings incurred in connection with it but after the date of cessation non-deductible - A.G.C. (Advances) Ltd. v. F.C. of T. (supra) at ATC p. 4071; C.L.R. p. 197 (Mason J.). And where cessation is temporary, losses or outgoings incurred in maintaining plant and premises may, according to the circumstances, be incurred in gaining or producing assessable income -
Queensland Meat Export Co. Ltd. v. D.F.C. of T. (1939) St.R.Qd. 240.
The cessation cases may be seen as one, albeit an extreme example, of altered circumstances which change the character of recurring payments. Whatever the alteration in the factual matrix of the outgoing, the essential question for deductibility remains - Is there a relevant connection of the type contemplated by subsec. 51(1)? In addressing that question, the evidentiary implications of the purpose of the outgoing in the light of the changed circumstances, its commercial realism or reasonableness and whether it is directed and to what degree, to securing tax benefits, may all be considered.
The Commissioner has not in this case advanced any such multi-factorial analysis but relies upon the simple proposition that because the land has been sold to another entity the relevant connection between the interest payments and the motel business carried on on the land no longer exists. In my opinion that factor alone is insufficient to so change the relationship between the interest payments and the business that they are no longer deductible. In a very practical sense, the honouring by the applicant of its commitments was necessary to its retention of the use of the land upon which, as legal owner and tenant of the beneficial owner, it carried on its business. And if questions of the motive and purpose of the continuing liability and the tax advantage to be derived from it are addressed in the way contemplated by the authorities to which I have earlier referred, the position is not so substantially changed as to change the characterisation of the payments. That is not to say that those questions would not have been relevant to the deductibility of the lease rents paid to East Street Nominees. But in my opinion, the continuing commitment to pay interest between 1979 and 1984/1985 was, in all the circumstances, a commitment to make
ATC 4046
payments incurred in producing or gaining assessable income and also answered the designation, as elaborated in the authorities, of outgoings necessarily incurred in the carrying on of the applicant's business.So far as the liquidator's fees, now claimed at $3,091 are concerned, it is sufficient to say that I am not satisfied that the evidence demonstrates that they are deductible in their entirety. Accepting that some time was spent to 30 June 1985 managing the applicant's surplus funds, I do however accept that not less than $2,000 could fairly be described as deductible. It may be that a greater figure could be justified, but the evidence in this respect was lacking. The figure of $2,000 represents a threshold below which I am satisfied that the expenditure was deductible.
Whether the sale and lease-back arrangements were void against the Commissioner under sec. 260
Counsel for the Commissioner submitted, in the alternative, that the sale and lease-back arrangements between the applicant and East Street Nominees were void against the Commissioner by force of sec. 260. No point was taken in the pleadings or otherwise that the rental payments were not deductible under subsec. 51(1). Nor was it suggested that the arrangements were a sham. The preliminary question therefore arises whether sec. 260 can annihilate a transaction giving rise to deductible outgoings under subsec. 51(1).
In Cecil Bros Ltd. v. F.C. of T. (supra), Dixon C.J. with whom Kitto and Windeyer JJ. agreed, as did Taylor J. on this point, said that he had great difficulty in seeing how sec. 260 could apply to defeat or reduce any deduction otherwise truly allowable under sec. 51. Obiter though it was, the observation has been adopted by the Full Federal Court on a number of occasions. In F.C. of T. v. Ilbery (supra) Toohey J. referred to it, noted the very restricted operation conceded to sec. 260 by the course of judicial decision and concluded (at ATC pp. 4669-4670; A.L.R. p. 183):
``On the assumption that the prepayment of interest was an outgoing incurred in the course of gaining or producing the assessable income, it was a transaction the taxpayer was entitled to enter into, a particular course of conduct he was entitled to adopt. There was no purpose or effect such as is described in sec. 260.''
Northrop and Sheppard JJ. agreed. In F.C. of T. v. Lau (supra), Beaumont J., with whom Jenkinson J. agreed, thought the views of the judges in Cecil Bros on the point should be treated as authoritative. The joint judgment of Woodward, Neaves and Wilcox JJ. in
F.C. of T. v. Just Jeans Pty. Ltd. 87 ATC 4373; (1987) 72 A.L.R. 213, concluded that in that case, which involved payment of licence fees for the right to use an assigned trade name, if sec. 51 had been found to apply there would have been no room for the application of sec. 260. And in
F.C. of T. v. Janmor Nominees Pty. Ltd. 87 ATC 4813; (1987) 75 A.L.R. 15, Lockhart J. with whom Fisher and Jenkinson JJ. agreed, held that as in F.C. of T. v. Lau (supra), the Court should regard the expressions of opinion in Cecil Bros as authoritative. Having concluded in that case that a deduction under sec. 51(1) was available, it could not be denied by sec. 260.
More recently in
F. and C. Donebus Pty. Ltd. v. F.C. of T. 88 ATC 4582; (1988) 81 A.L.R. 635, Pincus J. observed that the Judges in Cecil Bros had not expressed any principle based on a view that sec. 260 would not operate to extinguish a deduction otherwise properly allowable under sec. 51. To the extent that the approach taken in Cecil Bros was a reflection of the ``choice principle'' it had to be considered in the light of the re-examination of that principle in
F.C. of T. v. Gulland 85 ATC 4765; (1985) 160 C.L.R. 55.
There is, with respect, much force in his Honour's observation. However, there have been a number of unambiguous expressions of view by Full Courts about the interaction between subsec. 51(1) and sec. 260, the most recent being Janmor (supra) which postdates Gulland by nearly two years. In the absence of a clear departure by a Full Court from those views, I consider I should apply them. In so doing I note that in Gulland (supra) at ATC pp. 4774-4776; C.L.R. pp. 73-74 Gibbs C.J. (with whom Wilson J. agreed) relied upon Cecil Bros for the proposition that sec. 260 would not render void a service trust arrangement which had been made for the taxpayer doctor in that case.
The deductibility of the lease rents not being challenged in this case other than by way of
ATC 4047
sec. 260, the Commissioner's case on this point must fail.Conclusion
In the circumstances and for the reasons set out above, the appeals will be allowed. It would appear that this will result in all the amended assessment being set aside and that for 1984/1985 being remitted for reconsideration in the light of these reasons. I will however hear from the parties as to the appropriate orders.
The Court orders that:
- 1. The appeals be allowed.
- 2. There be liberty to the parties to apply for appropriate orders.
- 3. The respondent pay the applicant's costs of the appeal.
This information is provided by CCH Australia Limited Link opens in new window. View the disclaimer and notice of copyright.