Federal Commissioner of Taxation v. Riverside Road Pty. Ltd. (in liq.) formerly Captain Fremantle Motor Lodge Pty. Ltd.
Judges:Northrop J
Wilcox J
Hill J
Court:
Full Federal Court
Northrop, Wilcox and Hill JJ.
The appellant, the Commissioner of Taxation, appeals against a decision of a Judge of this Court upholding an appeal of the respondent, Riverside Road Pty. Ltd. (in liq.), against assessments made by the appellant in respect of the years of income ending 30 June 1979 to 1985 inclusive [reported at 90 ATC 4031]. The assessments for the 1979 to 1984 years of income were amended assessments. The 1985 assessment which related to the period 1 July 1984 to 31 January 1985, prior to the respondent going into voluntary liquidation on 1 February 1985, and to the period 1 February 1985 to 30 June 1985 was an original assessment. Also the subject of the respondent's application to this Court were consequential assessments of tax payable under Div. 7 of the Income Tax Assessment Act 1936 (Cth) (``the Act'') for the income years 1980, 1982, 1983 and 1984.
The principal issue between the parties was the availability, as a deduction under sec. 51(1) of the Act, of a portion of the amounts claimed in the respondent's returns of income in these years for interest on secured and unsecured loans. The amounts claimed in each return, being the total of all interest incurred by the respondent, and the amounts disallowed by the Commissioner were as follows:
Interest on Interest on Amount
Year mortgage loan secured loans disallowed
$ $ $
1978/1979 43,749 35,447 31,612
1979/1980 45,505 35,447 77,552
1980/1981 43,750 35,448 75,872
1981/1982 43,750 35,447 75,871
1982/1983 43,765 35,447
In the assessment for the period 1 February 1985 to 30 June 1985 the Commissioner disallowed an amount of $5,678 being the fees of the liquidator claimed to be an allowable deduction under sec. 51(1) of the Act. His Honour found that these fees were deductible to the extent of $2,000 only.
There was no appeal or cross-appeal in respect of so much of his Honour's decision as related to the allowance in part of the liquidator's fees.
Also at issue between the parties is the power of the Commissioner, to the extent that the interest allowed was not deductible, to amend the assessments for the years 1979 to 1984 inclusive, a matter which his Honour did not find it necessary to consider.
The facts
Except in one respect, to which we will later refer, the facts were not in dispute and may be shortly stated.
The respondent was formed for the purpose of operating a motel called the Captain Fremantle Motor Lodge near Fremantle in Western Australia. The respondent, then called Captain Fremantle Motor Lodge Pty. Ltd., purchased in September of 1969, the year of its incorporation, a parcel of land for that purpose at a cost of $102,000. A tender to build the motel for $199,100 was accepted and construction commenced. $36,100 was expended on plant and equipment. In 1971 the respondent purchased adjacent land for $45,000 and constructed extensions to the motel building for some $192,000. A further amount of approximately $53,000 was expended on furniture and fittings. These outlays were financed in part from share capital but substantially from unsecured loans from shareholders and loans secured by mortgage over the respondent's land.
The history of external borrowings by the respondent was summarised by his Honour as follows (at p. 4033):
``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.''
It seems that the increase in borrowings in 1976 and 1981 related to a borrowing for working capital. The position therefore was that as at 31 December 1978 and 1 February 1979 the respondent had external borrowings of $350,000 secured over the respondent's motel which loan was due to be repaid in May 1979.
As at 31 January 1979 the amount of unsecured loans outstanding to shareholders was $236,313 made up of $179,610 repayable on 1 February 1980 and $56,703 maturing on 31 December 1985.
ATC 4571
In mid-1978, Mr Walker, the respondent's company secretary and a member of the respondent's board of directors from 1969 until December 1984, who was also a chartered accountant, conceived the idea of transferring the ownership of the respondent's land and buildings to a related entity. In his evidence, which his Honour appears to have accepted, Mr Walker explained that his purpose in formulating the proposal was to protect the real property of the respondent against liabilities incurred in the conduct of the motel business. The transaction entered into in February 1979 achieved this purpose only to a limited extent because the respondent replaced its asset of land and buildings with a debt repayable on demand equal to the value, as at the date of the transaction, of those assets. Thus, any protection against creditors would only be to the extent to which thereafter the land and buildings increased in value.
Following legal advice, the respondent's board forwarded a circular to shareholders on 1 November 1978 setting out a proposal for restructuring the respondent. The circular under the heading ``Introduction'' read as follows:
``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 of the Company. In turn, this expense will reduce the taxable profit of Captain Fremantle Motor Lodge Pty. Ltd.
The separate entity selected is a Unit Trust because its profits are not subject to company tax. The Unit Trust will be designed to maintain the relative position of shareholders in relation to control and ownership of the land and building.''
Having regard to this circular and the objective consequences of the proposal, the appellant challenged any finding that his Honour may be said to have made that the purpose of the restructuring was the protection of the respondent's assets. Rather, it was submitted that, even if Mr Walker's evidence be accepted, his motivation should not be attributed to the respondent. The circular, it was submitted, provided the best evidence of the respondent's motive and purpose since it formed the basis of the subsequent resolution to effect the transaction contemplated. The circular, it was said, made it quite clear that the motive or purpose of the reorganisation was to be found in the tax consequences that would flow from it.
It seems to us that his Honour made no finding as to the motivation of the respondent for the reorganisation because, on the view he took, the motivation for the reorganisation was irrelevant. Although ultimately differing from his Honour as to the result in law of the reorganisation, we are of a similar view.
The steps necessary to the reorganisation as set out in the proposal were summarised by his Honour as follows (at p. 4033):
``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 income tax results of the transaction, as indicated in the proposal, were said to be that the respondent would, by continuing to operate the motel business, be entitled to a deduction for the rental payable by it to the trustee. The taxable income of the respondent would accordingly be reduced by an amount approximately equal to the rental paid and company tax payable by the respondent would be accordingly reduced. The unit trust would not be liable to tax although the net income of the trustee would be available for distribution to unit holders and inferentially taxed to them under the provisions of Div. 6 of Pt III of the Act.
The circular makes no direct reference to the continued deductibility of the interest on external loans and shareholders' loans although
ATC 4572
an illustration given in it assumes such continued deductibility.The proposal was duly approved at an extraordinary general meeting of shareholders held on 6 December 1978. A unit trust, designated as the Challenger Unit Trust, was established of which the corporate trustee was East Street Nominees Pty. Ltd. On 30 January 1979 a contract was entered into whereby the respondent agreed to sell the land and buildings to East Street Nominees Pty. Ltd. for $900,000, being the value of the unencumbered freehold as at 24 January 1979. The contract appears not to have been stamped at that time. It provided that the purchase money was to be payable interest free on demand and that possession was to be given on or about 1 February 1979. The trustee agreed to lease back the land for a term of one year commencing on 1 February 1979 with options for renewal at a rental of $95,000 per annum subject to periodic review. The rental was to be payable in advance in quarterly instalments of $23,750, the first instalment being due on 1 February 1979.
Possession was said to have been given on 1 February 1979 although, as his Honour observed, this was best characterised as a ``notional event'' as the respondent continued in uninterrupted possession operating the motel as before. Legal title was not transferred and the mortgage to Perpetual Trustees was not paid out. On 18 April 1979 Mr Walker, in his capacity as secretary of the respondent, sent a letter to himself as secretary of the trustee requesting the permission of the trustee to replace the Perpetual Trustee' mortgage with a new mortgage in favour of a third party, the Motor Vehicle Insurance Trust. Such a letter was apparently required to avoid the presumption of fraud. (See Sale of Land Act 1970 sec. 8.) Not surprisingly, consent was forthcoming. The mortgage to Perpetual Trustees was repaid on 1 May 1979 and a new mortgage in favour of the Motor Vehicle Insurance Trust was entered into for the same amount for a term of five years.
Rental was thereafter paid to the trustee and from time to time reviewed upwards. The amounts incurred in the relevant years, and which were claimed and allowed as deductions, were as follows:
Year Lease Rents
$
1978/1979 39,583
1979/1980 95,000
1980/1981 100,000
1981/1982 105,000
1982/1983 110,000
1983/1984 137,500
1/7/84 to 31/1/85 59,164
The deductibility of the lease rents was not in issue, either before the learned trial Judge or before us.
On 6 December 1984 the land and buildings were sold by East Street Nominees Pty. Ltd. to a third party, Tartaire Pty. Ltd., and the respondent sold the business together with the rights under the lease to another company, Girdis Management Pty. Ltd. All outstanding loans then owing to shareholders and external creditors were repaid and on 1 February 1985 an extraordinary general meeting of the shareholders of the respondent resolved that the respondent be wound up voluntarily.
The Commissioner initially allowed to the respondent a deduction for the totality of interest claimed in the assessments for the years ended 1979 to 1984 inclusive. However, on 21 April 1986 the Commissioner issued amended assessments for these years disallowing a proportion of the interest claimed. The precise basis of the apportionment is not clear. However, it appears that the proportion disallowed represents so much of the total interest as relates to the borrowings for land and buildings. On this basis the proportion of interest allowed represented so much of the interest incurred as related to borrowings for plant and equipment and working capital. The mathematical basis of the apportionment was not in issue before us and the case was argued on the basis that the interest disallowed represented the interest on so much of the respondent's borrowings as related to the purchase of the two parcels of land and the construction upon them of the motel operated by the respondent.
The Commissioner, both at first instance and before us, submitted that the interest disallowed was not deductible under the provisions of sec. 51(1) of the Act. Alternatively, it was submitted that the provisions of sec. 260 of the Act operated to disallow so much of the interest incurred as was disallowed. The respondent
ATC 4573
submitted that the whole of the interest incurred was an allowable deduction under sec. 51(1) and that the provisions of sec. 260 of the Act could not in these circumstances operate to disallow a part of the interest properly allowable under sec. 51(1).The judgment
His Honour, after setting out the facts and undertaking a careful analysis of the case law, concluded that the respondent was entitled to deduct the whole of the interest claimed. It was not in dispute that prior to the reorganisation in February 1979 the respondent was entitled to a deduction for the whole of the interest incurred by it on its borrowings both from internal and external sources. Those payments satisfied, as his Honour said, both of the positive limbs of sec. 51(1).
In his Honour's view, the sale and leaseback of the land did not in the circumstances of the present case result in severing the connection between the interest outgoings on the one hand and the business activity of the respondent on the other. His Honour's application of the well-established principles of law to the facts of the present case sufficiently appears in the following quotation from the judgment appealed against (at p. 4045):
``The Commissioner... 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 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.''
His Honour also rejected the appellant's submissions so far as they related to sec. 260.
In these circumstances his Honour had no need to consider the remaining issue of whether the appellant was empowered by sec. 170 of the Act to amend the assessments for the years ended 30 June 1979 to 30 June 1984 inclusive.
The law as to sec. 51(1)
Section 51(1) of the Act provides relevantly as follows:
``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.''
Section 51(1) is the section which permits a deduction for what might generally be called the working expenses of a business although the section is not limited to allowing deductions only to taxpayers carrying on a business. Perhaps because the circumstances that will give rise to a deduction under sec. 51(1) are almost infinitely variable, the section is framed in broad general terms yet with great economy of expression. The words of sec. 51(1) have been the subject of considerable discussion in the cases in an attempt to elucidate the concepts stated in the section.
In form the section divides into two positive limbs which provide the tests for deductibility subject to the exclusions thereafter set out. In the present case the respondent relies upon both of these limbs.
The first limb of the subsection is directed at expenditure incurred ``in'', that is to say ``in the course of'' (see
ATC 4574
Amalgamated Zinc (De
Ronpibon Tin N.L. v. F.C. of T. (1949) 78 C.L.R. 47 per Latham C.J., Rich, Dixon, McTiernan and Webb JJ. at p. 56 and see too the cases referred to by Lockhart J. in
F.C. of T. v. Total Holdings (Aust.) Pty. Ltd. 79 ATC 4279 at p. 4282.
It was early recognised in the cases that there must be some connection between the outgoing and the activities directed at gaining or producing the assessment income. That connection is often expressed by the notion that the expenditure must be relevant and incidental to the gaining or producing of assessable income: Ronpibon Tin N.L. v. F.C. of T. (supra) at p. 56. Thus in
Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344 Dixon C.J., Williams, Webb, Fullagar and Kitto JJ. said at p. 351:
``... 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.''
In referring to the requirement that the expenditure be incidental and relevant to the operations or activities regularly carried on for the production of income, Gibbs C.J., Stephen, Mason and Wilson JJ. in
F.C. of T. v. Smith 81 ATC 4114 at p. 4117; (1980-1981) 147 C.L.R. 578 at p. 586 said that:
``What is incidental and relevant in the sense mentioned falls to be determined not by reference to the certainty or likelihood of the outgoing resulting in the generation of income but to its nature and character, and generally to its connection with the operations which more directly gain or produce the assessable income.''
In other cases, it has been said that the expenditure must have a ``perceived connection'' with the gaining or production of income:
F.C. of T. v. Hatchett 71 ATC 4184 at p. 4187; (1971) 125 C.L.R. 494 at p. 499 (per Menzies J.).
However, as Williams, Kitto and Taylor JJ. observed in
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at p. 497 expressions of the kind ``incidental and relevant'' are ``not used in an attempt to formulate an exclusive or exhaustive test for ascertaining the extent of the operation of the section; the words were merely used in stating an attribute without which an item of expenditure cannot be regarded as deductible under the section''.
What is involved is a process of identifying the essential character of the expenditure to determine whether it is in truth an outgoing incurred in gaining or producing the assessable income: Lunney (supra) at p. 499.
Although the second limb is clearly concerned only with the deductibility of a business expense, it is clear from the cases that in the case of a taxpayer such as the respondent here, who at all relevant times was carrying on a business, the two limbs overlap and are not mutually exclusive. Indeed it has been said that the second limb ``in actual working... can add but little to the operation of the leading words `losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income''': Ronpibon Tin N.L. & Tongkah Compound N.L. v. F.C. of T. (supra) at p. 56. Thus in John
Fairfax & Sons Pty. Ltd. v. F.C. of T. (1959) 101 C.L.R. 30 at p. 40, Fullagar J. said of the two limbs:
``The first is directed to expenditure incurred in the actual course of producing assessable income: Amalgamated Zinc (De Bavay's) Ltd. v. F.C. of T. (1935) 54 C.L.R. 295 at pp. 303, 309 and
W. Nevill & Co. Ltd. v. F.C. of T. (1937) 56 C.L.R. 290 at p. 305. It is, primarily at least, concerned with expenditure voluntarily incurred for the sake of producing income. Its scope is not, of course, confined to cases where the income is derived from carrying on a business. The second may be thought to be concerned rather with cases where, in the carrying on of a business, some abnormal event or situation leads to an expenditure which it is not desired to make, but which is made for the purposes of the business generally and is reasonably regarded as unavoidable: Hannan, Principles of Income Taxation (1946) p. 291:
F.C. of T. v.
ATC 4575
Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431.''
Although it is clear that the wording of the present section is, as the learned trial Judge observed, to be traced to the recommendations of Ferguson J. and Mr Nixon, two of the Commissioners who reported in the Third Report of the Royal Commission on Taxation 1934, that report provides little explanation for the insertion into the second limb of the concept that the expenditure be ``necessarily incurred''. In any event the concept of ``necessity'' in the second limb was not intended to be interpreted restrictively against the taxpayer but rather was ``probably intended to mean no more than `clearly appropriate or adapted for''': Ronpibon (supra at p. 56). It expressed a requirement that ``the expenditure must be dictated by the business ends to which it is directed...'': F.C. of T. v. Snowden & Willson Pty. Ltd. (1958) 99 C.L.R. 431 at p. 437 per Dixon C.J. and see too per Fullagar J. at pp. 443-444.
Under the second limb, as under the first limb, it is clear that the purpose for which the business must be carried on (not, it will be noted, the purpose for which expenditure is incurred) must be a purpose of gaining or producing the assessable income, that is to say assessable income generally, rather than the assessable income of a particular accounting year:
A.G.C. (Advances) Ltd. v. F.C. of T. 75 ATC 4057 at pp. 4067, 4071; (1974-1975) 132 C.L.R. 175 at pp. 189, 196-197.
In the circumstances of the present case no different result was contended for under either limb and the differing wording of each will not affect the outcome of the case.
It is not in dispute that a liability for interest on moneys borrowed and used in a business will ordinarily be an allowable deduction. So much was made clear in the judgment of Dixon J. (as his Honour then was) in
The Texas Co. (A'sia) Ltd. v. F.C. of T. (1939-1940) 63 C.L.R. 382 where his Honour said at p. 468:
``Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant.''
Whether interest incurred by a taxpayer will, in a particular case, satisfy the test of deductibility depends upon the facts of a particular case: Total Holdings Pty. Ltd. (supra) at p. 4283 and the cases there cited. Lockhart J. there said:
``If a taxpayer with a continuing business incurs a liability for interest being incidental to or connected with the operations or activities regularly carried on for the production of income, the interest is an allowable deduction. The circumstance that each item of expenditure cannot be traced to a particular item of income does not prevent the deduction of the expenditure. See
Ward & Co. Ltd. v. Commr of Taxes (N.Z.) (1923) A.C. 145 at p. 148; De Bavay's case (supra) at p. 307; W. Nevill & Co. Ltd. v. F.C. of T. (supra) at p. 305; and The Texas Co. (A'sia) Ltd. v. F.C. of T. (supra) per Starke J. at p. 451.''
The language of the section introduces, as Professor Parsons points out in his work Income Taxation in Australia, Law Book Company, 1985 (para. 5-37 to 5-48), an element of contemporaneity. Thus an outgoing may be precluded from deductibility if it be incurred at a point too soon before the commencement of the business or income-producing activity
F.C. of T. v. Maddalena 71 ATC 4161; (1971) 45 A.L.J.R. 426;
Lodge v. F.C. of T. 72 ATC 4174; (1972) 128 C.L.R. 171) or if it is incurred after the business or activity has ceased (e.g. Amalgamated Zinc (De Bavay's) (supra)), at least in the latter case where a considerable time had passed and the taxpayer had given up all thought of mining. However, the subsequent case of A.G.C. (Advances) Pty. Ltd. (supra) while not a case where the business had wholly ceased, although operations had been suspended, suggests that there should be some qualification to the absolute principle suggested in De Bavay's case. Mason J. in A.G.C. (Advances) Ltd. at ATC p. 4072; C.L.R. pp. 197-198, discussing a loss incurred by writing off a debt after a company had ceased to carry on as a going concern the business in which the debt was created, remarked that:
``even in such a case it may be correct to speak of the loss as having been incurred in the carrying on of the business. This is because the occasion for the loss is to be
ATC 4576
found in a transaction entered into in the carrying on of the business for the purpose of producing assessable income...''
The present is not, of course, a case where the activities of the respondent in operating the motel ceased during any relevant year of income - except the year 1985 when the motel business was sold - although it is a case where in the year 1979, as a result of the sale and leaseback, the character of the activities of the respondent changed. Before 1 February 1979 the respondent's business was that of an owner/operator of a motel. After that date, its business can be characterised as that of an operator of a motel owned by others and of which it was only a tenant. Hence, the relevance of the interest outgoing to its altered business activities must be considered.
The learned trial Judge was of the view that the 1979 change was not sufficient to change the relationship between the interest payments and the business activity. In so saying he relied at least in part upon the fact that the respondent necessarily had to pay the interest to retain the use of the land upon which it conducted the motel business. But the fact that the interest outgoings (on secured borrowings) necessarily had to be met to retain the land, and therefore the business, does not conclude the question of deductibility. So much can be seen from the early decision of the High Court in
F.C. of T. v. Munro (1926) 38 C.L.R. 153.
In Munro, the taxpayer borrowed money upon the security of a rent-producing property. The moneys so borrowed were applied to acquire 20,000 shares in a company, 18,000 of which were by direction allotted to the taxpayer's sons as a gift, the remaining shares being allotted to the appellant. The remaining funds were advanced to the company interest free. The taxpayer argued that whenever money was borrowed by a taxpayer on the security of a rent-producing property the interest was deductible irrespective of the purpose to which or the manner in which the money borrowed was applied. It was said that, if the interest was not met, the income by way of rent would cease. It was held under the then provisions of sec. 23(1)(a) of the Income Tax Assessment Act 1922-1925 that no part of the interest was deductible. No apportionment was then possible having regard to the requirement in sec. 25(e) of that Act that the whole of the outlay be exclusively laid out or expended for the production of assessable income.
So too, here, it is no argument for the deductibility of the interest that, unless paid, the income by way of profits on the running of the motel would cease. Rather, the case must be resolved by determining whether the essential character of the interest outgoings after the sale and leaseback was such that it can be said that those outgoings were incurred by the respondent in the course of the gaining or production of assessable income or, having regard to the business then carried on by it, they were necessarily incurred by the respondent in carrying on that business.
Once this is appreciated, it is apparent that at some point of time at least the interest outgoings ceased to have this character or to be, in the sense used by the cases, relevant and incidental to the business activities engaged upon by the respondent after 1 February 1979. They had no real connection at all with the business of running a rented motel.
A question arises in this case as to when the interest outgoings ceased to have the necessary character of incidental and relevant outgoings. As at 1 February 1979 the loan to Perpetual Trustees was repayable on 1 May 1979. It was in fact repaid on that date. The remaining interest was incurred pursuant to the terms of a new borrowing entered into after the restructuring. It seems to us that it does not follow from De Bavay's case, particularly if regard be had to the comments of Mason J. in A.G.C. (Advances) Ltd. (supra) to which we have referred, that the mere fact that the land and buildings were sold necessarily results in the conclusion that as and from the date of sale the whole of the interest incurred was not deductible. The respondent, pursuant to the contractual arrangements it had entered into, was obliged when it was an owner/operator to continue to pay interest until 1 May 1979. Had it sought to discharge its obligation to the mortgagee, it could have been required to pay interest to this date. In the circumstances of the present case, therefore, it cannot be said that the change in character of the business activity of the respondent immediately excluded the interest payable by it to the mortgagee from deductibility. Rather, it seems to us that the respondent was entitled to a deduction of such part of the disallowed interest as related to the
ATC 4577
borrowing of moneys reflected in the Perpetual Trustees' mortgage until 1 May 1979 and as related to the land and buildings upon which the motel was situated. It will be necessary to remit the assessment of the 1979 year back to the Commissioner to reassess the amount of the deduction in accordance with these reasons, subject of course to the issues arising under sec. 170.The interest, so far as it related to the shareholders' loan accounts, is in a different position. Although these loans were as at 31 January 1979 not repayable until some time in the future, an arrangement was reached, presumably on 1 February 1979, with the shareholders that all shareholders' loans would be extended until 31 December 1985. In these circumstances we are of the view that the relevant connection between the interest outgoings and the respondent's business activities was broken on 1 February 1979 so that no part of the interest thereafter incurred was deductible.
As can be seen we have reached our conclusion without reference to the submissions of the appellant that after 1 February 1979 the deductibility of the interest was denied by the motivation of the respondent in entering into the rearrangements (being tax minimisation, so it was said) and the purpose, which was said to be apparent thereafter. That purpose was said to be tax avoidance and the purpose was said to be a sole or dominant purpose of the incurring of the interest.
These submissions confuse, in our opinion, motive and purpose, discrete concepts as the judgment of Brennan J. in
Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 at pp. 4544-4545; (1980) 33 A.L.R. 213 at pp. 215-216 points out.
It is not necessary for the resolution of the present case to consider the role of the purpose, subjective or objective, of the respondent, a matter dealt with in a different context recently by the High Court in
John v. F.C. of T. 89 ATC 4101 at p. 4105; (1989) 166 C.L.R. 417 at p. 426, and in particular the relevance to the question of deductibility of a motive or purpose (if that is a correct word in the present context) of tax avoidance. The result would be the same whatever the purposes of either Mr Walker, the directors or the shareholders in implementing the arrangements of 1 February 1979.
Having regard to our conclusions as to deductibility under sec. 51(1) it is unnecessary (except in the 1979 year to the extent to which we have already indicated) to consider the application of sec. 260 of the Act. For the 1979 year it suffices to say that there is nothing in the facts to which we have referred that would suggest that the incurring of the interest to the Perpetual Trustee Co. until 1 May 1979 could be categorised as a contract, arrangement or agreement having one or more of the purposes or effects referred to in sec. 260. Further, as is illustrated by the decisions of the High Court in both
Cecil Bros Pty. Ltd. v. F.C. of T. (1964) 111 C.L.R. 430 and John at ATC p. 4109; C.L.R. p. 433, there are real difficulties in applying the provisions of sec. 260 of the Act to disallow a deduction otherwise properly allowable under sec. 51(1) particularly where, as here (and in Cecil Bros), the suggested use of the section is to disallow only a part of a total outgoing otherwise allowable.
Whether the Commissioner was empowered by sec. 170 of the Act to amend the assessments for the 1979 to 1984 years inclusive
The 1979 assessment was issued on 16 January 1980. Tax payable under it was due and payable on 1 May 1980. The amended assessments were issued on 21 April 1986 just within the six-year limitation period contained in sec. 170(2). There was no suggestion in the present case that the avoidance of tax was due to fraud or evasion. All the other amended assessments were made well within six years of the date when tax would have become due and payable under the original assessments. Thus, the question whether the Commissioner had power to amend the assessments depends, under sec. 170(2), upon whether the respondent had made a full and true disclosure of all the material facts necessary for its assessment. The parties were agreed that if we were to find for the respondent upon this issue it would be necessary to send the matters back to the learned trial Judge to consider whether the Commissioner had made a mistake of fact, that being a matter in respect of which his Honour had made no findings, although having heard evidence directed to the question.
It is necessary therefore to turn to the returns lodged to see the extent of the disclosure made by the respondent. Reliance was placed on the returns of both the respondent and the returns
ATC 4578
of the trustee of the Challenger Unit Trust for the relevant years.The return of the respondent in the 1979 year disclosed that there had been a sale of land resulting in a capital profit of $279,826. It was apparent from a note to the balance sheet that the purchaser of the land and buildings was East Street Nominees Pty. Ltd. as trustee of the Challenger Unit Trust and that the mortgage loan from the Motor Vehicle Insurance Trust was secured over that property. The accounts showed the amount of $903,447 arising from the sale of the land as being at call and a note to the balance sheet disclosed that this was ``secured by a contract of sale, and the debt is repayable at call, and is interest free''.
The profit and loss account of the respondent showed a claim for interest on mortgage loans and unsecured loans, distinguishing the two. It also claimed for the first time, as an outgoing, ``rents'' of $39,583 although the recipient of the rent is not disclosed.
A detailed analysis of the balance sheet would, if undertaken by a sophisticated auditor, have revealed that some part of the borrowings related to the land and buildings upon which the motel was operated; because the issued capital was only $78,771 yet the land and buildings stood as at 1 July 1978 in the books at $688,259. It was clear too from the balance sheet of that year that the mortgage loan was $350,000 and that unsecured shareholders' loans totalled $236,313, i.e. that the total liabilities of the respondent in respect of loans were $586,313 as compared with fixed assets of land, buildings and plant standing in the balance sheet at 1 July 1978 of $758,175. The figure for land and buildings of $466,867 referred to as at 1 July 1978 was based on a 1976 valuation and not cost. The cost, however, could be determined by inference by subtracting the capital profit on sale from the net proceeds of sale of $903,447.
If it were relevant to take into account the returns of the unit trust and of the trustee, these would have revealed that the rental income was paid to the trust, that there were common directors, common addresses, public officers and accountants (if these be relevant matters) and that, save for one shareholder who did not participate in the reorganisation, the shareholders of the respondent and the holders of units in the unit trust were the same.
Since nothing turns upon the identity of the participants in the reorganisation, it is not necessary to consider whether the material disclosed in the trust returns should properly be taken into account in determining whether there was full and true disclosure by the respondent, assuming that the trust returns were lodged prior to the assessment of the respondent's returns or were assessed by the assessor who assessed the respondent's returns. Some evidence as to these matters was led by the respondent but his Honour made no findings upon them. We should not, however, be thought to accept the proposition that, in determining whether there has been full and true disclosure by a taxpayer, regard can be had to material contained in another taxpayer's returns even if lodged at the same office at the same time. The decision of the High Court in
Foster v. F.C. of T. (1951) 82 C.L.R. 606 is not authority for so wide a proposition. In that case Dixon J. said at p. 619 that:
``... a taxpayer can hardly be said to fail to disclose to the commissioner a fact which is not only within the commissioner's knowledge in connection with the exercise of his functions in the very matter, but which the taxpayer knows so to be within his knowledge.''
However, that is not the present case. The circumstances referred to by Dixon J. will rarely exist: cf.
F.C. of T. v. Levy (1961) 106 C.L.R. 448 and
Lee v. F.C. of T. (1962) 107 C.L.R. 329 with
F.C. of T. v. Slater Holdings Pty. Ltd. 80 ATC 4534 (Full Federal Court, Bowen C.J., Brennan and Lockhart JJ.). The mere simultaneous lodgment of returns will not enable a taxpayer to gain support from another return. At the very least, the taxpayer's return must make mention of the other return in such a way as to incorporate by reference material in the other return.
What is meant by full and true disclosure has been the subject of considerable discussion. In
Austin Distributors Pty. Ltd. v. F.C. of T. (1964) 13 A.T.D. 429 at pp. 432-433 Menzies J. said:
``The requirement of s. 170... is not met by anything less than full disclosure of all the material facts, and a disclosure which leaves the Commissioner to speculate as to some of the material facts is not sufficient... The matter can be tested in this way. If advice were to have been sought by the taxpayer
ATC 4579
whether or not the sum in question was a taxable premium, would the person from whom that advice was sought have required more information than this return disclosed to the Commissioner?''
In most cases, where the question of full and true disclosure has arisen, the discussion of failure to disclose was in the context of a matter which went to the liability, as a matter of principle, to tax of an income item or the allowability, as a matter of principle, of an outgoing. See for example
W. Thomas & Co. Pty. Ltd. v. F.C. of T. (1965) 115 C.L.R. 58;
Chamber of Manufactures Insurance Ltd. v. F.C. of T. 84 ATC 4315; (1984) 2 F.C.R. 455;
A.L. Hamblin Equipment Pty. Ltd. v. F.C. of T. 74 ATC 4001 at p. 4011; (1974) 130 C.L.R. 159 at pp. 174-175;
Stapleton v. F.C. of T. 89 ATC 4818 per Sheppard J.
The present is not such a case. A close examination of the taxpayer's return would have showed that the taxpayer had sold the motel buildings and site and leased back a motel, that it had not repaid its borrowings and that, to some extent, these borrowings must have related to the purchase of the site and the construction of the motel. The relevant matters going to the abstract question of deductibility of interest were therefore disclosed, although a reader might be excused for overlooking the significance of them having regard to the cryptic way in which the disclosure was made. But is that enough?
It must be remembered that what must be disclosed fully and truly are all the material facts necessary for the assessment of the taxpayer. By assessment is meant, as the definition in sec. 6(1) of the Act makes clear, the ``ascertainment of the amount of taxable income and of the tax payable thereon''.
In the present case, the process of assessment required not only that the Commissioner form a view as to the deductibility of interest in the abstract, in the case of a sale and leaseback of the motel, but also that he compute the amount of interest which was allowable (because related to the plant and fittings used in the motel business or working capital) and that which was not allowable (because related to the purchase of the site and construction of buildings). To determine the amount deductible, and so calculate the taxable income and ultimate tax payable thereon, it was necessary for the Commissioner to know how much of the overall borrowings related to the site and buildings and how much to the other matters. No amount of sophisticated analysis of the returns would permit that calculation to be made. The returns merely lead to speculation as to the quantum involved and invite requests for further information or a detailed analysis of the books of the respondent. Where further information of a material kind must be forthcoming before the quantum of tax can be assessed, it cannot be said that there is a full disclosure of the material facts necessary for the assessment.
We allow the appeals in part, as regards the 1979 year, and in full as regards the remaining years. The Div. 7 assessments raise no separate questions and the appeals in respect of them will also be allowed. We order, in respect of the appeal concerning the 1979 year, that the assessment be remitted to the Commissioner for amendment in accordance with these reasons. In relation to the remaining appeals, we set aside the decision of the learned primary Judge and, in lieu thereof, we order that the appeals against the disallowance of the respondent's objections be dismissed. The respondent must pay the costs of the appeals to this Court and of the proceedings below, save as to the first day which was taken up with argument concerning additional tax under sec. 226 of the Act ultimately conceded in the respondent's favour. The parties were agreed that if we were of the view that the appeals should succeed this was the appropriate cost order.
THE COURT ORDERS THAT:
1. The appeal be allowed in part.
2. The orders appealed from be set aside.
3. In lieu thereof it be ordered that:
- (i) the amended assessment in respect of the income tax of the respondent for the 1979 year of income be remitted to the appellant for amendment in accordance with these reasons;
- (ii) the appeals of the respondent in respect of all of the assessments and amended assessments for the years of income 1980 to 1984 be dismissed;
- (iii) the assessment for the year of income 1984-1985 be remitted to the appellant for amendment.
ATC 4580
4. The respondent pay the costs of the appeals to this court and of the proceedings below save as to the first day of the proceedings below.
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