CASE Y5
Members:P Gerber
Tribunal:
Administrative Appeals Tribunal
Dr P Gerber (Deputy President)
In Case W65,
89 ATC 590, Hartigan P. allowed in part, an application by this taxpayer, Discoverer Ltd (``Discoverer''), to amend its grounds of objection. The learned President decided that sec 190(a) of the Income Tax Assessment Act 1936 (``the Act'') permitted Discoverer to add an alternative ground of objection, but that the section did not allow the taxpayer to amend its grounds of objection to increase the amount of a claimed deduction or to add new grounds as a basis for objection.
2. Due to his Honour's illness, Hartigan P was unable to hear argument upon the substantive issues in dispute. In the result, I took over the conduct of this matter in March 1990.
3. At a hearing in April 1990, Mr Nettle of learned counsel for Discoverer, submitted the decision of Hartigan P was merely interlocutory and hence not a decision strictu sensu, a fortiori, it was said that I was not bound by it.
4. I observed that Hartigan P appeared to have adopted a very narrow view of sec 190(a) and that I may well have taken a somewhat wider view. I also agreed that the President's decision was merely interlocutory and, in any event, not strictly binding upon me, albeit highly persuasive.
5. Not surprisingly, Mr McEwen, of learned counsel for the Commissioner, challenged the correctness of Mr Nettle's submission and my tentative concurrence with it. After lengthy argument, both parties agreed that the parameters of an applicant's right to amend grounds of objection was an important question of law which warranted referring it to the Federal Court of Australia in pursuance of sec 45 of the Administrative Appeals Tribunal Act 1975. However, in a subsequent Directions Hearing, I was advised that the parties had abandoned the reference to the Federal Court since the applicant wished the matter to proceed expeditiously to trial. Hence, the matter proceeded to trial in July 1990 upon the original grounds of objection (as amended by agreement between the parties).
6. The primary question to be determined is whether interest income derived by Discoverer, a goldmining company, is exempt from tax under sec 23(o) of the Act.
7. Mr Shaw, of senior counsel for Discoverer, contends that if the Tribunal holds that interest income derived from the investment of surplus funds is assessable income, then the applicant is entitled to the following deductions:
- (a) housing costs under either sec 51(1) or sec 77 of the Act;
- (b) exploration expenses under either sec 122J or sec 77;
- (c) interest incurred under sec 51(1); and
- (d) donations under sec 51(1).
8. I now turn to consider the primary submission of the applicant.
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Interest Income
9. The Commissioner denied that the following receipts of interest were entitled to exemption under sec 23(o) of the Act:
Year Amount
$
1978 529,845
1979 728,010
1980 1,156,835
1981 1,984,425
1982 1,442,502
1983 514,891
10. Discoverer was incorporated in March 1935. Since incorporation, Discoverer has mined continuously at Mt Druid. In June 1980, Discoverer possessed a 50% interest in a joint venture with Silvo Ltd (``Silvo'') [of which Discoverer is a subsidiary]. The joint venture was undertaken to continue exploration on several goldmining leases at Brasso. The activities in the Mt Druid region and at Brasso constitute the entire mining operations of Discoverer.
11. Mr M, a director of both Brasso and Discoverer outlined, in a prepared statement, the history of Discoverer and the business environment in which it operated. He deposed that:
``During the first part of the 1970's Discoverer experienced financial difficulties. In August 1971, the Board announced that operations would be suspended when all economically extractable ore had been treated. Development was suspended and it was anticipated that operations would cease at the end of 1972.''
However, in the events that occurred, operations did not cease. Instead, Discoverer prospered during the mid to late 1970s, due mainly to soaring gold prices and the additional discoveries of extractable ore.
12. Mr M identified the inherent risks in goldmining because of (a) the need to reinvest extensively in exploration, development and heavy duty machinery; (b) volatile gold prices; (c) volatile exchange rates; (d) escalating costs; and (e) the difficulty in predicting future ore reserves and grades.
13. In view of the financial risks associated with gold prospecting, Discoverer was restricted in its capacity to obtain external finance. The company maintained a total liabilities-to-equity ratio of 1:4 which Mr M ``considered to be consistent with the prudent financial management of a high risk goldmining company''. Such a conservative debt-to-equity ratio could only be sustained by the retention of internally generated funds sufficient to meet future financial requirements, as opposed to reliance on external debt for such commitments.
14. Analysis of Discoverer's ``Statement of Source and Application of Funds'' (included in the company's Annual Reports), reveals, in the years in question, that on average, in excess of 50% of Discoverer's funds were derived from operations. The funds generated from sundry creditors and bank overdraft facilities accounted for 20%, whilst reliance upon deposits and other current assets accounted for almost 30% of the company's funding requirements in the period of 30 June 1978 to 30 June 1983.
15. Mr M observed that the ``degree of reliance upon internally generated cash flows could only be achieved by making cash management an integral part of Discoverer's business and, hence, the working of the mining property''.
16. The financial prosperity of Discoverer in the late 1970s meant that the company had large cash surpluses which were invested on the short-term money market. The Board of Directors of Discoverer regularly monitored the level of funds invested on the short-term money market through the periodic receipt of investment reports. The Board determined the terms of lending and the amounts placed with large companies, merchant bankers and financial institutions, all of which were active in the short-term money market. All funds, including borrowed moneys which could not be immediately utilised in working the mining property, were deposited in the financial market-place. The period of investment could be as short as overnight as funds were continually recalled to prevent overdraft accounts exceeding overdraft limits and this allowed the ``topping up'' of the overdraft account.
17. Discoverer also had two overdraft facilities: (a) $250,000 with Schroder Darling and (b) $250,000 with the ANZ Bank
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(increased to $500,000 on 25 February 1981). The overdraft facility with the ANZ Bank was granted against the security of an equivalent amount placed on fixed deposit with the Bank. Mr M stated in cross-examination that the overdrafts were used to meet the day-to-day operating expenses of Discoverer (eg to pay outstanding creditors) rather than drawing upon surplus funds invested on the short-term money market. However, the overdraft facilities were insufficient to meet the large sums payable for acquisitions of plant and equipment.18. Against that background, Mr Shaw submitted that the interest income derived from the investment of moneys on the short-term money market is within the exemption from tax provided by sec 23(o) of the Act. He placed particular reliance on the decision of McClemens J in the NSW Supreme Court in
Freeman v C of T (NSW) 6 AITR 93.
19. In Freeman, Bulolo Gold Dredging Ltd carried on goldmining operations by dredging and sluicing on leases at Bulolo (New Guinea). Bulolo was accessible only by air transport. The company had its own hydroelectric works which provided power for its dredges and electricity to houses and amenities provided for employees. By far the greater part of the company's income came from sales of gold, but in each of the years 1936 to 1939 inclusive, a relatively small amount of income was derived from one or more of the following sources: (a) tribute earnings paid as royalties by miners for the right to win gold from the company's leases, (b) payments by a neighbouring dredging company for the right to work one of Bulolo's claims which Bulolo found inconvenient to work, (c) sales of surplus electric power, (d) discounts designed to reimburse the company for overhead costs in connection with a store maintained for the convenience of employees, and (e) in one year a buying commission on the purchase of spares in America and stores for an air transportation company which carried about one-fifth of the company's own airfreight. Mr Freeman, a shareholder, appealed to the Supreme Court and argued that dividends received by him were not liable to tax, either for years ended 30 June 1936, 1937 and 1938 under the Special Income and Wages Tax (Management) Act 1936 or for the year ended 30 June 1939, under the Social Services Tax (Management) Act 1939, because such dividends were paid wholly and exclusively out of exempt income derived from the working of a goldmining property in the Territory of New Guinea within the meaning of sec 53(f) of the Income Tax (Management) Act 1936.
20. McClemens J adopted a very broad interpretation of ``goldmining property'':
``As to what was the company's `goldmining property', if this is a question of degree and fact, as I am of opinion it is, the goldmining property of Bulolo was everything it possessed in New Guinea. The gold leases, the dredges that worked the leases, the amenities which housed the men who worked the dredges, the aeroplanes which flew the supplies in and the gold out, the facilities at Lae without which not one drop of lubricating oil or one ounce of necessary stores or machinery would have got to the field, and the dams and generators of the hydro-electric plant all totalled up to comprise that entity which was the `goldmining property' of Bulolo. The inference I draw from the material before me is that Bulolo only carried on one business - namely, goldmining. It never intended to enter any other field during the material period. Its directors in their reports never adverted to anything other than (a) properties, (b) equipment of property, (c) air transportation, and (d) dredging, when discussing the business of the company. As far as I can see every bit of property Bulolo possessed was possessed to one end, namely, goldmining. I also find that it earned income from sources other than gold only fortuitously and accidentally.''
(my italics) (p 97)
21. McClemens J concluded the income derived from the sale of surplus power was exempt income because:
``... the maintenance of relations with other operators in the Bulolo district must be regarded as being, if not the actual working of the property, so closely incidental to it that one cannot separate one from the other. This appears to me to be an additional reason why it is reasonable to regard these sales of power as being part of the income derived from the working of a goldmining property.''
(p 98)
His Honour also held that the payment by Sunshine Gold Development for the right to
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work one of Bulolo's claims was income from the working of Bulolo's goldmining property and that the discounts received by the company were similarly exempt income, if only because: ``As Napoleon said, `an army marches on its stomach'; and without supplies this company could not have won any gold.'' (p 98). Applying the same reasoning, his Honour concluded that the commission received from Guinea Airways in purchasing aeroplane stores and spare parts in America was income derived from the working of a goldmining property, noting that:``It must be remembered that this item represents approximately one 2500th part of the value of the bullion won... [After reviewing the overall operations of the taxpayer company between 1936 and 1939, his Honour concluded that]: It would appear to me, therefore, that it would be reasonable to say that the performance of services by the appellant company in this year 1939 in the way of purchasing stores and spare parts for Guinea Airways, on whom they were to some extent dependent for the conduct of their actual mining operations, and with whom the maintenance of `good neighbourliness'... was eminently desirable, could be so referable to the actual working of the goldmining property as to be regarded as income derived from that property. To say that this was a separate and independent activity from goldmining would be to make the tail wag the dog. [see per Rich J in
Texas Australian Ltd v. Federal Commissioner of Taxation (1940) 63 CLR 382, at p 447].''(at p 99)
22. An application by the Commissioner for special leave to appeal to the High Court (6 AITR 225) was dismissed in part (to the extent that the appeal succeeded, the result has no bearing on this case). Dixon CJ, McTiernan, Webb, Fullagar and Taylor JJ concluded in a joint judgment:
``In disposing of these appeals, the learned trial judge took a very broad view of the matter, and one which may not have been justified upon the evidence. It appears - and his Honour was impressed by the fact - that the items of sundry income which are now in question represented but a very small proportion of the company's total income. This circumstance, of course, is no justification for the conclusion that the dividends paid to the respondent in respect of the relevant years were paid wholly and exclusively out of exempt income of the company. But it does not follow from the designation assigned to the items of sundry income in dispute that this conclusion is, by any means, impossible. It is essentially a question of fact. The income received in respect of power sales is the larger item and it was established in evidence that the income was received in respect of the sale of what was referred to as surplus power. The company's mining property is situated in a remote part of New Guinea, and it appears, and was so found by the learned trial judge, that the provision of electrical energy for its mining undertaking was a vital necessity, and that the installation of plant for this purpose was an integral part of the company's mining undertaking. The appellant, on the other hand, asserts that the expression `surplus power' is, in the circumstances of this case, a misnomer. It may be, it is said, that the plant, installed, as no doubt it was, with a view to the company's future development, had a potential beyond the requirements of the company at that time, but it was unnecessary for the purpose of working the mining property that surplus power should have been generated. The facts on this aspect of the case are, however, exceedingly meagre. But it is clear from the form of the arrangement made with New Guinea Goldfields Limited that Bulolo was not engaged in operating an independent business of generating and supplying power to customers. At the relevant time it regarded the power so supplied as `surplus' and it reserved the right to withdraw the supply at any time to fill its own requirements. It may well be that, if the facts were fully investigated, the conclusion might be reached that the production of surplus power was simply an incident in the generation of electrical power for the purposes of the company's mining operations, and if this was so we see no reason why income which it earned, merely as an incident of an activity directly undertaken for the working of its mining property, should not be regarded as income from the working of the mining property
ATC 125
itself. However, it may be, as we have indicated, that the paucity of the evidence is insufficient to enable a positive conclusion, one way or the other, to be reached. Much the same kind of observations may be made concerning the payments received from Sunshine Gold Development Limited and, indeed, concerning the items of sundry income received by the company in the two income years following that which ended on 30 June 1937.''(my italics) (at pp 230-231)
23. Mr Shaw appropriates the dicta italicised in the above case to the facts in this case and submits in that - as in Freeman - there is no evidence that Discoverer operates an investment business which is separate and distinct from the company's goldmining operations, so that the interest income derived from its investment of funds on the short-term money market ``should be regarded as merely incidental to the activity of working a goldmining property''. In further support of his argument, Mr Shaw emphasised that the moneys invested were retained wholly from the working of the goldmining property and that the funds would only be withdrawn to meet capital commitments which the company deemed necessary to undertake, adding that interest income constituted, on average, less than 5% of Discoverer's gross revenue.
24. Section 23(o) exempts from tax, subject to Division 16H,
``... income, other than income from the production, treatment or sale of pyrites, derived from the working of a mining property in Australia, where the working of the mining property by the taxpayer for the period from the commencement by him of mining operations on that property to the end of the year of income has been principally for the purpose of obtaining gold, or gold and copper, and where, in the latter case, the value of the gold obtained from that property by the taxpayer in that period is not less than two-fifths of the value of the output of that property in that period, other than the value of pyrites.''
(my italics)
25. For the contrary view, Mr Larkins of senior counsel for the Crown cites
Parker v FC of T (1953-1954) 90 CLR 489 as authority for the proposition that the phrase ``the working of a mining property'' refers purely to the exploitation of a mining lease or interest in the soil and submits that the interest income is thus not income derived from ``the working of a mining property'' and is therefore not exempt income within the ambit of sec 23(o) of the Act.
26. In Parker, the taxpayer was the holder of a goldmining lease and, for the surface of the same area, a machinery area lease. On this area, the taxpayer operated a crushing plant with which he crushed a small amount of ore won from his own mining lease as well as ore won from other mines, in two of which he held a part interest. After the extraction of the gold by crushing, the residues were run off in the form of slimes or tailings. The taxpayer purchased these tailings collecting them into dumps on the surface of his machinery area and treated them with cyanide and thereby extracted residual gold from them. The taxpayer claimed exemption in respect of income derived from the residual gold as being income derived from the ``working of a mining property... principally for the purpose of obtaining gold'' under sec 23(o) of the Act. Dixon CJ, Webb and Taylor JJ held that winning gold from such tailings by treating them by a cyanide process did not constitute the ``working of a mining property... for the purpose of obtaining gold'' and accordingly the income derived therefrom was taxable.
Dixon CJ stated:
``The word `working' has, I think, a definite meaning in its application to `mining property'. It describes the working of the thing itself - not the revolution of the machinery upon it nor the chemical treatment of residues brought upon it. We are not dealing with a case where from the raising of the ore to the extraction by every available means of the maximum gold content a series of processes is pursued in the working of the mining property in order to win the gold from the soil. Here the tailings are accumulated as a residual by-product substantially from the ore from other mines going through the crushing plant. They are acquired in effect by purchase, except as to the small part representing ore from the mine beneath. They are foreign to the `mining property' though resting upon it. The machinery area as such is not the `mining property' that is `worked'. No doubt some of the reasoning
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in
Henderson's Case (1943) 68 CLR 29 may be appropriated to the use of the appellant to assist his argument. But it cannot be done without distortion of the reasoning. For the expression `mining operations' is not the same as `the working of a mining property'. The former is plainly wider and the latter is directed to a different point. Mining operations means operations pertaining to mining and operations is a very large expression. The phrase `the working of a mining property' looks to the exploitation of a mining lease or other form of interest in the soil.''(pp 493-494)
27. At first blush, the reasoning in Freeman is not easily reconcilable with the decision of the High Court in Parker. The latter decision was applied in Case G74,
7 TBRD 38 (October 1956) without reference to Freeman, although the latter was handed down, at first instance in March 1954, and by the High Court in February 1956. The lack of congruence between Freeman and Parker may well be explicable by the undoubted fact that the former was decided per incuriam since a careful reading of the various judgments and the arguments of counsel, both at first instance and on appeal, reveals that Parker was not referred to. Whatever the reason, it is clear that their Honours in Parker adopted a narrower interpretation of the words ``mining property'' than in Freeman.
28. To the extent that there is a conflict between Freeman and the earlier decision of Parker as to what constitutes the ``working of a goldmining property'', I not only prefer the view adopted in Parker, but find that, in the circumstances, I am bound by it. Even if I am wrong in my conclusion, the passage from Freeman, appropriated by Mr Shaw, is, as pointed out before, clearly obiter dicta which, like all dicta, is persuasive but not binding.
29. In the result, I am satisfied that only income which is derived directly from the exploitation of a mining lease or interest in the soil may qualify for the exemption provided by sec 23(o) of the Act. Thus, interest income which is earned from the investment of moneys on the short-term money market, and which cannot, in any real sense be regarded as derived from the ``working of a mining property'', is not exempt income within sec 23(o). However, even assuming that the later decision in Freeman correctly states the law, it cannot be concluded on the evidence in this case that Discoverer derived interest income simply as an incident in the company's mining operation. Mr Shaw asserted that only the surplus of internally generated funds were invested, so that the investment income was even more incidentally earned than in Freeman's case. However, this assertion is contradicted by the evidence of Mr M who stated ``Discoverer's funds, including borrowed moneys which could not be utilised immediately in the working of the mining property, were invested in the short-term money market for periods as short as overnight'' (my emphasis). Further, it cannot be sustained that the proportion of interest income to total revenue is so small so as to be incidental. In the instant case the proportion is 1:20, whereas in Freeman, the commission received from Guinea Airways constituted 1:2500th of Bulolo's total revenue.
30. For the above reasons I find that the investment income earned by Discoverer is not exempt income under sec 23(o) of the Act.
(a) Employee Housing
31. Mr T, the resident manager of Discoverer, testified that the company has conducted a housing operation at Mt Druid for many years. The principal reason for Discoverer conducting the housing operation was to assist in attracting people to Mt Druid to work in the company's mining and exploration activities. Between 1978 and 1983, the housing operation comprised between 129 and 150 houses. Discoverer provided four basic categories of housing being (a) town cottages; (b) lease cottages; (c) old transportable houses and (d) new transportable houses. During the period 1978 to 1983 rents varied between $8.50 and $20 per week depending upon the type of house and the status of the lessee. In that period, rents for transportable houses increased from $14 to $20, and rents for cottages increased from $8.50 to $14 per week. Discoverer also operated a single men's quarters at Mt Druid. During 1978 and 1983 the single men's quarters had a capacity of between 62 and 78 rooms as additional units were constructed and some modified. Full board was provided to the residents of the single men's quarters. Employees of Discoverer who elected to take advantage of the company's housing facilities paid a weekly
ATC 127
rental which was well below market value. The housing operation was substantially subsidised by Discoverer as the expenditure necessary to fund the housing operation considerably exceeded the rental income derived from employee housing.32. Mr Shaw submits that if the Tribunal were to conclude that the derivation of investment income is not a mere incident of Discoverer's goldmining business, it follows that the housing operation is likewise not an incident of the company's goldmining business so that Discoverer is entitled to a deduction under either sec 51(1) or sec 77 for the net loss suffered on employee housing.
33. Mr Larkins, on the other hand, submits that as employee housing is provided to attract individuals to Mt Druid, and since an employee is required to vacate the premises upon termination of employment (Condition 21 of the tenancy agreement in respect of the single men's quarters), the evidence leads to the conclusion that the housing operation is merely an incident of the taxpayer's goldmining activity. Thus, Mr Larkins argues, the rental income is exempt under sec 23(o), and Discoverer is not entitled to a sec 51(1) deduction because there is no nexus between housing expenditure and the derivation of assessable investment income. For good measure, Mr Larkins pointed out that Discoverer had been extremely profitable between 1978 and 1983, and thus there was no loss incurred in the years of income by the company in carrying on an exempt business which is deductible under subsec 77(1) of the Act.
34. I am satisfied - again by reference to the decision in Parker - that the rental income derived by Discoverer is assessable income since the rent is not ``income derived from the working of a mining property''. It follows that expenditure on housing will ordinarily be deductible under sec 51(1) as the costs associated with producing such assessable income. In the instant case, I find that the rental income of Discoverer is not derived simply as an incident of the company's goldmining business, either ``accidentally or fortuitously'' (to adopt the language of McClemens J in Freeman) or ``merely as an incident of an activity directly undertaken for the working of its mining property'' (adopting the language of the High Court on appeal), nor does the housing operation constitute a separate business of Discoverer. However, like the investment of surplus funds, it does represent a separate and distinct activity. Indeed, the evidence of Mr T records that the housing operation, unlike the mining and explorations operation, is controlled by the personnel department. In addition, the housing operation constitutes a separate cost centre of Discoverer. It follows that the rental receipts of Discoverer are assessable income and that prima facie, the company is entitled to deduct expenditure incurred on employee housing under sec 51(1) of the Act.
35. Mr Larkins, in a forceful alternative submission, contended that the applicant had failed to establish that the aggregated items of housing expenditure contain only expenditures of a revenue nature. On the evidence presented at the hearing, this submission has considerable force.
36. Given the paucity of evidence relating to the ``housing'' component of the claim, I informed Mr Shaw at the end of the case that his evidence on this aspect was gravely deficient. I added that, bound only by the rules of natural justice and, having some sympathy for his client on the basis that, on one view, it was more sinned against than sinning in (i) the ruling on the right to amend its grounds of objection and (ii) the checkered history of this appeal, I would grant him leave, if he so desired, to file additional material which would assist me in identifying the legal character of these expenditures, subject to the Crown's right of reply. The Crown objected to this indulgence, an objection which I overruled. In the result, an affidavit prepared by Mr S, the personnel officer of Discoverer, was subsequently filed together with a bundle of additional documents.
37. I propose to consider in turn, the annual deduction claimed by Discoverer for the ``net loss on employee housing''. Based upon the additional material filed by Discoverer, an annual breakdown of receipts and expenditure is provided.
*Calculated as 90% of 1979 figures.
38. Mr S was unable to locate any additional records for the 1978 tax year. He considered that the costs of power, water and gas would not be expected to be less than 90% of their cost in 1979 (the details of which were in evidence). This leaves ``other'' expenditure of $188,186 unexplained. Mr T gave evidence in cross-examination that he could not give accurate figures upon what ``other'' refers to but that he ``would assume it would be something to do with just the maintenance of the houses''.
39. In the result, the Applicant has failed to satisfy me that ``other expenditure'' of $188,186 is of a revenue character. This component of the claim thus fails for want of evidence, if only because it goes no further than establish that Discoverer is entitled to a deduction of $89,786 as the net loss on employee housing after having offset assessable rental income.
1979
$ $
Rent received -
- Housing 62,420
- Single men's
quarters (SMQ) 45,691
------
108,111
Less Housing
maintenance
Catering - single men's
messing charges 155,003
Power 58,109
Water 13,780
Gas 8,437
Workshops 83,611
Other 10,418 329,358
------ -------
Net loss on
employee housing 221,247
-------
40. Mr T observed that the item ``Workshops'' may include expenditure on upgrading the accommodation facilities provided to employees. Both T and S stated that Discoverer had engaged in considerable upgrading of premises during the early 1980s. However, I am not satisfied that the 1979 ``Workshop'' expenditure of $83,611 is wholly comprised of expenditure in the nature of repairs and maintenance. For reasons identical to the 1978 tax year, I disallow a deduction of $94,029 (being for ``Workshops'' $83,611 and ``Other'' $10,418), but allow Discoverer a deduction of $127,218 as the net loss suffered on employee housing.
1980
$ $
Rent received - 132,237
Less Housing
maintenance
Catering - single men's
messing charges 200,498
Power 79,583
Water 24,919
Gas 10,231
Workshops 291,733
Other 39,721 646,685
------- -------
Net loss on
employee housing 514,448
-------
41. Discoverer is prima facie not entitled to a deduction of $331,454 being the aggregate of unidentified expenditures on ``Workshops'' $291,733 and ``Other'' $39,721.
42. Exhibit PTF has a capital in progress (CIP) total for 1980 of $177,979. The document also has columns for ``CIP 1981'',
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``Total CIP'', ``Maint. 1980/1981'', ``Grand Total''. The maintenance column does not discriminate between 1980 and 1981 expenditure. Since the Commissioner is prepared to treat the 1980/81 maintenance total of $109,013 as a component of the ``Workshop'' costs of 1981, it is unnecessary to apportion the maintenance costs between the 1980 and 1981 income tax years. Thus, Discoverer is entitled to a deduction of $182,994 as the net loss incurred on employee housing, but the applicant has not established that the additional expenditure of $331,454 is of a revenue character. 1981
$ $
Rent received 152,946
Less Housing
maintenance -
Catering 240,601
Power* 87,542
Water* 27,411
Gas* 11,252
Workshops - )
Other 313,082) 679,888
------- -------
Net loss on
employee housing 526,942
-------
*Calculated at 110% of 1980 costs.
43. Mr S stated that the applicant could not produce any supplementary material in respect of the 1981 year. He attempted to establish expenses for ``Power'', ``Water'' and ``Gas'', not unreasonably, by calculating them to be 110% of their cost in 1980.
44. The combined balance of ``Workshops'' and ``Other'' is $313,082, and of which the Commissioner concedes $109,013 as the costs of maintaining accommodation facilities (per Exhibit PTF). The balance of $204,059 has not been proven to be of a revenue character and thus the claim to deduct such sum must fail.
45. In the result, Discoverer is entitled to a deduction of $322,883 as the net loss on employee housing.
1982
$ $
Rent
- Housing 95,159
- Single men's
quarters (SMQ) 97,050 192,509
------ -------
Less Housing
maintenance -
Catering 264,949
Labour 26,467
Power 67,036
Water 29,799
Gas & Fuel 11,993
Vehicle costs 7,902
Workshops)* 274,579 682,725
------- -------
Other)
Net loss on
employee housing $490,216
--------
*Includes rates and taxes of $8,154 already allowed as a deduction under sec 72.
46. Mr S stated that Discoverer engaged in extensive upgrading of housing in 1982. In para 7 of his affidavit, he deposed that ``Discoverer has capitalised a very large amount in the year ended 30 June 1982 as being expenditure of a capital nature. The amount involved was $1,074,883. This amount included the cost of major upgrades of existing houses''.
47. Discoverer has an accounting cycle of thirteen four-weekly periods. Except for the sum of $12,757, records were found which provide details of expenditure on houses for twelve of the thirteen four-weekly periods. Therefore, the total traceable housing expenses (excluding rates and taxes already allowed) is $661,814.
48. The Commissioner is prepared to accept that any expenditure of a capital nature has been separately capitalised in the company's accounts and thus that the sum of $661,814 is on revenue account. I therefore allow Discoverer a deduction of $469,305 as the net loss on employee housing.
*Rates and taxes of $28,013 allowed as a sec 72 deduction have been excluded.
49. The combined sum of ``Workshops'' and ``Other'' is $185,046 in 1983. Mr S deposed that just $16,200 was capitalised in 1982 as there was no major upgrading of houses. He further deposed that only records covering the first seven of the thirteen four-weekly periods were able to be located. Based on his experience at Mt Druid, Mr S stated that ``the same pattern of expenditure prevailed in the remaining six periods so that I have no doubt that Discoverer incurred further expenditure on housing of $264,509 in those remaining periods''. The Commissioner contends that the item ``A 499 General: $60,064'' in Exhibit H3, a component of ``Workshops and Other expenditure'', has not been established to be of a revenue character. By a facsimile received on 14 September 1990, Mr S deposes ``I am able to confirm that the full cost of $60,064 which appears in Exhibit `JS1' relates to maintenance of lease housing which is rented out by the company''.
50. Exhibit H3 contains a detailed itemisation of the expenditures incurred on each house. However, the last figure listed in H3 is $60,064 being for expenditure classified as ``General''. This sum is based on the records located for the first seven periods, and becomes $111,547 when extrapolated on the basis of thirteen four-weekly periods. Mr Larkins submits the sum of $111,547 thus remains unexplained and ought not to be allowed as a deduction.
51. The last page of Exhibit H3 provides a detailed breakdown of ``General'' expenditure of $60,064. The items of electricity, fuel, gas, salaries, stationery, water and power are clearly expenditures of a revenue nature. The sum of these expenditures is $36,749 and which extrapolates to $68,248 based on thirteen four-weekly periods. This leaves the sum of $43,299 unexplained ($111,547 less $68,248). In the absence of more detailed evidence, and notwithstanding the assurance by Mr S that such sum pertains to the maintenance of lease housing, I am not persuaded that the sum of $43,299 is of a revenue character, and thus deductible under sec 51(1).
52. It follows that the amount of $592,019, being the total housing expenses claimed, must be reduced by $43,299. Discoverer is thus entitled to a deduction of $361,847 as the net loss incurred on employee housing.
(b) Exploration Expenditure
53. Discoverer claims to be entitled to a deduction in respect of exploration expenditure. I will deal separately with expenditure incurred at Mt Druid and exploration costs incurred on the joint venture with Silvo at Brasso.
(1) Brasso
54. Discoverer secured a 50% interest in the Brasso joint venture in June 1980. The object of the joint venture was to continue exploration upon several goldmining leases.
55. Mr D, the exploration manager of Silvo, accepted in cross-examination that the focus of
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the joint venture has been to explore exclusively for gold. Although other companies had mined for copper at Brasso, the Discoverer-Silvo joint venture had no primary target other than gold.56. Mr Shaw submitted that the company is entitled to deduct exploration expenditure of $399,425 in 1980, $796,299 in 1981, $3,543,664 in 1982 and $1,275,156 in 1983 under either sec 122J or sec 77 of the Act.
Section 122J(1) of the Act provides that:
``Subject to this section, expenditure incurred by the taxpayer during the year of income on exploration or prospecting on any mining tenements in Australia for minerals obtainable by prescribed mining operations shall be an allowable deduction.''
Section 122(1) defines ``prescribed mining operations'' to mean:
``mining operations on a mining property in Australia for the extraction of minerals, other than petroleum, from their natural site, being operations carried on for the purpose of gaining or producing assessable income.''
57. Mr Shaw submitted further that the evidence of Mr D establishes that Discoverer pursued minerals other than gold at Brasso and thus that Discoverer is exploring for minerals obtainable by ``prescribed mining operations''.
58. The evidence of Mr D is unambiguous - the Discoverer-Silvo joint venture was exploring exclusively for gold. I am satisfied that since income derived from the working of a goldmining property is exempt under sec 23(o), it follows Discoverer is not prospecting for minerals obtainable by ``prescribed mining operations'' as the mining operations have to be carried on for the purpose of gaining or producing assessable income, not exempt income. Thus, the claim for a deduction under sec 122J must fail.
59. Mr Shaw also submitted that the joint venture at Brasso constitutes a separate business of Discoverer and relies on the decision of the Full Federal Court in
FC of T v Ampol Exploration Ltd 86 ATC 4859 as authority for the proposition that an exploration business may constitute a business per se. Mr Shaw argued that Discoverer incurred a loss on an exploration business at Brasso and is therefore entitled to a deduction under sec 77(1) of the Act.
Section 77(1) states:
``Where a loss is incurred in the year of income by a taxpayer in carrying on an exempt business in Australia, that loss is an allowable deduction.''
In determining the extent of a loss incurred by an exempt business, sec 77(2) requires that ``no deduction may be made which would not have been an allowable deduction if the income (if any) had been assessable income''.
60. The facts in Ampol Exploration are a far cry from those of the instant case. The taxpayer in that case had engaged for many years in the business of exploration for petroleum in Australia both on land and in offshore waters and was the exploration arm of the Ampol group. In the present case, Discoverer is not purely an exploration company in a group of companies, but engages in exploration for gold and, if such exploration is successful, it will extract and sell this precious metal.
61. I am satisfied on the evidence that the joint venture at Brasso is not so much a separate business of Discoverer, but simply one alternative method of exploiting a goldmining lease; it is a separate goldmining operation and, in principle, merely a separate activity akin to the housing operation and the investment of surplus funds on the short-term money market. The goldmining business of Discoverer is comprised collectively of the joint venture at Brasso and the operation at Mt Druid.
62. For the purposes of determining any loss incurred by the exempt goldmining business of Discoverer, sec 77 requires an assumption that the exempt income is to be regarded as assessable income. From the assumed assessable income, there are to be deducted all the income tax deductions appropriate to the activities by which the assessable income is produced.
63. Total exploration expenditure (being the sum of exploration expenditure at Brasso and Mt Druid) at no time exceeded the exempt income, assumed to be assessable income for purposes of sec 77, derived from the goldmining operation at Mt Druid. Thus, Discoverer has not suffered any loss which would be deductible under subsec 77(1) of the Act.
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(2) Mt Druid
64. For the same reasons given above, Discoverer has not incurred any loss which is deductible under sec 77(1) of the Act.
65. Mr Shaw submitted the sums of $119,563 in 1980, $224,323 in 1981, $23,381 in 1982, and $195,589 in 1983 are allowable as deductible exploration expenditures pursuant to sec 122J of the Act.
66. Mr J, chief geologist of Discoverer, deposed that the company engages in mine exploration and project exploration. Mine exploration is essentially directed to gold. Project exploration, in contrast to mine exploration, is performed at considerable distances from existing mines and independently of them. The main focus of Discoverer's project exploration efforts at Mt Druid has been in various named areas described in evidence. Mr J deposed that Discoverer searches not only for gold but also for other minerals in the course of project exploration.
67. Mr J gave two reasons why project exploration is not directed exclusively to gold. Firstly, the history of development of Mt Druid and surrounding areas indicates that there are other elements to be found in economic quantities and so it makes economic sense to explore for minerals other than gold. Secondly, he stated that ``in contradistinction to the position which obtains at the mining sites, where the topography is such that the ore-bearing deposits are contained in exposed rock outcrops, the ore-bearing deposits in the outlying areas in which the project exploration is conducted are covered by up to 150 metres of `recent sediments' i.e. Tertiary such that the ore-bearing rock cannot be seen from the current ground surface. Accordingly, when exploration is conducted in the project exploration areas it is necessary to use geophysical and tectonic exploration techniques to identify areas to be tested by drilling through the recent sediments''. He put it cogently - ``common sense dictates that the tests be directed to all minerals likely to be found below''.
68. Mr J recalled in cross-examination that the area which could be pegged out for gold exploration was substantially less than the area which could be pegged for copper or nickel under the State's mining legislation. Thus in areas of outcrop, a prudent prospector would make a statutory statement that he/it was proposing to explore for a ``suite'' of minerals; the statement being designed to give the explorer the opportunity of achieving a monopoly right over as large an area as the statute permits. A prospector could then explore on a wider scale for gold than was otherwise possible.
69. Mr J accepted that goldmining and gold exploration is the principal activity of Discoverer. He also accepted, except for an area defined as ``Blue Fin'', that although Discoverer includes minerals other than gold in mining applications, the primary focus of exploration is gold. Mr J added that there were vast geological differences in the Blue Fin area. In the result, he stated that Blue Fin was searched for uranium and was not a gold metal target. Document A 1.5 of Exhibit KJ7 is a report by a Mr F of Discoverer dated September 1981 intituled ``Investigation of the Blue Fin Area''. The abstract records that the ``Blue Fin area was acquired to assess a tectonic target delineated by Messrs O and R (employees of Silvo) as being favourable for base metals and particularly favourable for gold''. Document A 1.3 of Exhibit KJ7 dated March 1981 is an ``Assessment of Mineral Potential of the Blue Fin Area''. The abstract to this document states that gold deposits would not be expected. This conclusion accords with the abstract of document A 1.5 which states that ``this high grade of metamorphism precludes the existence of a large gold deposit''.
70. The above evidence establishes that Blue Fin was viewed initially by Discoverer as attractive for gold, but upon a comparison of gravity and aeromagnetic patterns with those of other granulite terrains, drilling and outcrop sampling, the area revealed high grade metamorphism which effectively precluded the existence of gold.
71. Mr J testified that two-thirds of the leases held by Discoverer were under cover. Therefore, until the company possessed knowledge of the formation of the bedrock, it would be foolish to peg goldmining leases over an area which may be totally unsuitable for gold mineralisation.
72. I am satisfied that Discoverer, as a prudent prospector, would make a claim for
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minerals other than gold to procure as large an area of prospect as possible, especially when the company was unable to establish at the outset where within that general area, gold would be most likely to occur. Discoverer did not engage blindly in project exploration. The company would be keen to extract minerals other than gold which were available in commercially exploitable quantities. However, exploration for a full suite of minerals was rarely an end in itself; generally, investigations for arsenic, bismuth and mercury were made as pathfinder elements to the presence of gold.73. The evidence of J satisfies me that Discoverer was engaged in mine and project exploration predominantly for the purpose of discovering commercial quantities of gold. The fact that other valuable minerals may be found is, to use Mr Larkins' words, ``a fortuitous and no doubt joyful result of that exploration''. It follows that the tax returns lodged by Discoverer which claim the company is entitled to exemption under sec 23(o) of the Act for its income is derived ``from the working of a mining property in Australia principally for the purpose of obtaining gold'' correctly state the position, as does the Directors' Report in Discoverer's Annual Report of 1983, which states that ``the principal activities of the Company in the course of the financial year were goldmining and treatment operations and gold exploration. There was no significant change in these activities during the financial year''.
74. In my view as Discoverer was exploring predominantly for gold, the income of which is exempt upon exploitation, then the company is not performing a ``prescribed mining operation'' which has to be carried on for the purpose of gaining or producing assessable income. Therefore, the claimed deduction for exploration expenditure incurred in the Mt Druid region under subsec 122J(1) of the Act must fail.
(c) Interest
75. Mr Shaw submits that Discoverer is entitled to a sec 51(1) deduction for the following interest costs incurred in respect of borrowed moneys:
Year Amount
1980 $21,565
1981 32,999
1982 35,651
1983 47,490
76. Mr M stated that borrowed funds were used to supplement short-term shortages of cash required to pay operating costs, and that those borrowed sums which could not be used immediately were then placed on the short-term money market until required. He added that the overdraft account and the investment accounts were treated by Discoverer as, in effect, one combined facility designed to provide and smooth the necessary cash flows for the maintenance and expansion of operations.
77. The question simply is: is the interest on Discoverer's bank overdraft incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income? The answer is clearly ``no'' in respect of interest charges payable in respect of borrowed moneys which were used to meet the operating costs of the company's goldmining business. Discoverer is not entitled to a deduction as this outgoing is incurred in earning income exempt under sec 23(o) of the Act, viz income derived from the working of a goldmining property. The evidence of Mr M establishes that excess borrowed moneys were invested, and thus some interest costs were incurred in producing assessable investment income. However, the evidence does not disclose the sum so invested, nor the period of investment. The evidence does not, therefore, enable me to arrive at any reasonable dissection which would identify the proportion of the annual interest costs of Discoverer which may be deductible. In the absence of anything upon which I could even attempt to calculate the interest costs attributable to borrowed funds employed in the earning of investment income, I am left with no alternative but to disallow the deduction.
(d) Donations
78. Mr Shaw contends that Discoverer is entitled to claim a sec 51(1) deduction in respect of donations totalling $505 in 1981, $20,000 in 1982 and $22,100 in the 1983 income tax year.
79. The donations are particularised as follows:
80. Mr M testified that the Mining Industry Tertiary Scholarship Fund was established to assist students, particularly mature age students, to attend the Mt Druid School of Mines. The scholarship was open Australia wide although most applicants came from the home State.
81. I am satisfied these sums were donated by Discoverer in the course of its goldmining business. Income derived by Discoverer from the working of its goldmining property is exempt income under sec 23(o) of the Act, and hence, the claim for deduction cannot succeed as the outgoings were ``incurred in relation to the gaining or production of exempt income''. The applicant failed to establish any nexus between the donations and the derivation of assessable investment and rental income.
82. For the above reasons, the objections are allowed in part for each of the years now under review.
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