CASE 45/93
Members:BA Barbour SM
Tribunal:
Administrative Appeals Tribunal
BA Barbour, Senior Member
This is an application dated 21 September 1992 for review of a decision of the respondent dated 22 JuIy 1992 to disallow an objection of the applicant company (hereinafter referred to as C Co) dated 26 March 1991.
2. The issues before the Tribunal were two fold: whether a deduction claimed by the applicant was a bad debt (hereinafter referred to as the debt) and therefore an allowable deduction under section 63(1) or section 51(1) of the Income Tax Assessment Act 1936 (the ITAA); whether the taxpayer was Iiable to pay any additional tax pursuant to section 223 of the ITAA.
3. These issues are discrete and will be dealt with separately, as the amount for additional tax was imposed on adjustments to the 1988 return unrelated to the bad debt, which did not attract any additional tax pursuant to section 223 of the ITAA.
4. The Tribunal had before it documents lodged pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 (the 1975 Act). The applicant tendered a correspondence file between itself and another company (hereinafter referred to as L Co) (exhibit 1), and called R, its director, and M, an accountant. The respondent tendered correspondence from L Co (exhibit A), a statement of R dated 29 July 1992 (exhibit B), documents summonsed from L Co (exhibit C), and a copy of barrister's advice to the applicant dated 15 August 1988 (exhibit D) and called H, an auditor with the Australian Tax Office.
The debt
5. The debt which the C Co claimed as a bad debt resulted from a series of transactions
ATC 487
between itself and L Co. These related to three building projects.6. The first project involved C Co supplying aluminium/steel cladding (tiles) for a convention centre according to the specifications of L Co. The order for this material (dated 27 April 1987) included a term that the period for payment was to be 30 days from the end of the month in which the claim was made, and a notation on that order recorded ``... we claim on 20th payment not due until end of following month. 40 days approximately...''. A further letter from L Co (dated 9 July 1987) confirmed that claims should be lodged ``... no later than the fourth (4) working day before the twenty-first (21) calender day in any month. Payment... will occur thirty (30) calender days after the end of the month in which your claim is lodged...''. The letter also requested that Banker's Guarantees be lodged with L Co for the contract, and C Co subsequently lodged these.
7. The second project involved the fabrication by C Co of facade panels for a hotel connected to the convention centre, an order for which appears to have been placed by L Co in February of 1988, although there is no formalisation of the contract evident in the papers before the Tribunal.
8. The third project concerned work of C Co on a hospital at the request of L Co, and there is no material before the Tribunal explaining the nature or terms of that contract.
9. Delays occurred with the convention centre, apparently because L Co was late supplying C Co with drawings for the tiles, the glue for cruciform support plates was also late, and some problems occurred with the provision of pallets for transport. There was also a request from C Co for additional costs. At this stage considerable tension had arisen in the relationship between the parties.
10. On 20 June 1988, L Co requested that C Co produce extra tiles for the convention centre project, and on 22 June, C Co forwarded a letter outlining the cost of these extra tiles. A heated meeting ensued between R, C Co's director, and A, L Co's director, at which A stated that L Co would not pay C Co's outstanding accounts, and would use the bank guarantees to stave off any legal action by C Co.
11. On 23 June 1988 L Co forwarded to the applicant a letter outlining that the increased costs would not be met, and that L Co had no option but to have the tiles manufactured elsewhere. L Co also noted that work at C Co on the hotel project had ceased until the convention centre matter had resolved, and advised C Co that L Co had no option but to have the frames manufactured elsewhere, and requested the release of material. C Co forwarded to L Co a letter on the same day, outlining accounts due, totalling $69,150.10. These are made up as follows:
INVOICE
-------
NUMBER DATE AMOUNT ($)
------- ---- ----------
HOSPITAL
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1306 28/2/87 2107.00
CONVENTION
----------
CENTRE
------
1474 29/1/88 947.40
1742 18/3/88 562.04
1949 28/4/88 225.00
2007 18/5/88 50720.00
2058 27/5/88 414.00
2115 17/6/88 1732.00
--------
Total 54600.44
--------
HOTEL
-----
2008 18/5/88 6755.52
2116 17/6/88 5687.14
--------
Total 12442.66
--------
12. Letters from L Co dated 24 June 1988 outline that company's assertions that the applicant was in breach of contract in relation to both the hotel and convention centre, and that the work with respect to these projects would have to be completed by another at C Co's expense. L Co also state that C Co owe them $2,787.94, and that ``... we may be forced to recover this debt through other security...''.
13. These matters were discussed by R and E, Co's work manager, with M, the company accountant, and the company's solicitors, R & N. As a result of these discussions, a letter was forwarded to L Co at approximately 8:45am on 28 June 1988, by fax, stating that the applicant was not in breach of contract, and demanding the payment of the sum as per the 23 June account, within 14 days.
ATC 488
14. R and E met at around 10.00am on June 28 and reviewed the situation, determining to meet with M later that day. At that meeting, J, a senior partner of R & N, was contacted for advice. He phoned that evening and gave an opinion that there was a danger in losing not only the $69,150, but L Co may also enforce the bank guarantees. In oral evidence, R stated that the advice he received from J was that the debt was bad and that this advice was to be provided in writing. M stated in oral evidence that he thought the debt was not recoverable, and that the correct course was to treat the debt as bad.
15. On 29 June 1988, a meeting of the directors of the C Co was held at M's office. R and his wife, B, the two directors of C Co, resolved to write off the debt to L Co of $69,453.05, this being minuted. In cross- examination, R could give no reason for the discrepancy between this amount and the $69,150.10 invoiced to L Co on 23 June 1988. The accounting records of 30 June 1988 reflect the write off of the debt owed by L Co.
16. A letter from R & N dated 1 July 1988, confirms a telephone advice to R by J on 30 June 1988 that there was little chance of the debt being paid by L Co, although no guarantee that recovery would not occur, and any such recovery would only occur after exhaustive litigation. The letter requested further information to be provided so that counsel's advice could be sought. R noted that he was unsure if this letter came from J or from someone else at R & N. That advice was received by C Co on 17 August 1990, and deals primarily with the issue of the bank guarantees, although the final pages deal with the issue of any action C Co may have against L Co for the payment of various monies claimed to be due and payable.
17. R stated in oral evidence that counsel's advice was only sought in relation to the bank guarantees, the debts no longer being recovered from L Co as they had been written off. The applicant firm did not pursue these for fear that L Co may seek to enforce the guarantees, and place the applicant in an untenable financial situation. H, in cross examination, agreed that she had been told at a meeting between herself and R, M, E and J on 24 October 1990 that counsel's advice had only been sought in relation to the guarantees. The value of her evidence on this point is limited; the only possible purpose in adducing such evidence would be to support the truth of the assertion that counsel's advice was sought only in relation to the guarantees, and as such is strictly hearsay evidence. Although this Tribunal is not bound by the rules of evidence, they nevertheless provide a guide as to what weight ought be given to material. This evidence accords very little weight with the Tribunal.
18. Some of the material before the Tribunal does not support R's statement that the applicant did not continue to pursue at least some of the monies owed. It was conceded that the sum in respect of the Hospital was paid in full. A letter dated 17 May 1989 seeks recovery of monies owing pursuant to invoices 1474 and 1742 (these relate to the convention centre), these both being amounts wrtten off by the applicant on 29 June 1988. R was unable to explain these anomalies satisfactorily. The Tribunal does not draw any adverse inference from this attempt to recover monies after they have been written off. However, the inconsistencies in evidence do affect the credit of R.
19. The Tribunal accepts the bulk of the oral evidence of R, and found him generally to be a truthful, although at times vague, witness, but where there are conflicts between his own evidence and written materials, the Tribunal generally prefers the written material, especially if R's evidence is unsupported by other documentation or oral evidence. In particular, the Tribunal does not accept that J, the senior solicitor of R & N, told R that the debt owed by L Co was bad. Rather, the advice of J was as outlined, in the letter of 1 July 1988; that is, that there is little chance that the debt would be paid. The Tribunal is at a loss as to how to reconcile the date of the advice as recorded on the letter (30 June 1988) and the date stated in oral and written evidence by R and M (28 June 1988), but accepts their joint evidence on this point.
20. Further, the Tribunal finds that the advice of counsel was sought in relation to both the bank guarantees and the debts owed. The advice itself reflects this (see page 6 ``... Finally I am asked to advise...''), and the evidence of R does not persuade the Tribunal that this was not the case. As was noted previously, the evidence of H on this point was hearsay evidence, and the Tribunal gives it very little weight.
21. Section 63(1) of the ITAA states:
ATC 489
``Debts which are bad debts and are written off as such during the year of income, and-
- (a) have been brought to account by the taxpayer as assessable income of any year; or
- (b) are in respect of money lent in the ordinary course of the business of the lending of money by a taxpayer who carries on that business,
shall be allowable deductions.''
22. The 4 elements to section 63(1) are:
- (i) there must be a debt;
- (ii) the debt must be bad;
- (iii) the debt must be written off as a bad debt during the year of income in which it is claimed;
- (iv) the debt must be brought into account as assessable income in any one year.
23. The parties agree that items (i) and (iv) are satisfied. The applicant contends that the other criteria are also satisfied. It will be convenient for the Tribunal to deal first with the arguments concerning whether the debt was a bad debt.
24. Mr Hewitt, solicitor for the applicant, submitted that the question of whether a debt was bad depends upon the circumstances of the particular case after an objective view of all the circumstances. Only matters known at the time of the decision to write off the debt are relevant to the determination of a debt as bad, and anything that may occur after the date of writing off the debt is irrelevant; see
Elder Smith & Co. Ltd v Commr of Taxation (NSW) (1931) 1 ATD 241, and
11 CTBR (1945) (OS) 94 Case 26. Provided commercial judgement pointed to the debt being bad for the time being, it can be accepted as bad for the purposes of section 63(1). He argued that it is not necessary for the creditor to take every available legal step to recover the amount owed. He contended that the decision of C Co on 29 June 1988 to write the debt off was a sound commercial decision based on the information available at that time, and hence an allowable deduction under section 63(1) for that tax year. The fact that sums are later recovered is also not relevant to the issue.
25. Mr Hewitt also submitted that the decision of the respondent not to impose a fine on the applicant for the understatement of the income with regards to the bad debt pursuant to section 223 ITAA indicates that the Commissioner of Taxation accepts the bona fides of the applicant company in relation to the writing off of the debt, and is relevant to whether the applicant believed the debt to be irrecoverable at the time the decision to write it off was made. The Tribunal does not think that much turns on this argument. The Tribunal is to determine if the debt was a bad debt such that it is an allowable deduction, and the respondent's acceptance of the applicant's bona fides or otherwise is irrelevant to that inquiry.
26. Mr Brabazon, counsel for the respondent, identified two situations in which a debt can be written off: where the debtor is impecunious; and where there is a commercial settlement of the dispute. This matter, it was submitted, fell into the second category, and was properly claimed as a deduction under section 51(1) ITAA, as the debt's history subsequent to the writing off, as evidenced by correspondence between C Co and L Co, shows that it was written down or compromised by the parties to a lesser sum, and was used by the applicant as a bargaining chip in negotiations with L Co.
27. The respondent also argued that the debt was given up too easily, and that the applicant did not go far enough in pursuing it. For L Co to say that it would not pay the accounts is insufficient, and the correct question for the applicant to ask itself is ``... can we make them pay...''. It was impossible for the debt to be written off unless the applicant considered legal recovery, and this was not fully considered until the advice of counsel was received in August. This approach is supported by TR 92/18 INCOME TAX: BAD DEBTS, paragraphs 3, 31(e) and 32.
28. The Tribunal agrees with the applicant that the relevant time of inquiry as to whether the debt is bad is the time that the decision is made to write the debt off, and that the inquiry is a factual one and turns on the circumstances of the particular case. The Tribunal also accepts that the writing off of a bad debt does not mean that all efforts to recover it will terminate, and that it must be given up absolutely. Alternatively, a debt is not bad if it is merely doubtful, and a doubtful debt is not deductible under the lTAA.
29. In considering the matter before it, the Tribunal finds assistance in the criteria outlined in TR 92/18, including whether reminder notices were sent, what time period has elapsed between the due date and the date at which the
ATC 490
debt was written off, the issue and service of a summons, the service of a formal demand notice, entering judgement against the debtor, and execution of it, the value of securities held by the creditor, and the sale of any seized or repossessed assets. As well, matters such as commercial exigencies or pressures, or the relationship of the creditor and debtor, may be relevant in coming to a determination as to whether the debt is bad.30. Of the $69,150.10, all but $2,107.00 was less than 6 months old. The vast majority of the debt had been invoiced to L Co on or after 18 May 1988, and hence was less than 45 days old. It is to be noted that either the order of 27 April 1987, or letter of 9 July 1987, would not have envisaged that this sum would have been paid until 30 June 1988 at the earliest, and perhaps even 30 July 1988. The account of 23 June 1988 does not stipulate a payment date for the sum outstanding.
31. The letter of C Co dated 28 June 1988 also does not require payment until some 14 days later, and certainly not before 29 June 1988, when the debt was resolved to be bad and written off. This letter, it is noted, was sent after the heated meeting between R and A.
32. The Tribunal does not accept that J, the solicitor consulted in this matter, informed R that the debt was bad, but rather finds that J stated that there was little chance that the debt would be paid. The Tribunal also finds that counsel's advice was sought in relation to both the guarantees and the chances of recovery of the debt. The Tribunal accepts that R believed that A would seek to fight off any move by C Co to recover monies from L Co, and would use the bank guarantees to do so. The Tribunal also notes the close personal relationship between R and A, such that R would be in a good position to assess the legitimacy of such threats.
33. On balance, the Tribunal does not find that the debt of $69,150.10 was bad as at 29 June 1988. There had not been sufficient time between the letter of demand on 28 June 1988 and the writing off of the debt some 24 hours later by the directors. Further, the Tribunal finds that legal opinion in relation to the debt was not finalised until August of 1988, and that as at 29 June 1988, there was still a real and continuing dispute in relation to that sum, and that sound commercial judgement could not be exercised so that the debt be written off at that time.
34. While the Tribunal does not doubt the bona fides of the decision to deem the debt bad and write it off, and has regard to the close relationship between the two protagonists, R and A, it cannot, on any objective view, come to the conclusion that the debt was bad. It is unnecessary, therefore, for the Tribunal to go on to consider if the debt was written off during the year of income.
35. The Tribunal therefore finds that $69,150.10 of the amount claimed as a bad debt is not an allowable deduction under section 63(1) ITAA in the 1988 tax year. Similar considerations apply in relation to its deductibility under section 51(1) ITAA, and the debt cannot be written off as bad or compromised under this provision in the 1988 tax year, nor can losses be claimed in respect of it.
36. The amount of $302.95, the discrepancy between the amount owing by L Co, and the amount claimed by C Co, has not been explained by the applicant in any way. The Tribunal notes that the applicant carries the burden of proving that this should be an allowable deduction (see section 14ZZK Tax Administration Act 1953 (TAA)). The applicant has not produced any evidence on this point. This amount should be disallowed as a deduction.
The additional tax
37. The Tribunal is also to decide if the applicant should be subjected to additional tax pursuant to section 223(1) ITAA, in relation to adjustments made to the 1988 tax return other than the disallowance of the deduction in relation to the debt of L Co. The respondent imposed this culpability component of 15% in respect of these adjustments.
38. The applicant did not produce material in support of their claim that this additional tax ought not to be imposed, and the Tribunal has insufficient material before it to alter the assessment. Given section 14ZZK ITAA, the Tribunal affirms the respondent's assessment in this matter.
39. The Tribunal therefore affirms the objection decision under review.
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