CASE 39/95

Members:
BJ McMahon DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 6 July 1995

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BJ McMahon (Deputy President)

The applicant claims to be entitled to a deduction of $250,000 and certain legal costs in the year of income ended 30 June 1982. The principal claim is made alternatively under s 63 or s 51 of the Income Tax Assessment Act.

2. Section 63 allows as a deduction any debt which is a bad debt and which is written off as such during the year of income and which has been brought to account by the taxpayer as assessable income of any year, or is in respect of money lent in the ordinary course of the

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business of lending of money by a taxpayer who carries on that business. The applicant relies upon the second aspect of eligibility. Section 51 allows as deductions, all losses and outgoings to the extent to which they are incurred in gaining producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, except to the extent to which they are losses or outgoings of capital, or of a capital nature. The applicant relies upon the second limb of this section and alleges that the loss is not an outgoing of a capital nature.

3. The applicant is a member of a group of companies and trusts owned and controlled by Dr W. In 1981, Dr W had some discussions with Dr M and reached what he thought was an agreement by which interests associated with both doctors were to acquire a private hospital. Dr W seems to have been the principal organiser of the proposed enterprise. It was arranged that beneficial ownership of the undertaking should be divided in certain proportions. A dispute later arose as to the exact nature of those proportions. It seems to have been agreed that other parties were to be invited to participate in the venture. The percentage to be offered to those third parties was not finally settled.

4. It was agreed that the land on which the hospital was built would be acquired by Landco and that the business of the hospital would be acquired by Businessco. Why this particular arrangement was favoured was not made clear. At any event, no lease was entered into between Landco and Businessco so that after the acquisition, Businessco had no security of tenure and consequently had goodwill of dubious value.

5. There was an agreement of a general nature that the acquisition was to be financed through a new mortgage from the existing mortgagee and by a second mortgage from a finance company. For some reason which was not made clear, the mortgage from the finance company did not eventuate. At the last minute, it became necessary to find various sums of money to enable settlement to take place. These sums were provided by the applicant.

6. The sum of $298,968-52 was paid by the applicant to various parties for Businessco to enable it to complete its purchase of the private hospital business. At the same time, the sum of $250,272-26 was paid for Landco to assist it to complete the purchase of the land and buildings in which the business was carried on. There was no documentation for either loan. No good reason was advanced why this was so except that the arrangements were made at the last minute. There was some evidence of a conversation between Dr W and Dr M to the effect that interest was to be charged at the same rate that would have been payable to the finance company, namely 20 per cent per annum. As there was no agreement concerning the method of repayment of the moneys, it is alleged by the applicant that the payments constituted a loan repayable on demand.

7. The loan to Landco was subsequently retired by outside funds and is not relevant in these proceedings. Further payments were made for Businessco, namely $9,235-10 to meet the stamp duty liability and $400 to meet certain accounting expenses. In addition, a sum of $3,706 said to be interest to 30 June 1981 was charged, making the total amount of indebtedness alleged as at that date $312,309-62.

8. A meeting took place on Saturday, 13 June 1981 between Dr W and Dr M. Correspondence between their solicitors (exhibits E and F) indicates disagreement on their part as to their recollection of the course of the proceedings at that meeting. Nevertheless, settlement took place on Monday, 15 June 1981, when the moneys to which I have referred were paid over. At that stage, Businessco and Landco which had been acquired as shelf companies, still had their original directors shown in all official records, including those of the company. Article 15 of the articles of association of Businessco provided that ``questions arising... shall be decided only by a unanimous vote of all directors present... with the intention that the company will not embark on any course of action whatsoever without the full approval and the consent of each director of the company''.

9. On the evening of the same day, the secretary of the applicant visited Dr M to obtain his execution of the documents finalising the provisions of the 2 trusts of which Businessco and Landco were to be trustees, to obtain his signature on the minutes of those 2 companies formalising the issue of shares in proportion to the units issued in each trust, and to sign a minute confirming acceptance of the 2 companies acting as trustees of the 2 trusts. Dr

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M refused to sign these documents, indicating that he had not agreed with the provisions recorded in them.

10. The correspondence between the solicitors gives some record of the issues raised. Of relevance to the present proceedings, is the expression of surprise by Dr M at the existence and activities of the applicant. He alleged that all his negotiations were with Dr W on a personal basis and he was not expecting any third party associated finance company to intervene. Although Dr M was not called to give evidence, it is clear from the documents that he was not a party to the making of the payments by the applicant. All of these payments appear to me to have been made exclusively upon instructions from Dr W.

11. The disagreement continued. Formalising of the trusts and company records did not proceed. It was alleged by Dr W that the company was in an unworkable position. He then commenced proceedings in the Supreme Court of New South Wales to have Businessco wound up. These proceedings were subsequently amended to show the applicant as the petitioning creditor and the ground for winding up being an inability to pay a debt as it fell due. On 16 July 1981, a formal demand was made by the secretary of the applicant upon Businessco requiring it to pay ``forthwith and no later than 4 pm'' the amounts set out in a letter which included the amounts to which I have referred, together with 2 further sums. A provisional liquidator had been appointed on 30 June. Since then 2 further sums had been advanced by the applicant to the provisional liquidator to enable him to pay wages. These sums were included in the demand. The substitution of the applicant as the petitioning creditor and the later reliance upon an allegation of debt is part of a pattern of ``corrected errors'' to show a legal situation more favourable to the applicant which recurs through all these events.

12. Thus, within 15 days of making the payments which were said to be loans, the applicant had commenced proceedings to wind up the alleged borrower and had assumed that the debt was bad, because the borrower had no lease and therefore no goodwill asset which was said to have been acquired with the moneys said to have been advanced.

13. Late in 1981 the applicant received $36,389-34 from the liquidator, having had accepted a proof of debt for loan advances which I have described. This left a balance of $275,920-28. To achieve a rounded out figure, the applicant made allowance for a further possible distribution of $25,920-28 leaving a net balance of $250,000. Although this amount purports to have been written off on 30 June 1981, it is clear that it had regard to distributions received later in that calendar year and could not have been written off physically until the 1982 fiscal year. For that reason, leave was granted to amend the notice of objection in relation to the 1982 year, which was before the Tribunal in relation to the carry forward of losses aspect of the claim.

14. I will deal firstly with the claim under s 63. The applicant must show that there was a debt owing to it by Businessco, that the applicant carried on the business of the lending of money, that any money lent to or in respect of Businessco was lent in the ordinary course of such a business, and that the debt was a bad debt at the time it was written off.

15. The general principles to be applied in determining matters related to the business of lending money were reiterated by Bowen CJ (with whom Jenkinson J agreed) in
FC of T v Marshall and Brougham Pty Ltd 87 ATC 4522 at 4528-4529; (1987) 17 FCR 541 at 549 in these words-

``Section 63(1)(b) provides as follows:

`(1) Debts which are bad debts and are written off as such during the year of income, and-

• ...
• (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.'

It is generally accepted that three conditions must be satisfied in order to fit the words of sec. 63(1)(b). First, the debt must be bad. Secondly, the debt must be written off as a bad debt during the year of income in respect of which the deduction is claimed. Thirdly, the debt must have been 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 (see
F.C. of T. v. National Commercial Banking Corporation of Australia Limited 83 ATC 4715 at p. 4718; (1983) 50 A.L.R. 322 at p.

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325). Only the third of these conditions is the subject of dispute between the parties.

In order to satisfy the third condition as stated above the taxpayer must be in the business of lending money at the time of making the advance in respect of which the deduction is claimed. Further, the advance of the money in question should have been made in the ordinary course of the business of lending money then carried on by it. (See
Fairway Estates Pty. Ltd. v. F.C. of T. 70 ATC 4061; (1970) 123 C.L.R. 153.)

It is generally accepted that in order to be regarded as carrying on a business one must demonstrate continuity and system in one's dealings. In the case of money lending it has been said that a person must hold himself out as willing to lend money generally to all and sundry (subject to credit-worthiness) (see
Litchfield v Dreyfus [1906] 1 KB 584). It is not decisive whether the lender is a registered money-lender or not, although this will be a factor to take into account. It should be mentioned that it need not be the only business or the principal business of the taxpayer. It will be insufficient, however, if it is merely ancillary or incidental to the primary business. In the end, it will be a question of fact for the Court to decide by looking at all the circumstances involved (see
Newton v. Pyke (1908) 25 T.L.R. 127).''

16. The question whether it is necessary to show that a person must hold himself as willing to lend money to all and sundry before he can qualify as carrying on the business of a money lender, has been the subject of some debate. Whether a business was that of lending money has been considered for several purposes. The tests adopted have changed slightly, depending upon the statutory reason for the enquiry. Thus Litchfield and other similar cases dealt with the provisions of legislation relating to credit providers. Marshall and Brougham Pty Ltd dealt with the section with which I am now concerned.
FC of T v Bivona Pty Ltd 90 ATC 4168; (1990) 21 FCR 562 considered the requirements of the carrying on of a business of lending money in the context of whether interest income was income from personal exertion. In that case, a Full Court unanimously observed at ATC page 4173; FCR pages 567 and 568-

``In
Hyde v Sullivan & Ors (1956) S.R. (N.S.W.) 113 Street C.J., Roper C.J. in Eq. and Herron J. said at p. 119, with respect to the definition of `money-lender' in sec. 3(1) of the Money-Lenders and Infants Loans Act 1941 (N.S.W.):

`Speaking generally, the phrase ``to carry on business'' means to conduct some form of commercial enterprise, systematically and regularly, with a view to profit, and implicit in this idea are the features of continuity and system.'

See also
Kirkwood v. Gadd (1910) A.C. 422, especially per Lord Loreburn L.C. at p. 423 and Lord Atkinson at p. 431. Each member of the House of Lords stressed, however, that the inquiry was one of fact in each case.

The necessity for the repetition of acts or continuity is perhaps clearer from the phrase `carries on business' than the word `business' standing alone in a definition section (see the judgment of Mason J. in
Hope v The Council of the City of Bathurst at 80 ATC 4386 at p. 4390; 144 C.L.R. 1 at p. 8); but for a business to exist there must be activity of the body concerned to constitute a commercial enterprise and generally one must look for system, regularity or recurrence.

Is it possible to carry on a business of lending money with only one borrower or a limited number of borrowers? In
Litchfield v. Dreyfus (1906) 1 K.B. 584 Farwell J., when considering the question of what amounts to carrying on a moneylending business for the purposes of the English Money-lenders Act 1990 said at p. 589:

`Speaking generally, a man who carries on a money-lending business is one who is ready and willing to lend to all and sundry, provided that they are from his point of view eligible.'

This dictum has been cited since in many cases with approval: see, for example,
Austin Distributors Ltd. v. A.H. Paterson Car Sales Pty. Ltd. (1941) 65 C.L.R. 118, per Williams J. at p. 128;
Modern Permanent Building And Investment Society (in liq.) v. F.C. of T. (1958) 98 C.L.R. 187 per Williams J. at p. 191-192. But in Edgelow v. MacElwee (above) McCardie J., after citing Farwell J.'s dictum, said at p.

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207 that it `may require future consideration'.

In
Hungier v. Grace & Anor (1972) 127 C.L.R. 210, which concerned definition of `money lender' in sec. 3(1) of the Money Lenders Act 1958 (Vic.), Barwick C.J. said at p. 219: `It is, of course, possible to carry on the business of a moneylender with only one borrower'; but Walsh J. said at p. 224:

`The fact that loans were made to one borrower only is not decisive against a finding that the making of them constituted the carrying on of a business of money-lending. I think that it provides a very strong indication against that finding when it is accompanied by the circumstance that it was not the lender who stipulated the terms for repayment of the loans.'

The key to the passage from Farwell J.'s judgment lies in the introductory words `speaking generally...' Whether Farwell J.'s statement is consistent with modern authority is not a matter for us to consider because it is used in the context of moneylending legislation, whereas a different inquiry is involved in this case.''

17. The need for elements of continuity and system recurs in many of the approaches. In addition, there is an emphasis on the carrying on of a commercial enterprise. This appears particularly in the passage quoted from Hyde v Sullivan to which reference will later be made. A quality of usualness is also required. In
Downs Distributing Co Pty Ltd v Associated Blue Star Stores Pty Ltd (In Liq) (1948) 76 CLR 463 at 477 Rich J said-

``The provision does not require that the transaction shall be in the course of any particular trade, vocation or business. It speaks of the course of business in general. But it does suppose that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation.''

18. I turn now to an application of those principles to the facts of the present case, having regard to the elements which the applicant must establish. The first question to be determined is whether there was a debt owing to the applicant by Businessco. None of the moneys forming part of the claim were paid directly to Businessco. They were paid to third parties. Some of the gross sums were paid to the provisional liquidator. The mere fact that moneys were paid to third parties does not, in itself, preclude the founding of an obligation on the part of a borrower. There is a ``notional or imputed promise'' in those circumstances, provided that the moneys are paid at the request of the borrower.

19. In my view, there is no satisfactory evidence of this having occurred. At the meeting on 13 June, the 2 principals involved were clearly not ad idem. Nothing else could explain the subsequent course of events and the litigation. They were certainly not directors of Businessco at law, nor were they acting in accordance with that company's articles of association. Even assuming the economic reality that Businessco had been acquired with the intention that they should become directors, it is clear from the subsequent course of events that the plan for making the payments in the way in which they were subsequently made, was in the mind only of Dr W. Fifteen days after the events, namely on 30 June 1981, solicitors for Dr M expressed their client's surprise at the existence of the applicant and the fact that it had been involved in the settlement arrangements.

20. The fact that the liquidator admitted a claim from the applicant to prove in the winding up, does not of itself show that there was a debt or constitute some sort of ratification of what had gone on before the liquidation. The governing factors will be those present at the time the alleged debt is said to have been incurred.

21. Furthermore, even if it were found that the amounts were paid by the applicant at the request of Businessco, that fact in itself would not establish that there was a loan. There was no documentation. The terms are to be inferred only from oral evidence of the secretary of the company. Neither Dr W nor Dr M was called to give evidence in these proceedings. What was agreed and what was not agreed between these proposed directors of Businessco was therefore left up in the air. There was never any resolution of directors in accordance with the

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company's articles of association, authorising the making of the payments, or acknowledging their character. The only written evidence recording the payment appears in the books of the applicant. For reasons which are here irrelevant, even those original entries were made in error and related to a different company. The payments are just as consistent with a proposed acquisition of an equity interest by the applicant.

22. In short, I am not satisfied that loans made up in the way I have described were made by the applicant to Businessco upon the terms alleged by the applicant. In case this finding is found to be in error, I will proceed to look at the other elements which the applicant must prove in order to succeed.

23. The next question is whether the applicant carried on the business of the lending of money. In view of the conclusion to which I have come, it is not necessary to consider whether the ``all and sundry'' requirement is necessary or has been met. It is instructive, however, to consider the ``continuity and system'' and the ``business'' aspects. The applicant is a registered money lender. This fact alone, however, is not decisive.

24. The applicant acted as banker to the group, managing its cashflows, borrowing money in from companies with cash surpluses and lending out to companies needing funds. Moneys surplus to the group's requirements were placed on investment outside the group from time to time. The company secretary gave evidence that interest was charged if there was a loan made to a company in which there was a minority interest, other than that of the group. But even then in cases where there was little possibility of profit for the time being, interest was sometimes not charged. Within the group there was no fixed policy. The position and capabilities of companies were reviewed from time to time and when it was appropriate interest was charged, otherwise it was not. The usual, although not invariable policy was that if money was borrowed from a bank at interest, then an appropriate rate of interest was charged on the lending of that money to cover the bank charges.

25. Evidence relating to continuity and system appears exclusively in the accounts of the company up to and including the fiscal years in question. Different submissions could be, and were, made based upon that evidence, as to the number of loans and as to their nature. Apart from the general evidence of the company secretary, however, there is no indication of the terms of any particular loans, the circumstances in which they were made, the individual rates of interest for particular loans and the regularity with which advances were made. The evidence does support a submission that the overall rate of interest was certainly low reflecting, no doubt, the number of interest-free loans which the applicant made. The fact that interest formed one quarter or any other fraction of the applicant's income in any particular year, does little to assist a consideration of the elements of continuity and system. The overall impression one obtains from a consideration of this evidence is that the applicant largely relies on particular investments in particular projects or businesses, together with the unremunerated activity of acting as a conduit for the flow of funds within the group.

26. In determining whether there was a money lending business, it is also important to consider the nature of the business. It is an essential element in any such concept (as was stated in Hyde) that the activities be carried on with a view to a profit. I have referred to the applicant's policy as to the charging of interest. This policy is not one which can consistently stand with the carrying on of a business intended to yield a profit to the applicant. In fact by acting as a conduit or banker for the group, the applicant enabled other related companies by its interest charging policy to profit at its own loss. The applicant's ``substantial purpose'' was not the carrying on of a money lending business. Its dealings in money were in the interests of any member of the group holding businesses or conducting ventures from time to time with a view to promoting the best interests for the group as a whole. Having regard to the unsatisfactory evidence of continuity and system and to the evidence of the un-businesslike approach of the applicant, I am not satisfied that the applicant carried on the business of the lending of money at the relevant time.

27. The next question to be considered is whether moneys paid (if they constituted a loan) were lent in the ordinary course of such a business (if there was such a business). In my view, the circumstances leading to the payment of these moneys could not be described as being in the ordinary course of any business. The

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moneys were paid without documentation, without a clear agreement on the part of the persons most concerned with the fate of the moneys, and without a prospect of repayment 15 days after the moneys were paid. It could not be said that the transaction formed part of the ``undistinguished common flow of business done'' and that it called for ``no remark''. The payments certainly arose out of a special or particular situation. It is true that an advance may be of ``a new type or kind so far as the taxpayer's business is concerned and yet be in the ordinary course of that business'' (per Barwick CJ in
Fairway Estates Pty Ltd v FC of T 70 ATC 4061 at 4066; (1970) 123 CLR 153 at 162). Nonetheless His Honour, in that case, acknowledged and approved the observations of Rich J to which I have referred. Applying those observations to the present situation, it can not be said that the common flow of the applicant's business would be characterised by no loan agreements, oral or written, no security, no directors' meetings or no minutes. As in
Franklin's Selfserve Pty Ltd v FC of T (1990) 125 CLR 52, the transaction must be considered as one outside the ordinary course of any money lending business, if such a business existed.

28. An argument was submitted by counsel for the respondent that in any event the debt was not a bad debt at the time it was written off, as it was subsumed in subsequent events which involved the acquisition of the hospital and the real estate by other interests associated with Dr W. Having regard to the findings which I have reached in relation to the other elements of the s 63 claim, it is not necessary to pursue that submission. In my view, the applicant must fail in its claim for deduction of the $250,000 as a bad debt.

29. The claim based on s 51 must meet a similar fate. As I have held that the applicant was not carrying on the business of a money lender, the second limb of s 51 is not available. Looked at from the point of view of the first limb, the claim relates clearly to a capital loss.

30. In addition to the claim for a deduction of $250,000, there was also a claim for $14,846-60 for legal expenses. This sum was said to have been incurred in attempting to collect the debt from Businessco and in the subsequent winding up of Businessco. The amount was claimed as a deduction under s 51. A close examination of the terms of the account from the solicitors indicates that substantial, but unspecified, parts of the gross amount charged related to other matters. There was little evidence on this claim apart from the tendering of the account and on assertion that it had been paid. In any event, however, as I have held that the applicant is not entitled to a deduction, either under s 63 or s 51, then it follows that any associated legal costs would also not be allowable deductions.

31. The objection decisions under review are therefore affirmed.