STEELE v DFC of T

Judges: Gleeson CJ
Gaudron J
Gummow J

Kirby J
Callinan J

Court:
Full High Court

MEDIA NEUTRAL CITATION: [1999] HCA 7

Judgment date: 4 March 1999

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Kirby J

51. The decision of the Full Court of the Federal Court of Australia, ^[36] Steele v FC of T (1997) 73 FCR 330; 97 ATC 4239 (Burchett and Ryan JJ, Carr J dissenting). from which this appeal comes, caused a certain amount of consternation when it was published. ^[37] See eg Lehmann and Southon, ``Can interest have a capital nature? — The heresy in Steele's case — Part 1'', (1997) 40 Weekly Tax Bulletin [ 1095]; Part 2, (1997) 41 Weekly Tax Bulletin [ 1136]; Part 3, (1997) 42 Weekly Tax Bulletin [ 1174]; Part 4, (1997) 43 Weekly Tax Bulletin [ 1207]; Pane and Andreyev, ``The deductibility of interest post ERA and Steele '', (1997) 26 Weekly Tax Bulletin [ 658]; D'Ascenzo, ``Deductibility of Interest — Steele's Case '', (1998) Asia-Pacific Tax Bulletin 132. The Law Council of Australia, exceptionally, sought leave to appear as amicus curiae and referred to the ``novelty of the principle'' upheld by the Full Court and the ``uncertainty now prevailing''. The opinion was expressed that the treatment of interest deductions required by the decision was in conflict with more than 50 years of case law. <sup>[38]</sup> Lehmann and Southon, ``Can interest have a capital nature? — The heresy in Steele's case — Part 1'', (1997) 40 Weekly Tax Bulletin [ 1095]. And that it even challenged the understandings of that law held by the Commissioner of Taxation (the Commissioner) who was obliged, as a consequence, to withdraw a number of his rulings. ^[39] Taxation Ruling IT 166 (Interest on money borrowed to acquire an income producing asset); Taxation Ruling IT 2374 (Loss from rental property before being leased); Taxation Ruling IT 2461 (Deductibility of outgoings incurred before income derived from undeveloped land). The Full Court decision was denounced as ``heresy''. <sup>[40]</sup> Lehmann and Southon, ``Can interest have a capital nature? — The heresy in Steele's case — Part 1'', (1997) 40 Weekly Tax Bulletin [ 1095] at 919.

52. When fresh eyes are focused on a statutory text, it sometimes happens that new insights are secured. Assumptions, long accepted, when placed under a judicial microscope, are found to be wanting. ^[41] A dramatic example affecting the Constitution was R v Kirby; Ex parte Boilermakers' Society of Australia (1956) 94 CLR 254. In Grace Brothers Pty Ltd v The Commonwealth (1946) 72 CLR 269 at 289, Dixon J remarked: ``Time does not run in favour of the validity of legislation. If it is ultra vires , it cannot gain legal strength from long failure on the part of lawyers to perceive and set up its invalidity.'' Outside the field of constitutional law, see eg Scobie v KD Welding Co Pty Ltd (1959) 103 CLR 314; Zickar v MGH Plastic Industries Pty Ltd (1996) 187 CLR 310; Rathborne v Abel (1964) 38 ALJR 293; [ 1965] ALR 545. Those regularly engaged in the application of legislation such as the Income Tax Assessment Act 1936 (Cth) (the Act) enjoy the advantage of affectionate familiarity with its terms. But it is no more than a statute enacted by the Parliament. It is to be construed, as every statute must, in accordance with its purpose as disclosed in its language. Decisional authority provides necessary guidance, not least because of the complexity and size of the Act, the subtlety of some of its concepts and the high desirability that its application should be clear and predictable, without the need for undue litigation in the huge number of cases to which it is applied. But when an appeal comes, there is no substitute for a study of the legislative language and purpose.

53. At the risk of intruding a jarring note into the response to the appeal (and the critics) I am obliged by my opinion to offer a dissenting view from that reached by the majority of this Court. I can derive a measure of comfort from Bertrand Russell's assurance that every advance in civilisation has been denounced as unnatural while it was recent. ^[42] ``An Outline of Intellectual Rubbish'' in Unpopular Essays (1950). I am also reassured by the fact that my dissenting view is harmonious with the recent unanimous judgment of the Privy Council in Wharf Properties Ltd v Commr of Inland Revenue (Hong Kong) . ^[43] [ 1997] AC 505; 97 ATC 4225.

The facts

54. Most of the facts relevant to my opinion are set out in the reasons of Gleeson CJ, Gaudron and Gummow JJ. Mrs Kathleen Steele (the taxpayer) contests the decision of the Commissioner to disallow, as a deduction against her assessable income of later years, the interest payments on borrowings to acquire a property known as ``Tibradden'', together with rates and a small sum of other expenses - in all, $909,649. The taxpayer unsuccessfully challenged this decision, originally before the Administrative Appeals Tribunal (the Tribunal) and then before a single judge of the Federal Court. <sup>[44]</sup> See Steele v FC of T (1996) 31 ATR 510; 96 ATC 4131 (RD Nicholson J). Her appeal to the Full Court was dismissed by majority. However, on the issue which was determinative for the majority in that court (as it is for me), the dissentient specifically stated that there was ``no point of legal principle expressed in [ the majority's] reasons with which I would disagree''. ^[45] Steele (1997) 73 FCR 330 at 365; 97 ATC 4239 at 4266 per Carr J. His disagreement rested on a conclusion that the Tribunal had not ``correctly applied those principles to the facts of this matter''. ^[46] Steele (1997) 73 FCR 330 at 365; 97 ATC 4239 at 4266. Similarly, he did not disagree with the judgment

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ATC 4253

of the Privy Council in Wharf Properties . He distinguished it ``on the facts''. ^[47] Steele (1997) 73 FCR 330 at 365; 97 ATC 4239 at 4266.

55. Certain points about the facts need to be emphasised. When the taxpayer purchased ``Tibradden'', the zoning of the land forbade the kind of development necessary to permit the achievement of her general objective. The enquiries which she made about the possibility of rezoning before she purchased the property produced nothing more than the somewhat vague statement, from someone on the Council of the local government authority concerned, that ``there probably would not be a problem in getting it rezoned''. Any future development of the land for the motel and townhouse complex which the taxpayer envisaged would have required road closures and sewerage connections, none of which was ever commenced.

56. The Tribunal found that the taxpayer did not have any specific plan in mind as to how the investment might be made profitable. All that she had was ``an idea, at best, to develop a motel to be managed by herself''. <sup>[48]</sup> Kathleen Fay Steele v FC of T unreported, Administrative Appeals Tribunal, 4 March 1994 at 29 (constituted by Dr P Gerber (Deputy President) and Messrs RD Fayle and SD Hotop (Senior Members)). Her plans were never finalised. Project finance was never obtained. During 1982, the taxpayer approached a hotel chain to purchase an equity in the project and to manage her proposed hotel. It agreed to do so but this agreement was not carried through. In the following year, the taxpayer and the managing director of a construction company, Mr Williams, made an agreement with Malaysian investors for the formation of a company which would purchase the property and build a motel. This agreement was also never performed. After March 1984, the taxpayer made no attempt whatever to proceed with any development. As the majority observed in the Full Court, the ``idea'' which she formulated may not have warranted the ``more flamboyant language'' by which one member of the Tribunal described it. <sup>[49]</sup> The Tribunal described the ``motel development [ as] no more than a fond hope'', and commented: ``It is ... not enough to come within sub-sec 51(1) to buy some land and announce to the world 'I have a dream'''. Cited Steele (1997) 73 FCR 330 at 336; 97 ATC 4239 at 4243. By the same token, as a matter of practicality, the motel development project never went very far at all beyond the ``idea'' which the Tribunal found, even if it did rise to more than just ``a fond hope''.

57. Certainly, the ``idea'' never came within range of the reality of producing income to offset the huge deductions for interest from the taxpayer's taxable income which she claimed. Her ``idea'' may well have continued percolating in her conscious and subconscious mind from the first moment she saw ``Tibradden'' until her last interest in that property was sold. But, as found by the Tribunal (and as the objective facts indicate) it was a somewhat desultory tale of apparently unenthusiastic and ultimately fruitless endeavours to convert the ``idea'' into an income producing asset.

58. The Act, properly construed, may require that the large deduction for interest incurred to keep the taxpayer's ``idea'' afloat be allowed, although there was no relevant income from it ^[50] There was a very small income from the continuing agistment activities on the property which may be disregarded for this purpose. and very little real or effective endeavour to secure such income. But it is not a result to which one feels otherwise compelled by the apparent merits of the taxpayer's claim. That fact does not deny the taxpayer success. But it does concentrate the mind on the legal basis of her claim.

The Act and the issues

59. The only safe approach to the taxpayer's claim, and thus to the appeal, is to be found in an analysis of the applicable statutory provisions. Relevantly, in relation to the year of income in question, the Act read: ^[51] See now s 51(1AA).

``51(1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income... shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature...''

60. The provision appears under the heading ``Losses and Outgoings''. It provides ``allowable deductions'', ie from the income which would otherwise be liable to tax under the Act.

61. Two grounds of disallowance of the taxpayer's claim were relied on by the Commissioner. The first was that the first limb of s 51(1) was not satisfied, in that the ``losses and outgoings'' for interest, claimed as deductions, were not (save for the trivial agistment income undoubtedly earned from the property) ``incurred in gaining or producing the assessable income''. The Tribunal upheld the Commissioner's contention in this regard. The primary judge in the Federal Court found that the Tribunal's conclusion was open to it. ^[52] Steele v FC of T (1996) 31 ATR 510 at 519; 96 ATC 4131 at 4139 per RD Nicholson J. In the Full Court, the majority, whilst offering various criticisms of the reasoning of the Tribunal, did not finally resolve the application of the first limb of s 51(1). ^[53] Steele (1997) 73 FCR 330 at 336; 97 ATC 4239 at 4243 per Burchett and Ryan JJ. Instead, their Honours turned to the second head of the

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Commissioner's argument which, they held, was sufficient to sustain the primary judge's order rejecting the deduction claimed. The second argument rests on the proposition that, to the extent to which the ``losses and outgoings'' were incurred by the taxpayer, they were a ``losses or outgoings... of a capital... nature'' and thus not allowable.

62. Although I incline to the view that no error of law was shown in the conclusion of the Tribunal, and of the primary judge, that the ``losses and outgoings'' claimed as deductions were not ``incurred in gaining or producing the assessable income'', it is unnecessary for me (as it was for the Full Court) to determine that issue if the taxpayer is bound to fail on the ``capital... nature'' question. Because in my view she is, I will confine myself to that question, particularly because my opinion is a minority one whose value, if any, lies only in its appeal to the future.

63. The issue for decision is effectively, whether the Full Court erred in concluding that the ``losses and outgoings'', in the form of the taxpayer's large interest bill, was ``of a capital... nature''. In my view, the Full Court did not err. The majority judges were right to hold as they did.

`` [ O]f a capital... nature'': general propositions

64. A number of general propositions assist in resolving the problem presented by the exception to deductibility which the Commissioner successfully invoked in the Full Court:

65. First, as with any task of statutory construction, the starting point for anyone applying the Act to the facts of the case is to understand the meaning of the sub-section, read in its context and for the purpose for which the Parliament enacted it, and in particular the exception which is critical. ^[54] Bropho v State of Western Australia & Ors (1990) 171 CLR 1 at 20; Kingston v Keprose Pty Ltd (1987) 11 NSWLR 404 at 421-424; Newcastle City Council v GIO General Ltd (1997) 191 CLR 85 at 109-110; James Hardie & Coy Pty Ltd v Seltsam Pty Ltd (1998) ALJR 238 at 252-253; 159 ALR 268 at 287-289. The Act is not to be approached in a way antagonistic, or favourable, to the Commissioner or the taxpayer. To understand the deductions that are allowed by s 51(1) it is important to appreciate the place of the sub-section in the overall scheme of the Act. Sometimes it is useful to go back to such basics.

66. Relevantly, the Act levies tax on a taxpayer's assessable income. ^[55] The framework of Australian income tax legislation is such that assessable income is taken as a base and from it are deducted all allowable deductions: ss 6(1) and 48. Assessable income includes gross income according to ordinary concepts, gains which may not be ``income'', such as net capital gains (s 160ZO), specifically made assessable and some ``deemed income'' amounts, less amounts defined as ``exempt income'': s 23. The net result after deducting ``allowable deductions'' is ``taxable income'' which is subject to tax at rates declared by the Parliament: s 17. Section 51(1) is the generic provision allowing deductions providing a basis for the deduction from assessable income of most business related revenue expenditure. It permits ``losses and outgoings'' as ``allowable deductions''. But it only does so, relevantly, ``to the extent to which they are incurred in gaining or producing the assessable income''. Even then, it provides an exception, relevantly, to the extent to which the ``losses and outgoings'' are ``of a capital... nature''.

67. It is sometimes hazardous to specify the purpose of provisions of the Act, because of the complex terms in which this legislation is often expressed. But s 51(1) is a central provision of the Australian system of taxation. It is relatively simple and conceptual in its expression. Its overall purpose seems clear enough. It represents, in a sense, an accommodation between the taxpayer's legitimate claim to allowable deductions where and to the extent to which, the losses or outgoings in question were incurred in gaining or producing the assessable income upon which tax may be levied. Behind this part of the sub-section lies an acknowledgment by the Parliament that it is just that such ``losses and outgoings'' should be deducted from the income brought to tax. In part, this idea rests upon a notion that the income of the taxpayer may then, or in the foreseeable future, be diminished by the losses or outgoings concerned. In part, it represents a quid pro quo afforded by the Parliament to the taxpayer. It says, in effect: if you incur ``losses and outgoings... in gaining or producing the assessable income'' upon which we can levy tax, we (the community) will allow you (the taxpayer) deductions to that extent. We will do so out of recognition that, without the expenditures which constitute such ``losses and outgoings'', the taxpayer's assessable income might well be lessened and could even be non- existent.

68. A series of decisions of this Court demonstrate that a precise coincidence between the gaining of the assessable income and the incurring of ``losses and outgoings'' is not required. <sup>[56]</sup> See eg Commr of Taxation (NSW) v Ash (1938) 61 CLR 263 at 271; (1938) 5 ATD 76 at 77; Ronpibon Tin NL and Tongkah Compound NL v FC of T (1949) 78 CLR 47 at 56-57; (1949) 8 ATD 431 at 435; FC of T v Snowden & Willson Pty Ltd (1958) 99 CLR 431 at 436; (1958) 11 ATD 463 at 464; John Fairfax & Sons Pty Ltd v FC of T (1959) 101 CLR 30 at 35, 46; (1959) 11 ATD 510 at 511, 517-518; FC of T v Finn (1961) 106 CLR 60 at 68; AGC (Advances) Ltd v FC of T (1975) 132 CLR 175 at 185; 75 ATC 4057 at 4063-4064; Inglis v FC of T (1979) 28 ALR 425 at 427-428; 80 ATC 4001 at 4003; Fletcher & Ors v FC of T (1991) 173 CLR 1 at 16; 91 ATC 4950 at 4957. Instant returns upon investments are not always the reward of the entrepreneur. Sometimes there is no reward at all. But that is not to say that a link between the fact of the one and the possibility of the other is totally irrelevant. The words ``to the extent to which'' contradict a complete divorce between the two. The word ``in'' also suggests the necessity of a connection between the ``losses and outgoings'' in question and the real possibility of ``assessable income''. Further, the very notion of ``allowable deductions'', so described, suggests a relationship of some kind between

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the ``losses and outgoings'' in question and ``the assessable income''. The exception must be given meaning in that statutory context.

69. By the clear authority of this Court, the exception applies even where the taxpayer has been able to satisfy both of the positive limbs of s 51(1) which precede the exception. As Dixon CJ observed in John Fairfax & Sons Pty Ltd v FC of T : ^[57] (1959) 101 CLR 30 at 34; (1959) 11 ATD 510 at 511.

``Perhaps the most important thing to notice in sub-s (1) is the character of the phrase `except to the extent to which they are losses or outgoings of capital, or of a capital nature'. Its character is that of an exception which necessarily presupposes the possibility of the subject matter excepted falling under the description that precedes it. In other words it is supposed by the sub- section that a loss or outgoing incurred in gaining or producing the assessable income or in carrying on a business for that purpose may nevertheless be a loss or outgoing of capital.''

70. It must therefore be contemplated that cases will exist where the ``losses and outgoings'' in question have been specifically and exclusively incurred ``in gaining or producing the assessable income'' yet are not allowable. The reference in the exception to ``outgoings of capital, or of a capital... nature'' suggests that the purpose of denying the taxpayer the deduction in such circumstances rests on the footing that losses or outgoings of such a character are to be classified as insufficiently warranting the deduction. The enumeration of such losses or outgoings with those of a ``private'' or ``domestic'' nature suggests a legislative judgment that in such cases, despite the contribution which the losses and outgoings may have made to the actual gaining or producing of the assessable income, they are still to be classified, relevantly, as for the benefit of the taxpayer alone, and therefore denied deductibility.

71. Secondly, there is no point in complaining about the exception or the uncertainties which its application is said to cause for the decision of whether particular losses or outgoings are ``of a capital... nature'' or not. That is what the Act provides. The provision must be given effect. It necessitates a task familiar to every lawyer, and I venture to suggest to every accountant and tax agent. After all, characterisation of payments as being of an ``income'' or ``capital'' nature is not new. Judges and other commentators have been complaining about this distinction for more than a century. In Inland Revenue Commrs v British Salmson Aero Engines, Ltd, Sir Wilfrid Greene MR, after a review of much authority, observed: ^[58] [ 1938] 2 KB 482 at 498.

``There have been many cases which fall on the border-line. Indeed, in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons. But that class of question is a notorious one, and has been so for many years.''

72. To like effect were the comments of Starke J in this Court in Hallstroms Pty Ltd v FC of T . ^[59] (1946) 72 CLR 634 at 644; (1946) 8 ATD 190 at 193. In BP Australia Ltd v FC of T , ^[60] (1965) 112 CLR 386 at 397; (1965) 14 ATD 1 at 7-8. Lord Pearce, delivering the judgment of the Privy Council in an Australian appeal involving a dispute over allowable deductions under s 51 of the Act, described the process of reasoning which is required:

``The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer `depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process' (per Dixon J in Hallstroms' Case ^[61] (1946) 72 CLR 634 at 648; (1946) 8 ATD 190 at 195. ). As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallize particular features which may incline the

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scale in a particular case after a balance of all the considerations has been taken.''

The exception to s 51(1) has largely escaped a reasoned analysis. However, as I shall show, in FC of T v Energy Resources of Australia Ltd ^[62] (1996) 185 CLR 66; 96 ATC 4536. this Court brought into focus the capital/ revenue distinction found in this limb of s 51(1).

73. Thirdly, the suggestion that, of its very nature, the payment of interest is of an ``income'' character and not ``of a capital... nature'' is totally inconsistent, with the foregoing authority. It is also inconsistent with the recognition by this Court that, for some circumstances, interest may take on the characteristic of capital - not, of course, in the hands of the recipient (for whom it will be income) but in the hands of the payer. ^[63] FC of T v Munro; British Imperial Oil Co Ltd v FC of T (1926) 38 CLR 153 at 197-198. Whatever criticisms exist of the analysis of Munro in the Full Court, ^[64] See eg Lehmann and Southon, ``Can interest have a capital nature? — The heresy in Steele's case — Part 3'', (1997) 42 Weekly Tax Bulletin [ 1174] at 981-982. by reference to the statutory regime applicable in 1926, ^[65] Income Tax Assessment Act 1922 (Cth). the basic principle cannot be gainsaid. It is a simple matter of statutory law. Interest may certainly be a loss or outgoing within s 51(1). Whether it is of a capital or non-capital nature depends upon the facts of the particular case. No hard and fast, and certainly no absolute, rule can be adopted. This is because, as a matter of law, the Act denies such a possibility. Convenient and congenial as absolute rules are for those who live their lives in the company of the Act, they are fundamentally incompatible with the task of characterisation which the exception in the Act calls forth. Necessarily, that task requires evaluation and judgment of each particular loss and outgoing, including where it is in the form of interest and where it is propounded as an allowable deduction.

74. Where the Commissioner suggests that, in the particular circumstances, the interest payment, although undoubtedly a loss or outgoing to the taxpayer, is ``of a capital... nature'' it is therefore no valid answer to that proposition to assert, as the taxpayer did, that all interest payments, of their essence, are non- capital in nature. Such a proposition may have been accepted or assumed in earlier cases. It may have been assumed by the Commissioner in his earlier rulings. It may even have provided a false foundation for particular provisions of the Act, ^[66] See the Act, s 160ZH(6A). drafted and enacted upon an assumption about the universal character of interest. But that assumption simply will not stand with the legal characterisation which the exception to s 51(1) requires. The common likelihood that, in most circumstances, interest payments will not be characterised as capital in nature cannot deny the possibility that, in particular circumstances they can, and should be so classified.

75. Fourthly, to throw light on the interest payments claimed as an allowable deduction in this case, it is useful to have regard to what this Court said in its recent and unanimous decision in FC of T v Energy Resources of Australia Ltd. ^[67] (1996) 185 CLR 66; 96 ATC 4536. That case concerned not interest but promissory notes expressed in United States dollars, issued at a discount to the face value. The Court said: ^[68] (1996) 185 CLR 66 at 73-74; 96 ATC 4536 at 4539.

``... Where a taxpayer incurs loss or expense in raising funds by issuing promissory notes at a discount to their face value, its entitlement to a s 51 deduction for that loss or expense depends on the use to which the funds are to be put. ^[69] FC of T v Munro; British Imperial Oil Co Ltd v FC of T (1926) 38 CLR 153 at 197; Commercial & General Acceptance Ltd v FC of T (1977) 137 CLR 373 at 384; 77 ATC 4375 at 4381; Ure v FC of T (1981) 34 ALR 237 ; 81 ATC 4100; Fletcher & Ors v FC of T (1991) 173 CLR 1 at 19; 91 ATC 4950 at 4958. If the funds are to be used as working capital, the cost of the discounts will be deductible as a revenue expense. ^[70] Crawford v FC of T (1993) 27 ATR 326; 93 ATC 5234; Coles Myer Finance Ltd v FC of T (1993) 176 CLR 640 at 664-665, 668-669; 93 ATC 4214 at 4222, 4223-4224. If the funds are to be used to strengthen `the business entity, structure, or organisation set up or established for the earning of profit', <sup>[71]</sup> Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T (1938) 61 CLR 337 at 359; (1938) 5 ATD 87 at 93-94. the cost of the discounts will generally not be deductible because they will be a capital, and not a revenue, expense. <sup>[72]</sup> cf FC of T v Hunter Douglas Ltd (1983) 50 ALR 97; 83 ATC 4562; Associated Minerals Consolidated Ltd v FC of T (1994) 53 FCR 115 at 117-118; 94 ATC 4499 at 4502. But sometimes the raising of capital may be such a recurrent event in the business life of a taxpayer that the cost of raising the capital will qualify as a revenue expense. <sup>[73]</sup> Australian National Hotels Ltd v FC of T (1988) 19 FCR 234 at 239-241; 88 ATC 4627 at 4632-4633. As Dixon J pointed out in Texas Co (Australasia) Ltd v FC of T : <sup>[74]</sup> (1940) 63 CLR 382 at 468; (1940) 5 ATD 298 at 356. `Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible.'''

76. In Energy Resources , in the Federal Court, the primary judge ^[75] Energy Resources of Australia Ltd v FC of T (1994) 28 ATR 67; 94 ATC 4225 per Davies J. and a majority in the Full Court ^[76] FC of T v Energy Resources of Australia Ltd (1994) 54 FCR 25; 94 ATC 4923 per Beaumont and Gummow JJ. concluded that the funds were raised for the purpose of strengthening the capital structure of the business and not to finance its day to day operations. This Court acknowledged that `` [ a]t first sight'' that proposition was ``strongly arguable''. But the Court was not prepared to go behind the Commissioner's acceptance that the cost of the discounts was a revenue expense and therefore an allowable deduction. The issue now presented is different in two respects. Here, the Commissioner (perhaps encouraged by the analysis in the Energy Resources case) contests the application of the positive limbs of s 51(1).

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He also asserts the application of the exception. Whilst discount expense is not the same as an interest expense, there are obvious analogies. Each is a cost of raising finance. So far as commercial substance is concerned, interest on capital raised by way of loan (as in the present case) is not relevantly different from ``losses and outgoings'' incurred on a bill acceptance facility (as considered in Energy Resources ). <sup>[77]</sup> Crawford v FC of T (1993) 27 ATR 326 at 334; 93 ATC 5234 at 5240. If, therefore, interest on borrowed funds is used to strengthen ``the business entity, structure, or organisation set up or established for the earning of profit'', the logic of Energy Resources suggests that it should receive the same taxation treatment as discount expenses incurred in the same circumstances. Periodicity of payment and the recurrence of expenditure do not provide a universal differentiating criterion to exclude interest payments from characterisation as ``of a capital... nature''. Wages may certainly be ``of a capital... nature'' ^[78] Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T (1938) 61 CLR 337 at 362-363; (1938) 5 ATD 87 at 96; Mount Isa Mines Ltd v FC of T (1992) 176 CLR 141 at 148; 92 ATC 4755 at 4758. although liability to pay them is typically, if not invariably, recurrent. ^[79] Goodman Fielder Wattie Ltd v FC of T (1991) 29 FCR 376 at 394; 91 ATC 4438 at 4453.

77. Fifthly, the result of this analysis is that, if a capital asset is not being used to produce the assessable income, although it is accepted that the taxpayer has the intention to use it in that way at some uncertain time in the future, expenditure which is incurred in connection with the capital asset itself may be liable to characterisation as being ``of a capital... nature'' and thus not an allowable deduction. <sup>[80]</sup> Inglis v FC of T (1979) 28 ALR 425 at 428-429; 80 ATC 4001 at 4004. Note that the expenditures considered in that case included interest payments. In some cases, interest payments have been held to be ``of a capital... nature''. ^[81] Associated Minerals Consolidated Limited v FC of T (1994) 53 FCR 115; 94 ATC 4499. See also Temelli v FC of T (1997) 36 ATR 417; 97 ATC 4716; Stamoulis v FC of T (1997) 37 ATR 326; 97 ATC 5051 per Ryan J. Given the absence of absolutes and the requirement, in each case, to characterise the particular ``losses and outgoings'' against the disqualifying exception provided by the Act, there is no reason to doubt the correctness of these decisions. There is every reason to conclude that they were correct. Interest payments made in the context of current income gaining activities <sup>[82]</sup> As was the case in Texas Co (Australasia) Ltd v FC of T (1940) 63 CLR 382 at 430; (1940) 5 ATD 298 at 327. can be readily distinguished from interest payments made in relation to the acquisition or creation of a capital asset which the taxpayer has the ``idea'', rising to a sufficient ``intention'', later to utilise in income gaining activity, if only a myriad of obstacles can be overcome.

78. Thus, interest on a loan taken out to finance the acquisition of assets purchased with a view to the eventual conduct of a business may be incurred too early to be on revenue account. At that stage, the hoped for income is too remote and the asset being created is then viewed as of a capital nature. ^[83] Stamoulis v FC of T (1997) 37 ATR 326 at 344; 97 ATC 5051 at 5068 per Ryan J.

The reasoning in Wharf Properties

79. It is many years since the Privy Council has had the pleasure of labouring in the garden of s 51(1) of the Act, as Lord Pearce did in the BP Australia case. ^[84] (1965) 112 CLR 386; (1965) 14 ATD 1. However, in one of the last appeals from Hong Kong, their Lordships in Wharf Properties ^[85] [ 1997] AC 505; 97 ATC 4225. had to consider a problem analogous to that arising in this appeal, which was presented by the Inland Revenue Ordinance (the Ordinance) of the Colony. ^[86] Laws of Hong Kong, 1995 rev, c 112. Critics of Wharf Properties and of the use which the majority in the Full Court made of the reasoning of the Privy Council in that case, lay mphasis upon suggested distinctions between revenue law in England and the distinctive ``Australian system'', ^[87] See Dixon J in Texas Co (Australasia) Ltd v FC of T (1940) 63 CLR 382 at 468; (1940) 5 ATD 298 at 355-356. so described by this Court. Whatever may be that distinction, valid for the applicability of other decisions on revenue law, the suggested point of differentiation has no validity in respect of the applicable provision of the Ordinance considered in Wharf Properties .

80. That was a case bearing certain factual similarities to this. In 1987 the taxpayer had agreed to buy a tram depot with the stated intention, eventually, to redevelop the site to produce rental income. Part of the purchase price was paid in 1987 and the balance in 1988. To fund the acquisition, the taxpayer took short term loans from banks and financial institutions to which the taxpayer incurred a liability to pay interest. For the financial years 1987-1988 and 1988-1989, the taxpayer claimed deductions from its income for the interest payments incurred and paid. In those years it derived trivial income from the site, prior to its development. The Commissioner of Inland Revenue disallowed the deductions. As in the present case, there were two asserted foundations for the disallowance. The first was that the interest payments fell outside s 16(1) of the Ordinance, the positive limb affording deductibility for expenses incurred for the purpose of producing taxable profits in future years. It is here that a suggested point of distinction between Hong Kong and Australian revenue law might arise. But this point was decided, both at first instance ^[88] Wharf Properties [ 1995] 1 HKLR 347 per Patrick Chan J. and in the Hong Kong Court of Appeal ^[89] Wharf Properties (No 2) [ 1995] 2 HKLR 552. against the Commissioner. The Privy Council indicated their Lordships' unwillingness to interfere with these concurrent findings of fact. ^[90] Noted [ 1997] AC 505 at 509; 97 ATC 4225 at 4226-4227. That point

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was accordingly decided for the taxpayer. The Privy Council proceeded on the assumption that, prima facie, the interest was deductible under s 16(1)(a) of the Ordinance.

81. Their Lordships then turned to the exception provided by the Ordinance. This was relevantly indistinguishable from the exception provided in s 51(1) of the Act. It reads:

``17(1) For the purpose of ascertaining profits in respect of which a person is chargeable to tax under this Part no deduction shall be allowed in respect of -

• ...
• (c) any expenditure of a capital nature or any loss or withdrawal of capital.''

Except for the more imperative language of the Hong Kong Ordinance, the exclusion of deductibility is identical to that in the exception stated in s 51(1) of the Act. Nor is the scheme of the legislation relevantly different. A prima facie liability to bring taxable income (``profits'') to tax is enacted. <sup>[91]</sup> Ordinance, s 14. A deduction for ``outgoings and expenses'' is then provided. ^[92] Ordinance, s 16(1). This later entitlement is then qualified by an exclusion from deductibility where the expenditure for which deduction is claimed is ``of a capital nature''. ^[93] Ordinance, s 17(1)(c). The argument that the Ordinance is distinguishable from s 51(1) of the Act in this respect is unconvincing. It should be rejected.

82. This Court is not bound, as it was in the days of the BP Australia case, to follow the authority of the Privy Council. However, where the logic of that court's reasons is compelling and the matter of statute or common law is relevant to our own situation, we are at liberty to adopt that reasoning. In my view, that is what this Court should do here. The majority in the Full Court was right to feel the force of the persuasiveness of the judgment in Wharf Properties . ^[94] Steele (1997) 73 FCR 330 at 342; 97 ATC 4239 at 4248. So do I.

83. Lord Hoffmann, who gave the unanimous opinion of the Privy Council, rejected, as I have, the proposition that ``interest [ is] by definition a revenue payment and could not be anything else'': ^[95] Wharf Properties [ 1997] AC 505 at 511; 97 ATC 4225 at 4227.

``... [ T]his confuses the position of payer and recipient. It is true that in the hands of the recipient, interest will be either the earnings of capital advanced or, in some cases, additional income derived from trading in money. In either case, it will have the character of income. From the point of view of the payer, however, a payment of interest may be a capital or revenue expense, depending upon the purpose for which it was paid. The fact that it is income in the hands of the recipient and a recurring and periodic payment does not necessarily mean that it must be a revenue expense. Wages and rent are income in the hands of their recipients; periodic payments, in return for services or the use of land or chattels respectively. But whether such payments are of a capital or revenue nature depends on their purpose. The wages of an electrician employed in the construction of a building by an owner who intends to retain the building as a capital investment are part of its capital cost. The wages of the same electrician employed by a construction company, or by the building owner in maintaining the building when it is completed and let, are a revenue expense.''

84. The taxpayer complained that the examination of the purpose for which money was borrowed, in order to decide whether the interest was paid for a capital or non-capital (revenue) purpose, would involve inconvenience and uncertainty which the absolute rule propounded by it avoided. However, Lord Hoffmann indicated their Lordships' answer to that argument: ^[96] Wharf Properties [ 1997] AC 505 at 511; 97 ATC 4225 at 4228.

``... Their Lordships agree with Litton V-P, ^[97] [ 1995] 2 HKLR 552 at 562. that, on the contrary, there is no other way in which the nature of the interest payment can be discovered. The immediate consideration for each payment of interest is, of course, the use of money during the period in respect of which the interest has been paid, but since money is no more than a medium of exchange which may be expended for either capital or revenue purposes, the question can be answered only by ascertaining the purpose for which the loan was required during the relevant period.''

85. The ``derivative'' nature of the characterisation of interest was explained in similar terms in Ure v FC of T : ^[98] (1981) 34 ALR 237 at 249; 81 ATC 4100 at 4109-4110 per Deane and Sheppard JJ.

``In a case such as the present where the outgoing claimed as a deduction is interest paid on borrowed money, one cannot ordinarily look to the direct object or advantage which the outgoing was intended to achieve for the reason that that will ordinarily be the receipt of the borrowed money which is likely to be neutral in

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character. One must, of necessity, look more to the objects or advantages which the application and use of the borrowed money were intended to gain.''

86. These observations make clear a point which the argument for the taxpayer before this Court overlooked. All capital, of its nature, has the potential to generate income. Yet it is not every expenditure on capital which contributes to the gaining or producing of the assessable income. Depending on the purpose, some such expenditures will be ``of a capital... nature''. Where they are, they are no more allowable deductions under s 51(1) of the Act than they were held to be under the Hong Kong Ordinance. Their ``nature'' must be ascertained. When ascertained, it may forbid deductibility.

87. Lord Hoffmann addressed the problem, inherent in the ascertainment of the ``nature'' of the loss or outgoing concerned, that difficulties might be experienced in drawing the line between those ``losses and outgoings'' which are ``of a capital... nature'' and those which are not. He offered a practical solution. Whilst admittedly lacking the certainty of an absolute rule it has the merit of legal integrity, compatibility with the hypothesis inherent in the nature of the characterisation required and sufficient predictability to make its application workable: ^[99] [ 1997] AC 505 at 513; 97 ATC 4225 at 4229.

``... Each payment of interest must be considered in relation to the purpose of the loan during the period for which the interest was paid. Once the asset has been acquired or created and is producing income, the interest is part of the cost of generating that income and therefore a revenue expense. In this respect their Lordships agree with the judgment of McMullin J in Tai On Machinery Works Ltd v IR Commr ^[100] [ 1969] 1 HKTC 411. and are unable to follow the reasoning by which the National Court of Papua New Guinea arrived at a contrary conclusion in Travelodge Papua New Guinea Ltd v Chief Collector of Taxes .'' ^[101] (1985) 16 ATR 867; 85 ATC 4432.

88. In this Court, the taxpayer urged the merits of the decision in Travelodge Papua New Guinea Ltd v Chief Collector of Taxes and the rejection of the approach favoured in Wharf Properties . With all respect, I disagree. The Act posits that some ``losses and outgoings'', including some of which may be in the form of interest, will be ``of a capital... nature''. In such circumstances, no absolute rule is legally possible. Each loss and outgoing, including in the form of an interest payment, must be judged against the criterion of whether it is ``of a capital... nature''. To make that judgment no other course is available than to look to the purpose for which the particular payment is made at that stage of the taxpayer's investment. Whilst an exact correlation between the receipt of assessable income and the incurring of ``losses and outgoings'' (including interest) is not required by the Act, the more distant, nebulous, uncertain or unpromising the prospect of assessable income, the more likely it will be that the ``losses and outgoings'' (including interest payments) will be assigned to the classification ``of a capital... nature''.

89. That is how I see the scheme of s 51(1) of the Act operating. I believe that this view conforms more closely with the language and structure of the Act than does the appellant's proposition. In my respectful opinion, it also conforms more closely to common sense. It is more compatible with the treatment by this Court of the analogous problem which arose so recently in the Energy Resources case. ^[102] cf D'Ascenzo, ``Deductibility of Interest — Steele's Case '', (1998) Asia-Pacific Tax Bulletin 132.

Conclusion and order

90. The majority in the Full Court were therefore correct. It was open to the Tribunal, on the facts which it found, to conclude that the ``losses and outgoings'' incurred by the taxpayer with respect to interest (even if ``incurred in gaining or producing the assessable income'') were ``of a capital... nature'' and thus excepted from the allowable deductions to which the taxpayer was entitled. It is unnecessary to go further. That conclusion sustains the decision of the Commissioner to disallow the deduction. It affirms the decision of the Tribunal upholding that opinion, the conclusion of the primary judge and the orders favoured by the majority in the Full Court.

91. I would dismiss the appeal with costs.