ANOVOY PTY LTD v FC of T

Judges:
French J

Court:
Federal Court

MEDIA NEUTRAL CITATION: [2000] FCA 953

Judgment date: 14 July 2000

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French J

Introduction

1. In 1983 Anovoy Pty Ltd (``Anovoy'') acquired a run down house of some historical interest in Subiaco. The company intended to derive assessable income from the property by resale or in some other way. For a time it contemplated converting the house into an art gallery/restaurant. The company has claimed that interest payments made by it on money borrowed to renovate the property are deductible, either as expenses incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for that purpose. The Commissioner of Taxation disallowed the claimed deductions. An appeal to the Administrative Appeals Tribunal was dismissed on 3 October 1997 [reported at Case 43/97,
97 ATC 449] except as to a minor

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ATC 4447

apportionment not now in issue and the company now appeals to this Court. The case raises the question of the necessary connection between the interest payments made and the gaining of assessable income and whether or not the interest payments were in any event outgoings of a capital nature. The Commissioner concedes the latter point is foreclosed by the decision of the High Court in
Steele v DFC of T 99 ATC 4242; (1999) 197 CLR 459, delivered since the Tribunal decision and reversing the judgment of the Full Federal Court which had been relied upon by the Tribunal. The hearing of this appeal was deferred pending the outcome of the appeal to the High Court in that case.

2. The factual background that follows is based upon findings of fact made by the Tribunal.

Factual background

3. Anovoy was incorporated in April 1981. Peter Radosevich has been a director of the company since its incorporation. The only other director is his partner Saskia Vogel. In July 1983 the company acquired the property at Lot 284 Bagot Road, Subiaco. A home known as Totterdell Hall stood on the land. It had been constructed in the 1920's by Sir Joseph Totterdell a former Lord Mayor of Perth. It was described in a report on Municipal Heritage for the Subiaco City Council as ``A two storey residence featuring ornate ceilings and fire places, exterior verandahs, balconies, bay windows, & chimney pots.'' It was said to be important for its creative and innovative design. The zoning of the property at the time of purchase was ``Town Centre'' pursuant to the City of Subiaco Town Planning Scheme No. 1. The permitted use was Residential 100, a high density residential zoning within which various forms of residential development were possible. Other uses could, with the consent of the Town Planning Board (as it then was) be approved by the Council including offices, shops and some other commercial uses.

4. At the date of purchase the house had been declared Unfit for Human Habitation under s 135 of the Health Act WA and a work order issued under s 139 of the Act requiring return of the property to a habitable condition. The real estate agent who sold the property was advised of these matters by letter from the Council in March 1983 and also of the Council's intention under the proposed City of Subiaco Town Planning Scheme No. 3 to zone the property Residential R80 and remove the discretion then existing in respect of non-residential use. That rezoning occurred in March 1984.

5. The agent had advertised the property for auction on 12 March 1983 where it was passed in. A sign at the front of the property advertising it for sale said:-

``Auction on Site.

Building suitable for redevelopment as restaurant, boarding house, doctor's surgery, residence, home unit site

ZONING: Town Centre.''

Anovoy paid $100,000 for Totterdell Hall. The purchase price was made up of a $10,000 equity in Mr Radosevich's private home at Ashfield which was acquired by the vendor, a $10,000 cash contribution and $80,000 borrowed from Alliance Acceptance.

6. Anovoy's principal business was the sale of motor vehicles and, from 1985, car rentals under the name Apex Car Rentals. In later years, 1989 to 1993, the company carried on a business called Lee's Hire from premises in Subiaco hiring out builder's equipment. Through Anovoy and related companies Paradon Holdings Pty Ltd and Bewick Holdings Pty Ltd which he controlled Mr Radosevich also carried on a courier business and a property rental and development business.

7. On 13 July 1983 Mr Radosevich wrote to the Council saying it was Anovoy's purpose to restore and renovate the premises to their ``original splendour''. He sought authority from Council to live on the premises while the restoration was going on. At the time of the purchase, he had intended to restore the property as a single residence. He realised that it had the potential for profit whether restored as a residence, converted to offices or just swept out and resold. The Tribunal expressly rejected the contention from the Commissioner that the house was acquired as a future residence for him and his partner. In March 1984, he visited the USA. While there he saw an example of a combined gallery and café called the Merchant of Venice in a part of Los Angeles called Venice. After this visit he decided he would ``tizzy up'' Totterdell Hall ``to make it look like it had been there for centuries'' and use it as a venue for selling works of art and ``architectural antiques''. In November 1984 he submitted some sketch

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ATC 4448

plans to the Council setting out alterations and additions which Anovoy proposed to effect. The plans set out what was plainly a single residence containing several bedrooms, a sauna and a bar. They were approved by Council in January 1985 as conforming with the residential zoning of the area. Having regard to the rezoning of the area in March 1984 any other plan to convert the premises to offices and/or a restaurant/gallery would have required special approval as a non-residential use. The plans submitted bore little relation to the changes ultimately effected. Totterdell Hall remained in its derelict state until 1988 when Mr Radosevich began carrying out renovations and additions, borrowing money for that purpose. Interest expenses were incurred on the borrowed funds and claimed as deductions. Year by year these were as follows:

+----------------+
| 1988 |  $5,883 |
|----------------|
| 1989 | $26,505 |
|----------------|
| 1990 | $18,424 |
|----------------|
| 1991 | $35,084 |
|----------------|
| 1992 | $33,385 |
+----------------+
      

The only assessments of concern for present purposes are those which relate to the years 1991 and 1992 as the company made losses in the years 1989-1990 inclusive.

8. In 1989 Anovoy purchased the property next door to Totterdell Hall, No 286 Bagot Road. Subsequently another adjoining property, No 290, was acquired by Bewick Holdings Pty Ltd. A valuation of Totterdell from a local real estate agent in May 1989 suggested a listing price of between $540,000 and $600,000 in its then existing condition. Were the renovations to be completed it was said that it would not be unreasonable to expect a price in excess of $750,000. That valuation was not challenged. The improvements effected by Anovoy had significantly enhanced the sale value of Totterdell Hall. Had it sold the property in mid-1989 and obtained a sale price roughly within the range suggested by the agent it would have been taxed on the profit the gain being calculated by deducting the holding costs including the interest paid to effect the improvements.

9. The focus of the Tribunal's attention was on the question whether the borrowings to renovate Totterdell Hall formed part of Anovoy's trading activities rather than an addition to its capital. Having found that it was intended to restore the property as a single residence and having rejected the Commissioner's submission that it was acquired as the future residence of Mr Radosevich and his partner, the Tribunal also rejected the proposition for Anovoy that the borrowings in respect of which the deductions were claimed were made with the object of converting the building to an art gallery/ restaurant. The Deputy President said at para 61 [ at 461]:-

``61. However, on the evidence in this case, I am satisfied that there never was and never will be a gallery/restaurant. To come within s 51(1) of the Tax Act more is needed to become a gallery owner than to acquire a condemned dwelling, pencil in some ladies and gents toilets on a rough sketch plan for a domestic dwelling, fill the place higgledy- piggledy with some `repro' furniture, an old mummy and other `architectural antiques' and announce to the world ` I HAVE A DREAM '.''

The Deputy President found Mr Radosevich to be a witness who, while not deliberately distorting the events or his state of mind, nevertheless provided evidence that was less than wholly reliable. He characterised Mr Radosevich as a ``wheeler dealer willing to grasp at any straw to make a fast buck''. He ran a number of businesses simultaneously and was constantly on the lookout for, and actively engaged in ``other quirky deals designed to yield his company a profit''. It may be said, with respect, that the pejorative elements of these findings, and in particular the references to ``wheeler dealer'' and ``fast bucks'' were not necessary. Gratuitous character analysis may make entertaining reading but, if unnecessary, may also be unfairly damaging.

10. The Tribunal was satisfied that Anovoy acquired Totterdell Hall to invest in bricks and mortar to build up an equity in its business. It did so in the consciousness that the property at $100,000 was a bargain requiring no more activity on the company's part than to sweep the place out and comply with the minor repair requirements demanded by Council in order to substantially enhance its value. Had someone offered to purchase Totterdell Hall from the company at a sufficient profit there was little doubt that it would have been sold and other

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ATC 4449

properties looked for in that price range. To the extent that Mr Radosevich and his partner did move into the property during part of the time it was being renovated, the Tribunal found this to be ``purely incidental and relevant only to the extent that it may lead to some kind of apportionment''.

The Tribunal's reasoning on the deductibility of the interest payments

11. Having made the above findings of fact the Tribunal concluded that Anovoy could not succeed in its appeal against the disallowance of its objections to the assessments for the years ended 30 June 1991 and 30 June 1992. The taxpayer had failed to demonstrate any or any sufficient connection for the purposes of s 51(1) of the Income Tax Assessment Act 1936, between the outgoings on interest and future income producing activity from Totterdell Hall. Whatever ``commitment'' could be said to arise on the evidence was so vague as to be dismissed out of hand. By way of example, Mr Radosevich had made no attempt at any relevant time to obtain Council approval for his restaurant/gallery project. Instead, in the words of the Tribunal, ``... he kept adding to and altering [Totterdell Hall], so that it grew like topsy''. The Tribunal found that any necessary connection between the outgoing and future income earning activity was not satisfied merely on proof that Anovoy was a company ``... turning over every stone to see whether something may be hidden underneath which can, by one means or another, be turned to future profit''.

12. The above summary reflects the conclusions expressed by the Tribunal in three important paragraphs of its reasons for decision, they being paragraphs 65, 66 and 67. It is helpful to set them out in full [at 461-462]:

``65. On the above finding of fact, can the taxpayer succeed? I think not. The expenditure for which deductions were claimed may have been relevant to preserve [ Totterdell Hall] as a source of future income, but such expenditure does not become an outgoing incurred in gaining or producing future assessable income merely because [Anovoy] intends to use the property some time in the future to produce assessable income. As Brennan J (as he then was) noted in Inglis v FC of T 80 ATC 4001:

`... If a capital asset is not being used to produce assessable income, though it is intended for use in the future to produce assessable income, expenditure in merely preserving the asset until it is so used is not deductible. Rather, being expenditure upon a capital asset not employed in producing income, it has the character of a capital outgoing.'

(at 4004)

66. It is thus fatal to the taxpayer's claim that it failed to demonstrate any - or any sufficient - connection for purposes of s 51(1) between the outgoings on interests and the future income producing activity from [ Totterdell Hall]. Indeed, whatever `commitment' may be said to arise on the evidence is so vague as to be dismissed out of hand. To give but one example, [ Radosevich] made no attempt at any relevant time to obtain Council approval for his restaurant/gallery project. Instead, he kept adding to and altering [Totterdell Hall], so that it grew like Topsy.

67. I find that any necessary connection between the outgoing and future income earning activity is not satisfied merely on proof that [Anovoy] is a company turning over every stone to see whether something may be hidden underneath which can, by one means or another, be turned to future profit: see FC of T v Brand 95 ATC 4633 per Lee and Lindgren JJ at 4646-4647, and per Tamberlin at 4649).''

13. The Tribunal's finding at this point was that Anovoy had failed to satisfy the first positive limb of s 51(1) although as discussed later in these reasons it made no clear distinction between that finding and the capital outgoings question. Subject to the latter observation, the finding about the first limb having been made, it was not strictly necessary for the Tribunal separately to consider whether the interest payments were outgoings of a capital nature. It proceeded to do so however but without making explicit that it was proceeding upon the hypothesis that they fell within the first limb. It was in this way that the Tribunal turned to the decision of the Full Court of the Federal Court in
Steele v FC of T 97 ATC 4239; (1997) 73 FCR 330. At the time of the Tribunal's decision the application for special leave to appeal in that case was pending before the High Court. The decision of the Full Court supported characterisation of the interest payments as capital outgoings and it was sought by Anovoy to distinguish it on the basis that in

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ATC 4450

the Steele case there was no thought on the part of the taxpayer to sell the property in question. The distinction was found by the Tribunal to be without substance as it was not material or relevant that Mrs Steele had no dual purpose. The Learned Deputy President said at para 92 [ at 465]:

``92. If the majority decision in Steele (by which I am bound) is the current law, the present claim must fail on my finding that the advantage sought by the payment of interest was the creation of a capital asset. On this finding, the interest paid on the renovations will be deductible from whatever profit is generated if and when the property is sold. In other words, there being no income generated throughout the period of the alterations and additions (I have ignored for present purposes some minor windfall `rent' said to have been paid by the directors for the use of the premises as a residence), the claim to deduct the interest comes at a point too soon to be properly allowable.''

14. Having concluded that Anovoy's claim must fail, the Tribunal considered the question of apportionment. An apportionment if any would be based on evidence that some $1,040 was said to have been paid to Anovoy by the directors in the 1992 tax year for the use of Totterdell Hall as their residence. He rejected an argument that the use of Totterdell Hall to store the books of account of Anovoy and Bewick Pty Ltd made interest paid on the renovations an allowable deduction. However on the question of rent the Tribunal found that Mr Radosevich and his partner lived in Totterdell Hall's laundry/garage in 1992. On that finding it was prepared to assume that, in that year, Mr Radosevich's loan account with Anovoy was debited by that amount. The Tribunal therefore upheld the decision on the objection in the 1991 tax year and varied the decision in 1992 by allowing an amount of $1,040 by way of allowable deduction.

Statutory framework

15. This appeal concerns s 51(1) of the Income Tax Assessment Act 1936 as it stood at the time of the issue of the assessments. It provided relevantly as follows:

``51(1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.''

Also relevant is s 25(1)(a) of the Income Tax Assessment Act 1936 which provided:

``25(1) The assessable income of a taxpayer shall include:

• (a) where the taxpayer is a resident- the gross income derived directly or indirectly from all sources whether in or out of Australia; and
• ...

which is not exempt income, an amount to which s 26AC or 26AD applies or an eligible termination payment within the meaning of Subdivision AA.''

16. The appeal is brought in the original jurisdiction conferred upon this Court by s 44 of the Administrative Appeals Tribunal Act 1975. Section 44(1) of that Act provides:

``44(1) A party to a proceeding before the Tribunal may appeal to the Federal Court of Australia, on a question of law, from any decision of the Tribunal in that proceeding.''

The Court is given jurisdiction, by s 44(3), to hear and determine appeals instituted in accordance with subs 44(1). It is to hear and determine the appeal and may make such order as it thinks appropriate by reason of its decision (s 44(4)). The orders that may be made by the Court on an appeal include an order affirming or setting aside the decision of the Tribunal and an order remitting the case to be heard and decided again, either with or without the hearing of further evidence, by the Tribunal in accordance with the directions of the Court (s 44(5)).

The grounds of appeal

17. There are some 22 grounds of appeal, a number of which appear to be unnecessary and argumentative. Grounds 4.4, 4.5, 4.7 and 4.11 to 4.17 inclusive cite specific findings of fact of the Tribunal and in each case assert that the Tribunal erred in law in not allowing the deductions claimed in view of the finding cited.

18. Grounds 4.3 and 4.9 attack findings of fact by the Tribunal on the basis that the

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findings involve errors of law. Grounds 4.1 and 4.2 are expressed in general terms thus:

``4.1 The Tribunal erred in law in not holding that the interest was an outgoing incurred in gaining or producing the assessable income, or was necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

4.2 The Tribunal erred at law in holding that the interest was an outgoing of capital or of a capital nature.''

The balance of the grounds are essentially argumentative aspects of grounds 4.1 and 4.2. It is convenient to deal first with the grounds which attack the Tribunal's findings of fact and then turn to the issue of characterisation of the interest payments which lies at the heart of this case.

The findings as to credibility

19. Anovoy contended in ground 4.3 that the Tribunal erred in law and in fact in treating the evidence of Mr Radosevich ``with some degree of scepticism'' and as ``less than wholly reliable''. Although the ground does not spell it out, it is evidently submitted that because of its erroneous approach to the credit of Mr Radosevich the Tribunal wrongly found that Anovoy never had the intention of developing the property to an art gallery/restaurant. So it was said in the submissions on behalf of Anovoy that when the scepticism with which the Tribunal approached Mr Radosevich's evidence was removed, the evidence that Anovoy intended developing the property as an art gallery/restaurant should be accepted.

20. The comments of the Tribunal adverse to Mr Radosevich's credibility arose in the following way. In a witness statement dated 12 July 1996 which had been signed by Mr Radosevich and filed with the Tribunal he said:

``The intention for purchasing the property was for use both as an income-producing property, and as an asset that would generally assist Anovoy Pty Ltd in accomplishing it's (sic) income earning goals. Prior to purchase, I had a concept of eventually developing the property to an Art Gallery/Restaurant. This concept was researched through discussions with people in the food industry and a trip to the United States. Initial drawings were prepared. It was realised that ultimately the adjoining block would have to be acquired as the building would be completed in stages.''

And further:

``The initial plan of eventually developing the property for use as a Gallery/Restuarant (sic) has not been discarded, however it has been seriously curtailed by financial circumstances beyond the control of the Company.''

And further:

``That the original plan has not been discarded is supported by the fact that the Company and related entities has acquired the two adjoining properties necessary to facilitate the development. The purpose of the initial plan was to do whatever was required to maximise the utility of the property to the Company. Whilst the optimum commercial use has not yet been realised, the property is still used as a valuable asset of the Company, whilst deriving assessable income.''

21. Subsequently a further witness statement of Mr Radosevich dated 28 April 1997 was filed with the Tribunal. It opened with the declaration in par 2 that:

``This Witness Statement supersedes and replaces my earlier Witness Statement of 12 July 1996.''

22. At par 18 it was said:

``The purpose in acquiring 284 Bagot Road (and later 286 Bagot Road) was to have an asset of the company which, in some way or another, would be part of the business of Anovoy and would make a profit for the company. At that stage of purchase of 284 Bagot Road, I did not know precisely how the business of Anovoy could turn 284 Bagot Road to profitable advantage, but I intended that the company would use it to make a profit to the company some how.''

At par 28 Mr Radosevich spoke of a trip he took to the United States in March 1984:

``... I came across a great business for the property at 284 Bagot Road, which was a combined café and gallery called The Merchant of Venice. It was in a suburban part of Los Angeles called Venice. I felt that this would be a fantastic idea for my property in Subiaco.

...

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ATC 4452

I foresaw that I could develop the property, and either rent it out as a restaurant and art gallery, or there was also the possibility of sale of the whole redeveloped property. Although I did not have this project specifically in mind when Anovoy acquired the property, it fell within the general view I held when the company purchased the property that it could be turned to profitable account in some way or other.''

As is immediately apparent, the second witness statement was inconsistent with the first as to the time at which Mr Radosevich had the idea of converting the house into an art gallery/ restaurant. He was cross-examined on the inconsistency over objection from his counsel.

23. The provisions of the Evidence Act 1995 (Cth) relating to cross examination on prior inconsistent statements of witnesses (s 43 and s 106) do not apply to proceedings in the Tribunal as the Tribunal is not bound by the rules of evidence (Administrative Appeals Tribunal Act s 33(1)(c)) and is therefore not within the extended definition of ``Australian court'' under the Evidence Act. That is not to say that criteria of relevance and procedural fairness do not apply in full measure to the material to which the Tribunal may have regard and the ways in which it may inform itself. The purpose of the cross examination on the previous witness statement was, no doubt, to demonstrate that Mr Radosevich had been prepared to sign and lodge with the Tribunal a document which contained a false statement about his intentions in acquiring the property and in this case as it turned out, a demonstrably false statement. Asked if he had read the statement before signing it he said:

``I didn't - I would've just breezed straight through it. I didn't read them, study them, make sure the dates were correct. None of that sort of thing. I didn't do it because I didn't think it was important. I didn't think the case was settled in a Tribunal. I thought it was settled in a court. That's basically it was because the accountant I had handling it before Mr O'Connor said to me: all you do is sit around the table and have a talk. It's not like a court case. And in any case he insisted that this would be a case that would be settled in court. So, I mean, it was just my mis-interpretation, misunderstanding. That's why when you look at that, the dates are all over the place.''

He also said that he had not written the statement up, the accountant had written it up. He said:

``He had a habit of mucking things up. He's mucked up a hell of a lot of them, and they're no good. They're basically - I never placed the importance upon them because I didn't think that the Tribunal was the final end of the day hearing.''

24. The Tribunal found that the second statement from Mr Radosevich sat uneasily with his ``earlier sworn witness statement''. At par 16 of the Tribunal's reasons it said [at 452-453]:

``... In other words, his earlier statement that the gallery/restaurant concept was one of the options he had considered prior to the purchase of [Totterdell Hall] is clearly wrong and causes one to vet [Radosevich's] evidence with some degree of scepticism.''

Later in summarising the evidence generally the Tribunal found Mr Radosevich to have provided evidence which was less than wholly reliable.

25. The finding challenged in ground 4.3 is challenged on the basis that the Tribunal erroneously characterised the witness statement of 12 July 1996 as a ``sworn statement''. So it was said in submission:

``The decisive importance placed on the earlier statement of 12 July 1996 by the Tribunal is wrong because, contrary to its assertion and basis, in fact that earlier statement was not sworn. The Tribunal therefore made an error of law in rejecting Mr Radosevich's explanation for the difference between the contents of the earlier statement of 12 July 1996 and his testimony at the hearing.''

The Tribunal referred to the earlier statement as a sworn statement at pars 15, 16 and 17 of its reasons for decision. Counsel wrote to the Tribunal the day after the reasons for its decisions were published asking that the error be corrected. The Tribunal replied, on behalf of the Deputy President, that the reasons for decision could not be altered. Nevertheless when they were published in the Australian Tax Cases the word ``sworn'' had been deleted from pars 16 and 17 but remained in par 15.

26. In my opinion, while it is plain that the Tribunal did make an error in its characterisation of the statement, the essential

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foundation for its scepticism about the reliability of Mr Radosevich's evidence remained. Indeed given the cavalier approach to the first statement demonstrated by Mr Radosevich in his testimony about it, his explanation would seem to have been as damaging as the statement itself.

27. Counsel for Anovoy argued that there had been an error of law on the part of the Tribunal flowing from its misapprehension about the status of the witness statement as a sworn statement. Reliance was placed upon observations of Barwick CJ in
McCormack v FC of T 79 ATC 4111; (1979) 143 CLR 284 as indicating the approach which should be adopted if disbelief of a witness is founded on erroneous facts. But that was a case of an appeal from a decision of a Board of Review to the Supreme Court of Western Australia ``involving a question of law'' (s 196). It was not an appeal limited, as is the present proceeding, to questions of law. This is made clear in the function which Barwick CJ thought the State Supreme Court ought to have undertaken in the review proceedings as expressed at ATC 4116; CLR 293-294:

``... The truth is that the matter has never properly been tried. The Board of Review misunderstood the situation both in point of fact and in point of law. The appellant, who gave evidence before them, was not evaluated as a witness. The Supreme Court did not, it seems to me, adopt a correct approach to the appeal before it. It ought to have insisted on hearing the evidence itself and thus placed itself in a position to evaluate the witnesses.''

The Full Federal Court, on appeal from the State Supreme Court, had wrongly reached conclusions on questions of personal credit on the basis of the transcript of proceedings before the Board of Review. The function which, in the opinion of Barwick CJ, ought to have been undertaken by the Supreme Court reflected the mixed fact and law review that was available under s 196 of the Income Tax Assessment Act as it then stood. In this case the review process is confined by s 44 of the Administrative Appeals Tribunal Act to questions of law. The mischaracterisation of the witness statement by Mr Radosevich was an error of fact not of law. To the extent that the Tribunal's findings adverse to his credibility relied upon the inconsistency disclosed by his statement of 12 July 1996, there is no error of law.

28. There was a supplementary argument in support of ground 4.3 which relied upon the Tribunal's acknowledgment that Mr Radosevich ``did not deliberately distort the events or his state of mind''. There was therefore, it was said, no proper basis for not accepting the truthfulness of his evidence. That, with respect, is a non sequitur. Courts and tribunals frequently and properly find that the evidence of a witness is not reliable notwithstanding that there is no conscious attempt to mis-state the facts. A witness may be unreliable because of faulty memory or a demonstrable inclination to wishful thinking in reconstruction of past events or a degree of carelessness in testimony. The latter conclusion could quite properly have been made about Mr Radosevich having regard to the earlier statement filed with the Tribunal in his name and over his signature and his explanation of it.

29. A further line of argument under ground 4.3 turned upon an exchange which appeared in the course of re-examination of Mr Radosevich. In explanation of the approach he had taken to the statement of 12 July 1996 he said that the second statement was one he had written himself. He said:

``That's the only statement I've ever written in the whole case because, like I said, I just never ever gave any concern to the Tribunal because I was of the opinion wrongly...

The D President: It was no importance?... Well, I thought it was a pre-trial. I mean...

You are not the only one who thinks that anyway?... Unfortunately that wasn't the way it is but...''

It was said that the observation from the Tribunal was a ``sympathetic'' response and that the rule in
Browne v Dunn (1893) 6 R 67 required that Mr Radosevich should have been given the opportunity to further explain his position if an adverse interpretation by the Tribunal were to be placed on his answer. That is an untenable proposition. The misconception asserted by Mr Radosevich that the Tribunal process was some kind of pre-trial proceeding might have been a misunderstanding held in common with others. It would not prevent the Tribunal from coming to the view that whatever his understanding of the nature of the proceedings, the fact that he was prepared to

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sign a statement, drafted by his accountant without reading it, would reflect adversely upon his credibility.

30. Browne v Dunn recognised and offered a rule of practice applicable in civil and criminal litigation that, where it is intended to suggest that a witness is not speaking the truth on a particular point, his or her attention is directed to that fact by questions put in cross examination on the particular point. It is a rule designed to secure procedural fairness in adversarial proceedings -
R v Birks (1990) 19 NSWLR 677 at 688 (Gleeson CJ). See also the discussion of the rule in the judgment of the Full Court in
Eastman v R (1997) 76 FCR 9 at 101-102 (The point did not arise on the appeal in the High Court). It is flexible in its application. Its invocation in this case was misconceived. If a breach of procedural fairness is asserted outside the context of cross examination in an adversarial proceeding then want of procedural fairness can supply a ground of review without recourse to Browne v Dunn. Indeed that case itself may be seen as a particular application of procedural fairness closely related to, if not now entirely subsumed by, the familiar concept of the right to be heard. There was no unfairness disclosed in this aspect of ground 4.3.

31. For these reasons ground 4.3 fails and the Tribunal's findings of fact in relation to Mr Radosevich's credibility are not affected by any error of law and cannot be questioned in these proceedings.

Whether an art gallery was ever contemplated

32. Ground 4.9 of the grounds of the application asserts that the Tribunal erred in making the finding in par 61 that ``there never was and never will be a gallery/restaurant''. The text of the relevant paragraph has been set out earlier in these reasons. It is a finding of fact on the question whether the taxpayer ever formed an intention to convert the premises into a gallery/restaurant (even if that intention had later been abandoned). The finding was adverse to the taxpayer so the factual substratum necessary to attract the operation of s 51(1) in so far as it was invoked in relation to that particular proposal was never made out. As an error of fact that finding is not reviewable in these proceedings. Ground 4.9 also fails.

33. The remaining grounds go to the question of the characterisation of the interest payments claimed as deductions.

The characterisation of the interest payments

34. The main thrust of the applicant's case was that, on the findings of fact made by the Tribunal, the interest payments should have been held to be deductible under the first limb of s 51(1) and not treated as outgoings of a capital nature.

35. The deductibility of the interest payments depends upon the application of s 51(1) of the Income Tax Assessment Act 1936. Case law on its predecessor, s 23(1)(a) of the Income Tax Assessment Act 1922 read with s 25(e) of that Act, allowed a wide range of connections between expenditure and income to attract deductibility -
Amalgamated Zinc (De Bavay's) Ltd v FC of T (1935) 3 ATD 288; (1935) 54 CLR 295;
W Neville & Co Limited v FC of T (1937) 4 ATD 187 at 196; (1936-1937) 56 CLR 290 at 305. It is not necessary, for deductibility, to relate each item of expenditure to some item of income. It is sufficient that the expenditure is made in the given year or accounting period and is incidental and relevant to the operations or activities regularly carried on for the production of income. This approach applies to the first limb of s 51(1) -
Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431 at 435-436; (1949) 78 CLR 47 at 56-57;
FC of T v Snowden & Wilson Pty Ltd (1958) 11 ATD 463 at 468-469; (1958) 99 CLR 431 at 443. The requirement that expenditure be ``incidental and relevant'' to the production of income identifies a necessary condition of deductibility going to the essential character of the expenditure rather than its purpose -
Lunney v FC of T (1958) 11 ATD 404 at 411; (1957-1958) 100 CLR 478 at 496-497. Motive and purpose are not determinants of deductibility but may have evidentiary significance and, in some cases, may decide the characterisation of the expenditure -
Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542 at 4549 and 4558-4559; (1980) 33 ALR 213 at 222 and 234-235;
Fletcher & Ors v FC of T 91 ATC 4950 at 4957; (1991) 173 CLR 1 at 17. So the purpose of incurring an expenditure may stamp it as expenditure of a business or income earning kind or as having no relevant connection with the gaining or producing of assessable income -
FC of T v Ilbery 81 ATC 4661 at 4667; (1981) 38 ALR 172 at 180;
John v FC of T 89 ATC 4101 at 4105; (1989) 166 CLR 417 at 426. In the latter case it was said

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however in the joint judgment at ATC 4105; CLR 426-427 that:

``It is readily understandable that, if no income has been gained or produced and a question arises as to whether the occasion would be expected to produce assessable income, consideration of the purpose for which the expenditure was outlaid might not be wholly irrelevant. It may be too that even where income is produced `the purpose for which the advantage occasioning the loss or outgoing is sought may evidence a sufficient relationship with the income-earning process': Handley v FC of T 81 ATC 4165; [(1981) 148 CLR 182 at 189-90] per Stephen J.... But the cost of a step taken in the process of gaining or producing income must be regarded as an outgoing or taken into account in calculating the loss (if any) incurred, whatever purpose or motive may have attended all or any of the steps involved.''

36. It follows from the broad approach to the connection between losses and outgoings and the gaining of income that expenditure may be a deduction although only related to income generated in years other than that in which it is incurred. That proposition was established in relation to the 1922 Act by
Ward and Co Ltd v Commissioner of Taxes [1923] AC 145 at 148; Amalgamated Zinc (supra) at ATD 293, 296 and 297-298; CLR 303, 307 and 309 and W Neville & Co (supra) at ATD 197 and 199; CLR 306 and 308. While s 51(1) refers to losses or outgoings incurred in gaining or producing ``the assessable income'', the use of the word ``in'' prevents a reading of that phrase which would limit deductibility to expenditure producing income in the year in which it is incurred -
FC of T v Finn (1961) 12 ATD 348 at 351; (1961) 106 CLR 60 at 68; Ronpibon Tin (supra) at ATD 435; CLR 56; Snowden & Wilson Pty Ltd (supra) at ATD 464; CLR 436;
John Fairfax & Sons Pty Ltd v FC of T (1959) 11 ATD 510 at 511 and 517-518; (1958-1959) 101 CLR 30 at 35 and 46 and Fletcher (supra) at ATC 4957; CLR 16.

37. It is a corollary of the general principles governing deductibility of outgoings that where interest is paid on moneys borrowed to secure capital or working capital with which to gain or produce assessable income or for a business, that interest is deductible:
The Texas Co (Australasia) Ltd v FC of T (1940) 5 ATD 298 at 355-356; (1939-1940) 63 CLR 382 at 468;
FC of T v Total Holdings (Australia) Pty Ltd 79 ATC 4279 at 4283; (1979) 24 ALR 401 at 406.

38. The recent decision of the High Court in Steele v DFC of T 99 ATC 4242; (1999) 197 CLR 459 focussed on the question whether interest payments could properly be characterised as outgoings of a capital nature. The application of the first limb of s 51(1) was secondary and the subject of ultimate remitter to the Tribunal. The case involved the following factual elements:

• 1. The taxpayer was the purchaser of property who paid interest on the unpaid balance of the purchase price and also on moneys borrowed from a finance company and later a bank on the security of the land.
• 2. When the land was acquired the taxpayer intended to build and operate a motel on it.
• 3. At the time of purchase no feasibility studies or costings of the development of the site had been undertaken.
• 4. As a temporary measure the taxpayer used the land for the agistment of horses from which only a small income was derived relative to the interest outgoing.

The Tribunal had treated the interest outgoing as being of a capital nature save for a small amount apportioned by reference to the agistment income. This decision was upheld at first instance in the Federal Court (96 ATC 4131; (1996) 31 ATR 510) and on appeal in the Full Court (97 ATC 4239; (1997) 73 FCR 330).

39. In the High Court it was common ground that the question whether the interest incurred by the taxpayer was an outgoing of a capital nature was a question of law. The joint judgment of Gleeson CJ, Gaudron and Gummow JJ reiterated at 467 that the reference in the first limb of s 51(1) to ``the assessable income'' is not to be read as confined to assessable income actually derived in the particular tax year. Their Honours also pointed out that it only becomes necessary to consider the exceptions to s 51(1) if it has already been concluded or accepted by hypothesis that one or other of the positive limbs applies (at 468). The case on appeal was not said to fall within the second limb of s 51(1) however it would not be difficult to imagine examples of property development and pre-construction liability for interest which would fall within that limb and which could give rise to an issue as to the

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application of the capital outgoings exception. The appeal was argued on the basis that it was the first limb which was relevant. The principal question before the court was whether the interest expenses were outgoings of a capital nature.

40. Their Honours rejected the view expressed by the majority in the Full Court that the interest payments could be treated as capital in nature for a time and subsequently as on revenue account when a motel was constructed on the land and started to produce income. The purpose of the borrowing was to acquire the land with a view to building a motel and conducting a profitable motel business. The purpose of the borrowing would not change when at some unspecified time the original intention in acquiring the land came closer to fulfilment. Their Honours approved, as fairly reflecting the ordinary position under s 51(1), the proposition in Ilbery (supra) at ATC 4665; ALR 177 that interest on moneys borrowed for the purpose of acquiring an income-producing asset is deductible. Interest being ordinarily a recurrent or periodic payment securing, not an enduring advantage, but the use of borrowed money during the term of the loan is ordinarily a revenue item - citing
Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 at 359-363 and
Australian National Hotels Limited v FC of T 88 ATC 4627 at 4632-4634; (1988) 19 FCR 234 at 239-241. They allowed, however, the possibility that there might be particular circumstances where it would be proper to regard the purpose of interest payments as something other than the raising or maintenance of the borrowing and thus, potentially of a capital nature. Their Honours said at ATC 4248-4249; CLR 470:

``... However, in the usual case, of which the present is an example, where interest is a recurrent payment to secure the use for a limited term of loan funds, then it is proper to regard the interest as a revenue item, and its character is not altered by reason of the fact that the borrowed funds are used to purchase a capital asset. The fact that the asset has not yet become, and may never become, income-producing may be relevant to a decision as to whether the case falls within the first limb of s 51(1). However, once it is determined, or accepted by hypothesis, that the interest is, during the relevant year, an outgoing incurred in gaining or producing the taxpayer's assessable income, (even though no assessable income is derived during that year, and no such income may ever be derived), the circumstance that the capital asset has produced no income is not a reason to conclude that the interest is an outgoing of a capital nature.''

Contrary to the Full Court, the High Court treated the decision in
Travelodge Papua New Guinea Ltd v Chief Collector of Taxes 85 ATC 4432; (1985) 16 ATR 867 as being in accordance with Australian authority. That case held that interest paid on borrowed funds during the construction of a new hotel, even though capitalised in the taxpayer's accounts, was nevertheless deductible under the equivalent of s 51(1). On the other hand, and again contrary to the view of the majority in the Full Court, the High Court regarded the decision of the Judicial Committee of the Privy Council in
Wharf Properties Ltd v Commr of Inland Revenue (Hong Kong) 97 ATC 4225; [1997] AC 505 as not representing the law in Australia. On this basis it was held the majority of the Full Court had erred in deciding the case on the ground that the interest was an outgoing of a capital nature.

41. The secondary issue before the Court was whether the first limb of s 51(1) applied. In considering that point, which the majority in the Full Court had found it unnecessary to determine because of their conclusion that the outgoing was of a capital nature, their Honours referred to the dissenting judgment of Carr J. Carr J had made the point that it was extremely difficult to envisage any use of the taxpayer's property within the contemplation of the taxpayer which would not have produced assessable income. Their Honours in the joint judgment paraphrased, at ATC 4250; CLR 473, what Carr J had said:

``If the appellant had gone ahead with her plans to develop a motel complex then that would have produced assessable income. If, on the other hand, she had decided not to go ahead with the development, perhaps because it was too expensive, or because she could not find a suitable partner, then her only apparent alternative was to resell the land, or her interest in it. As things turned out, that is what happened. Having regard to the original purpose for which she acquired the land, Carr J said, any profit on a resale

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would have constituted assessable income. He considered that from the time the appellant acquired the land she had embarked on a profit-making undertaking or scheme. In those circumstances, the appellant's operations, were, in his view, sufficiently linked to the derivation of assessable income to be capable of falling within the first limb of s 51(1).''

Their Honours accepted that in some cases the necessary connection between the incurring of an outgoing and the gaining or producing of assessable income has been denied upon the ground that the outgoing was ``entirely preliminary'' to the gaining or producing of assessable income or incurred too soon before the commencement of the business or income producing activity:

``... The temporal relationship between the incurring of an outgoing and the actual or projected receipt of income may be one of a number of facts relevant to a judgment as to whether the necessary connection might, in a given case, exist, but contemporaneity is not legally essential, and whether it is factually important may depend upon the circumstances of the particular case.''

(at ATC 4251; CLR 475)

The taxpayer in the Steele case did not have in contemplation a variety of alternative possible uses of the land, some of an income producing nature and others not. There was no suggestion that she ever contemplated using the property for private or domestic purposes. While not financially committed to a motel development and not having decided upon any particular development, she did not appear to have envisaged any use of or dealing with the property other than one which would produce assessable income. Nevertheless, resolution of the issue ultimately involved a judgment of fact even though questions of law were involved and that meant that the course proposed by the dissenting judge in the Full Court of remitting the matter to the Tribunal was appropriate. It was not a case where on the evidence only one conclusion would be open to the Tribunal.

42. The Commissioner concedes that it cannot be asserted in the present case that Anovoy's interest expense is an outgoing of a capital nature. But that begs the question of the application of the first limb of s 51(1) which is not conceded. The Commissioner submits that the issue is whether, on the facts of this case, the Tribunal's reasoning about the application of s 51(1) involved an error of law. In the present case, it is said, the Tribunal found on the evidence that the expenditure in the income years was not sufficiently connected with any production of assessable income. Lot 284 had not been used by Anovoy for income production in the fourteen years between its acquisition in July 1983 and the Tribunal hearing in July 1997 although at par 20 of its reasons for decision the Tribunal noted that it was said that the applicant had earned rent from Lot 284 in 1984, 1985 and 1986 and an amount of $1,040 said to constitute rent was returned in 1992. The evidence, according to the Commissioner, established that the only potential income earning use for Lot 284 was its resale which would occur by unknown means at an unknown time in the future. If it were intended to use Lot 284 for income production before resale there was no plan by which that was to occur, of if there was a plan as to how that might occur, it lacked sufficient substance and any ``enthusiastic and continuing endeavour''.

43. The Commissioner argued that Steele is authority for the proposition that deductibility under s 51(1) requires the outgoing be incurred in the activity which is expected to produce income. Section 51(1) also requires that the period between the outgoing and the production of assessable income not be inordinately long taking into account the kind of income earning activities involved and that there be continuing efforts undertaken in pursuit of the activity which is expected to produce the assessable income. Consequently, it was submitted, Steele supports the proposition that s 51(1) is not satisfied where the asset to be used to produce assessable income is passive and there are no continuing efforts in pursuit of the activity which was expected to produce assessable income. An intention to revive the asset and pursue the income producing activity at some time in the future is not enough. To allow a deduction in these circumstances would amount to a construction of s 51(1) which allows deductions for outgoings incurred to keep intentions and ideas afloat and not to produce assessable income. It was also said to ignore the role of the concepts of commitment and contemporaneity, a role which the High Court acknowledged in Steele was a valid one in appropriate cases. In looking to commitment

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ATC 4458

and contemporaneity in making its factual judgment that there was not a sufficient connection in the present case, the Tribunal was said not to have erred in law. The evidence supported the factual judgment it reached.

44. In my respectful opinion however, and particularly having regard to pars 65, 66 and 67 of the Tribunal's reasons it appears to have elided the criteria of deductibility under the first limb of s 51(1) with the characterisation of the interest payments as capital outgoings. In par 65 the Tribunal quoted a passage from the judgment of Brennan J in
Inglis v FC of T 80 ATC 4001 at 4004; (1979) 28 ALR 425 at 428-429. There, his Honour, having found want of relevant connection between the expenditure claimed and income producing activities went on to make the observation quoted which dealt with the character of the expenses as capital outgoings. That case involved expenditure connected with a pastoral property in years of income during which the owners had ceased to carry on their pastoral business. There was no question of maintaining or upgrading the land for resale at a profit. In the present case the Tribunal's application of the decision of the Full Court in Steele cannot be quarantined from its consideration of the application of the first limb of s 51(1). That is not to say that the two questions are completely independent. The factual issues relevant to each overlap.

45. In the present case the land was acquired for a profit making purpose, albeit the timing and precise manner of the implementation of that purpose had not been crystallised. The time elapsed between the incurring of outgoings and actual or projected receipt of income is a relevant factor. In some cases it will result in the expenditure being characterised as ``entirely preliminary'' or ``too soon'' before the commencement of the business or income producing activity. Where the assessable income is to be derived from resale of the land and the land is acquired for that purpose, the elements of want of contemporaneity and lapse of time from acquisition to sale may be given little weight on the issue of connection between the costs of financing improvements and the realisable profit. They may of course have a logically antecedent relevance in negating the claimed purpose of the acquisition -
FC of T v Brand 95 ATC 4633 at 4646 and
Temelli v FC of T 97 ATC 4716. But that is not this case. The Commissioner has accepted in his own submission that ``given the evidence and findings as to the applicant's purpose on acquisition of Lot 284 if and when it occurs the sale transaction will produce assessable income''. In my opinion therefore the Tribunal's application of the Full Court decision in Steele has affected its application of the first limb of s 51(1).

46. While accepting that there is inconvenience for the taxpayer in remitting the matter to the Administrative Appeals Tribunal that is the only proper course in this case. On the application of the correct legal principles the Tribunal could well come to the conclusion that, given its findings of fact, the interest payments are within the first limb. But there may be aspects of the factual matrix which will attract a wider ranging consideration in light of the finding that the interest payments were not in the nature of capital outgoings. I consider that this can be done on the evidence that was before the Tribunal which heard the case over three days. However, if the parties are agreed that there are further facts or evidence that should be put before the Tribunal, they are at liberty to do so.

47. It was submitted by the Commissioner that Steele is not authority for the proposition that where a property is acquired for resale at a profit or for a profit making undertaking or scheme, the expenditure incurred in connection with the property is immediately deductible under s 51(1) in each income year in which the expenditure is incurred. Use of the Steele decision in this way, it was submitted, would overturn the long standing practice in Australian taxation law that it is the net profit from such transactions that is included in the assessable income. This practice, it was said, is established by ``decisions made over many years by the High Court, including the Whitfords Beach case. It could not be said that these precedents have been swept aside by Steele particularly where the judgment of the majority in the High Court indicates that the matter was not given any consideration.''

48. The question with which the High Court was concerned in
FC of T v Whitfords Beach Pty Ltd 82 ATC 4031; (1982) 150 CLR 355 was whether proceeds of sale of lots in a subdivision were assessable income under s 25(1) or s 26(a) as it then was. Deductibility of outgoings associated with the acquisition of the land was not in issue. The Commissioner's

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ATC 4459

contention amounts to the proposition that interest payments on moneys borrowed to fund the acquisition of land for resale, whether as part of a business of buying and selling land or otherwise, are deductible only in the year in which the profits are realised, being brought to account in the calculation of net profit. If that were so then it would seem that the majority in Steele significantly misconceived the operation of the first limb of s 51(1). That is not an argument which can be entertained in this Court. Nor is it consistent with the general principles of deductibility under s 51 and its statutory predecessors discussed earlier.

49. Anovoy sought to rely upon the second limb of s 51(1) contending that the interest payments in question were ``necessarily incurred in carrying on a business for the purpose of gaining or producing [assessable] income''. Whatever the company did it was said, it did in carrying on a business. The business was described, in counsel's submissions, as the business ``of making a profit by one means or another from the holding and development of property''.

50. In my opinion it is doubtful whether Anovoy can succeed under the second limb if it does not succeed under the first. The words of the first limb have a very wide operation which will cover almost all of the ground occupied by the second - Ronpibon Tin (supra) at ATD 435-436; CLR 56-57). The distinction between the two limbs was drawn by Fullagar J in John Fairfax & Sons Pty Ltd (supra) at ATD 514; CLR 40, where his Honour said of the first that it is:

``... primarily at least, concerned with expenditure voluntarily incurred for the sake of producing income. Its scope is not, of course, confined to cases where the income is derived from carrying on a business.''

As to the second limb he said:

``The second may be thought to be concerned rather with cases where, in the carrying on of a business some abnormal event or situation leads to an expenditure which it is not desired to make, but which is made for the purposes of the business generally and is reasonably regarded as unavoidable.''

51. The question whether the renovation expenses on Totterdell Hall were incurred in ``carrying on a business'' is a question of fact and degree. I am not prepared to find that if the expenditure did not fall within the first limb then it must have fallen within the second. There are questions of fact involved which it will be open to the Tribunal on remitter to consider free of concern about characterisation of the interest payments as outgoings of a capital nature.

The cross appeal and notice of contention

52. The Commissioner in this case filed a cross-appeal and notice of contention. The cross-appeal was discontinued. Paragraphs 5.1 and 5.2 of the notice of contention were abandoned. Paragraphs 5.4 to 5.7 inclusive of the notice of contention challenged the Tribunal's conclusions in relation to the first limb of s 51(1) and have been addressed in the preceding reasons relating to that issue.

53. That left par 5.3 of the notice of contention which was as follows:

``The Tribunal erred in finding that the Respondent had allowed the Applicant to deduct the interest on its borrowings to acquire the property when there was no evidence before the Tribunal to support such a finding and the Tribunal had been informed that the Applicant had not claimed a deduction for the interest expense on its borrowings to acquire the property.''

This ground refers to the observation by the Tribunal at par 5 of its reasons that [at 451]:

``5. One of the more eccentric features of these references is that the Commissioner, having allowed the taxpayer to deduct the interest on [Anovoy's] borrowings to acquire [Totterdell Hall], is disputing the deductibility of the interest on the amounts borrowed year by year to renovate the property.''

As appears from the preceding reasons nothing turns on the finding that the Commissioner had allowed the taxpayer to deduct interest on borrowings associated with the acquisition of the property. So even if wrong, it does not affect the outcome of this case.

Conclusion

54. For the preceding reasons the appeal will be allowed, the decision of the Tribunal set aside and the matter remitted to the Tribunal to determine according to law. The costs will follow the event. Counsel for the Commissioner sought costs, which had been reserved, of a

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ATC 4460

directions hearing on 17 November 1999. That directions hearing, sought by the Commissioner, led to the adjournment of the hearing of the application from 25 November to 18 January. Without traversing the detail of all that passed at that time the appeal book papers were not then ready for want of funding to Anovoy's instructing solicitors. A notice of proposed amended cross-appeal and contention had been filed but evidently no indication received from Anovoy as to whether it would consent to the notice. There was also a question of directions as to written submissions which were made at that time. In my opinion the costs of the directions hearing should be seen as an overhead of the action and should follow the event. I should add that if the parties are able to agree an order within twenty eight days in substitution for that made by the Administrative Appeals Tribunal there will be liberty to apply to substitute such order for the orders remitting the matter to the Tribunal. This is not an invitation to reopen the matter of remitter other than by way of consent order.

THE COURT ORDERS THAT:

1. The application is allowed.

2. The decision of the Administrative Appeals Tribunal made on 3 October 1997 is set aside.

3. The matter is remitted to the Administrative Appeals Tribunal to be determined according to law without the hearing of further evidence save by consent of the parties.

4. The Respondent is to pay the Applicant's costs of the application.

5. The parties are at liberty within twenty eight days to apply for an order by consent substituting a final determination of the objections for the order remitting them to the Tribunal.