Case J43

Judges:
AM Donovan Ch
RK Todd M

Court:
No. 2 Board of Review

Judgment date: 2 August 1977.

---

A.M. Donovan (Chairman) and R.K. Todd (Member): The taxpayer in these references had raised various grounds of objection but all matters save one had by the date of the hearing been resolved by agreement and made the subject of amended assessments.

2. The outstanding question is the deductibility of interest paid by the taxpayer to the mortgage pursuant to the provisions of a mortgage subsisting upon a home unit (which we shall call ``the B unit'') purchased by the taxpayer. The matter arose in this way: The taxpayer sold a house owned by him, which was his matrimonial home (and which we shall call ``the S home'') for $36,000. That property was mortgaged to the extent of $16,000 to a trustee company. Within a matter of days the taxpayer entered into an agreement to purchase the B unit for the sum of $23,750. His intention was to purchase the B unit outright with funds constituted by the net proceeds of sale of the S house and some other private funds. The taxpayer and his wife were at that time minded to embark upon a project to buy some land and build home units upon it (``the new units''), the same to be retained for the purpose of deriving rental income. The next step was that it was then discovered that the B unit was subject to an existing mortgage at a favourable rate of interest and that it was open to the taxpayer to assume the liability subsisting pursuant to this mortgage as part of the settlement of his contract of purchase. After this was discovered, but before settlement of the purchase of the B unit, the taxpayer and his associates committed themselves to purchase land for the purpose of erecting the new units. The ultimate cost of land and necessary construction was to be between $90,000 and $100,000. Something like $54,000 was borrowed from the same trustee company and half of the balance of what turned out to be some $43,000 had eventually to be found by the taxpayer, or more strictly by the taxpayer and his wife. To complete the factual resume, the taxpayer in settlement of his own purchase of the B unit assumed the obligations of the mortgagor under the existing mortgage to repay the principal sum of $13,000 and paid the balance effectively remaining due under the contract from his own funds.

3. We have taken time to consider this matter but there is in our opinion no way in which the taxpayer can succeed in his claim. The point is in our opinion clearly covered by authority, principally by what was said in
F.C. of T. v. Munro (1926) 38 C.L.R. 153, and by

---

ATC 415

what was said by Board of Review No. 1 in Case B11
70 ATC 46. We can add nothing useful to what was said in para. 10 of the joint reasons of the Board at p. 49 of the Report:

``As we see it, an outgoing incurred for interest on borrowed money is related directly and only to the principal in respect of which it is payable. Interest is in the nature of payment for use of the principal. Interest only comes into existence on account of the principal, and if interest can be said to be `incurred in gaining or producing the assessable income' (sec.51) it can only be so related through the principal on which it is paid. Whether, in any particular case, interest is incurred in gaining assessable income must logically depend on the use to which the principal is put (see
12 T.B.R.D. Case M13 and
14 T.B.R.D. Case P23).''

4. We respectfully adopt this reasoning and find that the use to which the principal was put in this case was the purchase of a private place of residence for the taxpayer. The interest paid to service that principal was thus private expenditure, and not incurred in gaining or producing assessable income.

5. For the taxpayer it was urged that the question was one of purpose, so that if, as we would be prepared to find, the taxpayer's general purpose, in the sense of motive, was, as part of the various arrangements into which he entered at this time, to provide funds for an income producing activity, then the taxpayer's claim should not fail because of the mechanics of the way he had gone about the transaction. By this it was meant that if the taxpayer had paid for the B unit outright as originally intended and then raised a loan of money for use in the income producing activity upon the security of the B unit, all would have been well. No doubt this is true, and it is well established that the nature of the security given for the loan is irrelevant (see Munro's case supra). But we have the greatest difficulty in seeing how such a test of purpose could be applied. Let it be supposed that a man borrows money to purchase a house for the purpose of using it as a residence. To effect the purchase he mortgages the property, the sum so raised to be repaid within three years. He occupies the house for one year and then lets it. The interest is not deductible in the first year but is deductible in the succeeding two, not because of any question of purpose but because in one year the loan was employed for a private purpose and in the later two it was used for the production of income.

6. The taxpayer's counsel sought to distinguish Munro's case (supra) upon the ground that the taxpayer there had a rent producing property and wishing to incur expenditure of a non-income producing character obtained a loan upon the security of the rent producing property. A number of Board decisions in which taxpayers had failed were sought to be distinguished upon the basis that in them the income producing asset was already owned and nothing had to be done so far as that income producing asset was concerned, and the money was not used in any way for that income earning asset. It was then said that this element of afterthought was entirely absent in the present case, in which the taxpayer at the inception of the transaction borrowed the money not because he needed it to complete the private transaction involving purchase of a dwelling for himself, but because he wanted funds for the contemplated non-private transaction. Only Case B11 (supra) was said possibly not to be distinguishable on this basis.

7. Having considered these submissions, we remain of opinion that the taxpayer's claim must fail having regard to the fact that upon an analysis of the legal character of the transaction the principal sum was in fact applied to no other use than to complete the purchase of the B unit, the use of which in the two years in question before us was personal occupation by the taxpayer and his family.

8. We would not wish to add to the discussion that has occurred from time to time over the distinction between ``purpose'' and ``motive'', but we cannot refrain from observing that in the present context the word ``purpose'' may be unnecessary and misleading. If ``purpose'' in the sense of ``motive'' be the test, the most casual connection between the interest payment and the income producing activities might be found to be sufficient, and in our opinion quite wrongly so. If ``purpose'' be used however only to describe the use to which the principal is put, it is surely better simply to say so and to avoid the use of the word ``purpose'' altogether.

9. Reliance was placed upon the decision of Board of Review No. 1 in
(1963) 14 T.B.R.D. Case P23. That Board saw no inconsistency between its decision in that case and its own

---

ATC 416

decision in Case B11 (supra), for in para. 10 of its reasons in the latter case, set out above, it expressly referred to Case P23 (supra). We need only say with great respect that we repeat our agreement with everything that was said in Case B11 but that we have reservations about the decision in Case P23 (supra) upon this point.

10. In our opinion the decisions of the Commissioner upon the portion of the objections before the Board were correct, and the amended assessments should be confirmed accordingly.

Claims disallowed