Case Q56

Judges:
KP Brady Ch
JE Stewart M
DJ Trowse M

Court:
No. 2 Board of Review

Judgment date: 1 July 1983.

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K.P. Brady (Chairman), J.E. Stewart and D.J. Trowse (Members)

The references arising for our consideration in this case were, by consent, heard together. They concern the years of income ended 30th June 1977, 1978 and 1979, and raise for our decision the question of whether amounts of procuration fees shown as income in the accounts of the taxpayer, a credit union as defined in sec. 23G(1) of the Income Tax Assessment Act, lodged with the returns of income for those years are in substance fees of that kind and assessable income in accordance with sec. 25(1) and 26(h) of that Act. In the alternative, the references raise the question of whether the fees are in substance interest and therefore exempt income under sec. 23G of that Act. If we should find that those amounts are procuration fees and not exempt income, the further question arises as to whether the deductions from assessable income allowed by the Commissioner in arriving at taxable income for the years ended 30th June 1977, 1978 and 1979, should be increased to allow further amounts based on calculations that were said by the taxpayer to more correctly relate outgoings to the fees derived. It was common ground that the taxpayer was a ``credit union'' for the purposes of sec. 23G of the Act.

2. In arriving at the assessable income for each year, the Commissioner excluded under the provisions of sec. 23G(2) interest that was received by the taxpayer in respect of loans to members. Bad debts recovered in the 1977 and 1978 income years were also excluded from the assessable income of those years.

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The Commissioner included in the assessable income of each of the years interest received from investments, procuration fees and, as an additional item in the 1979 year, profits obtained on the disposal of fixed assets. The taxable income for each year was determined by the Commissioner first, by identifying expenses that could be related (albeit indirectly) to the derivation of assessable income (including the procuration fees). Using this approach, the Commissioner deducted from the total of receipts expenses that related to member loans (viz. bad debts and loan collection costs and protection insurance), expenses not allowable under the Assessment Act and statutory deductions that related to superannuation. The net amounts thus calculated were regarded by the Commissioner as being the total deductions that were available for apportionment against the assessable income for each year.

3. As a second step in the determination of taxable income, the apportionable totals were reduced by the application of a formula that proceeded on the basis that (net) allowable deductions equalled assessable income over total receipts multiplied by the apportionable amounts. Finally, in determining taxable income, the Commissioner deducted from assessable income the sums of allowable deductions thus calculated and the statutory deductions referred to earlier.

4. The taxpayer objected to the assessments in issue in identical terms. As already indicated, the principal grounds were that procuration fees were essentially interest and exempt from income tax. In its subsidiary grounds concerned with deductions from those fees (if assessable), the taxpayer claimed that proportionate amounts in respect of wages paid to loan officers and in respect of printing costs, in addition to the whole of the stamp duties paid on loans and also registration expenses, should be regarded as expenditure directly related to the derivation of the fees and allowed as deductions against them. The claims concerning what the taxpayer regarded as direct expenditure introduced a further step in the process of determining taxable income; the claims did not eliminate the application of the formula referred to earlier, but reduced the apportionable amounts to be multiplied under it, with the consequence that the amounts calculated under the formula are less than the amounts calculated by the Commissioner.

5. The taxpayer's claims challenge the basis of the Commissioner's approach in his first step in determining taxable income, of deducting only the sum of amounts relating to bad debts, collection costs and protection insurance that concern member loans (putting aside expenses not deductible under the Act and statutory amounts) from the total of the amounts shown against the various items in the accounts and disregarding what might be regarded as direct expenses. Accepting that the taxpayer's claims represent outgoings to an extent to be determined for the purposes of sec. 51 of the Act, the question raised for our consideration, as indicated earlier, is whether the taxpayer's calculations are correct.

6. We consider that it is not helpful to an understanding of the matters raised by the claims to include details of the complex calculations that are necessary to show that they produce an excess of outgoings over procuration fees received in each year with the consequence that, if accepted by us, no amounts in respect of fees should be included in the assessable income of the years in issue. Similarly, we do not consider it helpful to include details of calculations that were submitted to us by the taxpayer's representative concerning the year of income ended 30th June 1977. While the latter calculations were of some assistance in gaining an insight into the submissions put for the taxpayer, they were based upon amounts that appear to be unreliable because, first, they contain a transpositional error, secondly, they include an amount in respect of an item not included in the grounds of objection and, thirdly, they include an amount in excess of the amount relative to an item that was included in the grounds of objection. However, those calculations do provide support for the conclusion that no amount in respect of procuration fees would be assessable in the 1977 year if the taxpayer's claims concerning deductions were to be accepted. Also, in this matter, we accept counsel's assurance that similar calculations, if made, in respect of the two succeeding years would produce similar results.

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7. The taxpayer objected to the Commissioner's disallowance of its claims and, upon those objections being disallowed, the matters have come before this Board for review. At the hearing, the Commissioner was represented by counsel and, as indicated earlier, so was the taxpayer.

8. It appears that the principal business of the taxpayer in the relevant period was to lend moneys to members essentially from moneys borrowed from fellow members. It seems that procuration fees (statutorily sanctioned under relevant State law) were first levied by the taxpayer in 1974 at a time when, in the particular State concerned, there were severe statutory constraints on the upper levels at which interest could be charged in the area of personal loans. It seems also that, although the statutory constraints on interest charges were abolished in 1976, procuration fees, as a matter of administrative convenience said to be associated with computer operations, were continued as a charge until they were abolished in the latter part of 1979. It appears that, throughout the 1977, 1978 and 1979 income years, the fees were levied at the rate of 1½ per cent of the amounts of the loans advanced to members and that the rate was increased to 2½ per cent after that time and before the fees were discontinued. It seems that the procuration fees were levied as service charges in respect of the establishment of new loans to cover the costs of such matters as processing applications, creating loan files and preparing the necessary securities, etc. It also seems that the fees to be paid by members could either be added to the amounts borrowed and paid over the loan period, or paid separately by borrowers at the times at which the loans were granted. Procuration fees were not subject to adjustment where loans were repaid before the expiration of the period for which they were granted. The loan application forms in use during the relevant period, and required to be filled out by intending borrowers, stated clearly that applications were subject to a 1½ per cent procuration fee; the forms also required applicants to indicate the desired method to be used for payment of the fees. From the loan repayment schedule set out on the application forms, and from the terms of the written agreements required to be signed by borrowers at the time of obtaining loans, it is apparent that it was both the intention and practice of the taxpayer and borrowers to distinguish between procuration fees as such and interest on loans that was to be payable at rates that were determined by the taxpayer from time to time.

9. In the matter of interest, it appears that for some time before 1974 the maximum rate permitted by statute to be charged in the circumstances of the present case was 10 per cent per annum. It also appears that, in 1974, the maximum rate permissible was raised to 15 per cent per annum, and that in 1976, as already indicated, the statutory constraints on the level at which interest might be charged were abolished. The interest rates charged to members in each of the three years in issue were as follows:

• 13.8 per cent per annum reducible for personal loans, which were said to include the major part of the taxpayer's lending activities.
• 11.75 per cent per annum reducible for housing loans.
• 12 per cent per annum reducible for bridging loans.

10. Finally, in the matter of evidence, it was agreed between the parties that certain nominated amounts (mainly estimates based upon arbitrary divisions of activities) should be treated by us as the amounts of direct expenses correctly allowable in respect of wages, printing, stamp duty and registration expenses if we were to conclude that expenses under those headings, either because of their intrinsic nature or because of the circumstances that gave rise to them, identify themselves as being directly related to the procuration fees received by the taxpayer. However, the documentary evidence and the evidence of the only witness called for the taxpayer, the present manager and former secretary, do little to assist us in determining whether those particular items should be regarded as having the status indicated. We consider that the evidence overall, together with the inferences that might be drawn from it (in so far as the expenses are concerned), establish little more than that, while the work concerned with the establishment of loans might be greater than that undertaken in monitoring and controlling the repayments

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of loans, it is not possible to quantify the costs associated with each type of activity.

11. In his submissions in support of the claims that the procuration fees were essentially interest, and therefore exempt income under sec. 23G, the taxpayer's representative appeared to rely, first, upon the proposition that commercial and economic considerations dictated that from about 1974 the taxpayer should take action to increase its returns from borrowers in relation to moneys lent and, secondly, upon the proposition that, having regard to the statutory constraints imposed in relation to interest levels, it was only possible in the taxpayer's particular type of business to achieve that result (and at the same time avoid an infringement of the relevant State law) by keeping its interest rates within the prescribed levels and, at the same time, by introducing new charges (to be called procuration fees) that were, however, essentially added amounts of interest under a different name. In our understanding, the representative did not challenge the proposition that the amounts in issue, if properly to be regarded as procuration fees, should be included as part of the taxpayer's assessable income under the provisions of sec. 25(1) and 26(h) of the Act.

12. We accept that sound business reasons gave rise to the need for the taxpayer to increase its overall receipts in 1974 and in subsequent years. However, the evidence does not support the proposition that for that purpose the taxpayer intended to, or sought to, circumvent the relevant State legislation by the unsophisticated method of simply calling receipts that were said to be essentially interest by another name. On the contrary, the evidence indicates that, even if there were a need at some time (which we do not accept as having been established) to disguise the true nature of part of the taxpayer's receipts as a necessary adjunct to maximising them, that need ceased to exist as a compelling force in 1976 when controls on interest rates were removed. We do not consider that administrative inertia or convenience (whether or not associated with computer programming difficulties) is an acceptable explanation for the receipts in the years concerned to be continued to be called procuration fees if in fact they were receipts in the nature of interest. If, on the other hand, the receipts were essentially procuration fees, we do not think on the authorities that their true nature is capable of being changed because of the explanations adverted to or because of a change in the nomenclature used to describe them.

13. The Income Tax Assessment Act acknowledges that a distinction exists between receipts that are procuration fees and receipts that are interest. As already indicated, the significance of the distinction for present purposes lies in the fact that procuration fees must be included as part of the taxpayer's assessable income even though it is a ``credit union'' for the purposes of the Assessment Act. Such fees received from members form part of assessable income, whereas amounts received from members by way of interest do not fall to be included as assessable income. However, the Act does not provide any guidance as to which category of income the receipts should fall into, with the consequence that, in the absence of direct authority concerning these matters from an income tax viewpoint, we must determine their true nature by having regard to general principles and the ordinary dictionary meaning of the relevant words contained in the Assessment Act.

14. The Shorter Oxford Dictionary (3rd ed.) gives the meaning of the term procuration fee as the fee paid for the procuring of a loan for a client; the Concise Oxford Dictionary gives a similar meaning to the term. From Words and Phrases Legally Defined (2nd ed.) it appears that, at least for the purposes of Australian criminal law, the meaning in general of the word ``procure'' imports ``effort, care, management, or contrivance towards the obtaining of a desired end''; in New Zealand, when considered for similar purposes, it appears that the word ``procures'', when used in its ordinary meaning, means ``obtains, arranges or agrees to supply''. Having regard to the dictionary meanings that might be attributed to the term procurement fee and the legal technical meanings of the words ``procure'' and ``procures'' adverted to above, it seems to us, based upon the application of general principles to the evidence, that the fees paid by members to the taxpayer fall naturally within the meaning of the words ``for procuring a loan[s] of money'' contained in sec. 26(h) of the Act. As indicated earlier, the

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taxpayer and members, first, as applicants for loans and, subsequently, as borrowers, were fully aware of the circumstances and conditions attaching to the grant of loans and of the method and nature of the repayments that were required to be made in connection with them. Clearly, in our opinion, the taxpayer sought to obtain fees from its members as a reward for its services in obtaining, managing and controlling funds (both before and during the life of loans) that were supplied in part at least in the form of loan moneys; upon the grant of loans, members paid amounts as fees that were separate and distinct from interest and were essentially monetary rewards for services of the above kind that were rendered by the taxpayer. We do not consider, as appeared to be suggested for the taxpayer, that the character of the fees underwent a change in some material way because the transactions involved only two parties, viz. the taxpayer and a member, and not a third party who in other circumstances might arrange a loan and be the recipient of a fee for services rendered.

15. Having regard to the conclusions that we have reached on the evidence, we do not find it necessary here to traverse the many authorities concerning the meaning of interest that we were referred to by both parties. However, we consider it desirable to refer to some features that are said to determine the character of receipts as interest for the purpose of providing a basis for distinguishing receipts that we see to be procuration fees from receipts in the present case that are essentially interest and not in dispute. As a starting point in this examination, we observe that the Concise Oxford English Dictionary defines ``interest'' as money paid for use of money lent or for forbearance of debt. In Halsbury's Laws of England (4th ed.) it is stated that ``interest (in general) is the return or compensation for the use or retention by one person of a sum of money belonging to or owed to another''. From these definitions and from the many English decisions that have examined the characteristics of interest from a tax viewpoint, it appears to be generally accepted that, in essence, interest is a payment for the use of money (by inference over a period of time) or is compensation for being without money and that it is calculated by reference to the time for which the money is used or the time for which the person owning the money is deprived of its use. In
Re Euro Hotel (Belgravia) Ltd. (1975) 51 T.C. 293 at p. 301 (also reported (1975) 3 All E.R. 1075 at p. 1083), Megarry J. described the position adequately for present purposes where he said that:

``It has, quite rightly, not been suggested that the language used by the parties to an instrument in describing payments to be made under it can bind the Inland Revenue, or affect the operation of a statute. The question must always be one of the true nature of the payment. The language, of course, is important, for the words used may mould or affect the nature of the obligation; but one must always return to a consideration of what, given that language, the payments made under the obligation truly are: are they `interest of money' within the meaning of the statute?

The relevant sense of the word `interest' as given in the Shorter Oxford English Dictionary, 3rd ed. (1944) at p. 1026, is `Money paid for the use of money lent (the principal), or for forbearance of a debt, according to a fixed ratio (rate per cent)'. A similar idea is conveyed by the language used in certain authorities. In
Bond v. Barrow Haematite Steel Co. (1902) 1 Ch. 353 at p. 363, a case on company law, Farwell J. said `Interest is compensation for delay in payment'; and he said that the term could not accurately be applied to a share of the profits of trading, though it could be used as `an inaccurate mode of expressing the measure of the share of those profits'. In
Bennett v. Ogston (1930) 15 T.C. 374 at p. 379, an income tax case on the expression with which I am concerned, `interest of money', Rowlatt J. said that `interest' was `payment by time for the use of money'.''

It is to be observed that in the extract cited Megarry J. apparently accepted the principles contained in the observations made by Rowlatt J. in Bennett v. Ogston and that, in deciding in the case before him that payments were not interest on loans but payments for non-performance of other obligations, he emphasised at T.C. p. 302;

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All E.R. p. 1085 that ``the payments are not payments by time for the use of money but payments by time for non-performance of... obligations'' (emphasis added). It appears to be implicit in the reasoning of Megarry J. (and in other cases brought to our attention, e.g.
Westminster Bank Ltd. v. Riches (1947) 28 T.C. 189) that interest charges must be related to periods of time and to the use of money for that time.

16. While in the present case the fees were calculated at the rate of 1.5 per cent of the principal sums loaned, so that there was a relationship between the fees and the amounts borrowed, there was not, as was the position with the interest charges, any relationship between the basis upon which the fees were calculated and the periods of time for which the loans were granted. As indicated earlier, the fees were payable at the same rate whatever the periods of the loans might have been and whether or not they ran their full course. The fees paid bore no relationship to the periods during which the moneys were used by the borrowers or during which the taxpayer was deprived of the use of its funds. In this connection, we do not consider that the method of payment of the fees, whether paid in a lump sum on obtaining the loan or paid over a period of time, is determinant of the true nature of the fees or is evidence that they were in the nature of interest. Likewise, we do not consider that statutory limitations on the rates at which interest charges could be made (whether or not they provided the historical reason for the introduction of the fees in the present case) or definitions of the term ``interest'' that might give an artificially widened meaning to the term for the purposes of State Lending of Money Acts or for similar legislation, are of assistance in determining for present purposes the true nature of interest and of the fees in issue. As already indicated, we consider that, on the evidence and the principles that we consider to be applicable, the fees in issue were essentially procuration fees and were not interest.

17. Finally, we turn to the question of whether expenses might be apportioned on the basis submitted for the taxpayer. We think not. We are satisfied on the evidence that the taxpayer's actions in making loans to its members were for the dual purposes of earning procuration fees and, secondly, the earning of interest. We do not think that the evidence supports the proposition that any particular item of expenditure or any particular part(s) of the total expenses incurred by the taxpayer were directly related to the earning of procuration fees if only for the reason that all of the expenses, or at least the greater part of those that arise for consideration in connection with this submission, would probably have been incurred whether or not those fees were payable by members. While it appears that the fees were directly related to the taxpayer's actions in establishing loans (and not with the use of the loan moneys over time), it is not a necessary corollary of that position, in our opinion, that the expenses associated with those actions relate only to them and not equally to the continuing administrative actions required to be undertaken in connection with obtaining, managing and controlling funds generally, including the establishment of loans without which interest would not have been derived. As indicated earlier, we do not think that the calculations submitted for the taxpayer concerning an alternative basis for determining allowable deductions for the 1977 year are reliable (see para. 6); in any event, the calculations are incomplete in that they do not extend to the subsequent two years in issue. Further, they fail to show what the amounts of the taxable incomes for the years in issue would be if losses calculated with reference to procuration fees were properly to be allowed as deductions against investment income (and profits in the 1979 year) that would appear to have been correctly included in assessable income by the Commissioner. In the High Court case of
Adelaide Racing Club Inc. v. F.C. of T. (1965) 114 C.L.R. 517, Owen J. had to consider the application of a formula used by the Commissioner in that case to ascertain the apportionment figure allowable as a deduction from assessable income. The formula considered by his Honour in circumstances where, as in the present case, apportionment of expenses was necessary, appears identical to that used in the present case and gave rise to the following comments (at pp. 525-526):

``In a case such as this, the Commissioner is faced with a difficult problem. Section

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51 requires him to determine and allow as a deduction outgoings to the extent to which they are incurred in gaining or producing the assessable income. Where a taxpayer receives income part of which is assessable and part is not, he must dissect the expenditure and, to the best of his ability, estimate how much of it relates to the production of assessable income and how much to the production of non-assessable income. This the Commissioner did in the manner which I have sought to explain. Before me the method adopted by him was subjected to considerable criticism and several alternative bases were suggested by counsel for the Club. But they were, I think, at least equally open to criticism and produced varying results. It is unnecessary to detail the alternatives put forward on behalf of the Club or the various criticisms made of them. The Commissioner made what he regarded as a just apportionment of the Club's expenditure, allocating against assessable and non-assessable income respectively the proportions of that expenditure that seemed right and I am not satisfied that the course he followed was wrong or that the resulting assessment, except in so far as it related to the deductions claimed under sec. 88(2), was excessive.''

18. Likewise, in the present case, we are not satisfied that the Commissioner's calculations of allowable deductions, made for the purpose of arriving at the taxable incomes in issue, were wrong. Further, we are not satisfied that the taxpayer has presented a satisfactory alternative basis (allegedly fairer or more just) that should be used to calculate figures allowable as deductions from assessable income in the process of arriving at taxable income. In the circumstances, we do not think that the taxpayer has discharged the onus imposed upon it by sec. 190(b) of the Act of proving that the assessments in issue are excessive.

19. For the above reasons, we would uphold the Commissioner's decisions on the objections and confirm the assessments in issue.

Claims disallowed