CASE 63/96

Members:
BH Pascoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 23 October 1996

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BH Pascoe (Senior Member)

This is an application for review of a decision of the respondent to disallow objections to assessments of income tax based on income of the applicant for the years ended 30 June 1993 and 1994. In each of these years the applicant had disclosed in his return of income a half share of the net loss or net income from property jointly owned with his wife. In his objection to the assessments he contended that

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ATC 580

the whole of the interest expense incurred was an allowable deduction against his assessable income in lieu of the one-half claimed in the return.

2. At the hearing, the applicant was represented by his father-in-law, a former officer of the Australian Taxation Office, now retired. The respondent was represented by two officers of the respondent. Prior to the hearing the parties provided an agreed statement of facts. On the basis of this statement, I make the findings of fact set out in the following four paragraphs.

3. The applicant is an employee of a major Australian bank and has been since 1974. In 1983 a block of land was purchased in Melbourne by the applicant and his wife as joint tenants. A house was built on the block and occupied as their residence by the applicant and his wife. Funding for the property was provided from savings and from loans from the applicant's employer bank. In 1985 borrowings were consolidated into one housing loan from the bank. The loan was in the joint names and on a basis of interest only. As at April 1992 the principal amount of the loan was approximately $84,000.

4. In April 1992 the applicant transferred to Adelaide with his employer bank. Initially, accommodation in Adelaide was in a rented property and the house in Melbourne was rented out to tenants. In March 1993 the applicant and his wife purchased a house in Adelaide. At that time further loans were taken out with the bank. The loan with which this application is concerned was for $148,000 for twelve months with interest only payable. This loan was in the sole name of the applicant and secured by mortgage on the Adelaide house and guarantees by the applicant and his wife. In March 1994 and March 1995 the loan was renewed for a further twelve months on the same terms other than the rate of interest. From the proceeds of this loan $36,000 was used as a contribution to the deposit on the Adelaide house and the balance used to re-finance the borrowings relative to the Melbourne house.

5. Between May 1992 and July 1994 the applicant and his wife dealt directly with the tenants of the Melbourne house and did not engage the services of any third party. In July 1994 an estate agent was engaged to manage the letting of the property. The property was sold in October 1995.

6. In the returns of income of the applicant and his wife the following amounts relative to the Melbourne property were disclosed:

``                            Applicant    Wife
Year ended 30 June 1993
  Gross rent                    4,680     4,680
  Interest deduction            2,054     2,054
  Other rental deductions       1,853     1,853
                                -----     -----
    Net Income                    773       773
                                -----     -----

Year ended 30 June 1994
Gross rent                      3,780     3,780
Interest deduction              6,529     6,536
Other rental deductions         1,482     1,475
                                -----     -----
Net loss                       (4,231)   (4,231)''
                                -----     -----
      

After the issue of notices of assessment based on the returns lodged, the applicant objected on the grounds that the total interest paid from 1 March 1993 on the borrowing in his name, and for which he was solely responsible and paid out of his own funds was deductible against his income. It was accepted that the gross rental and other expenses should be apportioned equally between the applicant and his wife. It was agreed between the parties that the total interest incurred in the year ended 30 June 1993 was $6,518 rather than the $4,108 claimed as $2,410 had been omitted inadvertently. It was agreed also that the interest amount in dispute from 1 March 1993 was $2,173 in respect of the

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ATC 581

year ended 30 June 1993 and $13,050 for the year ended 30 June 1994.

7. At the hearing the respondent contended that the amount of interest on the loan applicable to the $36,000 used as part of the purchase price of the Adelaide house represented private expenditure and only interest on the balance of $112,000 related to the Melbourne rented property. This was conceded for the applicant. It was not clear why interest on $112,000 was considered appropriate when the agreed statement of facts stated that the outstanding balance of the loan which was replaced by the 1 March 1993 loan was approximately $84,000. How the difference of $28,000 was used in relation to the Melbourne property was not made clear. Nevertheless, the respondent did not seek to argue this question and was prepared to regard $112,000 as being the amount of funds borrowed relative to the rented property. The result of these concessions is that the amount of interest in dispute is $1,644 for the 1993 year and $9,876 for the 1994 year. These figures represent 112/148 of the amounts shown in the preceding paragraph.

8. For the applicant, it was submitted that the whole of the interest in dispute was an allowable deduction to the applicant alone, in that he was legally obligated to pay the whole of the interest and did so pay it. It was said that the applicant's net income should be calculated by bringing to account a half share of the jointly derived rental income, a half share of the expenditure for which the parties were jointly liable and the total amount for which the applicant was personally and solely liable. It was argued that previous decisions of the Courts and the Tribunal such as
FC of T v McDonald 87 ATC 4541, Case 12/95,
95 ATC 175 and Case X48,
90 ATC 384 related to joint owners and joint liability for expenditure. Here, it was said, the applicant alone incurred the disputed interest expenditure.

9. For the respondent it was submitted that the applicant and his wife, as co-owners of rented property, were deemed to be partners under section 6 of the Income Tax Assessment Act 1936 (``the Act'') but it was not a partnership under general law. As such, each deemed partner was required to include in assessable income his or her net interest in the deemed partnership income according to the legal interests in the property. It was said that the applicant's wife had an equitable obligation to meet her share of the mortgage interest and the payment of the whole of the interest by the applicant leads to the presumption that 50 percent of that interest was incurred for the private purpose of making a gift or a loan to his wife.

10. Some time was spent in both submissions on whether it could be said that the applicant and his wife were in partnership in a general law sense or, as co-owners of property, deemed to be a partnership pursuant to section 6 of the Act as persons in receipt of income jointly. Whilst this question could be seen to be relevant to the decisions in cases such as McDonald and Case X48 (supra) which were sought to be relied upon or distinguished, I doubt that the distinction is relevant in this case. Both those cases involved the question of whether the co-ownership of a property constituted a partnership in general law so as to allow the partners to agree to an apportionment of profits or losses on a basis different from their share of the beneficial ownership of the property from which rental income was derived. Here there was no suggestion that the sharing of gross rental, or the expenditure other than interest, should be shared other than equally. The applicant sought to find some support from the decision in
FC of T v JD Roberts and FC of T v Smith 92 ATC 4380. However, here there was no suggestion of the partnership borrowing funds in order to repay capital of the partners. It was a matter of one of the co-owners borrowing funds. Although I do not see that this case turns on whether the relationship was one of partnership under general law, I do find that this relationship was not a partnership as such but simply one of co-ownership of real estate. There was a mere investment in property where the parties could not be said to have been carrying on a business. The very limited personal involvement as absentee landlords could hardly be described as business activities. In this matter I have no difficulty in arriving at the conclusion that there was no relationship which subsisted between the applicant and his wife which could be described as carrying on a business in common. There is nothing in this case which allows it to be distinguished from McDonald, Case 12/95 or Case X48 (supra).

11. In my view, this does not necessarily mean that, as co-owners and persons in receipt of income jointly and, therefore, a deemed

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ATC 582

partnership for tax purposes, every expense relative to that co-ownership, no matter by whom incurred or paid, must be first brought to account in arriving at the net income of the partnership for the purposes of section 92 of the Act. For example, it would seem that where two people agree to jointly purchase a property for rental purposes and one borrows money solely for the purpose of contributing his or her share of the purchase price, then the interest on that borrowing would be an expense of the borrower and deductible from his or her share of the net rental income. It would not be appropriate that such interest be required to be taken into account in arriving at the net income of the partnership. On the other hand where the parties jointly incur an expense related to the property as a whole such as rates, insurance and interest on borrowings to fund the joint equity, such expenses must be taken into account in arriving at the net income of the partnership notwithstanding that the payment of the expense was made by one of the partners only (see the decision of the Board of Review, cited as Case C66,
71 ATC 297).

12. Consequently, the decision in this case depends upon the answer to the question of whether the interest incurred by the applicant was an expense of deriving his interest in the net income from the joint ownership or whether it was an expense of the joint owners in deriving the rental income and to be taken into account in arriving at the net income of the partnership. Here, I find that it is the latter. It is clear that the test for deductibility of interest paid on borrowed funds is the purpose of the borrowing and the use to which the borrowed funds are put. As said by Hill J in Roberts and Smith (supra) at page 4388:

``... As the cases, including
Kidston Goldmines Ltd v FC of T 91 ATC 4538, all show, the characterisation of interest borrowed will generally be ascertained by reference to the objective circumstances of the use to which the borrowed funds are put.''

In this case the applicant borrowed these particular funds partly to provide a deposit on a private residence in Adelaide and partly to repay existing joint borrowings relative to the Melbourne house. The original borrowing which this replaced was taken out jointly to fund the joint interest in the property. Consequently, the later borrowing which was used to repay the earlier was also a borrowing to fund the joint interest, not the interest of the applicant alone. The result is that the amounts of $1,644 in respect of the 1993 year and $9,876 for the 1994 year are not allowable deductions to the applicant but to be taken into account in arriving at the net income of the partnership of himself and his wife. This means that the assessable income of the applicant in each of the years should include his individual interest in the net income of the partnership as follows:

Year ended 30 June 1993
  Gross rent                          9,360
  Other rental deductions             3,706
  Interest deduction
    Joint Loan               4,345
    Applicant Loan           1,644    5,989
                             -----    -----
      Net Loss                          335
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  Applicant's half share                168
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Year ended 30 June 1994

  Gross rent                          7,560
  Other rental deductions             2,957
  Interest deduction                  9,876
                                      -----
      Net Loss                        5,273
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  Applicant's half share              2,636
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ATC 583

The result is that the applicant's taxable income for 1993 should have been $941 less than that returned and assessed but taxable income for 1994 should have been $1,595 greater than that returned and assessed. These variations arise from the inclusion of an omitted interest claim in 1993 and the reduction in the interest claimed by exclusion of that proportion which related to the $36,000 of borrowings used for private purposes. Consequently the decision under review in relation to each of the years should be varied to give effect to these variations.