CASE 51/97

Members:
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 28 November 1997

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KL Beddoe (Senior Member)

In application QT96/255 the applicant seeks review of an objection decision notified on 19 June 1996 in relation to an amended assessment of income tax for the year of income ended 30 June 1992 (``1992 year'').

2. Application QT97/179 relates to review of an objection decision notified on 29 May 1997 in relation to an amended assessment of income tax for the year of income ended 30 June 1994 (``1994 year'') and application QT97/180 relates to review of an objection decision in respect of the year of income ended 30 June 1995 (``1995 year'').

3. Section 14ZZJ of the Taxation Administration Act 1953 operates to require these reasons for decision to be framed so as not to be likely to enable identification of the applicant. I have therefore adopted misnomers in relation to persons and real property at the heart of some of the issues so as not to identify the applicant.

4. At the hearing Mr West represented the applicant and Ms Holmes appeared for the

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respondent. The documents filed pursuant to s 37 of the Administrative Appeals Tribunal Act 1975 are before the Tribunal as the T documents (``TT'' documents in QT97/179-180) and further documents were tendered and marked as exhibits. Oral evidence was given by the applicant and an associate of the applicant, both of whom were directors of a company I will call L Pty Ltd.

5. Three separate issues arise. In relation to the 1992 year the issues are:

• (a) whether interest charges incurred by the applicant in relation to funds on-lent to L Pty Ltd are an allowable deduction within the terms of s 51 of the Income Tax Assessment Act 1936 (``the Act''); and
• (b) whether a deduction is allowable in relation to a net rental loss of $12,802.00 incurred by the applicant in respect of real property which I will describe as Ophir Place.

6. For the 1994 and 1995 years the issue is whether a loss incurred in relation to development and disposal of real property I will describe as 70 Camelot Place is an allowable deduction in terms of s 51 of the Act. If I find that the loss is allowance then the quantum of the loss claimed is also in issue.

7. In relation to the 1992 year I make the following findings of fact. Document T7 is a copy of the applicant's income tax return for the 1992 year. It discloses the applicant's residential address as 68 Camelot Place and the previous postal address as Ophir Place. Income disclosed includes salary and wages income derived from a large corporation not relevant to these proceedings and $21,163 derived from L Pty Ltd. Rent received of $1,267.00 less deductions of $14,069.00 was also disclosed. There is no apparent link between the two companies other than the applicant being an employee of each company. However, the applicant is one of two controlling minds in relation to L Pty Ltd.

8. The applicant claimed a deduction for interest incurred on funds borrowed from arms length sources and on-lent to L Pty Ltd. The amount claimed is $13,826. No amount of interest was disclosed as having been derived from L Pty Ltd by the applicant and it has not been suggested that any amount of interest was paid by L Pty Ltd to the applicant.

9. Schedule 3 of Exhibit A is a spreadsheet schedule of ``deductible interest'' for the 1992 year. The evidence of D, who is a director of L Pty Ltd, and who was called to give evidence for the applicant, sought to establish certain facts. It appears L Pty Ltd was, in effect, a joint venture by D and the applicant which carried on business in two distinct arms of business activity:

• (a) property development; and
• (b) international marketing.

D and the applicant agreed on formation of the company that they would capitalise the company by way of loan funds provided by them as the directors of the company and with the expectation that the company would become profitable and distribute those profits by way of dividends. Loan funds were to be provided on a 50/50 basis so as to maintain equality.

10. In the event that the loans provided to L Pty Ltd by D and the applicant were in an imbalance situation then an adjustment was made to acknowledge the unequal amount by payment of interest to the extent of the unequal amount. As I understand the evidence, interest was to be paid on these loans only when the loans from the directors were in temporary imbalance. Also, as I understand the evidence, the company repaid directors' loans from time to time as projects were completed and sold but it did not pay any interest nor did it pay dividends from profits. Schedule 1 to Exhibit A is a spreadsheet summary of the company's development projects and directors' loans. That summary shows substantial imbalances in the directors' loan accounts inconsistent with the tenor of D's evidence-in-chief. As Ms Holmes demonstrated in cross-examination D really had very little idea, or he was not prepared to admit, as to what actually occurred to maintain equality between the loans made by the directors, nor did he seem to have any real understanding of the company's development projects. It became clear to me that D did not have a sound recollection or understanding of the operations of the company - I am unable to say which. However, at page 10 of the transcript the following exchange between D and Ms Holmes is recorded:

``Q. There was never any agreement with the company that it would pay interest on borrowings?

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A. No. Quite frankly, it didn't seem necessary at the time.

Q. Well...?

A. We just - you know - we just - I mean, we took a quite simple view to business, and that was that we were going to lend some money, and we were equal shares, and when the company became profitable we'd get paid dividends.

Q. If you thought that the company - if you genuinely thought the company might be profitable, why not reach some agreement that it would pay interest on the money borrowed by you?

A. It didn't occur to us to need to do that. We have known each other for a period of time. We - we had worked together previously in other jobs. We trusted each other. It wasn't necessary.''

I am satisfied, however, on the basis of the evidence that the directors initially made loans to the company in the expectation that the company would make profits to be paid to the shareholders as dividends. What is also clear from the evidence is that by the beginning of the 1992 calendar year the company had ceased the redevelopment type projects (TT22 and p 11 transcript).

11. Having heard the evidence of D about the above matters the applicant's explanation about the loan accounts referred to Schedule 1 of Exhibit A. That schedule appears to be a spreadsheet reconstruction of the applicant's interest in various development projects undertaken by L Pty Ltd. Certainly the schedule shows that D and the applicant generally contributed loan funds to particular projects on a 50/50 basis but it also shows that the balances of the directors loan accounts at 30 June each year were not in balance with each other, ie the same amount owing by the company to each director. The applicant said that adjustments were made from time to time by payment of interest personally and not by the company. There is no evidence of such payments in the documents including the applicant's income tax returns before the Tribunal.

12. When asked why interest was not charged on the loan to the company he said:

``We didn't consider it necessary. The company would have invoiced us; we would have paid money back to the company and then distributed it back to ourselves. There didn't seem to be any point being serviced by that at all.''

A fair reading of the response reveals that the answer was not responsive to the question although the applicant's representative did not seek to remedy this. I am satisfied, however, that the applicant, like D, lent money to the company on an interest free basis, and I so find.

13. I turn now to the facts surrounding the claim for deduction concerning the net rental loss in relation to the house originally at Ophir Place. The property was purchased by the applicant and his wife in June 1990 (the applicant said he purchased the property in June 1989) for $405,000.00 and thereafter used as their principal place of residence until February 1992 when they moved to 68 Camelot Place.

14. The house at Ophir Place was then said to hav been let to the applicant's brother-in-law as tenant. However, the arrangement for the occupancy by the brother-in-law did not include his quiet enjoyment of the property because the applicant was in the course of and continuing to make extensive alterations and improvements to the house. Exhibit B is a schedule of outgoings incurred in relation to Ophir Place for the period 29 June 1990 to 31 May 1992. The schedule shows outgoings totalling $24,648.05 incurred up to 11 June 1991 and a total of $1,763.00 incurred for the period 7 March 1992 to 31 May 1992.

15. Exhibit F includes a report by a registered valuer prepared for a bank and dated 27 June 1991. While the report was clearly for the purpose of establishing the value for the bank's purposes the report is valuable as an objective snapshot of Ophir Place in June 1991. The valuer's report includes the following paragraphs:

``The owner has completed extensive works since purchasing the property which include the removal of the previous exterior walls and reinstated the chamferboard to a quality presentation, new roof, new floor coverings, new external and internal painting, covered verandah to the front of the dwelling, the removal of the ensuite and subsequent creation of a third bedroom and the clearing of some vegetation that was limiting the river views.''

And later:

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``The property has undergone substantial works to increase its presentation. However, at the date of inspection works were still required to the subfloor and landscaping.''

16. On 11 June 1991 the applicant lodged an application with Brisbane City Council regarding removal of the dwelling at Ophir Place to 70 Camelot Place. By letter dated 25 July 1991 the City Council set out the conditions required to be satisfied before building approval would be given for the removed dwelling to be resited at Camelot Place.

17. In June 1991 the applicant purchased 68 and 70 Camelot Place upon which a single house was constructed and the two lots then constituted a single residential lot. The applicant and his wife applied for electricity connection for 68 Camelot Place on 9 July 1991 but power was subsequently disconnected in August 1991 for alternations/additions and a new service was effected later that month (Exhibit 2). The explanation for these electricity connections and reconnections is that the house on the two lots at Camelot Place was moved on to No 68 exclusively in August 1991 so that No 70 became a vacant block of land.

18. The applicant then undertook substantial renovations of No 68 Camelot Place. Those renovations were apparently completed, or sufficiently advanced, so as to allow the applicant and his wife to move from Ophir Place to 68 Camelot Place in February 1992 which thereafter has become their principal place of residence. However, I note that No 68 Camelot Place was subsequently put to auction on 11 July 1992, but passed in, and the property has been listed for sale since then with an estate agent until at least 3 June 1997 (Exhibit D).

19. The move of the applicant and his wife from Ophir Place to 68 Camelot Place left the former unoccupied and the applicant said he wished to use that property for rental purposes, at least in the short term, pending removal of the house to 70 Camelot Place. There appears to be some uncertainty at this point in time as to the future course of action but that was eventually resolved on the basis that the house at Ophir Place was to be removed to 70 Camelot Place before the permit issued by the Brisbane City Council expired as to time.

20. Document T14 is a record of interview signed by the applicant and dated 14 June 1994 which includes the applicant's explanation as to his intentions regarding the house at Ophir Place. Having directed the applicant's attention to this statement the following exchange occurred between Ms Holmes and the applicant at page 40 of the transcript (edited to maintain confidentiality):

``Q. Now, [applicant], we were at page 253 and I was asking you about these statements in this interview?

A. Mm.

Q. And that your intention was to live at Ophir Place for a period and then to build on that property and sell the house that was moved; is that what you told [...]?

A. Yes, essentially.

Q. And that a decision was made to rent out the property as soon as the decision was made to move, which was when the other house was purchased?

A. Yes. Question 2 you are talking?

Q. Yes, all right. And then if we come on through to a letter from you of - sorry, it may not be from you; if you come to page 278 from the accountants?

A. Which number?

Q. 278. I take it your accountands did what you asked them to, is that correct?

A. We had discussed this matter prior.

Q. All right. And they wrote letters and you were kept informed of what they were doing?

A. Yes, I did not see a draft of this letter.

Q. At no stage did you see it?

A. I saw the letter subsequent to it being sent.

Q. All right. Well, if you come to the second page, 279, there is a chronology there. It says that you acquired the property at Ophir Place as your principal place of residence, and would I be correct in thinking that you would have applied for stamp duty exemption on that basis?

A. Yes.''

21. Document T22 (including folio 279) is a copy of a letter by the applicant's accountants addressed to the Australian Taxation Office which includes a chronology of events seeking to explain the applicant's actions (see paragraph

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36). That document asserts that the applicant formed the intention in July 1991 that 68-70 Camelot Place would become the applicant's principal place of residence, subsequently defined as 68 Camelot Place. It also asserts that the applicant obtained approval to remove the house at Ophir Place on 18 October 1991 but on 15 February 1992, having moved to 68 Camelot Place, changed his mind and decided to use Ophir Place as a rental property. By 9 October 1992 he realised that the approval to remove the house was about to expire so he re-evaluated his options and caused the house to be removed to 70 Camelot Place. The removed house was restumped at 70 Camelot Place and let to tenants four weeks after removal.

22. The applicant now asserts that Ophir Place was acquired for the purposes of property development. This is an assertion which directly contradicts his earlier signed statement and the assertions of his accountants noted above.

23. In his notice of objection for the 1992 year assessment dated 23 November 1993 the applicant asserted that the house at Ophir Place ``was a very small, one bedroom, unfurnished, old style house in need of renovation and some repairs''. That assertion was made to justify the rental income of only $65 per week for a property which had been purchased for $405,000.

24. However, document T35 includes a copy of a valuation report addressed to GIO Australia by Egan Leggett Rogers and signed by a registered valuer. The report is dated 5 December 1991 (ie, before the Ophir Place property was let) and includes the following description of the improvements:

``3 BEDROOMS (2 BUILT-IN): LOUNGE: DINING ROOM: FAMILY ROOM: KITCHEN WITH BENCH CUPBOARDS, PANTRY, STAINLESS STEEL SINK WITH GARBAGE DISPOSAL, UPRIGHT ELECTRIC STOVE: BATHROOM WITH CERAMIC TILED FLOORING AND SEPARATE SHOWER CUBICLE, VANITY BASIN AND TOILET SUITE: FRONT AND REAR PATIOS .

INTERNAL STAIRS ACCESS RUMPUS ROOM: SHOWER AND TOILET: LAUNDRY WITH CERAMIC TILED FLOORING AND TUB AND CABINET.

A SINGLE GARAGE WITH TITL-A- DOOR [sic] IS ALSO UNDER HOUSE, WITH AN ATTACHED SIDE CARPORT PROVIDING FURTHER CAR ACCOMMODATION.''

and ``other improvements'' were described in the valuation as follows:

``FLOOR COVERINGS, CURTAINS, LIGHT FITTINGS, FANS, SOLAR HOT WATER SYSTEM, EXTENDING CLOTHES LINE, FULL AGGREGATE CONCRETE DRIVEWAY, CONCRETE CAR TRACKS, BOAT RAMP, INGROUND SWIMMING POOL WITH BRICK SURROUNDS AND FILTRATION SYSTEM. A RENOVATED HIGH-SET DWELLING WHICH APPEARS TO BE STRUCTURALLY SOUND. SOME MINOR RENOVATION WORK IS YET TO BE COMPLETED. NEW ROOFING AND FLOOR COVERINGS TOGETHER WITH INTERNAL PAINTING HAVE BEEN ADDED.''

The valuer fixed the value of the land and improvements at $425,000.00 and rental value at $405.00 per week. There is nothing before me that causes me to doubt the veracity of the valuation report and I therefore accept it as an accurate description of the property at Ophir Place as at December 1991 and as a reasonable expression of opinion as to the rental value of the property at that time.

25. It follows that I do not accept the assertions of the applicant as to the circumstances of the Ophir Place property at the time it was let to the applicant's brother-in-law for a rental of $65.00 per week.

26. As cross-examination of the applicant revealed that his assertions of fact did not accord with the facts gleaned from disinterested third parties I am forced to the conclusion that I should not give any weight to the applicant's evidence except in so far as it is corroborated by other evidence. In this regard I have also taken into account that the applicant did not call evidence from any person, including his spouse who, it might be reasonable to assume, would be in a position to corroborate the applicant's evidence. In this regard the statutory declaration of the applicant's brother-in-law attached to the notice of objection is so obviously wrong in fact that I am not satisfied that the deponent was a tenant at Ophir Place in the 1992 year or the 1993 year. After asserting that he rented the

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property from 15 February 1992 to 30 June 1992 he described the house as a ``small, unfurnished, one bedroom old-style stucco dwelling''. That is a description which the applicant conceded in cross-examination was not correct. The deponent also described the house as being in a run-down state from the previous owner - a statement that seems to overlook the fact that the applicant and his wife had apparently occupied the premises for 12 months after purchase from the previous owner. I am satisfied that the deponent, who was not called to give evidence, may have perjured himself when making the statutory declaration but I am unable to come to any firm conclusion about that. I have not given any weight to the statutory declaration.

27. I am satisfied, however, that the applicant deliberately set out to mislead the respondent in relation to the rental of Ophir Place and part of the deception was the tendering of the brother- in-law's statutory declaration. It follows that I cannot be satisfied that the brother-in-law was a tenant at Ophir Place or at 70 Camelot Place after the house was removed to that address.

28. I turn now to the issues arising in the 1994 and 1995 years. The respondent assessed the applicant's taxable income as $27,636.00 and notified the assessment in a notice of assessment issued on 29 August 1994. Notification of an amended assessment issued on 16 May 1995 wherein the taxable income was reduced to $27,168.00. Neither of those assessments was disputed by the applicant.

29. By notice dated 20 January 1997 the applicant's agent requested amendment of the assessment on the basis that ``property development business loss of $41,449.00 incorrectly included as capital loss''. The amended taxable income asserted was a negative amount of $14,281.00. It is that amount which was claimed as a loss carried forward which is the basis for a request for amendment of assessment for the 1995 year.

30. The respondent treated the requests for amendment as notices of objection, which they quite clearly are not, because the word ``objection'' has been crossed out on the respective standard form requests. Nothing was made of this before me and I have proceeded, not without considerable doubt, on the basis that the applicant may be taken to have concurred in the respondent's action of treating the requests for amendment as notices of objection. In this regard I refer to the respective applications for review in this Tribunal.

31. In a statement of facts and contentions lodged in the Tribunal on 1 July 1997 the applicant set out the issues in dispute as (edited):

``1. Whether a loss made with respect to the development and subsequent disposal of the property 70 Camelot Place is a loss deductible under section 51(1);

2. The correct calculation of the amount of any such loss.''

32. Unlike the notice of 20 January 1997 the statement of facts and contentions does not quantify the amount claimed. It does, however, refer to a schedule where the applicant's calculation shows the development loss as $74,431.21. That was, in fact, the third figure submitted to the respondent as the claimed loss.

33. The uncertainty about the quantum of the loss claimed is but one of several aspects of the claim that have not been properly explained to the Tribunal. Another is the fact of the claim being first raised nearly 2½ years after the original notice of assessment.

34. There was also no explanation about the fact of the jointly owned house at Ophir Place being removed to 70 Camelot Place into the applicant's sole ownership apparently without consideration. I suspect that the applicant had given little thought to this issue until it was raised by Ms Holmes during cross-examination. In this context I am satisfied that the house had been substantially renovated prior to removal from Ophir Place to 70 Camelot Place.

35. The applicant's confusion about the removed house is at the heart of the issue which arises for the 1994 (and 1995) year.

36. As also stated in paragraph 21, document T22 is a copy of a letter to the respondent written by the applicant's accountant dated 2 November 1994, ie, after the applicant's 1994 return had been assessed. That letter was said to be written on behalf of the applicant and dealt with the claims in dispute in the 1992 year. It set out the history of Ophir Place in these terms (edited to maintain confidentiality):

``18 June 1990

Applicant acquired the property at Ophir Place as his principal place of residence.

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8 July 1991

Applicant acquired another property at 68-70 Camelot Place. He intended at the time of acquisition to undertake renovations on that property and then take up residence there, making the property his principal place of residence.

18 October 1991

Pursuant to an application lodged by him, applicant was granted approval by the Brisbane City Council to remove the house from Ophir Place and relocate it to 70 Camelot Place.

15 February 1992

Applicant completed renovations of 68 Camelot Place and took up residence there. He also on this date decided not to proceed with the removal of the house at Ophir Place to 70 Camelot Place but instead resolved to use Ophir Place as a rental property for the foreseeable future.

8 October 1992

Applicant realised his approval from the Brisbane City Council to remove Ophir Place to 70 Camelot Place was due to expire on 18 October 1992. He re-evaluated his options with regard to that property. Due to changes in economic circumstances he decided to move the house from Ophir Place to 70 Camelot Place. The house was restumped in its new position and then rented out on a commercial basis approximately four weeks later.''

While that is a summary only it does lack accuracy in some aspects which will be apparent from these reasons. It is, however, relevant because it does not suggest, on a fair reading, that 70 Camelot Place was being developed for resale at a profit as part of what the applicant calls property development. What the applicant did, in fact, was renovate the existing house now located on 68 Camelot Place which was occupied as the principal place of residence from February 1992. That property was put up for auction in June 1992. An auction was conducted by Ray White, licensed auctioneers and estate agents, on 11 July 1992 but the property did not sell. No 68 has been marketed by Ray White since that time and at 3 June 1997 was still listed for sale (Exhibit D).

37. The applicant's evidence-in-chief at page 26 of the transcript indicates that it was the failure to sell No 68 which was the catalyst for going ahead with the removal of the house from Ophir Place to No 70 Camelot Place because of the applicant coming to the conclusion ``that I may have a better chance in selling that house, than the one I was living in'' (page 26 transcript).

38. By May 1993 the applicant (and his wife?) had put No 70 Camelot Place to auction (Exhibit D) and the property was eventually sold in December 1993 for $180,000.00.

39. The applicant said during the course of cross-examination that the property 68-70 Camelot Place was purchased as principal place of residence and declared as such to the Stamp Duties Office. In fact, No 68 has been the applicant's principal place of residence since February 1992 but he says it was never his intention that No 70 was also to be part of his principal place of residence - notwithstanding the declaration to the Stamp Duties Office and notwithstanding his evidence to this Tribunal that his intended ``long term'' principal place of residence was Ophir Place. When that property was purchased in May 1990 it was declared as such to the Stamp Duties Office.

40. The evidence establishes that the value of the renovated house at Ophir Place, as a removal house, was between $12,000.00 and $18,000.00 (Exhibit 2) while it had an in situ value of $25,000.00 at Ophir Place and an in situ value of $45,000.00 at 70 Camelot Place (TT36). The applicant's case is that the correct value for the house is its in situ value at Ophir Place which he puts at $50,000.00 plus cost of improvements at $26,411.51, being a total amount of $76,411.51 - subsequently adjusted to $75,000 (Exhibit E).

41. It is that variation in valuation, about which the applicant was carefully cross- examined, that explains what this case is really about. The applicant purchased 68 and 70 Camelot Place so that he could convert one residential property into two residential properties. The advantage he sought was to realise the in situ value of the house at Ophir Place rather than merely realise its value as a removal house. He could only achieve this by removing the house to another site and 70 Camelot Place became this site. By realising the in situ value of the house the applicant sought to reduce the overall cost of redevelopment of

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Ophir Place as the family home. That is made clear by the applicant treating the house as having an in situ value ($50,000.00 plus cost of improvements) rather than the much lower removal value when calculating the profit/loss on the purchase and sale of 70 Camelot Place.

42. I turn now to consider the issues. In relation to the 1992 year is the claimed portion of interest charges an allowable deduction within the terms of s 51(1) of the Act?

43. The applicant loaned moneys to L Pty Ltd from time to time to allow the company to carry on its business. The applicant obtained these funds by borrowing and thereby incurred interest. He did not derive interest from L Pty Ltd nor did he have any right to payment of interest in the future. He said he expected to derive income from the company. Although he derived salary income there is no evidence of other income being derived.

44. The decision of the High Court in
FC of T v Munro (1926) 38 CLR 153 is authority for the proposition that interest incurred on borrowed money secured on a rent producing property is not an allowable deduction where the borrowed funds are used for a non-income producing purpose.

45. Referring to general principles the fundamental test which must be met in this case is the test applied by the High Court in
Ronpibon Tin NL & Tongkah Compound NL v FC of T (1949) 8 ATD 431; (1949) 78 CLR 47 was expressed in these words at ATD pages 435-436; CLR pages 56-57:

``For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words `incurred in gaining or producing the assessable income' mean in the course of gaining or producing such income. Their operation has been explained in cases decided under the provisions of the previous enactments: see particularly
Amalgamated Zinc (de Bavay's) Ltd. v. Federal Commissioner of Taxation (1935) 54 C.L.R. 295, 303-304, 307, 309-310; 3 A.T.D. 288, and
W. Neville & Co. Ltd. v. Federal Commissioner of Taxation (1937) 56 C.L.R. 290, 300-301, 305-306, 308; 4 ATD 187.

Notwithstanding the differences in other respects in the present provision, the expression `incurred in gaining or producing the assessable income' has been left unchanged and bears the same meaning. In brief substance, to come within the initial part of the subsection it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.''

46. In Case Z17,
92 ATC 188 at 194-195, I set out the relevant and significant portion of the judgment of the High Court in
Fletcher & Ors v FC of T 91 ATC 4950. In the ultimate appeal from the decision in Case Z17 (
Crawford v FC of T 93 ATC 5234) Gummow J summarised this extract from the High Court judgment at 93 ATC 5236-5237 as follows:

``The passage in Fletcher to which the AAT referred included the following propositions:

• (i) it is commonly possible to characterize an outgoing as being wholly of the kind referred to in the first limb of sub-s. 51(1) without any need to refer to the taxpayer's subjective thought processes;
• (ii) this ordinarily will be so where the outgoing gives rise to a receipt of a larger amount of assessable income because in such a case the objective relationship between the outgoing actually made and the greater amount of assessable income actually earned suffices, without more, to characterize the whole outgoings one which was incurred in gaining or producing assessable income;
• (iii) however, at least in a case where the outgoing has been voluntarily incurred, the end which the taxpayer subjectively had in view in incurring it may, in the circumstances of the particular case, constitute an element and possibly the decisive element in characterization of either the whole or part of the outgoing for the purposes of the subsection;
• (iv) what is in question is the existence of a `genuine and not colourable relationship' between the expenditure and the production of the income;
• (v) further, when no relevant assessable income can be identified or where it is less than the amount of the outgoing, the disproportion involved may give rise to a need to resolve the problem of

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  characterization of the outgoing by weighing the various aspects of the whole set of circumstances, including the direct and indirect objects and advantages sought by the taxpayer, so as to determine whether the outgoing is properly to be characterized `as genuinely and not colourably incurred in gaining or producing the assessable income'.''

47. But the applicant submits that this matter can be resolved by reference to the decision of the Full Federal Court in
FC of T v Total Holdings (Australia) Pty Ltd 79 ATC 4279; (1979) 43 FLR 217. There the taxpayer company incurred interest in relation to funds borrowed from its parent company. Some of the borrowed funds were on-lent to a wholly owned subsidiary company but no interest was charged to the subsidiary which used those funds. The Commissioner disallowed claims for deduction in respect of interest paid to the parent company by the taxpayer to the extent that the interest related to funds on-lent to the subsidiary interest free. The Supreme Court of New South Wales held that the interest was incurred in carrying on a business and allowed the company's appeal against the Commissioner's decision. The Full Federal Court dismissed the Commissioner's appeal against that decision.

48. Lockhart J gave the leading judgment. His Honour set out the test to be satisfied at ATC page 4283; FLR page 224 as follows:

``In my opinion if a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under sec 51. See Munro's case (1926) 38 C.L.R. 153;
Texas Co. (A'sia) Ltd. v. FC of T (1939-1940) 63 C.L.R. 382;
FC of T v. Green (1950) 81 C.L.R. 313 per Latham C.J., McTiernan, Webb, Fullagar and Kitto JJ. at p. 319; and
Usher's Wiltshire Brewery Ltd. v. Bruce (1915) A.C. 433.

I say `generally' as some qualification may be necessary in appropriate cases, for instance, where interest is paid by a taxpayer as a prelude to his being in a position whereby he may commence to derive income. In such cases the requirement that the expenditure be incidental and relevant to the derivation of income may not be satisfied. See
Lodge v FC of T 72 ATC 4147; (1972) 128 C.L.R. 171;
FC of T v. Hatchett 71 ATC 4184; (1971) 125 C.L.R. 494.''

49. The difficulty in reconciling the present case with the judgment of the Federal Court in Total is that here the applicant did not incur the interest for the purpose of his present or prospective income producing activities. Put at its highest the applicant incurred interest on money which he on-lent to L Pty Ltd interest free with an expectation that he may eventually derive income by way of dividends from the company. That he did not do so does not reflect upon the purpose but it does reflect upon the fact that the expectation that he would derive income by way of dividends was remote from the incurring of the interest charges.

50. In any event, with respect, this case must be decided on the principles enunciated by the High Court on many occasions including its judgments in Fletcher. In this regard I adopt the criteria as set out by Gummow J (then a Judge of the Federal Court) in Crawford and set out in paragraph 46 above.

51. On an objective view of the facts the funds loaned by the applicant to L Pty Ltd did not and could not be expected to derive assessable income in the hands of the applicant. The loans were made interest free.

52. But can it be said, contrary to Ms Holmes' submission, that the applicant's subjective intention was that the loaned moneys would result in derivation of assessable income? Was there a genuine and not colourable relationship between the interest incurred and production of assessable income? I am not satisfied, and I so find, that there was any reasonable expectation that the funds would derive assessable income for the applicant's benefit. This is made clear by the surrounding circumstances and, in particular, by the agreement between the applicant and D that the funds were loaned to the company on a pari passu basis without payment of interest by the company. A situation exemplified by the evidence that where the loans by the applicant and D were not for equal amounts then they made a private adjustment between themselves and not through the company.

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ATC 553

53. In these circumstances I must accept that the respondent's decision on this aspect of the objection is correct.

54. Turning now to the issue of the loss on rental income. I am not satisfied that the applicant's brother-in-law was ever the occupier of the house when it was at either Ophir Place or 70 Camelot Place. I have already explained why. It follows that I cannot accept the evidence that he was a paying tenant.

55. Even if I be wrong about the brother-in- law as tenant the circumstances of the arrangement were such that the deductions allowable should be confined to the quantum of the rent paid. The brother-in-law was not at arms length, was not paying a market value rental, and the property was used for a dual purpose during most of the relevant period because of renovations and alterations carried out by the applicant. On this basis the letting of the property to the brother-in-law lacked the necessary character of an income producing arrangement.

56. In the light of the decisions in
FC of T v Groser 82 ATC 4478 and
FC of T v Kowal 84 ATC 4001 I would have apportioned the deductions on the basis that they are allowable only to the extent that they were reimbursed by rent paid by the brother-in-law. As I have already explained I am not satisfied that expenses were so reimbursed in whole or in part, nor am I satisfied that the 1992 assessment is excessive.

57. For these reasons I will affirm the respondent's decision under review in relation to the 1992 year.

58. In relation to the 1994 year, for the claim to succeed I must be satisfied that 70 Camelot Place was purchased for the purpose of development and resale at a profit. I am not satisfied that is the case. The applicant's overall intention was to redevelop Ophir Place as a family home. To do that he had to remove the existing house. He decided to purchase 68-70 Camelot Place and move the there existing house onto No 68 so as to gain a site for the Ophir Place house. All of that is only explainable by an intention to recover the value to himself (and his wife) of the removed house as an in situ improvement rather than by sale as a removal home. As the applicant's own figures demonstrate the in situ value was put at $75,000.00 (including alterations) whereas the removal value, on the evidence of Mr Drake, was $12,000.00 to $18,000.00. That was the essence of the arrangement. The applicant did not expect, nor could he reasonably do so, to make a profit on resale of 70 Camelot Place. What he did expect to do and which he succeeded in doing was mitigate most of the loss occasioned by the removal of the house from the Ophir Place site.

59. I am not satisfied that the applicant did anything more than realise assets for the best return obtainable in the market.

60. I am not satisfied that the 1994 assessment is excessive and it follows that I am satisfied that the respondent's decision in relation to the 1994 objection should be affirmed.

61. Nothing was said to me which suggests that I should make a further remission of the additional tax assessed and that decision by the respondent will also be affirmed.

62. It follows that the decision in relation to the 1995 assessment must also be affirmed as there is no carry forward loss from the 1994 year. No issue as to additional tax arises for the 1995 year.

63. Whether the applicant made a capital gain during the 1994 year, taking into account the fact that the removed house was half owned by his wife, is an issue that was not before me.

64. The decisions of the Tribunal will be to affirm each of the objection decisions under review.