NMRSB LIMITED & ORS v FC of T

Judges:
Sackville J

Court:
Federal Court

Judgment date: 4 March 1998

Sackville J

The proceedings

These are eight appeals against appealable objection decisions made by the respondent (the ``Commissioner''), brought under s 14ZZ of the Taxation Administration Act 1953 (Cth). The decisions disallowed objections by the applicant (``the taxpayer'') against income tax assessments in respect of the 1987, 1988, 1989, 1990 and 1991 years of income. The assessments arose out of arrangements made in the course of what has been described as a merger between the taxpayer (formerly a building society) and the National Mutual Royal Savings Bank Limited (formerly known as the National Mutual Permanent Building Society Limited).

In general, I refer to the applicant as ``the taxpayer''. However, as will be seen, the taxpayer's status changed on 28 February 1987 from that of a building society to that of a savings bank incorporated under the Companies (New South Wales) Code (``Companies Code''). Prior to its conversion, the taxpayer was known as United Permanent Building Society Limited (``United''). After the conversion (although it has since changed its name again), it became known as National Mutual Royal Savings Bank (NSW) Limited (``NSW Savings Bank''). When referring to the taxpayer prior to the date of its conversion, I describe it as United; when referring to it after the date of conversion I describe it as NSW Savings Bank.

As the matters were argued, only two issues were raised for determination:

The facts

The Merger Negotiations

For a number of years prior to 1986, the taxpayer was a building society, registered under the Permanent Building Societies Act 1967 (NSW) (``PBS Act''), then known, as I have explained, as United Permanent Building Society Limited. In 1986, United had 189 branches in New South Wales and total assets of about $1.5 billion.

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National Mutual Royal Bank Limited (``NMR Bank''), which was jointly owned by National Mutual Life Association of Australasia Limited and the Royal Bank of Canada, commenced operations as a trading bank in February 1986. National Mutual Permanent Building Society Limited (``National Mutual PBS'') was a wholly owned subsidiary of NMR Bank. In February 1986, National Mutual PBS changed its name to National Mutual Royal Savings Bank Limited (``NMR Savings Bank'').

In early 1986, discussions took place between representatives of United and NMR Bank with a view to reaching agreement on a merger between United and one of the companies within the National Mutual Royal group. Handwritten notes for meetings prepared by Mr Willmott, the managing director of United, indicate that he considered it necessary to formulate a mechanism whereby ``shares'' could be offered ``to existing investors/ depositors, as an added inducement to support the conversion to a company''.

On 4 April 1986, the managing director of the NMR Bank, Mr Gurry, wrote a letter to Mr Willmott, setting out NMR Bank's proposal for a merger. The letter said, in part:

``The proposal we have been discussing to date involves the assets and liabilities of United Permanent Building Society being merged with those assets and liabilities we have within National Mutual Royal Savings Bank Limited (formerly National Mutual Permanent Building Society) to form a new savings bank which would have approx. $2 billion in assets.''

On 20 May 1986, Mr Willmott recommended in writing to the Board of United that it should proceed with the proposal put by NMR Bank. He expressed the view that there were only two basic options, namely, to remain a building society or to convert to some other form of financial institution. The question was how the long-term future of United was likely to be secured, having regard to the need to increase its capital base and to maintain comfortable levels of liquidity. He pointed out that the proposal from NMR Bank would inject some $50 million of additional capital into United. He also expressed the view that, if United continued as a building society, it would suffer from the restrictions on its activities imposed by State law.

Mr Willmott saw a number of advantages in a merger with an existing licensed bank, including access to additional capital, a more flexible structure, the availability of an expanded network and greater competitive opportunities. Mr Willmott said that

``[i]t has been readily accepted by both parties that, in order to make the proposed scheme attractive to United Permanent's investors, and to obtain their support for it, it will be essential to provide some additional inducement.''

The memorandum then set out a proposal for the issue of an interest bearing instrument to depositors with United.

On 21 May 1986, Mr Gurry prepared a memorandum for the Board of NMR Bank summarising the proposal. The memorandum noted that United was the second largest building society within New South Wales and provided NMR Bank

``with immediate control of $1.6 Billion of high quality assets, over 500,000 depositors, 129 branches, some 800 experienced staff, professional management, good EDP skills and reserves of $53 Million at a deferred cost to NMRB.''

The memorandum predicted that the effective merger of United with the NMR Bank would produce ``more than satisfactory returns''.

On 27 May 1986, the directors of United, meeting in committee, approved in principle Mr Willmott's recommendation to ``convert the Society to a savings bank and [to merge] its business... with that of the National Mutual Royal Savings Bank''. The minutes of the meeting record that the reasons why the proposal was of benefit to United had been outlined in Mr Willmott's memorandum.

Shortly after this in-principle approval, the Australia and New Zealand Banking Group Limited (``ANZ'') expressed interest in a proposal to convert United into a savings bank, all capital in which would be held by ANZ. The proposal envisaged that a cash payment would be made to shareholders of United, pro rata to their shareholdings, equal to 90 per cent of reserves in the Society and that shareholders would be entitled to subscribe to ANZ shares at a discount to market.

On 11 June 1986, Mr Gurry, on behalf of NMR Bank, sent a letter to the chairman of United summarising the progress in discussions

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on the proposal ``to effect the successful merger of our two organisations''. The proposal was to be implemented by United converting into a savings bank and then merging with the existing NM Savings Bank ``to create a Savings Bank approaching $2.2 billion in assets''. Mr Gurry said that the benefits of the proposed merger included the following:

``[t]o recognise existing reserves and the complex legal issues of rights of existing members vis-a-vis past and future members we propose a number of steps to financially reward existing members whilst at the same time recognising the interests of past members through a public spirited action and safeguarding the reserves for the future use of the organisation.''

The sum of $100 million would be invested in government securities for a five year period, protected by a trust arrangement. Eighty per cent of the interest derived from the investment would be applied to four purposes:

The Special Interest Offer was explained as follows:

``All existing members will receive an additional ¾% per annum for three years on their deposits to a maximum of their deposit balance at 31 May 1986.

All members will receive this offer. It will not be necessary for them to make any special application.''

The cost of the offer was estimated at $27 million.

On 11 June 1986, Mr Willmott provided a written assessment of the merger proposal to the Board of United. He identified five criteria against which the merger proposal could be evaluated. One criterion was whether the legitimate interests of members and borrowers would be recognised. In relation to that criterion, he noted that legal advice had been received to the effect that the statutory reserves of United were analogous to share capital and that members had only a contingent right to any surplus, arising on winding up. He pointed out that the duty of the directors was to exercise their powers in the best interests of the Society's members as a whole and

``thus they should consider not just the interests of present members but rather what course of action best fulfils the purposes of the Society.''

Mr Willmott noted that members would receive, among other benefits, an additional interest payment of 0.75 per cent in each of the three years following the merger. This benefit, now said to be worth $25 million, was to be provided by means of an investment of $100 million in government securities, eighty per cent of the income from which would be devoted to providing benefits to members, borrowers and future home owners. In addition to the Special Interest Offer, other benefits included a reduction in interest rates for existing home loan borrowers and subsidised loans for low income home buyers. Mr Willmott estimated that the ``direct financial benefits'' were in the range of $52 million to $60 million.

On 12 June 1986, the Board of United resolved that the proposal to merge the operations of United with those of the National Mutual group be submitted to a Special General Meeting of members and that it be unanimously recommended to members at that meeting that they approve of the proposal. The Board also resolved that the Chairman and Deputy Chairman be authorised to execute a merger agreement. The minutes of the meeting record that the benefits of the proposal included an interest bonus of 0.75 per cent per annum for three years in respect of shares held by members on 31 May 1986. The minutes also indicate that advice has been received from merchant bankers (Rothschilds) at the meeting as to the value of United's undertaking. Rothschilds reported that a formal valuation would take some time, but that a starting point was the value of United's reserves ($53 million). Discussion then centred on ``the benefits of the... merger proposal and the trading bank's takeover offer in the light of Rothschild's assessment of the Society's minimum net worth''. The directors concluded, unanimously, that the proposal was in the Society's best interests and should be recommended to the membership for approval.

On 12 June 1986, a Merger Agreement was entered into between NMR Bank, NMR

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Savings Bank and United. As will appear, this version of the Merger Agreement was effectively superseded by an Amended Merger Agreement executed in July 1986, to which I shall refer shortly. However, on the same date the original Merger Agreement was executed, a public announcement was made that United would merge with NMR Bank, subject to approval of the proposal by members of United at an extraordinary general meeting and to final approval by regulatory authorities.

The public announcement apparently stimulated interest among other banks in acquiring United. By letters of 17 and 19 June 1986, the Advance Bank Australia Limited (``Advance Bank'') suggested a merger between it and United, but indicated that some time would be required to formulate a detailed proposal. On 19 June 1986, St George Building Society Ltd (``St George'') expressed its interest in undertaking ``meaningful discussions'' with a view to the merger of the two societies. On 20 June 1986, ANZ ``restructured'' its offer to United to provide greater benefits to the Society's then current depositors and borrowers.

On the same day as ANZ made its revised offer, 20 June 1986, NMR Bank modified its offer to United. One of the changes proposed was that the special interest offer would apply to both share capital and deposits. Since these totalled $1,489.5 million, the maximum potential cost of the revised special interest offer of 0.75 per cent per annum was now estimated by NMR Bank at $33.5 million.

On 21 June 1986, a meeting took place between representatives of ANZ and of United to discuss the former's proposal. The Deputy Managing Director of United reported on the meeting to the Board. The report provided a ``quick valuation'' of the offer, on a discounted value basis, of $80.35 million, but the author expressed reservations about some aspects of the proposal. On the following day, 22 June 1986, the Board of United discussed the approaches that had been made by ANZ, Advance Bank and St George. The Board also discussed a letter received on that day from Mr Gurry, expressing NMR Bank's disappointment that United had received a further proposal from ANZ, and suggesting that any further proposals were likely to cause confusion in the market place. The Board of United resolved to consider any additional detailed proposals that might be put by ANZ and Advance Bank.

NMR Bank's disappointment did not prevent it from putting forward a proposal to amend the Merger Agreement executed on 12 June 1986. In a letter dated 25 June 1986, Mr Gurry suggested a number of changes to the agreement. The proposed variations included the following:

``1. SPECIAL INTEREST OFFER

All existing members will receive an additional interest payment each year for three years on their deposits to a maximum of their deposit balance at 31 May 1986 (this applies to both share capital and deposits).

The additional interest payments will be:

  • Year One1.25%
  • Year Two1.00%
  • Year Three0.60%

We have structured this offer recognising that most benefit should attach to the first year - members are more likely to withdraw their deposits towards the latter part of the thirty six months.''

The letter confirmed that a trustee would be appointed, so that ``an independent arbiter [ would] be vetting [NMR Bank's] performance''.

On 26 June 1986 the Board of United resolved to reject the revised take-over offer from ANZ. The Board affirmed the decision to submit the NMR Bank merger proposal to a Special General Meeting of United and decided to develop a campaign to advise the Society's members, depositors, borrowers and staff on the proposal.

On 27 June 1986, Mr Gurry wrote to the Chairman of United advising that NMR Bank had decided to vary certain aspects of the offer set out in the letter of 25 June 1986. The changes included an increase in the additional interest payment for the third year under the Special Interest Offer from 0.6 per cent to 0.8 per cent. On the same day, the Chairman of United PBS confirmed that the revised proposals were acceptable. This confirmation was endorsed by the Board of United on 30 June 1986. The following day, 1 July 1986, the Board resolved to execute an Amended Merger Agreement and to call a Special General Meeting for 29 July 1986 (later changed to 5 August 1986).

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The Amended Merger Agreement

Clause 4 of the Amended Merger Agreement provided that a Special General Meeting of United (which was referred to as ``the Society'') would be called to pass resolutions authorising the following proposals:

The expression ``New Company'' was defined in cl 1 to mean the company to be incorporated under the Companies Code in consequence of the application by the Society under s 42 of the PBS Act.

Clause 5(1) of the Agreement required the NMR Bank to execute a covenant in favour of a specified trustee providing for certain payments to be made by the Bank if particular events occurred. The nominated events included a failure by the New Company to comply with the obligations imposed on it by cl 8. The trustee was required to execute a trust deed, declaring that it held the benefit of the Bank's covenant on trust for the ``Original Shareholders'' of the Bank. The phrase ``Original Shareholders'' was defined to mean ``persons who hold a Relevant Share Account'': cl 1. That expression, in turn, was defined to mean a deposit account in the New Company which came into existence in consequence of the conversion of withdrawable shares into deposits with the Society and thereafter the registration by the Society as the New Company: ibid.

Clause 8(1) provided that the New Company and the Bank were to ensure that the New Company:

Clause 9 of the Amended Merger Agreement required the NMR Bank to ensure that interest rates charged in respect of loans for owner- occupied housing, applications for which had been approved as at 12 June 1986, would receive the benefit of lower interest rates. Clause 9(2) required the Bank to provide an interest subsidy of 0.5 per cent per annum to existing borrowers from the Society in respect of owner-occupier housing as at the Certification Date (that is, the date of incorporation of the New Company under the Companies Code).

Clause 10 dealt with the Special Interest Offer. It provided as follows:

``Subject to Clause 8 a Special Interest Offer will be made to holders of Relevant Deposit Accounts. That Special Interest Offer will confer upon Original Depositors in respect of a Relevant Deposit Account a contractual right (which may not be mortgaged, assigned or otherwise dealt with by the Original Depositor) to be paid by the New Company or any Successor Company until the third anniversary of the Certification Date (by crediting each of the Original Depositors' Relevant Deposit Accounts) an amount by way of additional interest in respect of the Relevant Deposit Account (over and above any interest otherwise payable in respect of the Relevant Deposit Account) calculated at the Special Interest Offer Rate on the Relevant Principal Amount of the Relevant Deposit Account.

Payment under the Special Interest Offer shall be made at the times and in the manner usually applicable to crediting of interest in respect of the Relevant Deposit Account. The right to such payment in respect of a

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Relevant Deposit Account shall cease upon the earlier of close [sic] of a Relevant Deposit Account and the third anniversary of the Certification Date. Where an Original Depositor closes all his Relevant Deposit Accounts he shall not thereafter be entitled to any payment in respect of the Special Interest Offer on any account opened after such closure.''

The expression ``Original Depositors'' was defined in cl 1 to mean persons who held a ``Relevant Deposit Account''. The expression ``Relevant Deposit Account'' was defined to mean

  • ``(a) a deposit account in the New Company or any Successor Company which was, prior to Certification Date, a deposit account with the Society... which was continuously in credit during the period commencing on the Nominated Date [31 May 1986] and ending on the Certification Date [that is, the date of incorporation of the New Company];
  • (b) a Relevant Share Account; and
  • (c)...''

The term ``Special Interest Offer Rate'' was defined to mean

  • ``(a) 1.25% per annum in the first Year after the Certification Date;
  • (b) 1.00% per annum in the second Year after the Certification Date;
  • (c) 0.80% per annum in the third Year after the Certification Date.''

Clause 12 provided that, as soon as practicable after completion of the steps set out earlier in the Agreement, the New Company and the Existing Savings Bank (that is, NMR Savings Bank) were to be ``merged pursuant to schemes of arrangement under the name National Mutual Royal Savings Bank Limited''. This merger was to be effected in such manner, including the transfer of assets and liabilities by the New Company to the Existing Savings Bank or vice versa, as would not affect any of the rights or privileges conferred upon any person under the Amended Merger Agreement.

The Amended Merger Agreement was further amended on 14 July 1986. However, it was common ground that the further amendments did not bear upon the issues in the present case.

Events Following the Amended Merger Agreement

On 2 July 1986, the Board of United resolved that Advance Bank be informed that its merger proposal had been rejected, as not in the best interests of the Society's members, depositors, borrowers and staff.

On 4 July 1986, United issued a circular to all home loan borrowers. The circular contained the following passages:

``The proposed merger also guarantees substantial financial benefits on all United Permanent's Members' savings. On top of the full interest rates normally paid on those accounts, the new National Mutual Royal Savings Bank will pay an additional 1.25% p.a. interest in the first year after the merger takes effect. Then, an additional 1% p.a. in the second year. And 0.6% p.a. [sic] in the third year.

...

[A] booklet containing full details of the merger will be mailed to you within the next few days. Also enclosed will be details of how you can support the proposal, and ensure the guaranteed financial benefits for your family, by voting for the merger if you are eligible to vote at the Special General Meeting....''

On 11 July 1986 United distributed to its customers a booklet setting out the details of

``all the benefits that the proposed merger between United Permanent and National Mutual Royal Bank will bring to the customers of United Permanent.''

The covering letter noted that, in order to be eligible to vote, members had to have had a continuous balance of at least $500 in one account from 5 May 1986 to 21 July 1986, as well as hold at least one $1 share in the Society on the day of the meeting. It pointed out that those who had the minimum $500 balance, but did not hold a share in the Society, could obtain a vote simply by opening a $1 share account, such as a Passbook Savings Account, to become a Member of the Society.

The booklet distributed to members of United provided details of what were said to be the advantages of the Society becoming a bank. The booklet stated that, following approval of the proposal at the Special General Meeting and all other necessary approvals, there would be

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immediate and substantial benefits to existing borrowers, low income first home buyers and Members and investors generally. The booklet included the following description of the Special Interest Offer:

``Special interest offer for existing Members and investors

Up to $39.65 million will be set aside for special interest payments to those persons who were Members of and investors with United Permanent as at 31 May 1986. The payments will be in addition to the interest otherwise payable on Members' and investors' deposit accounts excluding Professional Money Market Variable Deposits (Account Type 050) with the new savings bank, and effectively will boost the deposit rate on such accounts by-

  • (a) 1.25% per annum in the first year;
  • (b) 1.00% per annum in the second year; and
  • (c) 0.80% per annum in the third year;

after United Permanent becomes a savings bank.

The special interest payments will continue for three years from the date of conversion of United Permanent to a savings bank provided customers maintain a credit account with the savings bank during this period. You may withdraw funds and re- invest but you must maintain at least one deposit account with the savings bank at all times during the 3 year term to continue to enjoy the Special Interest Rates Offer.

The payments will be calculated by reference to the balance from time to time of each account up to a maximum in respect of your accounts of the aggregate of share or deposit account balances as at 31 May 1986 and will be made by the savings bank in the same manner as normal interest payments on accounts.''

On 14 July 1986, Macquarie Hill Samuel Corporate Services prepared a report for the Board of United to determine whether the conclusion of the Board, that the merger proposal was in the interests of the Society as a whole, was reasonable. The report advised that the conclusion was reasonable. In expressing this view, the report compared the discounted present value of the various interests subsidiaries (including the Special Interest Offer) with the value of the Society's reserves. Having regard to the limited nature of the access of members to the Society's reserves, the authors concluded that borrowers and depositors would be immediately financially advantaged by the proposal.

On 29 July 1986, a deed of covenant was entered into between NMR Bank and Permanent Trustees (Canberra) Limited. This deed, and other documents executed contemporaneously, gave effect to the arrangements contemplated in the Amended Merger Agreement.

On 30 July 1986, United forwarded a revised Explanatory Memorandum. This had become necessary because the date of the Special General Meeting had been postponed to 12 August 1986, apparently because of court proceedings relating to the proposed merger. The covering letter noted that the board of directors had unanimously recommended a vote in favour of the merger. The revised documentation included the same information on the Special Interest Offer as had previously been circulated.

The Special General Meeting was held on 12 August 1986 at Parramatta Stadium, and was attended by approximately 10,500 people. According to the poll declared on 28 August 1986, the meeting (including proxies) approved the motion to convert United to a savings bank and to merge its operations with NMR Bank. A total of 46,356 members voted in favour, and 4,409 against the motion. The number of voters (just under 51,000) compares with the total of about 500,000 depositors with United at the time of the conversion. There was no evidence as to the proportion of depositors who were eligible to vote at the Special General Meeting.

United was converted into a company on 28 February 1987 and, as I noted earlier, renamed ``National Mutual Royal Savings Bank (NSW) Limited''. On the same day, all withdrawable shares held by former depositors with United were converted to deposits with NSW Savings Bank and share capital of $60 million was subscribed to NSW Savings Bank by NMR Bank. From that date, NSW Savings Bank became a wholly owned subsidiary of NMR Bank.

Shortly after 1 March 1987, the assets and liabilities of the NMR Savings Bank (the former National Mutual PBS) were vested in the NSW Savings Bank, pursuant to the

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National Mutual Royal Savings Bank (Merger) Act 1987 (Vic). The NMR Savings Bank was dissolved.

Following the merger effected by the legislation, NSW Savings Bank paid interest to those depositors who satisfied the terms of the Special Interest Offer at the higher rate required by that offer. The documentary evidence showed that the additional interest was credited as bonus interest, and that this was done at the same time as regular interest was credited to each depositor's account.

It was common ground that the following amounts were those by which the interest incurred by the NSW Savings Bank exceeded the amounts of interest which would have been incurred, but for the Special Interest Offer: 

Year         $

1987     4,197,461
1988     8,139,919
1989     5,442,311
1990     2,817,992
1991       153,969

The NSW Savings Bank changed its name to National Mutual Royal Savings Bank Limited on 30 November 1987. It later changed its name once again, to its present name.

The legislation

Section 51(1) of the ITAA provides as follows:

``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.''

The sub-section has been in this form at all material times.

Sections 166 and 170 of the ITAA, as they stood at the relevant time, provided as follows:

``166 From the returns, and from any other information in his possession, or from any one or more of these sources, the Commissioner shall make an assessment of the amount of the taxable income of any taxpayer, and of the tax payable thereon.

...

170(1) The Commissioner may, subject to this section, at any time amend any assessment by making such alterations therein or additions thereto as he thinks necessary, notwithstanding that tax may have been paid in respect of the assessment.

170(2) Where a taxpayer has not made to the Commissioner a full and true disclosure of all the material facts necessary for his assessment, and there has been an avoidance of tax, the Commissioner may-

  • (a) where he is of opinion that the avoidance of tax is due to fraud or evasion - at any time; and
  • (b) in any other case - within 6 years from the date upon which the tax became due and payable under the assessment,

amend the assessment by making such alterations therein or additions thereto as he thinks necessary to correct the assessment.

170(3) Where a taxpayer has made to the Commissioner a full and true disclosure of all other material facts necessary for his assessment, and an assessment is made after that disclosure, no amendment of the assessment increasing the liability of the taxpayer in any particular shall be made after the expiration of 3 years from the date upon which the tax became due and payable under that assessment.

...

170(7) Nothing contained in this section shall prevent the amendment of any assessment in order to give effect to the decision upon any appeal or review, or its amendment by way of reduction in any particular in pursuance of an objection made by the taxpayer or pending any appeal or review.''

The term ``assessment'' was defined in s 6 of the ITAA to mean

  • ``(a) the ascertainment of the amount of taxable income and of any tax payable thereon; or
  • (b) the ascertainment of the amount of additional tax payable under a provision of Part VII.''

Submissions

Mr Bloom QC, who appeared with Mr Sullivan for the taxpayer, submitted that the additional interest paid to depositors, pursuant

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to the Special Interest Offer, fell within the second limb of s 51(1) of the ITAA. The payment of interest was an outgoing necessarily incurred in carrying on the taxpayer's business for the purpose of gaining or producing assessable income. It was simply a case of interest paid by a bank to its depositors in consideration of those depositors depositing and leaving moneys on loan to the bank.

Mr Bloom noted that it was not in contest that the additional interest paid by the taxpayer to the continuing depositors was properly described as interest. The characterisation of interest on borrowed funds is to be ascertained by reference to the objective circumstances showing the use to which the borrowed funds are put. In this case, NMRB's business was that of a bank and the borrowed funds formed part of its circulating capital or stock in trade. The additional interest was payable in respect of the borrowed funds at the same time in the same way as interest was payable in respect of other funds borrowed from depositors. The interest paid by the taxpayer was incidental to or connected with the operations or activities regularly carried on for the production of income. In these circumstances, it was not permissible to have regard to the subjective purposes of any person in relation to the taxpayer's decision to pay the additional rate of interest. The advantage obtained by a taxpayer from the payment of interest has to be objectively ascertained and, moreover, is to be determined by reference to the actual expenditure made by the taxpayer, not the antecedent promise to make the interest payment.

Mr Bloom contended that, in any event, it could not be said that the payment of interest was made in order to secure voting support for United's change in status. It was the payment of interest that had to be considered and that occurred after United had converted to a savings bank. Further, the offer was made to depositors of United (as the taxpayer was known prior to the date of conversion) regardless of whether they were members of the Society and regardless of whether they were members entitled to vote. While there was no evidence of the proportions in each category, it was clear that not all 500,000 depositors were members and equally clear that not all members satisfied the voting qualifications (notably that a depositor held a minimum of $500 in an account for the relevant period).

Mr Bloom also relied on the uncontested evidence of Mr Gurry. This was to the effect that deposits maintained by customers of a bank are an important source of funds for that bank's business. If the funds provided by United's depositors had been withdrawn at or prior to its conversion to a savings bank, and replaced from another source such as the wholesale finance market, the cost of funds to the taxpayer would have been little different from the cost of interest paid to the continuing depositors and may have been higher. Mr Gurry's evidence was that, during 1986 to 1987, interest rates payable to lenders in the wholesale market would have been about 0.75 per cent to 1 per cent per annum higher than interest rates paid to depositors in the retail market. Mr Bloom submitted that this evidence left no room for any suggestion that the interest payments were not connected with the taxpayer's business or were not payments made on revenue account.

Mr Slater QC, who appeared with Mr Fraser for the Commissioner, pointed out that what was at issue was only the deductibility of the additional interest paid by the taxpayer to depositors, not the deductibility of the ``base interest''. That additional interest was payable pursuant to an agreement entered into before the conversion of United to a savings bank, effected by its incorporation under the Companies Code. The agreement to pay interest was either constituted by the Amended Merger Agreement or by offers made by United in the booklets and other documentation sent to depositors prior to the Special General Meeting and, according to Mr Slater, accepted by them placing or retaining deposits with United prior to its conversion to a savings bank.

Mr Slater did not dispute that the payments of additional interest were necessarily incurred in carrying on the taxpayer's business as a bank. Nor did he dispute that the business was carried on for the purpose of gaining or producing assessable income. He submitted, however, that the additional interest paid to depositors pursuant to the Special Interest Offer was an outgoing of a capital nature. Since s 51(1) of the ITAA provides for a deduction in respect of outgoings except to the extent that they are of a capital nature, it followed that the additional interest was not an allowable deduction.

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In determining whether the payment of additional interest is an outgoing of a capital nature, it is necessary to determine the advantage obtained by a taxpayer's promise to pay that interest. In this case, the determination was to be made at the time the taxpayer committed itself to paying the additional interest; and it did this when it was a building society. Mr Slater contended that the advantage obtained by the taxpayer was support from depositors for the change in the taxpayer's status from a building society to a bank. When the matter was viewed from a business perspective, the advantage obtained by the taxpayer was the approval of members to the change in its capital structure. Consideration of the merger proposal and the events leading up to the Amended Merger Agreement and the Special General Meeting showed clearly that the taxpayer's purpose was to secure approval from voting members for the change in its status.

Reasoning

Capital and Revenue Items

It has frequently been said that the question of whether a payment is on capital or revenue account cannot be solved by the application of any rigid test. For example, Lord Pearce in
BP Australia Ltd v FC of T (1965) 14 ATD 1 at 7; (1965) 112 CLR 386 (PC) at 397, said that, although some categories of capital and income expenditure are distinct and easily ascertainable, the distinction is often difficult to draw in borderline cases.

Dixon J in his dissenting but frequently cited judgment in
Hallstroms Pty Ltd v FC of T (1946) 8 ATD 190 at 194; (1946) 72 CLR 634 at 646, counselled against regarding the distinction between expenditure on account of revenue and outgoings of a capital nature as ``so indefinite and uncertain as to remove the matter from the operation of reason''. In a well known passage, his Honour said (at ATD 194; CLR 647) it might

``... be useful to recall the general consideration that the contrast between the two forms of expenditure corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.''

In the course of what has been described as a ``classic passage'' (
FC of T v South Australian Battery Makers Pty Ltd 78 ATC 4412 at 4420; (1977-1978) 140 CLR 645 at 661, per Stephen and Aickin JJ), Dixon J in
Associated Newspapers Ltd v FC of T (1938) 5 ATD 87 at 95; (1938) 61 CLR 337 at 361 said this:

``In the attempt, by no means successful, to find some test or standard by the application of which expenditure or outgoings may be referred to capital account or to revenue account the Courts have relied to some extent upon the difference between an outlay which is recurrent, repeated or continual and that which is final or made `once for all', and to a still greater extent upon a distinction to be discovered in the nature of the asset or advantage obtained by the outlay. If what is commonly understood as a fixed capital asset is acquired the question answers itself. But the distinction goes further. The result or purpose of the expenditure may be to bring into existence or procure some asset or advantage of a lasting character which will enure for the benefit of the organisation or system `or profit earning subject'. It will thus be distinguished from the expenditure which should be recouped by circulating capital or by working capital.''

After noting that the ideas of recurrence and endurance or continuance over a period of time depend on ``degree and comparison'' his Honour summarised the position in another well-known passage (at ATD 96; CLR 363):

``There are, I think, three matters to be considered, (1) the character of the advantage sought, and in this its lasting qualities may play a part, (2) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part and (3) the means adopted to obtain it; that is by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.''

The difficulties to which Lord Pearce adverted in BP Australia often arise when it becomes necessary to apply these general

ATC 4200

criteria to the infinitely variable circumstances of particular cases. Mr Bloom, however, submitted that this case was relatively straightforward and certainly not borderline. He said that the starting point, apart from the well- known passages to which I have referred, was the judgment of the High Court in
GP International Pipecoaters Pty Ltd v FC of T 90 ATC 4413 at 4419; (1990) 170 CLR 124 at 137:

``The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid.''

Mr Bloom contended that the taxpayer in the present case satisfied both this test and the criteria stated by Dixon J, because the advantage obtained from the payment of interest was the use of moneys lent to it by depositors entitled to the higher rate. Since the taxpayer carried on the business of banking, money was its circulating capital or stock in trade. The payment of interest was therefore the quid pro quo for the retention of the taxpayer's trading stock. There was an obvious connection between the payment of outgoings in the form of interest and the business of the taxpayer. Moreover, the means adopted to obtain the advantage were periodic payments, rather than a single outlay.

In my view, there is little doubt that, if the advantage gained by the taxpayer from the payment of the additional interest is to be characterised as the retention or obtaining of deposits made or continued by United's depositors after the date of United's conversion to a savings bank, the additional interest could not be regarded as a capital expenditure. The position of businesses engaged in the borrowing and lending of money was explained by Gibbs CJ in
Avco Financial Services Limited v FC of T; FC of T v AVCO Financial Services Limited 82 ATC 4246; (1981-1982) 150 CLR 510, a case concerned with the tax treatment of exchange gains and losses by a finance company which had borrowed funds offshore. His Honour said this (at ATC 4251; CLR 518):

``Where a taxpayer carries on the business of borrowing and lending money, the moneys used for that purpose are analogous to trading stock - the taxpayer in effect deals in the money. Exchange gains and losses, regularly and frequently made and incurred, in the course of making repayments of borrowed money which is used by a taxpayer in making loans in the course of its finance business are outgoings made in the day to day conduct of the business and for the purpose of carrying on the business as a going concern. The first matter to be considered, in deciding whether a payment is of a capital or of a revenue nature, is what was the character of the advantage sought by the payment: Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T [(1938) 61 CLR 337 at 363]. The question has to be considered from a practical and business point of view: see FC of T v South Australian Battery Makers Pty Ltd 78 ATC 4412 at p 4419; (1978) 140 CLR 645 at p 659, and cases there cited. From that point of view, the additional moneys paid as a result of the unfavourable exchange variations - the exchange losses - were part of the price by which the appellant obtained the money which it used to make a profit - part of the process by which the appellant obtained regular returns. The payments were recurrent and frequent, although irregular, and they involved the exercise of judgment by the officers of the appellant who put its borrowing policy into effect as part of the conduct of the business. The exchange losses were in my opinion losses on revenue account, and of course the gains have the same character.''

See also at ATC 4257; CLR 528-529, per Mason, Aickin and Wilson JJ.

In
Coles Myer Finance Limited v FC of T 93 ATC 4341; (1993) 176 CLR 640, Mason CJ, Brennan, Dawson, Toohey and Gaudron JJ said (at ATC 4221; CLR 664-665) that the judgments in Avco, when properly understood, proceed on the proposition that, although the borrowing of money and repayment of loans by a finance company

``... are properly to be regarded as transactions on capital account, the relevant gains and losses are nevertheless to be regarded as revenue gains and losses. That is because the gains and losses were incurred in the course of and as an incident of making repayments of the borrowed money with which the taxpayer carried on its business as

ATC 4201

a finance company. The losses or outgoings were incurred in the day-to-day conduct of the business and for the purpose of carrying it on as a going concern. Though the borrowed moneys were capital, it was working or circulating capital from which the taxpayer derived its profits by turning the borrowed money to account at higher rates of interest than those paid to the taxpayer's lenders. The borrowing, as much as the lending, was an integral part of the day-to-day conduct of the taxpayer's profit- earning business.''

Their Honours cited with approval the remarks of Dixon J (with whom McTiernan J agreed) in
The Texas Company (Australasia) Ltd v FC of T (1940) 5 ATD 298 at 356; (1940) 63 CLR 382 at 468:

``... Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant.''

The Nature of the Advantage

The Commissioner did not seriously dispute that the second and third criteria formulated by Dixon J in Sun Newspapers suggested that the additional interest paid by the taxpayer was not of a capital nature. Mr Slater focused attention on the nature of the advantage obtained by the taxpayer by reason of the payment of additional interest to continuing depositors. That advantage was said to be the procuring of support from depositors for the proposed merger arrangements.

Mr Slater contended, and Mr Bloom disputed that in considering the nature of the advantage obtained by the taxpayer, it was permissible to go beyond the contractual or other legally binding arrangements pursuant to which the additional interest payments were made to continuing depositors. I shall return to that question shortly. The parties were also in dispute as to the nature of the contractual or other legally binding arrangements to which regard would be had in ascertaining the advantage obtained by the taxpayer.

Mr Bloom submitted that the critical question was the advantage obtained by reason of the expenditure. He distinguished between the expenditure, in the form of additional interest, and any antecedent promise to pay that interest. Of course, at the time the taxpayer paid additional interest to the continuing depositors United had already converted to a savings bank. Viewing the payments at the time they were made meant, according to Mr Bloom, that they could not be characterised as a quid pro quo for the support of depositors for the merger arrangements, since those arrangements had already been implemented.

I think that the taxpayer's approach is too narrow. Assuming that the advantage derived by the taxpayer is to be determined by reference to legally enforceable arrangements (as distinct from a taxpayer's subjective motives), I think that any binding arrangements entered into prior to the date of the taxpayer's conversion to a savings bank, pursuant to which the additional interest was paid, should be taken into account. As Stephen J observed in
Cliffs International Inc v FC of T 79 ATC 4059 at 4071; (1979) 142 CLR 140 at 162,

``... A bare payment of money is itself devoid of any character, either as on revenue or on capital account. It is only from surrounding circumstances that it acquires its character....''

If a payment is made to a contractual or other binding arrangement, the surrounding circumstances include that arrangement, even though it precedes (as it often will) the actual payment. It is therefore necessary to consider the Amended Merger Agreement and the promises made by United directly to depositors to determine the quid pro quo for the payment of additional interest to continuing depositors.

Clause 10 of the Amended Merger Agreement provided that a ``Special Interest Offer'' would be made to holders of ``Relevant Deposit Accounts''. Although cl 10 did not specifically identify the party which was bound to make the offer, it is clear enough from cl 5(1) that the obligation was imposed on ``New Company''. Despite the use of the expression ``New Company'' in the Amended Merger Agreement, it is clear from the PBS Act, that the taxpayer remained the same entity both before and after its conversion to a savings bank. The registration of United as a company under the Companies Code was effected pursuant to s 42 of the PBS Act. Section 45 of the Act provides that where a corporation (which includes a permanent building society incorporated under the PBS Act: see ss 27, 28(3), 29) applies under s 42 and, pursuant to the application becomes

ATC 4202

registered and incorporated, ``the identity of the corporation shall not be affected and it shall continue as the same entity''. Consequently, the obligation imposed on United by the Amended Merger Agreement to make the Special Interest Offer to depositors continued after its incorporation under the Companies Code and its consequent transformation to a savings bank.

Of course, no depositor of United was a party to the Amended Merger Agreement. However, it is at least arguable that cl 10 of the agreement was intended to permit United's depositors to enforce its obligation to make the Special Interest Offer to each of them. If so, the depositors are likely to have been entitled, on the principles laid down in
Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 5 ANZ Insurance Cases ¶60-873; (1988) 165 CLR 107, to enforce the taxpayer's promise to make the Special Interest Offer.

An alternative approach, as Mr Slater suggested, is that United made offers to its depositors, by distributing booklets to them prior to the Special General Meeting which approved the merger proposal. The booklet, which (so I infer) was distributed to all depositors of United, stated that ``members and investors'' would be paid additional interest at specified rates after the proposed merger took place, if they retained their deposits with the savings bank. The booklet specified the terms on which the additional interest would be paid and the mode of payment. The statements in the booklet can fairly be regarded as intended to create legal relations between the taxpayer and its existing depositors.

It is true that, if it had been necessary to consider United's obligations prior to its conversion to a savings bank, questions might have arisen as to how and when depositors could have accepted United's offer to pay the additional interest and, perhaps, as to whether United could have withdrawn the offer at any time after the Special General Meeting. But the fact is that United's offers were not withdrawn and the Amended Merger Agreement remained on foot. The additional interest was paid to those depositors who continued deposits or made fresh deposits with the taxpayer (then converted to a savings bank) after the conversion date, in accordance with the terms of the Amended Merger Agreement and the offers.

Having regard to this history, I think that an assessment of the rights acquired by the taxpayer in return for making the expenditure has to take account of the terms of the Amended Merger Agreement and of the offers contained in the booklet distributed to depositors. I do not think that to do so confuses the promise to make a payment and the payment itself; in a legal sense the two are closely connected, indeed inextricably intertwined. Even so, I do not think that the advantage obtained by the taxpayer can be regarded as that identified by the Commissioner, namely, support from depositors for the change in the taxpayer's status from a building society to a savings bank.

The additional interest payments were offered and paid to all depositors with United as at 31 May 1986 who maintained at least one deposit account with the savings bank during the three year period after the date of United's conversion to a savings bank. The additional interest was payable (and was paid) by reference to the balance of each account up to a maximum of the aggregate of share or deposit account balances as at 31 May 1986. The additional interest payments were to be made (and in fact were made) by the savings bank in the same manner as normal interest payments. The amount of additional interest payable to each continuing depositor therefore depended upon the balance in the depositor's account during the three year period, up to the specified maximum.

It follows that the additional interest was paid and payable strictly by reference to the sums invested with the building society by United's depositors during the three year period after the date of conversion. The advantage obtained by the savings bank during that three year period was the making and continuation of deposits by depositors. These deposits constituted part of the working capital of the savings bank. It was not contested that the deposits were applied to the business of the bank, namely, the lending of funds. It is true that the additional interest was over and above that paid to other depositors. But authorities such as
Cecil Bros Pty Ltd v FC of T (1964) 13 ATD 261; (1964) 111 CLR 430 and
FC of T v Isherwood and Dreyfus Pty Limited 79 ATC 4031; (1979) 46 FLR 1 (FCA/ FC), suggest that, so long as the payments to the continuing depositors can be characterised as interest, the taxpayer's decision to pay a

ATC 4203

higher rate to some depositors cannot alter the fact that the advantage obtained from the payments was to secure working capital for the taxpayer's business. Mr Gurry's evidence, that the additional interest paid to continuing depositors was broadly in line with the cost of obtaining equivalent funds from wholesale sources, supports this conclusion, but is not necessary for it.

I do not think that the position changes if attention is directed to the terms of the Amended Merger Agreement or to what I have described as the offers made to depositors. United's promise was made to all depositors, not merely those eligible to vote at the Special General Meeting. As I have said, there was no direct evidence as to the proportions of depositors eligible to vote at the time the promise was made, although only about ten per cent of all depositors ultimately voted on the merger proposal. Having regard to the voting qualifications (a continuous balance of at least $500 in an account from 5 May 1986 to 21 July 1986, plus at least one $1 share in United on the day of the meeting) it is a fair inference that many depositors were ineligible to vote at the time the promise was made. Precisely how many is a matter for speculation. But the fact is that United's promise was made to a larger group of depositors than those eligible to vote on the merger proposal.

United's promise was to pay additional interest on amounts deposited with the savings bank over a three year period, subject to a maximum. Under the terms of the promise, no depositor could receive any additional interest unless he or she left funds with the savings bank or made fresh deposits during the three year period . The savings bank's liability to pay additional interest (whatever its precise juridical character) crystallised only if the individual depositor retained or placed funds with the bank, to be applied by it to its usual commercial operations. The promise was made to all depositors, independently of whether any individual depositor voted for or against the proposal, or voted at all.

Of course, the occasion for payment of the additional interest to continuing depositors would not arise until the merger proposal had been implemented. But that is a very different proposition than suggesting that the advantage obtained by the taxpayer from the payment of additional interest to continuing depositors, in the sense of its legal rights against depositors obtained in return for the expenditure, was voting support for the merger proposal. The arrangements made between the taxpayer and its depositors, or for the benefit of its depositors, do not warrant any such conclusion.

The Question of Motive

Thus far, I have considered the problem from the perspective of the legal relationship between the taxpayer and its continuing depositors. The Commissioner's argument was that the advantage obtained by the taxpayer was to be ascertained after taking into account material other than its legal entitlements and obligations. In particular, it was appropriate to take into account the advantage United sought to achieve by offering depositors the ``incentive'' of additional interest.

Some authorities suggest that, in identifying of the advantage obtained by a taxpayer, inquiries are not necessarily to be confined to the contractual or other legal rights of the taxpayer. Yet another oft-cited statement made by Dixon J in Hallstroms' Case (at ATD 196; CLR 648) is this:

``... What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.''

Like all statements in this area, however, it is wise to bear in mind the circumstances of the particular case in which the observations were made. The issue in Hallstroms' Case was whether the costs incurred by a manufacturer of refrigerators, in opposing a competitor's application for extension of a patent, were on revenue or capital account. The Court divided on this question (Latham CJ, Starke and Williams JJ; Dixon and McTiernan JJ dissenting), reflecting the difficulty of applying general criteria to particular cases.

As Stephen and Aickin JJ pointed out in Battery Makers (at ATC 4420-4421; CLR 661-662), Hallstroms' Case was one where the taxpayer did not obtain enforceable rights in consequence of the expenditure and the character of the payment had to be ascertained by reference to the factors identified in Sun Newspapers, that is, the character of the

ATC 4204

advantage to be sought and the manner in which it was to be used. In Battery Makers, Gibbs ACJ said that Hallstroms' Case was a case where the advantage sought from the expenditure was known and the question was whether an expenditure made to secure an advantage of that kind had the character of capital or income. As his Honour explained (at ATC 4419; CLR 659):

``... In other words, the question in dispute was not `What was the expenditure for?', but `Was the advantage, known to be sought by the expender, of a capital or of a revenue nature?' It was held that in answering that question the nature of the advantage from a practical and business point of view had to be considered.''

The decision in Battery Makers was to the effect that, in determining the character of the advantage sought by rental payments made by a lessee, the advantage to be considered was that sought by the taxpayer for itself. The fact that the taxpayer was aware that an associated company had an option to purchase the premises, which was exercisable at a price that diminished according to the duration of the taxpayer's occupation of the premises, was merely a ``collateral advantage'' and was not the advantage sought or obtained by the taxpayer.

Mr Bloom submitted that the authorities established beyond doubt that the character of the advantage obtained by a taxpayer is to be determined exclusively by reference to the contractual or other legal rights the taxpayer received for the payment. I am not sure that the position is quite so clear-cut. Battery Makers, while establishing that it is the advantage to the taxpayer (and not a third party) that matters, left the question open: see per Gibbs ACJ, at ATC 4419-4420; CLR 659-660; per Stephen and Aickin JJ, at ATC 4421; CLR 662. The observation previously cited from GP International was made in a case that had to do with characterisation of moneys received rather than expenditure incurred, and in any event is not decisive of the question.

Mr Bloom, however, relied on
Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542; (1980) 49 FLR 183 (FCA/FC) to support his contention. The issue in that case was whether costs incurred by the taxpayer in defending criminal proceedings brought against some of its directors and agents, relating to the payment of what were said to be secret commissions, were deductible under the second limb of s 51(1) of the ITAA. The Court (Brennan, Deane and Fisher JJ) held that the costs were deductible and were not of a capital or private nature.

Brennan J referred to the two
Europa Oil Cases (Commr of Inland Revenue (NZ) v Europa Oil (NZ) Ltd 70 ATC 6012; [1971] AC 760 (PC);
Europa Oil (NZ) Ltd (No 2) v Commr of IR 76 ATC 6001; [1976] 1 WLR 464 (PC)), both of which involved the New Zealand equivalent of s 51(1). The second Europa Case had similarities to Cecil Bros, since it involved the purchase of trading stock as part of ``a complex of interrelated contracts entered into by various companies [within the same group]'': Europa Oil (NZ) Ltd (No 2) v Commr of IR at ATC 6007; WLR 472. Lord Diplock said (at ATC 6006; WLR 471-472) that

``... it is not the economic results sought to be obtained by making the expenditure that is determinative of whether the expenditure is deductible or not; it is the legal rights enforceable by the taxpayer that he acquires in return for making it.''

Brennan J commented on Lord Diplock's observation in Magna Alloys (at ATC 4547-4548; FLR 190):

``Though the principle may be too widely stated to be applied to sec 51(1) in every case (per Gibbs ACJ in FC of T v South Australian Battery Makers Pty Ltd 78 ATC 4412 at p 4420; (1978) 140 CLR 645 at p 660), it is susceptible of application where the activities and operations by which assessable income is gained or produced or by which a business is carried on are not reasonably open to dispute, and where the relevant expenditure is incurred solely in acquiring an asset or a legal right under a contract or in discharging an antecedent legal liability. In cases of that kind, of which Cecil Bros Pty Ltd v FC of T (1962-1964) 111 CLR 430 is an example, the connection between the asset or legal right acquired or the legal liability discharged on the one hand and the gaining or production of assessable income or the carrying on of a business on the other appears from `a rigorous and objective examination'. But there are cases where expenditure is not incurred solely to acquire an asset or legal right under a contract or to discharge a legal obligation,

ATC 4205

and there are cases where there is dispute as to the scope and nature of activities and operations by which assessable income is or is intended to be gained or produced, or by which a business is carried on. In cases of these kinds, the Europa approach does not give adequate guidance to a court in finding whether the expenditure is deductible under sec 51(1).''

His Honour continued as follows (at ATC 4548; FLR 191):

``Characterization of expenditure by a contractual quid pro quo requires an analysis of the consideration passing to the taxpayer under the contract, though analysis restricted to the consideration passing to the taxpayer may prove misleading... Where an advantage other than or beyond a contractual quid pro quo can be identified as an advantage for the taxpayer which the relevant expenditure is calculated to effect, the analysis of that advantage gives character to the expenditure (South Australian Battery Makers case [at ATC 4419-4420, 4421; CLR 659-660, 662])... When the question is whether expenditure has the character of capital or of a revenue payment,... the advantage for which the expenditure was incurred must be identified and the manner in which it `is to be relied upon or enjoyed' must be considered (Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T [at 363]). The role of the advantage in the income-earning under- taking requires examination. Similarly, when the question is whether expenditure is incurred in gaining or producing assessable income, the connection between the advantage for the taxpayer which the incurring of the relevant expenditure is calculated to effect and the taxpayer's income-earning undertaking or business must be considered. If the advantage can be sufficiently identified by reference to a contract, and the taxpayer's undertaking is known, the connection between the incurring of the expenditure and the undertaking is manifest, and it would be otiose to refer to the purpose of incurring the relevant expenditure. But purpose is relevant to describe an element of connection between expenditure and a taxpayer's undertaking or business in cases where a taxpayer incurs expenditure or agrees to incur expenditure without any antecedent obligation to do so or where the occasion of the expenditure (unlike the purchase of trading stock) is not manifestly to be found in whatever is productive of assessable income or in whatever would be expected to produce assessable income, or in the carrying on of a business.''

Later in his judgment (at ATC 4550; FLR 193) Brennan J said that the taxpayer's state of mind may be ``relevant evidence to show what expenditure is for where the Europa approach does not give adequate guidance''. His Honour identified the principal class of cases of this kind as those where payments have been made to directors or employees of a taxpayer company in or near retirement.

Brennan J's analysis leaves open the case ``where expenditure is not incurred solely to acquire an asset or legal right under a contract or to discharge a legal obligation'', although it is not clear whether his Honour intended to limit that case to one where expenditure is voluntarily incurred. It is clear enough, however, that Brennan J regarded the question of whether s 51(1) is satisfied as not depending, other than perhaps in unusual cases, on the taxpayer's state of mind, at least where the payment is not voluntary. A similar conclusion was reached by Deane and Fisher JJ (at ATC 4559; FLR 208), who said that

``... in the ordinary case of a payment under a contract, the nature of the outgoing will commonly be determined by reference to the contractual quid pro quo.''

This conclusion is consistent with what was said by the Court in
Fletcher & Ors v FC of T 91 ATC 4950 at 4957; (1991) 173 CLR 1 at 17-18, although that was a case concerned with the first limb of s 51(1). See also
FC of T v JD Roberts; FC of T v Smith 92 ATC 4380; (1992) 37 FCR 246 (FCA/FC) at ATC 4387-4388; FCR 256, per Hill J (with whom Jenkinson J agreed).

The present case is not one of voluntary payments, in the sense in which that expression is used in the cases. The additional interest was paid by the taxpayer to continuing depositors, pursuant to the legally binding arrangements I have identified. The payment of interest to the continuing depositors, including additional interest, had an obvious relationship with the conduct of the taxpayer's business as a banker. As I have explained, the additional interest was

ATC 4206

paid strictly by reference to the amount of moneys deposited with the taxpayer. In these circumstances, I think it is appropriate to determine the advantage obtained by the taxpayer by reference to the contractual quid pro quo obtained for the payment of additional interest. That advantage is most accurately described as a retention or provision of funds to be deployed in the taxpayer's banking business. It was not the procuring of support for the proposed merger from depositors entitled to vote on the proposal.

The Board's Motivation

For the reasons I have given, I do not think that the Commissioner can succeed in this case even if a finding were to be made that United's Board made the Special Interest Offer motivated solely by the desire to provide depositors with an incentive to vote in favour of the proposed merger. For the sake of completeness, however, I think it appropriate to consider whether such a finding is justified by the evidence.

It is clear from the account of the facts I have given earlier that one motive of Mr Willmott and (so I infer) of other directors of United supporting the merger was to provide benefits to depositors that would encourage voting members to vote in favour of the proposal. Those benefits included, but were not confined to, the additional interest payable to depositors.

But it is equally clear that this was not the directors' only motivation in agreeing to provide benefits to depositors in the event of the merger proceeding. Another very important motivation was the desire to recognise the contribution made by existing members to building up the assets of United and their entitlement, albeit contingent, to any surplus arising in a winding up. Mr Willmott's memorandum of 11 June 1986 to the Board of United acknowledged the need for directors to exercise their powers in the interests of the members as a whole. The meeting of directors of 12 June 1986, which approved the merger proposal, took into account advice received at that meeting that a starting point for an assessment of the value of United's business was the value of reserves, namely, $53 million. The benefits of the merger proposal were considered in the light of the assessed net worth of the business, even though time did not permit a detailed analysis. The directors concluded that ``the proposal was in the Society's best interests and should be recommended to the Society's membership for approval''.

Subsequent changes to the merger proposal, in particular improved benefits for depositors and borrowers, reflected the fact that competing bidders for United had emerged. Their bids or foreshadowed bids would have provided a range of different benefits for members and depositors. The Board of United, quite properly, used the competing bids to secure better terms from NMR Bank for the members of the Society, in accordance with the Board's desire to act in the interests of members as a whole. The Macquarie Hill Samuel report, which post- dated the Amended Merger Agreement, but preceded the Special General Meeting, assessed the benefits of the merger to members and borrowers by reference to whether their legitimate interests were recognised.

In my view, the motivation for the Board's decision to make the Special Interest Offer was not merely to induce members to vote for the merger proposal. I think that the Board's decision to make that offer, and to provide other benefits to its depositors and members, was motivated at least as much by the desire to accord appropriate recognition to their interests in the undertaking and to their contributions to building its reserves. That desire, in turn, was influenced by the Board's perception that its legal responsibility was to ensure that it acted in the interests of members as a whole. If it were necessary to make a specific finding, I would conclude that the Board's principal motivation in making the Special Interest Offer was to provide members and depositors appropriate recognition for their interest in the building society and their contributions to its success.

The amended assessments

Having regard to the conclusions I have reached, it is not necessary to address the second issue in the proceedings, namely, whether the issue by the Commissioner of a notice of assessment dated 28 November 1995, in respect of the 1987 year of income, was authorised by the ITAA. In case the matter goes further, however, I shall briefly consider the question. It is convenient first to set out the relevant course of events.

On 1 June 1988, the Commissioner assessed a document entitled ``NOTICE OF ASSESSMENT MADE'' to the taxpayer in respect of the year of the 1987 year of income. The notice of assessment specified a balance of

ATC 4207

$12,004.98 tax payable, after allowing for debits and credits. The due date for payment was 4 July 1988.

On 22 July 1988, the taxpayer objected against the assessment, on two grounds. One related to the entitlement to deduct from assessable income an amount in respect of the transfer of a provision for annual leave. The other related to the taxpayer's entitlement to carry forward certain losses for previous years. On 19 October 1989, the Commissioner issued a ``NOTICE OF AMENDED ASSESSMENT MADE''. This document showed, by the use of a symbol, that no tax was payable on the income shown on the return. The notice also showed that an amount of $30,224.50 was refundable to the taxpayer.

On 28 November 1995, the Commissioner issued a further document described as ``NOTICE OF ASSESSMENT MADE'', in respect of the 1987 year of income. This purported to assess $1,655,772.23 tax for the year ended 30 June 1987, together with additional tax of $1,341,892.74 for a late and incorrect return.

The terms of ss 166 and 170 of the ITAA have been set out earlier. The Commissioner accepted that

The Commissioner's argument was that, on 28 November 1995, there was no existing assessment for the Commissioner to amend. This was because there could be no assessment of a taxpayer in the absence of a calculation and notification of tax payable by the taxpayer:
Batagol v FC of T (1963) 13 ATD 202 at 204; (1963) 109 CLR 243 at 252, per Kitto J. According to Mr Slater's submission, the assessment of 1 June 1988 had been ``cancelled'' by the notification of 19 October 1989. Thus, after 19 October 1989, there was no extant assessment of the taxpayer. The assessment of 28 November 1995 was therefore not an exercise of the power to amend the taxpayer's assessment. Rather it was issued under the power in s 166, to make an assessment of the amount of taxable income of the taxpayer and of the tax payable thereon.

In the present case, the notice of assessment of 1 June 1988 was issued under s 166 of the ITAA. On any view, this was an ``assessment'' for the purposes of s 170 of the ITAA: Batagol, at ATD 204; CLR 252. What Mr Slater described as the ``notification'' of 19 October 1989, but which was headed ``NOTICE OF AMENDMENT MADE'', clearly enough was an exercise of the power of the Commissioner to amend an assessment conferred by subss (1) and (7) of s 170. As the heading on the notice suggested, the power conferred by those provisions was to ``amend any assessment''.

There is nothing in s 170 of the ITAA to suggest that the effect of amending an assessment is to cancel, revoke or extinguish the original assessment, whether retrospectively or prospectively. The power conferred is to amend an assessment and that is what the Commissioner purported to do. There may be an issue as to whether the amended assessment of 19 October 1989 was itself an ``assessment'' for the purposes of s 170 of the ITAA, in the light of Batagol: compare
Webb v DFC of T (No 2) 93 ATC 5123 at 5128; (1993) 47 FCR 394 at 399-400, per Hill J;
Ryan v FC of T 97 ATC 4645; (1997) 148 ALR 88 (FCA/Spender J). But that does not alter the character of the original assessment, issued on 1 June 1988. In these circumstances, s 166 of the ITAA did not authorise the making of a fresh assessment as though none had previously been made and, in particular, did not authorise an assessment increasing the liability of the taxpayer (there being no suggestion of fraud or evasion) more than six years from the date of the original assessment. I should note, should it be relevant, that the notice of amended assessment itself was issued by the Commissioner on 19 October 1989, more than six years before the purported assessment of 28 November 1995.

Had it been necessary to resolve the second issue, I would have held that the notice of assessment dated 28 November 1995 was not authorised by the ITAA.

Conclusion

The objection decisions made by the Commissioner should be set aside. Neither party's submissions addressed the form of order that should be made if the applicant were to succeed. Since the eight appeals raised some questions that were not pursued before me, I

ATC 4208

think the appropriate course is to stand the matter over for seven days and to direct the taxpayer to bring in short minutes of order. My present view is that there is no reason why the Commissioner should not pay the taxpayer's costs. However, I shall give the parties an opportunity on the adjourned date to make submissions on costs, should they wish to do so.

THE COURT ORDERS THAT:

1. The matters be stood over for seven days.

 

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