CASE 5/2001

Members:
BH Pascoe SM

Tribunal:
Administrative Appeals Tribunal

MEDIA NEUTRAL CITATION: [2001] AATA 831

Decision date: 3 October 2001

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BH Pascoe (Senior Member)

These applications are for the review of a decision of the respondent to disallow objections against assessments of income tax for the years ended 30 June 1996, 1997 and 1998. In the objection, the applicant had claimed that interest paid was an allowable deduction.

2. At the hearing the applicant was represented by Mr S. Steward, of counsel, and the respondent by Mr M. Flynn, of counsel. Evidence was given by the applicant and an accountant, Mr S. Stockdale. Pursuant to s. 14ZZE of the Taxation Administration Act 1953, the applicant requested that the hearing be in private.

3. The commencement of the claims for interest deductions was on 25 August 1998 when Mr Stockdale, as accountant for the applicant, wrote to the respondent seeking to amend income tax returns for the years ended 30 June 1992 to 1998 inclusive. It was said that the applicant had claimed a deduction of $169,468 for interest paid to Countrywide Building Society (in liquidation) (``Countrywide'') in the year ended 30 June 1991 but had failed to claim a further $2,667,449 paid in the subsequent five years to 30 June 1996 and consequent losses carried forward in the next two years of income. The reason for the omission was said to be that the

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relevant business activities had ceased by 30 June 1991 but the decisions in
Placer Pacific Management Pty Limited v FC of T 95 ATC 4459 and
FC of T v Brown 99 ATC 4600 had led the applicant to believe that subsequent interest expense was deductible. The respondent replied that s. 170(3) of the Income Tax Assessment Act 1936 precluded amendment to any year prior to the year ended 30 June 1995. On 9 December 1999, the applicant lodged objections to the assessments for the years ended 30 June 1995 to 1998 inclusive. In a decision dated 31 March 2000 the respondent determined that an objection to the year ended 30 June 1995 was out of time but treated as a request for amendment and then disallowed the objections to the subsequent three years. The primary reason was that the respondent considered that the relevant payments were made in the capacity of a guarantor after default of a company.

4. The applicant gave evidence he is an architect who first met a Mr S in 1988 or 1989. He said that Mr S proposed the purchase of a property in Richmond which appeared to the applicant to have good prospects of development. Mr S offered him a 50 per cent interest in the property and the applicant said that it was agreed to purchase the property in their individual names in equal shares. The applicant provided $100,000 as a deposit by borrowing on the security of his matrimonial home. He said that Mr S negotiated a loan from Countrywide. Mr S was shown on the Contract of Sale as the original purchaser of the property but, subsequently, a company H Pty Ltd was substituted as the purchaser. The applicant said that the advice of Mr Stockdale, after the property was purchased but prior to the loan, was that a company should be used as nominee/ agent. He said that the building development of four shops commenced and was completed in October 1990. He believed that the net rental income after interest would be approximately $20,000 per annum which would be taken out as directors' fees or in some other form. The applicant believed that the directors of H Pty Ltd were himself and Mr S but could not recall who were the shareholders. He was uncertain whether he or his family trust was a shareholder.

5. The applicant said that, by the end of 1990, the development boom had burst and tenants could not be found for the new shops. With no rental income, the obligations under the loan could not be met and Countrywide, which went into liquidation in December 1990, foreclosed. The development was sold by the mortgagee in January 1992. The applicant had been a guarantor of the loan to H Pty Ltd secured by a mortgage over his matrimonial home. Mr S, also a guarantor, was made bankrupt and made no payment to Countrywide. The original sum advanced by Countrywide in February 1990 was $1,718,762 but, by July 1995, a statement of claim by Countrywide was for $3,978,656 plus interest at 24 per cent per annum from 12 April 1995. Judgement against the applicant was given and, in February 1996, Countrywide received $278,145 from the sale of the applicant's home. By deed of 28 May 1996, Countrywide released the applicant from the balance of the liability subject to payment of $20,000, three annual payments based on income in March 1997, 1998 and 1999 and legal costs of Countrywide. Total amounts paid to Countrywide apart from proceeds of sale of the development appear to have been some $30,424 between February 1991 and April 1994 according to the attachment to Countrywide's Statement of Claim in July 1995. However, how much of this came from collections of rent, other sources or the applicant was not made clear.

6. It was the applicant's stated belief that H Pty Ltd was the owner of the land and the borrower from Countrywide in the capacity as nominee for himself and Mr S. However he was not able to point to any documentary evidence that this was the position other than a document dated 17 August 1990 headed ``Joint Venture Agreement'' and signed by the applicant and Mr S. The agreement stated:

``This Agreement dated 17.8.90 records the joint business activity agreed to between [ the applicant] and [S] in regard to the property... Road Richmond.

The Agreement relates solely to the above project and limits the borrowings on that asset and activity (... Road Richmond) to those currently in place with the Countrywide Building Society save and accept that any short term facilities may be procured from a Bank or financial institution with the commitment of both parties.

It is agreed by both parties that [H Pty Ltd] be appointed to act as Nominee for the

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project to hold the property on behalf of the joint venturers ([applicant and S]), until both parties agree to realise their interests in the investment.''

The applicant was unable to recall any specific reason why this agreement was prepared and signed at that time. Neither could he recall who prepared a document entitled ``Heads of Agreement'' dated 13 November 1989, which stated:

``Re:. Road, Richmond

It is hereby agreed that the contract of sale on the above property, while showing the purchaser to be [S], is now jointly owned by [ S] and [the applicant] (for [T P/L]).

The eventual purchaser will be a company yet to be incorporated but which will be jointly and separately owned and directed by [ S] and [the applicant] (for [T P/L]).''

He said that T Pty Ltd was the trustee of his family trust but could not recall whether that company was recorded as the shareholder in H Pty Ltd. The applicant acknowledged that no reference had been made to H Pty Ltd being solely a nominee or agent for a partnership in any loan documents, in a brief to counsel to advise on the defence against the Court action by Countrywide in April 1991, in his proof of evidence dated 26 April 1995, prepared for Court proceedings or in the deed of settlement with Countrywide in May 1996. In all these documents, H Pty Ltd was referred to as the borrower with the loans guaranteed by the jointly owned home of the applicant and his wife.

7. Mr Stockdale gave evidence that he had acted for Mr S since approximately 1981 and was informed by him that he had purchased a property in partnership with the applicant. Mr Stockdale said that he suggested that H Pty Ltd be nominated as purchaser to mask the identity of the beneficial owners and to simplify any required re-arrangement of ownership. He said that he did not recommend using the company as beneficial owners because of likely early losses and potential capital gains tax complications. Mr Stockdale said that he was not aware that the Countrywide loan had been arranged in the name of H Pty Ltd until after Countrywide commenced to pursue the guarantors after the default on the loan. He maintained that, if he had been involved in the loan application, he would have insisted that it be made in the names of the two individuals consistent with the partnership between them. He said that, during the property boom of the late 1980s, he advised many of his clients to use a company as nominee/agent. Mr Stockdale said that he lodged an application for a partnership Tax File Number (TFN) in May 1991 showing a date of commencement of a partnership between the applicant and Mr S trading as H Pty Ltd as 1 July 1990. He said that he prepared and lodged a partnership income tax return for the year ended 30 June 1991. When it was put to him that the respondent had no record of such a partnership return, Mr Stockdale accepted that it may not have been lodged. He said that records of that period had been destroyed and were no longer available to him. Mr Stockdale denied that the application for the TFN in May 1991 and the preparation of a partnership return was done only after foreclosure by Countrywide and the recognition of substantial losses with no prospect of a profit. Mr Stockdale said that he had calculated the figures for interest claimed in the application for amendment on 25 August 1998 by deducting the loan balance at date of completion of the building development from the final amount shown in the 1996 settlement deed. He calculated interest at the default interest rate for the years ended 30 June 1992 to 1995 and showed as interest for the year ended 30 June 1996 the balance to bring to $2,667,449.

8. It was submitted for the applicant that, whether the applicant was liable for the payment of interest as principal, with H Pty Ltd as nominee or agent, or whether as a guarantor to secure funds to enable H Pty Ltd to generate income which would come to him by way of dividends and/or directors' fees, such interest was deductible. It was said that the joint venture agreement of 17 August 1990, the TFN application in May 1991 and the heads of agreement corroborated the oral evidence of the applicant that H Pty Ltd was solely a nominee/ agent for a partnership of the applicant and Mr S. Mr Steward submitted that any payments against principal and accrued interest must be applied firstly against interest. He acknowledged that the liability, if solely as guarantor, was partly attributable to the applicant's wife as the joint owner of the house, which was provided as security and sold by the mortgagee. However, it was argued that this

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was solely a source of funds used to meet obligations of the applicant who was a guarantor of the loan. It was acknowledged that the objection in relation to the year ended 30 June 1995 was out of time and not a valid objection.

9. For the respondent it was submitted that any liability of the applicant in relation to the loan was as guarantor to secure money borrowed by H Pty Ltd as principal. It was said that, where 10 years have passed, the documentary evidence has greater weight than oral evidence. Mr Flynn argued that the joint venture agreement and the earlier heads of agreement could be interpreted as showing the applicant acting as nominee for T Pty Ltd as the shareholder in H Pty Ltd with the joint venture agreement being for joint ownership of a company, H Pty Ltd. It was said that any liability of the applicant arose by way of guarantee only in the event of default by the borrower and was of a capital nature but, in any event, not an expense incurred for the purpose of deriving assessable income.

10. The first question for determination in this matter is whether H Pty Ltd was acting purely as nominee/agent for the applicant and Mr S or whether as principal with the individuals as directors, shareholders and guarantors. It is clear that the evidence is not conclusive. Mr Steward submitted that oral evidence was the best evidence. However, and acknowledging that 10 years have passed, the applicant appeared to be somewhat unclear as to the specifics of the arrangement. As said by Fullager J in
Pascoe v FC of T (1956) 11 ATD 108 (at p. 111):

``Where a person's purpose or object or other state of mind in relation to a given transaction is in issue, the statements of that person in the witness box provide, in a sense, the `best' evidence, but, for obvious reasons, they must, as Cussen J., observed in
Cox v Smail (1912) V.L.R. 274, at p 283, `be tested most closely, and received with the greatest caution'.''

In the case, it is in the undoubted best interests of the applicant to argue that the ownership of the development property and the liability for the borrowing was as a partnership rather than as a company with the applicant as a guarantor. Unfortunately, there was no corroborating evidence from Mr S or any other person involved at the time of purchase or negotiation of the loan. Mr Stockdale could give evidence only of his recollection of advice given at the time and the application for a TFN and preparation of a partnership tax return. Both of these latter events were after H Pty Ltd had defaulted on the loan and it was clear that there was a substantial shortfall between the liability to Countrywide and the likely proceeds of sale of the development. The documentation of 13 November 1989 titled ``Heads of Agreement'' does little to advance knowledge of the intention of beneficial ownership. It states simply that the ``eventual purchaser'' was to be a company jointly owned and directed by the two individuals. If anything, it appears to indicate an intention for the company to own the land in its own right. It adds further confusion by the addition of the words after the name of the applicant, ``for T Pty Ltd'', indicating that any ownership recorded in the name of the applicant was to be as nominee/ agent for his family trust. The ``Joint Venture Agreement'' of 17 August 1990 may be of more weight in supporting the evidence of the applicant but even this refers to H Pty Ltd holding the property on behalf of the joint venturers. In
Ryvitch v FC of T 2001 ATC 4403; [2001] FCA 806, Sunberg J, at paragraph 16, found that ``joint venture'' was not a term necessarily synonymous with a partnership. After quoting the words of Mason, Brennan and Deane JJ in
United Dominions Corporation Ltd v Brian Pty Ltd (1985) 157 CLR 1 at p. 10:

``... The term `joint venture' is not a technical one with a settled common law meaning. As a matter of ordinary language, it connotes an association of persons for the purposes of a particular trading, commercial, mining or other financial undertaking or endeavour with a view to mutual profit, with each participant usually (but not necessarily) contributing money, property or skill. Such a joint venture. will often be a partnership. The term is, however, apposite to refer to a joint undertaking or activity carried out through a medium other than a partnership such as a company, a trust, an agency or joint ownership.''

He went on to say:

``... I am not persuaded that the parties' use of the term `joint venture' evidences the existence of an oral partnership agreement rather than a corporate structure. Even if it did point to the existence of a partnership,

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for the reasons I have given, the terms of the agreement were not proved with the requisite certainty to be enforceable. I am not satisfied that there was an oral partnership agreement as alleged.''

Subsequently, at paragraph 26, Sunberg J said:

``... It is to be remembered that the question is not simply whether the conduct and statements of the parties point to a partnership-type arrangement. The terms of the arrangement must be identified with sufficient certainty.''

Here, the only document which appears to support the arrangement is the ``Joint Venture Agreement''. But, as indicated earlier, all this states is that H Pty Ltd is to hold the property on behalf of the ``Joint Venturers'', a term which does not necessarily indicate partnership. It is further confused by the reference in the ``Heads of Agreement'' to the applicant's involvement being on behalf of the trustee of the family trust. In the brief to counsel of 2 May 1991, it was noted that T Pty Ltd was one of the two shareholders in H Pty Ltd. In his oral evidence, the applicant referred to a belief that net rental income derived by H Pty Ltd would be taken out by way of directors' fees or in some other form. Mr Stockdale said that his advice would have been to use a company as nominee not as beneficial owner and would have expected the loan to have been in the individual names. Given the limited evidence of a partnership between the applicant and Mr S, I am not satisfied that such a partnership existed nor that H Pty Ltd was not the beneficial owner of the property. It is relevant, in my view, that Countrywide sought and obtained judgement against H Pty Ltd with no defence that H Pty Ltd was not acting in its own capacity.

11. It follows that any liability of the applicant to Countrywide was in his capacity as guarantor. As such, his liability arose only after H Pty Ltd defaulted, the mortgagee entered into possession of the property, sold the property and was left with a shortfall. It could be argued that the liability did not arise until the applicant and his wife accepted judgement against them on 9 November 1995 but, in any event, it was not until after sale of the property and when there was no prospect or possibility of deriving assessable income. Any payment by the applicant was by way of discharging a liability as guarantor and consequently, was of a capital nature. Further, it could not be said as expenditure incurred for the purpose of gaining or producing assessable income. At the time the liability arose, there was no prospect of generating income from the project and no income-producing asset. In this case the issues are quite different from those in FC of T v Brown 99 ATC 4600. In Brown the taxpayer borrowed money and was liable for interest to enable the purchase of an income producing business. It was held that, notwithstanding the subsequent sale of the business, the occasion of the recurring liability for interest was the loan agreement, the purpose of which was for the taxpayer and his wife to acquire and carry on the business. In this case, the liability only arose after any income producing activity has ceased and the occasion of that liability was the meeting of a guarantee of the shortfall of H Pty Ltd.

12. There is a further problem for the applicant in this case. The claim for deduction appears to have been based on the difference between the liability shown on the 1996 settlement deed and the loan balance at date of completion of the building development. The first difficulty is that, in the original loan agreement, the applicant was one of three guarantors. Although the liability was joint and several, it is difficult to accept that the applicant was liable personally for the whole of the outstanding liability. The second difficulty is that, pursuant to the 1996 settlement deed, it was accepted that his liability would be satisfied by the proceeds of his home, $278,145, and some $50,000 over three years. Whether any part of the payments totalling $30,424 prior to April 1994 came from the applicant is not known.

13. As a consequence, it would seem that the applicant may have incurred no more than $328,145 rather than the $2,667,449 said to have been incurred. In addition the $278,145 came from the house jointly owned by the applicant and his wife so that it might be said that one-half of this amount was contributed by the wife. Given that the applicant cannot be said to have incurred any interest liability in carrying on a business it would seem that any amount incurred was equal to that paid rather than what might be said to have been accrued in the claim by Countrywide. If it had not been for my findings that any payments were made as guarantor and were both of a capital nature and

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not incurred for the purpose of producing assessable income, I would have found great difficulty in calculating the quantum of any deduction which was clearly less than that claimed.

14. It follows from the foregoing that the decision under review should be affirmed.