Case C41

Judges: FE Dubout Ch

G Thompson M
N Dempsey M

Court:
No. 3 Board of Review

Judgment date: 25 June 1971.

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Gordon Thompson (Member): In this reference the taxpayer is a private company incorporated in a capital city on 28 June 1963 and which, at all material times carried on business as a builder. In its return for the year ended 30 June 1968, it claimed a deduction in the sum of $6900, being a loss incurred as the result of discounting a mortgage. The taxpayer claimed that this sum was an allowable deduction pursuant to the provisions of sec.51 of the Income Tax Assessment Act 1936-1968. The Commissioner disallowed the claim for deduction and contended that it was not a loss or outgoing in gaining or producing the taxpayer's assessable income, nor was it necessarily incurred in carrying on a business for the purpose of gaining or producing such income. The Commissioner further contended that, in any case, the loss was one of capital.

2. During the year ended 30 June 1965, the taxpayer, a building company, constructed a block of flats which it sold to another company. The profit on this transaction was included in its taxable income for that year. These flats were built upon certain leasehold land, which the taxpayer had acquired from the Crown. In April 1965, taxpayer sold this leasehold land, together with the improvements thereon, for a total sum of $160,000 of which the sum of $16,000 was payable by way of deposit, $64,000 was payable upon completion and the balance of $80,000 was to be secured by a certain Memorandum of Mortgage.

3. The Contract of Sale in question, (Exhibit ``C'' in this reference) which is dated 9 April 1965, in cl. 19(b) thereof further provided the terms of repayment of the balance of the purchase price, together with interest thereon as follows -

``The said Mortgage shall be prepared and lodged for registration by the Vendor's Solicitors at the cost of the Purchaser and shall secure the payment to the Vendor of the balance of purchase money as aforesaid together with interest thereon payable quarterly at the rate of Ten pounds ( £ 10) (Twenty dollars ($20)) per centum per annum reducing to Eight pounds ( £ 8) (Sixteen dollars($16)) per centum per annum on payment within fourteen (14) days from the due date thereof. Such Mortgage shall contain a covenant by the Purchaser for repayment of the principal sum together with any interest due but unpaid at the expiration of five (5) years from the date of completion and shall contain such other provisions as the Vendor may reasonably require. In the case of any disagreement as to the form or contents of the Deed of Mortgage the same shall be settled at the cost of the Purchaser by Counsel nominated by the Vendor and as so settled shall be accepted by and be binding upon the parties.''

4. It will thus be seen that the Contract of Sale provided for the execution of a Memorandum of Mortgage by the purchaser back in favour of the vendor taxpayer to secure the payment of the balance of the purchase money. It will be observed that this is not a case of substituting some other asset as part of the purchase price of the land and improvements sold, but the mortgage was to be taken as security only for the due payment of the balance of the purchase price. It is true that the Memorandum of Mortgage (Exhibit ``D'') is somewhat peculiarly worded under the circumstances. The recitals speak of the sum of £ 40,000 ($80,000) lent to the mortgagor by the taxpayer. This recital is inaccurate as far as the true legal position in concerned. It cannot be taken to govern the operative parts of the Memorandum of Mortgage. It is plain that a Memorandum of Mortgage was taken by way of security to ensure the payment of the balance of the purchase price.

5. Subsequently, during the year in question, that is, the year ended 30 June 1968, the taxpayer required additional funds to complete another building project. It felt compelled to discount the said mortgage through a finance company thereby incurring the alleged loss of $6,900. In its return it claimed that this amount represented an expense in acquiring finance to construct an income producing property. At the hearing it was further submitted that the sale of the said mortgage debt at a discount was something akin to the factoring of trade debts by taxpayer. Reference was also made to cases involving discount and rebates which are regarded as allowable deductions to a trading company as a taxpayer.

6. In my opinion, the evidence in this case provides a clear distinction between the contention of the Commissioner on the one hand that the matter was an affair of capital, and the contention of the taxpayer that it was a discounting of a trade debt and was allied to the concepts of the factoring of trade debts. In my opinion, the mortgage back from the purchaser to the vendor taxpayer was as a security only, and did not operate in discharge or extinguishment of that part of the purchase price. The simple contract debt for the balance of $80,000 dollars contract price remained in esse but was merely reinforced by the real remedies afforded to the taxpayer by Memorandum of Mortgage. The present case is, in

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my view, not a case of the substitution of some asset such as shares or debentures for the previous simple contract debt. The cases relied on by the Commissioner are thus, in my view, not applicable.

7. I consider that the deciding principle applicable to the present case is to be found illustrated in the case of
16 T.B.R.D. 418 Case R.83. Although on the facts of that particular case, the decision was that the loss involved was of a capital nature, the distinction between that concept, and whether the original debt remains and is not extinguished by the security taken, is pointed out at p. 422 of the above report. The Chairman, Mr. Burke, wrote as follows -

``In my opinion the principle to be applied in the present case is correctly set out in Challoner and Greenwood Income Tax Law and Practice 2nd ed. at p. 518:- `Losses on the sale of securities accepted in full satisfaction of a debt or part of a debt are...not deductible for the reason that the acceptance of securities in full satisfaction of the debt discharges the debt and the subsequent loss on the security is clearly not a debt which has been brought to account by the taxpayer as assessable income (
11 C.T.B.R. 106 Case 30;
10 C.T.B.R. 106 Case 34(a);
1 T.B.R.D. 235 Case 64). The position may be otherwise of course, where assets are taken merely as security for the debt and the security is subsequently realised; however, it is not the loss on the sale of the asset as such, but an amount in respect of the original debt which then becomes deductible.''

8. The Chairman also went on to refer to the documentary evidence which indicated that the formal application for allotment of registered first mortgage debenture stock amounted to an accord and satisfaction as far as the original debts were concerned. The debenture stock was thus accepted in full satisfaction of the debts in question. Mr. Smith, Q.C. on p. 424 also referred to the same point when he stated that the debentures were issued according to the documents in a ``discharge of the balance of moneys owing.'' That case, whilst distinguishable from the present one on its facts, thus, in my opinion, illustrates the principle that where security for a debt is taken, the original debt remains and any loss suffered by factoring it or discounting it would, if it had a sufficient business connection, be deductible under sec.51 of the Act.

9. Some observations on the nature of a mortgage as applicable to the present case may be apposite. According to the long history of the matter in Equity, in principle a mortgage is a debt with an accessory security over land, and not an estate in land measured by the amount of the debt: In
re Williams 1945 V.L.R. 213 . Further cases on the subject are noted at 19 A.L.J. 341, 342.

10. The proposition that a mortgage is security for a debt, applies a fortiori in the case of a Memorandum of Mortgage over Crown leasehold land. Although the mortgagor always possesses an equity of redemption, it is at least doubtful that a mortgagee of Crown leasehold land has any right of foreclosure. See
Tannock v. North Queensland Securities Ltd. 1932 St.R.Qd.285, at 291, 298 . But the essential nature of such a mortgage is that it is a debt, or loan of money, secured in some fashion. These real remedies are accessory to the debt owing by the mortgagor to the mortgagee on the personal covenant. Thus the taxpayer company possessed a debt owing to it by the purchaser mortgagor.

11. A debt, or a book debt, for present purposes may be generally described as a debt connected with and growing out of the taxpayer's trade. In this case I think that it arose out of a transaction in the ordinary course of the business of the taxpayer. See hereon
Shipley v. Marshall (1863) 14 C.B.N.S. 566 ;
Independent Automatic Sales Ltd. v. Knowles & Foster 1962 3 All E.R. 27 ; and
Paul & Frank Ltd. v. Discount Bank (Overseas) Ltd. 1966 2 All E.R. 922 at 925, 926 . Those cases dealing with the judicial description, in the absence of definition, of a book debt are, in my opinion, apposite to describe the nature of taxpayer's debt in this particular case.

12. These considerations of the general law lead me to the conclusion in the present case that in essence the taxpayer discounted a trade debt. It sold its right title and interest in and to the Memorandum of Mortgage over Crown leasehold land at a discounted price. Thus, in my opinion, the operation is correctly described as being similar; for income tax purposes, to the simple discounting or factoring of a trade debt. Moreover, it was done in the ordinary course of business of the taxpayer, and for business reasons, that is, to raise funds for the very purpose of carrying on its trade or business. Accordingly, I think that it bore a revenue or income character, and was not akin to the sale of property simpliciter, so that it was not of a capital nature.

13. I am satisfied that the loss was incurred on revenue account. Both the creation of the debt and its discounting had a definite business connection with the affairs of the taxpayer building company. I am satisfied that it is therefore deductible under sec.51 of he Act.

14. Accordingly, I would allow the taxpayer's objection and order that the assessment be amended by excising from the taxpayer's assessable income the said sum of $6,900 claimed.

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