Case K16

Judges:
MB Hogan Ch
P Gerber M
GW Beck M

Court:
No. 3 Board of Review

Judgment date: 27 April 1978.

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M.B. Hogan (Chairman): The basic problem in this reference is to determine the extent to which losses or outgoings are incurred by a credit union in the gaining or producing of its assessable income. The Credit Union (by which title I shall refer to it in future) is from its title a credit union, the members of which are limited to a small group of public servants; nevertheless, the decision, in this instance, should have a substantial bearing on a very wide range of similar credit unions.

2. The problem arises as a result of the introduction of sec. 23G into the Income Tax Assessment Act by Act No. 126 of 1974. By sub-sec. (2) of sec. 6 of that Act, sec. 23G was made applicable to assessments in respect of income of the year of income that commenced

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on 1st July, 1973, and applies in respect of subsequent years of income. In brief, the effect of sec. 23G is to exempt from income tax income derived on or after 1st July, 1973, by an approved credit union (as defined), where that income consists of interest paid to the credit union by members of the credit union (not being companies) in respect of loans made to those members.

3. In the reference before the Board in respect of year ended 30th June, 1974, the Credit Union has been accepted by the Commissioner as an approved credit union in terms of sub-sec. (3) of sec. 23G and the Credit Union therefore must be accepted as qualifying for the exemption afforded by sub-sec. (2) of that section. In the year of income, the Credit Union derived income by way of interest paid on loans by its individual borrowing members amounting to $40,727. It is common ground that this figure represents the extent of income derived by the Credit Union which is exempt from income tax in the relevant year of income. The balance of the income derived by the Credit Union in the year amounts to $1,652, made up of $1,432 interest on moneys invested with bodies and persons other than members and $220 noted as ``Membership Entrance Fees etc.''.

4. In the year of income, there was no expenditure which could be shown to relate directly to the earning of assessable income. By agreement between the parties at the hearing, the amount described in the alteration sheet as ``indirect expenditure'', amounting to $34,964, was accepted as being the expenditure relevant and incidental to the earning of both classes of income (i.e. exempt and assessable) derived by the Credit Union in the year of income. It emerged in the course of the hearing that there was an error in computing this total and the correct figure should have been $34,974. It also emerges from an examination of the constituent parts of that total that an amount of $177 representing depreciation on office furniture and equipment has been incorporated under the heading of expenditure and dealt with as though it were a loss or outgoing appropriate to be considered under sec. 51 of the Act. It is clear that this last amount should be dealt with under sec. 54 and 61 of the Act. In the event, nothing turns on this as there is no dispute between the taxpayer and Commissioner as to the proportionate part of the deduction in respect of that particular item which has been allowed as a deduction. Indeed, apart from the manner in which the Commissioner has dealt with the sum of $21,490, representing interest paid by the Credit Union on funds borrowed, there is no dispute between the parties.

5. My colleague, Dr. Beck, has summarised the facts and arguments presented to the Board in relation to this reference and has dealt at length with the various bases of apportionment advanced. I have had the advantage of reading his reasons and do not propose to deal further with matters which have been so amply covered by my colleague.

6. In argument, the principal authority relied upon by counsel for the taxpayer was
Ronpibon Tin N.L. v. F.C. of T. 78 C.L.R. 47 . The decision appears to be a uniquely apposite one. The only assessable income derived by the Ronpibon company was interest on its invested funds and the company incurred expenditure which had a double aspect, being in part attributable to the gaining of assessable income and in part to other ends and activities which were not productive of assessable income. In dealing with this expenditure, the Full High Court, in its answer to the question raised by the trial Judge in respect of Ronpibon in the case stated, indicated that ``the learned judge should decide as a matter of fact what part of the remaining expenses were fairly and properly attributable to gaining the assessable income.'' The fair and proper standard of attribution directed in the answer, echoes earlier observations by the Court, which having found that the provisions contained in the first part of sec. 51(1) contemplated apportionment, went on to observe (at p. 59) in relation to the ``kind of apportionable items'' which consist ``in those involving a single outlay or charge which serves both objects (i.e. the object of producing assessable income and any other end or activity) indifferently'' -

``With the latter kind (of apportionable items) there must be some fair and reasonable assessment of the extent of the relation of the outlay to the assessable income.''

Again, the Court observed at p. 60 that -

``The Court must make an apportionment which the facts of the particular case may seem to make just...''

The Court went on to emphasise, after observing that ``the facts of the present cases are rather special'', that -

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``In making the apportionment the peculiarities of the present cases cannot be disregarded.''

And, finally, the Court defined the question of fact posed by the problem of ascertaining, by the method of apportionment, the actual expenditure in gaining the assessable income in the following terms -

``The question of fact is therefore to make a fair apportionment to each object of the companies' actual expenditure where items are not in themselves referable to one object or another.''

I would note also, at this juncture, that in his decision in the case of
Adelaide Racing Club Inc. v. F.C. of T. 114 C.L.R. 517 at p.526 , Owen J. adverted to the concept ``a just apportionment'' when he decided -

``The Commissioner made what he regarded as a just apportionment of the club's expenditure, allocating against assessable and non-assessable income respectively the proportion of expenditure that seemed right and I am not satisfied that the course he followed was wrong....''

Again we have judicial insistence on a ``just'' apportionment and a reference to a standard that ``seemed right'' - a reflection of the ``fairly and properly'' standard of the High Court in the Ronpibon case (supra) .

7. Applying these observations to the present case, the question posed by this reference emerges as to whether the apportionment adopted by the Commissioner in relation to the ``item'' of outgoing, ``interest paid'', is a fair and reasonable assessment of the extent of the relation of the outlay to the assessable income, having regard to the facts peculiar to this case. In short, is the apportionment such as the particular facts may seem to make just? I have come to a conclusion that on the evidence, I cannot give an affirmative answer to that question.

8. It is clear from the evidence that interest was paid on funds borrowed from a number of sources and that those funds were merged into a common fund from which investments were made by way of loans to members, some part being reserved to make advances to the Credit Union's central banking facility in order to ensure continuity of liquidity. It is equally clear that the invested funds of the Credit Union incorporated, at any one time, the capital and reserves, accruals and provisions, and the surplus of income over expenditure of the Credit Union; these latter sources of funds did not involve the Credit Union in any liability to pay interest.

9. No direct relationship can be established from the evidence between any particular source of funds and any particular application of funds by the Credit Union. Accordingly no direct cost in terms of interest paid can be established in relation to any particular income derived. Nor, for that matter, would it be possible (except, perhaps, by the most minute dissections in respect of a small range of items), to establish a direct cost in terms of administration expenses incurred in relation to any particular item of interest earned; but I do not have to concern myself with administration expenses as there is no dispute before the Board as to the manner in which they have been apportioned.

10. The question that is raised before the Board is simply, as I have already noted in para. 7, to determine whether the apportionment arrived at by the Commissioner in relation to the item, ``interest paid'', is such as ``the facts of the particular case may seem to make just'' or ``fair and reasonable'', vide Ronpibon case quoted at para. 6.

11. In my view, the evidence establishes that the funds available to the Credit Union from all sources are spread evenly through every application of those funds. To the extent that the funds are applied to investments that are productive of assessable income, it is possible, using the methods set out in Dr. Beck's reasons for decision, to calculate with precision the cost in terms of interest paid in respect of the average of funds applied to such investment ends during the year of income. I adopt those calculations. The ``interest cost'' is $2,149 on an ``average of funds invested'' of $33,085; it can in simple terms be expressed as a percentage of 6.495 per cent. The ``yield'' on the funds so invested was $1,432, which, expressed as a percentage on average funds invested, emerges as 4.328 per cent. It can be seen from these calculations, based on monthly average figures, that the Credit Union, in the year of income, utilised funds which bore an interest cost at the rate of 6.495 per cent of funds invested to produce a yield of assessable income at the rate of 4.328 per cent on those funds.

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12. If one turns to the Commissioner's calculations, it emerges that the Commissioner has allowed a deduction from the assessable income in respect of ``indirect expenses'' of $1,363. This figure had been calculated by apportioning a ``total of indirect expenses'' of $34,964 (including $24,190 ``interest paid'') in accordance with the formula approved by Owen J. in the Adelaide Racing Club Inc. case (supra) . The interest content in the figure of $1,363 would be $943 ($24,190/$34,964 of $1,363). Using this interest content figure of $943, the ``interest cost'' on average funds utilised for investment for purposes of producing assessable income emerges as a percentage of 2.85 per cent of average funds invested. The evidence is that the lowest interest rate paid by the Credit Union to depositors in the year of income was 7.2 per cent per annum. There were some other minor borrowings by the Credit Union during the year, and, though the relevant interest rates were not given in evidence, it is apparent they would bear interest at a comparable (and probably higher) rate.

13. The situation is then that a detailed study of the source and application of funds during the year in question establishes clearly that the interest cost to the Credit Union on borrowed funds invested for the purpose of producing income which is assessable income, is demonstrably higher than the yield from those investments. The Commissioner's method of apportionment produces a result that the interest cost factor, included in the apportioned ``indirect expenses'' allowed as a deduction, is decidedly lower than the assessable income from investments and is at a percentage rate very considerably lower than the lowest percentage rate at which the great bulk of funds employed by the Credit Union in this year of income had been borrowed. It is because of these facts that I have come to the conclusion that I cannot give an affirmative answer to the question as to whether the Commissioner's method of apportionment is such as the facts of this particular case may seem to make just.

14. Accordingly, I would join with Dr. Beck in directing that the assessment, notice of which issued on 6th August, 1975, should be amended to allow the objection in terms of para. 13 of my colleague's reasons for decision.