Ure v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
The appellant appeals under sec. 187 of the Income Tax Assessment Act 1936 (as amended) against an assessment of the Commissioner disallowing a substantial amount of certain deductions claimed by the appellant in his return of income for the year ended 30 June 1976. The deductions claimed were in respect of interest on three loans of money to the appellant and certain expenses in connection with the borrowing of those moneys.
The first loan was a loan of $17,000 at 10 per cent per annum by Herbert Russell Williams and Mary Magdalene Williams made about 29 October 1973. The second loan transaction took place about 5 November 1973 and consisted of a loan of $17,500 at 7.5 per cent per annum from the Commonwealth Trading Bank to the appellant and his wife as joint borrowers. The third loan of $29,000 at an interest rate which varied but approximated 12-12.5 per cent was made to the appellant about 15 August 1974, by one Thomas Anthony Duvernet Davis.
In his return of income the appellant, who at the time was an employed solicitor, set out his earnings from that source - $12,896 - and in addition included as income, the interest he had received, viz. $660 by lending out the abovementioned sums at one per cent. He claimed deductions as follows:
``Item 24. Interest and costs of borrowing
Loan from Herbert Russell Williams and Mary Magdalene Williams of Bayswater Road, Kings Cross.
Total expenses payable over term of loan (3 years)$ $ $ Interest 5,100 Legal expenses 171 Valuation fees 74 Guarantor's fees 1,020 To be apportioned as follows: Year ended 30th June 1974 1,414 30th June 1975 2,122 30th June 1976 2,122 2,122 30th June 1977 707 6,365
----- Loan from Thomas Anthony Duvernet Davis Australian National University, Canberra Amounts paid during year ended 30th June 1976 Interest 4,037 Guarantor's fees 580 4,617 Commonwealth Bank 1,997 ----- ----- 8,736 -----''
The Commissioner in the adjustment sheet attached to his notice of assessment refusing to allow the deductions as claimed, stated as follows:
Deduction for interest payments and expenses of borrowing reduced from $8,736 to $660 the balance being deemed to be expenditure of a private nature. Alternatively no business of money lending is deemed to exist for income tax purposes.
The Commissioner as is clear made no express distinction between the interest payments and the other expenses claimed and appears to have treated all on the same footing.
The appellant objected to the assessment and upon the objection being disallowed, the appellant requested the Commissioner to proceed under sec. 187 of the Act.
The facts in relation to the loans to the appellant and his subsequent use of the moneys reveal a somewhat complex series of transactions and it is necessary to refer in some detail to the evidence. The moneys from the loans ultimately by reason of a series of further lendings, substantially found their way into investments made on behalf of a trust referred to as the Joan Honeybourne Trust of which the beneficiaries (it was in the trustee's discretion to decide who from time to time should benefit, p. 39) were the appellant and his family ``and others'' and it is appropriate at this early point to refer to the various persons and companies involved in the transactions which have been placed before the Court.
The appellant as I have earlier said is a qualified solicitor although at present he is working as a credit analyst with a merchant bank. He is married and has two children. Listohan Services Pty. Limited (hereafter referred to as Listohan) was incorporated on 28 February 1969 and at all relevant times the appellant and his wife were directors and shareholders. Weston Park House Pty. Limited (hereafter referred to as Weston) was incorporated on 12 September 1973, and the appellant and his wife at al times were the only directors and shareholders. Weston was the trustee of the assets comprising the Joan Honeybourne Trust Fund. Weston had no assets of its own. Listohan, according to the evidence, acted as ``bankers'' for the appellant and his wife, and that fact explains why the dealings by the appellant and his wife and the moneys the subject of the various transactions disclosed by the evidence, are recorded in detail in the books of Listohan. In his evidence the appellant said:
``I do not have a trading account and have never had a trading account in this country. I have a savings account with $4 in it that I have not operated on for about seven years. Listohan Services has always received my salary wherever I have been employed and any other money that comes to me gets banked to Listohan Services' account bank account and is credited to my loan account. At the same time, if ever I have any expenditures of a personal nature that require to be drawn by cheque, as most of them do, or for my own money that I carry about from time to time, I cash a cheque drawn on the Listohan Services and debit my loan account.''
Listohan had accumulated losses but made a small profit in the year ended 30 June 1976. It became the owner of a property in Balmain in 1971. The appellant and his wife contracted to purchase the property for $18,995 and executed a deed of trust in favour of Listohan. The appellant and his wife jointly borrowed $8,000 from the Commonwealth Savings Bank and mortgaged the property to the Bank for this amount. They loaned the $8,000 and the sum of $11,000 from their joint loan account to Listohan to enable the purchase money to be provided by Listohan (p. 23). The property was in due course transferred to Listohan and Listohan discharged the mortgage by using part of the amount borrowed by the appellant from Mr. and Mrs. Williams - the first loan transaction. The appellant and his wife and family lived in the Balmain property for two and a half years, but the property then became income-producing. Listohan also had a loan account with Weston on which it received interest, and a deposit with the building society. In addition it received fees referred to as ``guarantee fees'' for providing security for loans made to the appellant. The appellant and his wife had a loan account with the company.
The Williams' loan
The first loan was the loan of $17,000 from Mr. and Mrs. Williams to the appellant and it took place on or about 31 October 1973. I shall refer to this loan hereafter as ``the Williams' loan''. The evidence shows (Ex. AD) that the amount was borrowed for a term of three years with interest at 10 per cent. The evidence given by the appellant was that the moneys were loaned by him to his wife on the same day as the loan to himself was made. The loan to his wife was repayable on demand and the interest rate was 1 per cent. The agreement between the appellant and his wife was an oral one but the terms of the agreement were subsequently reduced to writing (Ex. U). I should mention that the appellant was cross-examined in respect of this agreement but there is nothing in his evidence, in my view, which casts doubt upon the fact that it was made as he claimed.
The agreement provided as follows:
A. The borrower has for several years past supported herself by undertaking paid employment but is now and is likely to be prevented from doing so in the near future by virtue of her domestic responsibilities.
B. In order to restore some measure of financial independence the lender has agreed to lend the borrower certain funds as hereinafter appearing....''
The appellant's evidence is that his wife lent the money to Listohan at an interest rate of 10 per cent. The minute book of Listohan shows the following on 31 October 1973:
``LOAN FROM RESOLVED that the A.L. URE company borrow $17,000 from Mrs Ure, such loan to be repayable on demand and bear interest at the rate of 10% p.a., calculated at 30th June each year (or the date of final repayment) and credited to her current account with the company. LOAN FROM RESOLVED that the R.M. URE company borrow $20,000 from Mr Ure, such loan to be repayable on demand and bear interest at the rate of 1% p.a., calcu- lated at 30th June each year (or the date of final repayment) and credited to his current account with the company. LOAN TO RESOLVED that the WESTON PARK company apply the HOUSE P/L proceeds of the above loans as follows: (a) further deposit with Weston Park House P/L in its capacity as trustee of the Joan Honeybourne Trust $31,050; and (b) repayment of borrowing from R.M. and A.L. Ure jointly $6,857.''
The appellant claimed that the actual disposal of the $17,000 which he lent to his wife at 1 per cent was done by direction of his wife but his wife was not called as a witness.
In his affidavit the appellant stated (para. 29(a)) that he paid $6,857.25 to the Commonwealth Savings Bank to discharge the mortgage over the Balmain property and deposited $10,142.75 to his wife's bank account. He went on to say that on 5 November 1973 he withdrew $11,050 from this account and paid it on to Listohan's bank account. The books of Listohan show entries consistent with those bankings. The minute of 31 October 1973 has already been set out indicating the destination of the moneys and the books confirm this. The whole of the facts, in my view, clearly permit a conclusion that it was always the intention of the appellant that the moneys loaned by him to his wife should be ``re-lent'' by her to Listohan and be available to discharge the mortgage on the Balmain property and form part of the purchase price of a property at Epping (later referred to) and that the money would not have been lent to her if the appellant had not been fully aware in advance that this result would ensue. I should point out that the appellant in his evidence made clear that the loan of $20,000 referred to in the minute of 31 October 1973 was in fact the moneys comprised in the two loans made to him and his wife on 5 November 1973 by the Commonwealth Savings Bank and the Commonwealth Trading Bank which constitute the second loan transaction and with which I will deal shortly.
The evidence is uncontradicted that the appellant paid legal expenses of $171 in order to obtain the Williams' loan and also paid a valuation fee of $74 for the same purpose. These items were set out in the claim for deduction in the appellant's return (supra). The evidence also shows that Listohan granted a mortgage to Mr. and Mrs. Williams, over the Balmain property (which had been transferred to it) by way of security for the loan to the appellant. For this service the appellant agreed to pay Listohan an annual guarantee fee of 2 per cent of the amount of the Williams' loan. The item in the appellant's return ``guarantor's fees $1,020'' represents the moneys paid in this regard. Of this sum the evidence shows that $340 was paid during the year of income.
The amount of interest paid by the appellant under this loan was $5,100. The appellant in his return apportioned the total of the above sums to the various years after the loan was made and claimed in all a deduction of $2,122 in respect of the year 1976 for the interest and other expenses mentioned. Interest at the rate of 1 per cent was paid by the appellant's wife to the appellant in accordance with the loan made to her by the appellant and the amount credited to the current account of the appellant with Listohan and debited to his wife's account in the books of Listohan. The amount of interest received by the appellant in respect of the loan to his wife forms part of the $660 returned by him as assessable income.
The Bank Loans
The second loan transaction involved a loan to the appellant and his wife of two amounts viz. $17,500 at 7.5 per cent from the Commonwealth Savings Bank and $2,500 at 8.5 per cent from the Commonwealth Trading Bank. I shall refer to these as the Bank loans. The loans were made on 5 November 1973 and were secured by mortgage over a property 13 Warrington Avenue, Epping, which was purchased in the name of the appellant and his wife with part of the loan moneys. The purchase price was $35,950. The appellant and his wife held the Epping property in trust for Weston as the trustee of the Joan Honeybourne Trust. I mention here that the appellant in cross-examination admitted that neither the Commonwealth Savings Bank nor the Commonwealth Trading Bank was at any time aware of the interest of Weston in the property and the documentary evidence shows that as far as the Banks were concerned they considered they were lending money to the appellant and his wife for them to purchase a house in which to live. This matter has no special relevance to any matter I have to decide, and although it goes to the appellant's credit, it has not affected me in regard to any findings of fact which I have made. The appellant and his wife did in fact live in the Epping property paying a nominal rent to Weston.
Although the loan was made to the appellant and his wife jointly the evidence is that the appellant as between himself and his wife accepted the full responsibility for the repayment of the loan (that is confirmed as per Ex. U).
The evidence shows that the appellant on 5 November 1973 loaned $20,000 the subject of the two amounts advanced by the Banks to Listohan at 1 per cent interest. This money with the $17,000 loaned by Mrs. Ure to Listohan was paid on in part by Listohan to Weston and applied by Weston in the purchase of the Epping property in the name of the appellant and his wife. Weston as trustee for the Joan Honeybourne Trust was in possession of other funds besides the sum in question. According to the income tax return filed on behalf of the Joan Honeybourne Trust for the year 1976, these funds were an amount of $9,661 deposited with Metropolitan Credits Pty. Limited, $30,000 deposited with Waltons (most of this came from the Davis loan, the third loan transaction) and a deposit of $3,595 with the United Permanent Building Society Limited. But the destination of the moneys from the Williams' loan and the Bank loans was never in doubt:
``Q. Mr Ure, as far as you are concerned, and I want you to speak only for yourself, these 3 transactions were quite separate to each other, were they, these 3 loans? A. The third one certainly was, your Honour. The second one - really, yes, I suppose they were. The idea was that since the borrowing against Balmain had to come to an end, it was obviously desirable if we were going to exploit the capital appreciation of the property (meaning the Epping property) to the fullest, that we should borrow against it to the fullest. This meant, of course, that other moneys that Weston had on deposit, for example with Metropolitan Credits and the building society, did not have to be reduced.
Q. Coming to the moneys invested, the Bank moneys, that is the $20,000, $17,500, the housing loan, and the $2,500 fully drawn loan account; now it was always your intention that those moneys be used to purchase the Epping property as part payment of the Epping property? A. Used by Listohan.
Q. You borrowed the moneys from the Bank, the moneys were used in part payment of the Epping property? A. The moneys were used to lend to Listohan.
Q. When you say you used the money for the deposit that was in Weston account?
A. The deposit was a cheque drawn on Weston's account, your Honour.
Q. In regard to the Epping property, the Epping property so far as you were concerned was always intended to be used by you and your family as a residence? A. For the time being.
... (pp. 34-35)
Q. When you got the money from the Bank, am I to assume from what you have already said that once again your intention was to produce a small amount of income to yourself but with the ultimate intention of benefiting the Joan Honeybourne Trust? A. That is correct, your Honour.''
The monetary advantage to the Joan Honeybourne Trust of the purchase of the Epping property was not expressly disclosed but the appellant acknowledged in his evidence that the capital appreciation of the Epping property, which in fact took place, meant that ``Weston would have done very nicely out of the investment, very nicely indeed.'' This of course advantaged the Joan Honeybourne Trust. The appellant acknowledged that it was his intention that the Epping property should be a residence for himself and his wife as in fact came to be and that it was his intention that the trust should, if he was not occupying it, receive an income from it. Whilst the appellant and his wife occupied the property he paid a nominal rent of $1 per week to Weston.
On the Bank loans the appellant claimed a deduction of $1,997 for interest paid during the year of income. (His affidavit shows a payment totalling $2,344, but nothing turns on this.) The interest (at 1 per cent) which the appellant received from Listohan formed part of the $660, returned by him as assessable income.
The Davis loan
The third transaction was a loan by Mr. Davis, the appellant's brother-in-law, of $29,000 on about 15 August 1974. I shall refer to this as the Davis loan. The appellant explained in his evidence that his brother-in-law
ATC 4270had inherited money from his late father's estate and the appellant had offered ``to look after it'' for him and that the money was then loaned to him. The interest fluctuated but seems to have been 12-12.5 per cent. The appellant's obligations to his brother-in-law under the loan were guaranteed (Ex. B1) by Weston - that company had granted an equitable charge over its assets to Mr. Davis - and the fee for this guarantee was 2 per cent per annum of the amount of the loan. The amount of $580 shown in the appellant's return was the guarantee fee in respect of this transaction, so far as the year of income was concerned. The amount of interest claimed as a deduction by the appellant in his return was $4,037. The interest (at 1 per cent) which he received from Listohan was included in the sum of $660 returned by him as assessable income.
It should be mentioned here that the appellant admitted that $500 of that amount was a pre-payment to his brother-in-law of interest which had not fallen due but counsel for the Commissioner expressly stated this matter was to be disregarded for the purposes of this appeal. Likewise, it should be noted that the evidence shows that the amount of interest actually paid to Mr. Davis was not $4,037 but $3,949.47, but again no point is taken by the Commissioner in regard to this.
So far as the third transaction is concerned, no writing has been produced to evidence the loan made, but the deed of equitable charge dated 18 August 1974 expressly refers to the loan, and I have no doubt that it was made.
The appellant loaned the $29,000 to Listohan at 1 per cent interest and Listohan then loaned moneys to Weston at 1 per cent (p. 37) and in due course Weston invested a sum slightly larger viz. $30,000. In the ultimate, this investment of $30,000 was placed with F.N.C.B. Waltons Corporation Limited at 12.5 per cent. The evidence is that the amount of interest paid to Mr. Davis was slightly in excess of that received from the investment of the amount borrowed. The appellant made clear in his evidence that having funds to invest was, in his view, important - ``if one sees money coming one's way one does not normally turn it away'' (p. 29) - and that it was a matter of getting the best return he could. He made clear what his expectation was:
``Q. But the real purpose (of the initial borrowing) was it not, was that the moneys could be invested by Weston on behalf of the beneficiaries of the Joan Honeybourne Trust at a rate which would be a commercial rate and which would be substantially more than was being paid to you? A. Yes.
Q. So you agree then that the purpose was to give the beneficiaries of that trust - the ultimate purpose - a benefit? A. Only so long as Listohan was prepared to pay me interest in the first place.''
So once again in respect of the loan of $29,000 to him the appellant freely conceded that it was his intention to receive 1 per cent from Listohan on the loan of the money by him to it, and also to benefit the Joan Honeybourne Trust.
As I have earlier said the appellant in his return of income showed as assessable income both the interest he received from the loans made by him at 1 per cent and the salary he earned as a solicitor. If the interest paid by him on the money he had borrowed and the other expenses relating to those loans were deductible his liability to taxation was substantially reduced.
Section 51 is in the following terms:
``(1) 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.
As the appellant was not carrying on any business, it is unnecessary in this judgment to give any consideration to that part of the section which provides ``or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income...''.
Section 51 it should be observed is not limited to deductions from income derived as being the proceeds of a business. Section 51 is a general provision relating to deductions claimable in relation to expenses, losses or outgoings incurred in gaining or producing any income whatsoever and not merely in relation to income derived from a business. (
F.C. of T. v. Green (1950) 81 C.L.R. 313 at p. 319.)
It is to be observed that the section only allows a deduction ``to the extent that'' the outgoings under consideration are ``incurred in gaining or producing the assessable income'' and accordingly attention is directed immediately to the relationship between the outgoing and the gaining of assessable income in order to determine whether the section permits deduction or not. The expression ``incurred in gaining or producing assessable income'' has been the subject of judicial explanation. In
Nevill (W.) and Co. Ltd. v. F.C. of T. (1937) 56 C.L.R. 290, Dixon J. (as he then was) said (at p. 305) in regard to the expression, ``This means that it must have been incurred in the course of gaining or producing the assessable income''. In
Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 the Full High Court (Latham C.J., Rich, Dixon, McTiernan and Webb JJ.) at pp. 56 and 57 said:
``For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words `incurred in gaining or producing the assessable income' mean in the course of gaining or producing such income... In brief substance, to come within the initial parts of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income''
``What matters is their connection with the operations which more directly gain or produce the assessable income.''
Charles Moore & Co. (W.A.) Pty. Ltd. v. F.C. of T. (1956) 95 C.L.R. 344 at p. 351.)
(See also the judgment of Williams, Kitto and Taylor JJ. in
Lunney v. F.C. of T. (1958) 100 C.L.R. 478 at p. 497.)
Once it is found that the outgoing has been incurred in gaining assessable income it will be deductible provided it is not an outgoing ``of capital or of a capital, private or domestic nature''. In some cases at least to some extent the questions whether an outgoing is incurred in gaining the assessable income and whether it is of a capital nature can overlap because they involve an examination of the same question, namely the relationship of the outgoing to the production of the assessable income, but they are separate and distinct questions and must be so treated.
The enquiry in the present case as to whether the items of expenditure claimed are to be viewed as having been incurred in gaining the assessable income and whether they are ``of a capital, private or domestic nature'' is to be made firstly by reference only to the fact that the moneys borrowed were immediately used for the purpose of earning interest at 1 per cent, for unless the outgoings can, on this basis, be shown to be deductible under the section, nothing further need be considered. Let me refer to some pronouncements as to what is and what is not expenditure of capital or of a capital nature.
Hallstroms Pty. Ltd. v. F.C. of T. (1946) 72 C.L.R. 634, Starke J. in referring to sec. 51(1) said at pp. 643-644:
``But it must not be an expenditure of capital or of a capital nature. The Act does not define these terms but the cases have attempted various definitions or descriptions of the terms. Thus when expenditure is made not only once and for all but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade `there is very good reason... for treating such an expenditure as properly attributable not to revenue but to capital' (British Insulated and
Helsby Cables Ltd. v. Atherton (1926) A.C., at pp. 213, 214; 10 Tax Cas., at pp. 192, 193). `In a rough way... it is not a bad criterion of what is capital expenditure... to say that capital expenditure is a thing that is going to be spent once and for all, and income expenditure is a thing that is going to recur every year' (
Vallambrosa Rubber Co. Ltd. v. Farmer (1910) 5 Tax Cas. 529 at p. 536).
But none of the so-called definitions or tests or any other definitions or tests suggested by the cases are decisive.
They are all matters which may be considered for the purpose of determining whether the expenditure in question is of a revenue or of a capital nature.
In the end, as in the beginning, the question is one of fact, as was said in the
British Insulated and Helsby Cables case (1926) A.C. 205; 10 Tax Cas. 155, which must be determined on the facts of each particular case.''
B.P. Australia Ltd. v. F.C. of T. (1965) 112 C.L.R. 386 the Privy Council said at p. 394:
``A valuable guide to the traveller in these regions is to be found in the well-known judgment of Dixon J. (as he then was) in the case of
Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 C.L.R. 337 where he discussed the nature of certain sums spent in buying up the competition of a rival and concluded that they were capital. `There are, I think,' he said, at p. 363, `three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) 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 (c) 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.' And he also said `the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely', at p. 362.''
Their Lordships went on to quote from Viscount Redcliffe in
F.C. of T. v. Nchanga Consolidated Copper Mines Ltd. (1964) A.C. 948 at p. 959:
``And `again, courts have stressed the importance of observing a demarcation between the cost of creating, acquiring or enlarging the permanent (which does not mean perpetual) structure of which the income is to be the produce or fruit and the cost of earning that income itself or performing the income-earning operations. Probably this is as illuminating a line of distinction as the law by itself is likely to achieve, but the reality of the distinction, it must be admitted, does not become the easier to maintain as tax systems in different countries allow more and more kinds of capital expenditure to be charged against profits by way of allowances for depreciation, and by so doing recognise that at any rate the exhaustion of fixed capital is an operating cost...'.''
It is to be observed that the legal expenses and valuation fees are expenses directly incidental to the matter of borrowing money and in this regard would seem to be different in character from interest payable on moneys borrowed; they relate to the matter of bringing into existence the asset, namely the sum of money which is to be put to use in the gaining of assessable income whilst interest is a payment for the use of money in fact received.
The view has been expressed that expenses paid to obtain a loan are expenses of a capital nature.
Texas Land and Mortgage Company v. Holtham (1894) 3 T.C. 255 (English); CCH Australian Federal Tax Reporter vol. 2 ¶34-800; Gunn Income Tax, 7th ed. 929 and cases there cited. Such expenses, in my view, do appear to fall squarely within the concept of an expense of a capital nature as defined in the pronouncements set out earlier.
The legal expenses and valuation fees were, in their nature, ``once and for all'' payments and payments directly related to the coming into existence of the asset which was to be put to use to produce assessable income and were thus expenditure of a capital nature and not deductible under sec. 51(1). It can also be said, on the same reasoning that they were not ``incurred in the course of gaining or producing assessable income''. Likewise with the guarantee fees. The fact that they were payable annually during the currency of the loan, does not
ATC 4273alter their essential nature which was that of expenditure necessary to obtain the loans - the loans would not have been made but for the provision of the guarantees and the guarantee fees are thus unrelated to the matter of the earning of income. The obtaining of the guarantee was a step preparatory to the earning of income and thus ``outside the circumference of the transactions from which the income arises''.
(Bennett & White Construction Limited v. M.N.R. (1949) Can. Tax Cases 1 per Rand J., at p. 7.) As I have said the manner of their payment does not alter this conclusion for it is always entirely in the discretion of the guarantor as to whether a lump sum should be made payable forthwith or regular payments made during the loan or howsoever. A guarantee fee has no intrinsic nature requiring recurring payments.
The interest paid on the moneys borrowed, however, is in a different position. As I have stated earlier interest is payment for the use of money. ``Interest is compensation for delay in payment...'' (per Farwell J. in
Bond v. Barrow Haematite Steel Co. (1902) 1 Ch. 353 at p. 363). ``Interest, is in general terms, the return or compensation for the use or retention by one person of a sum of money, belonging to in a colloquial sense, or owed to another'' (per Rand J. in
Re Farm Security Act, 1944 (1947) S.C.R. (Canada) 394). ``Interest has been defined as compensation paid by the borrower to the lender for deprivation of use of his money'' (see per Lord Wright in
Riches v. Westminster Bank Ltd. (1947) 1 All E.R. 469 at p. 472). ``... The essence of interest is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had had the use of the money, or, conversely the loss he has suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation.''
Ridge Securities Ltd. v. I.R. Commrs. (1964) 1 All E.R. 275 per Pennycuick J. at p. 286.
The capital sum borrowed by the appellant in each case and giving rise to the payment of interest, was borrowed to be lent by him to produce the assessable income and thus the payment of interest may, as a matter of ordinary English, be regarded as having been ``incurred in the course of gaining or producing of the assessable income''. It was plainly ``incidental and relevant'' to the gaining of assessable income so as to make it an ``outgoing incurred in gaining or producing the assessable income''. Lockhart J., in
F.C. of T. v. Total Holdings (Aust.) Pty. Ltd. 79 ATC 4279 at p. 4283, expressed views consistent, in my opinion, with this conclusion. Being a recurring payment and made during the course of the gaining of assessable income, it was not an outgoing ``of a capital or private or domestic nature'' - the position is very much akin to that of a payment of rent for premises on which assessable income is earned. The situation may be compared with that which arose in
C.F. Thomas v. F.C. of T. 72 ATC 4094. There the appellant, who was a barrister, borrowed money from a bank to build additional rooms onto his house, one of which was used by him as a study for personal purposes. Whilst the loan was current he invested moneys from his general account, which was in credit, and these investments produced interest which he declared as income in his income tax return. He preferred to make these investments rather than apply the funds in reduction of the loan. He sought to claim as a deduction portion of the interest which he paid to the bank. He claimed that the interest had been incurred partly for private purposes, partly for business purposes and partly for the making of the investments which produced assessable income. Walsh J. held that the expenditure was ``of a capital, private or domestic nature''. At p. 4097 he said:
``The appellant did not spend money in erecting premises suitable only for use as business premises. He added rooms to his house. It is natural to suppose that the addition increased the capital value of the improvements on the land. In my opinion the appellant does not obtain any support for this claim from the fact that he made the investments which have been mentioned and obtained some income from them. He did not borrow money to make those investments. (The emphasis is mine.) It is true that if he had used the money with which they were made to reduce the debt to the bank he would have paid less interest. But in my opinion, that is irrelevant to the determination of the nature of the outgoing consisting of the
ATC 4274payment of interest to the bank. That outgoing had no relationship, in my opinion, to the gaining or producing of the income derived from the investments.''
F.C. of T. v. Munro (1926) 38 C.L.R. 153 at pp. 197 and 217.)
In the result then, it is my view that only the interest on the loans is to be considered as deductible under sec. 51(1) and the question now arises as to whether that interest is wholly deductible or not. Given that it has the characteristic of an outgoing incurred ``in gaining assessable income'' is it to any extent an outgoing ``of a capital, private or domestic nature''? If it partakes at all of any of these characteristics then the Commissioner is entitled to allow as a deduction that portion only which he considers is solely attributable to the object of producing assessable income; viz. interest at 1 per cent. (Ronpibon Tin N.L. and Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47.)
In that case the operation of sec. 51(1) was explained:
``That provision is in great part made up of expressions taken from sec. 23(1)(a) and 25(b) of the Income Tax Assessment Act 1922-1934, expressions that have been elucidated by many decided cases. But there are very important differences between the operation which the present sec. 51(1) is framed to produce and the manner in which the former sec. 23(1)(a) and sec. 25 worked. Some of these differences it is desirable to mention. In the first place the principle expressed by the former sec. 25(e) has been abandoned. The principle was, in the words of that provision, that a deduction should not in any case be made in respect of money not wholly and exclusively laid out or expended for the production of assessable income. Instead of imposing a condition that the expenditure shall wholly and exclusively be for the production of assessable income the present sec. 51(1) adopts a principle that will allow of the dissection and even apportionment of losses and outgoings. It does this by providing for the deduction of losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income. In the second place it introduces an alternative ground or head of deduction; it allows the deduction of all losses and outgoings to the extent to which they are necessarily incurred in carrying on a business for the purpose of gaining or producing such income... (p. 55)
It is therefore necessary to return to the opening words of sec. 51(1) and inquire to what extent the expenditure of the respective companies was incurred in gaining or producing the assessable income. The question is how far was it incurred in the course of, how far was it incidental and relevant to, gaining or producing the assessable income.''
In the case with which the Court was there dealing, a company had prior to the outbreak of war in Japan carried on mining operations in Siam from which it received substantial income. After war broke out its income from that source, such as it was, was treated as exempt income. In the year of income it had in fact no income from that source but received interest from investments. It had, however, maintained its administrative structure in Melbourne and incurred expenditure such as directors' fees and expenses of management in the central administration of its affairs. The Commissioner allowed only a small portion of this lastmentioned expenditure as a deduction. In the judgment of the Court at p. 59 the following explanation of how the matter of apportionment is to be dealt with appears:
``The charges for management and the directors' fees are entire sums which probably cannot be dissected. But the provision contained in sec. 51(1), as has been already said, contemplates apportionment. The question what expenditure is incurred in gaining or producing assessable income is reduced to a question of fact when once the legal standard or criterion is ascertained and understood. This is particularly true when the problem is to apportion outgoings which have a double aspect, outgoings that are in part attributable to the gaining of assessable income and in part to some other end or activity. It is perhaps desirable to remark that there are at least
ATC 4275two kinds of items of expenditure that require apportionment. One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. Of this directors' fees may be an example. With the latter kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income. It is an indiscriminate sum apportionable, but hardly capable of arithmetical or ratable division because it is common to both objects.
In such a case the result must depend in an even greater degree upon a finding by the tribunal of fact. (p. 59)
It is important not to confuse the question how much of the actual expenditure of the taxpayer is attributable to the gaining of assessable income with the question how much would a prudent investor have expended in gaining the assessable income. The actual expenditure in gaining the assessable income, if and when ascertained, must be accepted. The problem is to ascertain it by an apportionment. It is not for the Court or the Commissioner to say how much a taxpayer ought to spend in obtaining his income, but only how much he has spent: see per Ferguson J. in
Tooheys Ltd. v. Commissioner of Taxation (1922) 22 S.R. (N.S.W.) 432, at p. 440; per Williams J. in
Tweddle v. F.C. of T. (1942) 7 A.T.D. 186, at p. 190. 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 the other. But this must be done as a matter of fact and therefore not by this Full Court.''
The directors' fees and some of the other expenses claimed were referable in part to the production of assessable income and an apportionment had to be made. The Court declined to interfere with the apportionment which the Commissioner had made.
Now in the present case the appellant had borrowed money at interest rates of 10 per cent, 7.5 per cent, 8.5 per cent and 12.5 per cent and then invested the money borrowed at 1 per cent. Interest paid on money borrowed for the purpose of being advanced at interest can, as I have said, be regarded as incurred in the course of gaining or producing assessable income, but the degree of disproportion between the income intended to be gained and the expenditure outlaid is so great as at least to suggest that the expenditure has some other object in addition to the mere production of income by way of interest at 1 per cent, and one looks, therefore, to the evidence to determine what other object than the receipt of assessable income is shown. Once the objects of the expenditure are identified, it is possible to determine whether and what apportionment should be made.
I obtain guidance in regard to the present problem from
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412; (1978) 52 A.L.J.R. 640. There a company which was one of a number of companies in a group was paying rent for a property under a lease and another company in the group had an option from the lessor which enabled it to purchase the property and, in effect, have credited towards the purchase price a substantial part of the payments made by the first company under the lease. The Commissioner claimed that the payments of rent by the first company were only partly deductible being in part outgoings of a capital nature. At ATC p. 4417 and A.L.J.R. p. 643, Gibbs A.C.J. said:
``The real problem in the case is not to determine the character of the advantage sought, once it has been identified, but to decide what was the advantage sought by the taxpayer by making the payments. If the only advantage sought was the right to possession under the lease, and what was called `rent' really answered that description, clearly the outgoings were entirely of a revenue nature. If on the other hand one advantage sought by the
ATC 4276outgoings was the acquisition of a capital asset (the land and buildings), the fact that the payments were called `rent', and were made periodically, would not necessarily prevent them from being in part outgoings of a capital nature - see
Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1953) 89 C.L.R. 428;
Poole and Dight v. F.C. of T. 70 ATC 4047; (1970) 122 C.L.R. 427; and
A.P.A. Fixed Investment Trust Company Ltd. v. F.C. of T. (1948) 8 A.T.D. 369 at p. 371.''
A little later his Honour said at ATC p. 4418 and A.L.J.R. p. 643:
``I have said that in deciding whether outgoings made by a taxpayer are of a revenue or of a capital nature, it is necessary to consider `the character of the advantage sought'. In my opinion, in principle, that must mean the character of the advantage sought by the taxpayer for himself by making the outgoings. Of course, as I have already indicated, a taxpayer may derive an advantage if someone else, such as a subsidiary, acquires an asset. But the fact that someone else incidentally derives an advantage of a capital kind in which the taxpayer does not share is not enough to give the outgoings the character of capital.''
His Honour later, at ATC p. 4418 and A.L.J.R. p. 645, expressed the view that the two
Europa cases 70 ATC 6012, (1971) A.C. 760; and 76 ATC 6001, (1976) 1 W.L.R. 464, including the dissenting judgments therein, supported the proposition that it was ``the advantage which the expenditure was intended to gain directly or indirectly, for the taxpayer, that is relevant in determining the character of the expenditure, and that when an expenditure is genuinely made in payment of the price of trading stock, or in payment of rent, it is not permissible, for the purpose of deciding whether the expenditure was in part of a capital nature, to consider an advantage gained by another person as a result of the payment, when the taxpayer neither shares in that advantage, nor can secure its enforcement''.
In the same case, Jacobs J., at ATC p. 4425 and A.L.J.R. p. 648, said that ``the relevant advantage or benefit sought and the nature of which falls to be examined will be the advantage or benefit - directly or indirectly - to the person who claims to have expended the money on revenue account''. Ascertainment of the advantage sought and obtained is ``the anterior step'' to be taken (per Stephen and Aickin JJ. at ATC p. 4421 and A.L.J.R. p. 645) before characterising the nature of that advantage. The Court in that case (Jacobs and Murphy JJ. dissenting) held that the taxpayer there did not seek and obtain any advantage other than that which arose from payment of rent as a lessee. With the considerations just referred to in mind, let me turn to the facts in the present case with a view to ascertaining whether the taxpayer sought and obtained from the expenditure an advantage ``of a private or domestic nature''.
There was an outgoing - interest - which had as its object the producing of assessable income and it was not to that extent an outgoing ``of capital or of a capital, private or domestic nature'' within sec. 51(1). It is deductible to an extent. But to the extent that the object of the expenditure was not the production of assessable income, it will be outside the character of expenditure deductible under the section - it will, in the circumstances of this case, be expenditure of ``a private or domestic nature''.
The evidence as to the three transactions makes plain that although the moneys borrowed by the appellant were lent respectively to his wife and Listohan with the object of receiving interest at the rate of 1 per cent, nonetheless the application of the moneys in this way was part of a much wider scheme. One might say that the fact that the moneys were loaned at 1 per cent meant that as a matter of ordinary business prudence some steps would need to be taken to ensure a proper receipt of interest on the moneys borrowed, and it is thus not surprising to observe that the moneys the subject of the borrowings later found their way into the purchase of the Epping property and other investments enjoyed by the Joan Honeybourne Trust. It is appropriate to observe that the substantial reason at all for the three loans at 1 per cent was the expectation of the appellant that the making of these loans would render the interest paid by him on the moneys borrowed, deductible from his income as a solicitor and the appellant admitted as much in his evidence.
That consideration is, of course, irrelevant in determining whether the expenditure is deductible, but stating it tends to expose starkly the fact that the actual borrowings made which gave rise to the expenditure claimed to be deductible were always intended for the ultimate purposes to which they were put - the receipt of interest at 1 per cent was but a device inserted into the implementation of those purposes.
As to the Williams' loan, the evidence discloses not only the object that income at 1 per cent should be received, but also the use by Listohan of the sum of $17,000 received by it from the appellant's wife in part for repayment to the appellant and his wife (this part was ultimately used to pay off the mortgage on the Balmain property which had been transferred by the appellant and his wife to Listohan) and in part for deposit with Weston, ultimately leading to the provision of funds by Weston to the appellant and his wife to purchase the Epping property in trust for Weston. The fact that the appellant's wife loaned the $17,000 lent to her by the appellant to Listohan at 10 per cent does not mean that the enquiry as to the object of the expenditure must stop at that point - the entirety of the transaction must be considered. I have already referred to the circumstances surrounding the loan by the appellant's wife to Listohan. The Bank loans, as the minute book of Listohan showed were used in the same way. At this point then the factual situation disclosed in the evidence is that the moneys from the Williams' loan and the Bank loans were directed to Listohan - in the one instance per medium of a loan to the appellant's wife - and Listohan then applied the moneys in part to the repayment of the appellant and his wife of $6,857.25, being the balance of the amount of $8,000 which had been borrowed by them from the Commonwealth Savings Bank in respect of the Balmain property and which they had loaned to Listohan. This payment enabled the indebtedness of the appellant and his wife to the Commonwealth Savings Bank to be discharged. To use the words of Gibbs A.C.J. in F.C. of T. v. South Australian Battery Makers Pty. Ltd., supra, the appellant acquired, ``an advantage for himself'' from the outgoings - the payment of interest on the loans - additional to the receipt of income at 1 per cent, and to that extent the outgoing is to be treated as an outgoing of a private or domestic nature. As to the balance of the two loans, it is claimed that the appellant at least had the object in borrowing those sums of providing himself, his wife and his children with a home; but the title to the Epping property was taken by the appellant and his wife in trust for Weston, which itself was trustee of the assets comprising the Joan Honeybourne Trust. The appellant occupied the property at a rental of $1 per week. Mere occupation of the property by the appellant would not affect the character of the expenditure claimed to be deductible. But the appellant was a discretionary beneficiary under that Trust and it is that fact, in my view, which enables it to be said, firstly, that the object he sought ``for himself'' from the expenditure was the use of the sums borrowed for the benefit of the Joan Honeybourne Trust and, secondly, that that expenditure for that purpose was of ``a private or domestic nature''. The capital sum of the Davis loan $29,000 was ultimately invested with Weston and the same conclusion follows in regard to it. Of course others beside the appellant were beneficiaries under the Trust, and in fact in the year of income the appellant received no income from the Trust - his children did. But the important matter is that the appellant was a ``potential beneficiary'' as he described himself, under the Trust, with enforceable rights as such in regard to the assets the subject of the Trust, and accordingly the expenditure of the interest was to the extent that it was incurred with the object of placing the borrowed money at the disposal of Weston for the benefit of the Trust both unrelated to the production of the assessable income and an advantage - albeit potential - to the appellant; it was so far as the taxpayer was concerned to that extent an outgoing of a ``private or domestic nature''.
I turn then to the Commissioner's assessment. The Commissioner allowed a total deduction of an amount of $660. Has the appellant shown that the assessment is excessive? (sec. 190) In my view the Commissioner was entitled to treat the payment of interest at rates of 10 per cent, 7.5, 8.5 and 12.5 per cent to receive income at 1 per cent as only fractionally related to that end and as essentially related to the
ATC 4278ultimate use of the moneys for purposes unconnected with the production of the assessable income, and I do not consider that he made any error in allowing only the small amount which he has. No argument has been addressed to me that if the Commissioner was entitled to apportion, he should have allowed a greater amount, or that, if the legal expenses, valuation fees or guarantee fees were not deductible, the Commissioner would wish to reduce still further the amount to be allowed as a deduction.
Counsel for the appellant, however, has submitted that whether the expenditure set out in the appellant's return is deductible or not and whether in whole or in part, under sec. 51(1), it is wholly deductible under sec. 67 of the Act.
``(1) Subject to this section, so much of the expenditure incurred by the taxpayer in borrowing money used by him for the purpose of producing assessable income as bears to the whole of that expenditure the same proportion as the part of the period for which the money was borrowed that is in the year of income bears to the whole of that period shall be an allowable deduction.
It does not appear that the section has been the subject of judicial consideration in this country, but in its terms it is restricted solely to expenditure ``incurred by the taxpayer in borrowing money''. Such expenditure would, in my view, include the legal expenses, valuation fees and the guarantee fees, but would not include interest paid by the taxpayer on the moneys in fact borrowed. The very words ``incurred in borrowing money'' indicate a point of time prior to and unrelated to expenditure arising in the course of the loan and confine the expenditure to that incurred in the borrowing of money. Expenditure incurred in borrowing money is readily distinguishable (in most cases) from expenditure incurred in producing assessable income, the former generally being regarded as being of a capital nature and the latter being more often related to expenditure of a revenue kind. I have earlier made observations on this distinction in considering whether the expenditure claimed to be deductible was of a capital nature or not within sec. 51(1).
If sec. 67 is to be given the interpretation I have suggested, then to the extent that it permits a deduction of expenses - in this case the legal expenses, valuation fees and guarantee fees - which are of a capital nature, it operates by way of an exception to the terms of sec. 51(1).
However, the section only permits deduction where the money borrowed by the taxpayer is money ``used by him for the purpose of producing assessable income''.
As a preliminary observation it can be said that if the expression ``for the purpose of'' means no more than that the money is in fact used to produce assessable income, then, as there is nothing in the section to indicate that apportionment is available to the Commissioner, the section puts the expenditure to which it relates in a much more favourable position from the taxpayer's point of view than outgoings coming within sec. 51(1) where apportionment can be made.
However, there is authority that ``purpose'' can mean the dominant purpose of the taxpayer. In
Evans v. D.F.C. of T. (S.A.) (1935) 55 C.L.R. 80 the Court considered sec. 16(b)(i)(1) of the Income Tax Assessment Act 1922-1932 which excluded from assessable income profits arising from the sale of assets which were not acquired ``for the purpose of resale'' at a profit. ``The purpose of which it speaks is the dominant purpose actuating the acquisition of the assets - the use to which they are to be put'', (p. 99). In
Pascoe v. F.C. of T. (1956) 11 A.T.D. 108 at p. 112, Fullagar J. applied the dominant purpose test to sec. 26(a) of the Act 1936-1952 which provided that the assessable income of the taxpayer should include ``profit arising from the sale by the taxpayer of any property acquired by him for the purpose of profit-making by sale... ''.
In my view to give that meaning to the word ``purpose'' in sec. 67 is consistent with the fact that sec. 67 is bringing within the scope of deductibility at least some expenses which otherwise would not be deductible. It could be said to be a somewhat strange result that Parliament would make such expenses wholly deductible on mere proof of use of the money borrowed for the purpose of producing assessable income, when other expenses can be apportioned if it appears
ATC 4279that they are partly of a capital nature and partly not. Both sec. 67 and sec. 51(1) were in the Act of 1936 when it was passed, and it seems to me much more consistent with harmony between the two sections to take the view that Parliament only intended the section to operate when the dominant purpose of the taxpayer in the use of the money was the production of assessable income.
What then was the dominant purpose of the appellant in incurring the expenditure in question. The evidence makes clear that the appellant intended that the money which he had borrowed should be used by him not merely to gain the assessable income, but that it should be also used for purposes quite unconnected with the production of assessable income. I have already referred to the evidence in that regard. The use of the money by the appellant for the purpose of producing assessable income was but an incident in the use of the money for the purpose of repaying the appellant and his wife the amounts loaned by them to Listohan in connection with the mortgage of the Balmain property, and acquiring the Epping property for and providing funds for the Joan Honeybourne Trust. In my view, it is open to conclude that this was the dominant purpose so far as the use of the money borrowed is concerned and accordingly the claim to deduct the legal expenses, valuation fees and guarantee fees paid in respect thereof fails.
I should finally mention that the Commissioner has submitted that the Court would regard the transactions involving the loans at 1 per cent as shams but I am not prepared to uphold this submission. I am satisfied that in each case there was a loan transaction intended to produce income at the rate of 1 per cent, and that the further transactions involving the money borrowed were all real and genuine. A transaction will not be held to be a sham unless the parties thereto ``have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating'', per Lord Diplock in
Snook v. London and West Riding Investment Ltd. (1967) 2 Q.B. 786; (1967) 1 All E.R. 518 at p. 528. The book entries made in respect of the various transactions arising out of the various loans made to the appellant, and the Bank records showing movement of the moneys between the various parties to the transactions are all, in my view, in accord with the transactions to which they are alleged to relate (cf.
Albion Hotel Pty. Ltd. v. F.C. of T. (1965) 13 A.T.D. 435 at p. 443), and they cannot be regarded as suspect merely because it is plain that the appellant as the controlling hand - and he freely acknowledged this - was seeking to reduce the incidence of income tax and be as little affected as possible by estate duty laws.
However, notwithstanding that the transactions were not shams, the Commissioner, in my view, has not been shown to have made any error in allowing only the deduction he has. In the result then the appeal fails and is dismissed and the assessment is confirmed. The appellant is to pay the Commissioner's costs.