Alliance Holdings Limited v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
These matters involve two appeals by the plaintiff from a decision of the defendant Commissioner resulting in the disallowance of two similar deductions from the assessable income of the company for the years ended 30th June, 1976, and 1977.
The appellant company carries on the business of a financier and its activities involve in the main the borrowing and leading of money. Its income is substantially in the form of interest received. During the years in question it borrowed money from the public secured by debentures issued following invitations contained in prospectuses. For the most part it paid interest to those persons who took up debentures but in respect of some of the debentures the interest was accrued but unpaid. Such debentures were referred to as deferred interest debenture stock.
The first relevant prospectus is numbered 22 and dated 12th May, 1975. The cover of that document contains the following notation:
``Up to 12.5% p.a. for debenture stock three to five years, unsecured deposit notes 12 months and deferred interest debenture stock 13.5% p.a. 3-10 years for details please turn to page 2.''
Page 2 of the prospectus referring to the deferred interest debenture stock contains after a statement of the interest rate the words ``not compounded'' in parentheses. On the same page under a subheading ``Highlights'' is stated:
``Interest accrues from day to day but no interest is payable or credited prior to maturity, at which time the principal and interest is paid in full (see schedule below).
Investor selects own maturity date.''
On p. 5 of the document, in answer to an assumed query, ``When do I get my interest?'', there appears the following statement in relation to a selection of deferred interest debenture stock:
``No interest is payable or credited prior to maturity at which time the principal together with the deferred interest is paid in one lump sum. The maturity date is fixed by the terms of the debenture stock certificate.''
On p. 11 there is set out information concerning redemption prior to the maturity date and the terms upon which the company may redeem and the facilities available to investors to withdraw prior to the due date. Information is also given concerning appropriate trust deeds.
On p. 12 there is a statement that the deferred interest debenture stock certificate will contain the following condition:
``The maturity date means the date referred to on the face of the certificate or such earlier date on which the trustee determines to enforce the security constituted by the trust deed.''
Such a condition did in fact appear on the back of the certificate.
There is, as part of the prospectus, a form of application for debenture stock which states:
``I/We hereby apply for debenture stock of the company as set out hereunder upon the terms and conditions of the prospectus of the issue dated 12th May, 1975.''
Provision is made for nomination of deferred interest debenture stock and particulars in relation thereto. References in the application are made to pages of the prospectus.
Prospectus number 23 was issued dated 16th December, 1975, containing substantially similar information. The interest rate payable was increased, that in relation to deferred interest debenture stock to fourteen per cent per annum. Page 2 of this document is devoted entirely to information concerning the deferred interest debenture stock. It states that the interest is not compounded and that it accrues from day to day but that no interest is payable or credited prior to maturity. The prospectus contains the necessary application form.
Further information is given in relation to withdrawal before the due date than was contained in the previous prospectus particularly in relation to cases of hardship, unemployment or sickness or death. This appears on p. 12 of the document. Otherwise the document contains information similar to that set out in the previous prospectus.
Prospectus number 25 dated 31st May, 1976, was issued. This was in terms similar to the documents previously referred to.
A copy of the relevant trust deed dated 19th June, 1958, was tendered to me. Paragraph 3 provides:
``The company acknowledges that it is indebted to the trustee in the amount of the issued stock and interest thereof.''
Clause 8B provides that, until any issued stock is redeemed or paid off, the company shall pay to the stockholders interest thereon in accordance with the conditions upon which such issued stock is held as shown or endorsed on the relevant stock certificate.
By cl. 10(a) the company as beneficial owner, by way of first charge, charges in favour of the trustee with the payment of the principal and interest moneys from time to time payable the undertaking and assets of the company.
Clause 13 provides that subject to cl. 20 and 24 of the deed the security shall become enforceable on the happening of any one or more of a number of stated events.
There was produced to me the usual form of certificate of deferred interest debenture stock. This document bears the following endorsement:
``This stock bears interest at % per annum computed from the day of 19. Payment of interest is deferred until the maturity date (as defined on the back of this certificate) at which time the principal and interest will become due. This stock shall be redeemed on the maturity date being the day of 19 or such earlier date as hereinafter provided at a value of $ at that date.''
There appears on the back of the document a number of statements under the heading, ``Extract from conditions''. None of these appears to relate to the contract or to any agreement made between the holder and the company prior to the issue of the certificates. They deal in the main with method of payment, the establishment of registers and what is to be entered in such register, the keeping open of such registers, that no notice of any trust is to be entered therein, and the form of transfer of debenture stock. The only relevant statement to deferred interest debenture stock relates to the maturity date which is defined as meaning a date referred to on the face of the certificate or such earlier date on which the trustee determines to enforce the security constituted by the trust deed.
The plaintiff claims to be entitled to deduct from its assessable income from year to year the interest amounts incurred although not then payable by virtue of sec. 51 of the Income Tax Assessment Act 1936. The relevant provisions of that section are:
``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...''
In its return for the year ended 30th June, 1976, the taxpayer included in the amount claimed as a deduction an amount of $64,483 referred to as interest which had accrued on deferred interest debenture stock. The method of accounting adopted by the appellant is the ``accrual basis'' and in accordance therewith the cost of borrowing funds has been set off against the income received from the ``on-lending'' of those funds. It is not disputed that this method of treatment of the interest which accrued on deferred interest debenture stock during the year ended 30th June, 1976, and in each other financial year of the appellant's trading in which such interest has accrued, namely to accrue such interest for that financial year and to charge the same against the revenue for that financial year and to credit the amount of that charge to a deferred interest debenture suspense account, is in accordance with the generally accepted accounting principles in Australia and is a correct method from an accounting point of view of treating such interest.
I am satisfied that if the interest payable on the deferred interest debenture stock had not been accrued in the accounts of the appellant in order to present accurately the state of the accounts its auditors would have had to note that fact in their audit report to such accounts.
In its return for the year ended 30th June, 1977, the taxpayer included in the amount claimed as a deduction an amount of $199,456 being interest which had accrued on the deferred interest debenture stock.
The above amount of interest will not be credited to the investors' accounts or paid to them until the debentures have been redeemed. In the meantime the interest has been credited in the books of the taxpayer to an account styled ``accrued interest - deferred interest debenture suspense''.
I make similar findings in relation to this claim as I did in relation to the earlier claim of $64,483.
Insofar as it is relevant, I find that in the accounting treatment given by the taxpayer to the interest on deferred interest debenture stock it has used the basic concept of matching the costs and revenues of any particular period to determine the periodic income. Funds raised from the issue of deferred interest debentures have been employed in loans and advances to various customers. The interest ultimately due to the debenture holder must be allocated to the period the funds are used. Not to do so would distort the cost and consequently the net earnings of the company and understate the liabilities of the company and understate the liabilities of the company at the end of the accounting period. I am also satisfied that as regards determination of income for the years ended 30th June, 1976, and 30th June, 1977, the procedure adopted by the taxpayer is correct and the balance sheets as at those dates are also correct.
That the accounting procedure adopted by the taxpayer is a correct one does not force an interpretation of sec. 51 which the section cannot sustain. There is a difference between the English income tax law and the Commonwealth statute. The report of 1936 of the Income Tax Codification Committee, para. 76, contains the following description of the English system:
``It has often been the subject of judicial comment that the existing Acts contain no general direction as to the ascertainment of business profits. Such guidance as they give is confined to a statement that the amount to be assessed is `the balance of the profits or gains' of the business, subject to a series of provisions prohibiting certain specific deductions - some of which, being in the form of limitations, are taken as authorisations of deductions within the limits. It has been left to the Courts to lay down that `the balance of the profits or gains' must, in the absence of express provision to the contrary, be arrived at in accordance with ordinary commercial principles, and to formulate the principle that a proper debit item in a trading or in a profit and loss account is, in general, a proper debit item in an income tax computation.''
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 at p. 505.)
James Spencer & Co. v. I.R. Commrs. (1950) S.C. 345 at p. 352, Lord Cooper said that from an examination of the numerous cases:
``the broad working rule that emerges as a guide to the crediting or debiting in a tax computation of subsequently maturing
ATC 4641credit or debit is to inquire in which accounting period the right or liability was established and to carry the item into the account in that year. I use the vague word `established' advisedly for we are now in the region of proper commercial and accountancy practice rather than of systematic jurisprudence.''
In the James Flood case the Court said, in relation to the passage last quoted (p. 506):
``This passage must be qualified in its application under the Commonwealth Act. For under our law the facts must satisfy the expression `losses and outgoings incurred'. These words perhaps are but little more precise than the word `established' or the expression used above `definitively committed'. But they do not admit of the deduction of charges unless, in the course of gaining or producing the assessable income or carrying on the business, the taxpayer has completely subjected himself to them. It may be going too far to say that he must have come under an immediate obligation enforceable at law whether payable presently or at a future time. It is probably going too far to say that the obligation must be indefeasible. But it is certainly true that it is not a matter depending upon `proper commercial and accountancy practice rather than jurisprudence'. Commercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down by section 51(1) but it cannot be substituted for the test.''
It may be that the procedure adopted by the taxpayer, based upon the use of the basic concept of matching costs and revenues over a particular period, produces a result coincidental with an interpretation of the effect of sec. 51(1) in accordance with the authorities. (See also
Nilsen v. F.C. of T. 79 ATC 4520, per Deane J., at p. 4526; 81 ATC 4031.)
Mr. Simos of Queen's Counsel for the Commissioner made a number of submissions to me some of which were made purely for the purpose of protecting his position in subsequent proceedings. In the first place he submitted that the word incurred in sec. 51 meant due and payable in the sense that the creditor could immediately sue and be entitled to judgment payable forthwith. He contended that it was not sufficient that the creditor of the taxpayer could obtain a declaration of present indebtedness payable at some time in the future.
He next submitted that the alleged deductions were not liabilities incurred within the meaning of the section because the amount of the liability may be changed if the taxpayer decided upon early redemption or determined to and did negotiate the contract. He contended that in those circumstances the taxpayer is not definitively committed or completely subjected to the liability. On neither of those submissions did he anticipate success.
His principal submission was that there was in circumstances no present liability in the relevant tax years to pay money in the future.
In other words the task was to determine whether there was a present liability to pay money in the future. If there was such a liability then the taxpayer would succeed. But there was no such present liability in the relevant years. That question must be determined by looking at and construing the contract made between the parties to determine whether it was their intention that there should be a present liability to make payment in the future or alternatively whether it was their intention that no liability should come into existence until the maturity date.
The Nilsen and the Flood cases involved a construction of legislation or awards. In that class of case the Courts sought to construe the appropriate instrument with a view to determining whether a present liability arose. Mr. Simos sought to apply to the facts of this case comments of the Chief Justice in
Nilsen's case 81 ATC 4031 at p. 4032 when his Honour said:
``Consequently, none of those employees had in that year become entitled to be paid money either in respect of long service or in respect of annual leave. Their entitlement to be given leave in due course had become indefeasible, though the amount of the wages to be paid to them whilst on leave of either kind when the time came for it to be taken was not
ATC 4642finally and unalterably fixed. Indeed, it is conceded that the taxpayer has not come under any obligation to pay any sum of money to any of those employees in respect of leave of either kind during the year of income, though it had in or by that time become certain that, in due course, the taxpayer would become liable to pay an amount of wages, i.e. when the employees entered upon the leave to which they were then indefeasibly entitled.''
He referred to the comment of Gibbs J. (as he then was) at p. 4037 in that case that:
``... What is clearly necessary is that there should be a presently existing liability.''
Insofar as the determination of this matter depends upon the existence of a contract and its terms it seems to me that the statements in the prospectus do form part of whatever the contract is between the company and the creditor. The Commissioner contends that the prospectus Ex. A is not part of the contract. In my view the prospectus is of itself nothing more than an invitation to treat. The application however is clearly an offer to make a contract which contains as part of its terms the relevant matter set out in the prospectus. That offer is in my view accepted by the issue of the appropriate stock certificate. Some contract exists between the parties and surely at the very least it involves the lending of money by the applicant for the stock to the taxpayer at a rate of interest and to be repaid at some specified to that date together with interest thereon calculated to that date such loan being made upon such other terms and conditions as appear to have been agreed upon between the parties. Those terms must be found in the application read in conjunction with the prospectus. That was certainly clearly the intention of the parties.
The main thrust of the Commissioner's argument was that there was not in the relevant tax year a present liability to pay money in the future. Counsel conceded that if there was then, in the light of the authorities which are binding upon me, the taxpayer would succeed. Whether there was such a present liability it was submitted depended upon the construction of the contract that was made between the parties. It was contended that, on the true construction of the contract between the taxpayer and the bondholders, it was clearly intended that no liability should come into existence until the maturity date.
In my view the judgment of Barwick C.J. in Nilsen's case lends no support to the Commissioner's contention. In referring to the expression ``accrued liability'' used in the course of argument his Honour said that the provision allowed in the taxpayer's account as representing an accrued liability referred to a liability not in the sense of a present one but in the sense of a liability which is now certain to arise in the future. The claim in my view with respect to his Honour and to Brennan J. was disposed of by the latter's statement that a pecuniary liability could not arise in that case before the time when an employee went on leave, or his employment was terminated or he died. Although it was clear that a pecuniary liability would be imposed by the award as soon as one of those events occurred no pecuniary liability was imposed during the income year.
In an effort to support the contention that there was no present liability reliance was placed upon the decision in
Law v. Coburn (1972) 1 W.L.R. 1238, and some earlier English decisions which were applied in that case. That case involved a dispute as to whether, for the purposes of attachment, a debt had been incurred. It was held that a debt was not incurred unless there was a present liability to pay the debt either in the present or in the future. Reliance was placed in reaching a decision upon the earlier decision of
Webb v. Stentor (1883) 11 Q.B.D. 518. In that case Lindley L.J. said at p. 527:
``I should say, apart from any authority, that a debt legal or equitable, can be attached whether it be a debt owing or accruing; but it must be a debt and a debt is a sum of money which is now payable or will become payable in the future by reason of a present obligation, debitum in presenti, solvendum in futuro. An accruing debt, therefore, is a debt not yet actually payable but a debt which is represented by an existing obligation.''
In my mind there is no doubt that the contract that existed between the taxpayer and the stockholders constituted and obligation on the part of the taxpayer to repay to the stockholder the money lent and
ATC 4643interest thereon at the rate stated. The obligation was created at the time the contract was made. The debt however was not payable until some time in the future.
The Commissioner's final contention was that if the liability of the company to the stockholders was a present one it was relevant to ascertain whether the interest accrued daily or annually. On its proper interpretation the contract was a contract to pay interest which accrued annually. That being so the 1975 interest did not accrue until 1976 and so was wrongly claimed in the year in which it was claimed. This contention does not allow for the operation of sec. 144 of the Conveyancing Act 1919. The relevant provisions of that Act are as follows:
``144(1) All rents, annuities, dividends, and other periodical payments in the nature of income (whether reserved or made payable under an instrument in writing or otherwise) shall, like interest on money lent, be considered as accruing from day to day, and shall be apportionable in respect of time accordingly.
(2) The apportioned part of any such rent, annuity, dividend, or other payment shall be payable or recoverable in the case of a continuing rent, annuity, or other such payment, when the entire portion of which such apportioned part forms part becomes due and payable, and not before; and in the case of a rent, annuity or other such payment determined by re-entry, death, or otherwise, when the next entire portion of the same would have been payable if the same had not so determined, and not before.''
As a result of the above section and on its proper interpretation the contract was one to pay interest which accrued from day to day. Even were I wrong in this regard so that the interest accrued from year to year it would not aid the contention of the Commissioner and not affect my ultimate decision.
It seems to me unnecessary to refer specifically to a number of authorities to which my attention was invited in the course of the argument. In addition to those already quoted I refer to Nevill & Co. Limited v. F.C. of T. (1937) 56 C.L.R. 290;
New Zealand Flax Investments Limited v. F.C. of T. (1939) 61 C.L.R. 179;
Emu Bay Railway Company Limited v. F.C. of T. (1944) 71 C.L.R. 596.
I am satisfied that in respect of the deductions claimed by the taxpayer there was in each relevant tax year a present liability to pay the determined interest at a future date and that in those circumstances the claim of the taxpayer should be allowed. In each matter therefore I uphold the taxpayer's appeal and order the defendant Commissioner to pay the appellant's costs.