Mutual Acceptance Limited v. Federal Commissioner of Taxation.Judges:
Supreme Court of New South Wales
This matter comes to the Court as an appeal pursuant to sec. 187 of the Income Tax Assessment Act 1936, as amended.
The taxpayer objected to its income tax assessments for the years ended 30 June 1975 and 1976. There are two appeals, but I give this one set of reasons for judgment; the two matters have been heard together.
The appellant is ``Mutual Acceptance Limited'' although it has now changed its name to Standard Chartered Finance Limited. It is a finance company which engages in the business of making loans to customers, mainly for the purpose of assisting them to purchase consumer type goods. Only a small proportion of its business deals with mortgage finance. To enable it to carry on its business, it borrows, inter alia, on the security of debenture stock which it issues pursuant to a trust deed. It borrows from both individuals and institutions.
During 1975, the appellant was approached by four of its institutional holders of debenture stock with a request that they be permitted to redeem their debentures. Their reasons given for requesting redemption, were that they were receiving interest on the stock at a rate of about 8% and rates of interest in the market place had significantly increased and there were opportunities for them to re-invest and re-lend their funds out at higher rates if they could persuade the appellant to consent to redemption.
The appellant agreed to redeem at a discounted ``price'' although it had no obligation to do so. The discount was because redemption was before the date when the debentures would have matured. The result was the amount paid out to the debenture holders was less than the face value of the debentures and there was a resultant ``gain'' to the appellant. The debts had been discharged for less than their full amount.
The appellant's taxation return for 1975 showed a sum of $115,251 as having been gained in this way. It was described by the appellant as ``capital profit as per detailed profit and loss account''. The Commissioner however treated the sum as ``profit... considered to be assessable income - redemptions of debentures''.
It was this treatment of the $115,251 as ``profit'' and as assessable income that was objected to and which is the subject of this appeal. The basic question is - was the $115,251 in the nature of a capital gain or a gain in the nature of income.
The ``Notice of Objection'' dated 21 May 1976 described the problem as follows:
``1. During the year of income the taxpayer redeemed debentures issued to Wales Nominees Victoria Limited, National Mutual Life Association of Australasia Limited and Yorkshire and General Life Assurance Co. Limited. The amount paid on redemption of the relevant debentures was less than the amount received on subscription of the relevant debentures and the difference is not income according to ordinary concepts and usages nor is it income or assessable income within the meaning of sec. 25 or any other section of the Income Tax Assessment Act 1936 (as amended) (the Act).
2. The said amount of $115,251 referred to as `Capital Profit as per detailed Profit and Loss Account' on schedule 13A of the taxpayer's 1975 income tax return is not income according to ordinary concepts and usages nor is it income or assessable income within the meaning of sec. 25 or any other section of the Act.
3. No part of the difference referred to in ground I above nor any part of the amount of $115,251 referred to in ground 2 above is income according to ordinary concepts and usages nor is any part of the said difference or said amount of $115,251 income or assessable income within the meaning of sec. 25 or any other section of the Act.
4. Section 26(j) of the Act does not apply so as to include the whole or any part of the difference or sums referred to above in the assessable income of the taxpayer.
5. It is wrong in law to conclude that where any payment is made in satisfaction of a debt owing that debt is satisfied or compounded to the satisfaction of the creditor by paying less moneys than may have been required had the debt been satisfied at some other point in time, the difference between the amount so paid and the amount otherwise payable is income within any relevant meaning of that term. It cannot be said that what does not go out has therefore come in.
6. The amount of $115,251 referred to in ground 2 above is a capital sum or is of a capital nature.
7. No part of an amount received in respect of any debenture issued by the taxpayer is income.
8. No part of an amount held by the taxpayer in connection with the redemption of a debenture issued by it is income.
9. The transaction of redeeming a debenture before or on maturity is an affair of capital and is not a transaction entered into for the purpose of profit making nor is it a profit making undertaking or scheme.
10. A debenture issued by the taxpayer is not the property of the taxpayer.
11. A debenture ceases to exist when it is redeemed and cannot at any point in time said to become property of the taxpayer issuing the debenture.
12. A debenture issued by the taxpayer is a liability of the taxpayer and is not available as security in respect of any other liability of the taxpayer.
13. The business of the taxpayer does not include the redemption of debentures.
14. The amount of $115,251 referred to in ground 2 above is not a gain of circulating capital on revenue account.
15. (a) Section 25 of the Act does not operate to include a profit, that is to say a net amount, per se, in assessable income. (b) Alternatively, Section 25 of the Act cannot so operate in the circumstances in the present case.''
Not all these points were relied on.
In the year 1976, similar redemptions occurred. In 1976, the amount was a gain of $22,030. This too, was described in the appellant's tax return as ``capital profit on debenture redemptions...''. Again, the Commissioner treated the $22,030 as ``profit... included as assessable income''.
The relevant facts and circumstances are to be found in the affidavits of Mr. F.H. Allchin, the then Group Manager of the appellant and Mr. I.R. Dowson, the then Funds Manager of the appellant, and in the trust deed and the various prospectuses inviting subscriptions from lenders seeking to ``buy'' debenture stock in the appellant company.
Mr. Allchin's affidavit asserts that, ``prior to August 1974 interest rates were relatively stable''. Lender institutions applied for the debentures and that the appellant did not give a right to redeem. The appellant never stood in the market for the purchase of debenture stock issued by it nor did it purchase on the market any of its debenture stock. Prior to 1975, there had only been two occasions when debentures had been redeemed prior to maturity date, other than at par. The inference I am invited to find is that these occasions were unusual. The appellant never approached debenture holders and sought redemption. It was debenture holders who approached the appellant. Mr. Allchin made the decisions to redeem. In making the decisions, he considered it was in the company's interests to redeem early at a discount. The appellant had funds available at the time which were surplus to its requirements. He also said that ``when interest rates are rising you find you get a lot of people finding a reason why they would like redemptions...''. Approximately 80% of people requesting redemptions were given redemptions.
The question of redeeming debenture stock is a matter of contract between the borrower (the appellant) and the lenders.
Some of the terms are to be found in the prospectuses, which are all in similar terms. They vary in that different rates are prescribed for different terms. The terms vary from three months to 20 years.
I have taken the following provisions as to repayment from the 12th issue at page 5:
Debenture Stock and Notes will, on surrender of the relevant certificate, be repaid at par on the due date or such earlier date as may apply in any of the circumstances specified in this Prospectus.
The Company will be pleased to negotiate with any Investor who, in exceptional or unusual circumstances, seeks early repayment of his investment. (The emphasis is mine.)
Superannuation and Provident Funds
Trustees of Superannuation or Provident Funds will be permitted to withdraw up to 10% of the investment in any calendar year, subject to any necessary adjustment of interest to the rate appropriate to the period for which the amount withdrawn was actually held by Mutual.
Upon the death of a sole Investor, the Company will, on application, pay to the executor or administrator of the estate, upon production of the necessary authority, the whole or part of the investment, subject to normal proofs of title under the relevant Stamp Duties and Probate Acts. Any repayment before due date will be subject to adjustment of interest rate on the amount withdrawn to the rate appropriate to the period for which the amount withdrawn was actually held by Mutual.''
Only the paragraph dealing with ``Emergencies'' is relevant.
The ``negotiations'' lead to the terms of the negotiated redemption. This provision for ``Emergencies'' advances the goodwill of the appellant whilst at the same time, giving it control over whether or not a redemption should take place. Mr. Allchin, in oral evidence, said goodwill was an important consideration to the appellant. The appellant had no general policy
ATC 4834on the matter and a lender's reasons for seeking redemption were important. At p. 9 he said:
``in the case of applicants who did not show exceptional circumstances, the redemption did not take place at a discount,''
and in such circumstances, redemption took place at par. When appropriate, interest was adjusted to the term for which the money was originally held. He gave an example to the effect that if the original had been for five years, and the rate for the five years was 8%, and an application for redemption was made after four years and the four year rate was 7%, the appellant might have paid 7% interest as though it had contracted for four years.
The paying out price was set by Mr. Allchin. In doing so, he took into account the interest rate differentials, bearing in mind the rates of interest at which the debenture was initially issued and the prevailing market interest rate.
At p. 10 of his evidence, Mr. Allchin agreed to what is trite and obvious - that the way in which the appellant made its profit, was having the rates of interest at which it borrowed its money, less than the rates at which it lent its money. The company is a money lender. Its goodwill is as important in its business as in any business.
Mr. Hill, who appeared for the appellant, accepted that a gain or profit had occurred and he referred me to a number of cases.
The applicable principles are reasonably clear. It is the application of the principles that create the difficulty.
His submissions can be summed up as follows:
- 1. The exchange rate cases such as
Texas Company (Australasia) Limited v. F.C. of T. (1940) 63 C.L.R. 382 are distinguishable.
- 2. The gain was not a consequence of a borrowing because it was a result of unforeseen events and in any event, a borrowing on fixed long-term borrowings was different from a borrowing on a short-term borrowing on an overseas market where there was always a risk of exchange rate gain or loss.
- 3. All that had happened was that a calculation of the present day value of a debenture had been made.
- 4. Because it arose out of unforeseen events, it was not a recurrent gain, as in the case of ordinary trading operations, but more in the nature of a windfall gain.
- 5. It was a gain which reduced the indebtedness of the borrower and would normally go to the capital account.
The problem is a matter of classification and I begin by yielding to the temptation to cite the comment of Lord Greene M.R. in
I.R. Commrs. v. British Salmson Aero Engines Limited (1938) 2 K.B. 482 at p. 498.
``There have been many cases which fall on the border line. Indeed, in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons.''
However, having cited his Lordship's comment, I put it aside and from the authorities, I extract the following principles.
Many of the cases are ``expenditure'' cases. They all illustrated the difficulty in deciding whether a case falls on one side of a line or not.
I cite from the Judicial Committee of the Privy Council in
B.P. Australia Limited v. F.C. of T. (1965) 112 C.L.R. 386 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
Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (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
ATC 4835must 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).''
From pp. 398-399:
``The first point involves the question of recurrence. The Lord President in the
Vallambrosa Rubber case (1910) 5 Tax Cas 529 said, as a rough criterion, `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' (at p. 536). But as Rowlatt J. pointed out in
Ounsworth v. Vickers Ltd. (1915) 3 K.B. 267 the words `every year' are not to be taken literally but mean pursuant to a continuous demand (at p. 273).''
``Their Lordships agree with Owen J. in thinking that if regard was had to `the whole picture' the expenditure was recurrent. To find whether expenditure is of a recurrent nature one must take a broad view of the general operation under which the expenditure was incurred. Here it was made to meet a continuous demand in the trade. Prima facie matters connected with the ever recurring question of marketing and customers, though not themselves recurrent in an identical form, share the same quality of recurrence possessed by matters `connected with the ever-recurring question of personnel'.''
At p. 406:
``An advance payment for a period is not unusual in many revenue matters (e.g. purchase of stock). These payments were not current payments made annually over the period of benefit but on the other hand it was clear that they would have to be made again at intervals of a few years. In a durable company of this nature recurrent five yearly payments certainly cannot be said to have a `once and for all' quality. Had the payments been for one or two years they would point towards revenue; had they been for twenty years they would point towards capital. But the actual period of time for which these particular payments were made, as in the consideration of the nature of the advantage (above), gives no indication which could outweigh the indications given by other considerations.''
From the Texas Company (Australasia) Limited v. F.C. of T. (1940) 63 C.L.R. 382 at p. 428:
``If a taxpayer carrying on business in Australia is to discharge a debt incurred in dollars in the United States of America he must spend a number of Australian pounds dependent upon the current rate of exchange in order to obtain control of the necessary amount of dollars in America. Such expenditure of Australian pounds is an ordinary business expenditure, and the taxpayer is entitled to claim as a deduction the actual outgoing which he makes in order to discharge his normal business debts for stock-in-trade and the like: Cf.
Moreau v. F.C. of T. (1926) 39 C.L.R. at p. 70). As I have already said, the fact that he has made a preliminary estimate of the amount required to discharge his foreign debts does not, in my opinion, preclude him from claiming later a deduction of any increased amount which in fact he has to pay. This deduction is claimable simply as an outgoing incurred in gaining or producing assessable income. In one sense it is true that it is not incurred in gaining or producing the assessable income of the later year in which the money is actually paid, but a business is properly regarded as a continuing enterprise, and if a business man in one year were to decline to pay his debts incurred in previous years it is obvious that his business would soon come to an end. Accordingly, the payment made in subsequent years has a real relation to the assessable income of the later year, although it is also related to, for example, the price of goods purchased in an earlier year, an estimate of which price has already appeared in his accounts and has been allowed in the assessment for that year.''
At p. 468.
``But notwithstanding that so much must be conceded to the contention of the Commissioner, I think that the outgoing is not wholly of a capital nature and to the extent to which it is attributable to the discharge of liabilities incurred on revenue account ought to be allowed. From the fact that the increase in the expenditure arose from a delay in payment designed to create a fund for working capital, it by no means follows that it is a capital outgoing. The variations in the cost of exchange for
ATC 4836discharging liabilities in foreign currency are continual sources of credits and debits in accounts into which the liabilities have already been taken. It is true that the credits and debits do not, or-at all events may not, record actual losses and gains incurred or obtained independently of the previous expression of the liability in the accounts. But they are continually recurring variations in the position of the business in its course of profit earning. Whether the variations are on account of capital or revenue cannot depend on the purpose of the business policy or measures to which as a matter of causation the size or direction of the variation may be traceable. Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant. No doubt the difficulty of assigning an outgoing to capital or income is often very great... Here I think that there are factors which place the expenditure in the category of an outgoing on account of revenue, so far as it is not referable to capital liabilities. First among these factors is that the circumstances that the liability discharged is ex hypothesi of an income nature. Next the chance of loss or gain in the expenditure required to discharge it, owing to variations in exchange, is a matter attendant upon the use of funds transferable from one country to another, which is continual, recurrent and not independent of judgment and policy on the part of those managing a business of which such funds form a part. It is a loss or gain ordinarily regarded in business as detachable from the fund, and susceptible of treatment as a trading profit or loss.
The delay increased the chances of a loss expressed in pounds, but the fact that the reason for the delay related to capital does not make the outgoing a capital loss. It is rather a standing contingency representing the recurrent expenditure which must be incurred to obtain the use of the money and is much more like an annual outgoings to obtain the use of capital assets, such as rent, hire or interest.''
Australasian Catholic Assurance Company Limited v. F.C. of T. (1959) 100 C.L.R. 502 at pp. 505-506:
``The main argument for treating the profits in question as assessable income is that they were profits from the carrying on of the taxpayer's life assurance business and were accordingly income according to ordinary concepts, and properly taxable as such. That they were profits from the carrying on of that business is, I think, an inescapable conclusion. The flats were bought as good investments and were sold to avoid their becoming bad investments, which was what was intended from the very first, although it was hoped and, indeed, expected, they would not have to be sold until a long time after 1951... `... the definition only refers to proceeds which would be held to be income in accordance with the ordinary usages and concepts of mankind, except in so far as the Act states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income' ((1946) 73 C.L.R. at p. 615). It is said that these profits were the proceeds of the business in a very special sense, since they arose out of transactions outside the ordinary course of the taxpayer's business and the sales were forced upon the taxpayer by unexpected developments. I am ready enough to accept this contention to the extent that it was unexpected developments that dictated the sales in 1951, but I cannot agree that the sale of the flats purchased as investments was outside the ordinary course of the taxpayer's business and I do not think that to say that there were but few transactions establishes any such thing... I cannot think that the sale in 1952 would stand on a different footing from an earlier sale. When investments are bought to be sold eventually, one sale must always precede the others. If, however, the sales were in the ordinary course of the taxpayer's business, as I think they were, the particular reason for deciding to sell cannot be decisive of the question whether the profit made is income or not. As was said in
Colonial Mutual Life Assurance Society Ltd. v. F.C. of T. (1946) 73 C.L.R. 604: `Prima facie the depreciation in or accretion to the capital value of a security between the date of purchase and that of realization is a loss of or accretion to capital and is therefore a capital loss or gain and does not form part of the assessable income:
Lomax v. Peter Dixon & Son Ltd. ((1943) K.B. 671). But in the words of the Lord Justice Clerk in
Californian Copper Syndicate v. Harris ((1904) 5 Tax Cas. 159 at p. 166) which have been so often quoted, `it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business'' ((1946) 73 C.L.R. at p. 614). The distinction that I find in this quotation from the Lord Justice Clerk is between a profit which is in the carrying on of a business and a profit which is not, because a change of investments is made which is not in the course of carrying on a business at all, e.g., a doctor selling some shares and buying others, or because it constitutes the realization of the capital assets of a business which has come to an end, e.g.,
Scottish Australian Mining Co. Ltd. v. F.C. of T. (1950) 81 C.L.R. 188) or for some other reason. The instant case, it seems to me, is one where the enhanced values were obtained in the carrying on of the taxpayer's business.''
As against that there is part of what was said and quoted in
AVCO Financial Services Limited v. F.C. of T. 82 ATC 4246 at p. 4249 et seq. by Gibbs C.J.:
``The gains which resulted from variations in the rate of exchange will be assessable if they can be regarded as income in accordance with ordinary usages and concepts and so within sec. 25(1) of the Income Tax Assessment Act 1936 (Cth.), as amended (`the Act'). The losses will be deductible if they fall within sec. 51(1) of the Act, i.e. if they were losses or outgoings incurred in gaining or producing the assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing such income, and if they were not losses of a capital nature. Where, as a result of variations in the rate of exchange, a taxpayer, in the course of carrying on a continuing business, makes gains or incurs losses of a revenue and not of a capital nature, the gains are assessable income in the year in which they are realized and the losses are allowable deductions in the year in which they are incurred....
In the forefront of the argument advanced on behalf of the Commissioner is the submission that an exchange gain or loss incurred on the repayment of the principal sum borrowed is always of a capital nature. Support for this argument is found in some dicta of my own in
Commercial and General Acceptance Ltd. v. F.C. of T. 77 ATC 4375; (1977) 137 C.L.R. 373. I there said, at ATC p. 4377; C.L.R. p. 377:
- `I incline to think that an exchange gain or loss on the repayment of moneys lent will always be a capital gain or loss, and can never be taken into account in the assessment of income. That seems to have been the view of Latham C.J. in the Texas Co. case [(1940) 63 C.L.R. 382 at p. 428]. But if that be too extreme a view, I agree with Mason J. that the repayment of the borrowing in the present case was an expenditure on the capital account, within the principles stated in the leading case, Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. (1938) 61 C.L.R. 337, at pp. 359-363.
In the same case Murphy J., at ATC p. 4382; C.L.R. p. 386, formulated a number of propositions, including the following:
- `(5) If an amount receivable by a taxpayer (the principal sum) is not assessable income, then any increase or decrease in the principal sum caused by exchange rate variation is not to be taken into account in determining the taxable income of the taxpayer.
- (6) If an amount payable by a taxpayer (the principal sum) is not allowable expenditure, then any increase or decrease in the principal sum is not to be taken into account in determining the taxable income of the taxpayer.
Those propositions are consistent with what I said in that case, and some remarks in the judgment of Mason J. suggest that he took a similar view. He said, at ATC p. 4380; C.L.R. p. 383:
- `The exchange gain was in reality a saving or reduction in the amount of Australian currency equivalent which the taxpayer required to repay its indebtedness. In essence it was a windfall advantage stemming from a reduction in a liability to repay a borrowing of capital.
- I can see no persuasive reason for saying that the gain was a receipt of income.'
Notwithstanding these statements it was not necessary for the decision in that case to hold that an exchange gain on the repayment of moneys lent will always be a capital gain. The main purpose of the borrowing in that case was to strengthen the company's business entity, structure or organization set up for the earning of profit, and the obtaining of the loan was not part of the process by which the company operated to obtain regular returns. The direct application of the tests formulated in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T. led to the conclusion that the foreign exchange gain was not income.
It does seem true to say, at least in general, that if an amount payable by a taxpayer is allowable as a deduction, then any increase or decrease in that amount caused by a variation in the rate of exchange is to be taken into account as an allowable deduction or as assessable income as the case may be: see the second of Murphy J.'s propositions in Commercial and General Acceptance Ltd. v. F.C. of T., at ATC p. 4382; C.L.R. p. 386. In such a case, ex hypothesi the amount originally payable will not be of a capital nature. For example, there is no doubt that where the payment in connexion with which the gain or loss is made is the price of goods used by the appellant as trading stock the gain or loss will be of a revenue nature: see Texas Co. (Australasia) Ltd. v. F.C. of T. and International Nickel Australia Ltd. v. F.C. of T. However, expenditure may be deductible in some cases even if it is designed to secure an advantage of a capital nature. In Texas Co. (Australasia) Ltd. v. F.C. of T. the taxpayer, an oil company, purchased its petroleum products from its parent companies in the United States, and since its share capital was insufficient to meet its requirements for working capital, was allowed to delay payments in respect of the purchases in order to provide it with funds large enough for its needs. Before payment was made the rate of exchange moved against Australia. It was held that the fact that the increase in expenditure arose from a delay in payment designed to create a fund for working capital did not mean that the exchange loss was of a capital nature.
Dixon J., at p. 468, after saying that the credits and debts resulting from variations in the rate of exchange were `continually recurring variations in the position of the business in its course of profit earning', went on, at pp. 468-469, as follows:
- `Whether the variations are on account of capital or revenue cannot depend on the purpose of the business policy or measures to which as a matter of causation the size or direction of the variation may be traceable. Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant. No doubt the difficulty of assigning an outgoing to capital or income is often very great... Here I think there are factors which place the expenditure in the category of an outgoing on account of revenue, so far as it is not referable to capital liabilities. First among these factors is that the circumstances that the liability discharged is ex hypothesi of an income nature. Next the chance of loss or gain in the expenditure required to discharge it, owing to variations in exchange, is a matter attendant upon the use of funds transferable from one country to another, which is continual, recurrent and not independent of judgment and policy on the part of those managing a business of which such funds form a part. It is a loss or gain ordinarily regarded in business as detachable from the fund, and susceptible of treatment as a trading profit or loss.'
In the same case Latham C.J. said, at p. 427, that the increased outlay required in a subsequent year to discharge the constant debt might be regarded, not as payment of the price of the goods, but as `a necessary outgoing made in the normal course of the continuance and maintenance of the business as an enterprise conducted for the purpose of profit'.
Similarly, it appears right, in a case such as the present, to regard exchange gains and losses resulting from the repayment of borrowed money as detachable from the borrowed fund, and as not necessarily
ATC 4839sharing its character. The difficulty of adhering to the view that exchange gains and losses resulting from the repayment of borrowed money must always be of a capital nature is made manifest by comparing the case in which a taxpayer who regularly buys trading stock has ninety days after each delivery in which to pay the supplier, with the case in which the taxpayer arranges with his bank to pay the supplier each time a delivery is made and has himself ninety days in which to pay the bank. The authorities cited show that a gain or loss resulting from a change in the rate of exchange during the ninety days would be on revenue account in the former case. It would be anomalous if the gain or loss was on capital account in the latter case. In
Thiess Toyota Pty. Ltd. v. F.C. of T. 78 ATC 4463; (1978) 1 N.S.W.L.R. 723, where a company which sold motor vehicles paid for the imported vehicles with moneys advanced by a bank in the form of letters of credit in favour of the exporter in Japan, and the company had ninety days to reimburse the bank, it was held by Meares J. that the arrangements with the bank were all part of a transaction relating directly to, and having the purpose of, the purchase of trading stock and that the exchange gain was on revenue account and assessable income... In the United States, it has also been held that an exchange gain on payment of a debt due for trading stock was taxable as income.
America-Southeast Asia Co. Inc. v. Commr. of I.R. (1956) 26 T.C. (U.S.) 198.
Where a taxpayer carries on the business of borrowing and lending money, the moneys used for that purpose are analogous to trading stock - the taxpayer in effect deals in the money. Exchange gains and losses, regularly and frequently made and incurred, in the course of making repayments of borrowed money which is used by a taxpayer in making loans in the course of its finance business are outgoings made in the day to day conduct of the business and for the purpose of carrying on the business as a going concern. The first matter to be considered, in deciding whether a payment is of a capital or of a revenue nature, is what was the character of the advantage sought by the payment: Sun Newspapers Ltd. and Associated Newspapers Ltd. v. F.C. of T., at p. 363. The question has to be considered from a practical and business point of view: see
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at p. 4419; (1978) 140 C.L.R. 645 at p. 659, and cases there cited. From that point of view, the additional moneys paid as a result of the unfavourable exchange variations - the exchange losses - were part of the price by which the appellant obtained the money which it used to make a profit - part of the process by which the appellant obtained regular returns. The payments were recurrent and frequent, although irregular, and they involve the exercise of judgment by the officers of the appellant who put its borrowing policy into effect as part of the conduct of the business. The exchange losses were in my opinion losses on revenue account, and of course the gains have the same character. The view which I expressed in Commercial and General Acceptance Ltd. v. F.C. of T., at ATC p. 4377; C.L.R. p. 377, that an exchange gain or loss on the repayment of moneys lent will always be a capital gain or loss, must, on reconsideration, be rejected. In a case such as the present the gains and losses do not have the same character as the repayments that produced them, and, considered separately, but in the light of all the circumstances, are seen to be revenue in character.''
Per Mason, Aickin and Wilson JJ. at pp. 4255-4259:
``The Commissioner's primary submission derives support not only from Gibbs J. in CAGA but also from Latham C.J. in Texas Co. (Australasia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382, at p. 428, where the Chief Justice said that `no exchange... should be allowed' in respect of `remittances sent by the company to America in repayment of moneys lent or in payment for plant which became part of the capital assets of the company'. Latham C.J.'s observation, unlike that of Gibbs J., was not directed to the situation of a finance company. It reflects the view that a loan and the repayment of a loan are generally an affair of capital. And so they are. The money lent, judged from the viewpoint of both borrower and lender, is in general capital; on the other hand, the interest payable on the money lent is generally income in the hands of the lender
ATC 4840and a revenue outgoing in the hands of the borrower.
Thus Menzies J. said in
Caltex Ltd. v. F.C. of T. (1960) 106 C.L.R. 205 at p. 251: `Borrowing money to carry on business or to pay liabilities incurred in carrying on business is prima facie to increase the capital employed in the business...' Jenkins L.J. (with whom Cohen and Singleton L.JJ. concurred) had expressed a similar view in
Davies (H.M. Inspector of Taxes) v. The Shell Company of China, Ltd. (1951) 32 T.C. 133, at p. 157, saying that it was perhaps `only another way of saying that they (i.e. loans) must prima facie be considered as part of the Company's fixed and not of its circulating capital'....
But it is one thing to say that a borrowing of money and the repayment of a loan are generally an affair of capital. It is quite another thing to say that they are always an affair of capital. In his dissenting judgment in
Tip Top Tailors Ltd. v. Minister of National Revenue (1957) 11 D.L.R. (2d) 289, Cartwright J. said (at p. 300):
`... in the case of a taxpayer carrying on a commercial undertaking such as that of the appellant, whose business is not that of dealing in foreign exchange or borrowing and lending money, a gain or loss related to dealings between borrower and lender is prima facie one of capital and not of income.'
... The majority held that the profit was taxable. They drew a distinction between the capital machinery within and by means of which the business earning the income is carried on and the business itself, fluctuations in the value of the former having no bearing on profits and losses from the business.
- `It is not the business of either of the appellants to engage in financial operations.... Of course, like other business people, they must have capital to enable them to conduct their enterprises, but their financial arrangements are quite distinct from the activities by which they earn their income.'
The consequence was, in Montreal Coke, to use the words of Lord Macmillan, that `expenditure incurred in relation to the financing of their businesses is not... expenditure incurred in the earning of their income'. By way of contrast, in Tip Top Tailors the `loan produced working capital used in the course of the company's business' (p. 292).
The majority judgments, as well as the dissenting judgment, in Tip Top Tailors, and the speech of Lord Macmillan in Montreal Coke recognize, rightly in our opinion, that the borrowing of money and the repayment of loans by a finance company in the ordinary course of its business stand in a different situation from borrowings by a company not undertaken in the ordinary course of its income-earning business. The essence of the business of a finance company as carried on by the taxpayer is the borrowing and lending of money, the rates of interest payable on money lent being significantly higher than the rates payable on the money borrowed, for it is from the difference in the rates that the company generates its profit, after making provision for bad debts. There is therefore an important and material difference between borrowing by a finance company in the ordinary course of its business and borrowing by a manufacturing or trading company. In general the finance company's borrowings provide money which it turns over at a profit. Borrowing otherwise than for on-lending or for the repayment of funds borrowed for on-lending, that is, borrowing undertaken for capital rather than revenue purposes, as in CAGA, is an exception to the general rule. On the other hand, borrowing by a manufacturing or trading company is often undertaken to strengthen the capital or profit-earning structure of the company. A finance company usually borrows in order to increase its working capital which is then turned over at a profit; the manufacturing or trading company frequently borrows to strengthen its permanent capital.
Exchange gains and losses are an ordinary incident of overseas borrowings by a finance company. If an overseas loan, the proceeds of which are to be used in the Australian business of the finance company, is to be repaid in the foreign currency, the company has, in the first instance, to exchange the foreign currencies for Australian dollars, and
ATC 4841later to buy the foreign currency with Australian dollars. Exchange gains and losses are therefore an incident of the borrowing.
The answer to this argument is to be found in the judgment of Dixon J. in Texas where the issue was whether the taxpayer could deduct the increased outlay in Australian dollars necessary to discharge debts in United States dollars incurred in respect of stock-in-trade and supplies, the increased outlay having been caused by devaluation of the Australian dollar in the period of one year which elapsed between the incurring of the debts and their payment. The Commissioner argued that because the purpose of the delay in payment was to provide the taxpayer with more working capital, the amount in question was capital.
Dixon J. acknowledged (at p. 468) that `the true nature of the deduction claimed is for the increase in the cost of discharging a past liability for which provision in the accounts was made at a lower figure'. He noted that the variations in the cost of exchange were `continually recurring variations in the position of the business in its course of profit earning'. He went on to say (at p. 468):
- `Some kinds of recurrent expenditure made to secure capital or working capital are clearly deductible. Under the Australian system interest on money borrowed for the purpose forms a deduction. So does the rent of premises and the hire of plant.'
Speaking of the factors which led him to the conclusion that the increased costs were an allowable deduction, after first mentioning that the liability discharged was of an income nature, his Honour said (at p. 469):
- `Next the chance of loss or gain in the expenditure required to discharge it, owing to variations in exchange, is a matter attendant upon the use of funds transferable from one country to another, which is... recurrent... It is a loss or gain ordinarily regarded in business as detachable from the fund, and susceptible of treatment as a trading profit or loss... the fact that the reason for the delay related to capital does not make the outgoing a capital loss. It is rather a standing contingency representing the recurrent expenditure which must be incurred to obtain the use of the money and is much more like annual outgoings to obtain the use of capital assets, such as rent, hire or interest.'
In the United States it has been decided that a gain made by a taxpayer in repaying a sterling loan made by a bank to enable the taxpayer to buy burlap in India in the ordinary course of its business of importing and selling burlap, sterling having been devalued before repayment of the loan, was taxable as income on the ground that it was a gain which arose directly out of the taxpayer's trade or business (America-Southeast Asia Co. Inc. v. Commr. of I.R. (1956) 26 T.C. (U.S.) 198). In that case Rice J. after noting that the taxpayer entered into two transactions - one a purchase of burlap, the other a foreign exchange transaction, said (at p. 200):
- `... the nub of its argument here is that because there were two transactions, the gain in question must be taxed as a capital gain, since it was a dealer in burlap and not a dealer in foreign exchange. We do not think that necessarily follows. While we recognise the presence of two transactions and agree with petitioner that there is a marked similarity to its trading in foreign exchange and a short sale, we think the fact of overriding importance here is that petitioner's transaction in foreign exchange was an integral part of its ordinary trade or business and that the gain in question must, therefore, be taxed as ordinary income realised in such trade or business.'
With respect to those who think otherwise, the proposition that exchange variations affecting the repayment of loans in foreign currencies are always an affair of capital in the case of a finance company is supported neither by principle nor by authority. The true principle is that in the case of a finance company which borrows money overseas in the ordinary course of its business and not for some special purpose, the added cost of repayment in foreign currency caused by the
ATC 4842devaluation or depreciation of the Australian dollar is an additional cost of the borrowing and, like other costs of the borrowing, is an allowable deduction under sec. 51(1). Conversely, a saving in the amount of foreign currency needed to repay an overseas loan due to a revaluation or an appreciation in the value of the Australian dollar is to be considered as income arising directly out of the finance company's ordinary business.
As we have already observed, the borrowing and repayment of a loan in an overseas currency involves connected exchange transactions when the proceeds of the loan are to be employed in Australia - the finance company first buys Australian dollars with the foreign currency and later buys the foreign currency with Australian dollars in order to effect repayment. Like the borrowing transactions with which they are associated, the foreign exchange transactions are entered into by the taxpayer in the ordinary course of its business and form an integral part of that business. The gains and losses made and sustained in these transactions are therefore made in the ordinary course of carrying on that business, the more so because the gains and losses are an ordinary incident of transactions of this kind.
In the argument emphasis was given to the notion that the money stock of a finance company is similar to the trading stock of a trading company. There are some obvious similarities. However, there are some differences. Money is not dealt with in specie as a commodity and money is not included in the definition of `trading stock' for the purposes of the Act - see sec. 6. Despite these differences, what is of immediate importance is the strong similarity between the getting in and the turning over of trading stock by a trading company and the borrowing and on-lending of money by a finance company. This similarity is so strong as to suggest that just as exchange gains and losses on the acquisition of trading stock are to be included in the assessable income of a trading company, like gains and losses in connection with the borrowing and repayment of loans by a finance company, are also to be included in its assessable income.
Avco's business may properly be described as money-lending, with the possible exception of its hire-purchase operations - as to which see
Transport and General Credit Corporation v. Morgan (1939) 1 Ch. 531, at p. 551, per Simonds J. and
Austin Distributors Ltd. v. A.H. Paterson Car Sales Pty. Ltd. (1941) 65 C.L.R. 118.
The relative proportions of the three major types of activity engaged in by Avco do not appear, but for present purposes hire-purchase transactions bear a sufficient resemblance to money-lending to be treated as in the same category for present purposes. It involves an outlay of money which is recovered from the customer by periodical payments rather than in a lump sum at the end of a period.
There is also a common feature between Avco's business and that of bankers. Each borrows money for the purposes of lending it to its customers, or repaying former lenders whose loans are due for repayment.
The point of this analysis of Avco's business is that it has been said on a number of occasions that money is the stock-in-trade of bankers and moneylenders. Thus in
I.T. Commr. v. Singh (1942) 1 All E.R. 362 at p. 365, Lord Thankerton, speaking for the Privy Council, said: `It has to be remembered that money is the stock-in-trade of a moneylender'.
Guinea Airways Ltd. v. F.C. of T. (1950) 83 C.L.R. 584, at p. 593, Kitto J. said:
- `In the case of a banker, money is his stock in trade, and any profit or loss he makes in dealing with money in the course of his business is on revenue account, notwithstanding that the money is in a sense held in reserve.'
Permanent Building and Investment Society (In Liquidation) v. F.C. of T. (1958) 98 C.L.R. 187, at p. 191, Williams J. referred to those two cases and said:
- `No doubt money can in a somewhat metaphorical sense be said to be the stock-in-trade of a moneylender or a bank. It is dealing in money and in that which it represents, that is to say, the debts which are owed to it as a result of putting out its money at interest. Any loss
ATC 4843upon a loan that such a trader might incur in the course of carrying on its business would be a loss incurred in gaining or producing the assessable income and be an allowable deduction under sec. 63 of the Act. But a loss incurred upon the realisation of such loans in order to put an end to the business or part of it would, in the absence of legislation to the contrary, be a capital loss.'
The decision in Texas established that exchange gains and losses encountered in financing the purchase of trading stock are to be regarded as on revenue account. Avco's borrowings to obtain funds to finance its lending and hire-purchase business bear a sufficiently close resemblance to the borrowing of funds to purchase physical stock-in-trade and the deferring of payments due to suppliers of such stock to require exchange gains and losses to be treated in the same way, i.e. as being on revenue account.
A distinction is to be drawn between moneys borrowed by a finance company in the ordinary course of its business and moneys borrowed for some special purpose which excludes the use of the money in the ordinary course of the finance company's business, e.g. for on-lending or for the repayment of a loan the proceeds of which have been employed in the ordinary course of its business. CAGA was an instance of a borrowing for a special purpose, the company undertaking not to use the funds for on-lending and to employ them in such a way that they could be regarded as part of the permanent capital structure of the business.
There is a question whether for present purposes a distinction should be drawn between moneys borrowed for the purpose of on-lending and moneys borrowed for the purpose of repaying loans previously borrowed for on-lending. In our view no such distinction should be drawn. In each instance the transactions are continuously and regularly entered into in the ordinary course of the finance company's business; they are an integral part of that business. The gearing of the borrowing programme to accommodate the requirement for funds for on-lending and the requirement for funds to meet repayment of maturing loans so as to maximise profits without incurring an unnecessary liability for interest on such loans shows that it would be impractical to draw a distinction. Borrowing for the two purposes is interrelated and a fundamental element in the business of generating the taxpayer's income.
We would therefore reject the Commissioner's primary submission that exchange gains and losses in connection with overseas borrowings by a finance company are always an affair of capital. Indeed, the application of the principles discussed in
Sun Newspapers, Texas, Armco (Australia) Pty. Ltd. v. F.C. of T. (1948) 76 C.L.R. 584, Caltex and CAGA to borrowings by a finance company in the situation of the taxpayer will generally result in the exchange gains and losses being characterised as revenue items. The result in CAGA depended on its special circumstances. Our discussion of the principles and their application in the present case shows that the exchange gains and losses of the taxpayer were revenue items and that Kearney J. and Fisher J. were right in so holding.''
From Commercial and General Acceptance Limited v. F.C. of T. 77 ATC 4375 at pp. 4380-4381; (1977) 137 C.L.R. 373 at p. 383:
``The exchange gain was in reality a saving or reduction in the amount of Australian currency equivalent which the taxpayer required to repay its indebtedness. In essence it was a windfall advantage stemming from a reduction in a liability to repay a borrowing of capital. I can see no persuasive reason for saying that the gain was a receipt of income.
The evidence accepted by his Honour established that the principle purpose of the borrowing was not to arm the taxpayer with more funds to lend or apply in the ordinary course of its finance business - 35% only of the loan could be so applied - but rather to provide a base of additional assets which would generally strengthen the taxpayer's financial standing and enable it the more readily to borrow moneys from the public by demonstrating that it was free of liquidity problems.... No doubt the effect of the loan was to enable the taxpayer to divert other funds into the more profitable channels of its finance business, but this does not affect the character of the loan transaction itself.
In these circumstances the principal purpose of the borrowing was to strengthen `the business entity, structure, or organisation set up or established for the earning of profit'; it was not part of the process by which the organisation operated to obtain regular returns... In truth the transaction was designed to strengthen the framework within which the taxpayer intended to carry on business...
It remains only to dispose of the suggestion made in support of the Commissioner's case that money borrowed by the taxpayer should be regarded as trading stock.... As trading stock does not ordinarily embrace money, the submission was based on the statutory definition of `trading stock' contained in sec. 6. The definition includes `anything produced, manufactured, acquired or purchased for purposes of manufacture, sale or exchange, and also includes live stock'. Although the decision in
Investment and Merchant Finance Corporation Ltd. v. F.C. of T. 71 ATC 4140; (1971) 125 C.L.R. 249 shows that `trading stock' in its statutory sense includes choses in action such as shares and is not confined to goods and commodities, the definition is not wide enough in my opinion to comprehend money borrowed by a finance company for use in its business, in particular for the use to which the taxpayer applied the moneys which it borrowed from the Bank of America. Even if the moneys were `anything acquired', they were not acquired for purposes of `exchange', as the Commissioner argued. What the taxpayer did with the moneys which it borrowed could not, by any feat of imagination, be accurately described as an `exchange of money'.''
Lombard Australia Limited v. F.C. of T. 80 ATC 4151 at pp. 4174-4175 per Powell J.:
``It is, in this situation, necessary, in my view, to go further than labelling the taxpayer a `financier', `money lender' or `currency trader'; what one must do, in my opinion, is to determine how this particular taxpayer carried on its business. It is clear, at the outset, that substantial though the subscribed capital and shareholders' funds of the taxpayer may have been, they, at no relevant time, were sufficient to enable the taxpayer to carry on business on the scale which it did: it was, at all relevant times essential for the taxpayer's business that it have access to substantial borrowed funds to on-lend to its customers. It is also clear that, at all relevant times, the taxpayer obtained its borrowed funds from a variety of sources, overseas institutions, local institutions and local public subscriptions. Finally, it is clear that the funds which were borrowed by the taxpayer for the purposes of its business were, at all relevant times, borrowed pursuant to a variety of contractual arrangements, and for varying periods, the object, as I understand it, being to permit the taxpayer to on-lend to its customers by way not only of short-term, but, also, of medium-term and long-term, loans (see Transcript p. 53). It follows, in my view, that while it is correct to say, as Mr. Priestley has submitted, that the taxpayer's business was not that of a dealer in foreign currency, it is, nonetheless true to say that the taxpayer's business was that of a dealer in credit, its profit being derived from the margin between, on the one hand, the cost to it of obtaining, `holding', `selling', `protecting' and collecting the funds (or credit) which it had or which it borrowed, and, on the other, the interest charged to, and received from, its customers.
If this be so, then, so it seems to me, the application by the taxpayer of the funds from time to time borrowed by it cannot be described as expenditure on the structure within which profits were to be earned: rather, the application of those funds by on-lending them was an integral part of the process by which the taxpayer earned its income. It follows, in my view, that the borrowed funds of the taxpayer, wherever borrowed, so applied by the taxpayer ought to be categorised as circulating capital.
The question thus is, whether the `foreign exchange losses' can properly be described as `losses or outgoings... necessarily incurred for the purposes of gaining or producing (assessable) income'. While I am by no means persuaded that the phrase `foreign exchange loss' is an entirely appropriate description of what is involved - I prefer to think of the additional cost of repayment of the relevant loans as an additional cost of borrowing - I am satisfied that the `losses' ought properly to be treated as losses or outgoings necessarily
ATC 4845incurred in the income earning process. The evidence would seem to demonstrate that, at all relevant times, borrowing overseas was an integral part of the process by which not only the taxpayer but most, if not all, major financiers in Australia funded their lending activities; so too the evidence would seem to demonstrate that, at all relevant times, fluctuations in the value of currencies were an established feature of the world-wide monetary scene. This being so it seems to me that the `losses' in question `represent that kind of casualty, mischance or misfortune which is a natural or recognised incident of (the) particular trade or business the profits of which are in question (and that they were) characteristic incidents of the systematic exercise of a trade or the pursuit of a vocation'...''
Strick (Inspector of Taxes) v. Regent Oil Co. Ltd. (1966) A.C. 295 at p. 317:
``... In Commissioner of Taxes v. Nchanga Consolidated & Copper Mines Ltd., Viscount Radcliffe said:
- `... 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.'
Perhaps it is, but the illumination is very dim, and as Lord Radcliffe goes on to say, it `leads to distinctions of some subtlety between profit that is made `out of' assets and profit that is made `upon' assets or `with' assets.' I must say that I distrust as a guide any criterion which leads to verbal distinctions of that kind, but fortunately it is not the only guide...''
And at p. 345:
``I do not for one moment think that these long-term trading contracts can possibly be described as part of the profit-earning structure of Regent. But that does not mean that it necessarily follows that the lump sums paid under that contract are necessarily to be regarded as the expenses of carrying on the trade; it merely means that I do not think that the demarcation suggested by Lord Radcliffe in the Nchanga case is of assistance in the completely different circumstances of this case.
How, then, is this problem to be solved? My Lords, there is one matter upon which counsel on both sides are agreed. That it is the duty of the court to consider every relevant fact, giving it its due weight, and then to reach a conclusion upon the whole matter. I cannot but recall the observations of Lord Greene M.R. in I.R. Commrs. v. British Salmson Aero Engines Ltd., where he said:
- `There have been many cases which fall on the borderline. Indeed, in many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find reasons.'
Somewhat cynical but true. It is a question of fact and degree and above all judicial common sense in all the circumstances of the case and, while no one regrets it more than I, I do not believe it is possible to lay down any principle when dealing with trading contracts, which would be of any guidance alike to Crown and subject in future cases.''
My task is to decide whether the facts in this case fall on that side of the line which make the ``gain'' income or on the side that makes it capital.
In my opinion, notwithstanding Mr. Hill's valiant efforts the ``gain'' resulting from the redemptions was a ``gain'' in the nature of income. The decision whether to redeem or not was an exercise in judgment exercised by the appellant's officers. It was part of the ongoing business of producing revenue from the lending of money.
It was in the nature of that business that application for redemption would from time to time be received. They were contemplated in the prospectuses. It was part of the trade of the appellant and was sufficiently recurrent. Mr. Allchin's evidence clearly indicated that, although applications for the redemption of the kind and subject of this hearing, were not common before 1975, they did in fact occur and it was part of the company's business that they should occur. The company's concern to
ATC 4846maintain its goodwill ensured that they would very often be granted.
Maintenance of goodwill is an ongoing consideration with manifestations that are recurrent. The transactions were not merely a reduction of debt and as such was within and part of the ordinary course of the taxpayer's business. It met the interests of its lenders from time to time in this way. It was not a windfall gain. It was an incidental source of income and profit.
In making these findings I am not saying that some of the features associated with a capital gain were not present but to the extent that they were they were incidental to the production of income within ordinary usages and concepts. I have looked at the whole picture.
From a practical and a business point of view, the gain had the character of income which could be expected to arise from time to time from the difference between the price of its borrowed money and the price of the money it loaned out. The gains were incidental to that main object. In my opinion they are properly classified as revenue or income. They are similar in that respect to exchange rate gains that are regarded as incidental to the main purpose for which money has been borrowed when that purpose is the production of income.
Both appeals are dismissed. I order the appellant to pay the respondent's costs.