Federal Commissioner of Taxation v. Carberry

Davies J

Federal Court

Judgment date: Judgment handed down 14 November 1988.

Davies J.

These are appeals from a decision of the Administrative Appeals Tribunal constituted by Senior Member P.M. Roach delivered on 15 January 1988 [reported as Case V30,
88 ATC 276, which upheld objections lodged by the respondents, Mr and Mrs Carberry, against assessments of income tax for the years 30 June 1983 and 30 June 1984.

The appeals are brought under sec. 44 of the Administrative Appeals Tribunal Act 1975 (Cth) which provides that a party to a proceeding before the Tribunal may appeal to the Federal Court of Australia on a question of law from any decision of the Tribunal in that proceeding.

It has been pointed out in
F.C. of T. v. Brixius 87 ATC 4963 and in
F.C. of T. v. Total Holdings (Australia) Pty. Ltd. (1980) 43 F.L.R. 217, that many decisions under sec. 51(1) of the Income Tax Assessment Act 1936 (Cth), the relevant provision in this case, are decisions of fact or mainly of fact.

Even so, it may be demonstrated that an error of law appears from the reasoning of the Tribunal or that the Tribunal breached rules of natural justice in the conduct of its proceedings or that it took into account some immaterial consideration or that it failed to give attention to a material consideration or that its decision was so unreasonable having regard to the facts before it that no reasonable tribunal could have come to such a conclusion. See e.g.
Edwards (Inspector of Taxes) v. Bairstow & Another (1956) A.C. 14.

All those grounds, which are grounds of judicial review provided by the Administrative Decisions (Judicial Review) Act 1977 (Cth) provide, in my view, grounds of law which may be encompassed in an appeal under sec. 44 of the Administrative Appeals Tribunal Act. I approach the matter on that basis.

Section 51(1) of the Income Tax Assessment Actreads:

``51(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.''

It has been established that, when the deduction of interest under that provision is under consideration, what is relevant is the purpose for which the money was borrowed or applied, that is to say, was that purpose directed to the earning of assessable income or was it directed to some other purpose?

Ure v. F.C. of T. 81 ATC 4100, Brennan J. said at p. 4104:

``Section 51 requires that a deductible expenditure be incurred `in' gaining assessable income, that is to say, it must be incidental and relevant to the gaining of that income
Ronpibon Tin N.L. & Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at p. 56). An outgoing of interest may be incidental and relevant to the gaining of assessable income where the borrowed money is laid out for the purpose of gaining that income
F.C. of T. v. Munro (1926) 38 C.L.R. 153 at pp. 170, 171, 197:
Texas Co. (Australasia) Ltd. v. F.C. of T. (1940) 63 C.L.R. 382 at p. 468). The laying out of the borrowed money for the purpose of gaining assessable income furnishes the required connection between the interest paid upon it by the taxpayer and the income derived by him from its use.


The purposes for which money is laid out is an issue of fact, turning upon the objective circumstances which human experience would judge to be relevant to the issue (cf.
Magna Alloys and Research Pty. Ltd. v. F.C. of T. 80 ATC 4542 at p. 4549).''

At p. 4109, Deane and Sheppard JJ. said:

``The question whether an outgoing should properly be seen as being wholly or in part `incidental and relevant' to the `end' of gaining or producing the assessable income and the question whether the outgoing is wholly or in part of a private or domestic nature are both questions of characterization. Where liability to make the outgoing has been voluntarily incurred, those questions of characterization will ordinarily be determined by reference to `the object' which the taxpayer had in view (Latham C.J.,
W. Nevill & Co. Limited v. F.C. of T. (1937) 56 C.L.R. 290 at p. 301),

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the `result aimed at' by the taxpayer (per McTiernan J., ibid. at p. 308) or `the advantage which the expenditure was intended to gain, directly or indirectly, for the taxpayer' (per Gibbs J.,
F.C. of T. v. South Australian Battery Makers Pty. Ltd. 78 ATC 4412 at p. 4420; (1978) 140 C.L.R. 645 at p. 660) in the context of the relevant facts and circumstances. In the ordinary case where the income which is expected to flow from an outgoing offers an obvious commercial explanation for incurring it the relevant characterization can readily be determined by reference to the gaining or producing of that income. In the more complex case however, where there is no such obvious commercial explanation, the solution of the problem of characterization must be derived from a weighing of the many aspects of the whole set of circumstances including direct and indirect objects and advantages which the taxpayer sought in making the outgoing. Some of those circumstances may point in one direction, some in the other. In such a case, as was said by the Privy Council in
B.P. Australia Limited v. F.C. of T. (1965) 112 C.L.R. 386 at p. 397) in relation to the question whether a particular outgoing was of income or capital according to ordinary concepts, it is `a common sense appreciation of all the guiding features which must provide the ultimate answer'.''

See also
F.C. of T. v. IIbery 81 ATC 4661, and
F.C. of T. v. Janmor Nominees Pty. Limited 87 ATC 4813.

In so far as apportionment is required, the principles to be applied are those which were laid down in Ronpibon Tin N.L. & Tongkah Compound N.L. v. F.C. of T. (1949) 78 C.L.R. 47 at p. 56 and Ure v. F.C. of T., cited above. See also the principles enunciated in Magna Alloys & Research Pty. Ltd. v. F.C. of T. 80 ATC 4542.

The brief facts of the present matter are that Mr and Mrs Carberry are husband and wife. Mr Carberry was employed but Mrs Carberry was not. They saw an opportunity to increase their earnings by purchasing a property which came on the market, the property having both a private home on it and a child-minding centre or kindergarten.

It was anticipated by them that, if they purchased that property, they would run a kindergarten in partnership, with Mrs Carberry managing the kindergarten. With that in mind, Mr and Mrs Carberry sold their then existing residence for a price which netted them $80,000. The new property was purchased for $120,000 plus an additional $20,000 for goodwill, plant and equipment. There were some other expenses such as the purchase of a motor vehicle. The real estate was purchased in their joint names.

To assist with the purchase of the new property and with the purchase of the additional equipment required, Mr and Mrs Carberry borrowed the sum of $68,000.

Partnership accounts drawn up for the year ended 30 June 1983 which were attached to the partnership return for that year show as follows:

                                                ``$          $          $
Partners Capital                                                   10,300
Represented by:
Land & buildings - as cost                               3,413     48,195
Furniture, toys & equipment                              1,172      2,241
Less: provision for depreciation
Motor vehicle & trailer                                 14,150
Less: provision for depreciation                         5,671      8,479
Cash at bank                                                        1,993
Goodwill - at cost                                                 20,000
Less: Liabilities
Mortgage - State Government Employees Credit

               Union      65,608

Loan - motor vehicle                                     6,960
Less: prepaid interest                        1,960      5,000     70,608
                                             ------     ------    -------

There was evidence given by Mr Carberry, which is referred to in para. 7 of the Tribunal's reasons for decision, that the outlay on the purchase of the real estate and the goodwill, furniture and fittings should be apportioned: as to residence $70,000, nursery premises $50,000 and nursery goodwill $20,000.

That evidence in conjunction with the partnership accounts would suggest that the partners treated the partnership as owning the kindergarten and the assets related thereto and that they had borrowed in respect of the partnership and in respect of those assets the sum of $68,000 plus the motor vehicle loan of $5000.

The partners' capital of $10,300 would then seem to represent the difference between the $80,000 which Mr and Mrs Carberry gained from their previous home and the cost attributable to the purchase of the new residence, which Mr Carberry put at $70,000.

The issue arises with respect to the interest payable by Mr and Mrs Carberry to the State Government Employees Credit Union on the borrowing of $68,000, a borrowing which was secured upon the total real estate.

As the Tribunal pointed out, the security is not significant. What has to be examined is the purpose for which the moneys were borrowed and the use to which those borrowed moneys were put. Mr and Mrs Carberry took the view that the moneys were borrowed for the purpose of the new partnership business and solely for that purpose.

The Tribunal made the comment that ``as they saw it `the business' and only `the business' occasioned the cost of borrowing''. The Commissioner, on the other hand, took the view that the borrowing was used to purchase the totality of the property comprising the land, the home and the kindergarten. He considered that, as the moneys had been borrowed to enable Mr and Mrs Carberry to purchase that particular property and as the moneys borrowed had been applied for that purpose, the interest on the moneys borrowed must be apportioned as between the two purposes. The purchase of the home was a private purpose whereas the purchase of the kindergarten was made for the purpose of earning assessable income.

In examining this matter it is, I think, of some use to go back to the case of
Chapman v. F.C. of T. (1968) 117 C.L.R. 167, which has another topical relevance in that Mr P.M. Roach was junior counsel for the Commissioner of Taxation, and it was an appeal from a decision of a Board of Review of which Mr J.D. Davies was then a member.

There the issue arose under sec. 26(a) of the Income Tax Assessment Act. One large parcel of land had been acquired and the question was whether part of that property could be regarded as having been purchased for use as home and hobby farm and whether part could be regarded as having been purchased for the purpose of resale at a profit.

The Board of Review had come to the view that a notional apportionment of the land could be made and Menzies J., on the appeal to the High Court, upheld that view. At pp. 170-171, his Honour said:

``Looked at by itself, the land other than the seventeen acres was acquired for the purpose of sale at a profit. The problem which has troubled me is whether this can be done, and whether it is possible to treat what was one acquisition, as having been made with one purpose as to part, and another purpose as to the remainder. I have reached the conclusion that it is, and that to do so, is in accordance with common experience.''

I mention that case because it is an example, and no more than an example, of a circumstance where the acquisition of one parcel of land in one title could be regarded as having, as to part of the land, one purpose and, as to another part of the land, another purpose. His Honour pointed out (at p. 171):

``There is no doubt, however, that where the purchase is of an entirety it often

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happens that the purchaser in making the purchase has the purpose of breaking up the entirety and of using part in one way and part in another. The simplest instance of this no doubt is the sort of purchase which I am now considering. In such a case it is in vain I think to search for a dominant purpose for the purchase. There are in truth two purposes, and it cannot be said that one is dominant and the other servient.''

In the present case, evidence before the Tribunal would have entitled the Tribunal to come to the conclusion that Mr and Mrs Carberry purchased this one property with two distinct ends in mind, that they purchased the property to use the house as their private residence and solely as a private residence, and the kindergarten - the kindergarten being a separate building - for income earning.

That is the way the accounts treated the matter. Mr and Mrs Carberry in their accounts treated the partnership, and there undoubtedly was a partnership between them, as owning the kindergarten and as having borrowed the totality of the $68,000 for the purposes of the partnership. They treated the remainder of the property as being privately owned and fully paid for from the moneys that they had received from the sale of their private home. It was for that reason that only $10,000 came into the partnership by way of capital and that the only part of the land which is shown in the partnership accounts was the kindergarten shown as acquired at a cost of $48,195.

Those being the facts, the Tribunal in a careful decision came to the conclusion that it was the partnership which had borrowed the $68,000, that that sum was a partnership borrowing and that the interest payable thereon was an obligation of the partnership and ought to be treated as such. The Tribunal took the view, therefore, that the interest was fully deductible as the sum borrowed had been applied by the partnership solely for the purpose of earning the assessable income of the partnership and for no other purpose.

The Tribunal went on to say that, whether or not the matter was looked at strictly on a partnership basis, that was nevertheless the way the parties had regarded their affairs. The Tribunal said [at 88 ATC p. 281]:

``... that analysis of legal relationships accords with the understandable expectations of the parties. They had previously substantially owned a home. They transferred to another home of less appeal and value. If it could have been purchased separately it would have cost less than the equity they had in the previous property. In effecting the change they did, they were seeking to improve their financial situation.''

Thus, the Tribunal made a finding that the partnership suffered the entire burden of the interest and even if that were not correct as a matter of partnership law, nevertheless, the outgoing should be treated under sec. 51(1) of the Income Tax Assessment Act as being fairly and properly attributable to the gaining of assessable income.

It does not seem to me that there was any error of law in the Tribunal's approach. As to the facts of the matter, there was material before the Tribunal which justified its findings of fact. And the Tribunal's decision was not unreasonable.

Indeed, in my opinion, the Commissioner's view could be upheld only if the partnership had acquired the whole of the land and had applied part of that land for the private use of Mr and Mrs Carberry. There was no reason why Mr and Mrs Carberry should not have entered into a partnership and arranged their affairs in that manner. If they had done that, then the Commissioner's assessment would have been correct, for part of the interest would then have been applied for a private purpose.

However, the facts that were before the Tribunal do not suggest that the whole of the property was a partnership asset.

Indeed, the Tribunal suggested in one passage of the reasons for decision, in para. 20 thereof, that none of the land was a partnership asset; but that does not appear to accord with the partnership accounts that I mentioned, and the particular finding does not seem to vitiate the conclusions of the Tribunal.

In the result, therefore, I find that there was no error of law in the Tribunal's decision.

A ground of appeal was raised at the hearing that the Tribunal came to its conclusion by reference to a question of partnership law which had not been referred to in argument. This ground arose from a reference in para. 18 of the Tribunal's reasons to the fact that, in

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argument, it was not put ``that the borrowings of money, and the payments of interest flowing in consequence of them, were related to the partnership''.

It is a little difficult to assess the significance of this statement, there being no transcript of the proceedings before the Tribunal, no doubt because of a quota being applied to the reporting of its proceedings. However, that particular statement was made in relation to Mr and Mrs Carberry who, the Tribunal said, were ``unrepresented taxpayers''. Whatever were the precise arguments put, the Commissioner's representative was a person who ought to have been versed in partnership law and in taxation law. It cannot be suggested that he could have been taken by surprise by the Tribunal's consideration of the partnership or by a question as to whether the borrowing of the money was related to the partnership. That was the issue with which he had to deal. It was central to the question to which he had to turn his attention.

It seems to me that the passage to which this ground of appeal directs its attention is simply illustrative of the care that was taken by the Tribunal in its consideration of the matter before it. The Tribunal properly did not restrict its consideration solely to the matters put forward by Mr and Mrs Carberry. A tribunal which has before it unrepresented applicants must often give its own consideration to and take into account matters that were not drawn to its attention by the applicants themselves.

It could not have been a matter for surprise that Mr and Mrs Carberry were claiming that they had a partnership and that the borrowing was made by that partnership solely for its own purposes. That was precisely how the accounts had been drawn up, how the partnership returns had been presented and the basis upon which the objections were lodged.

It follows, in my view, that the appeals should be dismissed with costs.

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