Federal Commissioner of Taxation v. Hurley Holdings (N.S.W.) Pty. Ltd.

Gummow J

Federal Court

Judgment date: Judgment handed down 25 September 1989.

Gummow J.

This matter comes before the Court under sec. 44 of the Administrative Appeals Tribunal Act 1975 (``the AAT Act'') as an appeal on questions of law from a decision of the Administrative Appeals Tribunal (``the Tribunal'') [reported as Case V146,
88 ATC 918].

The issue before the Tribunal was whether a portion of the gross proceeds of a bill of exchange purchased by the respondent (``the taxpayer'') and held until maturity was assessable income within the meaning of sec. 25 or (what was then) sec. 26(a) of the Income Tax Assessment Act 1936 (``the Act''). By notice of objection dated 21 February 1985, the taxpayer had objected to an assessment to income tax in respect of the year ended 30 June 1984, claiming that the assessment should be reduced by the sum of $57,800; this was described in the adjustment sheet which accompanied the relevant notice of assessment as ``profit on discounted bill included in assessable income...''. The objection was disallowed by the applicant (``the Commissioner'') on the ground that the full amount of $57,800 was assessable income of the taxpayer by dint of sec. 25, 26(a) or 26AAA of the Act. Before the Tribunal the taxpayer was successful. In a decision supported by reasons given on 8 September 1988, the Tribunal set aside the Commissioner's decision on the objection, and allowed the objection. Before the Tribunal the Commissioner relied on sec. 25 and 26(a), but not on sec. 26AAA. It is from this decision that the Commissioner brings the present proceedings in this Court.

Before the Tribunal, there was no real dispute as to the facts and the primary facts as found by the Tribunal were not called into question before the Court. Rather, the debate before the Court was as to the application to the facts of legal standards, that is to say those propounded in sec. 25 and 26(a) of the Act. The primary submission for the Commissioner was that the sum of $57,800 constituted income within the meaning of subsec. 25(1) of the Act. A lesser degree of reliance was placed by the Commissioner upon sec. 26(a), which his counsel described as affording a fall-back position.

Counsel for the taxpayer took the point that the Commissioner was appealing to this Court on questions of fact rather than on questions of law, so that the proceedings under the AAT Act were not competent.

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In my view, to maintain that the Tribunal erred in not holding that the sum in question constituted income of the taxpayer within the meaning of subsec. 25(1) of the Act, is to propound a question of law for the purposes of sec. 44 of the AAT Act:
TNT Skypak International (Aust.) Pty. Ltd. v. F.C. of T. 88 ATC 4279 at p. 4284;
F.C. of T. v. Markey 89 ATC 4600 at p. 4605.

In my view, the same is true of the submissions by the Commissioner concerning the application of sec. 26(a):
Statham v. F.C. of T. 89 ATC 4070 at p. 4074. On this branch of the case, the Commissioner raised the questions (i) whether the acquisition by a taxpayer of property for a consideration, with the intention and expectation that within approximately one year the taxpayer would realise on maturity or disposal of the property a sum of money in excess of the consideration given, comprised a profit-making undertaking or scheme within the meaning of subsec. 26(a), and (ii) whether on a proper construction of the second limb of sec. 26(a) of the Act, it is necessary for a taxpayer to have a dominent purpose of profit-making. However, as will become apparent, it will not be necessary to resolve these questions, because I decide the case in the Commissioner's favour, upon the first ground put by him.

I now turn to the relevant facts. The taxpayer's income tax return for the year ended 30 June 1984 disclosed its business or income-producing activity as that of ``partner in an hotel''. The taxpayer derived substantial income and after deduction of expenses and overheads, there was a profit before tax of $87,923. The taxpayer also disclosed in its return as a capital profit, $57,800.88, being a discount of a bill of exchange. It is that amount which, as I have indicated, is in dispute in these proceedings.

On 3 January 1983, the taxpayer purchased for $442,199.12 a bill of exchange with a face value of $500,000, a due date of 9 January 1984 and a ``yield rate'' of 13%. Bill Acceptance Corporation Limited (``Bill Acceptance'') was drawer and endorser of the bill, and the acceptor was Mortgage Management Limited. The bill was an accommodation bill within the meaning of the Bills of Exchange Act 1909, sec. 33, and not a trade bill. The character and incidence of accommodation bills are explained by Aickin J. in
K.D. Morris & Sons Pty. Ltd. (In liq.) v. Bank of Queensland Ltd. (1980) 146 C.L.R. 165 at pp. 198-199; see also
Handevel Pty. Ltd. v. Comptroller of Stamps (Vic.) 85 ATC 4706 at pp. 4714-4715; (1985) 157 C.L.R. 177 at pp. 194-195.

As is apparent from those authorities, for various purposes in the law the raising of funds by the discounting of accommodation bills is quite distinct from raising of funds by borrowing moneys. Further, the difference between the price at which the bill is purchased and the face value (the ``discount'') differs from interest in that the discount does not accrue from day to day:
Willingale v. International Commercial Bank Ltd. (1978) A.C. 834 at p. 841. In the present case, I did not understand the Commissioner to submit that whatever the surrounding circumstances, the discount in respect of an accommodation bill is ipso facto to be classified for the purposes of the Act in the same way as interest received upon a loan of money.

The taxpayer purchased the bill with the intention of holding it until maturity, rather than itself selling the bill in the interim. It held the accommodation bill until maturity and received the face value of the bill in January 1984. This was the only bill of exchange purchased by the taxpayer up to and including the tax year ended 30 June 1984. The taxpayer had in the past invested on the short-term money market.

Paragraph 7 of the Tribunal's reasons for decision is in the following terms [at p. 920]:

``7. The [taxpayer's] principal business over the years has been investments in the hotel industry. The director [Mr F.C.L. Hurley] who gave evidence before the Tribunal has, although clearly the controlling mind of the [taxpayer], retired from the hotel business and because of the sale of the various interests in the industry, the [taxpayer] had become highly liquid in funds. The director gave evidence that he intended that his two sons would take over the operations of the business in due course when they had completed their studies and in the meantime the [taxpayer] had determined to maintain its assets in a liquid form so as to be ready for the change in its operations when the sons assumed control of the [taxpayer]. None of this is very relevant

ATC 5036

to the issue before the Tribunal except to explain the obvious concern of the director that the [taxpayer] should maintain its assets in a liquid form, but in such a way that those assets would not decline in value because of the effects of inflation. Hence the [taxpayer's] decision to purchase the bill of exchange.''

In his evidence before the Tribunal, Mr Hurley said that he had approached Bill Acceptance after taking advice from his accountant. He told the officer of Bill Acceptance with whom he dealt that he wanted the taxpayer's moneys to be invested where they would be secure, with no risk and a reasonable return. Mr Hurley was advised by Bill Acceptance to achieve this result by the medium of a discounted bill. He understood the yield rate of 13% to be the return for his outlay and to represent the difference between the face value of the bill and the money invested in purchasing the bill. In seeking a safe and secure investment, Mr Hurley was prepared to accept a lower interest rate, appreciating that the higher the risk the higher the interest rate.

The Tribunal answered in the negative the question where the difference between the face value of the bill and the sum paid to purchase the bill was income in accordance with the ordinary concepts and usages of mankind, so as to attract sec. 25 of the Act.

In support of its conclusion, the Tribunal placed reliance upon
Lomax v. Peter Dixon & Sons Ltd. (1943) K.B. 671. The taxpayer in that case, an English manufacturer of newsprint, formed a Finnish company with a view to making better arrangements for the supply of wood pulp. The shareholders of the Finnish company were nominees of the taxpayer. The taxpayer made advances to the Finnish company of £319,600. To secure the position of the taxpayer, the Finnish company issued to it 680 notes of £500 each, with a combined face value of £340,000. The notes were issued at an effective discount of 6%. This was because the consideration given for the notes was lower by 6% than the amount receivable on maturity. Each note carried interest at a commercial rate and, if the profits of the Finnish company permitted it, each note was to be paid at a premium of 20%. The result was that the taxpayer, in addition to the principal, stood to receive three things, (i) interest at the specified rate, (ii) a sum on maturity representing the 6% discount, and (iii) the premium of 20%.

The agreement pursuant to which the notes were issued provided no assistance in determining the character of items (ii) and (iii), the discount and the premium. The Court of Appeal did not look merely to the terms of the contract; it had regard to factors which it assumed had been taken into account by the parties in fixing the terms of the loan. In particular, there was a threat of non-payment by the Finnish company if war broke out. The premium and the discount were seen as compensation for the risk of losing the capital or for the depreciation which the capital suffered by reason of that risk. Further, a reasonable rate of interest was provided for under the agreement. This strengthened the conclusion reached by the Court of Appeal that the premium and discount were capital.

This decision thus deals with a factual situation far removed from the present; the question of whether a receipt comes in as income must always depend for its answer upon a consideration of the whole of the circumstances:
The Squatting Investment Co. Ltd. v. F.C. of T. (1953) 86 C.L.R. 570 at p. 627, per Kitto J. However, whilst reliance was placed upon the Lomax case by the Tribunal to support its finding against the Commissioner, before this Court the Commissioner sought to draw support from certain observations made by Lord Greene M.R. in the course of his judgment.

His Lordship referred to the decision of the House of Lords in
Brown v. National Provident Institution (1921) 2 A.C. 222. The earlier case had raised the question whether certain taxpayers were liable to be assessed to income tax on certain transactions in respect of British Treasury Bills; the taxpayers had been assessed not in respect of profits and gains of a business, but in respect of profits or income derived from profits on discounts, within the meaning of Case 3 in Sch. D of the relevant British legislation. (Both categories were but species of the genus ``income''; see the speech of Viscount Haldane at p. 233.) The transactions in question consisted of the purchase of Treasury Bills which were documents issued by the British Government by which it undertook to pay on the expiration of a term fixed in the bill a certain sum of money in consideration of a smaller sum paid down at once. The bills

ATC 5037

therefore were issued at a discount. Some of the bills in question had been held until maturity, and others had been realised by sale. The taxpayers were assessed to income tax in respect of the amount by which the sums received at the maturity of the Bills were in excess of the price given for them by the taxpayers, and upon the profits made upon the sales of the bills before maturity. The House of Lords held that the whole of the difference between the amount paid for the bills, and the amount received on sale or maturity, was a profit on a discount within the meaning of the legislation.

It was in the course of discussing this decision that, in Lomax v. Peter Dixon & Son Ltd. (supra) at pp. 681-682, Lord Greene M.R. said:

``In the discounting of bills of exchange, Exchequer bills, etc., the discount is the reward, and, in the normal case (since such bills do not as a rule carry interest), the only reward, which the person discounting the bill obtains for his money. Lord Sumner pointed out in the
National Provident case ([1921] 1 A.C. 222 at p. 255) that in the case of a `discount' two economic elements are present, `one the value of the usufruct forgone, as measured by interim interest, and the other the risk that the money will never be repaid at all'. He says, further: `there is nothing to show that under this section profits or discounts have to be analysed into a return for the use of money by way of income and a possible accretion to capital'. If I may add my own gloss on this latter observation, if the bill of a solvent debtor is discounted at a low rate and the profit from the discount is regarded as interest, it seems logical to regard as interest also the profit from the discount where the bill of a debtor in poor credit is discounted at a high rate. In the former case, the capital risk is very small, or, perhaps, negligible and, in the case of a Treasury bill, to use Lord Sumner's words, reaches its vanishing point. In the latter case, the capital risk may, as Lord Sumner says, be the most important factor in the transaction, but it is nevertheless to be regarded as expressed in terms of interest, and, if the parties choose to express a capital risk in terms of interest, it must normally be so treated and no apportionment can be made.''

In Brown's case (supra) at p. 239 Viscount Cave had said:

``The value of a bill in the market may vary with the rise or fall of the value of money; but there is no real accretion to capital, for the amount secured by the bill remains unaltered.''

On the other hand, in his work Income Taxation in Australia at sec. 11.253, Professor Parsons makes the point that in a context such as that considered by their Lordships:

```Capital risk' includes the possibility of a fall in the purchasing power of the currency in which the loan was made. So far as the premium or discount does recoup a fall that has in fact occurred, it is in substance a return of the money lend and not a gain derived from the money lent. This recognition of a consequence of inflation is some concession by income tax law to a reality which has otherwise been steadfastly excluded from consideration in the judicial development of the law.''

The submission of counsel for the Commissioner was that the amount representing the discount had the character of recompense to the taxpayer for loss of the use of the moneys invested by the taxpayer during the currency of the term of the accommodation bill and thus was income according to the ordinary concepts and usages of mankind; cf.
Federal Wharf Co. Ltd. v. D.F.C. of T. (1930) 44 C.L.R. 24 at p. 28. The taxpayer purchased the bill, seeking to invest its funds with no risk and a reasonable return. The circumstance that the purchase of the bill was an isolated transaction would not, of itself, deprive the amount in question of the character of income:
F.C. of T. v. Myer Emporium Ltd. 87 ATC 4363 at p. 4,367; (1987) 163 C.L.R. 199 at p. 211. I accept these submissions.

I should add that no attempt was made by the taxpayer (and it may have been quite impracticable to make the attempt) to sever the amount in question so as to deny to a portion of it the character of income, and attribute to that portion the character of a receipt to cover ``capital risk'' (cf. Parsons (supra) at sec. 2.283, sec. 2.284). So no question arises as to whether in law such an attempt would have been successful for the taxpayer, given the remarks of Lord Sumner and Lord Cave (albeit

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directed to other legislation) to which I have referred.

Rather, the Tribunal in holding for the taxpayer said that ``all that happened was that the bill realised more than it cost''. Counsel for the taxpayer put the point to the Court by submitting that what was involved here was recognition of the value of money over time and the risk of dishonour. But that is an incomplete and inadequate description of the circumstances. The taxpayer was seeking a reasonable return upon an investment, albeit a secure one. That return is represented by the amount representing the difference between the face value and the purchase price of the bill. It was also said in the Tribunal that ``[t]here was no fruit from the tree - the tree just grew a bit bigger''. But if one is yet again to use metaphor as the means of conveying the meaning of legal concepts (a practice in which the Tribunal is in august company), the point is that the ``tree'' is the cost of the bill and the fruit the discount between that cost and the face value, received at the end of the term of the bill.

Accordingly, I would allow the appeal on the ground that the amount of $57,800 is assessable income of the taxpayer under sec. 25 of the Act. It is unnecessary to consider the further submissions as to sec. 26(a).

The decision of the Tribunal given 8 September 1988 will be set aside. The disallowance by the Commissioner of the taxpayer's objection dated 21 February 1985 will be affirmed. The taxpayer will pay the costs of the Commissioner.

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