Hill J

Federal Court

Judgment date: Judgment handed down 26 June 1991

Hill J

Kidston Goldmines Limited, the applicant, appeals to this Court against the decision of the respondent Commissioner of Taxation disallowing objections of the applicant in respect of income tax assessed for the periods 1 January 1985 to 31 December 1985 and 1 January 1986 to 31 December 1986, these being substituted accounting periods for the years of income ending 30 June 1986 and 1987 respectively.

Two matters are in issue. The first is whether certain income from short term investments derived by the applicant is exempt from income tax pursuant to the provisions of s. 23(o) of the Income Tax Assessment Act 1936 (Cth) (``the Act''). The second, which arises only if the first issue is answered adversely to the applicant, is whether the applicant is entitled to a deduction of a part of the interest outgoings which it incurred for monies borrowed by it.

The facts are not in dispute. In March 1978, the applicant acquired an option over a mining property for the mining of gold at Kidston, which is near Cairns in Queensland. The capital

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cost to the applicant of establishing a mine on the site was approximately $139,000,000. Financing was initially by way of $25,000,000 capital subscribed by Elders IXL Limited for a 20% interest in the applicant, an interim loan of $25,000,000 from Westpac Banking Corporation (``Westpac'') and an interim loan of USD25,000,000 provided by Chase Manhattan Bank N.A. (``Chase''). Subsequently, the applicant entered into an arrangement with Chase for a credit facility of USD115,000,000 in September 1984. The amount of the facility was later reduced at the request of the applicant to USD100,000,000. Amounts borrowed under the facility attracted interest, as would be expected. Draw-downs on the facility were available to be made until a date referred to in the facility as the ``Project Completion Date''. That date ultimately became 31 July 1985. The Chase facility was obviously entered into by both parties to finance the development of the mine, including the repayment of the temporary facilities to which I have already referred.

The interim financing was repaid from the Chase 1984 facility. Thereafter, three draw-downs were made on the Chase facility in 1985 of: USD5,000,000, USD8,000,000 and USD30,640,000. The last-mentioned draw-down was used to repay an earlier gold borrowing from Chase under and in accordance with the terms of the credit facility. A part of the gold borrowing represented interest.

Under the terms of the credit facility amounts borrowed could only be repaid in either April or October of each year.

On 1 March 1985, the mine commenced commercial production producing gold and a relatively small amount of silver in monetary terms. Nothing turns upon the silver in question. In the 1985 calendar year gold produced at the mine was sold for a total of $97,090,774; in 1986, gold sales were $130,972,450.

In addition to the Chase facility, the applicant had short term borrowing facilities from Westpac, Barclays Australia Limited (``Barclays''), Elders Finance & Investment Company Limited (``Elders''), CIBC Australia Limited (``CIBC''), Capel Court Corporation Limited (``Capel Court'') and Placer Industries Limited, a related company. The short term borrowings were for working capital for use in the business of the applicant, to fund the operation of the mine, to pay interest and principal on the loans and to fund dividend payments. In 1985, total drawings under the short term borrowings were $16,199,038; in 1986, $55,561,650. Interest incurred by the applicant in the two years of income on the Chase facility and the short term facilities was as follows:

    1986 year of income:

  •          Payee               Interest Amount
          Chase Manhattan         5,515,972
          Westpac                    19,979
          Barclays                    1,346
          Elders                     16,961
          CIBC                          553
          Capel Court                29,122

    1987 year of income:

  •          Payee              Interest Amount
          Chase Manhattan         5,466,631
          Westpac                    34,757
          Elders                     63,999
          Placer Industries           1,644
          Capel Court               199,224
          Citibank                  185,450

In addition, in the 1987 year of income there were some small amounts claimed as interest being the interest component of a forward sale of gold, ``interest'' on a forward rate agreement and for interest on short shipments of gold. These miscellaneous amounts total $11,358.

The cash balances in the business of the applicant fluctuated considerably between gold sales, gold being shipped when a large enough quantity had accumulated to make a sale economical, and having regard to the fact that repayments of the Chase facility could only be made in April and October in each year. In the result, there were times when the applicant had surplus cash, being the proceeds of gold sales. Prudently, the applicant invested this cash in short term deposits on the money market in 1985 and 1986 to earn interest. The funds would, as the occasion required, be recalled for use in the applicant's business. In so doing, it had regard to its policy to maximise the dividends that it could declare and pay. Its policy to this effect, namely that during the period in which the applicant had outstanding borrowings approximately 50% of any surplus

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funds available after meeting debt service, working capital and other obligations would be paid as dividends with the balance used for the repayment of borrowings, was the subject of public announcement in a prospectus issued on 17 July 1984. This policy was given effect to in quarterly dividend payments. The applicant also sought to repay the Chase facility as quickly as possible. In fact it was repaid 18 months before the end of the five year term of the loan.

In the result, the applicant earned interest income in the 1986 year of $652,773 and in the 1987 year of $390,214. Of the income earned in the 1986 year of income, $30,333 was earned by the investment of a part of the Chase facility drawn down prior to the funds being required to be expended.

The Commissioner, in the assessments complained of, treated the interest income as not exempt from tax pursuant to s. 23(o) of the Act. He also disallowed any part of the interest incurred as an allowable deduction under s. 51(1) of the Act, treating the whole of that amount as having been incurred in gaining or producing the exempt income directly from gold sales. These assessments were objected to, and the objections being disallowed, the applicant appealed to this Court against the objection decisions.

Section 23(o) of the Act at the relevant time (it has now been made subject to Division 16H, with the consequence that s. 23(o) does not apply to income derived after 31 December 1990, unless the income derived consists of a dividend to which sub-section 23C(2) of the Act applies) provided:

``23 The following income shall be exempt from income tax: -

  • ...
  • (o)... income, other than income from the production, treatment or sale of pyrites, derived from the working of a mining property in Australia, where the working of the mining property by the taxpayer for the period from the commencement by him of mining operations on that property to the end of the year of income has been principally for the purpose of obtaining gold, or gold and copper...''

Counsel for the applicant commenced his submissions with the admonition that s. 23(o) was an exemption provision and should be given a benevolent construction; cf
FC of T v Reynolds Australia Alumina Ltd & Ors 87 ATC 5018; (1987) 18 FCR 29, per Beaumont J at ATC 5022; FCR 35, and per Burchett J at ATC 5031; FCR 46. This can be accepted. Since the 1922 Commonwealth income tax legislation, and until the exemption was effectively repealed in 1990, Parliament has legislated to exempt income derived from the working of mining properties for the purpose of obtaining gold. Clearly the Parliamentary intention was to encourage gold mining, which has had a special place in Australia's history, and this purpose must be given effect to. However, to accept this proposition is not to say that the Court should give to the words used by Parliament a meaning which they do not bear. The ambit of the exemption intended by Parliament is to be found within the very words which Parliament has used. It is to these words that we should turn.

The first thing that is apparent from the terms of the exemption is that it does not exempt the income of a taxpayer who conducts a gold mining operation. The exemption is framed in terms rather narrower than that. It is limited to so much of the income from such operations as falls within the words: ``income from the working of a mining property''. These words are, as counsel for the applicant pointed out, elliptical. The mere working of a mining property does not, of itself, produce income. That income will ordinarily be derived from the sale of the proceeds of the mine produce resulting from the working of the mining property. However, it does not follow, as the applicant submits, that the sub-section should be read as if it exempted all income derived from the business of working a mining property.

It is clear that the applicant carried on one business, and one only, that is to say a business of gold mining. Its activity of putting out money on the short term money market were an adjunct to this gold mining business, and not of themselves a separate business activity; cf
Stuart v Diplock (1889) 43 Ch D 343;
A Lewis & Co (Westminster) Ltd v Bell Property Trust Ltd [1940] 1 Ch 345, and cf also
FC of T v Marshall & Brougham Pty Ltd 87 ATC 4522; (1987) 17 FCR 541. Although this was not

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conceded by the Commissioner, no real argument was put to the contrary. But the interest income which the applicant derived could not fairly be said to have been derived by it from the working of its mining property. Rather, that income arose from the turning to account of the income which directly arose from the mining property, namely the proceeds of gold sales.

The applicant relied upon the judgment of McClemens J in
Freeman v C of T (N.S.W.) (1954) 11 ATD 21. The issue which arose in that case was whether certain income from a company, Bulolo Gold Dredging Limited, out of which the taxpayer was paid dividends, was income wholly and exclusively derived from the working of a gold mining property in New Guinea. There were several categories of income. One was the sale of power said to be surplus to the needs of the mine, another a payment by an adjoining mine owner for the right to work part of Bulolo's mining tenements, which could more conveniently and profitably be worked by the adjoining owner, another category was ``discounts'', presumably rebates, on purchases of food and drink for employees, yet another was a commission received from Guinea Airways in purchasing aeroplane stores and spare parts in America.

The Court found that Bulolo was carrying on only one business, that the amounts of income in dispute were relatively small (one 2,500th part of the value of the bullion won) and that the power sales were accidental and incidental to the gold mining activity. In these circumstances, his Honour found the whole of the income from the various activities was income from the working of the mining properties. No appeal as of right was available to the High Court, having regard to the sums involved, treating each income year separately. The High Court refused special leave to appeal (reported at (1956) 11 ATD 38). While a decision of the High Court refusing leave to appeal does not stand in the same position by way of authority as a decision of that Court on appeal, what was said by their Honours is of course to be treated with great respect.

Their Honours described the view of McClemens J as being a ``broad one'', ``which may not have been justified upon the evidence''. The relative smallness of the amounts was not regarded by their Honours as of great significance. Their Honours then said (at 40-41):

``But it does not follow from the designation assigned to the items of sundry income in dispute that this conclusion is, by any means, impossible. It is essentially a question of fact... It may well be that, if the facts were fully investigated, the conclusion might be reached that the production of surplus power was simply an incident in the generation of electrical power for the purposes of the company's mining operations and if this was so we see no reason why income which it earned, merely as an incident of an activity directly undertaken for the working of its mining property, should not be regarded as income from the working of the mining property itself. However, it may be, as we have indicated, that the paucity of the evidence is insufficient to enable a positive conclusion, one way or the other, to be reached. Much of the same kind of observations may be made concerning the payments received from Sunshine gold Development Limited and, indeed, concerning the items of sundry income received by the company in the two income years following...''

Prior to Freeman, the High Court had had cause to consider the operation of s. 23(o) in
Parker v FC of T (1953) 10 ATD 287; (1953) 90 CLR 489, a decision which does not seem to have been referred to in Freeman. In Parker the taxpayer, who carried on gold mining operations, operated on the mining lease a crushing plant with which he crushed the small amount of ore won in his own operations. The taxpayer purchased gold tailings (the residue after crushing) from other miners, collected them in dumps on the surface of his machinery area and treated them with cyanide to extract residual gold from them. He performed the same operation with respect to his own gold tailings and the Commissioner conceded in respect of the treatment of these tailings that he was in so doing working the mining property.

The High Court held unanimously that the income derived by the taxpayer from treating the gold tailings of others so as to extract residual gold from them was not exempt under s. 23(o). Dixon CJ, with whose judgment Webb J agreed, after pointing out that the word ``working'' described the working of the

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mining property itself, rather than the treatment of residues brought upon it, said (at ATD 291; CLR 494):

``... the expression `mining operations' is not the same as `the working of a mining property'. The former is plainly wider and the latter is directed to a different point. Mining operations means operations pertaining to mining and operations is a very large expression. The phrase `the working of a mining property' looks to the exploitation of a mining lease or other form of interest in the soil.''

Taylor J, in the same case, with whose judgment Webb J also agreed, said (at ATD 293; CLR 498):

``The expression `the working of a mining property... for the purpose of obtaining gold', it seems to me, denotes the exploitation of the soil for the purpose of the recovery of gold. This is not equivalent to the operation of a plant established for the treatment of tailings brought from mining properties, though, of course, that operation might well constitute, in appropriate circumstances, one incident in the working of a mining property.''

Neither case is inconsistent with the other. Both show that the question will be one of fact and degree. The income exempt from tax under s. 23(o) will not, in an appropriate case, be limited to the sale of gold. It might extend to profits on gold future contracts provided that they correspond to estimated production and there is a subsequent sale of gold in the physical market cf Taxation Ruling IT 2085 (13 June 1984). It might extend to a profit made on the sale of plant used directly on the mining property to work the mine. It might, in an appropriate case, as the High Court suggests in Freeman, extend to the sale of power surplus to the requirements of the mine, where the power is generated in the course of mining the property. But the income to be exempt must be proximate to the exploitation of the mining lease, so that it can be said that the activity is an incident of the working of that mining property.

Although it can be said here that the investment on the short term money market is an incident of the taxpayer's gold mining business, and represents the investment of monies derived from gold sales, it is not sufficiently proximate from the activities which more directly generate that income and which are properly to be described as the working of the mining property. A similar conclusion was reached by a Deputy President of the Administrative Appeals Tribunal, Dr Gerber in Case Y5
91 ATC 120, on facts not greatly dissimilar to the present. With respect, although agreeing with the conclusion which the learned Deputy President reached, I think that in saying that the income must be derived ``directly'' from the exploitation of the lease, the learned Deputy President expressed the test perhaps too favourably in favour of the Commissioner. I would prefer to say that there must be found a sufficiently proximate relationship between the income and the exploitation of the mining property such that it can fairly be said that the income is an incident of the working of the mining property. If that relationship exists the income will be exempt from tax under s. 23(o).

There remains to be noted an alternative submission put by the applicant based, at least in part, upon the legislative history of s. 23(o). Section 23(o) took its present form, for relevant purposes, as a result of the 1936 Act. Prior to that time, the exemption in the 1922-31 Act (s. 14(1a)) exempted:

``the income derived by a person from the working of a mining property in Australia or in the Territory of New Guinea principally for the purpose of obtaining gold...''

(emphasis added)

The deletion of the words ``by a person'' were said to be significant in that after the 1936 Act the legislation was concerned not to see whether a person had derived the requisite kind of income but whether the particular income itself was derived from the stated source. The word ``derived'' was said to be coextensive with the word ``source''; cf
Commissioner of Inland Revenue v NV Phillips' Gloeilampenfabrieken [1955] NZLR 868 and
Kemp v Minister of National Revenue (1948) 1 DLR 65. It was submitted that the income exempted from taxation under s. 23(o) should therefore be seen as being the income which had its source (quaere whether ultimate source) in the actual exploitation of the mining property.

With respect to this argument, it is hard to see the significance of the deletion of the word

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``person'' which appeared in the 1922 legislation in contradistinction to ``resident of any Territory'' or ``bona fide prospector'' which appeared in the paragraphs which immediately preceded and followed it. To substitute the word ``source'' for the word ``derived'' is unhelpful in my opinion. What has to be considered under s. 23(o) is the income which accrues or arises (ie is derived) from the exploitation of the mining property. That derivation must be by a taxpayer. I can see no significant difference between the form of the legislation before the 1936 Act and the present section which would suggest that in 1936 some significant difference was made to the legislation by the omission of the word ``person''.

The allowability of a portion of the interest deduction

The applicant's claim for a deduction for a portion of the interest which it had incurred both under the Chase facility and the other facilities for working capital was based upon s. 51(1) of the Act. Relevantly that sub-section allows a deduction for:

``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... except to the extent to which they are... incurred in relation to the gaining or production of exempt income.''

It will be noted that both in regard to the positive limbs of s. 51 and to the exclusionary limb, apportionment of deductions is contemplated. The task under the positive limbs has been described by the Full High Court in
Ronpibon Tin NL v FC of T (1949) 8 ATD 431 at 436; (1949) 78 CLR 47 at 58 as involving the enquiry:

``how far was it [ie the expenditure] incurred in the course of, how far was it incidental and relevant to, gaining or producing the assessable income.''

The question under the exclusionary limb asks in essence the same question relating to the production of exempt income.

In Ronpibon Tin the High Court distinguished between two kinds of outgoing which are apportionable. First, there are those which consist of (at ATD 437; CLR 59):

``undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause.''

Then there are outgoings which involve:

``a single outlay or charge which serves both objects indifferently.''

As a matter of logic there are two other kinds of outgoings which are not apportionable: those which consist of expenditure devoted exclusively to the gaining or producing of assessable income and those which consist of expenditure devoted exclusively to the gaining or producing of exempt income.

For the applicant it was submitted that apart from the interest outlay on the Chase facility which was made before construction of the mine commenced and where the proceeds of the borrowing were placed for a short time on the short term money market and produced assessable income of $30,333 (the deductibility of which was not in dispute), the whole of the interest outlays came within the second category referred to in Ronpibon Tin so that a ``fair and reasonable assessment of the extent of the relation of the outlay to assessable income'' should, in accordance with the principles espoused in that case, be made. If this submission were accepted, there was no dispute between the parties as to how this apportionment should be made. Both accepted that the apportionment should follow the formula advanced by the Commissioner in
Adelaide Racing Club Inc v FC of T (1964) 13 ATD 361; (1964) 114 CLR 517 and found by the High Court not to be shown to be wrong on the facts of that case, namely to take a slice of the interest deduction corresponding to the ratio which assessable income bears to total assessable and exempt income.

For the Commissioner, however, it was submitted that the case fell within the exceptions to apportionment, that is to say that there were here a series of single outlays devoted wholly to the production of exempt income. The Commissioner's submissions focused upon the Chase facility, rather than the other short term facilities, no doubt because this was the easier case. It was said (apart from

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the monies advanced before construction of the mine) that the whole of the monies borrowed were used to construct the mine, and so should be seen as being devoted to the gaining or production of income from the working of the mining property. That was not as obvious with regards to the other facilities, all of which were, so far as material, to provide working capital.

I have no doubt that if a taxpayer borrows for the purpose of working capital and that capital is used in his business which produces both assessable income and exempt income, that the case is one where the interest on the borrowing serves each purpose indifferently, so that the case is one for apportionment. However, that does not dispose of the Chase borrowing.

Counsel for the Commissioner referred to the well-known decision of the High Court in
FC of T v Munro (1926) 38 CLR 153. That case concerned the borrowing by a taxpayer on the security of a rent-producing property where the purpose of the borrowing was the use of the funds for a non-income producing purpose. It was held that the interest on the borrowing was not deductible. The Court focused on the purpose of the borrowing, rather than the security upon which the borrowed funds were taken.

In most cases, the purpose of the borrowing will be ascertained from the use to which the borrowed funds were put; in Munro a non-income producing use. Where the funds are employed in a business devoted to assessable income, it may be said that monies borrowed to secure capital or working capital will be clearly deductible:
The Texas Company (Australasia) Ltd v FC of T (1940) 5 ATD 298 at 355-356; (1939-1940) 63 CLR 382 at 468 per Dixon J. If the business is devoted to the gaining of both assessable income and exempt income, some part of the interest outgoing will be deductible and it will be necessary to carry out a fair and reasonable apportionment of the interest outgoing.

The apparent logic of the Commissioner's submission lies in the fact that virtually all the monies borrowed under the Chase facility found their way into the acquisition (by way of refinancing or construction) of its mine. The funds borrowed could not be traced into the monies invested on the short term money market; the Chase facility was not repaid and new funds borrowed to finance the short term investments.

In determining deductibility under s. 51(1), reliance on the tests both of purpose of the borrowing and of application of the funds present difficulty. If the true test were confined to purpose of the borrowing, a taxpayer who borrowed funds for an income producing purpose would continue to receive a deduction, notwithstanding that the income producing activity had ceased. Such was shown not to represent the law in
FC of T v Riverside Road Pty Ltd (in liq) 90 ATC 4567; (1990) 23 FCR 305. Conversely, if funds were borrowed for a non-income producing purpose, eg to purchase a home in which the taxpayer resides and later the home was let, no deduction would be available to the taxpayer for the interest payable which is a direct cost of the income producing activity of letting the house. A test of application of funds borrowed also presents difficulties. Where funds are borrowed with the intention that they be used to purchase, for example, a property for letting, and the proceeds of the borrowing are paid into a bank account from which funds are drawn both for the purchase and to satisfy non-income producing outlays, a tracing of funds approach would require an apportionment of interest, yet it would generally be accepted that the taxpayer would be entitled to a deduction for the whole of the interest, at least provided that the equivalent to the amount borrowed found its way into the purchase of the income producing asset.

This is not to say that tests such as the purpose of the borrowing or the use and application of the borrowed funds are irrelevant. Rather, they are tools to assist in the resolution of what is essentially a question of fact. To be deductible the outgoing, or in a case of apportionment a part of an indivisible outgoing, must be seen to be incidental and relevant to the activity which is directed to the gaining or production of assessable income. In the normal case, the fact that the funds borrowed have been borrowed for the purpose of that activity and can still, in the year of income in which the deduction is claimed, be seen as having that purpose, will lead readily to the conclusion that the interest will be incidental and relevant to the income producing activity. Again, in the usual case the application of funds to an income producing

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purpose will demonstrate the relevant connection between the outgoing and the income producing activity. Indeed there is much to be said for the view that the tests of purpose and application of funds are but two sides of the one matter.

However, there is a danger in substituting for the words of the sub-section language which does not appear in it. The statutory issue is whether the interest outgoing was incurred in (ie in the course of) the income producing activity, or in the case of the second limb of the sub-section, whether the interest outgoing was incurred in (ie in the course of) the business activity which is directed towards the gaining or producing of assessable income. Where, as here, the taxpayer carries on a business, which business is directed both at the gaining or production of assessable income and to the gaining or production of assessable income and to the gaining or production of exempt income, and the interest expense is ``necessarily incurred'', in the sense of ``clearly appropriate'' to or ``adapted for'' that activity (see
FC of T v Snowden & Willson Pty Limited (1958) 11 ATD 463; (1958) 99 CLR 431 at ATD 464; CLR 436-467 per Dixon CJ and at ATD 469; CLR 444 per Fullagar J, then provided there is a relevant connection between the outgoing and the business, the outgoing will be apportionable.

The interest outgoings here in question, both under the Chase facilities and under the other facilities, constitute working expenses of the business of the taxpayer. The interest outlaid is, in a real sense, a cost of the short term investments, just as it is a cost of the activity of extracting ore from the ground and selling gold. It is relevant and incidental to the gaining of the interest income, just as it is relevant and incidental to the taxpayer's business which is directed at earning both assessable and exempt income. It follows, in my view, that a portion of the interest on the facilities is deductible. I am advised that the parties are content to determine the appropriate apportionment after judgment is given. Should there be any difficulty, there should be liberty to restore the matter to the list on seven days' notice.

It follows that the objection decision in each year of income should be set aside and the assessments remitted to the Commissioner to be amended to give effect to the allowance to the applicant of the agreed deductions. As each party has been partly successful, it is appropriate that each side bear its own costs of the application. I will accordingly make no order as to costs.


(1) The appeals in respect of the periods ended 31 December 1985 and 31 December 1986 be allowed in part.

(2) The objection decisions of the Commissioner of Taxation for the periods ended 31 December 1985 and 31 December 1986 be set aside and the assessments remitted to the Commissioner for amendment in accordance with the reasons for judgment.

(3) There be no order as to costs.

(4) Either party shall be at liberty to restore the matter to the list on seven days' notice.

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