Spender J

Federal Court

Judgment date: Judgment handed down 31 December 1991

ATC 4007

Spender J: This is an appeal from the decision of the Deputy Commissioner of Taxation upon an objection dated 25 January 1983 against an assessment dated 25 November 1982 to income tax based on income derived during the year ended 30 June 1974. The objection was forwarded to the Supreme Court of Queensland and was subsequently transferred to this Court. There are similar applications concerning subsequent years to June 1983.

In the income tax year ended 30 June 1974, the Commissioner disallowed deductions claimed by the applicant for a number of borrowing expenses associated with the acquisition of shares in a public company by Raymag Pty Ltd (Raymag) of which the applicant taxpayer was, at the time of the share acquisitions, one of two directors and shareholders. The deduction is claimed under either ss. 51 or 67 of the Income Tax Assessment Act 1936 (the Act).

In 1973, the applicant, Mr Grant Harvey McGuiness, and Mr Rayson Lionel Satchell were the directors and principal shareholders of a group of four companies, namely Realty Projects Pty Ltd, Park Regis Development Pty Ltd, Swanbank Pastoral Pty Ltd and Nelson Developments Pty Ltd. Other but minor shareholders were Mary McGuiness, Avis Satchell, Donald Lochinvar Glen and Colleen Glen. The group of companies was called the Realty Projects Group and was involved primarily in land subdivision and development in Queensland. The group had been borrowing from the Commercial Bank of Australia for their projects, but was experiencing difficulties with corporate financing because of its structure.

In November 1973, the assets of the group were valued at $2.25 million, its mortgage liabilities were $1.3 million, producing a net tangible asset value of $.957 million as certified by Messrs Coopers and Lybrand.

Mr McGuiness said that in 1972, at the suggestion of the group's bank manager, consultations were had with the bank's merchant bank International Pacific Corporation (IPC) for the purpose of rationalising the company structure and reorganising the borrowings. He expressed the view:

``It was preferable from the shareholders' point of view also as difficulties were being experienced by the individual shareholders at the time in extending collateral securities for borrowings as the assets spread between the individuals wasn't equal.''

Mr McGuiness and Mr Satchell spoke with a Mr Ken Hayland of IPC who suggested the group acquire a public listed company and do a ``back door listing'' of the group's assets. Mr Hayland recommended that the acquisition and holding of the shares in the public company should be done by one entity and recommended that Mr McGuiness and Mr Satchell form a new company for that purpose. Raymag Pty Ltd (Raymag) was incorporated in 1972 with Mr Satchell and Mr McGuiness as sole shareholders and directors and was incorporated for the purpose of achieving the ``back door listing''. There were proposals for loans by IPC and General Credits Limited (GCL) in an amount of $2.1 million in order to refinance existing mortgages over realty of the Realty Projects Group and to finance the purchase by Raymag of up to 100% of the issued share capital of a public listed company. The general proposals included the sale to the public company of shares in Realty and the associated companies in return for shares in the public company.

Several public listed companies were originally investigated as potential corporate targets, namely Kennard Brothers Holdings Limited and North State Ten Pin Bowling Limited, and initial share acquisitions were made in these companies. However, the directors of these companies were not in agreement with the plans of Mr McGuiness and Mr Satchell and the shareholdings in those companies were eventually sold. Ultimately, Bunny Industries Ltd (Bunny) was the publicly listed company of which Mr McGuiness, Mr Satchell and Raymag obtained control.

In respect of the attempted acquisition of Kennard Brothers Holdings Pty Ltd, the minutes of a directors' meeting of Raymag on the 25 September 1973 record that it was resolved:

``... that the Company hold the said shares acquired as Nominee and all arrangements entered into by Raymag Pty. Ltd. be on behalf of Grant Harvey McGuiness and Rayson Lionel Satchell equally.''

The authenticity of this and other minutes of Raymag were not challenged in these proceedings. The minutes of a meeting of

ATC 4008

Raymag on 2 November 1973 record, in respect of the Kennard attempt, that:

``... all Kennard shares were held on behalf of Grant Harvey McGuiness and Rayson Lionel Satchell, and all proceeds of shares to be divided equally.''

The minutes of a meeting on 20 November 1973 recorded:

``The transfer of shares were executed on behalf of Grant Harvey McGuiness and Rayson Lionel Satchell''

again, referring to shares in Kennard.

In respect of the minutes of a meeting on 5 December 1973, it is recorded:

``Resolved that the Company as Nominee for G.H. McGuiness acquire 138,353 ordinary shares of 50c each in the capital of Bunny Industries Limited for the sum of $1.10 per share''

and there was a similar resolution in respect of Mr R.L. Satchell. As well, 4,000 extra shares were acquired for Mr McGuiness, Mr Satchell, Mr Kerr, who is a solicitor, and a Mr D.W. Kendall. The initial shareholding was purchased on-market by stockbrokers May and Mellor.

By agreement of 5 December 1973, members of the Bunny family sold their Bunny shares to Raymag, the shares numbering 278,707 shares, at a price of $1.10 per share.

Also pursuant to that agreement, Bunny Industries Limited had agreed to allot a total of 957,740 ordinary shares at a premium of 50c per share to Raymag as nominee allottee of the shares, on behalf of the six shareholders of the companies in the Realty Projects Group in consideration of those persons transferring to Bunny their shares in the companies in the Realty Projects Group. No funds were therefore required by Raymag for the acquisition of these shares. These shares were held by Raymag as trustee pursuant to a trust deed dated 21 December 1973 on behalf of the shareholders of the Realty Projects Group as beneficiaries, to be held in the same proportions as the respective shareholdings in the group of companies.

As a consequence of the then stock exchange regulations in Victoria, Raymag had to stand in the market place for 30 days after the initial acquisition of the Bunny family holdings and had to buy all shares that were offered for the price of $1.10. During this 30 day period, Raymag was forced to acquire an extra 323,315 shares, bringing its total shareholding in Bunny to 1,561,762 shares. This represented 92% of the total issued capital of Bunny.

The 1,561,762 shares held by Raymag were held as follows:


"HELD IN TRUST FOR             Grant Harvey McGuiness         367,819
UNDER TRUST DEED FOLIO         Rayson Lionel Satchell         367,819
95-97                          Grant Harvey McGuiness         174,561
                               and Rayson Lionel
                               Satchell                        11,885
                               Mary June McGuiness             11,885
                               Avis Satchell                   11,886
                               Donald Lochinvar Glen           11,885
                               Colleen Glen                     [sic]

MARKET BY MAY &                                               600,002

SHARES PURCHASED ON            After mentioned shares
MARKET BY MAY &                being Directors qualifying
MELLOR ON BEHALF OF            shareholdings:
McGUINESS:                     G.H. McGuiness                   1,000
                               R.L. Satchell                    1,000
                               D.A. Kerr                        1,000

             Kendall                     1,000

RESULTANT SHARE-               G.H. McGuiness                 756,111
HOLDINGS HELD ON               R.L. Satchell                  756,110
BEHALF OF THE                  M.J. McGuiness                  11,885
AFOREMENTIONED                 A.I. Satchell                   11,885
PARTIES AS A RESULT OF         D.L. Glen                       11,886
THE ABOVE ISSUES &             C. Glen                         11,886
PURCHASES ARE AS               D.A. Kerr                        1,000
FOLLOWS:                       D.W. Kendall                     1,000

LIMITED:                                                    1,707,740

The 600,002 shares purchased on market are made up of the initial acquisition in Bunny of 276,707 before the allotment took place, together with 323,315 shares purchased as a result of Raymag having to stand in the market place, with a small arithmetical error. This error accounts for the various references to ``600,022'', ``600,002'' and ``300,011'' in several of the documents.

This appeal is concerned with the borrowing expenses associated with the 600,002 shares purchased on-market by Raymag.

To support the acquisition of shares in Bunny, certain security documents were entered into. By a Deed of Counter Indemnity dated 21 December 1973, General Credits, another subsidiary of the Commercial Bank, guaranteed the amounts owed to IPC pursuant to the finance facility arrangement. In consideration of this, Raymag gave a share mortgage over all the shares already purchased by it in Bunny and all future shares to be acquired. Property mortgages were also given over the assets of the property Realty Projects Group of Companies and were supported by the personal guarantees of Mr McGuiness and Mr Satchell. In 1975, due to a slump in the real estate market, the shares in Bunny were significantly reduced in value. After some negotiations, Mr McGuiness agreed to buy out Mr Satchell's interest.

The practical effect of what was done was that Raymag acquired, by purchase or subscription, 92% of the issued share capital in Bunny and for the purpose of that acquisition borrowed $1.3 million from IPC; GCL guaranteed to ICL payment of this loan; as security for the repayment of the loan, Raymag mortgaged in favour of GCL the shares acquired in Bunny and the Realty Projects Group mortgaged or encumbered its realty in favour of GCL and Bunny acquired the shares in the Realty Group.

In its tax return for the year ended 30 June 1974, the applicant claimed as deductions:

    Interest paid to IPC              $34,106
    Commitment and loan fees          $ 5,265
    Management fees                   $ 3,910
    Unused limit fee                  $   196

The return also showed dividend income from Bunny Industries Limited of $18,916.

The question is whether the above amounts claimed in the 1974 tax return are deductible items under either s. 51 or s. 67 of the Act. In his notice of objection, Mr McGuiness indicated that those amounts should be allowed as deductions from his assessable income or the dividend income should be excluded from his assessable income as the case might be.

It is accepted by the parties that all of the claimed deductions stand or fall together. These claimed deductions will be referred to under the compendious heading of ``Borrowing Expenses''.

I am satisfied that Raymag was acting on behalf of Mr McGuiness and Mr Satchell in the acquisition of the 600,002 shares acquired on market. The minutes of a meeting of directors held on 31 January 1974 record as follows:

     "PURCHASE            It was resolved that the
     OF SHARES IN         Directors affix the
     BUNNY                Common Seal of the
     INDUSTRIES           Company to instruments
     LIMITED ON           evidencing the purchase
     BEHALF OF            of 323,315 shares in
     G.H.                 Bunny Industries
     McGUINESS &          Limited acquired
     R.L.                 through May & Mellor
     SATCHELL--           on the Stock Exchange
                          of Melbourne at a price
                          of $1.10 per share
                          pursuant to an offer
                          made on behalf of G.H.
                          McGuiness and R.L.

     USE OF               It was resolved that the
     COMMON               directors affix the
     SEAL IN              Common Seal of the
     RESPECT OF           Company to `The Notice
     SHARES               by Substantial
     ACQUIRED IN          Shareholder Pursuant to
     BUNNY                Section 69D', giving
     INDUSTRIES           notice that the Company
     LIMITED ON           is the registered holder
     BEHALF OF            of 600,022 fully paid
     G.H.                 ordinary shares in
     McGUINESS &          Bunny Industries
     R.L.                 Limited and that the said
     SATCHELL             shares were acquired by
                          the Company as
                          Nominee for G.H.
                          McGuiness and R.L.

The minutes of a meeting of directors held on 11 December 1973 record:

     "BUNNY               It was resolved that the
     INDUSTRIES           Company enter into
     LIMITED              arrangements with
     SHARES               International Pacific
     PURCHASED            Corporation Limited to
     ON BEHALF            borrow up to $1.1
     OF G.H.              million on behalf of
     McGUINESS &          G.H. McGuiness and
     R.L.                 R.L. Satchell on the
     SATCHELL             terms and conditions set
                          out in the Facility Letter
                          dated 29th November,
                          1973, which is attached
                          and forms part of these

Section 51(1) provides:

``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.''

Section 67(1) provides:

``Subject to this section, so much of the expenditure incurred by the taxpayer in borrowing money used by him for the purpose of producing assessable income as bears to the whole of that expenditure the same proportion as the part of the period for which the money was borrowed that is in the year of income bears to the whole of that period shall be an allowable deduction.''

There is in the evidence some references to Raymag holding the shares otherwise than on behalf of Mr McGuiness and Mr Satchell. One document refers to the holding of 300,011 fully paid ordinary shares in Bunny Industries Limited ``as trustee for the McGuiness trust'' and the same number ``as trustee for the Satchell trust''. There is also a minute dated 11 February 1974 to a similar effect. Both these documents, I am satisfied, were prepared by a Mr Brian Bartholomeaus and notwithstanding the date of the minute of the meeting of directors, did not come into existence until at least December 1974, after his appointment. Neither document, in my opinion, reflects the true position. Also there are some security documents which refer to Raymag as ``the beneficial owner'' of the shares. I am satisfied that in respect of the 957,740 shares which correspond to the transfer of shares in the Realty Projects Group of Companies, those shares were held by Raymag pursuant to the trust deed of 21 December 1973. In respect of the 600,002 shares, I am satisfied that Raymag held those shares on behalf of Mr McGuiness and Mr Satchell.

When Raymag borrowed funds from IPC it did so on behalf of Mr McGuiness and Mr Satchell. In respect of the shares acquired with those funds, Raymag had the legal ownership of those shares but the beneficial ownership of the shares was in Mr McGuiness and Mr Satchell,

ATC 4011

each being beneficially entitled to one-half of those shares.

For the Commissioner, it was submitted that it was not shown that a borrowing had occurred as opposed to, for instance, the provision of funds by way of a discounting of bills of exchange. In my opinion, the evidence establishes that there was a borrowing by Raymag from IPC, on behalf of Mr McGuiness and Mr Satchell. In particular, a letter from IPC of 24 June 1974 provides ``details of outstanding loans'' to Raymag totalling $1.076 million.

It was next submitted that no expenditure ``had been incurred by the taxpayer'' and then submitted if there had been the incurring of expenditure by the taxpayer, it was not incurred with the end of gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income. It said that the characterisation of the expenditure was of a capital kind, relying on
Fairfax and Sons Pty Ltd v. FC of T (1959) 11 ATD 510; (1958-1959) 101 CLR 30 and
Sun Newspapers Limited and Associated Newspapers Limited v. FC of T (1938) 5 ATD 23; (1938) 61 CLR 337. It was said that the expenditure was not directed towards obtaining assessable income or carrying on a business but towards the restructuring of the group of companies.

I will deal with each point in turn.

In my opinion, the borrowing expenses were incurred by the taxpayer. In
FC of T v. Australian Guarantee Corporation Limited 84 ATC 4642, Toohey J. said at 4645:

``It is well established that an outgoing may be incurred though the sum in question has not been paid or the liability discharged.
New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 C.L.R. 179 at p. 207 and
F.C. of T. v. James Flood Pty. Ltd. (1953) 88 C.L.R. 492 at p. 507. In a passage from his judgment in the former decision, referred to with approval by the Court in the latter, Dixon J. said:

`To come within that provision there must be a loss or outgoing actually incurred. `Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected.'''

When Raymag borrowed from IPC, it did so (as to half of the borrowings) as the agent of the taxpayer. When an agent expends on the principal's behalf, the principal is primarily liable for those expenses. The principal is under a general duty to indemnify his agent for all liabilities incurred while acting within the scope of his actual, implied or customary authority: Bowstead on Agency, 14th Ed. p. 201. The taxpayer would be under an obligation to indemnify Raymag for those borrowing expenses. As such, in my opinion, the outgoing was incurred by the taxpayer.

In my opinion, the borrowing expenses are properly to be analysed on the basis of a relationship of principal and agent, although Raymag holds the shares as trustee for Mr Satchell and the taxpayer. As to the right of a trustee to look to the beneficiary for liabilities incurred by the trustee by the retention of the trust property, Lord Lindley, speaking for the Privy Council said, in
Hardoon v. Belilios [1901] A.C. 118 at 124:

``... where the only cestui que trust is a person sui juris, the right of the trustee to indemnity by him against liabilities incurred by the trustee by his retention of the trust property has never been limited to the trust property; it extends further, and imposes upon the cestui que trust a personal obligation enforceable in equity to indemnify his trustee. This is no new principle, but is as old as trusts themselves.

Balsh v. Hyham (1728) 2 P.Wms 453, 24 E.R. 810, the trustee sought indemnity in equity, not against a liability incidental to the ownership of the trust property, but against a liability incurred by him by borrowing money at the request and for the benefit of his cestui que trust. The Court decided that the plaintiff was entitled in equity to the relief which he sought on the broad ground `that a cestui que trust ought to save his trustee harmless as to all damages relating to the trust.' This language (although open to criticism if applied to cestuis que trustent who are not sui juris and also sole beneficial owners) shews plainly enough that it was taken for granted as well settled that, speaking generally, absolute

ATC 4012

beneficial owners of property must in equity bear the burdens incidental to its ownership and not throw such burdens on their trustees.''

Ure v. FC of T 81 ATC 4100; (1981) 50 FLR 219, Brennan J. said at ATC 4104; FLR 223:

``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.''

In my opinion, the borrowing expenses are incidental and relevant to the gaining of assessable income by Mr McGuiness. The borrowed money was used for the purpose of gaining assessable income by the taxpayer and did, in fact, result in the derivation of assessable income by the taxpayer. The dividend income from Bunny declared in Mr McGuiness' return was $18,916. In my opinion, if one borrows to purchase an income producing asset, the cost of that borrowing, generally speaking, is deductible.

It may be that in some circumstances, of which ``negative gearing'' might be one area, that conclusion might have to be carefully examined. Regard would have to be had to all the circumstances, including, perhaps, the taxpayer's motives:
Fletcher & Ors v. FC of T (High Court, 14 November 1991) 91 ATC 4950; (1991) 15 Leg. Rep. 1.

The present is not such a case.

It does not detract at all from the conclusion expressed above that one of the objects of the public company listing sought by Mr McGuiness was to remove perceived impediments to borrowing in the previous group structure. One of the purposes in acquiring the public company structure was to facilitate trading, and the generation of profits, by assisting corporate financing.

I note that the taxpayer in a letter to Messrs Coopers and Lybrand of 23 March 1984 said, inter alia:

``The background of the Bunny share acquisition was that there were a group of four companies with unrelated shareholdings, having two principal shareholders in each Company, namely McGuiness and Satchell. The Group was having difficulties in corporate financing due to its structure, and difficulties between the interests of the shareholders due to the collateral securities. On the advice of its Accountants, it looked to gaining control of an existing public company and, upon it obtaining control, it would back-door its own group of Companies into a public company as a wholly owned subsidiary. In doing this, they would reflect the shareholdings of each of the beneficial entitlements of the shareholders and would provide them with a structure which satisfied Corporate Financiers. The principals formed Raymag Pty. Ltd. to be the nominee to acquire shares in likely targets. Shares were purchased in Kennard Industries, North State Ten Pin Bowling and Bunny Industries in the name of Raymag Pty Ltd as nominee and on behalf of the shareholders. The main purpose in acting through a nominee was that the Companies Act had not included thresholds in major shareholding at that stage, and as Raymag Pty. Ltd. was acting on behalf of nine people, it was unruly from a financing point of view and from a buying standpoint. At no time did it ever act in its own right.''

In my opinion, the borrowing expenses were incurred in gaining assessable income and are deductible pursuant to s. 51.

As to the dividend income, that dividend was received by Raymag as a bare trustee for the taxpayer who, being sui juris, is a beneficiary who is presently entitled under s. 97(1). It follows that the dividend income is properly included as part of the taxpayer's income.

I uphold the taxpayer's appeal with costs and set aside the notice of assessment dated 25 November 1982. I declare the following amounts should be allowed as deductions from

ATC 4013

the assessable income of the taxpayer for the income tax year ending 30 June 1974:
                                  Management Fee            $3,910
                                  Borrowing Expense         $5,265
                                  Unused Limit Fee          $  196
    Interest             $34,106

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