Caltex Ltd v Federal Commissioner of Taxation

106 CLR 205

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(Decision by: Fullagar J)

Between: Caltex Ltd
And: Federal Commissioner of Taxation

Court:

Judges: Dixon CJ

Fullagar JKitto J
Taylor J
Menzies J

Subject References:
Taxation and revenue
Income tax
Debt payable in foreign currency
Exchange loss
Allowable deduction

Legislative References:
Income Tax Assessment Act 1936 (Cth) - s 51(1); s 80; s 136

Hearing date: 7 September 1959; 8 September 1959; 9 September 1959; 10 September 1959; 1960 September 1959; 5 April 1959
Judgment date: 5 April 1960

SYDNEY

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Decision by:
Fullagar J

This is a case stated by Taylor J. in an appeal by the taxpayer company, Caltex Ltd , against a decision of a Board of Review, which disallowed an objection by the company to an assessment of income tax. The accounting period of the company is the calendar year, and the assessment in question relates to income of the year 1939. The company claims that, for the purpose of ascertaining its taxable income of that year, it is entitled under s. 80 of the Income Tax Assessment Act 1936-1940 (Cth) to deduct from assessable income a "loss" alleged to have been "incurred" by it in the year 1936. The question whether it incurred such a loss in 1936 depends in turn primarily on whether the company, for the purpose of ascertaining its taxable income of that year, was entitled under s. 51 of the Assessment Act to deduct from assessable income what has been described for brevity as an "exchange loss" -that is to say, a loss alleged to have been incurred by reason of variations in the rate of exchange subsisting at relevant times between the United States dollar and the Australian pound. The first of the two questions asked by the case stated is whether such a deductible loss was incurred in 1936. The second question (which does not arise if the first is answered in the negative) is concerned with a contention of the Commissioner that no such loss can in any case be deducted from the company's assessable income of 1939, because the company's liability to tax for the income year 1936 was determined not by the normal process of ascertaining assessable income and allowable deductions, but under the special provisions of s. 136 of the Assessment Act 1936. The facts relevant to the first question are set out in detail in the case stated, and may be summarized as follows.  

The company was incorporated in New South Wales in 1918 under the name The Texas Company (Australasia) Ltd It changed its name to Caltex Ltd on 1st January 1941. Under its original name it was the appellant in Texas Co (Australasia) Ltd v Federal Commissioner of Taxation. ^[F10] That appeal was concerned with income of the years 1929 to 1933 inclusive, and one of the questions raised related to certain "exchange losses" which the company claimed were allowable deductions under s. 51, and it will be necessary later to refer to this case. The company carried on business in Australia, but it was controlled by persons resident in the United States, the whole of its shares being held by or on behalf of persons there resident. Its business (so far as material) consisted in selling in Australia petroleum and petroleum products imported by it from the United States.  

Before 30th June 1936 the company had obtained its trading stock from an American company which was from time to time referred to in its books by different names, but which was owned or controlled by the Texas Corporation of New York, and which is described in the case stated as "the old supplier". In addition to trading stock the company also purchased from time to time from the old supplier plant and equipment and other items of a capital nature, and the old supplier from time to time rendered financial assistance by way of loan and otherwise to the company. All debts owing by the company to the old supplier, whether for trading stock or of a capital nature, were payable in dollars in the United States. Remittances in partial payment of its indebtedness were from time to time made by the company, which for this purpose used Australian pounds to purchase U.S. dollars. Such payments were not specifically appropriated in the company's books to particular items, but it was possible "to trace the liabilities which the remittances during a year operated to discharge, and, by apportionment or otherwise, to attribute a proper part to liabilities incurred on account of revenue". ^[F11]  

In the books of the company the invoice price of trading stock (which included f.o.b. cost, freight and insurance) was credited to the old supplier at or about the date of shipment. (This was, of course, in accordance with ordinary commercial practice ^[F12] ). But a considerable period (apparently never less than a year) elapsed between the entry in the books of a particular shipment of trading stock and the making of a remittance to New York in payment for that shipment. If, therefore, the rate of exchange between the Australian pound and the U.S. dollar rose or fell in the period between shipment and payment, the company would have to pay less or more than the invoice price in Australian pounds in order to obtain the necessary dollars for the making of the payment. The way in which the company kept its accounts from time to time with a view to providing for and dealing with fluctuations in the rate of exchange is described in the case stated, and references are made to it in the Texas Co's Case. ^[F13] It is a matter of considerable complexity, and the practice varied from time to time, but I do not think that it affects the substance of the position now in question, and I do not think it necessary to refer further to it.  

Up to the end of 1929 the exchange rate between England and Australia and between Australia and the United States remained fairly steady and expressed perhaps little more than cost of transfer. At the end of 1929 the cost in Australia of PDE100 was PDA102 2s. 6d., and the PDA would purchase $4.783. In 1930 there was a slight movement against Australia, but it was negligible. In 1931 there was a further downward movement, and in September of that year, when England abandoned the gold standard, the PDA became worth only $2.981. The lowest point ($2.547 to the PDA) was reached in November 1932. A partial recovery of the PDA in terms of dollars took place during the next three years. During the years from 1930 to 1933 the company retained and invested very considerable sums in Australia, but, although it carried at all times a very large dollar indebtedness to the old supplier, it continued to make remittances from time to time effecting payments on account of that indebtedness in dollars in New York. For this purpose it used Australian pounds to purchase U.S. dollars. It was in respect of these remittances that the company (under its original name) claimed deductions for income tax purposes which were the subject of one of the questions raised in the Texas Co 's Case. ^[F14]  

The question in the present case is not concerned with those remittances, but arises out of events which took place in 1936. It is necessary, however, to refer first to something that was done in 1932. In August of that year a letter was sent to the company in Sydney from its office in New York (where, as has been said, control of the company resided). The letter referred to the "alarming situation" created by the depreciation of the PDA which had followed England's departure from the gold standard in September 1931. It stated that an arrangement had been made with the old supplier to defer payments on the indebtedness incurred prior to 25th September 1931 until some later date, and it directed the Australian office of the company to separate its account current with the old supplier into two accounts to be called "Account A" and "Account B". In Account A were to be entered all transactions booked since 25th September 1931, and the balance of indebtedness incurred before that date was to be carried to Account B, subject to the qualification that remittances made during the last three months of 1931 were to be debited to Account B. The directions contained in this letter were carried out by the company. All dealings between the company and the old supplier were thereafter debited or credited in Account A. As for Account B, some further entries were made in it in pursuance of a direction given by New York in 1933, but, apart from that, it stood unaltered until it was closed, as will be seen, in 1936. The practical effect of what was done in pursuance of the letter of August 1932 was to "fund" the company's debt to the old supplier as at 25th September 1931, no date being fixed for payment of the funded debt, and no interest being payable thereon.  

In 1936 the Texas Corporation of New York and the Standard Oil Co of California formed a new company named California Texas Oil Company Limited, and this new company, which is called in the case stated the "new supplier", became as from 1st July 1936 the sole supplier of petroleum and petroleum products to the appellant company.  

At the time of, or very shortly after, the incorporation of the new supplier, it was apparently decided in New York that the account of the appellant company with the old supplier should be closed as at 30th June 1936, and that the outstanding indebtedness of the company to the old supplier should be transferred to the new supplier. This was effected by means of two payments made in dollars in New York. The first of these payments was made on 1st July 1936, and the second on 27th November 1936. In each case the new supplier lent to the company a sum in dollars, drawing a cheque for that sum and paying it into the company's bank account in New York. (The terms of the "loan" are not stated.) On the same day the company drew a cheque on that account for the full amount of dollars received from the new supplier, and paid it into the bank account of the old supplier in New York. No Australian money figured in any way in either loan or in either payment. The effect of the second payment was to discharge completely the indebtedness of the company to the old supplier, and to leave the company owing a debt of the same amount in dollars to the new supplier.  

These transactions in New York had, of course, to be recorded in the company's books of account in Australia. As at 30th June 1936 the company's Account A and Account B with the old supplier were combined into one account, so as to produce one combined balance expressed in dollars and also in pounds. The combined dollar balance was converted to Australian pounds at the rate of exchange prevailing on 30th June 1936. The amount of Australian pounds arising upon this conversion substantially exceeded the combined balance of pounds produced by the combination of the balances of Accounts A and B, and the amount of the excess was treated by the company in its books of account as an "exchange loss", and carried to a "deficit adjustment account". When the first of the two payments in New York was made on 1st July, the old supplier's account was debited with the amount paid in dollars, and the equivalent in pounds was obtained by converting at $4 to the PDA, which was approximately the rate of exchange then prevailing. When the second payment in New York was made on 27th November, the old supplier's account was debited with the amount paid in dollars and an amount in pounds equal to the balance of pounds remaining to the credit of the old supplier in the combined account. The number of pounds thus entered to close the account was greater than the pounds equivalent of the dollar payment at the rate of exchange prevailing on 27th November, and the difference was treated by the appellant company as a further "exchange loss" and carried to "deficit adjustment account". The total amount which the company debited to "deficit adjustment account" was PDA398,065 16s. 9d. and it claims to be entitled to deduct from its assessable income of 1936 a sum of approximately PDA380,000, which is arrived at by eliminating all capital items from the account. Upon this case stated, however, we are not concerned with any question of amount.  

If the appellant company is to succeed in its claim that the amount carried to deficit adjustment account (or any other amount) is deductible from its assessable income of the calender year 1936, it must bring the case within the terms of s. 51 (1) of the Income Tax Assessment Act 1936: Federal Commissioner of Taxation v James Flood Pty Ltd. ^[F15] That is to say, it must show that the amount of the deduction claimed represents a "loss incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income". The case stated does not, in my opinion, disclose that any loss was "incurred" by the company in 1936 by reason of variations in the rate of exchange between the Australian pound and the U.S. dollar.  

It is not, of course, to be denied that variations in a rate of exchange between two countries may involve, as a consequence to a trader, either an assessable profit or a deductible loss. The position has been twice fully explained by Dixon C.J.-once in the Texas Co 's Case, ^[F16] and again in Armco (Australia) Pty Ltd v Federal Commissioner of Taxation. ^[F17] An Australian taxpayer who imports goods for which payment must be made in dollars in New York must (whether or not he keeps his accounts also in dollars) record his purchases in his books in the year of purchase in terms of Australian pounds, and for this purpose he will apply the rate of exchange prevailing at the time of purchase. Let it be assumed that that rate is $4 to the PDA. On the day when he comes, in the same or a later accounting period, to pay for a purchase so recorded, the rate of exchange may have moved to $3 to the PDA or $5 to the PDA. The taxpayer will have to expend, in order to provide the necessary dollars in New York, either more or less in PDA than the amount at which the goods were entered in his books. In the former event there is an "exchange loss": in the latter event there is an "exchange gain". If the payment is made in an accounting period later than that in which the purchase was taken into account, the exchange loss or gain will be properly brought into account in the later accounting period. This is because it is only in the later accounting period that the gain has been "derived" or the loss "incurred". The gain derived is assessable income of the later period: the loss incurred is an allowable deduction in the later period.  

A good illustration of the position outlined above is found in the Texas Co 's Case. ^[F18] In that case the present appellant, under its earlier name, successfully maintained that it had incurred deductible exchange losses when it made payments in dollars in New York for goods purchased and entered in its books in earlier accounting periods when the rate of exchange was more favourable to Australia than on the dates of the payments. Another example of the same kind of thing arose incidentally in Ballarat Brewing Co Ltd v Federal Commissioner of Taxation, ^[F19] where discounts treated as allowable in an earlier period might be disallowed in a later period.  

But the present case appears to me to be entirely different from the Texas Co 's Case. ^[F20] In the earlier case it could be truly said that a loss had been incurred, because payments had been made in final discharge of debts owing for goods supplied, and the real financial effect on the company of exchange variations was, in respect of each relevant consignment of goods, definitively fixed and ascertained by the payment and as at the date of payment. The company's American indebtedness was pro tanto discharged, and nothing that happened thereafter could affect this position. It is only in such circumstances that a loss of the nature in question can be held to have been "incurred". The present case is entirely different. It may no doubt be said, as a matter of legal analysis, that the debt of the company for goods supplied by the old supplier was finally discharged by the two payments made in New York in 1936. But this is only part of the truth. The substance and reality of what happened was simply that one creditor was substituted for another. That was what was intended, and that was what was achieved. The same result could have been achieved in other ways. It might have been achieved by a contract of novation, without any payment being made at all. If this course had been adopted, it would have been clear that no exchange loss was involved. In fact the transaction took another form, doubtless because it was considered simpler and more expeditious and convenient - and perhaps with a hopeful eye on Commonwealth income tax law. But the question whether an exchange loss arose from it cannot depend on the form which the transaction took. That question must depend on the substantial effect of what was done on the financial position of the company, and the essential facts are that the company's American indebtedness was not discharged, but remained unchanged, and the real financial effect on the company of exchange variations was not, in respect of the goods remaining to be paid for, definitively fixed and ascertained by payment and as at the date of payment. If we take our stand at the end of 1936, we find ourselves unable to say whether the company will if and when it does come to discharge finally its American indebtedness, make an exchange gain or an exchange loss. As at that time, no exchange gain has been derived, and no exchange loss has been incurred. If the exchange movements before 1936 had been in favour of Australia, I have no doubt that the company would have strongly (and rightly) objected to being assessed on the footing that it had derived an exchange gain.  

It was said that the effect of the transactions of 1936 was to substitute a debt on capital account for a debt on revenue account. If this be so-and I am far from satisfied that it is so-it may affect the internal accounting of the company, but I am unable to see how it is relevant to the present question, or how it makes it possible to say that a loss has been incurred.  

I should perhaps add that I do not regard the mere fact that there was in 1936 no actual transfer of funds between Australia and New York as necessarily decisive against the taxpayer. I would think it quite possible that an Australian trader might make a real exchange loss as a consequence of receipts and payments of dollars in New York without any actual exchange operation. An example may be taken. A. an Australian trader, whose accounting period for income tax purposes is the calendar year, on 1st August purchases goods in New York for $1,000,000 payable in New York. The rate of exchange on that date is $5 to the PDA, and he takes the goods into his books as "Purchases-PDA200,000". On 1st November he sells goods in New York for $1,000,000. By this time the rate of exchange has fallen to $4 to the PDA, and he takes these into his books as "Sales-PDA250,000". On 2nd November, the rate of exchange being still $4 to the PDA, he receives $1,000,000 in New York as the price of the goods he has sold, and on the same day he uses this sum to pay for the goods bought in August. On the face of things A. has made a trading profit of PDA50,000, but the dollars which he used to pay for the goods bought were worth not PDA200,000 (the figure at which the goods purchased stand in his books) but PDA250,000, and it may well be that A. could be said to have made an exchange loss of PDA50,000, which could be set off against the nominal trading profit of PDA50,000. But this example is quite different from the present case. In the example, if A. can be said to have incurred a loss, it is only because a trading debt has been finally discharged by him and nothing has taken its place. A knows exactly where he stands by reason of an exchange movement. In the present case the company has merely substituted one creditor for another, and it does not know with certainty whether it will ultimately be richer or poorer by virtue of exchange movements.  

The first question in the case stated should, in my opinion, be answered: No. On this view the second question does not arise, and I express no opinion upon it.