Between: Caltex Ltd
And: Federal Commissioner of Taxation

Judges: Dixon CJ
Fullagar J
Kitto 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

SYDNEY

Judgment by:
Menzies J

The taxpayer is an Australian company whose principal business during the time with which this appeal is concerned was to sell in Australia petroleum products bought from companies in the United States of America belonging to the American group by which the taxpayer was itself controlled. During the income year ended 31st December 1936 the taxpayer, by two payments, one of $7,000,000 on 1st July and the other of $3,830,013 on 27th November, paid off liabilities amounting to $10,830,013. This sum was owing to one supplier called the old supplier and was in the main for oil supplied before the end of 1932, but as to $1,134,056 it was for supplies from the beginning of 1933 up to 30th June 1936, and as to $643,635 it was for supplies subsequent to 30th June 1936. The dollars to make these payments were provided by borrowing from another supplier, the new supplier, with which the taxpayer placed its orders after 1st July 1936.  

The taxpayer kept its Australian books in dollars and pounds, and following generally the practice fully described by Dixon J. (as he then was) in Texas Co (Australasia) Ltd v Federal Commissioner of Taxation, ^[F36] it kept a supplier's account in which it expressed its dollar commitments and payments in terms of Australian currency by converting expenditure and payments in dollars to pounds at the rate of exchange prevailing at the date of expenditure or payment and, as to stock on hand, revising its pound figures monthly according to the fluctuations of the rate of exchange; it seems that it also adjusted the expression in pounds of its large outstanding dollar liabilities at the end of each month at what might be called the average exchange rate of the preceding month. This process of adjustment did not secure an exact correspondence between the book figures and the actual result of the conversion of the balance outstanding at any particular date at the exchange rate of that day, but it did achieve a rough approximation thereto. The taxpayer's outstanding liabilities at 31st December 1932 (which were in effect then funded in "B Account") were not adjusted monthly beyond 31st December 1933 and on that date a total liability of $9,052,351.3 was expressed at PD1,866,605 2s. 1d. On 30th June 1936 this dollar liability, together with the further liability of $1,134,056.99 then outstanding (arising out of transactions between 31st December 1932 and 30th June 1936-"A Account") which stood in the books at PD283,993 12s. 10d., was converted into Australian pounds at an exchange rate of $3.996763 to PD1 to arrive at a figure of PD2,548,664 11s. 8d., which was PD398,065 16s. 9d. in excess of the sum of the earlier book figures in pounds.

It is this sum that the taxpayer claims and the Commissioner denies is in the nature of an exchange loss deductible under s. 51 of the Income Tax Assessment Act as a loss or outgoing of the taxpayer's business. It is to be observed that the taxpayer is not in strictness claiming as a loss or outgoing the difference between its book figures for dollars owing expressed in pounds and the value in pounds of the dollar payments when actually made; it may be that the PD398,065 16s. 9d. claimed as a deduction should be regarded as substantially that difference so far as $10,186,408 of the $10,830,013 paid as aforesaid is concerned, and, in order to deal with the substance of the matter, I am willing to so regard it, leaving the actual figures to be ascertained if this should be necessary. On this basis, the question here at issue comes to this: when the taxpayer bought trading stock at X dollars and later paid for that stock with X dollars obtained without any actual expenditure of pounds, is it entitled to have as a deduction for the purposes of income tax the amount whereby B exceeds A, when A is X dollars expressed in pounds at the rate of exchange prevailing at the date of purchase, and B is X dollars expressed in pounds at the rate of exchange prevailing at the date of payment?  

The Texas Case ^[F37] establishes that such a difference is deductible when pounds are in fact paid for the dollars, and it is necessary by quotations to indicate the basis of that decision. Latham C.J. said:

"If a taxpayer carrying on business in Australia is to discharge a debt incurred in dollars in the United States of America he must spend a number of Australian pounds dependent upon the current rate of exchange in order to obtain control of the necessary amount of dollars in America. Such expenditure of Australian pounds is an ordinary business expenditure, and the taxpayer is entitled to claim as a deduction the actual outgoing which he makes in order to discharge his normal business debts for stock-in-trade and the like". ^[F38]

Later, in rejecting an argument that the exchange in question was not an allowable deduction because it did not constitute payment for goods, he said:

"In my opinion, the payment may be described as a payment of the price of goods, but it may also be described as an ordinary outgoing ... for the purpose of carrying on a business as a going concern and a necessary outgoing for that purpose. Accordingly, the amount can be deducted under s. 23 (1) (a)". ^[F39]

Dixon J. (as he then was), after stating the facts, said:

"We are therefore concerned with the difference between, on the one hand, the pounds in which a dollar liability taken into a prior accounting period is expressed or valued for the purpose of accounting or assessment, and, on the other, the actual amount in pounds found in the subsequent accounting period to be required to discharge it". ^[F40]

Later, his Honour said:

"The true nature of the deduction claimed is for the increase in the cost of discharging a past liability for which provision in the accounts was made at a lower figure". ^[F41]

After indicating the nature of the deduction claimed, his Honour said:

"Where liabilities are not fixed in their monetary expression, whether because of contingencies or because they are payable in foreign currency, a difference between the estimate and the actual payment must be borne as a business expense". ^[F42]

Although in that case what was claimed as a deduction was naturally enough described as exchange, it seems to me that the quotations I have made direct attention to the value in pounds of the dollars paid, and the deduction that was allowed was for the increase in the cost in pounds of discharging a past trading liability in dollars over and above the provision made in pounds for doing so.  

At first I was disposed to think that the Texas Case, ^[F43] in addition to deciding what I have just set out, went further and recognized that the course which the taxpayer followed in making monthly adjustments to bring up to date the expression in pounds of its dollar commitments to its supplier, was a permissible course for the purposes of income tax. On further consideration, however, I do not think the decision in that case went beyond recognizing that the monthly adjustment of the cost of stock on hand was unobjectionable; it accepted the adjusted figures of what was owing to the supplier for the purpose of calculating the loss when the dollar debt was actually paid but it gave no countenance to the process of adjustment itself as something permitted by the Income Tax Assessment Act. I merely add that if the Texas Case ^[F44] had recognized that such a practice was permissible for taxation purposes, it would have seemed to me to indicate that the adjustments from time to time of a dollar liability still owing would inevitably presage a final adjustment at the date of its discharge however effected. Furthermore, an immediate consequence of this limited view of the decision in the Texas Case ^[F45] is that it removes any foundation for the argument which was at one time advanced on behalf of the taxpayer but subsequently discarded, that the recalculation which took place on 30th June 1936 did of itself entitle the taxpayer to the deduction claimed; but even if the Texas Case ^[F46] had gone further than I think it did, it would not have supported that argument.  

Mr. Tait, for the Commissioner, contended, however, that even upon payment of the dollar debt there was no loss or outgoing for the purposes of s. 51, because no pounds had been outlaid or lost. The answer to this argument is, I think, that dollars worth some hundreds or thousands of pounds more than the number of pounds at which trading goods were necessarily taken into stock for income tax purposes were expended to pay for the goods and that expenditure therefore involved the taxpayer, who had of necessity to keep accounts in Australian pounds, in a loss or outgoing in carrying on its business. In reaching this conclusion, I rely upon the Texas Case ^[F47] as a decision that the difference between the taxpayer's estimate or book entry in terms of pounds of the dollar payment to be made and the actual payment expressed in pounds is an allowable deduction as part of the taxpayer's cost of carrying on its business. There are also practical considerations that support this conclusion. These are indicated by the instances given by Taylor J. in his reasons for judgment which I have had the advantage of reading. What these show in essence is that where an Australian taxpayer uses dollars available to it in the United States for the discharge in the United States of a dollar trading liability which it has, perforce, expressed in pounds in its Australian books for income tax purposes, there would seem to be no good reason for treating it as in a different position from that it would have been in if it had transferred its dollar resources to Australia and had then, by the expenditure of pounds, purchased dollars with which to discharge its dollar liability in the United States. In either case, it would seem that the words of Dixon J. already quoted from his judgment in the Texas Case ^[F48] are applicable:"A difference between the estimate and the actual payment must be borne as a business expense". ^[F49]  

Against my conclusion, it can fairly be said that all that happened was the discharge of a dollar liability of X by the payment of X dollars and as X dollars had already been taken into account in Australian currency when the expenditure was incurred, there was, upon payment, no further expenditure in dollars which, by virtue of s. 20 of the Act, ought to be expressed in pounds, nor was there any actual expenditure of pounds; instead of owing X dollars to the old supplier, the taxpayer merely came to owe X dollars to the new supplier. If there were simply a novation or even if the debt to the new supplier should be treated as owing upon revenue account, as the debt to the old supplier clearly was, it may be that the transactions with which we are concerned should be regarded as nothing more than an intermediate adjustment having no significance for income tax purposes and leaving the determination of whether there was a deductible loss or outgoing to be made when the liability was finally discharged. Here, however, the new supplier lent the taxpayer dollars to discharge a liability on revenue account, and that discharge is what seems to me to be important for income tax purposes. An item on revenue account disappeared from the taxpayer's books and was replaced with a new liability to a different creditor on capital account, so that any allowance as a loss or outgoing for income tax purposes must, as it seems to me, be made at the stage of the discharge of the liability for goods or not at all. The purchase of pounds to repay the dollar loan that was obtained from the new supplier could not affect revenue account unless the borrowing of the money was itself part of the taxpayer's trading activity. Borrowing money to carry on business or to pay liabilities incurred in carrying on business is prima facie to increase the capital employed in the business, and there is not sufficient here to give the taxpayer's borrowing any different character. What occurred, therefore, was the discharge of a revenue liability owing to the old supplier with dollars borrowed upon capital account from the new supplier, and at the point of discharge it is necessary to decide whether the taxpayer was worse off in terms of Australian currency than it was when it incurred the original liability. I think it was and that the difference does represent part of the cost in pounds of carrying on business to produce assessable income.  

It is not necessary for the purposes of this case to come to any conclusion about the extent of the deduction to which the taxpayer is entitled by reason of the discharge of its dollar debt to the old supplier. This is a matter which the case stated expressly leaves open, and if it be that the adjustments made from time to time in the expression in pounds of the taxpayer's dollar liability should be disregarded altogether for the purpose of taxation, the only consequence would be that a larger deduction would now be available than if those adjustments were to be taken into account, because the result of making them was to increase the expression in Australian currency of the dollar liability.  

The first question in the case stated is:

"Upon the facts stated did the appellant as claimed in par. 48 hereof incur in the income year 1936 a loss or outgoing in the nature of an exchange loss, in relation to the discharge of its indebtedness to the old supplier as set out in par. 44 and 45 hereof, which was an allowable deduction under s. 51 of the Income Tax Assessment Act 1936?"

I think it should be answered Yes.  

This conclusion necessitates an answer to the second question in the case stated, which, in its amended form, is as follows:

"If so whether the appellant was, in the circumstances of the case, entitled to a deduction, pursuant to s. 80, in the income year ended 31st December 1939, of any part of the loss disclosed in the year of income referred to in question 1 after taking the so called exchange loss into account."

The circumstances of the case to which this question refers are that for the year 1936 in which the taxpayer claims it suffered a loss in the sense of an excess of allowable deductions over assessable income following upon the exchange loss referred to in question 1, the taxpayer was assessed in the first instance under s. 136 of the Act, and it is the contention of the Commissioner that notwithstanding what occurred subsequently, the taxpayer was for the year 1936 liable to pay tax under s. 136 and not otherwise. The Commissioner contends, furthermore, that even if it be a fact that the taxpayer did suffer the exchange loss which it claims to have suffered in the year 1936, that is an immaterial circumstance because an assessment under s. 136 could not result in a loss for the purposes of s. 80, that is, an excess of allowable deductions over assessable income. It is necessary, therefore, to turn to s. 136 of the Act. In the case of an Australian business controlled from abroad-and the business of the taxpayer was admittedly such a business-when it appears to the Commissioner "that the business produces either no taxable income or less than the amount of taxable income which might be expected to arise from that business", s. 136 imposes liability to pay tax "on a taxable income of such amount of the total receipts ... of the business as the Commissioner determines." The taxable income of a taxpayer falling within the operation of this section is, accordingly, not arrived at by making deductions from assessable income; indeed the raison d'être of the provision is that where such a method produces what may be described as the misleading result of no taxable income at all-to take the extreme case-the taxpayer is not to escape tax but is to be taxed upon a taxable income determined by the Commissioner in the manner provided. The Commissioner claims, therefore, with what appears to me to be sound justification, that an assessment under s. 136 inevitably denies the occurrence of a loss in the year to which the assessment relates which would be available for deduction in subsequent years in accordance with the provisions of s. 80. This conclusion is supported by (1) the method which s. 80 (1) indicates is to be followed in determining whether there has been a loss; (2) the reference in s. 80 to "net exempt income", a conception entirely foreign to s. 136; and (3) the fact that application of s. 136 must result in a "taxable income" which is something quite inconsistent with there being a "loss". The critical point is, therefore, whether or not the taxpayer's taxable income for the year 1936 was determined under s. 136.  

The original assessment made on 22nd April 1938 was, as I have said, admittedly based upon s. 136; it was for PD25,695 14s. 0d. upon a taxable income of PD513,914 0s. 0d. To this assessment the taxpayer on 1st June 1939 objected, claiming inter alia that s. 136 had no application to its income for the year. At the time, the litigation which led to the Texas Case ^[F50] (which was concerned with assessments for the years 1929 to 1933 inclusive) was proceeding, and after the decision of the High Court in that case in March 1940, negotiations were put in train between the taxpayer and the Commissioner covering taxation for the years 1934 to 1938 as well as for the earlier years. In the course of these negotiations, the Commissioner on 26th March 1941 offered to assess taxation for the years 1929 to 1938 inclusive at PD27,121 19s. 10d. and showed how this sum was arrived at. One element in the calculation was that no taxable income and no tax was attributed to the taxpayer for the year 1936. After further negotiations and some modification of the offer which is not material for present purposes, the offer was accepted by the taxpayer, and in a departmental memorandum the Second Commissioner recorded that he had assessed the taxpayer's taxable income and tax for the years 1929 to 1932 inclusive at the figures set out, and for the year 1933 at Nil. The memorandum proceeded as follows:

"(c)

In respect of each of the income years ended 31.12.1934 to 31.12.1937 (for which years the company has been assessed on an amount equal to 20% of its total receipts) I consider that the company is properly assessed under the provisions of Section 28 (Section 136 for the income year ended 31.12.1935 and subsequent years) but in the circumstances do not think it proper to assess and charge tax on any percentage or amount of the total receipts of the business."

It concluded with the following statement:

"There are undetermined objections against the assessments for 1935/36 (income year ended 31.12.1934) to 1938/39 (income year ended 31.12.1937) inclusive. Those objections have not been considered in arriving at the above stated decisions, therefore as the taxable income for each of the financial years 1935/36 to 1938/39 has now been reduced to Nil, the objections should be regarded as having lapsed."

The Second Commissioner thereupon on 5th May 1941 wrote to the taxpayer noting its acceptance of the amended offer and informing it as follows:

"I am advising the Deputy Commissioner, Central Office, Melbourne, accordingly in order that he may, under the guidance of the Deputy Crown Solicitor, take the steps necessary to give effect to the settlement."

On 26th May the Deputy Commissioner, Central Office, Melbourne, wrote to the taxpayer to inform it "that your assessments for the years ended the 31st December 1929, to the 31st December 1938, inclusive, have been adjusted in the manner indicated" in the offer of the 26th March 1941. The letter concluded with this statement:

"In view of the action now taken to reduce to `Nil' your assessments on income derived during each of the years ended the 31st December, 1934, to the 31st December, 1937 inclusive, the objections lodged in connection with those assessments are being regarded as having lapsed."

The taxpayer contends and the Commissioner denies that as a result of what occurred there was not left outstanding any assessment under s. 136 for the year 1936. Upon the whole, I agree with the contention of the taxpayer. The starting point in its favour is that if its taxable income and tax was Nil, such an assessment could not have been made under s. 136, because s. 136 is clearly enough directed to imposing tax upon a taxable income in a case where the usual method of assessment would show no taxable income-a nil assessment is not possible under that section. The Commissioner contends, however, that there was no such assessment or, if there was, it was not effective to alter the original assessment, which still stands. There is, indeed, a good deal of uncertainty about the legal effect of what was done, but it does seem clear to me that at the end of the chapter which I have narrated, the original assessment no longer stood: it disappeared either by withdrawal or amendment. To fit what occurred as nearly as may be into the framework of the Act, I am disposed to regard the letter of 26th May 1941, taken with the letter of 26th March 1941, as notice of amendment of the original assessment to reduce the taxpayer's taxable income and tax to nil. It is, of course, extremely unlikely that the Commissioner arrived at such an assessment by process of determining the taxpayer's assessable income in making deductions therefrom, but, whatever he did, he could not have arrived at the result which he did by the application of s. 136. For the Commissioner, it was contended that once s. 136 applied, it applied exclusively and resort could not thereafter be had to any of the other provisions of the Act to determine the tax liability of the taxpayer, and reference was made to the decision of Williams J. in Lever Bros. Pty Ltd v Federal Commissioner of Taxation. ^[F51] For myself, I see no reason why a determination of taxable income under s. 136 should not have been followed by an amended assessment under s. 170 determining taxable income in the ordinary way, if what had previously appeared to the Commissioner to make s. 136 applicable should no longer appear to the Commissioner to involve the application of that section. In the events which happened, it seems to me that the original assessment based on s. 136 disappeared either because the taxpayer's objections were allowed and in consequence the assessment was simply withdrawn, or because the assessment was followed by an amended assessment of no taxable income and no tax made otherwise than under s. 136. In either event, there was for 1936 no such outstanding assessment of taxable income pursuant to s. 136 as to preclude the taxpayer from showing in 1939 that it was entitled under s. 80 to deduct a loss made in 1936.  

In view of the objection taken by Mr. Tait, I should say in conclusion that I consider that the taxpayer's objection to its 1939 assessment was wide enough to cover the matters upon which I have decided in its favour, because among the grounds of objection there were "(3) That the Company is entitled to a deduction in respect of losses of previous years allowable under section 80" and "(4) That the Commissioner should not have decided" (in respect of the year 1936) "that the Company was assessable under Section 136 but that no amount should be fixed as the taxable income". It is really in answer to the claim for a s. 80 deduction for 1939 that the Commissioner sets up a s. 136 tax liability for the year 1936 and this the taxpayer clearly enough disputes.  

In consequence, I think the second question should be answered Yes.