FC of T v JONESJudges:
MEDIA NEUTRAL CITATION:
 FCA 1153
1. This is an appeal from a decision of the Administrative Appeals Tribunal allowing as deductions for tax purposes certain interest payments made by the respondent between 1 July 1992 and 22 May 1996 [reported at 2000 ATC 2103]. The respondent cross-appeals from the decision of the Tribunal disallowing as deductions interest payments made by the appellant between 22 May 1996 and 30 June 1998. For the tax years 1992-3 to 1995-6, the respondent claims such deductions pursuant to subs 51(1) of the Income Tax Assessment Act 1936 (Cth). For the 1997-8 year, the claim is made pursuant to s 8-1 of the Income Tax Assessment Act 1997 (Cth).
2. Subsection 51(1) provides that:
``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....''
3. The current provision (s 8-1) is to similar effect. The appeal was conducted upon the basis that the provisions are materially identical.
4. In 1967 the respondent and her late husband commenced to conduct a trucking and equipment hire business in partnership. The terms of the partnership were never reduced to writing. It continued until 30 December 1992 when it was terminated by the death of the respondent's husband.
5. In early May 1990 the partners owed the following debts:
- (i) just over $7,000 to Suncorp on their home mortgage;
- (ii) just over $61,000 to A.G.C. pursuant to a hire-purchase agreement relating to a back- hoe;
- (iii) about $10,000 to G.M.A.H pursuant to a hire-purchase agreement relating to a Toyota Land Cruiser; and
- (iv) an unspecified amount relating to an Hino Tipper.
6. On 16 May 1990, the partners entered into a re-financing agreement with the ANZ Bank. The purpose of this agreement was to ``restructure'' the debts owed to Suncorp and AGC and to provide working capital for the business. Pursuant to this agreement the respondent and her husband borrowed $70,000, with their home as security. Settlement was effected on 30.5.90. The debts to Suncorp and
ATC 4609AGC were cleared. The balance of the loan was used to pay bank and government fees. The bank also granted an overdraft facility, limited to $20,000 to provide a cash flow for the business.
7. On 31 May 1990 the partners entered into a second re-financing agreement, this time with Esanda. This enabled them to purchase a second-hand back-hoe ($25,000) and to pay out the debts associated with the Land Cruiser ($10,000) and the Hino Tipper. Thereafter they were obliged to pay instalments of $815.51 per month for the backhoe and $326.50 per month for the Land Cruiser. On 15 April 1991, the partners entered into a lease agreement with Custom Credit in relation to a tower lift. Pursuant to this agreement they were obliged to make thirty-six monthly payments of $648.07, with a residual value of $5,000 attributable to the equipment.
8. During 1992 the respondent's husband became seriously ill. In September, partnership assets were sold, apparently extinguishing the Esanda and Custom Credit debts. By 25 November 1992 the partnership was overdrawn at the bank in the amount of $48,476.40. This debit was transferred to their home loan account, presumably to secure it against the home. The respondent's husband died on 30 December 1992. In 1993 the respondent received $20,000 from his superannuation policy. This amount was used to reduce the ANZ debt to about $80,000. The last tax return filed on behalf of the partnership was for the tax year 1992-3.
9. Since the cessation of the partnership business the respondent has been engaged in full-time employment and has been using her salary to repay the ANZ debt. At 22 May 1996 it stood at approximately $74,000. On that day the respondent entered into a new loan arrangement with RAMS. The ANZ loan was paid out with no penalty incurred. It seems that a penalty would have been incurred had the debt been repaid during the first two years of its term. As at June 1998, the respondent's liability pursuant to the RAMS loan was $71,755.
10. The Tribunal found that [at 2105]:
``There is no question of Mrs Jones making a voluntary decision not to repay the loan and to continue to pay interest instalments. She is attempting to repay a commercial loan on a non-commercial income. Whether or not Mrs Jones had an entitlement to repay the loan, immediately after cessation of business, without penalty, is not relevant in her case because she simply did not have the financial capacity to do so.''
11. Other relevant findings were [at 2108]:
- ``(a) That the `occasion' of the claimed loss or outgoing, being interest paid because of the recurring liability for interest on the ANZ loan, was the ANZ loan agreement, the purpose of which was for Mrs Jones and her late husband to carry on in partnership the trucking and hire business.
- (b) That Mrs Jones was obliged to pay under the ANZ loan agreement after the death of her husband, that is, after cessation of the partnership business.
- (c) That the liability to pay interest remained the original liability to pay that interest under the ANZ loan.
- (d) That Mrs Jones had no capacity to repay all of the loan after she reduced the loan by selling all of the business assets.
- (e) That the period of time between the cessation of business and the payment of interest was sufficiently proximate to the activities of the business to be deductible until the loan arrangement with ANZ came to an end on 22 May 1996.
- (f) That the new loan arrangement entered into by Mrs Jones with RAMS on 22 May 1996 and the simultaneous pay out of the ANZ loan broke the nexus between the interest payments (now made to RAMS) and the original liability to ANZ Bank which directly related to the trucking and hire business.''
12. Much of the language in these findings reflects that found in a number of decisions of the High Court and of this Court. The first of these is the decision of the High Court in
AGC (Advances) Ltd v FC of T 75 ATC 4057; (1974-1975) 132 CLR 175. In that case the taxpayer had written off debts which had arisen in the course of carrying on a money-lending and finance business, which business had been terminated and subsequently recommenced. It claimed such debts as deductions. The Commissioner asserted that expenditure and losses were only deductible if they related to the assessable income as returned for the year in
ATC 4610which they had been incurred. At ATC 4071-4072; CLR 197-198, Mason J said:
``... It is inconceivable that Parliament intended to confine deductions to losses and outgoings incurred in connection with the production of income in the year in question and to exclude losses and outgoings incurred in connection with the production of income in preceding or succeeding years....
... In the Ronpibon case [(1949) 78 CLR 47] the Court suggested... that the second limb (of subs 51(1)) may have a slightly wider operation than the first limb and that it may authorize the deduction of losses incurred in a distinct business. At first glance it may be thought that these observations overlook the possible limitations inherent in the words `incurred in carrying on a business for the purpose of gaining or producing such income', viz assessable income generally. It may be argued that if the taxpayer has ceased to carry on a particular business, a loss subsequently sustained in relation to that business cannot be described accurately as a loss incurred in carrying on that business, or at any rate one incurred in carrying it on for the purpose of gaining or producing assessable income. But the soundness of the argument depends on what is meant by `incurred'. A loss constituted by the writing off of a bad debt is no doubt incurred, in the sense that it is sustained, at the time when the debt is written off, and that may occur in a given case after the taxpayer has ceased to carry on as a going concern the business in which the debt was created. Yet even in such a case it may be correct to speak of the loss as having been incurred in the carrying on of the business. This is because of (the business) the occasion for the loss is to be found in a transaction entered into in the carrying on of the business for the purpose of producing assessable income, that is, in the agreement by which the debt was created. Because the loss had its origin in such a transaction the loss may be said to be one which was incurred in the carrying on of the business for the purpose of producing assessable income, notwithstanding that its true character as a loss is not finally ascertained until the debt is written off.''
Placer Pacific Management Pty Limited v FC of T 95 ATC 4459, the Full Court of this Court (Davies, Hill and Sackville JJ) considered the decision in AGC. At 4464, their Honours said:
``In our view AGC should be taken as establishing the proposition that provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally, the fact that that outgoing was incurred in a year later than the year in which the income was incurred and the fact that in the meantime business in the ordinary sense may have ceased will not determine the issue of deductibility. There is no relevant distinction to be drawn between losses and outgoings. Provided the occasion for the loss or outgoing is to be found in the business operations directed to gaining or producing assessable income, that loss or outgoing will be deductible unless it is capital or of a capital nature.''
Steele v DFC of T 99 ATC 4242; (1999) 197 CLR 459, Gleeson CJ, Gaudron and Gummow said of this problem:
``44. There are cases where the necessary connection between the incurring of an outgoing and the gaining or producing of assessable income has been denied upon the ground that the outgoing was `entirely preliminary' to the gaining or producing of assessable income or was incurred `too soon' before the commencement of the business or income producing activity. The temporal relationship between the incurring of an outgoing and the actual or projected receipt of income may be one of a number of facts relevant to a judgment as to whether the necessary connection might, in a given case, exist, but contemporaneity is not legally essential, and whether it is factually important may depend upon the circumstances of the particular case.
45. As Lockhart J said in FC of T v Total Holdings (Australia) Pty Ltd:
`... [I]f a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income-producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that
ATC 4611interest will be an allowable deduction under s 51....
I say ``generally'' as some qualification may be necessary in appropriate cases, for instance, where interest is paid by a taxpayer as a prelude to his being in a position whereby he may commence to derive income. In such cases the requirement that the expenditure be incidental and relevant to the derivation of income may not be satisfied.'
46. This is consistent with cases which have decided that a taxpayer may be entitled to a deduction after a business has ceased, provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally. However cessation of business may be of factual importance.''
15. In Steele, the taxpayer had claimed to deduct interest payments made in connection with borrowings used to fund the purchase of land with the intention of building and operating a motel thereon. She subsequently sold half of her interest in the land, then re- acquired it, again sold half and later, sold the balance. The taxpayer claimed deductions in respect of losses incurred, largely represented by interest paid on the original terms contract and subsequent loans. The claims all related to outgoings incurred in years prior to her disposition of the whole of her interest in the property. At par 47 their Honours said:
``The respondent (Commissioner) placed reliance upon the concept of commitment as an aid to the formation of a factual judgment, in a case such as the present, as to the sufficiency of the relevant connection between outgoing and income. The utility of that concept may vary with the circumstances of individual cases.... The present is not a case in which the appellant had in contemplation a variety of alternative possible uses of (the land), some of an income-producing nature and others not. There was no suggestion, for example, that she ever contemplated using the property for private or domestic purposes. That was never an option. As Carr J pointed out, whilst she was not financially committed to a motel development, and had not decided upon any particular development, she does not appear to have envisaged any use of or dealing with the property other than one which would produce assessable income.''
FC of T v Riverside Road Pty Ltd (in liq) 90 ATC 4567; (1990) 23 FCR 305, the Full Court of this Court, (Northrop, Wilcox and Hill JJ) again considered this question. In that case the taxpayer had obtained secured and unsecured loans for the purpose of buying land, erecting a motel and providing plant, equipment and working capital. The taxpayer subsequently sold the land and buildings to a unit trust and leased them back to enable it to continue carrying on the business. The Commissioner disallowed a claim to deduct interest payable in respect of that part of the loan which related to the land and buildings. Their Honours were of the view that at some stage the interest outgoings ``... ceased to have this character or to be, in the sense used by the cases, relevant and incidental to the business activities engaged upon by the respondent.... They had no real connection at all with the business of running a rented motel.'' (At ATC 4576; FCR 315.)
17. I take this to mean that after the restructuring, the taxpayer was not incurring liability for such interest payments as an incident of earning assessable income because such earnings were being derived from the use of rented premises. To that extent the decision to sell and the subsequent sale had severed the nexus between the obligation to meet the interest payments and the earning of assessable income. However their Honours made one exception. Under the financial arrangements as they were prior to the restructuring (in February 1979), the taxpayer was required to continue to pay interest, in any event, until 1 May 1979. Their Honours observed that [at 4576-4577]:
``... Had it sought to discharge its obligation to the mortgagee, it could have been required to pay interest to this date. In the circumstances of the present case, therefore, it cannot be said that the change in character of the business activity of the respondent immediately excluded the interest payable by it to the mortgagee from deductibility. Rather, it seems to us that the respondent was entitled to a deduction of such part of the disallowed interest as related to the borrowing of moneys reflected in the Perpetual Trustees' mortgage until 1 May 1979 and as related to the land and buildings upon which the motel was situated.''
18. Finally I refer to the decision of the Full Court of this Court in
FC of T v Brown 99 ATC 4600; (1999) 43 ATR 1. In that case the Court (Lee, Nicholson and Merkel JJ) considered a claim by a taxpayer to deduct interest payments on a loan taken out to finance the purchase of a suburban delicatessen business. The business was purchased in 1988 and sold in 1990 for a sale price substantially below the amount of the borrowings. The claim related to interest on the outstanding balance. There was some uncertainty as to whether the taxpayer was at liberty to repay the loan early. The learned Judge at first instance held that the occasion of the outgoing was the original loan transaction which constituted a binding legal commitment on the part of the taxpayer and his wife to make the interest payments. On appeal the Full Court proceeded upon the basis that there was no demonstrated entitlement to repay the loan early, although the Court also accepted that the bank was willing to accept early repayment without penalty. Their Honours said:
``22.... Plainly, in the present case it is appropriate to approach the issue of the `occasion' of the loss or outgoing, being interest paid, by reference to the purpose of the taxpayer and his wife in borrowing the money and the use to which those borrowed funds were put. Thus, the occasion for the recurring liability for interest on the Bank loan was the Bank loan agreement the purpose of which was for the taxpayer and his wife to acquire and carry on in partnership, the delicatessen business. As stated in the majority judgment in Steele..., the taxpayer may still be entitled to a deduction after the business ceased in respect of a recurrent liability for interest:
`... provided the occasion of a business outgoing is to be found in the business operations directed towards the gaining or production of assessable income generally.'
23. Obviously, cessation of business is of factual importance. In the present case its significance relates to whether, as a result of the cessation, the occasion of the recurrent loss or outgoings in question was no longer to be found in the business operations directed towards the gaining or production of assessable income generally of the partnership business....
25. As his Honour pointed out there may come a period of time between cessation of business and the payment of interest which is such that, in all the circumstances of the case, the payment is no longer sufficiently proximate to the activities of the business to be deductible under s 51(1) with the consequence that those activities no longer provide the occasion for the outgoing. However, the evidence in the present case did not establish that that point had been arrived at during the 1993 or 1994 financial years....
27. We turn to the Commissioner's reliance on the `entitlement' of the partners to pay out the loan. The fact that the Bank might, as a matter of practicability rather than legal obligation, allow early repayment does not alter the analysis in the present case. In our view his Honour was correct in characterising the occasion for the liability in such circumstances as depending upon the terms of the contract rather than upon whether or not the partners might or might not have availed themselves of an opportunity to repay the loan on a particular day because of an indulgence shown by the lender on that occasion. In that regard, it is significant that the partners did apply the net proceeds of sale in repayment of the loan and his Honour did not appear to be prepared to find that the taxpayer and his wife had any other partnership assets which were available, had the Bank agreed, to discharge the loan when, or even after, the partnership business ceased.
28. Had the loan agreement in question been a `roll over' business loan facility which entitled the taxpayer conducting the business, on the date of each monthly payment, to elect to repay the principal and thereby avoid incurring liability for interest or to `roll over' the loan and continue to be liable for interest, that may have been a different situation. In that circumstance there may be considerable force in a contention that the occasion of the liability was the election to `roll over' the loan on each monthly payment date, rather than any liability arising under the terms of the original loan agreement establishing the
ATC 4613terms of the `roll over' facility. In such a case the cessation of the business or sale of the income-producing asset acquired with the borrowed funds might properly be regarded as breaking the nexus in much the same way as certain post cessation interest payments were not allowed as deductions in Riverside Road. However, as explained earlier, that is not the situation in the present case.''
19. The appellant asserts that on the application of the proper test, all interest payments are beyond the scope of deductibility. The respondent asserts that all payments, including those made pursuant to the re- financing arrangement with RAMS, are deductible. The observations of the majority in Steele at pars 44-47 demonstrate that the relevant test is essentially a matter of judgment based upon assessment of the facts of the case in question. That might suggest that the Tribunal's decision is beyond appeal provided it has applied the correct test. However the appellant asserts that the appeal raises a question of law, namely:
``... whether, on the facts as found by the Tribunal, the Respondent was entitled to an allowable deduction under subsection 51(1) of the Act. In particular, what is the proper test for determining when an outgoing is necessarily incurred in carrying on a business for the purpose of gaining or producing such income?''
20. The respondent asserts a similar question of law arising with respect to the payments made after the RAMS re-financing arrangement. The nature of such an appeal was considered by the Full Court in Placer at 4462 where their Honours said:
``With respect to the submissions carefully made by senior counsel for the Commissioner, there is no doubt that the present case involves a question of law capable of appeal to this Court. An issue as to whether an outgoing is incurred in gaining or producing assessable income may involve a pure question of fact.... But the words of s 51(1) are not used in the section just in their ordinary sense. Terms such as `income', `capital' and `incurred' have been the subject of much judicial exposition. The issue in the present case is not one to be resolved by a finding of fact. It is a question of law, an issue turning on the proper construction and operation of s 51(1). Another way of stating the question of law is: whether, when all the facts have been fully found or agreed, those facts must fall within the section....''
21. In carrying on their partnership business, the respondent and her husband incurred a substantial debt. It has not been suggested that anything hangs upon the fact that at some stage, a small amount was owing in respect of the matrimonial home. It also has not been suggested that interest payments made whilst the business was on foot would not have been deductible. The appellant points to nothing other than the cessation of the partnership business as justifying the assertion that such payments were thereafter not deductible. It is said that the cessation of business resulted in a break in the relevant nexus, but the cases seem to suggest otherwise. The obligation undertaken whilst carrying on the business was to repay principal and interest. That obligation having been undertaken in the course of earning assessable income and for that purpose, it seems to follow that the interest payments on such borrowings continued to be outgoings incurred as contemplated in subs 51(1) until some event or circumstance arose to break the necessary nexus, cessation of the business of the partnership not necessarily being sufficient for such purpose.
22. As is observed in some of the cases, the passage of a substantial period of time after the cessation of business may be relevant to the question but not necessarily conclusive. In such cases passage of time may lead to the inference that the taxpayer has kept the loan on foot for reasons unassociated with the former business. Similarly, where a conscious decision is made to extend the loan in the way contemplated in Brown, it will often be clear that there is an ongoing commercial advantage to be derived from such extension which should be seen as unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred. These are not the circumstances of the present case. It is clear from the findings of the Tribunal, and it is consistent with the way in which the case has been conducted that the respondent has not been in a position to repay the loan, although she has been attempting to do so as best she can
ATC 4614from the resources available to her. This demonstrates that the failure to repay the loan over the quite lengthy period since her husband's death is attributable to her financial position and not to any decision to keep the loan on foot for other reasons.
23. I consider that interest payments on the indebtedness to the ANZ Bank made after the cessation of business were occasioned by the loan effected for the purpose of earning assessable income. Neither that cessation nor the passage of time thereafter until 22 May 1996 had the effect of breaking the nexus between such payments and the obligations incurred whilst the partnership was trading. No other view is open on the facts.
24. The cross-appeal concerns interest payments made after 22 May 1996 when the RAMS re-financing was effected. The Tribunal found that the respondent re-financed because she was able to obtain a lower interest rate from RAMS and [at 2108]:
``That the new loan arrangement entered into by Mrs Jones with RAMS on 22 May 1996 and a simultaneous payout of the ANZ loan broke the nexus payout between the interest payments (now made to RAMS) and the original liability to ANZ Bank which directly related to the trucking and hire business.''
25. Such an outcome is, at least commercially, difficult to understand. Is it the change in identity of the lender or the change in the terms upon which the lending is to continue which is the relevant factor? Had the ANZ Bank offered a reduced interest rate in exchange for restructuring of the loan, could it have been said that the nexus had been broken? The moneys borrowed and the obligation to repay with interest undertaken in the course of conducting the business would still have been the occasion for incurring the outgoings. Similarly, if the ANZ Bank had, for reasons associated with its own corporate structure or business, chosen to transfer the debt and any accompanying securities to an associated company or to a company at arm's length, it is difficult to believe that the change in the identity of the lender would have affected the tax liability of the respondent. Assistance is to be found in the judgment of Mason J in AGC to which I have already referred. At ATC 4071-4072; CLR 197-198 his Honour said:
``... A loss constituted by the writing off of a bad debt is no doubt incurred, in the sense that it is sustained, at the time when the debt is written off, and that may occur in a given case after the taxpayer has ceased to carry on as a going concern the business in which the debt was created. Yet even in such a case it may be correct to speak of the loss as having been incurred in the carrying on of the business. This is because the occasion for the loss is to be found in a transaction entered into in the carrying on of the business for the purpose of producing assessable income, that is, in the agreement by which the debt was created. Because the loss had its origin in such a transaction the loss may be said to be one which was incurred in the carrying on of the business for the purpose of producing assessable income, notwithstanding that its true character as a loss is not finally ascertained until the debt is written off.''
26. Although re-financing of the loan may be a relevant factor in determining whether the relevant nexus has been broken, it does not seem to me that in the present case the RAMS re-financing can be said to have had that effect. Re-negotiation of a loan for the purpose of achieving better conditions is, as the evidence in this case demonstrates, in no sense unusual. The RAMS re-financing did not in any way detract from the fact that the borrowing represented by the loan was incurred in connection with the earning of assessable income. Until that borrowing is repaid, the respondent will be liable to pay interest on it as a direct consequence of the borrowing. That the identity of the lender has changed and the rate of interest has been reduced appear to me to be irrelevant circumstances in the present case.
27. I would therefore dismiss the appeal and uphold the cross-appeal. I understand that the appellant has agreed to pay the costs of the appeal and the cross appeal in any event. I will adjourn the matter to enable the parties to bring in a draft order. This should be done within fourteen days.
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